Citizens Financial Group Inc

NYSE:CFG

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, everyone, and welcome to the Citizens Financial Group First Quarter 2019 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.

Now I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

[Ellen Taylor, Head, IR]

Thanks so much, Brad. Hello everyone. We really appreciate you finding time to join us this morning. We're going to kick things off with our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, reviewing our results and then we'll open the call up for questions. We're really happy to have Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking with us.

Of course, I need to remind everyone that in addition to today's press release, we have also provided presentation, financial supplement, and you can find these materials at investor.citizensbank.com.

And our comments today will include forward-looking statements which are 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 our 8-K that we filed today.

And then we utilize non-GAAP financial measures and we provide you information and a reconciliation of those measures to GAAP in our SEC filings and earnings materials.

And with that, I will hand to Mr. Bruce.

[Bruce Van Saun, Chairman & CEO]

Thanks, Ellen. Good morning, everyone, and thanks for joining our call.

We're pleased to announce strong quarterly results today; it's always great to get off to a good start to the year. But importantly beyond the short-term results, I feel we're really doing a good job of staying focused on evolving our long-term strategy, given the rapid changes in technology, customer expectations, and the competitive dynamics that we face.

We've changed from opportunity and risk; we seek to exploit opportunities that will strengthen our franchise, while minimizing potential risk. We have a significant cross section of our leadership team engaged in these efforts and the key will be to make good decisions to prioritize wealth and then go out and execute. The balancing the long and short-term requires skill and I believe we're doing a good job overall on this.

Let me give you a few high-level takes on the quarter, before John gives you the full details.

Now the quarter had some seasonal impacts but the year-over-year comparisons are the most meaningful. Our underlying earnings per share was up 19% year-over-year aided by the strong operating leverage which was 3.2% and even more impressively was 5% excluding acquisitions. What really stood out for me was strong fee income growth of X% ex the acquisitions compared with only 2% expense growth ex-acquisitions. We have consistently invested in our commercial fee businesses and regaining real traction in deepening relationships.

Our capital markets revenue hit a record in the quarter; up 38%, has been our Global Markets business which is foreign exchange and interest rate products where revenues were up 33%. We just handled some great talents and were able to compete highly effectively against the biggest banks and our peers.

And our TOP programs really are differentiating allowing us to become more efficient while serving customers more effectively. We bumped our TOP 5 estimated impact to $95 million to $105 million which is up $5 million and were hard at work on TOP 6 which is expected to be bigger and potentially more transformational.

Another highlight for the quarter was our strong year-over-year average loan growth of 6% along with sequential loan growth of 1.5%. We continue to focus on attractive areas to deploy capital and improve our risk-adjusted returns.

On the deposit side, we grew average deposits 6% year-on-year and 2% sequential quarter. We bought the spot quarter and loan to deposit ratio down below 95% with some nice performance from Citizens Access which has $4.6 billion in deposits as of quarter end.

Even with the strong deposit growth, our deposit costs were manageable and our NIM held steady. We now have some additional balance sheet flexibility as we look ahead.

On balance sheet management overall, I'm pleased with our DSO efforts which provide us a razor sharp focus on enhancing our growth, our NIM, and our return on capital.

We continue to deploy some great new technology to better serve customers and to run the bank better. Slide 14 of our presentation provides you with some of the color including four new fintech partnerships in the quarter. Sufficed to say we expect a big leap forward in our technology capability and delivery in 2019. To me, it is one of the keys to our year.

So overall we maintain a positive outlook for the balance of 2019 as we expect another year of good execution and further progress across the board.

Let me stop there and turn it over to our CFO, John Woods.

[John Woods, CFO]

Thanks, Bruce, and good morning everyone.

We're pleased with solid first quarter results that highlight steady execution against our enterprise level initiative, 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.

So let me kick-off by covering several important highlights of the quarter. So on Page 4, we delivered EPS growth of 19% year-on-year with PPNR up 13%. A strong focus on growing the top-line, while being disciplined on expenses, drove positive operating leverage of 5% before the impact of our recent acquisitions. Overall credit quality remains very good with a relatively stable net charge-off ratio of 31 basis points and a decrease in the non-performing loans ratio.

Our consumer and commercial banking segments are delivering strong and prudent loan growth, 1.5% linked quarter and 6% year-over-year and we continue to gain traction in fee income with this quarter's results highlighted by record capital markets and FX and interest rate products fees.

Deposit growth outpaced loan growth during the quarter in part due to ongoing momentum in Citizens Access, and as a result, we drove a nice improvement in our spot LDR to 94.9%. This puts us in a strong liquidity position as we head into the second quarter.

In addition, DDA was stable year-over-year as we continue to do a nice job of executing on our initiatives together low cost deposits more efficiently and effectively.

We also continue to actively manage our capital base returning $349 million of capital to common shareholders through higher dividends and share repurchases. We delivered underlying ROTCE of 13.1% which is up 141 basis points year-over-year. And our tangible book value per share was up 9% year-over-year and 3% sequential quarter.

We finished the quarter with a strong 10.5% CET1 ratio.

Across both business segments, we continue to make significant investments in broadening our capabilities and strengthening the franchise, as we balanced delivering on our near-term objectives and executing against our long-term strategy. We have some exciting things to talk about this quarter and I'll expand on our strategic initiatives in a few minutes.

On Page 6, our net interest margin came in broadly stable for the quarter, even though average LIBOR rose than the prior quarter and the long end of the curve was lower than anticipated. The December short-term rate drives drove higher loan yields but this was tempered a bit by robust growth and shift mix in deposits which put some upward pressure on deposit costs as well as by an increase in securities premium amortization due to drop in loan raised.

