Citizens Financial Group's (CFG) CEO Bruce Saun on Q4 2016 Results - Earnings Call Transcript

| About: Citizens Financial (CFG)

Citizens Financial Group (NYSE:CFG) Q4 2016 Earnings Conference Call January 20, 2017 9:00 AM ET

Executives

Ellen A. Taylor - EVP & Head, IR

Bruce Van Saun - Chairman and CEO

John Fawcett - Interim CFO

Brad L. Conner - VC, Consumer Banking

Donald H. McCree - VC and Head of Commercial Banking

Analysts

Matt O'Connor - Deutsche Bank

Scott Siefers - Sandler O'Neill

Erika Najarian - Bank of America Merrill Lynch

Vivek Juneja - JP Morgan Securities

Matthew Burnell - Wells Fargo Securities

John Pancari - Evercore

Kenneth Zerbe - Morgan Stanley

Kevin Barker - Piper Jaffray & Co.

David Eads - UBS Securities

Kenneth Usdin - Jefferies

Geoffrey Elliott - Autonomous Research

Scott Valentin - Compass Point Research

Operator

Good morning everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2016 Earnings Conference Call. My name is Brad, and I'll be your operator on today's call. Currently, all participants are in a listen-only mode. Following the presentation, we'll 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 A. Taylor

Thanks so much, Brad, and hello everyone. We really appreciate you joining us on our call today. Our Chairman and CEO, Bruce Van Saun; and our Interim CFO, John Fawcett will begin by reviewing our fourth quarter and full year results and then we will open up the call for questions. We're also real proud to have here in the room with us today Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking.

I'd like to remind you all that in addition to today's press release we have also provided presentation and financial supplement and these materials are available at investor.citizensbank.com. And of course our comments today will include forward-looking statements which are subject to risks and uncertainties. And we provide information about the factors that may cause our results to differ materially from the expectations in our SEC filings, including the Form 8-K we filed today. We also utilize non-GAAP financial measures and provide important information and a reconciliation of those measures to GAAP in our SEC filings and in our earnings material.

And with that, I will hand it over to you Bruce.

Bruce Van Saun

Great. Thanks Ellen and good morning everyone. Thanks for joining our call today. We are pleased to repeat another quarter of strong and improving results and a great finish to a year of significant progress and good execution. We continue to run the bank better every day, we are taking good care of our customers, and we enter 2017 with some nice momentum.

The highlights of the quarter from my perspective was the continued delivery of good top line growth with 11% year-on-year revenue growth and robust positive operating leverage at 6% while for the full year revenue growth was 8% and the operating leverage was 4.2% on an adjusted basis. The commitment to positive operating leverage has powered improvement in our key metrics. Our ROTCE hit 8.4% in Q4 and our efficiency ratio improved to 62%. We continue to execute well on our strategic initiatives and we're making progress on our customer, colleague and community stakeholder objectives doing better for all of these key stakeholders. We also announced an increase in our Q1 dividend of 17% or $0.02 to $0.14 and we repurchased 180 million in common shares during Q4.

As we look at 2017 we expect our agenda to be largely consistent with 2016. We have a great playbook and we're going to continue to execute against that playbook. We're hopeful that the macroeconomic environment may deliver some tailwinds but we will stay focused on execution and what we can control.

I'm going to turn it over to John Fawcett, our interim CFO to review fourth quarter and full year 2016 results. I’ll then come back to discuss the outlook for 2017. First I'd like to personally thank John for shelving his vacation plans to step back in and cover the CFO duties for a couple of months as we transition CFOs. It's very much appreciated by me and by your colleagues John and it's great to have you back with us during this period.

John Fawcett

Thanks Bruce and good morning everyone. Since Bruce hit the highlights let me direct you to a few pages in our slide deck with some color on our financial results. On slide 6 on a GAAP basis we generated net income available to common stock holders of $282 million and EPS of $0.55 per share which was up 31% year-over-year driven by strong revenue growth of $131 million or 11% year-over-year.

Our net interest margin increased 13 basis points while the efficiency ratio improved 3.5% from the fourth quarter of 2015 to 62%. On slide 7 we present the results on an adjusted basis. As a reminder third quarter results included $19 million of after-tax notable items that benefited our EPS by $0.04 in the third quarter. We grew EPS on an adjusted basis by 6% linked quarter and 31% in the fourth quarter of 2015. The strong focus on operating leverage delivered revenue growth of 11% year-over-year with expenses up just 5%. We improve the efficiency ratio by over 1% versus the prior quarter and 3.5% year-over-year.

Our results also reflect $180 million in share repurchases. On slide 10 and 11, you can see the continued benefit of our efforts to grow our balance sheet and expand our net interest margin. We grew average loans 2% linked quarter and 8% year-over-year reflecting growth across commercial and in mortgage unsecured retail and student on the consumer side. Net interest margin was up 6 basis points in the quarter and 13 basis points year-over-year reflecting improved loan yields partially offset by higher deposit costs.

We've got a nice job of improving our loan yields given our balance sheet optimization efforts, a loan with greater discipline on pricing. We also benefited from higher LIBOR during the quarter as the market anticipated the tightening by the Fed. On the funding side we held our cost flat to linked quarter despite a 1 basis point increase in deposit costs as we benefited from the runoff of paid fixed swaps. On a year-over-year basis deposit cost were up slightly and net borrowing costs relatively flat. We remain well positioned to capitalize on the rising rate environment with asset sensitivity to a gradual rise in rates at 5.9% as of quarter end.

