Earnings Call: Q3 2019

Oct 18, 2019

Good morning, everyone, and welcome to the Citizens Financial Group Third Quarter 2019 Earnings Conference Call. My name is Brad, and I'll be your operator 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, event is being recorded. Now I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin. Hey, thanks so much, Brad, and happy Friday, everybody. We're really pleased to have you all join us. First off, this morning, our Chairman and CEO, Bruce Van Son and CFO, John Woods, will provide an overview of our results and our and then we'll reference the earnings presentation, which you can find at investor. Citizensbank.com. Then we'll be happy to take questions. In the room with us today are Brad Connor, Head of Consumer Banking and Don McCree, Head of Commercial Banking and Deb will be able to provide some additional color. So now for some quick housekeeping. Our comments today will include forward looking statements, which are subject to risks and uncertainties, And you should review the factors that may cause our results to differ materially from the expectations on Page 2 of the presentation and in our 2018 Form 10 ks. We also utilize non GAAP financial measures, so it's important to review our GAAP results on Page 3 of the presentation and to utilize the information about these measures and the reconciliation to GAAP in the appendix. And with that, Bruce, it's all yours. All right. Thanks, Alan, and good morning, everyone. Thanks for joining our call today. We're pleased to announce another strong quarter. In spite of interest rate and yield curve headwinds, we grew our revenue 5% versus a year ago and 1% versus last quarter. Our earnings per share was up 5% versus a year ago and up 2% sequentially. The key to these results were strong performance in our mortgage business, Continued good expense discipline and robust capital return. We progressed well on our efforts around POP6 and on some of the strategic investment initiatives that we outlined last quarter. We continue to actively manage the balance sheet through our BSO program and we've maintained a loan to deposit ratio of around 94%. We managed deposit down aggressively in the quarter with interest bearing deposit costs down 6 basis points versus last quarter and we expect deposit betas to tick up as we see further rate cuts. Our credit metrics remain strong overall and both Consumer and commercial are in really good shape. Our view is that the economy is holding up reasonably well, though growth has slowed somewhat versus a year ago. While we don't see a recession on the horizon anytime soon, we are being duly cautious in selective areas on new loan originations. So overall, I'd say we've executed well year to date and we feel we are positioned to close out the year with a good Q4. Our formula for 2020 will remain consistent, namely grow our balance sheet prudently, definitely manage our NIM, to invest in our fee businesses and reap the returns, carefully manage the expense base by finding fresh efficiencies and then self funding new initiatives, stay disciplined on credit and actively manage our capital base. We celebrated an important milestone during the quarter, The 5th anniversary of our IPO on September 24, it's been quite a journey. We've made much progress in building a great bank We are now delivering better and better for customers, colleagues, communities, shareholders and regulators. We know there is more work to do we are energized by the challenge. I'm confident that our track record of strong and disciplined execution will continue and will differentiate us from our peers. And there is no reason the next 5 years can't be even better than the last 5. With that, let me stop and turn it over to our CFO, John Woods. Great. Thanks, Bruce. Good morning, everyone. We're pleased to report a strong quarter with record fee income, good expense discipline and continued execution against our strategic initiatives. Let me kick off by covering important highlights of our underlying results on Page 4. On a year to date basis, our EPS is up 11%. And for the quarter, we delivered EPS growth of 5% year over year with PPNR up 2%. This reflects relatively stable net interest income as 3% loan growth helped offset the impact of the decline in net interest margin to 3.12 percent in rates and the yield curve. We delivered record fee income of nearly 5 $100,000,000 up 19% year over year, illustrating the diversity of our business model. Commercial and consumer loan growth were each up 3% year over year as we seek attractive areas to deploy our capital and grow our customer base. Strong deposit growth was paced by continuing momentum in Citizens Access, which grew to $5,600,000,000 by quarterend. Our spot LDR was 94.5%, providing us with funding flexibility as we head into the end of the year. Given the environment, we remain highly focused on expanding discipline and continue to execute extremely well in our top programs. We now expect to realize a pre tax run rate benefit for our top five program in the range of $105,000,000 to $115,000,000 by the end of the year. This is a $10,000,000 increase in our prior estimate. Overall credit quality remains strong with a stable nonperforming loan ratio of 67 basis and an allowance for the loans ratio of 107 basis points. On an underlying basis, the effective tax rate is 22.3% as a reported rate of 20.5% includes a $10,000,000 tax benefit associated with an operational restructuring. We delivered underlying ROCE of 12.6 percent and tangible book value per share was up 14% year over year to $31.48 This quarter, there were some noise in several line items due to an aircraft lease restructuring in our non core portfolio. This was triggered by a client merger and reflects our continuing efforts to accelerate the rundown of the non core lease portfolio. This reduced CPNR by about $3,000,000 with an increase in expense of $10,000,000 $7,000,000 increase in fees. Charge offs and provision were also $5,000,000 higher to the strength due to this transaction. Important impact of this restructuring is that there is positive operating leverage to 30 basis points on a linked quarter basis and an efficiency ratio of 57.8%. On Page 6, net interest income was relatively stable year over year despite the impact of the challenging year in the recurring environment. RUM growth of 3% helped largely offset the impact of a 10 basis point decline in net interest margin to 3.12% Given the rate backdrop, contributing to the decline in NAND was a 3 basis point impact year over year from higher premium amortization tied to significantly lower long term rates. This is partially offset by the benefit of higher interest earning asset yields, given continued mix shift towards better returning assets and modestly higher short term rates. On a linked quarter basis, the margin decreased 9 basis points, including a 3 basis point impact from premium amortization. On a positive note, we managed deposits well with a 6 basis point decrease in interest bearing deposit costs. Given the challenging rain and barn, we have continued to actively manage our asset sensitivity, which came in at 2.7% to a gradual 200 basis point rising rate versus 2.9% in the prior quarter. Year over year, our assets since the beginning of the year come down, which was driven by the addition of approximately $7,000,000,000 of net received swaps over the past 4 quarters, including a net $2,000,000,000 forward starting position we added this quarter, as well as evolving expectations for balance sheet mix. As you look at the effect of our hedging activities over the last year, plus our balance sheet mix changes had the effect of shifting our sensitivity to the long end of the curve, with about 20% to 25% of our exposure now tied to 6 months and shorter. Our current outlook is for additional rate cut in October. However, we expect to see a lower level of wind compression in the 4th quarter reflecting further declines in interest bearing deposit costs, broadly stable premium amortization and the benefit of our hedges. These factors, along with an expected resumption of