Citizens Financial Group, Inc. (CFG) Q3 2018 Earnings Report, Transcript and Summary

Good morning everyone, and welcome to the Citizens Financial Group Third Quarter 2018 Earnings Conference call. My name is Brad, and I’ll be your operator on the call today. Currently all participants are in a listen-only mode. Following the presentation, we will conduct a brief question-and-answer session. As a reminder, this conference is being recorded. I’d now like to turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

Thanks so much, Brad, and hello everyone. 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, he will review our third quarter results, and then we're going to open up the call for questions. We’re also really happy to have in the room with us today Brad Conner, who's 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 of course 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 from expectations in our SEC filings, including the 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 material. And with that, I'm going to give it over to Bruce.

Okay thanks, good morning everyone, and thanks for joining our call. We're pleased to report another very strong quarter today, paced by strong top line growth of 7% excluding FAMC, Franklin and good expense discipline which combines for positive operating leverage of 4.4% year on year. And we continue to achieve good balance sheet growth in the current environment with sequential loan growth excluding FAMC of 1% and year over year growth of 4%. That's a very good result considering we're still running off non-core assets and reducing our auto and leasing portfolios. We've focused on some great niches, on the consumer side, and we've invested in broader coverage on the commercial side to achieve this growth. Our strong execution to-date in 2018 has led to some very nice improvement in key metrics. EPS growth year on year is 37% underlying and 34% on a year to date basis. Our ROTCE reached 13.5% underlying which is into our target range of 13 to 15% and the efficiency ratio was 58% underlying. We are confident in our Q4 outlook and we expect to finish the year strong. Our capital strength continues to be a real advantage as we have the capacity to grow our balance sheet and drive organic growth to make small smart key based acquisitions and to return significant capital to our shareholders which we did and exceeded 500 million in the current quarter. We've had a couple of great slides in the deck today covering our progress against our strategic initiatives and some of the recognitions we've been garnering. I've just crossed my five year mark at Citizens and I feel really good about how we've been able to turn around the bank and shift from defense to offense. We now have a clear view of what it will take to be successful longer term and become a fast performing bank, and we're making significant investments to position us well for the future. That said, we understand the need to deliver consistently strong and improving results each quarter, and I feel our team has done a great job of getting that balance right. So with that, let me turn it over to our CFO, John Woods, to take you through the numbers in more detail and provide you with some color, John.

