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Edited Transcript of CFG earnings conference call or presentation 20-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Citizens Financial Group Inc Earnings Call

Providence Apr 21, 2017 (Thomson StreetEvents) -- Edited Transcript of Citizens Financial Group Inc earnings conference call or presentation Thursday, April 20, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brad L. Conner

Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank

* Bruce W. Van Saun

Citizens Financial Group, Inc. - Chairman and CEO

* Donald H. McCree

Citizens Financial Group, Inc. - Vice Chairman and Head of Commercial Banking Division

* Ellen A. Taylor

Citizens Financial Group, Inc. - Head of IR and EVP

* John F. Woods

Citizens Financial Group, Inc. - CFO and EVP

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Conference Call Participants

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* David Eads

UBS Investment Bank, Research Division - Director and Equity Research Analyst

* John G. Pancari

Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst

* Matthew Hart Burnell

Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst

* Richard Lee Dodds

Deutsche Bank AG, Research Division - Research Associate

* Scott Jean Valentin

Compass Point Research & Trading, LLC, Research Division - MD and Research Analyst

* Vivek Juneja

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to Citizens Financial Group First Quarter 2017 Earnings Conference Call. My name is Brad. I'll be your operator on the call today. (Operator Instructions) As a reminder, this event is being recorded.

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

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Ellen A. Taylor, Citizens Financial Group, Inc. - Head of IR and EVP [2]

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Thanks so much, Brad, and good morning to all of you. We're really pleased that you have joined us this morning. We're going to start things off with our Chairman and CEO, Bruce Van Saun; and our new CFO, John Woods, covering the highlights of our results, and then we'll open up the call for questions. Also joining us on the call today are Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking.

Of course, I have to remind everyone that in addition to today's press release, we've also provided a presentation and financial supplement and these you can find those at investor.citizensbank.com. And 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 those results to differ materially from expectations in our SEC filings, including the Form 8-K filed today. We also provide non-GAAP financial measures and information and reconciliation of those measures to GAAP in our SEC filings and earnings materials.

With that, I'll hand it over to Bruce.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [3]

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Good morning, everyone, and thanks for joining our call today. We are pleased to report another quarter of strong results picking up where we left off in Q4 and well-positioned to continue our momentum going forward.

We're doing an excellent job of executing on our strategic initiatives, taking care of our customers and demonstrating a mindset of continuous improvement and how we're running the bank. The highlights of the quarter from my perspective include strong loan and deposit growth, good net interest margin expansion, excellent results in our fee-based businesses and good control of expenses. Revenue growth was 12% year-on-year, positive operating leverage was 7%. This drove ROTCE higher, reaching 90% (sic) [ 9% ] after excluding our nonrecurring tax benefits. Our efficiency ratio is now at 61.7% and NIM is at 2.96%. I'd like to recognize our commercial bankers for an exceptionally strong quarter.

We’ve built great platforms in capital markets and in our FX and interest rate management businesses and attracted first-class talent. We also continue to up our game through an ongoing investment program in Treasury Solutions. We’ve added great coverage bankers and our team approach to how we cover clients and provide tailored solutions is really paying off.

This quarter shows the quality, strength and potential of each of these businesses. I'm also pleased at our continuing ability to innovate. Our Apple partnership is going well. We've added 2 more partners and have a nice pipeline as well.

We continue to access FinTech capabilities through partnerships, and we will roll out our robo-advisory product to clients this quarter. And our Ed refi loan products continue to address a real market need. We have stayed nimble on how and where we deploy our capital with balanced and attractive loan growth in both Consumer and Commercial. Growth in Consumer is expected to continue in Mortgage, personal unsecured and student lending. We have ended our flow agreement with SCUSA on auto loans, part of an overall strategy to shrink our auto loan book. We continue with our SoFi flow agreement on Education Refinance loans. We've been pleased with the results to date. And we remain focused in Commercial on those borrowers and industry segments where we see growth and an ability to develop a meaningful relationship.

At the risk of stealing John's thunder, we're working through a TOP IV program and hope to have it ready by our Q2 earnings call to provide you with some details. I believe that this ability to consistently find ways to run the bank better and tap the potential of our franchise is a key differentiator of Citizens relative to our peers.

So with that, let me turn it over to our new CFO, John Woods, to offer his first impressions and then take you through the numbers. John?