loan growth, should help support net interest income in the 4th quarter. Moving to fees on Slide 7. As I mentioned, our fee based business discipline delivered record results this quarter with fee income hitting 30% of revenue. Non interest income was up 7% on a linked quarter basis and up 19% year over year, driven by strong results in mortgage banking, card fees and foreign exchange and integrated products. Service charges and fees were up $2,000,000 or 2% linked quarter, reflecting seasonality and car fees were up 5% sequentially driven by seasonally higher volumes. Our acquisition in Franklin is playing out as we hoped and served as a nice hedge against the backdrop of lower rates. Mortgage banking fees were up $55,000,000 as the originations business led to lag with production revenue of $31,000,000 on higher volumes and improved dealer sale margins. Overall mortgage servicing revenue increased $24,000,000 given favorable MSR heading results and our larger servicing portfolio. Capital market speed came in at $39,000,000 this quarter, which represents the lowest level since the Q1 of 2018 In the face of overall market weakness, we did sell, we increased our market share and position. Syndicated fees were down 1.4%, reflecting the impact of significant slowing and middle market activity and seasonality, while bonds underwriting fees were higher as fixed income markets picked up later in the quarter. We are entering the 4th quarter with a strong overall capital markets pipeline, which includes the impact of several deals that were crushed out from the 3rd quarter to the 4th quarter. Wealth fees were 6% lower in late quarter from record second quarter levels as investment sales were impacted by volatile market conditions. In FX and interest rate products, we executed exceptionally well despite challenging conditions, delivering near record level fees in line with the 2nd quarter, we would anticipate a seasonally slower quarter. We are pleased with the progress we made diversifying our fee revenue by broadening capabilities, executing well on strategic initiatives and integrating key acquisitions to build scale in mortgage, expand our M and A business and enhance our wealth capability. And as we look forward, the investments we have been making across the platform over the past 5 years should continue to gain traction as we seek to do more for our customers and be their trusted advisor. Turning to Page 8, underlying non interest was up $10,000,000 in the quarter, reflecting the impact of the lease transaction. Excluding this impact, expenses were flat, illustrating our strong commitment to expense discipline as we continue to deliver efficiencies from our top programs. We continue to recycle cost savings and top E2 revenue generating opportunities. Salaries and employee benefits are being relatively stable and equipment and software expense is up 3 given our ongoing technology efforts. Compared to the prior year, underlying non interest expense before the impact of acquisitions Annual lease restructuring is up 3% as we efficiently manage our costs while investing for growth. Let's move on to Page 9 and discuss the balance sheet. Average loans were relatively stable this quarter, largely reflecting the impact 2nd quarter loan sales as well as relatively higher repayments and lower line utilization in commercial. Year over year, average loans were up 3% driven by growth in both commercial and retail with some modest headwinds from asset dispositions. Adjusting for the impact of loan sales in the first half, loan growth was 4% year over year. Commercial loans rose 4% year over year with as well as planned reductions in commercial leases. On the retail side, loans were up 3% year over year 1% leased quarter, given growth in mortgage, education refinance and our merchant finance partnership. Regarding the leasing structure this quarter, I should mention that we've done a nice job running down the non core leasing portfolio and the total non core book, which are both down about 30 year on year, while the overall credit volume of the book continued to improve. Overall, period end loans were up 1% next quarter, providing momentum for Q4 1 year. Moving to Page 10, we saw nice deposit growth of 1% linked quarter and 6 percent year over year. We continue to benefit from our City of Defense digital platform, which has contributed nicely to our funding diversification and the optimization of our deposit levels and costs. At the end of the quarter, we reached $5,600,000,000 in keyless access deposits. Given the rate environment, we have been aggressively executing our deposit playbook to manage down our deposit costs across all channels, reducing TV rates, retail money market promo rates and taking down the savings rate in our direct bank. We've also been reducing rates to some commercial clients where they can. As a result, our total deposit costs were well controlled, down 5 basis points in the next quarter, a nice improvement from the 3 basis point increase last quarter. Interest bearing deposits were down 6 basis points in the quarter. Next, let's move to Page 11 and cover credit, which continues to look quite good overall. This reflects an improving risk profile in retail and a relatively stable risk profile at reasonable levels in commercial. Net charge offs came in at 38 basis points in the quarter, up modestly from relatively low second quarter levels. Net charge offs were up $27,000,000 year over year with a $16,000,000 increase in commercial, largely driven by a small number of uncorrelated losses At the broad portfolio risk profile, they are being relatively stable. Retail net charge offs increased $8,000,000 reflecting an expected season in our growth portfolios. Provision credit losses of $101,000,000 was up in prior quarter and prior year levels reflecting the higher charge offs. The non performing loan ratio of 67 basis points is relatively stable linked quarter increased 6 basis points year over year. Non performing loans decreased 5% year over year driven by improvements in retail. On a linked quarter basis, nonperforming loans increased 3%, driven by an increase in commercial, primarily tied to a small number of loans, while we saw improvements in retail driven by home equity and education. Our allowance to loans coverage ratio remained relatively stable the quarter at 107 basis points. The NPL coverage ratio was also stable this quarter at 159 basis points. On Page 12, we maintained our strong capital and affinity position, ending the quarter with a CET1 ratio of 10.3%, which compares well with years and gives us excellent financial flexibility. During the Q3, we repurchased 14,100,000 shares of common stock Including dividends, we returned $652,000,000 to shareholders, up 25% year over year. Going forward, we continue to target a dividend payout ratio of 35% to 40%. And our planned glide path reduce our CET1 ratio remains on track. Let's move to Page 13 and discuss CECL. We expect that the day 1 impact For CECL on a pro form a basis will be about a 30% to 35% increase in the existing reserve, which was about $1,300,000 at the end of the quarter. From a capital perspective, this represents about 22 to 25 basis points of Set 1 on a fully phased 5 basis points to 6 basis points in year 1. This range considers the current economic outlook and mix and credit characteristics of the portfolio. In addition, a key factor is the impact of longer duration loans such as education, home equity, auto and residential mortgages that tend to attract a higher level of reserve. At the same time, the commercial portfolio is generally shorter duration and so is expected to require less reserves than it does today. Ultimately, the impact of the initial impact will reflect both the portfolio mix and the macroeconomic outlook when we get to the end of the year. On Page 14, I want to highlight a few exciting things that are happening across our bank. First, we ranked number 4 in the 2019 J. D. Power U. S. Home Mortgage Satisfaction survey. Since last year, we moved up 6 positions in that survey, which is a real testament to the hard work our mortgage