Citizens Financial Group, Inc. (CFG) Q1 2018 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Citizens Financial Group First Quarter 2018 Earnings Conference call. Now my name is Kevin, and I'll be your operator today. [Operator Instructions]. As a reminder, this event is being recorded. Now I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

Thanks so much, Kevin, and good morning, everybody. We really appreciate you joining us today. We're going to start things off with prepared remarks from our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, who will review our first quarter results, and then we'll open up the call for questions. We're really happy to have in the room with us today, Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking. In addition to our release, we have a presentation and financial supplement available at investor.citizensbank.com. And I need to remind you that our comments today will include forward-looking statements, which are absolutely subject to risks and uncertainties. We provide information about the factors that may cause our results to differ materially from expectations in our SEC filings, including the 8-K -- this Form 8-K we filed today. We also need to remind you that we utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and our earnings release materials. And with that, I'll hand over to Bruce.

Okay. Thanks, Ellen. Good morning, everyone, and thanks for joining our call today. We're pleased to report that we're off to a good start to 2018. We continue to deliver good top line growth. We had 5.6% year-on-year revenue growth. We're also doing a nice job of managing expenses. This resulted in positive operating leverage of 2.1%. Our ROTCE improved to 11.7% as we chart our course towards our new medium-term targets of 13% to 15%. We achieved year-on-year average loan and deposit growth of 3% in the first quarter. We saw linked quarter spot and average loan growth of around 1%. Based on our pipelines, we feel this will pick up as the year progresses. Similarly, based on strong Capital Markets pipelines and the benefit of seasonality, we expect to see some good fee growth in the second quarter. We continue to execute well on our strategic initiatives, building out our customer coverage and our product capabilities, while making critical investments in technology, in our digital platform and data capabilities as well as in our customer experience initiatives. We continue to find new ways to streamline our processes and organization in order to become more efficient and to self-fund these investments. Our projects, TOP and BSO, are delivering consistent results. And as you may suspect, we are working hard on the development of TOP V. Stay tuned for our July call and for more details. We continue to make progress in building excellence in our capabilities. We're now gaining some external recognition for our progress. For example, we were named the #1 bank in the U.S. in terms of customer experience by Temkin. We also were ranked the Best Bank by Global Finance magazine in the Northeast and in the Great Lakes regions. There's certainly more work to do, but we're making good progress, and we're poised for a strong 2018. We have a good plan. We have a good leadership team. It's executing well across the board, and we have an engaged and motivated colleague base. So with that, let me turn it over to our CFO, John Woods, who will take you through the numbers in more detail, and provide you with some color. John?