Next on slide 12 we cover non-interest income which on an adjusted basis was up $9 million in the quarter. Service charges and fees were slightly up and mortgage banking fees were up $3 million reflecting improved mortgage servicing rights valuation, partially offset by lower sales gains. Security gains were $3 million tied to portfolio adjustments. FX and letter of credit fees improved $2 million largely reflecting increased customer hedging activity given U.S. dollar volatility. Capital markets fees were strong and in line with record 3Q 2016 levels given continued good loan syndication activity.

Let's take a closer look at expenses on slide 13. On an adjusted basis non-interest expense was up $16 million linked quarter reflecting higher vendor contract license and maintenance costs, outside services tied to consumer loan origination and servicing, and an increase in fraud legal and regulatory costs. Salaries and employee benefits expense remained stable on an adjusted basis as higher revenue based incentives were largely offset by a reduction in benefits.

Our headcount is down 75 year-over-year reflecting the impact of our efficiency initiatives which more than offset sales force and strategic hiring. We grew loans 8% annualized with nice performance in both consumer and commercial during the fourth quarter which you can see in more detail on pages 15 and 16. In consumer growth was led by continued expansion in residential mortgages, student and other unsecured retail loans which was driven by our partnership with Apple and our new personal unsecured product. We have recently announced a new partnership with Vivint, a major security alarm company and expect to announce another program soon.

We continue to do a nice job of re-pointing our growth to higher return categories as the yields in consumer expanded 5 basis points in the quarter. We also saw a nice growth in commercial where we continued to execute well in mid-corporate and industry verticals and commercial real estate, which helped to offset the effect of $1.2 billion in loans and leases transferred to non-core. U.S. was up 11 basis points reflecting higher short-term LIBOR rates.

Next let's move over to slide 18 and cover credit. Overall credit quality continued to improve reflecting our focus on growing high quality, lower risk retail loans compared with growth in the larger company segment of our commercial book which tends to be higher credit quality. Our non-performing loan ratio improved to 97 basis points of loans from 105 driven by a reduction in consumer real estate secured. The net charge off rate increased to 39 basis points. Our commercial net charge offs decreased $3 million from last quarter while retail net charge offs increased $24 million driven by lower recoveries in home equity from relatively high third quarter levels.

We also saw a $7 million increase in the auto portfolio related to a one time methodology change. Provision for credit losses of $102 million increased $16 million driven by a $14 million reduction in recoveries of prior period charge offs from relatively high third quarter levels. As we continue to grow at a higher quality retail portfolios and one of our non-core portfolio our allowance to loans and leases ratio has moved down modestly to 1.15%.

On slide 19 you can see that we continue to maintain strong capital liquidity positions. This quarter as part of our 2016 CCAR Plan we have repurchased $180 million in stock at an average price of $28.71 and returned $241 million to shareholders including dividends. As Bruce mentioned we announced a 17% increase in the dividend. We ended the quarter with a common equity Tier One ratio of 11.2%. As a reminder our CCAR capital plan targets, the repurchase of up to $260 million dollars in shares throughout the first half of 2017.

On slide 20 we show our progress against our strategic initiatives. We believe it's important to assess our progress against these initiatives each quarter. Importantly we continued to drive attractive loan growth across a number of areas. We have considerably made good progress over the past few quarters in mortgage ending the year with 538 loan officers ahead of our target. We fine tune our auto programs to enhance returns and we've seen really strong growth in our education refinance loan product which has attractive risk adjusted returns.

In wealth we've had some near term revenue headwinds as our sales mix is shifting towards more fee based business. But we have continued to add FCs and overall transaction volumes are up. Overall we are pleased with our results in commercial this year and we expect to continue to build on this strength. We launched our broker dealer this year which allows us to expand our capabilities and deepen relationships with existing customers. We've experienced strong growth in our mid corporate and industry verticals with particular success in healthcare and technology. We look for continued growth in our capital and global markets business given our strong loan syndication capabilities and enhanced interest rate product offerings.

Moving on to slide 21, the Top programs have successfully delivered efficiencies that have allowed us to sell fund investments to improve our platforms and product offerings. In 2016 our Top 2 program delivered $105 million in annual pretax benefits across our revenue and expense initiatives. Our Top 3 program launched in mid 2016 is on track to deliver $100 million to $115 million in 2017 benefits. We will keep working towards delivering greater benefits given our mindset of continuous improvement.

Slide 22 can be read at your leisure. Suffice it to say that we made good progress across consumer and commercial in terms of customer experience, market share, and product capabilities. On slide 23, you can see the steady progress we're making against our stated financial targets. Our adjusted return on tangible common equity of 8.43% improved 168 basis points year-over-year. Also our adjusted efficiency ratio improved 113 basis points linked quarter and 358 basis points versus the fourth quarter of 2015 and now stands at 62%. And EPS continues on a nice trajectory.

And with that let me turn it back to Bruce, thanks.

Bruce Van Saun

Thanks John. On slide 24 we identify the key to a successful 2017. Achieving good loan and deposit growth, expanding the NIM, progress on our fee businesses, strong expense discipline, and further capital normalization are key objectives very similar to 2016.

On slide 25 we detail the ambitious guidance that we gave last January for 2016 on the left side of the page and on the right side we show what we actually achieved. The good news here is that notwithstanding an adverse interest rate and GDP backdrop, we hit just about all of our targets. Very proud of the 4.2% positive operating leverage which is near best in peer group. Only miss was on fee growth which is taking somewhat longer than expected but, we feel we are on the right track.