colleagues have done to integrate Franklin American, while relentlessly focusing on our customers. We are also very excited to announce that we just entered into a new consumer banking partnership an iconic technology company to be announced shortly. We will provide more details around the launch of this program, which is later this quarter, This is another great example of our commitment to innovation and strong focus on the customer experience. In commercial, we are really progressing well with the client migration to AccessOptima, our best in class cash management platform. About half of our clients are on the platform and we expect the transition to be complete by the end of the year. And in addition to TOP 5, which I mentioned earlier, substantial work is underway on our TOP 6 program, which is targeting a pre tax run rate benefit about $300,000,000 to $325,000,000 by the end of 2021. Our outlook for the Q4 is on Page 15 It reflects continued good position for both our top and bottom line results. Our current view is that we expect an additional rate cut in October And as a result, we expect net interest income to be relatively stable in the 4th quarter as loan growth should offset further but less net NIM contraction due to rates. Our outlook for loan growth reflects stronger period end trend, coupled with healthy pipelines driven by our geographic product and client focused expansion strategies. So we expect a moderation of 3rd quarter commercial pay down and utilization trends as well as continued growth in mortgage, student and other retail. We are expecting non interest income to be down modestly from the record level last quarter. Strength in capital markets revenues should largely offset a from record mortgage fees. Given our continued focus on expense discipline, we expect non interest expense to be flat to slightly down. Additionally, we expect provision expense to increase by about $10,000,000 And finally, we expect to end the year with a CET1 ratio of approximately 10.1%. To sum up on Page 17, our results this quarter demonstrate our continuing strong performance As we execute against our strategic initiatives, grow customers and revenues, carefully manage our expense base, deploying new technologies and improve how we run the bank. Now, let me turn it back to Bruce. Okay. Thanks, John. Operator, Brad, let's open it up for some Q and A. Thanks. And we go to the line of Ken Zerbe with Morgan Stanley. Please go ahead. Great. Thanks. First of all, great job on reducing your interest bearing deposit costs this quarter. We've heard from other banks that deposit competition is still really aggressive. Bruce, I know you mentioned that you expect your deposit betas to increase next quarter. Does that imply that some of that deposit competition might be easing? Yes. I'll go ahead and start off I mean, I think it's a number of factors. I mean, when you have a rate cut like we had in September, it's just a natural operational lag, if you will. And we talked in previous calls that there's a deposit lag that maybe, call it, 3 to 6 months. And so as we get farther away from that September cut, the impact of that cut gets operationally and you're going to see deposit betas increase from 3Q into 4Q. Therefore, we expect interest bearing deposit costs to actually decline by a larger amount than they did this quarter. Okay, great. And then, just my second question is in terms of your energy exposure. We've had 3 other banks that I cover announced higher energy charge offs this quarter. And I know you guys didn't mention it at all, which is certainly a positive. But can you just address what you're seeing from a credit perspective in your energy portfolio? Yes. So, Ken, it's I'll talk about that for a second. We've actually been working through our energy exposure for a little over a year now. Our NPLs are way down. They're down about 25% of our total NPLs to 9%. So we structured and worked through a lot of them. Our overall portfolio is down. And I think one of the things that we have in our portfolio, I don't other things have a very low exposure to oilfield services and that's where a lot of the distress looks like it's happening in the oil sector. So We tend to be good RDL structures and good midstream structures, and we're pretty confident we don't see any promote the stress in the portfolio that is together at this time. All right, great. Thank you. And we can move to the next question with John Pancari with Evercore. Please go ahead. Good morning. Hi. I wanted to see if you can give a little bit more color on the commercial credit I know your commercial non performers were up 25% linked quarter, and you noted in the release that It's small number of uncorrelated credit. So just want to see if you can give us a little bit more detail on the industry, on Maybe the sizes and the types of loans as well. Thanks. You want to go again, Ben? Yes. I'll take that one. So we did have a couple of charge offs in the quarter, one in the real estate division, which is a regional mall. So we set a small charge off to basically position ourselves to hopefully exit out of that credit in the sale or restructuring in the near future. Our non performer move was really one credit, which is in the automotive linked sector, which we've been working through. It's well reserved. We don't think there's a We took a non performing, it's a restructuring deal that we did about a year ago. There's a significant amount of junior capital for Wallace now. We feel okay about the credit, but we thought it was prudent to take a non pro form a given the cash flow dynamics of And I would add that what Don mentioned on that first credit, we're close to having that one resolves, which would allow NPAs to fall back down in Q4. I think more generally, As I think John said, we feel good about the general trends in the portfolio. We feel like we're identifying any issues early. We're aggressively addressing them. We're trying to move them off the portfolio to the extent we think there's future risks. So we're trying to move through And in the 4th quarter, we really think we have any significant loss pattern there. Yes, be proactive. Good model. Okay. Got it. Got it. And then Bruce, you indicated in your remarks that you're being cautious prudently cautious in certain lending areas. What type of areas are they and what are you seeing that's making you get more cautious? Thanks. And I could throw that one to Don as well, but I'll kick off But I think, in general, there's some very competitive conditions in certain parts of the market, particularly middle market, we have a lot of non bank competition there. And so we're competing where we want to hold up our relationships with our customers, but we're not being aggressive to try to grow the book there and take on Tough spread situations or tough term situations. So that's one. I think in certain areas like Restaurants, we're certainly actually taking a posture towards reducing exposure and not adding exposure. And I think we're also being proactive there and we have some good momentum there. So, I'd just say it's around the edges of being disciplined And then seeking out areas of growth, our specialty verticals, we get some better spreads there. We're moving up market and competing effectively in mid corporate. So, we think we'll see some growth there. And I think we did indicate that we will see a return to overall loan growth in Q4 and also in commercial in Q4. So our pipelines look quite good. We have seen in Q3 elevated pay downs, refinancings, lower line utilization. So even though we had a pretty strong quarter in terms of originations, we are fighting against that a little bit. But I think in Q4, we would expect to see less of that and we're continuing to see a nice pipeline. Donnie, you can add? Yes. I'll just give you a little more sense of that. A year ago, we were seeing pay downs right about 2 thirds of our originations. They were basically 1 to 1 this quarter. So We really got hurt on the new origination side from pay downs. I think there's a combination of things going on. I think particularly in the middle market, but