Thanks, Bruce, and good morning, everyone. Let's get started with our first quarter results on Page 4. We continue to execute well and are off to a good start to the year. We generated net income to common shareholders of $381 million, diluted EPS of $0.78 and ROTCE of 11.7%. Last year's first quarter and fourth quarter reported results are impacted by notable items largely related to tax matters. So to make it easier to see underlying trends, let's turn to Page 5, and we will focus on our underlying results that exclude these items. Year-on-year growth in Q1 was very strong as we grew net income to common shareholders by 31% and EPS by 37%. This reflects our continued focus on driving positive operating leverage, which came in above 2%, along with favorable credit costs and a lower tax rate due to tax reform. Strong net interest income and a continued focus on expense discipline helped deliver an efficiency ratio improvement of 125 basis points to 60.4%. We also see the impact of our disciplined risk management on our credit quality metrics as we continue to drive improvement in the mix of the portfolio overall. Provision expense came in at $78 million for the quarter, which was a little lower than expected despite an $8 million build in the reserve. Nonperforming loans remained relatively stable at 78 basis points of loans. We continue to actively manage our capital base, returning $283 million of capital to shareholders through higher dividends and share repurchases. Tangible book value per share increased 5% year-over-year to $27.24, and our CET1 ratio was a robust 11.2%. Taking a deeper look into NII and NIM on Page 6. We delivered attractive and disciplined balance sheet growth, which helped drive a 1% linked-quarter increase in NII in spite of the impact from day count. We've benefited from the earlier-than-anticipated move in 1-month LIBOR this quarter and a relatively steeper yield curve overall for much of the quarter. As a reminder, approximately 75% of our sensitivity is associated with the short end of the curve. Linked quarter net interest margin increased 8 basis points, reflecting improving earning asset yields, given higher rates, and improved mix, which drove a 16 basis point improvement. This was partially offset by an 8 basis point impact from higher funding costs. Year-over-year, net interest margin improved 20 basis points, reflecting a 42 basis point benefit from earning assets, partially offset by a 22 basis point impact from funding costs. Our margin performance continues to benefit from our balance sheet optimization efforts, which again drove about 1/3 of our year-over-year NIM improvement. We also continue to be well positioned to capitalize on the rising rate environment with our asset sensitivity relatively stable at 5%. Turning to fees on Page 7. On an underlying basis, non-interest income decreased 4% linked quarter, reflecting an expected seasonal decline in service charges as well as a reduction in mortgage banking fees and trust and investment services fees, largely related to the impact of long-term rates on product demand. In mortgage, our originations were down about 19%, in line with overall industry headwinds, given rates and a shift away from refi volume. We're making investments to grow our MSR portfolio and to shift production towards more conforming volume. In wealth, investments in the business are helping to drive improvement in the mix of our fee-based sales, which came in at 42% this quarter. However, we saw a reduction in transaction fees from strong fourth quarter levels, which was paced by strength in fixed-rate annuity sales. Capital Markets fees declined modestly from fourth quarter and first quarter, as there was a market fall-off in Middle Markets-indicated transactions. As a partial offset, we did see a pickup in debt and equity Capital Markets activity, which benefited underwriting fees. Our Capital Markets pipeline's very robust heading into the second quarter, including several deals that were originally targeted for the first quarter. Overall, the pipelines have improved significantly since the start of the year. Turning to expenses on Page 8. On an underlying basis, expenses were up 3% linked quarter, reflecting seasonally higher salaries and employee benefits. Outside services were seasonally lower, and other operating expenses reflect lower insurance and pension costs. Year-on-year, our expenses were up 3% on an underlying basis, as salaries and benefits expense was higher, reflecting annual merit increases, increased stock-based compensation costs, revenue-based incentives and the impact of strategic growth initiatives. We also saw an increase in outside services costs tied to our consumer strategic growth initiatives. We continue to remain disciplined on the expense front as we identify opportunities to streamline our operations and organization to find efficiencies. This allows us to self-fund our growth initiatives and enhance our capabilities to serve customers. Let's move on and discuss the balance sheet. On Page 9, you can see we continue to grow our balance sheet while expanding our NIM. Total average and spot loans were up 1% on a linked-quarter basis and 3% year-over-year, with core loan growth rates slightly higher. We grew the average core retail portfolio 5% year-over-year, with expansion in residential mortgages and higher risk-adjusted return categories like education, which is largely tied to our refinance product, as well as nice traction in other unsecured retail loans, driven by our merchant finance -- financing partnerships and our personal unsecured product. This growth was partially offset by planned reductions in the auto portfolio and run-off in home equity, given high levels of payoffs in line with industry trends. On a spot basis, core retail loans were up 4% year-over-year and relatively stable linked quarter given the auto and home equity trends. Average core commercial portfolio growth of 2% year-over-year reflects strong momentum from our geographic expansion strategies, Private Equity, Industry Verticals and Commercial Real Estate. On a spot to basis, the commercial core loan growth came in at 3% year-over-year and 2% linked quarter. Growth was impacted by the sale of about $190 million of commercial loans late in the first quarter as part of a strategy to source, underwrite and distribute leverage loans as well as some softer results in small business lending. We expect to deliver stronger loan growth in the second quarter. This reflects the strong Q1 spot growth in commercial banking and overall strength in their lending pipelines, which are up over 35% from the beginning of the year through mid-April. Additionally, in retail, we expect particular strength in education finance, given higher seasonal volume and our continued investment in the space as well as the renewal of our flow agreement with SoFi for high FICO score loans. On Page 10, looking at the funding side, we saw a 6.5 basis point sequential quarter increase in our cost of deposits, reflecting the impact of higher rates and spot deposit growth of 1%, partially offset by progress on our initiatives to control deposit costs. We continue to fund attractive balance sheet growth at accretive risk-adjusted returns. Our overall funding costs were up 9 basis points sequentially. Year-over-year, our cost of funds was up 25 basis points, reflecting deposit cost increases of 20 basis points as well as the structural shift to more long-term borrowings, including our $750 million senior debt issuance near the end of the first quarter. Year-on-year, spot and average deposit growth was 3%. Note that while funding costs were up 25 basis points, overall asset yield expansion was 43 basis points. Our deposit betas remain in line with our overall expectations given where we are in the rate cycle. We did see our betas tick up a little, which is what you would expect to see in a quarter following a Fed hike, but we are right on our expected glide path. Our cumulative beta on interest-bearing deposits is in the mid-20s. We've seen some increased competition for deposits, but for the most part, deposit costs have been well behaved. We are continuing to invest in analytics and improve our targeting through digital and direct mail offerings on the consumer side, and we're continuing to migrate away from our historical approach to promotional pricing. In commercial, we are making investments to build out additional product capabilities and roll out our new cash management platform early next year. We feel good about our ability to execute against our optimization strategies and drive greater efficiency and deposit gathering. Next, let's move to Page 11 and cover credit. Overall credit quality remains strong, reflecting the ongoing mix shift towards high-quality, lower-risk retail loans and a relatively clean position in the commercial book. The nonperforming loan ratio improved slightly to 78 basis points of loans linked quarter, while improving 19 basis points year-over-year. The net charge-off rate improved to 26 basis points from 28 basis points in the fourth quarter, given seasonal impacts. Our commercial charge-offs were very low again this quarter, and retail net charge-offs were $3 million lower than the fourth quarter, primarily due to seasonality in auto and education. Provision for credit losses of $78 million was $8 million above charge-offs. Despite this reserve build, the provision was down $5 million compared to the fourth quarter and down $18 million versus a year ago, reflecting improvement in overall credit quality. On Page 12, you can see that we continue to maintain robust capital and liquidity positions. We ended the quarter with a CET1 ratio of 11.2%. This quarter, we repurchased 3.9 million shares and, including dividends, returned $283 million to common shareholders. On Page 13, we have provided color on how we are progressing against our strategic initiatives. We've changed this slide a little in order to highlight some of the progress we are making against our efforts to optimize the balance sheet, investments in our fee-generating capabilities and our top program revenue and efficiency initiatives. We also wanted to highlight some interesting things that are going on in the businesses. Overall, we are executing well in our TOP IV program, which is on track to deliver $95 million to $110 million of pretax run rate benefit by the end of 2018. The TOP programs have successfully delivered efficiencies that have allowed us to self-fund investments, to improve our platforms and product offerings, while achieving profitability goals. We are already looking at opportunities to find further efficiencies in the future by expanding the work we are doing around customer journeys, lean process improvements and agile ways of working to more areas of the bank. I can tell you that we are constantly challenging ourselves to do better, and we have plenty of wood left to chop in the efficiency area. Let's turn to our second quarter outlook on Page 14. We expect average loan growth to come in at about 1.5%, and we expect NIM to be up modestly in the quarter. In noninterest income, we are expecting to see a mid-single-digit pickup from seasonally lower first quarter levels. We expect to keep expenses broadly stable in the second quarter with positive operating leverage and with efficiency improving. We expect the credit environment to continue to be relatively benign, and that provision expense will push a little higher into the $80 million to $90 million range. On the tax rate, we came in a little lower than expected for the first quarter, given a change in timing on certain tax items that moved to Q2 from Q1. For the second quarter, we are expecting our effective tax rate to come in at about 23%. To sum up, on Page 15, we feel like we've delivered solid results in Q1. We feel our balance sheet across capital, liquidity and credit position remains robust. We will maintain our mindset of continuous improvement in 2018 and look to drive more TOP and BSO program benefits. We are also driving innovation across the bank and investing heavily in technology, our digital platform and customer journeys, which positions us well as we work towards becoming a top-performing bank. We will maintain our mindset of continuous improvement in 2018 and look to drive more TOP and BSO program benefits. We are also driving innovation across the bank and investing heavily in technology, our digital platform and customer journeys. And lastly, we are positive about our outlook for the second quarter and the rest of the year. And we reiterate broad full year 2018 guidance, although we expect we'd be better than the guidance range on credit. With that, let me turn it back to Bruce.