Thanks, Bruce, and good morning everyone. We delivered another strong quarter that highlights steady execution against their enterprise level initiatives with particular focus on robust positive operating leverage. We continued our momentum in delivering cost efficiencies while making the long-term investments required for sustainable success. Some quick highlights, we grew our underlying EPS 37% year on year. We delivered operating leverage of 4.4% excluding the impact of the Franklin American Mortgage acquisition, which closed on August 1. We continue to make progress on improving returns with underlying ROTCE for the quarter of 13.5%, up nearly 60 basis points linked quarter and 340 basis points year-over-year. Our consumer and commercial banking segments are delivering improved returns by driving prudent balance sheet growth and controlling our deposit costs in a very competitive environment, across both business segments we are growing our customer base, deepening relationships, running our capabilities and investing in new technologies to enhance the customer experience. I'll expand on our strategic initiatives a little later. On Slide 3, we provide information on the Franklin American acquisition and related integration costs, and in order to make it easier to see underlying trends, we show you our results without the integration costs and provide further color on our result, excluding Franklin on Slide 4 and 5. As I mentioned, you can see that we delivered positive operating leverage of 4.4% excluding the impact of Franklin with an efficiency ratio of 57%. Also, PPNR growth year-over-year was 13% excluding Franklin. On Page 6, net interest margin results came in as expected with a two basis points increase excluding the impact of Franklin even though average LIBOR rose less than anticipated. We are pleased that despite a fairly competitive landscape, we continue to drive disciplined balance sheet growth and delivered a 2% sequential quarter increase in net interest income. Turning to fees on Slide 7, you can see a $28 million improvement driven by mortgage banking fees given the addition of Franklin. Excluding net impact, fees were up 1% linked quarter and up about 3% year-over-year. Our capital market fees were relative flat sequentially this quarter, notwithstanding some pretty significant headwinds in the space. Overall loan syndications market volume was down approximately 40%, but we were down less than the market in the space and offset to syndication volume with bond underwriting where we continue to gain traction and M&A advisory fees given our ability to leverage the Western Reserve Partners acquisition. In global markets where we continue to build out our offerings, fees were down slightly from record second quarter levels, reflecting a $3 million adjustment related to CDA methodology change. Interest rate product fees were down 4% due to a decline in variable rate loan demand and the impact of the flattening yield curve. In FX, we held our ground by being proactive with clients against the backdrop of increased dollar volatility and looming trade policy concerns. On the consumer side of the house, we saw good traction on our wealth business with increased sales volumes and a 5% linked quarter increased in managed money revenues and 23% growth year-over-year. And in our mortgage business, we've hit the ground running with the integration of Franklin. We are very excited about the scale that business brings us in servicing and the opportunity to serve over 200,000 new customers. The integration is on track and while the current environment is challenging, we continue to believe this is an attractive and important customer business for us to be in over the long-term. Turning to Slide 8. On our reported basis, our expenses were driven up by the impact of Franklin and about $9 million of integration cost largely in salaries and benefits outside services and other expense. Excluding Franklin, we are pleased to report that linked quarter expenses were flat given continued strong expense discipline and benefits from our top program. Let me elaborate a bit on that. Our commitment to self funding investments continues to drive our ability to ensure our expenses remain well controlled, this is a direct result of all of the work we’ve done over the past two years with our top programs. The efficiency and revenue benefits from those programs have a compounding effect that has funded our growth initiatives allowing us to expand our capabilities across the bank and facilitate various business initiatives such as Citizens Access and many others. Let’s move on to discuss the balance sheet. On Slide 9, you can see we continue to grow our balance sheet and expand our NIM. Despite slower growth across the industry, we continue to see strength in certain segments and commercial. This was against the backdrop of heightened non-bank competition and very liquid corporate balance sheets given the benefits of tax reform and repatriation. And while we are very selective about CRE, we are still finding some attractive opportunities for growth. On the retail side, we saw nice tractions in some of our attractive risk adjusted return categories like education and secured as well as important categories like mortgage. Overall, we grew loans by 1% linked quarter. As a reminder, we sold corporate loans late in the second quarter which had about 25 basis points impact on third quarter growth. Loans grew by 4% year-over-year, notwithstanding headwinds from the planned runoff in auto, non-core and leasing which was around $1.6 billion year-over-year, which impacted the growth rate by about 1.5%. The gross of our planned runoff, our loans were up 5.5% year-over-year. Loan yields improved by 12 basis points in the third quarter, which was lower than what we saw in the second quarter, this reflects the backdrop of the lower increase in average LIBOR over the same period which had a corresponding benefit to our overall funding costs. Also we continue to results from our balance sheet optimization efforts and remain well-positioned to benefit in a rising rate environment. I'm pleased with what we are able to accomplish in deposits this quarter. As you can see on Slide 10, we continue to do a nice job of growing deposits, which were up 2% linked quarter and 4% year-over-year. And in particular, we continue to gain traction on DDA balances, which were up over 1% linked quarter and 4% year-on-year excluding the escrow balances contributed by Franklin. Our total deposit costs were well-controlled, up 10 basis points compared with 11 basis point increase in the prior quarter. Interest-bearing deposit cost rose at a slower pace this quarter as well, increasing 14 basis points compared with a 15 basis point increase in the second quarter. For the most part deposit costs have been relatively well-behaved, despite increased deposit competition we are seeing in the industry overall. Our cumulative data on interest-bearing deposits is in the low 30s as expected and remains in line with our overall expectations given where we are in the rate cycle. And given the actions we are taking, we expect cumulative betas to remain relatively stable in the fourth quarter. We continue to be optimistic on the trend of deposit costs. We are benefiting from investments that began back in 2016 in areas like increasing our brand marketing spend to closer to peer levels and in analytics to improve our targeting through digital and direct mail offerings on the consumer side. In commercial, we are making investments to build out additional product capabilities like escrow services and are rolling out our new cash management platform early next year. Also in July we launched Citizens Access, which contributes to our funding diversification and optimization of deposit levels and costs, through the end of the quarter we raised about 1 billion dollars, and we expect to hit about 2 billion of deposits by the end of the year. While this is a relatively modest part of our overall deposit strategy. We're very pleased with the progress so far. About 97% of these deposits are from new customers and the average account size is about $70,000. We are right on target with the type of affluent customer, we are looking for. Year-over-year our, asset yields expanded 47 basis points, reflecting the benefit of higher rates and the impact of our BSO initiatives. Our total cost of funds was up 35 basis points, reflecting the impact of higher rates and a continued shift to greater long-term funding. This included the impact of the 750 million senior debt issuance late in the first quarter of 2018. Our borrowing costs were positively impacted by the slowing pace of LIBOR this quarter. We also benefited from the mix shift this quarter as we redeemed higher cost sub debt at the end of June and replaced it with lower cost filled advances. Next, let's move to Slide 11 and cover credit. Overall, credit quality continues to be strong, reflecting the continued mix shift towards higher quality lower risk retail loans and a relatively stable risk profile in our commercial book. The non-performing loan ratio improved to 73 basis points of loans this quarter down from 85 basis points a year ago. The net charge-off rate of 30 basis points for the third quarter was relatively stable linked quarter and up modestly year-over-year from relatively low levels. Retail net charge-offs were up modestly, reflecting seasoning in the portfolio which is very much in line with our expectations and performing in line with the model loss curves. Commercial net charge offs for the third quarter were relatively stable versus last quarter and up from the prior year which benefited from higher recoveries. Overall, we feel good about the credit metrics and trends in the book including a meaningful drop in criticized asset levels reflective of continued favorable credit quality. Provision for credit losses of $78 million declined from the second quarter with particular improvement in the real estate secured portfolios. Our allowance to loans coverage ratio remain relatively stable and in the quarter at 1.08%. And as we increase the mix of higher quality retail portfolios in our overall loan book, the NPL coverage ratio improved to a 149% as we saw continued improvement in NPLs and run-off in the non-core portfolio. On Slide 12, we continue to maintain strong capital and liquidity position ending the quarter with the set-one ratio of 10.8% which came down from 11.2% in the second quarter with approximately 18 basis points of impact from the Franklin acquisition. Also this quarter, we repurchased $400 million common stock and returned a total of $529 million to shareholders including dividend. Our Board of Directors has declared a dividend of $0.27 a share and we have the ability through CCAR to increase the quarterly dividend another 19% to 0.32 per share beginning in the first quarter of 2019, subject to our board's approval. Our plan glide path to reduce our set-one ratio remains on track and we remain confident in our ability to continue to drive improving financial performance and attractive returns to shareholders. Third quarter achievements against our enterprise initiatives are highlighted on Slide 13. I’ll point out that we are making traction on our balance sheet optimization effort as we recycle capital out of lower return categories like auto and leasing. With the core yield have improved and portfolios have decreased by more than 7% and redeploy it against higher return categories like our education refi and merchant finance portfolios as well as in higher return relationships in commercial. Additionally, we continue to deliver beyond expectations in our top programs where we now expect top four to be at the higher end of our range and deliver $105 million to $110 million in benefit. As we work on running the bank better, we’ve launched the next phase of process reengineering opportunities with the focus on consumer operations, mortgage and project delivery. As we’ve seen some real benefits from the work so far, for example, in consumer banking our efforts to improve new relationship experience for deposit account opening have reduced new to bank customer attrition increased the net promoter score by 10 points and increased mobile enrollments by more than 30%. And for our commercial clients, we’ve implemented our concierge service model which has significantly increased the speed with which we address client requests. We are also leveraging enhanced data analytics and transformative technology such as AVIs, robotics and cloud to improve the customer experience and work more efficiently. We have been able to use robotics and process reengineering to improve cycle times for key clients processes. For example, we’ve reduced on boarding times for new cash management clients by 60% since the first quarter this year. On Slide 14, we highlighted some of the longer-term investments we are funding in order to precision us for sustainable success. Bottom line, we have been able to successfully lean forward with our longer-term strategy while also executing well and delivering strong results in the near-term. On Slide 15, you can see the steady and impressive progress we are making against our financial targets. This quarter we hit the lower end of our 13% to 15% medium-term ROTCE target. Since 3Q '13, our ROTCE has improved from 4.3% to 13.5% underlying, and our efficiency ratio has improved by 11 percentage points from 68% to 57% excluding the impact of Franklin. And EPS continues on a very strong trajectory as well up to $0.93 on an underlying basis from $0.26. Our outlook for the fourth quarter is on Slide 16 and it reflects continued momentum in both our top and bottom line results. We expect to produce linked quarter average loan growth of around 1% to 1.25%, given strong commercial lending pipelines and solid growth in education and retail unsecured particularly with a strong showing in third quarter Apple iPhone upgrade loans. We also expect net interest margin to expand by approximately 3 to 4 basis points linked quarter reflecting the ongoing impact of our BSO activities, particularly our deposit initiatives and the benefit of rising rates. In non-interest income, we're expecting to see growth around 5% to 7%, with a strong quarter for capital markets, given strong pipelines and some seasonality. Also, we will see an additional lift from the full quarter impact of Franklin. Excluding Franklin, core growth is expected to be about 2% to 4% linked quarter. We expect noninterest expense to be up around 2% to 3% in the fourth quarter also including a full quarter impact from Franklin. Excluding Franklin and notable items expense growth is expected to be around 1% to 2% with positive leverage and further efficiency ratio improvement. Additionally, we expect provision expense to be in the range of 85 million to 95 million. And finally, we expect to manage our step one ratio to end the year around 10.8% and we expect the average LDR to be around 98%. In addition, we are anticipating a tax gain as we finalize the impact of tax reform, which is expected to be largely offset by costs associated with top five. To sum up on Slide 17, our strong results this quarter demonstrate our continuing strong performance as we execute against our strategic initiatives and continue to improve how we run the bank to drive underlying revenue growth and carefully manage our expense base. We are very pleased to have closed the Franklin acquisition and successfully launched Citizens Access this quarter. Our outlook remains positive as we continue to work to become a top-performing regional bank. Let me turn it back to Bruce.