On slide 26 and 27 we detail our guidance for 2017. Quite similar you’ll see to 2016 with good top line growth, 3% to 5% positive operating leverage target, further efficiency ratio improvement, and capital normalization. A few points of color, first slightly slower loan growth in commercial given higher rates which is offset by higher securities portfolio growth. So, overall earning asset growth about the same. Strong NIM improvement largely due to yield curve benefit that’ll be slightly less self-help benefit then in 2016. The provision continues to gradually normalize largely due to reserve bill tied to loan growth. Credit quality is expected to remain very strong, and LDR is projected at 98%, CET1 ratio at 10.7 to 10.9 with solid growth in our dividends.

Slide 28 provides some additional color on the NIM. We expect continued good discipline on how and where we play in the loan book and in raising deposits cost effectively. The rate curve as of December 31st delivers a benefit of slightly over a 100 million to 2017 NIM assuming two hikes in 2017 and continued steepness in the yield curve. This obviously will move around on us. So we'll see how things will actually play out.

On slide 29 you can see the NII walk, top of the page is 2016 bottom of the page is the 2017 target. We expect slightly lower earning asset growth and slightly lower NIM expansion as deposit betas and borrowing costs rise but overall a very strong 8% to 9% growth outlook for 2017.

On slide 30, we show the same format for expenses. The story again is very consistent from 2016 to 2017. Underlying expense growth of around 5% which includes merit and inflation increases as well as business growth spend supporting our strategic initiatives. This is partially offset by top efficiency initiatives of almost 2% bringing the net expense growth to around 3% to 3.5%.

On slide 31, we provide our guidance for Q1 relative to Q4. This is typically a seasonally softer quarter for us given several factors including day count, seasonal activity levels, and the FICA taxes associated with incentive compensation. We also pay our preferred stock dividends in Q1 and Q3 of each year. That said we feel good about the year-on-year comparison relative to 2016.

So to sum up on slide 32 we feel that we've delivered strong results in Q4 and for the full year of 2016. We will maintain our mindset of continuous improvement in 2017 and we will look to drive even more top program benefits. We also feel our balance sheet and capital and our credit position remained rock solid. So there's also lots of good stuff in the appendix in the supplemental materials which you can review at your convenience.

So with that operator Brad, we're ready to open up for some Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. And we will go to the line of Matt O'Connor with Deutsche Bank.

Matt O'Connor

Good morning.

Bruce Van Saun

Hi.

Matt O'Connor

If I could just follow up on the loan growth, obviously you guys have had very strong loan growth and still solid outlook, a little bit less now than you've seen and you mentioned less commercial loan growth given higher rates. Maybe you can just elaborate on that and in the consumer side as we think about the drivers of growth there and maybe less drag from home equity, just walk us through what you think on the consumer side?

Bruce Van Saun

Yes sure, I'll start and then Don and Brad can chime in with some color. But I think we really hit the ball out of the park with loan growth this year and pleased with what we were able to accomplish on both sides on commercial and consumer. I think a fair amount of the activity that you've seen on the commercial side has been companies that are taking advantage of lower rates doing some refinancing, doing some recaps, taking out dividends and doing -- putting some leverage back into their companies. And you've seen commercial real estate very, very robust and so I think as rates move up a little bit you'll see a little less of that activity. Although I do think if you see that the growth come through that the market is expecting that hopefully is made up with loan demand that really is in support of a faster growing real economy.

So we'll wait and see how that plays out. I think we're just marking it down a little bit. But having said that I think we have the same coverage force out there taking market share, winning on the battlefield with good ideas. So we'll continue to follow that playbook and then maybe we'll see some upside there.

On the consumer side I think there's also some rates impact that we would anticipate particularly around the mortgage areas or mortgage refi product. Obviously the opportunities there will be somewhat limited. Our hope is that with the bigger sales force that we've assembled that we can certainly make up for some of that and that the purchase market will stay strong during the year. We should also see a little bit of a shift towards more conforming products which also could crimp the mortgage growth on the balance sheet a little bit. But I think that's probably the main impact of the higher rates on the consumer side. There might be a little impact on Ed refi market but I still think many of the borrowers who are refinancing will still see it worthwhile to do that.

And then I think on a personal unsecured product generally people are coming off of very high cost revolving credit card debt into something quite a bit less from an interest rate standpoint. So I think that will be very modest if any impacts on that. So in general I think we will be looking to follow the playbook that we followed this year and should see very strong growth in the same areas that we saw this year. But we're being I think just appropriately a little cautious given the higher rates. I don't know guys, Don.

Donald H. McCree

No, I think mark down is the right word. And we saw a little bit of deceleration on the commercial side as we got to the back end of the year for exactly the reasons that we have cited. We're hopeful if the economy starts to take off that that we will see good loan demand but we're just not seeing it in the pipelines yet. The other thing that’s happening in some portions the portfolio is we're getting a little disintermediation as people hit the capital markets with the expectation that rates are going to go up. That's helping our fee lines a little bit so capturing…

Bruce Van Saun

Pipelines for fees Don.

Donald H. McCree

Pipeline for fees, so we're seeing a toggle between NII and the fee line a little bit, I think you characterized it correctly.

Brad L. Conner

Bruce, I think you cover it very well and the consumer side. The only thing I would add to it is we probably will see slowing growth in auto because we’re intentionally taping the brakes on auto. So and we've talked about this in previous quarters which is the pressure continues to be there in terms of the margin returns on that business. So that the growth we’re getting in the other asset classes in a little bit better risk adjusted returns were intentionally going back on the growth in auto. Okay.

Matt O'Connor

Okay, that’s good color. Thank you very much.

Operator

And your next question will come from Scott Siefers with Sandler O'Neill. Please go ahead.