in general, We're seeing people deleverage in anticipation for uncertainty in the next year. So they're not putting on incremental debt. There's not as many special There's not as many releasing capital or buybacks that we're seeing in the core of our portfolio. And that developing people just We're going to take your utilization down. We are seeing some sense of that moderating. So that's got some of our loan growth going forward. As Luis mentioned, some of the challenging portfolios, our restaurant portfolio is down by about 50% of where it was at the peak, so we're working that down. Portfolio down. So there's a lot of things that we're actually trying to address on a portfolio standpoint that is ragging the numbers on a net basis. And then as you heard John talk about, we are actively adopting in the HDDSO and where we don't see adequate returns Over the next 2 to 3 years on exposures we have, we'll consider moving them off the balance sheet. So I think the new business feels good in areas that is actually grown And just to echo, we said it is very competitive. People search for long and we want to stay disciplined on both terms and conditions and pricing standpoint, so we can maintain that in terms of the loan. And we'll go to the next question in queue will come from Scott Siefers with Sandler O'Neill. Please go ahead. Good morning, guys. Thanks for taking the question. Maybe John, first question is best for you. Hoping you can just put a little bit of a finer point on The fee guides for the Q4 including some of the expected drivers, you mentioned capital markets in the pipeline there. But I guess I'm just curious given that Yes, pretty substantial MSR benefit. So, right off the bat, it could be kind of a $25,000,000 hole or up to $25,000,000 hold. Just curious if you can talk a little bit more detail about the puts and takes, please? Yes, sure. I'll I was going to add. I think the main point here is that, as we mentioned, the capital markets pipelines were quite strong. When you look at 3Q, that was a little bit more of a down quarter at $39,000,000 when we see the outlook into 4Q. We had some deals push out of 3Q into 4Q. We had a very soft syndication quarter in 3Q that looks to be burning up into the 4th quarter. M and A advisory was an area that was flattish from 2Q to 3Q and we look to see that being meaningfully significantly up in the 4th quarter. So I'd say that when we tend to look at this in the early part of July, we looked at our pipelines and how that would play out in 3Q. Now we're looking at the pipelines in early October here and it bodes well for a really nice rebound in capital markets. I should also mention that the service charges in card, which had a nice quarter in 3Q look to be up a bit further. And trust, I mean, I think there were some choppy market conditions that impacted trust and investment services and I think that you'll see that our expectations are that that will improve going into the Q4 too. So it's a couple of different levers that will all tend to have an impact into 4Q that will largely offset as we said the mortgage decline. Okay, perfect. Thank you. And then a broader question just on rate sensitivity. You pulled back a little bit of the Asset sensitivity this quarter as well. I'm wondering if you could just comment on whether there's sort of an end goal as to where you want the company's rate positioning has to be, I mean, obviously, it's kind of tough given all the volatility in rates, but just what the broader or long term thinking on rate sensitivity this point? Yes. I mean, I think you've seen us take our asset sensitivity down over the last year, and I think that we've been prudent on As you know, a commercial bank has a natural asset sensitive profile and we use derivatives and other techniques to frankly dampen that profile. So I think you would see us in a low to moderate asset sensitive position over time, maybe converging towards neutral as we see as we get towards the end of the cut the easing cycle, if you will. And so I think we're getting pretty close to a stable place. We do like and have the view that we are at historically low long term interest rates. We've changed our sensitivity From a majority exposure to the short end of the curve, over the last year to now, the majority of our exposure is to the long end of the curve. So we have a view over time that long end of the curve will rise and we've executed our hedging activities with that in mind. And with a general sense that we should take some efforts in Citi off the table. And that's just on the net interest income line. And as you know, Mortgage provides a very nice overall revenue lift when and if rates were declined by a lot, which is what in the Q3. So it's not just our derivatives and not just our sensitivity on net interest income. We look at how we try to preserve revenues overall And you saw the power of that diversification in the 3rd quarter. Perfect. All right. Thank you very much. I appreciate it. And next in queue, we've got Brian Foran with Autonomous. Please go ahead. Hi, good morning. Good morning. I wonder if just conceptually on net interest margin, once the Fed stops, I guess we'll have to decide when that is, but let's say it's mid-twenty 20, the Fed stops easing. There's one school of thought that the banks could get a little bit of a bounce back in margin because of the deposit repricing lag you mentioned and that will catch up. And then there's another worry that while the assets don't all reprice immediately and you're still going to have that kind of rollover of fixed rate assets to lower rates. I guess as you think about it, not getting into the basis points of what the actual margin is going to be, but just conceptually, when the Fed stops, is your bias kind of A roughly stable margin or up on the deposit repricing or still some pressure on the asset yield rollover? Yes. I mean, I'd say a couple of things. I mean, I think you mentioned the deposit lag, and I think that provides a tailwind once you get 3 to 6 months out, that's helpful. I think it matters where loan rates are. As I mentioned earlier, if the Fed Get to the end of the season cycle and we end up with a positively slow deal curve, I think you could see some positive impacts in net interest margin over the call it 2, 3, 4, 5 quarters out into 2020. And so that's an important aspect. And I think that the Bextran book dynamic is given the fact that we are Roughly split fifty-fifty with a fixed loan portfolio and a floating loan portfolio. You're right that when rates fall, we get the immediate impact on the floating part of the portfolio, But the fixed part provides that buffer. And if we can see some of this in the long rising in after you get 3 to 6 months beyond a Fed easing cycle. So, yes, I think you see some stabilization here over the next quarter or 2. And with those dynamics I mentioned, Possibly even from the left when we get towards the end of 'twenty five. Yes. The other thing I would add also is that if we get a little more loan growth, which we expect in the Q4 and to be able to sustain that in 2020. That facilitates more BSO actions in terms of kind of the loan side of the balance sheet. And so hopefully that will kick in and then be accretive to our end as we go through 2020. Thank you. One small one, I don't mean to jump into the weeds, but on Page 20 of the supplement, I had a few people ask about this negative $48,000,000 in the provision for unfunded lending commitments. Can you just talk through was that a release or was it like a transfer because a loan drew down, what drove that negative $48,000,000 provision for unfunded lending? Yes. Thanks for the question and looking at our supplement. We appreciate that. I didn't look at it. Someone else pointed it out to me. So yes, it is exactly as you mentioned. It was we had an unfunded loan where over time we built the reserves on the unfunded part of the reserve in the ACL, if you will. So all of the provisioning and reserves happened while it was unfunded. And then once it was fully reserved, is funded and then got transferred and needed to get transferred