Thanks, John. And Brad, why don’t we open it up for some questions from our viewers.

[Operator Instructions] And our first question, here is going to come from Matt O'Connor with Deutsche Bank. Please go ahead.

I was wondering if you could about the prospects to accelerate the share buybacks just given how weak your stock has been and obviously the earnings and capital levels are quite strong.

I will go ahead and start off with that Matt. I mean I think, I think we done a nice job this quarter of returning capital to shareholders. As you saw in our remarks, we have returned $529 million, 400 million of that coming from repurchases. And we like the opportunity to return capital to shareholders over time as we talked about. We have a glide path that we are pursuing that allows us to balance, not just the return of capital, but also deploying that capital into growth opportunities. We still see nice opportunities for growth and we will continue to monitor that over time and react accordingly in terms of how that glide path plays itself out.

I guess within the parameters that we set, Matt, in CCAR, we did have more weighted earlier in the fourth quarter period, and obviously on this, we're taking in more stock. So, we can’t exactly market time. But as you said, stocks that kind of astonishing valuations at this point. So we'll take advantage of that.

And then just separately, if you look at the revenue growth, not just this quarter but year-to-date, among the highest in the industry, and obviously, hopefully, that's sustainable. But if it's not, do you have leverage to cut costs? You can continue to meet your targets, obviously, you got the top initiatives and even focused on the operating leverage, but frankly you haven't needed to maybe manage the cost as much because of revenues been so strong. But if it does, slow you have the flexibility to meaningfully bring down the expense growth.