Scott Siefers

Good morning guys. Obviously a pretty good margin performance this quarter and the outlook with of course benefit from high rates just curious Bruce what are you guys thinking about deposit cost as we sort of lean into a higher rate environment, I guess, the only thing that might be a little different about you guys as you start with a higher loan to deposit ratio but I am just curious what your overall thoughts are -- what you're seeing and what you would anticipate going forward?

Bruce Van Saun

I’ll start off and anybody here can chime in again but I think we have done a very good job of getting better at raising deposits costs effectively. And so one of the things that we -- as we were in the shrink mode in RBS is we've pretty much shooed away deposits on the commercial side and they were higher cost. And we I think on the consumer side had a fair amount of term and time which we had moved back out as well. So as we've kind of been growing the balance sheet, we've kind of I'd say growing our loan book at about 2X of our peers. We have to grow deposits 2X our peers given the relatively high LDR after the Chicago region sale.

It's been really important that we get that muscle back in terms of going out to commercial with strategies to raise deposits, to have balance in the industries that we're banking so that we have the chance and the opportunity to get some cash rich companies to put deposits with us. And on the consumer side to actually get much better at segmenting the customer base and making very targeted offers to different segments of the base that are appealing and just being sharper and not just posting one rate that everybody benefits from and then your whole back book re-prices.

So I think we've done we've made real strides in that regard. And so if you look at the overall borrowing costs this year. They're pretty flat deposit costs that inched up a little bit but you know I think on the other borrowing costs we did some retirement of higher costs sub debt and replaced it with senior debt in term FHLB borrowings. And so, I think we've done a pretty good job of managing the cost of borrowings overall. That game plan has to continue so, again if we're looking to grow loans at a good clip in 2017 we have to keep staying really sharp on the strategies, we have to grow those deposits cost effectively, and I think we can do that. So anyway, John, Don, Brad any color on that.

John Fawcett

I think in the short time I've been here and since the first time we did the road show with the public offering it's always been very clear that we're going to fund loan growth with customer deposits from the time that I have been back it's very obvious that there are dedicated programs and disciplines in place to make sure that continues to happen. I think it happened this year with 9% loan growth. That was a steep hill to climb and I think it was achieved in my sense is in the first quarter. We are doing just as well and deposit gathering is job won, so feels good.

Scott Siefers

Okay, perfect, I appreciate the thoughts. Thank you.

Bruce Van Saun

Okay Scott.

Operator

And the next question will come from Erika Najarian with Bank of America. Please go ahead.

Erika Najarian

Yes, good morning. You mentioned earlier that there's slightly going to be a toggle between fee growth this year versus NII and I am wondering if you could give us a little bit more color in terms of your confidence in hitting that 3% to 5% non-interest income growth target for the year and sort of what line should we look forward to in terms of more contribution for this year?

Bruce Van Saun

Yeah. So I say one of the things you can look at there Erika is in the in the Q4 results. We were up 4% on a year-on-year basis. So I think as the year has gone on we see some very strong performance on the commercial side capital markets as we've grown the overall relationships of the bank. We have more swings with the bat and we have really good capabilities in capital markets particularly our loan syndications area. And we're adding additional capabilities over time. So that is broadening out things like the bond to economics that we can now get with our broker dealer in place. So I feel very good about that.

I think our -- what we call global markets, the interest rate and FX risk management products, we've separated from RBS and we have put our own platform in place and it allows us to do a lot more frankly than we could when we had to back to back everything with RBS. So I think we're poised and positioned to continue growing there and we've been helped out a little bit by the environment with the volatility after Brexit and after the administration change in Washington. And hopefully I don't wish a lot of volatility on 2017 but I think we can anticipate some so that also feels pretty good.

And also the cash management side we've got some great product capabilities, we keep working to strengthen our core capabilities but things around our card products and payables are all very strong and have nice growth associated with them. So I think we're doing very well on the commercial side. The challenge has been more on the consumer side and there I think the -- it's -- we are seeing some good momentum in mortgage and the hiring, I think gives us confidence that we can put up some good numbers again in 2017.

Wealth we've had the hiring but we've had a mixed shift towards more fee based product sales which is great I think for the long-term but in the short-term it's replacing transaction oriented sales. And it hurts your revenues in the near-term. So we've had a little headwind on that. I think the lines cross at some point and again with the bigger sales force we should be able to see some growth in wealth next year. And I think just generally in service charges on deposit accounts we will continue to see some modest levels of growth if we keep that in the low single-digit range that helps because that is such a big category overall. So those are the areas that I would see and I think you can see a little bit of progress there on the Q4 year-over-year numbers.

Erika Najarian

Got it and my second question is speaking of volatility, if we do get some form of regulatory relief this year or next year, specifically as it relates to the definition of SIRI, a domestic SIRI in United States, how would you approach capital returns differently if at all and what is your view on the potential trajectory of regulatory related expenses over the next year or two?

John Fawcett

Sure, I think we have to wait and see how things play out. Our life pass down in terms of managing our capital position to peer levels has been I think well thought out and well telegraphed and so we've been coming down 40 or 50 basis points a year. We've pretty much been able to have our cake and eat it too, that we are funding very robust loan growth at almost 100% returns of capital to shareholders. And what we're trying to do obviously is get the ROTCE up to levels that are self-sustaining so we can do that in balance as opposed to meeting the draw down on that surplus capital account. I'm comfortable with that. I don't think that the being de-designated as a SIRI as the level goes up to 250. Obviously we will see what the peers are doing and whether they move down. We certainly are trying to move towards the peer so there might be some potential there. But I feel quite comfortable with the strategy that we've laid out and that we're executing against.