over to the ALLL. So overall, really the driver was a transfer of an unfunded It actually was a backup letter of credit. Yes. Not a backup loss, but Ultimately drew down and we moved it over. Yes, I think we released them as well because we moved it now for sale as well. Great. Thank you. Thanks. Okay. And we'll go to next question in queue that will come from Matt O'Connor with Deutsche Bank. Please go ahead. Good morning. Fees were obviously strong this quarter and you gave some pretty good granularity in your thoughts on the 4th quarter. But just looking out more medium term, can you talk about the magnitude of fee growth you think you can generate and some of the drivers? I mean, obviously, it's incrementally important from here given kind of the pressures on the interest income and trying to maybe quantify The growth that you expect and again some of the drivers? Well, I think, Matt, I'll start it first, John can pick up. But When I think about where we've been and how we've grown through time, we've pretty much been growing commercial fees, Probably high single digits, keeping pace with recently robust loan growth over that period. And that's reflective of the investments that we've made in building out the platform, hiring some great bankers, standing up our own Global Markets, FX and interest rate business, investments in the cash management business, acquisitions of M and A shops. And I think we're really just gaining traction reaping the benefits of those investments. So I would expect to see continued good growth on the commercial side. Q3 was a little bit of an air pocket. We think Q4 is going to be a bounce back quarter. On the consumer side, We've had a harder time growing. I think we addressed some of those issues. We've been investing organically and building out the sales force and coverage folks in wealth and in mortgage, but I think the acquisitions that we've done, particularly mortgage looks very timely in light of being able to catch the refi wave. But I think there's a lot we can really do with that business. So it's really scratching the surface of its potential in terms of building out more tools for the correspondent and wholesale customers that we have. So I think we can grow our market share there very nicely and then get better penetration into our branch channels as we continue to add LOs. So even though we came off high with the refi wave. I think that will continue some through Q4 and early into the first half of 2020, but there's other levers to continue to, I think, gain market share in the mortgage business. And then wealth, we've now addressed the high end of the pyramid with Farfetchdahl, and we're looking, frankly, to do more in terms of acquisitions to further that growth on the wealth side. So if we average the commercial and then the slower growth on consumer, I think with the rearview mirror, we probably were in the mid single digits range and certainly would think that that's a goal we could going forward when we think out a number of years to at least be able to continue to do that. That was helpful. Can you just elaborate on the type or maybe size of wealth deals that you'd be open to? I You did relatively modest one. Yes. I think all these deals we've described as bolt ons. And I think what we really need to make sure of is, it has a good strategic fit that the company has a great culture that's going to mesh well with us and that we can get attractive financial terms. And I think if you buy smaller, you can get a little better handle on all of those things. If you buy bigger, it's a little harder to achieve those three objectives. So I would think you'll still consider these deals smart, but more in the bolt on category. So you probably need to do several to continue to scale up our business. Okay. Thank you. And we can go to the next line in queue. It will come from Saul So I wanted to I know you've addressed this to a certain degree, I know there's a lot of volatility and probably some seasonality in this, but can you just give a little bit more color on how we should think about What a more normalized run rate is for mortgage income assuming the long end of the curve stays where it's at. You had I think $80,000,000 of production revenue, which is very strong, The MSR valuation gain, as we think about that going forward, how should we think about the sort of the moving parts there and what it could trend to not only in the Q4 but just beyond that? Yes. Thanks for the question. It's John here. I'd say we could break that down into 3 P and Ls, right? And you talk about production and servicing and then the MSR valuation, that will be economic hedge, right? So and when you go across each of those 3 going forward, I think you could see production being production P and L basically coming down a bit, right, in the Q4, but I would call it higher than where it was in the 2nd quarter. We had a good quarter in the 2nd quarter. We had a phenomenal quarter in the 3rd quarter. So I think maybe coming off those highs, But kind of stabilizing at higher levels than what we've seen in the past in production. We're really excited about that. Very strong production, really strong margins, which is important to how we generate those revenues and just a growing integration of the Franklin platform. So that's how I see that part of the P and L. I'd say a similar comment on the operating servicing part of the P and L where we're having we're retaining all the UPB That was previously being sold by this platform before we acquired it. So our servicing EPD is growing nicely as well as the servicing fees and ancillaries that we're recognizing on that P and L. So that P and L is stabilizing and rising, And we're completing the full integration and in sourcing of the servicing platform from what Franklin was using, which was an outsourced platform to bring it in house, will give us more control over data and direct access to the customer. So we're excited about that. And then the last one, of course, is the MSR valuation net of economic hedge. During the quarter, when we see large swings this past quarter, we were positioned to benefit if mortgage were to widen out. When we get to extremes, we tend to moderate positions and assume that they will of liver over time and it did. That's something that I think you could see more of in the future and that will jump around a lot. But I think we've demonstrated a really solid job of managing the what is otherwise available asset for the last 4 quarters that we've had this platform going into the 5th. We've managed that really well with a flat to upper bias on the MSR You might just want to add a little bit some of the innovation in the new technologies that we're delivering in the mortgage business, because I it's quite exciting what's actually there. I was actually just going to do that. Just one thing I'll also chime in with John. I think you hit it Spot on. And one thing to keep in mind, the industry is quite full of capacity right now and that gives us great optimism around margins maintaining for a period of time. So those Signs are good from a margin perspective. But to the point, Bruce, that you made, we've invested heavily in our digital capabilities in the mortgage business. And so we put a new digital front end on front end onto our origination platform. This past quarter alone we saw more than a third of our applications come through the front end digital platform, which gives us efficiency opportunities for 1, but also gives us more opportunity to build our direct to consumer side of the business. We also invested in digital capabilities on the back end of the business, whether digital or mobile servicing application. We're seeing a lot of our customers transition over to using that digital platform on the back end. So a lot of good things happening other than just a rate environment. I mean, I think the integration, as you said, has done extremely well, we're starting to reap the rewards of investments that we made in the digital capabilities and the service capabilities. Yes, That's great. Thank you. That's great color. If I could switch gears and also ask a question on reserving On CECL specifically, I mean, the day 1 impact is not a big deal from a capital standpoint. How do we think, John, about the day 2 impact of CECL? Because a lot of your growth, If you look at the balance growth over the last year, a relatively large portion of it is coming from education, it's coming from other retail lending that tends to either have longer tenors or higher loss content than others and obviously has a higher provisioning load as you originate those loans. How do we think about the loan loss provisioning outlook, in light of that loan growth and mix shift into 2020? Yes. I think so we've just kind of come out with a first real quantitative outlook for where this where this adopting the standard will affect us in early January. So I mean, I would say Couple of things, but also caveat that we have more work to do and we're continuing our parallel runs and completing all the validation of our models. So with all of that said, I think there are 2 big forces that you have to think about. 