Okay. Thanks, John. Kevin, I think we can open it up for Q&A now.

[Operator Instructions]. And the first question comes from the line of Matt O'Connor, Deutsche Bank.

I was just wondering if you could talk a bit more about the fee revenues. We're seeing it in some other banks as well, but just kind of some softness across a number of categories. And you were pretty clear about Capital Markets pipeline being strong and bouncing nicely in 2Q, but just some of the other categories were also a little bit soft, and I'm wondering kind of what that says about just the underlying activity among the customer base and maybe why that is the case.

Sure. Why don't I start, and then we can pass it around here for color? But, Matt, I would say probably the disappointments in Q1, really Capital Markets, where we saw, I'd say, a number of transactions push from Q1 to Q2. We, I think, had seasonal slowness at the start of the year, and things seemed to pick up nicely in March, although, as I said, didn't get everything done. So that bodes well for, I'd say, a quite positive outlook in Q2 in Capital Markets. The other area that I'd call out is the mortgage business, where I think there was just general market softness. There's a shift away from refi. Some rates have gone up. And so it was just a tougher quarter than we expected in the mortgage base. Most of the other lines, I would say, were really just impacted by seasonality. We get an extra day in Q2. We get some seasonal benefit. Service charges and fees is always up. There's -- so there's things that we anticipate when we give the guidance for Q2 that we have pretty good visibility into. So John, I don't know if you want to add to that.

No, I think that's right. I mean, I think you're seeing -- as we get to the end of the quarter, we mentioned that pipeline's looking much better in Capital Markets as we get into the second quarter. A little bit of seasonality on -- in the IRP space. And as you mentioned, in mortgage, although it was a down quarter, we're seeing some improvement in our conforming mix. So that will bode well going forward as well.

Yes, okay.