Well, Matt, I think we've had a very consistent model here to deliver that top line growth. And so, we've got very strong capital position, we’re growing loans prudently with that by finding niches in consumer and by our expanding our coverage for us, and overall size of our business in commercial, and I think there is still room to go with that. So, if you start with roughly 70% of your revenue is net interest income and you can grow your loans, we been able to grow roughly 5%. But a nice level of loan growth and an asset sensitive balance sheet with in a rising rate environment plus our DSO initiative means that’s the formula to get very strong kick up in revenues. Then combine that with the investments we've been making in our fee based businesses and deepening relationship with our customers, we should be able to keep growing feeds. I think and certainly in this single-digit level ex acquisitions. So, I’m still optimistic that the formula that's worked will continue to work. And if you look last year, we had 10% revenue growth, which was top in our peer group. I think my memory serves me against 3% expense growth with 7% positive operating leverage. We’re probably now in a 7% or 8% top line growth, keeping expenses down around 3%. So we’re 4.5% operating leverage on an underlying basis. And I think the good news on, if you can achieve that revenue growth, you can continue to fund the investments for the future that we've made and keep your expense growth in check. So, one thing I would point out that I think differentiates us versus peers, is the consistency of the top programs that relentless focus on improving end-to-end processes and customers experiences while extracting costs that frees up dollars, so that we can hire more customer facing people, invest in the fee business, invest in great technology. We were first to market in our peer group with online mobile advising with our specified product first to roll out to national digital bank. So, I think we’re doing a great job and having a top line growth allows us the flexibility to make those investments and still deliver the positive operating leverage and still drive our ROTCE higher.

And our next question will come from Peter Winter with Wedbush Securities. Please go ahead.

I'm just wondering if I look out, are you seeing any let up on pay down activities or borrowers getting near the end of tapping some of this excess liquidity for growth that could lead to better loan demand next year?

John, you want to take that.

Yes, I'd say, there is not a perceived trend where we've seen it is a little bit of drop in utilization. So, we pretty consistently strong new business pipeline across the board, all year long, and we continue to see that as we look into the fourth quarter and into next year and that’s both lending in our fee business. That's is going to offset a little bit by what Bruce mentioned, which is a little bit more selectivity on our part, we see terms and conditions overstretched and a little bit lower utilization. So, I think that the utilization trend, we don’t see it changing right now and are seeing a particular change in sentiment among borrowers, but we’re seeing a lot of activity across the board. So, we continue to be optimistic around growing our business.

And then the loan to deposit ratio, it's 98% I guess it's supposed to be stable in the fourth quarter. Do you think that ratio could move lower next year with some of these deposit strategies that you have?

Yes, I will go ahead and take that. I mean I think the idea here is that we want to have deposits fund our loan growth, and the outlook that we have now is for deposit to grow at least as fast as we grow loans. And so, we've seen great frankly take up in our deposit growth, and I should add that a big part of that deposit growth comes in the DDA space, which we’re really pleased to be able to -- to be able to continue to do that here throughout 2018, consistently growing that. And in terms of where the LDR goes, I mean I think we’re pretty comfortable in that upper 90 range call it 97, 98, 99. And we've had a demonstrated ability to manage to that and feel like that's likely to be durable into the future.

And our next question will come from Saul Martinez with UBS. Please go ahead.

First question and I know you spent some time on the strategic initiatives. So forgive me, if this is a little bit repetitive. But where do you think you are just more broadly on the balance sheet optimization efforts? And maybe to use a baseball analogy with the Red Sox going to the World Series, what inning are you in? And where do you see the most opportunity still? Is it still in education lending? Can you just walk us through the various initiatives to optimize the left and right side of the balance sheet, and kind of how much further you can go there?

Sure, it's Bruce. I will start and flip it over to John. But if I have to put it into baseball terms, I would say we’re still maybe only in the middle innings, fourth inning or so. If you go back 3 to 4 years ago, we were doing this on an informal basis. So it was really kind of myself, CFO, Treasurer working with the Vice Chairman, trying to figure out which way we needed to tilt capturing deposits, regaining our deposit market share after -- under our, yes, the balance sheet had shrunk and we needed to reflate the balance sheet, that was pretty easy pickings. And so, commercial really was going out doing the heavy lifting getting the deposits back on the balance sheet. But as times moved by, we thought the success we've had with top, we could try to replicate and put in place a more formal PSO program where we would have specific initiatives on the left side of balance sheet and the right side of balance sheet with actions that would be monitored ownership, et cetera, same kind of structure that we have running top. And so, I think we're making traction on the asset side. We are running down certain portfolios. So, you can see auto is running down, leasing running down, those are not credit concerns. Those are simply not a good use of capital. We’re not making the returns that we would like there. And then you saw us make a loan sale in the second quarter out of corporate, and so I think we got to be very disciplined, if we’re not getting deeper relations and cross sell than we have to exit credits, and we can do some of that naturally but we can also punch some and sell them. So those have been kind of minuses and then growth is really focused on consumer trying to find attractive niches, education refinance we’re one of the pioneers of that market it is still a very attractive market. The upgrade program we have with Apple and merchant financing at point of sale as another very attractive area we have another relationship and another one coming soon. And so, we're excited about that, so we will continue to push into areas where we see opportunities. On a commercial side, I think we build out our industry verticals, so we can go up market a bit into the mid corporate space. Those tend to be full relationships where we can get a good share of wallet. So, we’re seeing some nice traction there. In commercial real estate, we really have become very under scale, in RBS, under RBS ownership because they were running off commercial real estate exposures globally. So, we really just been regaining our market share and again, being very, very selective about where we’re playing. In fact, I should point out we have a sell of these from work out is running commercial real estate. And with Don and his acumen, I feel really good about what we’re doing in commercial real estate. On the right side of the balance sheet again, we wanted to have more tools in the tool kit. So, we launched Citizens Access, which is off to a fantastic start. It's exceeding all of our metrics that we set out at this point, so very pleased with that. We have noticed that in commercial, we're not always playing with a full toolset there as well. So, we're investing in having full escrow capabilities. The bankruptcy capabilities, there is a new cash management platform we're rolling out, so we want to gain a bigger share of natural deposit relationships, which should come with less pricing pressure. So, those are a few other things, I feel there's still and one of the great thing about Citizens is we've been a self-help story. And if something is not great that's a good thing because that means we can fix it and continued to propel our earnings higher. Let me go around the horn here and see if anybody wants to add to that. It was a longwinded answer, so I don’t want to take the whole call out of it. John, next