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [4]

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Thanks, Bruce. Good morning, everyone. I'd like to first say that I am extremely pleased to have the opportunity to join Bruce and the Citizens team on the journey to build a top-performing bank. Since the IPO, Bruce and the team have made tremendous progress with great momentum coming into 2017. Since my early days here at Citizens, I am taking on the leadership in 3 high-priority areas. First, balance sheet funding optimization; second, continuation of our TOP initiatives to grow the bottom line and self-fund strategic initiatives; and third, partnering with Don and Brad in driving fee-revenue growth. We had some success in these areas, and I hope to contribute to further enhancements going forward. I'm impressed by the quality of our leadership team and a clear understanding of our direction and what we're trying to achieve. In short, I'm excited about the opportunities that lie before us.

So with that, let's jump into our first quarter financials, which start on Slide 4. We generated record net income of $320 million and diluted EPS of $0.61 per share. These results were up 13% and 11% linked-quarter and up 43% and 49%, respectively, year-over-year. I'd like to remind you that we did benefit from approximately $23 million related to the settlement of certain state tax matters that lowered the tax rate by 5.2 percentage points and added $0.04 to EPS. Excluding the tax settlement impact, net income was up 33%, EPS was up 39% and the tax rate would have been 31.6%. Note also that under new accounting rules for equity compensation, we had a modest benefit in tax expense. This has been included in our first quarter and full year guidance. Operating leverage was positive linked-quarter, and year-over-year we generated positive operating leverage of 7%, driven by revenue growth of 12%. Our net interest margin increased 6 basis points linked-quarter and 10 basis points year-over-year, and we improved our efficiency ratio 50 basis points from fourth quarter and roughly 4% year-on-year to 61.7%. These strong results reflect good execution of our strategic initiatives and our commitment to drive revenue growth, while maintaining operating expense discipline. Our ROTCE of 9.7% improved 1.3% from fourth quarter and 3.1% year-over-year.

On an underlying basis, ROTCE of 9% was up 55 basis points linked-quarter and 2.4 percentage points year-over-year. Taking a deeper look into NII and NIM on Slides 5 and 6, we continue to deliver strong balance sheet growth, which helped us to deliver a record $1 billion in NII. We grew average loans 1.5% linked-quarter and 8% year-over-year, and I'll provide some additional color on the growth in a few minutes.

Net interest margin improved 6 basis points linked-quarter and 10 basis points year-over-year, which reflects improving loan yields, thanks to the pickup in interest rates and the impact of our balance sheet optimization efforts. These benefits were partially offset by higher deposit and funding costs. The deposit costs increase reflects growth in commercial deposits over the quarter, the impact of higher interest rates and mix shift in consumer to more term and time. Note that we grew period-end deposits by over 2% in Q1, which reduced the spot LDR to 97%.

Turning to fees on Slide 7. Linked-quarter fees were up slightly as strong results in capital markets and card fees helped overcome some seasonal impacts. Linked-quarter service charges were slightly down, reflecting seasonality and day count. Card fees increased from revised contract terms commencing this quarter for core processing fees and a reduction in rewards expense. We had another record quarter in capital markets, driven by loan syndications, bond underwriting and advisory fees. We saw a $5 million increase in trust and investment services fees, thanks to higher investment sales volumes, as we've added wealth advisors and continue to invest significantly in our wealth platform.

Foreign exchange and interest rate products fees were down modestly from strong fourth quarter levels, while mortgage banking fees were down from fourth quarter levels that included higher MSR valuations and higher origination volumes. On a year-over-year basis, we delivered outstanding noninterest income growth, which was up $49 million or 15%. The story is much the same, as the biggest drivers of improvement came from capital markets, card fees and foreign exchange and interest rate products income.

Turning to expenses on Slide 8. We saw a slight increase in linked-quarter expenses, largely as a seasonal increase in salaries and benefits and occupancy, was partially offset by lower insurance, fraud and regulatory costs, outside services and equipment expense.

Compared to first quarter 2016, expenses increased 5%, but there's some noise in those numbers that I want to call out for you that elevate the growth in salaries and benefits and other expense line. The biggest driver was an increase in salaries and benefits of $19 million, but that includes a change in the timing of incentive payments. Last year, the payment was made in second quarter and we pulled this forward this year into the first quarter, impacting payroll taxes and 401(k) expense. Other expense increased $11 million, which includes the impact of the FDIC insurance surcharge, which was not a factor in 1Q '16. When you exclude those items, the year-over-year expense growth rate was closer to 3%.

Let's move on and discuss the balance sheet.