Turning to fees on Page 7. We delivered very solid results despite some seasonal headwinds. As I mentioned earlier, we saw record results in both capital markets and in foreign exchange and interest rate products, reflecting continued benefits from investments in broadening and enhancing our capabilities, as we are increasingly able to win lead less mandates against the larger national players. This helped overcome expected seasonal headwinds in mortgage, service charges, and card fees.

Capital markets delivered a 38% increase in fees year-over-year, with strengthened loan syndications, M&A and advisory fees, and bond underwriting fees, overcoming lower market volumes and loan syndications which were down significantly.

Results were up 20% linked quarter largely tied to an increase in M&A and bond underwriting activity as market conditions improved from the fourth quarter which helped offset the impact of the typical seasonal decline in loan syndications.

In global markets, FX and interest rate products were up 33% year-over-year led by the IRP team, which was able to win some nice lead transactions and take advantage of the flat yield curve by restructuring the existing client hedges. In FX, higher dollar volatility created the opportunity for favorable hedging across a number of currencies. Because of what we saw happening with the long end of the curve, we took the opportunity to lock in some securities gains and executed on targeted asset dispositions which increased other income in the first quarter. This helped offset headwinds in mortgage where Franklin fees was down $14 million linked quarter largely as lower rates and an $11 million of MSR losses and also origination levels dropped reflecting tough market conditions.

The integration of Franklin is on track and while the first quarter was challenging, we see an improving environment in 2Q and continue to believe this is an attractive and important customer business for us to be in over the long-term.

Turning to Page 8. Expenses were up 3% linked quarter reflecting seasonally higher salaries and employee benefits, partially offset by seasonally lower outside services costs. Year-over-year before the impact of acquisitions, non-interest expense was very well controlled up 2% reflecting strong expense management and benefits from our TOP program.

We are identifying further opportunities to streamline our operations and activities across the organization to capitalize on the next level of efficiencies which include a strong focus on end-to-end automation across the front and back office. These activities will be critical to maintain our operating objectives over time. As a result, we remain committed to self fund our growth initiatives and deliver compelling products and services to an increasingly digitally oriented customer base.

Let's move on and discuss the balance sheet. On Page 9, you can see we continue to grow our balance sheet and generate nice returns from the investments we've made in our geographic and industry verticals expansion strategies with strong progress and higher growth geographies like the Southeast and Texas.

We are also seeing attractive risk adjusted return opportunities in commercial real estate with growth tied to high quality projects largely in office and multifamily.

We remain disciplined around client selection where we are focused on larger MSAs. On the retail side, we also continue to drive growth in innovative and attractive risk adjusted return categories like education refinance and unsecured including our merchant partnerships.

Overall, we grew loans by 1.5% linked quarter and 6% year-over-year, despite the impact in the planned runoff and auto non-core and leasing as well as some modest impact from asset dispositions tied to balance sheet optimization.

Loan yields improved by 13 basis points in the first quarter reflecting continued mix shift towards higher returning categories and a backdrop of higher short-term rates driven by the December rate increase.

As you can see on Page 10, we are doing a nice job of growing deposits which were up 2% linked quarter and 6% year-over-year with stable results in DDA, as we continue to do a nice job of executing on our initiatives to gather low cost deposits and capitalize on the inherent value of our franchise.

Our total deposit costs were relatively well controlled given the strong growth of 15 basis points linked quarter reflecting the impact of higher rates and a shift in deposit mix as we drove new customer acquisition and managed down the LDR from 97.6% to 94.9% at the end of the quarter. Note that interest bearing deposit costs grew 16 basis points sequential quarter.

We continue to make investments across Citizens Access digital platform where we are gaining share nationally in the mass affluent and affluent segments. This platform has contributed nicely to our funding diversification and optimization of deposit levels and costs. At the end of the first quarter, we reached $4.6 billion in Citizens Access deposits.

Year-over-year, our asset yields expanded 49 basis points reflecting the benefit of higher rates and the impact of our BSO initiatives.

Our total cost of funds was up 48 basis points reflecting a shift towards a more balanced mix of long-term and short-term funding and higher rates.

Next, let's move to Page 11 and cover credit, which continues to look quite good with the continued mix shift towards higher quality low risk retail loan and a relatively stable risk profile in our commercial book. The non-performing loan ratio improved to 66 basis points of loans this quarter down from 78 basis points a year ago.

The net charge-off rate of 31 basis points for the first quarter was relatively stable linked quarter and up modestly year-over-year from relatively low levels. Overall, we feel good about the credit metrics and trends in the book including a downward shift and criticized asset levels.

Provision for credit losses of $85 million was relatively stable with prior quarter and prior year levels.

Our allowance to loans coverage ratio remains relatively stable ending in the quarter at 1.06% and as we increase the mix of higher quality retail portfolios in our overall loan book.

The NPL coverage ratio improved to 160% as we saw improvement in NPLs and runoff in the non-core portfolio.

On Page 12, we maintained our strong capital and liquidity positions ending the quarter with a CET1 ratio of 10.5% which came down from 10.6% in the fourth quarter. Also this quarter, we repurchased $200 million of common stock and returned a total of $349 million to common shareholders including dividend.

Our planned glide path to reduce our CET1 ratio remains on track and we remain confident in our ability to drive improving financial performance and attractive returns to shareholders. Our current plan is to announce our buyback plans later in the second quarter. As a broad comment, we expect to meet expectations.

On Page 13, I want to highlight a few exciting things that are happening with our enterprise wide initiatives. As we work on running the bank better and improving our customer experience, we've launched a new digital mortgage application and home buying platforms that we're very excited about as it will drive cost efficiencies and an improved customer experience.