I will just add just a high level point or two, if that was well covered. And I think I would highlight the fact that, year-over-year net interest margin is up 15 basis points and 5 basis points of that comes from BSO. And so even without rates, we remain self-help on the net interest margin space, and that's good. And I think we got a lot of room to run. We’re still about call it 10 or 15 basis points short of peers in terms of net interest margin, and one of the places that manifests itself is in non-interest-bearing deposits where about 25% of our deposits are in non-interest-bearing space. We continue to grow that space because we’re making up ground that since the IPO and even you could see that getting overtime, north of 30 that's really our target is to get north of 30. And all of the initiatives that we have in place in the consumer side and commercial side, which we won't go into in too much detail, but investing in data and analytics, increasing our markets spend back to peer levels, our product offerings in commercial, replatforming the cash management business will all support that engine of net interest margin growth overtime.

Just let Brad.

Yes, I was just going to add one other things and it really ties in what you guys would say. One of the positive stories for us has been our ability to grow DDA in lower and no cost deposits. And part of the reason for that goes back to Bruce, what you are saying is, we were underway. We have a very attractive -- we’re not getting our fair share from our own customer base. So, we have a very attractive affluent customer base and we weren't getting our fair share of the low cost deposits. And I think with all the initiatives we have around, rebuilding the value proposition for our affluent customers and then the investment we’re making in segmentation and targeting that gives me a lot of confidence. We can continue to grow. We can outpace the growth of those low cost deposits.

That's Great. If I could follow up on regulations, we should get proposals on S.2155. I would think fairly soon, and if we do move to a more of a potential standards that are based on complexity versus risk. Does that change at all? How do you manage capital and liquidity? Specifically on capital, could it help trigger at least a rethink of 1025 CET1 target potentially going lower?

Well, look, I think we have always said that our risk profile is certainly no worse than median. In fact, we think it's slightly better than median. So, there's no reason over time for us to carry capital surplus versus the peer median. So, most peers are professing that they are going to move down, but they think, they have plenty of capital to safely run the bank. And so, we will calibrate off of that, so if the peer median moves down, we will move our goal post down. But I think the nice thing of the rethink on the bracket we’re in under 250 is that it would just increase flexibility around decisioning. So just like Matt said earlier, in one of the first questions on the call today now that the stock price of regional banks and ours in particular washed out would you maybe want to buy more stock, you have to go through a process today, the way CCAR works that you probably gain some new flexibility based on the rethink that’s taking place. Anything, John?

Yes, I think that's exactly right. I think flexibility on the capital side increases, I would say that occurs either with us as 155 or with the SEB. Both of those things are either financially would allow for that flexibility and would allow us to balance RWA deployment against capital return much more effectively. On the liquidity side, we got less of an impact. I mean we tend to run ourselves in a conservative way in terms of our internal models with respect to that. And so from that standpoint, I think capital is going to be the bigger impact versus liquidity.

And our next question will come from Brian Klock I believe its Keefe, Bruyette & Woods.

A bigger picture question I guess first for you Bruce. The progression and profitability and expansion profitability in the best in the group, and anything about your bottom lower end of your 13% to 15% ROTC guidance range. I guess, is there a thought process maybe enter into this yearend planning process and for next year that, would that be an opportunity to think about updating? And how do you think about maybe moving that up since you guys have executed pretty well here?

Yes. So, look we’re quite pleased that we’ve run ahead of pace to get into that 13% to 15%, we’re certainly ahead of the budget for the year and I think coming into the year consensus has been taken up about 10%. So, again reflects very good performance throughout the year. We typically look at all of the metrics and the targets at yearend when we put our budgets to bed, and then on the January call we’ll give you detailed guidance for '19. And then potentially look at whether we want to refresh those medium targets. I think the thing that everybody is aware of is that, as you get farther into this expansion, at some point you’ll have credit costs rise and start to normalize, which would create some headwinds against PPNR. But at this point, we feel good I mean we feel good about the economic outlook for 2019. We don’t think any recession is around the corner. I feel good personally through 2020. At this point, we don’t see the build ups and accesses that you would start seeing, if you were getting closer to a recession. So, I think we’ll take all that into account when we consider whether we’re going to move to 13% to 15% higher.

And maybe to follow up on some questions and discussions on the NIM earlier, and John, I just wanted to get double check that. The NIM expansion, the guidance for the fourth quarter, so they would include obviously the impact of the good growth from Citizens Access, which that has come in at a higher deposit beta and even the impact of the FHLB advances. Was that sure the $2 billion of long-term borrowings increased on a spot-to-spot basis so that from FHLB advances in that increase?

Yes, I think that what you’re seeing there, maybe just I’ll take the deposit part of this first in the context and then I’ll cover borrowings. But that does include in the fourth quarter, the impact of Citizens Access going from $1 billion to $2 billion. Really what that does is, it basically balances and optimizes our promotional activities across the whole platform. So as we’re profitably supporting the loan growth in the fourth quarter, we can do that in a much more efficient way with the combination of our input print activities connected with Citizens Access trajectory. So that’s all included and is beneficial to the NIM in the fourth quarter. As it relates to borrowings, yes, I mean borrowings are up on a spot basis. On an average basis they’re pretty flat over the last couple of quarters going into the third quarter. You may be seeing an increase in spot that occur just in terms of natural variability that you’re seeing in the commercial deposit flows. And so at the end of the quarter, you have some deposits what was that they come back in and that’s really you’re seeing not really a signal that is headed north in the significant way.