With respect to cost there could be potentially a little bit of a dividend there depending on whether you can do things I guess with a little less exactitude and the robustness that goes into the current requirements. I think a lot of the whole process is very worthwhile and we'll continue to do that. So I think there might be a small dividend but I wouldn't put it as something that really should move estimates to a material degree.

Erika Najarian

Got it, thank you.

Operator

And our next question will come from the line of Vivek Juneja with JP Morgan. Please go ahead.

Vivek Juneja

Hi, couple of things. Tax rate, Bruce you’ll give an outlook of 32% I know in Top 3 that’s one that you're working on, given that does that 32% in corporate debt benefit and if so why no change from 2016 to 2017?

Bruce Van Saun

Well we're growing income as you can see so, this year we grew our net income around 20% and we have again some very robust if you look at the midrange of the guidance you have very robust net income growth again. And so if the statutory rate stays high where it is for 2017 which I think most people anticipate, some of the credit program investments that we're making, the low income housing, or the wind farms and things like that you're doing those things just to kind of keep the rates where it is with the growth in income. So we'll keep looking for opportunities. I think the big event on the horizon would be corporate tax reform because clearly if something gets done this year and it's effective in 2018 with our tax rate at 32%, we could have a real meaningful benefit overall to the bottom line and to EPS and the growth fee. So we'll keep our eye on that. We'll keep working on this but, anyway I think that's probably reasonable guidance given the strong net income performance that we anticipate.

Vivek Juneja

Different question, capital account, you obviously had a nice jump in 2016 CCAR. At what point can we start to think about accelerating that to over 100% capital return?

Bruce Van Saun

Yeah well I think I just answered that in the last question. And we'll keep our eye on kind of where the peer group is going from an absolute level and where we think the requests of our couple banks that went over 100 in this last cycle but broadly speaking we like our derived path as we're still improving our growth fee in demonstrating that we are running the bank better and better. I think that gives us more confidence just to keep bringing it down but I think we’ll take that under advisement and see what's happening with the peers.

Vivek Juneja

Okay, thanks, sorry I missed that one, just lots of earnings today.

Bruce Van Saun

Yes, I got you.

Operator

And our next question will come from the line of Matt Burnell with Wells Fargo Securities. Please go ahead.

Matthew Burnell

Good morning, thanks for taking my question. Bruce I just want to dive into a couple of the comments that you've already made. One is on slide 20 with sort of the where you stand relative to most of your efforts across the bank to drive better performance. I guess I'm just curious in terms of the commercial of the mid-market businesses that signaled as being not quite fully where you wanted to be. Given the position of the bank as being a mid market bank, what do you need to do to fully color in that slide I guess for lack of a better phrase in 2017?

Bruce Van Saun

I'm going to start and John obviously can offer his thoughts on this. But I think that what we've seen in the middle market is --- and really that just for definitional purposes that companies with revenues up to about 500 million. So call it 25 million to 500 million that those companies have not grown much over the over the past few years. They've been cautious, they haven't been quite the level of loan demand that we're seeing with bigger companies. We've had some very nice growth in what we call mid corporate which is companies from 500 million to 2.5 billion. And so I think one of the things that we're hopeful of is that and we're hearing this from these investors is that with the change in administration and focus more on growth that maybe the animal spirits kick in and we see more loan demand coming from that sector.

I do think we've done a good job of strengthening the client relationships we have in middle market. We're seeing some modest growth in market share. We've closed the back door and so we -- I think we're doing a good job of keeping clients happy and in the house. And we're doing a good job of getting a bigger share of wallet and being able to offer some of our capital markets and risk management products. So there are some things that we like but there's also I think a backdrop that that part of the market hasn't been seeing robust growth. So, John why don’t you take it from there.

John Fawcett

Yes, so I think that's exactly right. It's been all about loan demand in the middle market and I think particularly the regulatory environment over the last several years has been very constraining in terms of mid market companies just engaging in any kind of expansion or M&A activity. We have had very strong fee growth and very strong deposit growth in our middle market business. And I think as Bruce said, as we turn into 2017 we begin to get some expansion in the economy. The early indicators coming out of the management teams and the Boards of the middle market companies is much more bullish in terms of where they want to take their businesses. One of the results of the slack on demand in the middle market has been incredible in terms of competition and very, very, very tough pricing environment.

So we've been disciplined in terms of where we do want to play and we've seen a little bit of a downward calibration of loan growth because of that. The other thing we're doing and I think people may have seen it is we've hired a team down in the Southeast to expand our business. Geographically it will be aimed slightly higher than the middle market at the outset because we're focused on credit quality as we move into a new region. But we are anticipating significant client account growth as we go into 2017 and the years beyond. So we are more optimistic than we were this time last year in terms of the environment that we are operating in and we are confident that our products and services are resonating well with our clients.

Matthew Burnell

Okay, and then for the second question I am just curious, you mentioned the higher rates potentially affecting demand on the commercial side for loan growth, looking on the consumer side presumably the consumer would be a little bit less affected by a 25 or 50 basis point increase in rates over the next year or so. But at what level of rates do you think consumers might begin to rethink the incremental dollar of debt that they put on to their balance sheet are we ways away from that or perhaps not so much?