1 is, With all of those portfolios that are longer duration, we have a very we have a big back book. And the way the dynamic that we're dealing with is the that we're being asked to reserve over the entire life of the entire back book for those longer duration loans in early January. And so going forward, if our models are reasonably accurate and reflect the future, which is A big question for all banks. Then really the provisioning for that entire back book is really behind us and it's really already up on the balance sheet. And so what you're left with is the other side of the ledger, which is the front book and the front book originations that you have to basically put through P and L, all of the reserves that you're likely to run. So I think for portfolio by portfolio, the gearing of ratios, if you will, the benefit of the fact that the back is no longer being provisioned, which would otherwise have been provisioned in the incurred loss model under the existing standards is now going to be already handled and probably closer to 0 against the magnitude of the front book. And I think The answer with respect to whether that's positive, negative or neutral is it varies by portfolio and that's going to play itself out. Yes. And what I would say just to add to that is that we're working through our kind of 3 year strat plan that we finished in July To kind of overlay portfolio by portfolio, what's the interplay between those dynamics that John described back book, front book? And then how does that play out from an accounting standpoint over, say, the next 3 years? There may be certain product twists that we're offering a longer duration version of a loan and it may not make as much sense. We might tweak something, but I would Say that at the end of the day, the economics are the economics and the accounting is something we have to contend with, but we'll get on top of it. And then obviously, when we do our guidance in January. In the next call, we'll be able to take you through that in some more detail. But we're working at it. We're analyzing it. And I think We feel broadly fine about it. Got it. All right. That's very helpful. Thank you very much. Yes. And next in queue, we'll go to Bruce, you touched on growing the fee revenue and I wanted to 0 in on the Capital Markets business since you guys have had good success and expanding that business. And I understand the Q2, if I read the press release correctly, was a record level. 3rd quarter came down a bit. So two questions. 1, you mentioned the pipeline is very strong going into the 4th quarter. Can you compare that pipeline to Prior quarters, is it higher or lower? And then second, what will it take for you guys to bring this business up to be a $70,000,000 a quarter run rate. Is it hiring more people or expanding geographies? How can you grow it to that level? I'll let Don take the I think about I'll talk about a combination of few lines for the commercial bank activity. So You saw our FX and interest rates and commodities hedging activities for clients and those have been running at incredibly strong levels for the last couple of quarters. So This quarter, it hurts on the capital market side, it benefited us on the interest rate and currency side, and we're seeing that continue. On the capital market side, we generally play in the middle market and middle market levered finance space. And what happened this quarter was That market was way down year on year and effectively the market will all close for about 6 weeks in the middle of the summer As the Fed changed its interest rate posture, we saw a great lift in September on the back of an opening up of the bond market and we've said high yield activities grew exponentially. So that all being said, I think that we've got the pieces in place to allow us to take advantage of the opportunities to present themselves, the really big growth area over the next quarter if you've been M and A as the acquisitions begin to kick in. So we've been running it kind of between 4 EBITDA back to 4 in terms of M and A fees, those should go up significantly this quarter and the pipeline look very, very strong. So our strategy is to get that feel on even higher are a couple of fold. One is, high yield business, we started high yield selling trading activity this quarter, which allow us to take larger positions in high yield underwrites and our splits on those transactions could double or triple, so that will drive the high yield side of the business. We've been building credibility in our loan syndication and leverage financing capability over 4 years and we're seeing larger transactions and even more transactions as we build comparables and a reputation for execution with our clients and with our investor base. And we're seeing this general activity growing in the Q4. Well, that continues in the Q1, Q2, Q3, it's a little too early to say, I think there's upside on all of those key elements. The other thing we try to do is grow our client base. So as we've said, at the time of the IPL, we moved into the mid corporate and industry vertical sectors. We've built very strong corporate finance industry advisory teams. So the way we're engaging with our clients, I would have argued maybe 4 or 5 years ago It's very much around provision credit and now it's about advice and basically ownership transition and complex financing. Think it's only been the last couple of years where we've had all those pieces in place and they're really jelling well. I think they're jelling well that I've seen in any time in my career And we're just in a lot of very interesting conversations with our client base. I would just add to that, Gerard. We have knocked on the door of $60,000,000 quarter before. I hate to put my neck on the line, but I think this 4th quarter It shapes up potentially to be a record, a new record quarter for us in capital markets. So we're not that far away on that 70 a quarter. I don't think we really need to hire more people or acquire another M and A boutique to get to that kind of a level it would require. I think that the markets are healthy and open over the next year. And then some of the investments that we've made and the approach to how we cover, All that would have to continue to progress and come to fruition, but there's not a lot of incremental investments that we need to make in order to continue to drive higher revenues in this business. And further to that point, Gerard, just to be a question earlier about pipelines. Our pipelines in early October Our up across the board, whether you're looking at the combination of syndications and bond underwriting or FX, IRP And M and A in particular, they're all up since early July when you look in early October, just to close that out. Great. Thank you for the color. And Bruce, Since the BBT SunTrust merger, many investors and myself all thought more deals were going to be announced. Obviously, nothing's happened. But when you look at the BBT stock, it's outperformed the general bank indexes. So it looks like the markets supporting that type of transaction. Is that something citizens