And then I can just squeeze one more in. One of the things that you guys have done this quarter, which you’ve kind of bucked the trend for the industry this quarter and for the full year, for that matter is have DDA growth. And I know you mentioned even excluding the First American Mortgage escrow deposit that’s up quarter-over-quarter and year-over-year. So maybe just kind of highlight the fact that to me it sounds like that’s growth in customer accounts, and I think Brad you commented on that to, but it does seem like to me that commercial customer accounts that you’re growing. So maybe can you just talk about how you guys are executing better than the rest of the industry is on DDA growth?

Yes, I will start with that and it's really a combination of deepening with our existing customers and new household growth. So, we've got good strong household growth. And part of that is the investment we made in data and analytics which allows us to spend more on marketing to acquire customers, and then I mentioned this in my comments earlier. We've long had a very attractive household base at Citizens very steeped in affluent customers, and we really haven't got our fair share over time of their low cost, their DDA deposits. And a lot of work we've done in the last year or two is really very hard on the value proposition we launched and we platinum values, lot of segmentation work around building the right value proposition, and that has allowed us to grow our DDA balances with our existing customer base. The last point I'll make and then turn it over to Don is just to that point of household growth. I do want to make a point that’s been very, very high quality household growth. So our primary household relationship our mobile active metrics are some of the best we've ever had, so it's not only good household growth but its primary and active households.

On our side, I will just add, Bruce mentioned the investments we’re making in our cash management business and that goes really from the product level all the way through to the service level and it's allowing us to add business on our credit services platform. And that should accelerate as we roll out the new platform in 2019.

Your next question here will come from Kenneth Zerbe with Morgan Stanley. Please go ahead.

With Citizens Access, obviously, you're up to a really good start. I know you’re targeting the 2 billion by year end. But I guess the question is, how do you stop that growth because I just went online, I saw you’re offering 212 on savings accounts. Like, how do you get people to not continue to go into that product?

Well, I will start and, Brad, you can chirp right on it. But it’s a very elastic market with respect to pricing, so you can turn the dial up or down based on where you are kind of in the forced ranking of those offering. So that's one thing Ken, if you wanted less deposits from that channel, you could just drop your pricing and it will kind go to the level that you want. So that's one thing. But what I would say more broadly than just competing on rate, I think one of the reasons we've been so successful is that we really, really focused on delivering a great customer experience which we try to do everything, but I think we really nailed it here. Then you can you can go online Ken, we will happy to have you as a customer, but you could -- after this call, you could get on our website open and fund an account in under five minutes. That's basically proven. So it's really a great, easy to use experience and ability to get reporting on what you got and some nifty stuff. The other thing that I think we done exceptionally well is I think we have really regional peer leading data capabilities. And so, we put back to work to target households and keep our overall account acquisition costs quite well. And so that's part of the equation as well. So, it's really your functionality where you are on the pricing ladder. And then your account acquisition your data capabilities that determine your success factor, and I think on all those dimensions, we've pegged it almost perfectly.

Yes. Bruce, I agree with all that. And then one of the points that I would make is, if the question is sort of around this concept of cannibalization and you just going to continue to encourage your own customers to take that the higher cost offers, the answer is. We’re getting 75% of our customers out of footprint, so this has given us a national capability. So 75% of customers are coming in our out of footprint and only 3% are coming from our own customer base. So, this is a whole new customer segment that we’re attracting that we weren't reaching because they’re not traditional branch users.

Got it.

I think it also gives us just more confidence around. It's almost a petri dish to improve our digital and data capabilities which is only going to help us in the long run with our core franchise as well.

And I understand you can drop the rate on. I guess that presumably implies that your customers are pretty much hot money customers and you're going to lose the customer so they are, I mean is the right way to think about this customer base more or like on a wholesale borrowings to some extend like you’re…

Not at all.

Let me jump in. It’s John. I mean I think just throwing some numbers out there, just to give you a sense of where we are. So, after the last rate hike we did, we lagged our rate rise, and so it’s not just dropping rate, but it's also lagging rate. There is a customer experience part of this story and there are product enhancement in the future phases of this platform that we’re going to invest in to deepen the relationship. This is not intended to be a won and done launch. And so, you’ll see more build out in the test and warm way, using this is the backbone of a digitally savvy channel that serves incredibly attractive customer segment that we want to learn, learn more about how to serve. So, again we lagged at the last 25 basis points rise from the Fed, we rose by 12 basis points. On the next Fed hike, we’ll take a look at what make sense there and is clearly a very efficient way lower cost channel that is superior to wholesale funding.

I think, Ken, the stress test assumptions around that and really would say, that this is analogous to just your own affluent customers. If you have a lot of cash, you care more about the rates that you’re getting. And so in our core customer base, the folks who of means are going to try to make sure they’re getting a good break on the deposits and that’s really all this is. The average account size as John indicated was $70,000. So, these are relatively affluent customer.

And we have Scott Siefers with Sandler O'Neill Partners. Please go ahead.

I think most of my questions have been hit. I guess one though which is on the fee guide, John said it’s a little actually quite a bit stronger than I had anticipated. I know you mentioned in your prepared remarks, capital markets should be a good quarter. But I wonder if you can just spend a moment or two talking about sort of what’s going well what’s not going as well as you hope to as you look at that fee guide into the fourth quarter and beyond?