Brad L. Conner

This is Brad. I think that really depends on the asset class is the answer. I think you're close to that point in mortgage because there's been a lot of momentum taken out of the mortgage refi market over the last year or so. So you are probably close to that point in mortgage. I think there's quite a bit of runway left on the education refi loan now. Certainly there will tranches to that. Most of what we refinanced in education loans were refi people out of fixed rate loans. So you kind of look at tranche over that but there's an enormous untapped market. So I think we're still quite a ways away from taking a significant piece of the market away. But those are really the two areas with mortgage refinance and student refinance where we see we might see some dampening as rates rise.

Bruce Van Saun

And I would also add to that, that in terms of credit card debt, I would say that is more a function of how people -- what people's outlook is than actually sensitivity to the interest rates there. So if in fact people feel that we have a little bit higher growth rate to look forward to for the next couple of years, that unemployment is at low levels and will continue to fall then I think the confidence of individuals to go out and buy things and sometimes finance on revolving debt is higher notwithstanding if the overall cost of debt is moving around.

Brad L. Conner

I completely agree with Bruce and by the way I would say that same thing holds true in the small business space. So we have seen very limited demand for small business loans over the last year mainly from a confidence perspective and if that comes back they are probably less sensitive to interest rate and we might see some loan demand that comes from this improved confidence.

Matthew Burnell

Thanks for the color.

Operator

And our next question will come from John Pancari with Evercore. Please go ahead.

John Pancari

Good morning

Bruce Van Saun

Hi.

John Pancari

I am sorry if I missed the comment on this at all earlier in the call but when it comes to the tax reform that could be coming under the Trump regime can you just give us your thoughts on how much you think could ultimately accrete to the bottom line at Citizens whether it be through any tax benefit or tax advantage investments that go away or if you're going to spend any of that potential benefit? Thanks.

Bruce Van Saun

I think most of it falls through actually John, we're operating with the Federal rate of 35 and if you got to something like 25 or 20 that would be a meaningful benefit to I think the whole regional banking group since we're all hovered around maybe 28 to 32 as our tax rate. There's little global allocation of resources that we have going on. So what we're left with is really investing in Federal tax credit programs or State tax planning and it really doesn't move the needle down that far from the Federal rates. So the big benefit is to get that Federal rate lower and I don't think the Federal credit programs since they're generally seen to promote investing in something's that are socially good such as alternative energy or low income housing. I'm not sure they're going to be negatively impacted but we'll have to wait and see how that plays out.

John Pancari

Okay, got it, thanks Bruce and related to that though, I feel like a broken record asking this on lot of these calls but it's important to get your take. Do you think that in that benefit that you do expect to accrete to the bottom line ends up getting competed away by the industry at all?

Bruce Van Saun

I don't know I mean John I’ll ask your view on this but I have seen some folks say that if you went into a credit relationship for example with a corporate you would try to get an after tax rate of return. If the tax rate goes down then you can offer the credit at lower spreads. I don't think that's the way the world works because I think the credit right now is offered very thin in terms of returns and the only way you can justify extending the credit is by having an overall broader relationship where you’re getting a cash management or you're getting to participate in their capital market needs or other needs. And so I think the industry would hopefully hold their discipline there and say gosh, this is good. We're going to see an overall improvement on the return on these relationships. John?

John Fawcett

I think that's exactly right and as we compete on the credit side every day we're competing in the public market the non-bank and other banks and as Bruce said I think pricing is very thin in terms of where margins hit today. So I don't think you’re going to see any kind of tax effective change in the returns we generated.

John Pancari

Got it, thank you. If I could just ask one more I know you commented on your deposit pricing and your efforts around that, can you just remind us what has been the data that you've seen so far from the recent Fed hike and then your expectation how that could play out if we see incremental hikes this year?

Bruce Van Saun

And we've had extremely low betas which you would expect early on with particularly the December 15th hike. They were close to zero. I think hike that just occurred is probably maybe 15% to 20%. It is probably a little lower on the consumer side and a little more than that on the commercial side but kind of blending out to those levels. And I think you'll see a very gradual retracement up towards a beta that kind of overall is probably 55% to 60% as you go back to a normalized natural rate. But I think you'll still see if there's a June hike beta that maybe 30 or 35 or something like that and just kind of inching your way back towards that kind of through the rate hike cycle overall level.

John Pancari

Got it. Thank you.

Operator

And our next question will come from Ken Zerbe with Morgan Stanley. Please go ahead.

Kenneth Zerbe

Hey, thanks, good morning. You guys had actually some pretty good growth in commercial real estate just wondered, are you able to tell that you're actually seeing a benefit from some of the increased regulatory scrutiny on some of the smaller weaker SIRI lenders I mean is that a factor in driving your SIRI growth or is it just not really relevant for you?

Bruce Van Saun

Yeah, I don't think that's palpable and I'll let Don throw some color here. But I think as I said before when we were owned by RBS we really stopped doing new lending and started to run our book down. And then as we embarked on our journey to independence we said boy, we're way underweight where peers are in commercial real estate and we turned the shop closed sign to shop open. We turned it around and went back to many of our long standing relationships and said hey, we're playing again and we want to develop the relationship and we're here to stay. And so a lot of this growth that we've experienced has been on the back of both strong growth in the market but then also regaining some of that lost market share.

So I say that's really why we've been able to come in kind of mid to high teens for two years in a row. When I look out the next year I think we will probably be closer to 10% at those levels but we still think that there's interesting projects to do. The money might be a little more circumspect with the higher rates but we still see good fundamental demand and we've rebuilt those relationships with developers and added some new ones to boot. So Don you…

Donald H. McCree

Like I said the only thing I will add to it is we have hired some key people which we've been able to build the franchise again. I think and the other thing I'd say is we have maintained a really high level of discipline about what we would do in terms of pricing structures. So we've actually seen returns in the real estate business creep up as we've grown. So we've been very disciplined in terms of what we've been targeting. And I would say that the only thing with the margin in terms of competitive environment we stay pretty consistent through the year and we grew our book pretty straight line through the year. We saw some people kind of pull away a little bit from the market as they filled up their real estate baskets towards the end of the year. So we might have benefited slightly at the margin at the end of the year. But as Bruce said it's really about reinvigorating the franchise, doing some key hires, and then being consistent in the marketplace.