could ever consider in the future? Well, I think The stock answer to that is we're going to always consider anything that benefits our shareholders. But I would say whether that deal proves to be a good one depends on the quality of the execution. And so you've had and I've been part of a big MOE in Bank of New York and Mellon. And the spreadsheets When you announce the deals always look great and it comes down to you make the right personnel decisions, you get the cultures to mesh and do you fundamentally execute well. So we'll see if that happens. I think for Right now, we're very focused on continuing to run the bank better and we're in a period of very rapid change in terms of customer expectations, new technologies, and we're very focused on being on the front foot With our top 6 program and some of our strategic investments, I think we can carve a path that's very exciting and fulfilling for our stakeholders by really staying focused on our own current agenda. One of the risks of getting involved in larger transactions is it can be distracting and take your eye off the ball in a period where you really have to be all over the current agenda. So Those are few thoughts, Gerard. No, I appreciate your candor. Thank you. And our next question in queue comes from Erika with Bank of America. Please go ahead. Hi, good morning. Hi, good morning. Hi. I just had one follow-up question. It's really what sort of Ryan Foran was asking earlier. So as I think about what's unique to Citizens as we look out over the next few quarters, Obviously, you've done a lot of work in terms of driving your business momentum upward and accelerating it. And second, you do have high deposit costs. So as we think about beyond the 4th quarter, right? And you're still feeling good about loan growth, you're still feeling good about the economy. And based on the forward curve, Should we think that the worst case scenario for NII next year could be stable? I'm trying, Ellen. I mean, I think Eric, it's John. I mean, I think we stay tuned for January, right? We'll be we'll come out with Relatively specific expectations for what 2020 will be on NII. But I think you have The broad contours, they're directionally correct. I mean, we expect when you think about where our loan growth has been year over year, we're in the neighborhood of that four percent range, which is a percent or 2 above GDP. So next year, we want to aspire to continue to build platform at levels that are similar to that are better. And that plus all of the work that we're doing on the net interest margin side of things. And we did have, As you know, maybe some betas that were when we're in a tightening cycle, we had some deposit cost rises that were higher, but that's starting to retrace itself here and you'll see our deposit betas Rising in the Q4 and continuing to reflect the fact that we've done an amazing amount of work on Frankly, we've been outperforming now through the cut cycle on deposit funds. Yes. We have. So in the Q2, we did and then we outperformed. In the Q3, we did. And I think you can almost consider a trajectory there that we expect I'm sorry, in 3rd quarter we did in the 4th quarter, we're going to have meaningful improvement in the interest bearing deposit cost decline. So We're excited about that. So I think a few levers will cause that kind of stabilization that you're talking about. But stay tuned. We tend to try to Yes. Now, we made till January, so good try there. We got I understand the timing is odd, but it just sounds like If you're relatively stable next quarter with pressure from October and not the underlying pressure from what's happened so far so quickly with only taking your deposit cost down the way you did, it seems like The stable seems like a potential for just I guess I'm not asking you to confirm that, but that's just how I was looking at that. So I appreciate the color. That wasn't actually a question. I'm going to take myself off We were to have another question or do you have a question? All right. Thanks for that. Okay. Sure. And next we'll go to the line of Ken Usdin with Jefferies. Please go ahead. Thanks guys. Good morning. Just a follow-up on the overall balance sheet. Guys have shown really good deposit growth in the money market accounts and then the non interest bearing. And obviously, we're starting to see the term deposits come down against that And Citizens Access kind of flattening out. Can you just talk us through just that mix and how you expect just overall balance sheet to project from here, especially as loans look to be still growing and securities have kind of flattened out just given where that rate dynamic is. So I guess just talk about the earning asset base and the mix within and how you'd expect that to go forward? Thanks guys. Yes. I mean, I think so Overall, you're seeing the fact that we continue to year over year, we're growing deposits of 6% and loans a bit less in that. So you look at the LDR ratio around 94.5% in the 3rd quarter, that's down Reasonably, yes, down to the 90 or so, probably a year and a half ago, a year or a year and a half ago. So I think The balance sheet strength is quite good, really solid liquidity position as we head into the end of the year. Deposit growth has remained, I think, greater than loan growth. That gives us optionality in terms of how we execute our playbook in terms of deposit pricing and that's part of how we've been able to drive deposit costs down is all of the good work that we've been doing in terms of generating deposits. On the loan side, we gave you that color about the fact that year over year our trends during that 4% range or so, that's something we'll aspire to accomplish over time, but deposit costs will continue to fully fund loan growth. And I think that's our main I think one piece of color I would add, Ken, is that We're quite pleased that we've been able to grow our demand accounts and outperform relative to peers. Brad, you might want to add some color on that, but really the focus on the mass affluent customer and some of the investments we've made in customer experience and customer journey, We're gathering them, targeting them, getting them in the door using data analytics and then they stay. And so retention is up there and that's really fueling that growth in demand accounts. Yes. I think you nailed it, Bruce. I think we've talked for quarter on quarter about our investment in analytics and that has given us the ability to really target the right customers, improve the value proposition, which we've done that with a focus on the NASA Fluent client, which is deepening our relationship with them and We're getting them active quicker than we were in the past and we're improving our attrition and our net promoter scores are showing that they're much more satisfied customers and We really think that's what's fueling the growth in non interest bearing deposits. Understood. And thanks for that. And one follow-up on the securities So the securities book, you mentioned that the premium amortization was a 3 basis point hit to the net interest margin. I'm just wondering at this point, Where you able to reinvest cash flows at versus the back book, if we could try to isolate for what's happening aside from the premium M? Thank you. Yes. I mean, I think on the front book, back book trends here, I mean, you've got reinvestments in the 3rd quarter Our around, call it, 250 or thereabouts and you still have a positive front book back book in securities with one off is in the neighborhood of 220, 223 or so. So I mean, I think we're feeling It's nice that against this backdrop, we've done a reasonably good job of holding our cash And investing and deploying that cash at points during the quarter where rates are a little higher. At the sites. Yes. I mean, it's hard to do that all the time, but we in the last couple of quarters, we've been holding our powder a bit and some of the big declines in rates moderate and then we put all the cash to work. So like I said, you still got a positive call it 25 basis points of sale of front book, back book on the securities portfolio. And one quick one