Given our strong focus on strengthening our advice based model and consumer, we recently opened a new banking and wealth center in Downtown, Boston. This approach allows us to deliver tailored advice ideas and solutions to help our clients with all of their banking and investment needs.

We are full steam ahead on the integration of Clarfeld which is progressing ahead of schedule. We continue to gain traction on our merchant partnership platform where we recently signed agreements with several new partners including ADT which should be announced later in Q2.

In commercial, we continue with the build out of our Treasury Solutions business as we begin piling -- we began piloting accessOPTIMA our new cash management platform which offers clients a comprehensive suite of online cash management resources and real time mobile capabilities.

We also launched real time payments to make customer payments more efficient and we are partnering with Worldpay to expand our international payment capabilities. These are just the latest examples of the significant investments Citizens is making in the commercial banking technology and solutions in order to meet and exceed the ever changing financial management needs of our clients.

Finally, we continue to exceed expectations in our TOP programs where we have now increased the expected benefit from our TOP 5 program by about $5 million with an expected estimated benefit in the range of $95 million to $105 million.

Our outlook for the second quarter is on Page 14 and it reflects continued momentum in both our top and bottom-line results. We expect our linked quarter average loans to be up approximately 50 basis points and we are considering selling some loans in the quarter as we seek to redeploy capital under our BSO initiative.

We also expect net interest margin to be stable to down slightly due to continued but decelerating deposit repricing that will abate over the back half of the year. The NIM should bottom out in the second quarter and gradually rise in the second half of the year given less deposit pressure and the benefit of fixed loan and securities repricing at higher rates, along with further balance sheet optimization impacts.

In non-interest income, we are expecting to see growth in the mid-single-digits range given continuing strength in commercial and a seasonal uptick in consumer. We expect non-interest expense to be flat to up 1% as seasonal decreases are offset by higher revenue related expenses. We also continue to expect to deliver positive operating leverage and further efficiency ratio improvement.

Additionally, we expect provision expense to be in the range of $95 million to $105 million.

And finally, we expect our CET1 ratio to be broadly stable. Overall, we expect our full-year results to be broadly in line with our overall guidance. But there will be puts and takes with modestly lower net interest income offset by better fee income and expense performance.

Also in response to the rapidly changing environment and a little less tailwind from rising rates, we've been doing some early work on a transformational expense program designed to boost efficiency and effectiveness. This will provide additional capacity to invest more heavily in revenue producing capabilities, while ensuring that we maintain strong financial performance into the future. Stay tuned for more details on our second quarter call.

To sum up on Page 15, our results this quarter demonstrate our continuing strong performance as we execute against our strategic initiatives, carefully manage our expense base, and improve how we run the bank to drive underlying revenue growth.

Let me turn it back to Bruce.

[Bruce Van Saun, Chairman & CEO]

Okay, thanks very much John. Brad, I think it's time to open it up for some questions.

[Operator]

Thank you, Mr. Van Saun. We're now ready for the Q&A portion of the call. [Operator Instructions].

And the first question in the queue will come from the line of John Pancari with Evercore. Please go ahead.

[John Pancari, Evercore]

Just looking to get a little bit more color on the deposit efforts this quarter. In what areas, what types of deposits were you pushing, was there any broad-based increase in stated rates and then what's your outlook there. Is there a continued push beyond your existing national platform that you're going to continue to push the products and therefore deposit rates higher? Thanks.

[John Woods, CFO]

Yes, so how are you doing? Its John here, I'll go ahead and comment on that. So average deposits to total deposits were up very strongly this quarter we were very pleased to see the take up. It was driven primarily by term and savings. Those were the two drivers. I think we saw some good performance in the DDA area as well. We've been making lots of investments in that play -- in that space. So year-over-year DDA was relatively flat. We were very pleased with that. We had a strong 2018 and we look to continue that momentum going forward.

Citizens Access had an excellent quarter. That'll continue into the future. I'd say that strong deposit growth really drove the LDR down to around the 95% level as you heard earlier. I think looking forward, I think you could see that LDR level staying relatively stable into the second quarter and continuing to see growth looking forward in the term and saving space.

But I think big picture a big deceleration. I would say in interest bearing deposit costs, the further away you get from the Fed rise in December is going to see that deceleration in the second quarter to where that solidifies in H2 which connects back to our NIM guide which will look to increase in the later part of the year.

[Bruce Van Saun, Chairman & CEO]

I would just add a little color there is that there is broader efforts in just Citizens Access. Citizens Access in and of itself is a huge success story, but on commercial we've been investing in certain areas where we think we can gain some real traction in picking up natural share deposits with our pre-existing customers where we maybe didn't have the capabilities we talked about ex-growth, we talked about bankruptcy. So we're building those out. Those don't turn on a dime, they build gradually with time. So we're pleased with how that's developing.

And then on the core consumer side, continuing to invest in data and analytics and being a little sharper in our offerings and targeting them to different segments of the market particularly mass affluent and affluent, we are seeing traction there. So pretty good performance across the board and very pleased the LDR is at a lower level now so which gives us a lot of flexibility going forward.

[John Pancari, Evercore]

Got it. Thanks Bruce. And then, separately just on what you just mentioned in your -- in the end of your prepared remarks transformational expense program that you're looking at. I know you said it would be fair to give us details on the second quarter call but just in general how do you view it being transformational and using that phrase, I mean is it more about how you're looking at your branches or is it a longer-term profitability change in terms of where you're operating on an efficiency ratio basis. Just a little bit more color there on how you view it as transformational? Thanks.

[Bruce Van Saun, Chairman & CEO]

Sure. So I think what we've done for the five years prior has been really just work on ideas and coming up with deployment of different strategies around organizational design, spans and layers, automating starting to look at process automation and robotics. I think what we're -- and also some branch thinning and the like.