Kenneth Zerbe

Alright, perfect, thank you very much.

Operator

And the next question will come from Kevin Barker with Piper Jaffrey. Please go ahead.

Kevin Barker

Good morning, you guys mentioned that you had a couple rate hikes in your outlook for NIM going forward but you also made a mention that you assume the continued steepness of the yield curve, are your assuming that the yield curve stays where it is or it continues to steepen from current levels?

Bruce Van Saun

Well if you look at the guidance page that we showed, we showed that kind of ten year in a 250 to 275 range. So, I think there would likely be a parallel shift if we have a mid-year hike. But it could just be kind of stay where it is. But that's kind of NIM here. We break out on one of the slides what the impact is of having the curve move up so that the ten years in a 240 to 250 range and we would anticipate that it's likely to stay there and then potentially drift up. So we didn't see that happen in 2016. We actually saw, ten year plummet all the way down to 150 to 160 which created some real headwinds. But at this point with the ten years where it is and the curve where it is, one of the nice things we have going on is that as mortgage cash flow comes in off the securities portfolio we're putting it back out at rates that are either neutral or slightly accretive to what's coming off the books. And so that's a real help. So, that is baked into our forecast and let's hope that that's what we see.

Kevin Barker

And then also on the auto portfolio I understand net charge offs were up roughly 27 basis points on a year-over-year basis and you mentioned about 70 basis points was normalized last quarter. Do you have a new view on a normalized level given the changes in your methodology on assessing auto credit?

Bruce Van Saun

You are talking about the new charge off rate. Charge off rate yes, should be in the low 50's would be our expectation. I don't -- I think we had this one time change in terms of how we were accounting for the repossessions which is now behind us and I think we are anticipating stability in the auto charge off rate going forward.

Ellen A. Taylor

Yeah, Kevin I will just add, if you look at our NPLs as a forward indicator of sort of charge off levels going forward, we think they're at normalized level this quarter.

Kevin Barker

So absent the methodology change where would the charge off level come in?

Ellen A. Taylor

In auto that would have been roughly -- to our total charge.

Bruce Van Saun

Are you talking auto Kevin…

Kevin Barker

In auto portfolio in particular.

Bruce Van Saun

Yes auto, yeah I think to this quarter it would have been in the neighborhood of 10 to 12 basis points for auto.

Kevin Barker

Okay.

Operator

And our next question will come from David Eads with UBS.

David Eads

Hi, good morning. I think you talked about expanding some of these consumer lending programs, the dividends and I think you're going to announce another one obviously the other one seems to be going pretty well. Can you just give a little more color on kind of the trajectory for that, whether it continues growing at where some of the levels where it is growing now and how large you kind of like that portfolio to total kind of secured consumer portfolio to get?

Bruce Van Saun

I’ll start and pass to Brad but I think we've had a two pronged strategy here. So one is the partnership model where we're aligning ourselves with partners and helping them offer the installment credit to their customers. So Apple driven are two of the examples of that and had very nice growth with the Apple balances and I think they're -- they feel that we're doing a good job in terms of the customer experience. So that's been a great relationship and we've kind of wedded the whistle here and said there's another one coming soon. So you will just pay attention but we have another one in the works, but that's one factor.

The other factor has been on just the personal unsecured direct product that we're offering through the branches and direct mail largely to the footprint and it's targeting folks who have high revolving debt balances who can have a debt consolidation opportunity into a personal unsecured loan that offers a more attractive interest rate. And we've seen really good take up on that and I think again there we’re being very selective, one of the things that's consistent across these programs is a very strong credit discipline trying to keep the FICA scores well ahead of 750.

And so I think the risk adjusted returns look pretty good for both sides of the equation. But they're still running room so I think you'll see similar growth to what we've seen this year again next year. We're not bumping up against any limits. One of the things that we have that we wish we didn't have is a relatively smallish credit card portfolio. So when you look at that straight unsecured this is another way to play that game and to get in that game and do it in a way that is more accretive more quickly than if we were trying to build up the card book. So Brad…

Brad L. Conner

Bruce I think you covered it extremely well. I think we would expect new growth rates to be somewhere in the range of what we've seen in the last few quarters. The organic demand for the Apple like programs continues to be there when I say organic we have retailers coming to us wanting to talk about the program. We do expect to add another program very soon and I would say there's a pipeline building of people that are interested. So the opportunity is there, we're being incredibly disciplined to just monitor the overall credit results. So far they look great. It is a very high prime customer base that we're dealing with so continued good opportunity.

David Eads

Alright, great Then maybe one quick follow up, on deposit beta, looking at the NII outlooks supplied on slide 29 where you have your loan yield and then a higher deposit cost is about half of that, is that implying that you have kind of baked in something like a 50% deposit beta in the NII outlooks slide and could that be conservative or how do those dynamics play out?

Bruce Van Saun

Yeah, I think that there could be some conservatism built into that. I think it's not just the deposit beta there is also the fact that we're growing the loan and deposit base 2X versus client. So it's hard to kind of discern is it just from the yield curve impact versus the fact that we are growing deposits a bit faster than peers. But I think that's what's in that and the good news there is that the NIM should still expand in a fairly robust fashion

David Eads

Thanks for the color.