just on the PremiumM. If rates stay flat, does that 3 basis Point headwind just go away, meaning it doesn't it goes to 0 as an increment. If you expect if you realize it on like a realized basis and is there any lag to the premium M that we continue to roll forward just because of where rates have gone to? Thanks. Yes. I think you said it. There's a couple of factors. I mean, I think our outlook is that it's relatively stable quarter over quarter such that the drag of 3 basis points this quarter was because there was an increase from 2Q Q to 3Q. Our current outlook with outlook for rates, etcetera, is that, that will be flattish from 3Q to 4Q, so therefore no longer arise. And then over time, maybe that can moderate, but even again back to 2020, we'll get back to you on that later. But yes, it will be flattish from 3Q to 4Q. Understood. Thank you. Okay. The Next question in queue will come from the line of Peter Winter with Wedbush Securities. Please go ahead. Thanks. As you guys get ready to implement the Top 6 initiative. Are there any thoughts, maybe that you'd be willing to delay investments or maybe accelerate some of the planned cost saves just to ensure you generate positive operating leverage going forward? Well, first off, we're trying to get this thing off the ground and we have a number of work streams basically 7 or 8 work streams with individual leaders and as soon as they're good to go and launch, we're already moving ahead. So we've given the green light on 2 of those work streams already and we'll have more that launch in the Q4. The bulk of the top program is accretive right away. So we want to get those things going quickly. The places where we would be in turn reinvesting, the next gen tech is one of the big work streams. That has probably the most value of any work stream to the bank in terms of how we're running the bank and how we can deliver for customers, But it is somewhat reliant. It doesn't generate immediate savings. It requires some investment and then the savings come later. But as long as the rest of the streams are moving ahead, then our disposition is we got to move on that. It is really, really critical. When we announced the TOP6 program, we also talked about some strategic investments that we were assessing and prepared to make. And those include further expansion of Citizens Access, our digital bank or of our point of sale merchant finance platform or new ways to cover business small business customers and low and middle market customers with more digital and data applied. And so we're working through those. I think we have an ability to gate those based on how fast the savings come through on the other streams and then also the overall macro environment next year. And We do have this commitment that we've held fast to since the IPO of trying to deliver positive operating leverage and that's probably the lever that we have would be to gate some of those investments. But our objective, our hope is that we can move on those because I think they're really exciting and I think they really will drive medium term revenue growth for us. Great. That's really helpful. And because I guess when I look at the medium term profitability targets that you laid out, obviously, the rate environment is much different than when you originally gave that. And so I'm assuming you're still expecting to see then continued improvement in the profitability in terms of the efficiency And ROTCE? Yes. I mean, that's the only way to really get it is you're going to have to drive the operating leverage. One of the things to keep your eye on is if some of these trade tensions and that are holding back the economy a little bit, a bit, that obviously is going to be a tailwind into next year and that could also result in the long end of the curve moving back higher. That's actually been a bit of a crusher when it looks when you look at ROTCE because year on year growth in OCI related to the growth in the value of the securities portfolio actually has clipped 75 basis points of ROTCE. So if you had the long end move back, you could actually throw that right back onto the equation. So there's a number of factors there, but yes, commitment to operating leverage key in terms of continuing to drive forward and reach those ROTCE goals. That's great. Thanks, Bruce. Yes. And we'll go to our next question queue. It will come from Marty Mosse with Boenning Sparks. Please go ahead. Thanks. And this is a good question to follow that last question. When you look at banks, there's so many intricate details that we'd spend all this Tom talking about, but really investing in it comes down to 3 different metrics. 1 is return on tangible common equity, the other is a dividend yield and third is basically how fast can you grow tangible book value? So while your ROTCE has been under pressure, one statistic that hadn't really been talked about was your Growth in tangible book value was 14% over the last year, which is the counter of that. So When you look at those three metrics, let's say, assuming we don't have a credit event or a credit downturn, how do you see those three metrics moving forward Over the next, let's call it, 12 to 24 months, given the environment that we have, do you see progress in those metrics? Where we're at right now is very positive. I think the valuation reflects some deterioration in those metrics. So Just wanted to get your take on that. Yes. I mean, obviously, the objective is to be driving the ROTCE and driving the book value per share higher. And if we execute well and the environment stays okay or improves, I think we'll certainly be able to do that. If we do that, the stock should reflect positively. So our dividend yield would go down, which wouldn't be a bad thing. Ultimately, we're still committed to raising our payout ratio and getting to a 35% to 40% dividend payout ratio, but the yield obviously is a function of the stock price. And then, John, I want to dive into a very so from a big picture to a very minutiae Type of question. Given that what we're seeing is consumer allowances are going up precipitously on the CECL and commercials are going down. While that day 1 impact is negative for those that have more consumer, What I'm trying to get at is as we go into day 2 through 200 is the consumer because it's less lumpy And the commercial is getting impacted because of how low we are in the cycle right now and their losses tend to come in big pieces. Is the consumer possibly going to be less volatile over a cycle versus commercial When you have big pieces coming in and out having to adjust those factors when you go through those economic cycles? We're still, I would say, developing our intuition about this new standard and how the models will work. I think there are A series of factors that impact both sides. I think just the prevailing market conditions and of how your reasonable and deportable projections will revert over time. I think that has meaningful impact on both portfolios, To tell you the truth, it's one of the reasons why we've all been scratching our heads about why this standard is necessary. It's going to be very difficult to compare across institutions for a period of time. And it's going to be a lot more difficult to frankly anticipate where P and L impact will go over time. All of that said, as you heard earlier, Bruce, Economics are still something that we have to keep our eye on that ball and we'll deal with the impact as necessary. But I don't know that I'm ready to say that one of the 2 portfolios is going to be less volatile. I think it's possible that either portfolio could contribute to significant volatility in any given period. And stay tuned for the continuing Disposures that we'll do on this in the first in January as we finish out, frankly, our parallel run and our model validations which are happening here Yes, I think Yes, no further question at this time. All right. Very good. Thanks everyone for dialing in today. We always appreciate your interest and support. Have a great day. Thank you. And that does conclude the call for today. 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