That's helpful. And then just separately, if we look at the deposits, the noninterest-bearing demand deposits continue to grow year-over-year. Obviously, there's just some seasonality linked quarter, but you're still growing those year-over-year. Some of the bigger banks are seeing outflows, and I'm just wondering if you could talk about maybe how your mix is a little bit different. Or do you think it's more granular in terms of why you're still able to grow the free deposits in this higher rate environment?

John, why don't you start, and then, Brad, offer some color?

Yes. I think that's right. I mean, we did see that we've been investing a lot in this over the last couple of years, as you know. And on the deposit, I think this is a reflection of our deposit initiatives starting to take hold. On the consumer side, we're seeing some traction. We're -- we've been investing in data and analytics. We're improving our targeting and promotional efficiency, and that's starting to play itself out. We've revised our promotional approach to attract more stable deposits at attractive rates. And the emphasis is basically shifting from rate-led to more of a moderating on rate and starting to close the gap a little bit on marketing. We've been extending the duration and targeting direct mail and move mass promos. So that's nice to see on the consumer side. And similar themes on the commercial side where we've been making ongoing investments in our product offerings and targeting certain segments, where deposits are more likely to be able to be driven versus others. So yes, we're pleased to see that improvement, and those investments will continue.

Yes. John, I think you hit it. I think the big thing for us has been the improvement in analytics and targeted offerings. The other area that you didn't touch on, and we've signaled this for several quarters in a row now, is our focus on our Mass Affluent and Affluent customer base and redesigning the value proposition and the product set for that. So we relaunched a whole new value proposition. Our Platinum product suite, I guess, about a year ago, we just think we're getting good traction from that in investment and analytics.

And some of the interest rates are coming with that initiatives.

Exactly, exactly.

Yes.

Your next question comes from the line of Ken Zerbe, Morgan Stanley.

If we have [indiscernible]

Ken?

Ken, we're having a little trouble hearing you, Ken.

Yes, you're on a bad line. Ken, you're on a bad line.

Is this better?

A little bit.

A little bit.

Okay. Sorry. Hopefully, this will be clear.

That's good. Now you're good.

Okay. If we do get SIFI reform, because you're no longer subject to CCAR, can you just talk about how you think about accelerating capital return? Has your thinking changed at all over the last several months or quarters?

I'd say we're probably more optimistic that we can maybe move down our glide path a little faster overall. But generally, I think we've been measured in terms of bringing the capital down. I think as a relatively new public company with not a very long track record that that's a sensible approach. We're thinking 40 basis points, maybe 50 basis points this year was the target we set out at the beginning of the year. As you know, last year, we stated 11.2%. We were trying to get down to the 10.7% to 10.9% range. But because we overshot and did better than our budget, and we also had the benefit of tax reform on our DTL, we ended up with earnings that we couldn't return to shareholders given the way CCAR works. So one of the things that we're actually excited about is the de-designation, and then also the new proposal for the stress capital buffer, which I think gives more flexibility back into the hands of the banks. And so you have guardrails about where you need to operate. But then you also, if you have situations like we had, where you're outperforming and making extra income, you can potentially return that to shareholder as the year -- as you're in the middle of the year as opposed to waiting for the next cycle, which is a real benefit. Or if you were anticipating you were going to get 6% loan growth, and it turns then to be 4%, then you can do something with that extra capital that's piling up. So anyway, I'd say, in general, we feel more positive, but I think we'll continue to be measured, and we'll just bring this down. And as I said in the past, there's no reason that we need to be above the median of our peers. Our stressed credit losses are actually slightly below the medium. And so over time, I think we can certainly provide it right into where the median of our peers are.

All right, great. And then separately, with your NIM guidance, can you just help reconcile the 5% asset sensitivity that you guys mentioned versus the guidance that NIM should be up only modesty in second quarter given the rate -- the recent March rate hike? Like what are the pluses and minuses there that would limit the NIM expansion?

Yes. I'll go and take that. Thanks. And you know what? I think you should know that, as we mentioned, the NIM performance in the first quarter, we did have an earlier 1-month LIBOR benefit. So that was up maybe about 9 basis points on average. And by March, a 1-month LIBOR was 20 basis points higher than we had expected at the beginning of the quarter. And so we're not planning on that recurring. So that would be one item that I would highlight in terms of the second quarter. Also, we mentioned that there was a big increase in the long end in the first quarter, which had an impact on our premium amortization in our securities book, which was slowed down as a result of that movement, and you wouldn't necessarily plan on seeing that happening again in the second quarter. Lastly, I'd highlight the fact that the full quarter of mix shift in our funding, where we did a senior unsecured issuance at the end of the first quarter, and you'll see the full quarter effect of that in the second quarter. So those are some of the takes. But nevertheless, even with all of that, we're still expecting that NIM will expand. And that's given by our ongoing asset sensitivity, driven by the fact that loan yields are expected to be up again and up very nicely with good solid loan beta offsetting our deposit beta in the second quarter.