Yes. I’ll go ahead and start and then maybe Don, can follow up. But in the outlook, the cap markets and global markets are both expected to be drivers. But really a lot of our fee categories contributing to our expectations for 4Q, including service charges and frankly onsie-twosies across several of the other categories including investment and trust. So, in the cap market space our pipelines are strong, that's the business that you have monitor the external environment very closely because of the ebb and flows there and we probably made a lot of investments and capabilities there and in global markets that is providing that lift. And I'll let Don elaborate.

I would say that’s all correct. Go back to where what John said in his remarks, the syndicating lending business was quite weak in the third quarter, just to the market down raps across the board and we’re seeing that come back. In the fourth quarter, I would also the M&A business is kicking in as we begin to benefit from Western Reserve now that we're a year and half in. So those obviously transactions take a long time to mature but what we’re beginning to see transactions lined up to close in the fourth quarter.

And then Don, in global markets, which is FX and interest rate, risk management we built a great team. We've got a great platform and we're expanding our capabilities, we’re now offering options capability to some of the things that we had to standoff as we separated from RBS we’ve now got those in place, we’re gaining traction there.

I think that’s important. I think you have realized a lot of these businesses were two or three years into and it take a while to build the products build the team and get out in front of the client base and market them. And I think the number of wins we’re achieving across the board is quite encouraging.

And we will go to the line of Erika Najarian with Bank of America.

Given your strength in lending trends, I was wondering, if you could give us your perspective on how non-bank competition has potentially accelerated in the businesses that you have been expanding in? And how sort of the structure and the rate offerings are different from that over the traditional banks?

So, obviously, the growth of the non-banks has been something that we've been dealing with for years. I go back 25 years ago when we begin to sell risk to non-banks when the old age FHLB designation came in the commercial banking industry. But we see in that twofold, obviously, they're competition, but they're also a distribution channel for us. So, we originate a lot of leverage risk and sell to the non-banks as part of our distribution efforts. And our strategy in leverage finance is to hold very little of the origination that we undertake particularly responses, so our whole levels versus our volumes are quite well. So, we view them as a different type of competitor. They don’t have some of the same accounts challenges. We have as banks as some of the ratio that we didn’t manage to, but I don’t see them as a massive limitation in terms of the ability to continue to grow the business.

Yes, on the consumer side, I would say there is two asset classes where we’re non-banks compete. One is on personal unsecured lending program and the other is education refinance. And we particularly in the personal unsecured space we have seen the non-banks be pretty aggressive there. I think the big differentiation between us and the non-banks is they're playing a lower credit, profile then we are. So we maintained our discipline of staying really up in high prime space and were seeing our competitors go down credit.

Got it and just, oh I am sorry, don't mean to interrupt.

That’s fine. Go ahead, if you have another one.

Just a follow up, could you help us size the residual risk that is on the balance sheet? And also do you have any term exposure on any sponsor back transactions that you do keep?

We have about 2% of our assets in sponsor leverage finance right now, so it's relatively small. Some of it will be….

That's commercial.

Some of it will be trend. Some of it will be revolver.

Got it.

We kind of play and maybe a five-year kind of maturity bucket on the pro rata side.

And the next question in line will come from the line of Lana Chan with BMO Capital Markets.

Just a quick question, have you given an estimate on terms of FDIC surcharge savings going into next year?

No, we haven’t done that. But we’re very much looking forward to it because it is an attractive number, so stay tuned. We’ll probably that will be in our guidance when we do that in January.

Okay.

You want to add something, John.

Yes, I just mentioned, it's about $15 million a quarter for us. And if anybody’s guess when, it will actually and the general sentiment is that by the end of this year, we’ll go ahead and stop that of the surcharge from being applied, but a $15 million a quarter and we’ll -- as Bruce said we’ll build that in to our outlook as we consider how we want to make investments and drive profitability into 2019.

And just a follow-up on the securities book and you will see a backup of the long end of the curve recently. Does that change how you view securities deployment or investments opportunities?

No, I mean I think securities portfolio is primarily a liquidity store as we try to manage against LCR and our internal view about liquidity stress. It also helps us moderate our interest risk exposure. Those are the top two reasons and then we attempt to ensure that we’re doing that in, with the lowest cost way with the highest profitability. In the third quarter, I think front book yields were about 350, 360, run-off yields were about 245 or thereabouts so you’re going to see continuing improvement in that book if the long end continues to behave as the way it’s been behaving. So that’s a good trend for us.

And our next question will come from Gerard Cassidy with RBC. Please go ahead.

Can you share with us, clearly as you’ve already discussed about your capital levels being very strong. One of the largest mortgage originators out there Wells Fargo and in case that there's excess capacity in mortgage bank, residential mortgage banking, now that you have Franklin. Are there opportunities to make other acquisitions to build up even more economies of scale? And if so, do you kind of have to wait until integrate Franklin before you could do something?

I think Franklin was the silver bullet that got us where we need to be in mortgage. So, I wouldn’t see us stepping out and doing any more acquisitions in the mortgage space. Having said that, I do think there will be consolidation in the industry, there’ll be marginal players that are driven out of the business given where gain on sales has moved and that bodes well for the scale players. So, I think we should benefit from that trend.

And second when you look at optimizing your balance sheet and when you get it to the level where you, where it's optimal. Where do you think, I know ROE is the function of the denominator equity of course and the numerator. But, when you look at it from an ROA perspective some of our best regional banks have ROAs that are in 160s, 170s. What do you think in an optimal environment your ROA could get to?