I think what we're after in this go round is something that's a little broader in scope and so really deploying new technologies, artificial intelligence, and the like to new strategies for technology development. So there's a lot around technology and operations and they've guts of how we're running things. There's a lot in looking at processes end-to-end in terms of the transactions that we have customer-facing transactions and how are we going to improve those both in terms of their cost efficiency and their effectiveness and customer experience. So we have a fair amount there.

So it's a broader look and typically in the TOP programs up to now, we've looked for very quick paybacks. So we didn't look at having significant technology investments and we wanted things that we would pay back within 18 months. And so in this version, we'll look at things a little more broader that might require some technology and might payback over two or three years but I do think we'll be able to move the needle on the efficiency ratio with the payback from these efforts. So we're quite excited, it’s early days. We're working through some ideas.

The thing I would also emphasize here, John, is that we want to pair that with efforts that are going on for finding new revenue growth and finding different trusted ways to serve customers or create new products and services potentially a bit disruptive. There's a huge effort that we're undertaking now to really focus on how can we differentiate ourselves and similar to how we grew the education refinance business or we do the Apple relationship and having a very strong point of sale financing offering.

We want to drive forward, so we can have more revenue growth in our peer set and actually keep the top-line going and then create a virtuous circle where we've got a good top-line we can afford the investment et cetera. So it's really a one, two punch. So part of it is let's really go after the cost base and transformational, and some of that will drop to the bottom-line. But some of that will help fund these investments to really drive future revenue growth.

[Operator]

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

[Saul Martinez, UBS]

Hey guys, good morning. Couple of questions. First can you give a little surprised with the outlook that you've actually seen NIMs ratcheting up in the second half and you gave some broad strokes as to why but if you could us, John, give us a little bit more detail on what's underlying -- what kind of assumptions are underlying that outlook? I assume you still expect deposit costs creep. But how much of it's being driven by balance sheet optimization, what kind of balance sheet optimization and also where you expecting the security deal to gravitate up as well in that assumption?

[John Woods, CFO]

Yes. I will jump on that. So I think if I'd taken in two pieces. I mean I think if you look at what we expect in 2Q and then how those forces expect to unfold over the second half of the year. I think where as we mentioned stable to down slightly in 2Q. The real driver there is rates. I mean I think when you look at where LIBOR is expected to be in 2Q, all the other drivers which I'll cover in a second basically offset and you're left with short-term rates being potentially down a couple of basis points which has an impact on our floating loan portfolio.

The other drivers that all seem to offset are expected to offset in the second quarter is all of those front book, back book dynamics. So you've got loan front book and loan and securities front book, back book which is positive in the second, it's positive in the first quarter, it's positive in second quarter, it will be positive for the rest of the year although possibly diminishing a bit as loan rates stay where they are.

But that's been offsetting the front book back book dynamic on the deposit side. And so I think you'll see, as I mentioned in my remarks, a significant abatement of deposit cost increases the farther away you get from the Fed rate rise in December. And so then -- so a combination of that front book, back book plus our balance sheet optimization initiatives is offsetting those other forces on the deposit side in 2Q and all you're left with is rates.

So when you get out of the second quarter as rates stabilized both on the short and the long end. You see deposit costs stabilizing and therefore you're left with front book, back book on our fixed portfolio driving some uplift. And I think those are the dynamics that we see at the moment in terms of the back half of 2019.

[Saul Martinez, UBS]

So even if rates remain where they're at long end and rates remain where they're at. The Fed funds remain where it's at. You still have positive new money yields over portfolio yields on your loan and your securities books right now?

[John Woods, CFO]

We do. So in the first quarter that was 80 basis points or so in terms of that net difference in the first quarter for investments. As an example a variety of our loan books or you could call it ranging from 25 basis points all the way up to 150 basis points but basically almost every category has a positive front book, back book across all of our earning assets.

And as if rates stay where they are, it's possible that will shrink a bit over time but it'll and maybe a portfolio too will eventually convert to something more neutral as you get later in the year. But all in, our overall portfolio as a positive front book by dynamic 50% of our loans are fixed and so that momentum continues through the rest of the year as a positive dynamic.

[Saul Martinez, UBS]

Got it. That's helpful. If I could change gears on credit. I think John in various forums recently and in the past you've talked about the challenging environment in the casual dining space. And can you just comment a little bit about where -- what you're seeing there. Is that a concern and what the size of the book is and then just more broadly what you're seeing in terms of credit and what drove the uptick in your loan loss provisioning guidance for 2Q, is that just normal the fact that it is so low and you're seeing some normal seasoning on the book?

[Don McCree, VC & Head, Commercial Banking]

So it's Don. I'll comment on casual dining, it's a relatively small portion of the book and it's actually coming down a little bit. So we're working through that which we signed a couple of quarters ago. We've really slowed down if not see certain segments of our franchisee in restaurant originations. So we don't see large loss content, it's not reflected in provisions already. So we feel like we've got our hands around that book and I'll just mention we had a charge-off this quarter which was in our real estate book which was reasonably significant. It's a kind of 2013 vintage origination, so it's quite old and we've been working it through our workout groups for about four, five years now. So it kind of went a little sideways, so we charged it off this quarter and almost --

[Bruce Van Saun, Chairman & CEO]

Really it is idiosyncratic, I would add it's Bruce. But I think that was one that was in a unique bubble wrap and trying to part it over, so we don't see any read across anything else in commercial real estate.

[Don McCree, VC & Head, Commercial Banking]

And I agree that, that's true of the overall book. What we've seen is as problems over the last five or six quarters have been very idiosyncratic. We feel very good about the overall book and the condition of the economy and what we're seeing in terms of performance by our underlying credit.