And your next question comes from the line of Peter Winter, Wedbush Securities.

I was curious about the guidance for net interest income for the full year. Last quarter, you said it was 7% to 9%. It does seem like the margin is coming in better than what you expected for the full year, and you're getting that rebound in loan growth. So I'm just wondering if you could talk about the guidance for the full year on net interest income.

Yes. What I would say, Peter, we're just broadly saying that we hold to what we said. I think you could go down each of the major income categories, and we haven't been specific on that. But given trends, certainly net interest income is pushing out to the upper side of the bounds with the NIM performance. And I still think that we'll see a decent level of loan growth over the course of the year. And then kind of when you go down, I still think we can hit the range for fee growth. And the expense growth is tracking to be in the range. And the one thing that John called out is that I think given the first quarter result and the guide for second quarter on credit that we're likely to be certainly below the range we set on credit. So that's a little more color for you. But where we really try to focus our comments on these quarterly calls is the upcoming quarter and not get into reforecasting explicitly that full year guidance. But we're certainly comfortable with the numbers we've put out there for the full year back in January.

Okay. And just a follow-up. Is there any update you can give on your Apple partnership, and/or -- and also just the personal unsecured lending and how that's going?

Yes. I'll just start, and I'd say that our view is that we have a very strong relationship with Apple, that's centered around our shared focus on customer experience, and we would continue to see growth in the relationship. And then secondly, on the personal unsecured product, we've really launched that with a vengeance maybe 18 months ago, and we've had a tremendous takeup. We're using our data analytics capability to target not only our customers, but also prospective customers. And we're bringing new customers into the bank. And I think that's going exceptionally well, but I'll turn it over to Brad for additional color.

Yes. Not sure I have a lot more to add, Bruce. On the Apple front, we have a great relationship with Apple, and we've stayed focused on giving them great service. I think we do that, and that's a good relationship. On PERL, we're very pleased with the product. It's performing, credit-wise, the way we expected, good demand for the product. We have stayed in the prime-plus space. So we've stayed at the very, very high end of the market. I think there's opportunity to go in the credit spectrum there. But at this point, we're staying focused on our knits -- sticking to our knitting and staying in a really high credit quality area and feel very good about it.

Your next question is from the line of Erika Najarian, Bank of America.

Just following up on Ken's question, could you give us a sense of -- on your variable rate loans on the asset side, if could you give us a sense of what the short-term benchmarks are? And on the liability side, if your long-term debt is swapped out and, if so, what the underlying benchmark would be.

Sure, I'll jump in on that one. So basically, on the floating rate side of things, you have a couple of key benchmarks in the C&I book. It's primarily 1-month LIBOR, although we do have a few million dollars of three-month LIBOR indexed on the commercial side, but generally at the one-month LIBOR book. And when you think about the other big floating books, you've got the home equity portfolio, which is essentially a prime base, Feds funds base book. So that's from the asset side. On the liability side, we do have primarily a floating rate book there. And the -- what we swapped that too, is actually one-month LIBOR and three month LIBOR as well. So there's a mix there with, frankly, the majority of that actually going to 1-month LIBOR. And when you think about what's contractual with respect to three month LIBOR on the asset side and three month LIBOR on the liability side, we've been monitoring that because of what's been going on with three month and 1-month LIBOR over the quarter. We're pretty balanced, at least contractually, with respect to the asset side and the liability side of the three month point on the curve. So let me know if that's responsive to what you were looking for.

No, that was very clear. And a follow-up question is, of course, we'll hear more about your new -- about TOP V in July. And given how successful these initiatives have been, I'm wondering if you could give us a sense on how much of TOP V will be revenue-driven rather than expense-driven?

Sure. I'll start. John, you can add color. But I think each year, what we try to focus on is an effort around efficiency and extracting inefficiencies to streamline how we're running the bank. And we'd like that to make up, I'd say, at least 40% of the pot to whatever total number we get to. We also then have always great ideas in terms of how we can serve our customers better and deliver additional products and services or expand into some new adjacencies, we've done, for example, geographically into the Southeast region on the commercial side. So I think there's opportunity there as well. And I'd say what we find heartening here is that we're able to come back and do this year in and year out, which I think sets us apart really from peer banks, who might have a major, major program maybe every 3 years or so. But we've tried to instill this into our culture and our DNA at Citizens that it's our responsibility to come up with these ideas about how we're going to run the bank better and do more for our customers and do more for our shareholders. So John, maybe you could add some additional thoughts?

Yes. Just maybe a bigger picture when you think about our targets for ROTCE progression over the medium term that we talked about last quarter. We've built in that there would be, on the expense side, something on the order of 60 basis points over that period of increasing our ROTCE. And if you triangulate that back to our expense base, that comes in somewhere between 1% and 2% of our expense base in savings each year coming out of TOP. So that's been an incredibly important part of how we're driving expense saves. So we'll continue to do that.