Operator

And we’ll go to the line of Ken Usdin with Jefferies. Please go ahead.

Kenneth Usdin

Thanks, good morning. Hey, Bruce with the really good progress you're now you're making on ROE and your medium term goal of 10%. Given your expectation for rate hikes to happen just wondering if you could give us any color in terms of do you have a line of sight now on when you think 10% is doable now that we're kind of getting in ear shot of it?

Bruce Van Saun

Yeah, I've been fairly consistent that I'm not -- I don't want to get pinned on this because there's been a lot of anticipation of rate hikes or yield curve movement that hasn't happened. But I guess just as background if you look at the trajectory we are on, we've added about 4% over three years to the ROTCE with very little of any rate benefit. And year-on-year the ROTCE was up to eight four in the fourth quarter and that's up 1.7% from where it was in the fourth quarter of 2015. And we've had really no rate hike benefit in that. So it's clearly possible that we're in striking distance of the 10% ROTCE if we continue to execute well and we get some hikes that help provide a little bit of tailwind. But again I'm not going to put a line in the sand and chase it. I just think if we keep doing what we're doing, we keep executing well the ROTCE is moving in the right direction and we'll get there hopefully reasonably soon.

Kenneth Usdin

Okay, and then second question just on credit which just continues to be really good and I know I heard the comments about expecting some normalization but where at all would you even see normalization. It seems like you could still have it done with the way that the underlying trends are going where would you even expect any changes to be happening underneath on the credit side?

Bruce Van Saun

I would, the normalization to me is probably more in the provision line than it is in charge offs. So we saw a little bit of movement in the commercial side this year from basically nothing to maybe 10 basis points that cannot move into a 10 to 15 basis point level in 2017 sure. But I still think it's -- we don't see any big migrations or anything but you've been living on the good side of life for a long time so you should expect I think a little move higher. On the consumer side we've basically had less good assets from a credit quality standpoint like our non-core and service by others running off. And we are replacing it with really high prime and super prime Ed refi and some of this unsecured which I think is helping to also improve the overall credit quality on the consumer side.

But we had at those kind of clean ups have occurred and those run down have occurred, we've benefited from that in terms of having offset to the normal provision bill that you would expect as you're growing the loan book the way we are growing the loan books. So when we give our outlook for next year I think there might be a little bit of that -- less of that back book clean up effect that means that you could see more of a reserve build. But I really don't see tremendous movement at all in the charge off rates.

Kenneth Usdin

Okay, thanks a lot.

Operator

Your next question comes from the line of I have Geoffrey Elliott from Autonomous Research. Please go ahead.

Geoffrey Elliott

Hello, good morning. Thanks for taking the questions. On the partnerships that adding Apple being one but I know there are a few offers, what are you watching there to make sure that you don't run into credit issues down the line, what are the kind of early indicators that you can focus on to make sure if you do one of those partnerships and it doesn't work out, you pay it back pretty quickly?

Bruce Van Saun

Yeah, I think the answer to that is the traditional credit measures metrics, right. So, the first is through the door of credit quality so we were at that income ratio, the FICO score through the credit metrics which look extraordinary and then we are incredibly diligent around looking at the early loss emergence curves. So, what these early stage delinquencies look like if any we have the early loss emergence curves look like, we can get a feel for the loss emergence current versus what we priced for then in three to four months of the origination and I would say we just feel very good about that up until this point in time. We've got over a year under our belt now with the Apple program. So we are starting to get a really good feel for how these things, how these things mature and develop over time and they are relatively short term assets. So you get a pretty good feel really on.

John Fawcett

Yeah and I would just add some color that it seems hard that you can achieve this. But we're achieving it. It's almost what I would refer to as the hat trick for two years. But we are you know focused on improving our asset yields, improving the risk adjusted returns on these portfolios, and actually seeing if our stress losses picture can improve and we've actually achieved that. And it's partly because we've run off some of the higher risk stuff and we’re replacing it with better quality stuff. And so that’s been really impactful on the consumer side to be able to achieve that.

Brad L. Conner

Just one more thing to add to Bruce our standard model calls for risks sharing with our partner as well so there's a vested interest in our partner in and through the quality which is a big factor in these programs.

Geoffrey Elliott

And just to follow up on that, there is only one Apple and there are lots of banks out there. So when you're competing for this sort of partnership, what is it that sets you apart, there must be something that you are doing different or better or pitching better that means they want to partner with you rather than somebody else so...?

Bruce Van Saun

On the -- I think this sounds very basic but I know it’s true which is being able to provide extraordinary customer experience. Apple in particular of all the partners that we are working with and expecting this to be a value add program and expect us to be able to provide a customer service level that's consistent with the brand and that their own expectation and I think we've been able to do that. We are getting very good feedback from our partners that we are doing that well and I think that's the key. And obviously understanding the credit risk as well.

John Fawcett

I think it how we do business, how we look to partner in line with the customer objectives has been good. And I think we’re of the size that we can -- these are very big important relations to us and so we put a lot into making sure that we're doing a good job.

Geoffrey Elliott

Thank you.

Operator

And our next question will come from the line of Scott Valentin with Compass Point. Please go ahead.

Scott Valentin

Thanks my questions have been asked and answered. Thank you.

Bruce Van Saun

Okay.

Operator

And no further questions at this time.

Bruce Van Saun

So, great. Very much appreciate everybody dialing in today. We do appreciate your interest and we look forward to another year of focused execution. So, have a great day.

Operator

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

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