[Bruce Van Saun, Chairman & CEO]

Let me also add that credit class came down again.

[Don McCree, VC & Head, Commercial Banking]

And all the credit ratios are very historically low and we don't see those changing.

[Bruce Van Saun, Chairman & CEO]

Yes.

[John Woods, CFO]

And I said it's just the outlook for 2Q being up a bit. I mean I think we've historically had a significant amount of recoveries that come through the book and credit has been excellent. And so the outlook there remains so but possibly recovery is moderating a bit and I'm not sure --

[Bruce Van Saun, Chairman & CEO]

The overall [ph] LIBOR.

[John Woods, CFO]

Yes, exactly. So that's the reason for that.

[Saul Martinez, UBS]

Do you disclose the size of the casual dining book?

[John Woods, CFO]

No, no, I don't think we give.

[Operator]

Question will come from Ken Zerbe with Morgan Stanley. Please go ahead.

[Ken Zerbe, Morgan Stanley]

Great, thanks morning. I was actually wondering, can you guys talk just a little bit about how your plans around your balance sheet optimization are changing now that Fed maybe done raising rates this year?

[John Woods, CFO]

Yes, I'll go ahead and start on that. I'd say I'm not sure they changed very much. I mean we've been talking about the broad strokes of that program primarily on the deposit side where you would focus on all of the things you've heard from Bruce earlier. In commercial, new interesting I think ways to fund our loan growth in the escrow space and in consumer a lot of the data analytics and efforts around customer experience that are driving DDA take up. So I mean, I think all of that remains just as important in a world where the Fed is not raising rates as it is in a world where they are. So that that continues in that direction.

On the asset side similar I mean when you look at our rotation into we call it the asset categories that have really solid risk return profiles for us like such as student or unsecured investments we want to make in our commercial business to get more swings at the bat. With respect to our customers all of that is not meaningfully impacted by the Fed going on hold. I think that that continues and it's really something you would do with or without I think the Fed.

[Bruce Van Saun, Chairman & CEO]

I'd say that the one thing there where we might be pivoting a little bit is that mortgage growth that we've had -- we'd like to taper that off a little bit and actually we could consider some sales of mortgages that we have on the balance sheet. So back in a low rate environment fully 30-year fixed on your books is a great trade. And so we think we can offset that. We've been talking for a while about how we're going to leverage our point-of-sale offering to some new partners.

One of the things we're quite pleased about is that we've now signed several important new partners including one which we can mention today, ADT it's in the press release will be out shortly on that but there's several other significant ones that will come out over the next several weeks. John, you want to comment on that?

[John Woods, CFO]

I will just say we've got a very good pipeline. We felt like we built a very unique value proposition with the Apple program and there's tremendous interest in the marketplace and we've got a really strong pipeline and I think there will be more news after ADT. I'm really excited about ADT.

[Ken Zerbe, Morgan Stanley]

Got it. Okay, perfect. And then your capital markets business held up really well this quarter especially relative to peers, looks like some of that was due to bond underwriting. Can you just remind us how your capital markets business or the business mix may differ from some of your peers?

[John Woods, CFO]

Sure. So I will take that. So first of all, we really have a very small equity business. So if you broadly talk about capital markets, I'd say ex-equity we do a little bit of equity in the REIT space with a partner who does the equity underwriting. Our business is really threefold, it's bond underwriting with both high yield and investment grade. It's syndicated financing which is largely leveraged syndicated financing aimed at the mid-market sponsor community, and thirdly it’s M&A.

So this quarter we benefited from bond underwriting particularly high yield bond underwriting as things recovered from the weak market last year and there was some pent-up demand, so a lot of our clients issued in the high yield market. And then we saw Western Reserve in particular kick in and we had a quite, quite a strong M&A quarter and that we expect to continue through the end of the year both with Western Reserve and with Bowstring which was our latest acquisition. And the way I think about M&A is it took two or three quarters to have the capabilities on our platform to begin to see deal origination. And so our win rates are very high on the M&A side, our client base is very active. We did have quite a weak quarter in our syndicated financing business and that should be bouncing back as we go through the balance of the year. So what I like about the mix of our capital markets business is far more diversified than it was in terms of different fee streams a couple of quarters or a couple of years ago. So we're getting nice degrees of offset based on different markets being active.

[Bruce Van Saun, Chairman & CEO]

Yes. And what I would also add to that, it’s Bruce, Ken is I think that what Don and his team have been able to do very effectively is marry the solution set by having our coverage officers work very closely with these enhanced product capabilities.

So when we go out and call on clients we show up with value-added ideas and we're able to win the jump ball against very significant competition out there. We do a really good job of that and start to see the traction we get records -- capital markets speaks, we get records, FX and interest rates. So coming up with good ideas on how to hedge risks is also something that I think we've got huge traction. And so very pleased to see the maturation of the model and the very strong team approach in terms of how we're covering funds.

[John Woods, CFO]

And I'll just add to that Ken. We're very disciplined as we add new clients around capital deployment against opportunities where we will -- where we do think there will be good cross-sell. So I think our new business process of several years now is beginning to yield flow based on where we've deployed capital and added clients on a net basis.

[Operator]

And our next question will come from Erika Najarian from Bank of America.

[Erika Najarian, Bank of America]

Just had a follow-up question on the comments in capital return. I think there was some confusion on how to treat your press when investors were putting in your financials in the Fed template. And John, I just wanted to clarify you said that capital return would likely meet expectations. I have a consensus of about $2.15 billion right now for capital return, is that the bar that you're looking to potentially meet?