And your next question comes from the line of Saul Martinez, UBS.

On asset quality, the $425 million to $475 million, keeping that obviously implied a pretty big ramp-up, and you mentioned that there's a high probability of being below that range. But I guess, a couple fold question. One, why not just change the guidance? But maybe more importantly, just as you look across the different parts of your portfolio, obviously, credit has been remarkably good, but are there any areas that either you're concerned about or that you're watching a little bit more closely as being a little bit more vulnerable to a normalization credit?

Yes. So I guess, to my earlier answer, we don't want to be in the habit of updating our full year guidance quarter in and quarter out, so which is why we're using those broadly comfortable. But I think the beat on credit is materially enough outside of that initial range that I think we needed to call that out. So that's the answer to the first part of your question. On the second part of your question, I'd say, certainly on the consumer side, there's nothing in terms of delinquencies or roll rates that gives us pause. So I think we're going to have a very good clean year on consumer credit. And again, on the commercial side, we have a net recovery position, which is pretty fantastic. But again, when you look at what we have in NPLs, what we have in criticized assets, we're in very good shape there as well. So you're likely, over time, to take a hit here or there. Maybe you have a recovery that allows you to offset it on the commercial side, but we could see that migrate up a little bit over the course of the year. Specific portfolios, they all look in pretty good shape. Energy's certainly in great shape. We're keeping our eye in the franchise world on some of the casual dining segment, but that's relatively modest, and I think that will behave okay. But anyway, I'd say those would be the areas I would highlight. John, anything you'd want to add?

No. I would just -- just to add to the point on the consumer delinquencies. Even the 30- to 90-day delinquencies quarter-over-quarter and year-over-year are down. So we're just seeing good trends there and wholesale credit quality hanging in there very nicely with net recoveries. So that's really the story.

No, I think I agree with that on the wholesale side. The things we're struggling with are generally idiosyncratic and not that large. So we feel very good about where we are.

Yes, good.

That's helpful. Just on deposit competition, you mentioned the deposit pricing. You mentioned cumulative betas around, I think, mid-20s, but can you just give a little bit more granularity across the different businesses, retail, commercial, wealth, where you're at, what's the dynamic, and also where you feel betas are maybe relative to where terminal beta could be for each of those segments?

Yes. I'll tell you what, we'll talk about the terminal betas maybe top of the house. We don't -- haven't necessarily gotten into where it would be across each individual segment. But in terms of within consumer, you'll see terminal betas that are lower than commercial, of course. But overall, we've mentioned that through the cycle, we would be at approximately 60% cumulative beta over the entire tightening cycle, which we tend to think about at approximately a 300 basis point or so Fed funds number. When you break that down, as I mentioned, consumer on the lower end, commercial on the higher end, within consumer, we are breaking that down a little bit further. When you look at the core consumer in the retail space as well as even when you get up into Mass Affluent, we're seeing betas being pretty well behaved in the low single-digit range. It's when you get into the wealth sectors that things start to get a bit higher, and those betas get up into the high 20s and the low 30s. But overall, still very solid single-digit betas cumulatively through the first quarter in the consumer side. Now on the commercial side, you'll see cumulative betas that are maybe a bit higher than that and maybe up into the 30s or so, and that gives us the overall cumulative beta in the mid-20s. So let me see if that's responsive, and if there's any follow-ups.

No, no. That's helpful. So if I think about the 60% cumulative beta, obviously, commercial's going to be above that, and the other retails are going to serve both of those?

Yes, yes. Commercial is 70% to 75%. Let's call it, cumulative, in apples-to-apples relates, that's 60%, and for consumer maybe 35% to 40% to give you something to anchor to with respect to the 60%.

Your next question comes from the line of Vivek Juneja, JPMorgan.

Bruce, a question for you. I heard a question on capital return overall. I just wanted to talk to you about dividend payout. Where do you see that going? I know you've had good increases, but obviously, you're still well below peers. And recognizing, yes, you're still relatively in your infancy after the IPO, but what are you thinking since the Fed has now said the 30% line has also been removed, and your peers are talking about 40% type getting to those levels?

Yes. No, I think we've said that kind of in the medium term, we were targeting to get back up around 40% or so. And you saw us make 2 moves in the last CCAR cycle, very significant increases. One of the challenges we've had is our earnings have grown so quickly that you end up actually lagging where you'd like to be in terms of your payout ratio. So again, as we get more flexibility under the new kind of Fed proposal, then, potentially, we could accelerate as we're growing our earnings. If we are exceeding our estimates we've set out at the beginning of the year, potentially we could move -- be more responsive and move that dividend up quicker. But again, I think bank stock should trade with a healthy yield. We understand that. I think we, currently, with our capital surplus, can have our cake and eat it, too. We can continue to have nice loan growth and support the organic needs of the business, and certainly return shareholder capital at a good clip. And the dividend would be the top of our list in terms of what we want to do for shareholders.