I guess we haven't focused that much on that metric, Gerard, you know I think we continue to see that move higher as we run the bank better. You know we have, you have to consider where you are in the cycle and your business mix and so I think our focus is really been on ROTCE we mentioned earlier we’re currently targeting 13 to 15, we’re now in that range. I think if we continue to run the bank well the way we've run it and we can keep delivering operating leverage and get the balance sheet optimizer, there is certainly room for those metrics to move higher.

That would imply, I mean there's just the math associated with that that would imply that we would get to the mid ones or thereabouts. You get to the mid teen, on returns you’re basically talking.

Into the reserve math our focus has really been on the ROTCE.

And next question comes from John Pancari with Evercore. Please go ahead.

On the margin side, I just want to engage your updated sensitivity for an increase of 25 basis points by the Fed. What would that equate to in terms of your expected margin benefit at this point?

I think that would be on a parallel shift, which is really the issue there, I mean on a parallel shift you’re in that call it $10 to $15 million range in the first quarter and that compounds thereafter close to around 15. In the short end, our sensitivity is about 75%. So we get most of the benefit even if the long end does not rise.

The stat that we quote typically has been to a gradual 200 basis point rise what would be the impact there. And I think last quarter that was high fours. I think were actually trending up a little bit towards the mid fives some of that is just fine tuning our models but we kept the asset sensitivity reasonably stable. We think that's the proper position to have in a raising rate environment. So we'll continue to benefit as the Fed lifts rates.

And then also on the NIM, is that, that 5 basis points of structural upside to your NIM annually that you see from the balance sheet optimization. Is that still intact that still around 5 basis points that's in your outlook?

Yes, we said that previously that without rates we're looking to get somewhere in the neighborhood of approximately five basis points.

And on a year-over-year by quarter basis this quarter, I think we got 5 out of the 14. So I think we are trending towards that this year and we can update that as part of our guidance for next year in January.

Thank you and last thing for Don. What you mention that you do lead a good number of leverage transactions, but a syndicate a lot of it out what percentage of your leverage deals that you syndicate? Are you in the lead position? And then what is your average hold level?

I would say our hold level is in the 10ish range, I don't have the exact number so just to call it 10 million, so relatively small. We plan a lot of deals that are kind of 300 million to 400 million in size so that will give you a sense. I think the general rule in my careers been you want to hold less than 5% of the risk you're originating that’s what we try to do. And I would say we’re probably leading of that 65% to 70% of the deal, these are I believe leads or jointly.

And our next question will come from Kevin Barker with Piper Jaffray. Please go ahead.

In regards to some of the movements around the liabilities, we know the wholesale deposits went up quite a bit this quarter. And some of that could be seasonality and how you are funding your balance sheet specifically at period end. Given that Citizens Access has come on board and you should see an acceleration of deposit growth there. Do you expect wholesale deposits to decline in the fourth quarter? Or was there some seasonal aspect that you would see a shift between your interest bearing deposits and your wholesale funding?

Yes. I think on the wholesale side we tend to see that relatively stable where the trade off is that at least in the near-term on Citizens Access is, as we’re trading off promotional activities that might otherwise have occurred in the businesses, in the branch businesses that we can do more efficiently through Citizens Access. So, there is a little bit of trade off there. And sure at the margin, you might find a little bit of impact on the wholesale, but that tends to be structurally a bit stable and we’ll be in place of the near-term.

And then when you think about your fee income going forward, you expect Franklin to continue at this rate with the margins that they’re generating given the capacity constraints within the mortgage industry beyond the expense phase that you’ve already laid out?

Yes. I‘ll start up with that and maybe Brad will add, but I mean our margins are down in the industry for both our legacy Citizens business and which we’ve seen, and we’ve seen that in the data that came over in the history for Franklin. I think there is, two forces there that are going to correct that. One is, we are endeavoring to get much more efficient and take capacity out ourselves which Brad can talk about. And therefore to offset that decline in revenue due to margin by being more efficient on our platform. And then as Bruce mentioned earlier, the other participants in the marketplace there is some non bank players they’re just aren’t going to make it. And we expect that the capacity will come out therefore you’ll see margin stabilize a bit over time, it’s just a natural ebb and flow of the mortgage market. But I’ll stop there and see Brad has anything more to add.

Yes, really not much more to add beyond this. I think you said it right, we would fully expect and we’re already started to see it with the competitors taking capacity out and that will have the natural balancing impact of bringing margins back to more normal level. And then in the mean time, we’ll be very, very disciplined about expenses.

Look, I would just add. It's Bruce. That we’re very excited about this acquisition that is really gets us the scale that we needed. It diversifies our originations channels. It’s a real quality operation with great technology. We’re going to keep moving aggressively to better customer experience and digitizing frontend origination got some great plans in the business. And so, we have high hopes for the business, and the market is a little soft that we'll work our way through that. But this is something that we wanted to be in and we think it’s an important product capability that we need to offer to our consumer customers on their life journey where we can be their trusted advisor and help them go through a very big personal transaction for them. And now I think we’re in the business with the right scale and the right way.

And there are no further questions in the queue at this time. With that, I’ll turn the call over to Mr. Van Saun for closing remarks.

Okay. Well thanks again for dialing in today. We appreciate your interest and support. I think there is a great opportunity to make money in this stock. I’ll just add fortuitously. We continue to execute well and we maintain a positive outlook for the fourth quarter. So, have a great day. Thank you.

And that’s concludes today’s conference call. Thanks for your participation. You may now disconnect.