[John Woods, CFO]

Yes, without necessarily commenting on a particular number, we have seen a range of estimates externally where I think we're broadly in line with where the market expects our buyback capacity to be. We have that flexibility. I mean the Fed template as you know we're a Category 4 firm where we're subject to the Fed template this year. We overall have a glide path that that Fed template allows us to continue to execute against and we have a dividend return expectation over time of 35% to 40%. We've talked about our expectation of getting the CET1 ratio down to about 10.2% by the end of the year.

So I think the main message is number one the Fed template allows us the flexibility to execute against what we want to do and we think that will deliver against broadly against what the market expects for buybacks in the windup.

[Bruce Van Saun, Chairman & CEO]

And so the 10.2% projection for CET1 at year-end is still in production, so.

[Erika Najarian, Bank of America]

Got it. And just a follow-up Bruce in terms of the TOP 6 program that you're looking to announce, as we think about the potential impact right now the consensus is expecting something like a 57% efficiency ratio for your company this year. That's about in line with peers should we expect that TOP 6 could bring you to a position that's better than peers, let's say in the mid-50s from a natural efficiency standpoint?

[Bruce Van Saun, Chairman & CEO]

Yes, so we have a stated medium-term objective to bring that down to 54%. And so I think a TOP 6 like program is going to be required to accomplish that. So I do think it's important particularly if the Fed is done raising rates and maybe I will hold for a while here to get less in tailwinds than we had previously. So I think we have to go back and look at what are some of the offsets that you can deliver certainly control of your expense basis. One, but doing it smartly doing it in ways that actually provide the funding capacity just so by office, so that's what we're all about. Thanks.

[Ellen Taylor, Head, IR]

Operator, can you mute that, please. Okay.

[Operator]

Okay, please go ahead.

[Bruce Van Saun, Chairman & CEO]

Yes, another area that we're really focused on is the growth in the fee based businesses where I think we have gotten off to a great start on the commercial side in Q1 and the outlook remains strong for the year. We got off to a little bit of a rough start on the consumer side but the outlook for Q2 is quite, quite good on the consumer side. So I'd expect to see some bounce back in mortgage and then also bounce back in wealth. So things move around there's puts and takes but I think the expense base is going to be important and then also driving that fee growth.

[Operator]

And our next question in queue will come from Ken Usdin with Jefferies. Please go ahead.

[Ken Usdin, Jefferies]

Hi, good morning guys. A follow-up on the capital structure question, it's nice to hear that that guide pack to 10.2% is intact and your long-term target you talked about in January to get to 10% CET1, some peers are distinctly talking about much lower than that at this point. And then given the tailoring in the Category 4 that you just talked about, how do you evaluate at what point you might be able to run the company even lower than 10%. And then how do you also evaluate the choice of how you choose to get there or was it just the buyback or just leaving room for balance sheet growth? Thanks guys.

[Bruce Van Saun, Chairman & CEO]

Sure. So I'll go first, John you can chime in. But I think we're gradually bringing it down to 10% and we don't really take the decision though until we get there. And then I think we need to look at a number of considerations including where our peers, what's the regulatory and rating agency comfort with operating at a lower number including our own that's importantly comfort with being there. I think there's no reason structurally or from a business standpoint that we should maintain a ratio that's above peers, our kind of business risk profile certainly is in line with peers. In fact I think we're slightly on a prudent side. So if you look at how we model the stress scenarios we come out quite robust and even in that modeling certainly our credit losses were at a median or slightly better than the median. So I think we'll have that flexibility.

When we think about how we deploy our capital obviously if we can deploy it smartly to further organic growth that's kind of Mission one. So if we can get loan growth, if we can do some of these accretive small acquisitions that broaden our capabilities, we can get more from our relationships on the commercial side and the consumer side those are things that we're continuing to put on the list ahead of buybacks I think frankly. But again if we certainly don't want to have capital lying around. So we'll try to keep that ratio sharp and relatively in line with peers. John?

[John Woods, CFO]

Yes, I would just say just to emphasize the last point, I think given where we are in our lifecycle, I think the opportunities to deploy capital organically and in strategic initiatives including fee based bolt-ons that we've been doing remain into the future. So that's job one is to put that capital to work on behalf of our shareholders in an accretive way.

And then we monitor all the other sources and uses, the outlook for earnings et cetera, organic loan growth and then we take it from there. I think we also have another lever which is our capital stack is a little bit more oriented towards CET1 and some others and most peers have more preferreds outstanding than we do. So that's another lever we can look at over time that provides benefits as well. So just really solid cash strength in the capital positioning.

[Bruce Van Saun, Chairman & CEO]

Five [ph] points to go.

[John Woods, CFO]

Yes.

[Bruce Van Saun, Chairman & CEO]

Yes.

[Ken Usdin, Jefferies]

Yes, thanks and my sort of follow-up on that, John, you just hit on it was going to be just you did have done a couple of those preferreds to start to move the capital stack towards that more efficient place, you're only about halfway there, so is that something we should expect over time as you continue to bring CET1 down we logically see that preferred stack that went underneath it?

[John Woods, CFO]

Yes, I think that's logical over time. I mean we're not going to have commensurate to an exact execution day on that but I mean I think that we've done this in the right way. I mean as our ROTCE has improved over the years, it becomes much more appropriate to consider the repositioning of the capital stack such that if preferred, the cost of preferreds are attractive and they are versus ROTCE and we find a good execution point, we'll consider that. But that's a nice bit of flexibility as you heard earlier in terms of our ability to reallocate and remix our capital profile.

[Operator]

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

[Peter Winter, Wedbush Securities]

Good morning. In the prepared remarks you mentioned that net interest income was coming in a little bit lower for the full-year, is that mostly driven by less margin expansion than you originally thought?

[Bruce Van Saun, Chairman & CEO]

Yes. So it probably reaffirmed the full-year outlook. And I think whenever you start moving through the year there's going to be some modest puts and takes.