Question for Don, since I heard him on the line. Don, any color on sort of what's giving you the confidence that some of the slowdown we saw in Capital Markets activity in Q1 should start to dissipate soon? What are you seeing that's giving you -- in terms of timing, and that it actually should start to pick up?

I'll repeat what Bruce said, is we started the year with pretty weak pipelines actually. And literally, since early February, we've just seen them build and build and build and build. So the activity levels on the teams are quite strong right now. We're seeing it flow through already on the fees that we're printing for the quarter. So we're confident in both our client's desire to transact, given the environment and the tax rate and general growth that people are seeing. Sponsors are quite active right now, and we're seeing it in our pipelines.

I would say also, Vivek, that we would expect to see M&A pick up as the year goes by. And we feel it's fortuitous or maybe we were good, but doing the acquisition of Western Reserve last year gave us the capability that we can now really serve those Middle Market companies that are looking to use acquisitions as part of their growth strategy.

And when I said, pipelines, I'm talking about M&A also. And I think we're actively adding to our M&A teams because they can't handle the business that they have in-house right now. So it's quite strong.

Your next question comes from the line of Marlin Mosby, Vining Sparks.

A very detailed question, but we have heard a lot of pressure from the mortgage banking and production side. And some mentioned gain on sales. Sometimes, that's when rates are moving higher. You kind of are repricing fast enough. That's just as kind of a norm that you get a little bit of squeeze temporarily. Is this more pricing or rate-related in the sense of maybe gain on sale of margins going down a little bit this quarter?

Yes. I think it's more a function of as volume comes down with higher rates, the industry is trying to fill up the capacity that you have the excess capacity you have available, and you see a squeeze on margins. So I think it's just a normal market volatility -- a normal market activity as people are trying to fill up the capacity they have.

Got it. And then when we think about -- your capital ratios have been relatively flat. As you now move into the next phase with more flexibility on returning this capital, do you envision meaningfully kind of bringing that number down? And do you have kind of a target you'd like to get to in the next couple of years?

Yes. So the flexibility actually comes down the road. So it's not really here yet in terms of the CCAR cycle. So I think we gave guidance for this year that we'd like to bring our capital ratio down towards the 10.7%, 10.8% if you look at our full year guidance. We also set out our medium-term targets, which we said we'd like to bring it down to 10% to 10.25% when we set out those targets. So you could see us at 11.2%, bring it down 40 basis points, and then do that again, and then continue to chisel it. And it may be the case that the median moves lower, and that there's opportunities for us to move below that range. But that's the kind of flag that we've planted at this point in our planning process.

Yes. Maybe just to add on top of that, I think Bruce is right. I mean, that flexibility point that we're very pleased and supportive of is really an NPR, and we're working our way through that process with the Fed. And if all goes as originally indicated, this would be a CCAR 2019 cycle that -- where the flexibility would come later in '19 and into '20. We're supportive of it, taking away the soft cap on dividends and addressing some of the concerns from the industry around balance sheet growth. That's all very positive. Lots more questions to be asked in the NPR, but the flexibility will come later, as Bruce indicated.

And it's positive in the sense that you have so much earnings growth right now with the tax benefit and just the organic growth that payout ratios are going to be up '19, '20. That keeps the momentum into the last two years -- or that next two years after we get the top-end earnings really creating a lot to give back this year.

Yes.

Your next question comes from the line of Gerard Cassidy, RBC Capital Markets.

Can you share with us -- you had some, as you've pointed out, some nice growth in your demand deposit accounts, which some of your peers haven't really seen. And when you look at that, could you share what percentage of your consumer customers have checking accounts, where there's no fees associated with them because either they keep a higher balance or there's a special product that they're using that doesn't charge them fees?

To give you a percentage that don't have fees, I, unfortunately, don't have that in front of me. I will tell you, our core checking products or our -- sort of our baseline checking product is something we call, One Deposit, which is they have the ability to waive your monthly service charges just by making a single deposit every month. So the majority of those customers do not incur a fee. But in terms on an overall percentage, I don't have that available.

Okay. And then, Bruce, obviously, as you've pointed out, you're relatively new. As a publicly-traded company, you have very strong capital. Of course, you've got a glide path to give it back to shareholders. Another angle would be, of course, to do acquisitions. Could you just give us your views on what you see on the merger landscape for other depositaries over the next, let's call it, 12 to 24 months?