I think when you look at NII; the volume side of that equation is solid. So I think we're still looking to be solidly in the loan growth range that we set out to achieve. I think the NIM given the flatness of the curve and some of what we've experienced here early on in the year will be maybe a couple of basis points lower than what we anticipated, still positive in terms of NIM for the year-on-year. But maybe there's a little leakage there.

I say where we'll make that up is I think a more robust view on fees and a better performance on expenses. So our ability here is to protect PPNR I think is pretty solid.

And then we've had beats in the past couple of years on credit. So we'll see how that plays out. I feel pretty good right now where we sit in terms of the credit outlook. So that gives us the confidence that broadly reaffirms the outlook, Peter.

[Peter Winter, Wedbush Securities]

Thanks Bruce. And then just on credit, I'm wondering can you make any comments on how you're thinking about CECIL?

[John Woods, CFO]

Yes, I will go ahead and cover that. I mean as you saw we Regional Bank, Peter had some commentary that we were engaging with regulators and the fact beyond and just more recently that has been -- that has been adjudicated to result in moving forward full steam ahead with executing on CECIL. We never really stopped our programs. We are launching data related pilots for the pipes and plumbing in the first quarter here and full dress rehearsals as you get into the second and third quarter on CECIL just from a process standpoint.

Later in the year we'll have some more views about what that will do and how that might impact the day one capital impact of adopting CECIL. But in general as you know longer dated loans will have a bigger impact than some other categories. We do think that CECIL is cyclical which is not exactly what we think is the right way to portray exposures going into downturn. And it's very sensitive to your outlook of the economy going forward. So we are on track for our internal program, we'll talk to you a little -- talk to you some more about this later in the year in terms of the impacts but we do think that our capital glide path and our ability to execute against that is not at risk as a result of CECIL.

[Operator]

And our next question in queue comes from the line of Gerard Cassidy with RBC. Please go ahead.

[Gerard Cassidy, RBC]

Can you guys share with us clearly the direct deposit -- the Digital Deposit Program has gathered a good amount of deposits. Can you share with us, are you hoping to develop deeper relationships with those customers aside from just the savings product that they're using right now? And if so are they going to be some metrics that we can look at as outsiders to see the success of deepening those relationships?

[Bruce Van Saun, Chairman & CEO]

Yes. So let me start, it’s Bruce and I will flip it over to Brad for more color. But I would have to say that this is the tremendous success this development since Citizen Access launched and I described all these goals. So what's goal today is gathering deposits in this environment, gathering new customers. We have $4.6 billion in deposits, we have over 60,000 new households that are customers in Citizens Bank and we have developed digital capabilities and the ability to use data that I think puts us in the Vanguard of our peer group and that's cold us well, so a lot of real positives coming out of this.

I think that the next day now this is up and running we certainly want to fine tune the offerings to make sure we're gathering those deposits cost effectively, while meeting customer expectations. But if you have 60,000 customers what else can you do with them. And so that's really a Phase 2 project that we kicked off. And if you think about it Gerard, we had roughly 60% of our consumer loan products today are digitally originated. So there's a possibility -- there's a potential we have a digital robot advisory service that we can also marry with ability to Skype a person right here. So there's a hybrid -- there's pure digital event, there's a hybrid person/digital offering that also could work through that channel. So there's some really interesting things to think about but I think it's going to take us a while to actually bring that to market.

With that, I will flip it over to Brad.

[Brad Conner, VC, Consumer Banking]

Yes, Bruce, I think you've covered it really well. There are some immediate things we're doing to enhance the platform including the fact that we're adding trust accounts which we launched with our trust account. But we see tremendous opportunity, it's a perfect client base for us, it hits right in our target customer segment of mass affluent and affluent customers.

Digitally savvy as you mentioned we built Specify which is one of the first digital advisory capabilities in the market. We think that's a perfect complement to this customer base and then several lending opportunities and lending products that we're working on all of those and what are the next steps for continuing to enhance the relationships.

[Gerard Cassidy, RBC]

Very good. And then pivoting to the loan growth which again was strong for the quarter as you guys pointed out and I think you guys highlighted that in the commercial real estate area, you saw some growth in the office and multi-family. Can you give us some color on the geography, where are you guys seeing the best growth geographically in your footprint and outside the footprint?

[John Woods, CFO]

I think it's our real estate business is national and it's really, I'd say it moves quarter-to-quarter. So I'll give you two examples of expansion. We actually move people into Texas and people into Los Angeles where we have seen growth over the past few quarters. So that's both be active on the existing book of business but also do some origination. But it's really across the Southeast and in growth areas of the country where we're seeing the highest levels of growth.

I say our real estate business in general, the growth will slow down over the balance of the year and that's strategic because we're focusing on the better end of the opportunity set that we see. So we have to originate a fair amount just to replace what's on our books already. But I think you should expect to see our real estate growth on a gross basis be a little slower than it's been in the past from a strategic standpoint.

[Bruce Van Saun, Chairman & CEO]

And I would also say there's still attractive opportunities in the footprint in Boston and the Seaport District for example. So it's a combination of things that are in the traditional footprints some these growth markets that Don mentioned. And when it comes to office, we typically focus on owner occupied, so there's a low risk type of project that we're financing.

[John Woods, CFO]

And what's flat lining is really multifamily and anything retail. We're really not growing those with any kind of significance.

[Operator]

Thank you. And our next question here will come from Marty Mosby with Vining Sparks. Please go ahead.

[Marty Mosby, Vining Sparks]

Thanks for taking the questions. Got kind of a rapid fire here of about three or four questions, your mortgage hedging this quarter was a negative, was that just unusual, some basis risk in there or were you just not had it hedged or as a percent of the portfolio or you make any adjustments. So is this going to be unusual or should this be something we expect as rates go up and down have positives and negatives?

[John Woods, CFO]

Yes, Marlin, I will take that. This is John. So I mean I think that you're going to have, when you have an asset of this size that is $600 million, $700 million depending upon if we have a split between fair value and low comp but large assets, it's a complex asset to hedge and you're going to have some variability from quarter-to-quarter. Last quarter we had a $2 million net positive MSR valuation net of hedge. This quarter we had $2 million negative MSR valuation net of hedge. So quarter-over-quarter that's $4 million.

There were other rate impacts as well. When you look at outside of just the straight hedging piece you also have to estimate what's your amortization is just in the mean servicing P&L and we had an increase of $7 million from $25 million to $30 million -- $32 million in amortization that was largely rate related as well. So all-in and quarter-over-quarter you got $11 million of largely rate driven MSR related valuation impacts. So hopefully that gives you some context.

[Marty Mosby, Vining Sparks]

It helps and I really appreciate your guidance. So this is kind of a statement as well as a question. We talked about the front book versus the back book. That's really what we've been trying to outline for investors is the fact that you have this historical spread between what's still in the market even though rates have come down versus what's on the books just because rates were so low for so long. And then over time that's kind of a grind up as you kind of just see that coming through. And in relation to that, you mentioned some balance sheet flexibility. I just didn't know if that was liquidity wise because your loan to deposit ratio would come down or there was some other flexibility that you were talking about there?

[John Woods, CFO]

Yes, I think that we have some flexibility primarily due to the fact that we've had a really strong deposit quarter after several prior quarters that were strong. But our first quarter was particularly strong and that led the LDRs come down to around 95%. I mean that provides some flexibility. We have -- we've demonstrated the ability to grow deposits at least as quickly as we grow loans.

When you think about, as a good example, when you think about the big impact that growth has on the increase in interest bearing deposit costs as were 16 basis points in the quarter approximately half of that was driven by just deposit growth. So if you get ahead of things a little bit, then and you can fund your growth without necessarily having to grow a lot in future quarters. That has a beneficial impact and underpinning of net interest margin going forward.

[Bruce Van Saun, Chairman & CEO]

The other thing, so John is describing the flexibility on the deposit side that we have. I think we had some nice flexibility on the asset side as well. So we've been well positioned to have an origination engine both on the commercial side and the consumer side that is pretty robust that gives us the wherewithal to then look into the back book and make asset sales and we made approximately $300 million of sales in the first quarter. And so we can look to do that as we go through the year and still report net loan growth. So that's all part of BSA -- BSR it's working for us on the deposit side but it's also working for us on the assets side.

[Marty Mosby, Vining Sparks]

And then just two bigger picture questions. You've been the easiest bank to kind of estimate what's going to be market consensus every quarter. Just wanted to get you to kind of think about, why and this may be a highlight for us because you all do ask for models every quarter. So I know you're tracking, what are buyers putting out there but what are the earnings surprises that people just start catching up to. And then Bruce I just wanted you to give us a little bit of a thought given some of the other transformational let's call mergers or placements of banks in the country. How does Citizens fit into this competitive landscape? I mean how do you see the bank being able to evolve over the last five years really talking about how you're competing a lot with everybody around you but just wanted to kind of get your thought on how you fit in there?

[Bruce Van Saun, Chairman & CEO]

Yes, sure. So with respect to the consistent track record of being able to beat pretty much every quarter that we've been a public company, I just think it's a reflection of our very strong focus on execution and we're all I think very aligned on where we're trying to take the banks and what the key drivers of a successful turnaround were and what the next phase is going to require to become a Top performing bank. So I think we've got great people, great leadership team, and we've good alignment through the organization that people know of what's expected of them. They're empowered and then we hold them accountable and they're doing a great job. So hats off to our colleagues here at Citizens.

With respect to where we fit into the landscape, I do think we have really come a long way from where we started. So foreign ownership foreign parent had a bunch of difficulties and left us with a strong potential franchise but had accumulated some baggage, some lack of investment in key areas like technology, our people program, and our risk capabilities, build business model wasn't fully built out to really serve customers on an integrated way both on the commercial side and the consumer side.

Balance sheet had shrunk to a position where our profitability was really emasculated. So we had a lot of work to do and I think we've now certainly made our way back into the pack and in many cases I feel that we're doing better than our results indicate and certainly better than our stock price would indicate. But I'll leave that for another day.

But certainly on the commercial side, I'm so pleased that Don and his folks have put together the level of talent that we have, people who worked in big banks, who are covering the middle market and the big corporate clients so well and then we can go out and we can lead deals we could have money center banks on the right of us. We can go out and compete for an interest rate hedge and win it against money center banks which we did several times in the first quarter. We've got really, really good talent and we're well positioned.

And then on the consumer side, some of the things that Brad talked about Citizens Access and our fintech partnerships and thinking about end-to-end customer experiences and the customer satisfaction is moving up nicely. I think we're doing a really good job there too.

So I think we have a strategy and a capability to continue to drive this company forward and become a great bank. But I certainly would have to say as you look around the landscape and people are making scale arguments. You always keep an open mind about those things, if there's opportunities to benefit our shareholders, we have an open mind towards that but I think the more important news is that we're well positioned to continue on the path that we're onto it.

[Operator]

And it does conclude the questions for today.

[Bruce Van Saun, Chairman & CEO]

Okay. It was great. I know it’s a busy morning for you all; you probably have to hop to the next call. But certainly appreciate that you dialed in today and we appreciate your interest and support. Have a great day.

[Operator]

Thank you. That does conclude today's conference call. Thanks for participation. You may now disconnect.