Yes. I think, Gerard, we've been pretty clear that where we're focused in terms of looking for acquisitions would be really in the fee space. So it would be adding to our capabilities, as I'd like to say, getting a little farther down the track faster in areas in the commercial side and Capital Markets or on the consumer side and wealth or in mortgage MSRs, for example. So those have been the areas that we have interest. And we've had dialogue, and I think we'll eventually do some more things this year, much like we did the Western Reserve M&A boutique last year. So I think they'll be of probably modest size because we have a lot of organic growth. So we want to stay focused on executing our plan, but then supplement that with things that we can easily plug and play. The other area that I think we're focused has been on the fintech space. And so we have about half a dozen relationships currently with various fintech partners, and some really great stuff, our specified digital wealth offering, our business banking loan origination and fulfillment platform that we have with Fundation, just to name a couple. But I think our intent is out, and we probably could add a handful of additional ones also this year. So when it comes to straight depositaries, that's really not on our shopping lists, and you won't see us looking to do that in 2018.

And your next question comes from the line of John Pancari, Evercore.

You have mentioned the better loan beta, where you're trending right now. How much of that is the pricing environment? I mean, we're hearing that it's certainly not terribly accommodative right now, and that there's some spread compression a lot of your peers are dealing with. And then, therefore, how much of that is also just your structure, and that you've got a fair amount of portfolios that you're still sub-scaling, but are higher yielding and you're growing there, so the remix is helping your loan yield?

Yes. I'll go ahead and hit that. I mean, loan yield's up 14 basis points in the quarter, and you think about converting that into a beta. I mean, that's really driven by our floating fix mix. And we're basically about 52% or so, as I recall, the percentage, swap adjusted floating loans versus approximately 48% on the fix side. So that's the big driver in loan betas. And you heard a little bit earlier the indices that we're exposed to, that the indices are going to be primarily 1-month LIBOR and Fed funds in terms of driving that beta on the loan side. And you could think about that beta cumulatively being around 60% or so. When you think about a much higher beta on the commercial side, say, call it in the 80s, being offset by more of the term lending that sits on the consumer book. So I think that's how you should think about our loan betas on that side.

Okay, all right. And then, actually, on that front, the new money loan yields, where you're bringing on new production, do you have that for commercial versus consumer?

Yes. I mean, so I would say overall, on the commercial side, new monies coming in, call it, 25 basis points or so over runoff money. And then on the consumer side, basically every book, new money coming in, in a healthy way over runoff, with maybe the possible exception to mortgage, where you've got the negative or the convexed aspects of that kind of portfolio, where you see the bias towards refinancing the higher rate stuff. So I think that's a natural industry-related phenomenon. But basically, across the board, when you run the table across consumer and commercial, we're in a situation where our new front book is accretive versus our runoff. And that's providing upward lift as well, and will continue into the second quarter.

And that extends, John, to the securities books as well.

Absolutely, yes. On the security side, our runoff is about $250 million. Our reinvestment is about $320 million on the securities side.

Yes.

Got it. That's helpful. One separate thing on the expense side. I know you indicated a couple of times that you continue to invest heavily in IT. Can you remind us of the size of your IT budget? I believe you have previously indicated about $195 million in CapEx. I'm just wondering what the overall IT budget would be in terms of the...

Yes, John, we went through a period probably from 2010 to 2016 or probably 6 years there. We've had it up around $250 million. We've pulled it back a bit last year to the $195 million. As you said, I think we needed to pause and digest some of the things that we've put in place. But this year, I'd say we're probably in a $225 million, $235 million ZIP Code. And the nice thing that I'd say about that is it's really moving and pivoting towards offense. So much of that spend now is directed at how do we serve customers better, how do we digitize, how do we use data. And so I think there's an unlimited appetite that folks have inside the company. And I remind folks, Rome's not built in a day. We have to pace ourselves. But I think we're really spending much more on offense, and the results are showing by you can see the awards we're picking up for customer experience or best bank. I think it's really great to see.

Maybe just add to that just briefly. So because of the way accounting works, and there's some capital budgets, and across peers, sometimes, it's hard to normalize apples-on-apples. But some of the industry materials that we've been able to get our hands on would indicate that maybe in the neighborhood of 8% of revenues is about where our peers are coming out. And you would see us on an apples-to-apples basis being around 10% of revenues. When you consider our capital expenditures, plus some of the things that get expensed and the other support from an IT perspective of the businesses on a customer-facing standpoint. So when you think about it like that, we feel like we're in line or in pace with the industry or maybe a little better.

And your next question comes from the line of Ken Usdin, Jefferies.

Ken? Maybe we lost him.

Ken? Maybe his question got answered or -- okay. Next? Is there anyone else, Kevin?

No. At this time, we have no further questions in queue. And with that, I'll turn things back over to Mr. Van Saun for closing remarks. Please go ahead.

Okay, great. So thanks, everyone, again for dialing in today. We certainly appreciate your interest and your support. We're off to a really good start. I think we maintained a positive outlook for 2018, and also for another year of strong progress for Citizens Bank. So thanks, and have a good day.

Now that does conclude today's conference call. Thank you for your participation. You may now disconnect.