On Slide 9, you can see the continued benefit of our efforts to grow our balance sheet and expand our NIM. We grew average loans 1.5% linked-quarter and 8% year-over-year, reflecting growth across most of our commercial business lines and in education, mortgage and unsecured retail on the consumer side. NIM was up 6 basis points in the quarter and 10 basis points year-over-year reflecting improved loan yields partially offset by higher deposit costs. We've done a nice job of improving our loan yields giving our balance sheet optimization efforts along with greater discipline on pricing. We've also benefited from higher LIBOR during the quarter as the market anticipated the tightening by the Fed. We remain well positioned to capitalize on the rising rate environment with asset sensitivity to a gradual rise in rates at 6% as the quarter end.

On Pages 10 and 11, we provide more detail on the loan growth in Consumer and Commercial. In Consumer, 6% average growth was led by continued expansion in education, residential mortgages and other unsecured retail loans, which was driven by our partnership with Apple and our new personal unsecured product. We continue to improve and enhance our portfolio mix by driving growth in higher-return categories. We are slowing growth in auto and that will likely accelerate in the back half of the year as our partnership with SCUSA comes to a close in April and we further reduce volumes in select geographic areas. As a result of these efforts in addition to higher rates, we expanded portfolio yields by 10 basis points in the quarter and 22 basis points year-over-year.

We also saw a nice growth in Commercial where we continue to execute well in Commercial Real Estate, Mid-corporate and Middle Market, Industry Verticals and Franchise Finance. The increase in rates and enhanced rigor around required portfolio returns have helped drive a 23 basis point improvement in yields linked-quarter and a 41 basis point increase year-over-year.

On Page 12, looking at the funding side, we saw a 5 basis point increase in our total funding costs with a 4 basis point increase in deposit costs, mostly tied to growth in Commercial deposits. Year-over-year, our cost of funds were up 9 basis points, reflecting substantial growth in higher-cost Commercial deposits to fund robust loan growth as well as the impact of higher rates and terming out some of our borrowed funds.

Next, let's move to Slide 13 and cover credit. Overall credit quality continues to be strong, reflecting the continued mix shift towards high-quality, lower-risk retail loans, paired with growth in the larger company segment of our Commercial book. The nonperforming loan ratio remained flat to fourth quarter levels at 97 basis points of loans and improved from 107 basis points a year ago. The net charge-off rate decreased to 33 basis points from more elevated 4Q levels that included a $7 million increase in the auto portfolio related to a onetime methodology change. Retail net charge-offs decreased $20 million, while our Commercial net charge-offs were up slightly. Provision for credit losses of $96 million decreased $6 million from relatively high fourth quarter levels. As we continue to grow higher quality retail portfolios, our allowance for total loans and leases ratio has moved down modestly to 1.13%.

On Slide 14, you can see that we continue to maintain strong capital and liquidity positions. This quarter, as part of our 2016 CCAR plan, we repurchased 3.4 million shares and returned over $200 million to shareholders, including dividends. We ended the quarter with a CET1 ratio of 11.2%. As a reminder, our CCAR capital plan targets the repurchase of up to $130 million in shares in the second quarter of 2017. It's also worth noting that total amount returned to shareholders to date through 3 quarters of the 2016 CCAR window is $756 million, including dividends.

On Slide 15, we show an update on progress against our strategic initiatives. I'd like to highlight that we continue to drive attractive loan growth across a number of areas. In Consumer, we’ve continued with strength in our mortgage loan officer recruitment efforts, reaching 560 at quarter end, which should help provide an offset to industry-wide origination headwinds. We’ve continued reducing the auto program to enhance return, and we've seen really strong growth in our Education Refinance loan products, which have attractive risk-adjusted returns. In wealth, we saw a nice lift in fees this quarter with the total investment sales up 13% linked quarter and 25% year-over-year.

We continue to make progress on a year-over-year basis in shifting the mix of our sales towards a more fee-based business, which came in at 36% compared to 14% in 1Q '16. In addition, our FC headcount is up 9%, which is contributing towards the scaling of the business. Commercial continues to deliver impressive results with the strong quarter in Capital and Global markets demonstrating the potential of these businesses given our expanded capabilities. The build out of Treasury Solutions is also on the right track with higher fee income growth linked quarter and year-over-year, along with strong momentum in our Commercial card program. Moving on to Slide 16. The TOP programs have successfully delivered efficiencies that have allowed us to self-fund investments to improve our platforms and product offerings. In 2016, our TOP II program delivered $105 million in annual pretax benefits across our revenue and expense initiatives. Our TOP III program, which launched in mid-2016, is on track to deliver targeted run rate benefits of $100 million to $115 million by the end of 2017. We have been working on a TOP IV program, and we expect to provide additional details on this on our second quarter call.

On Slide 17, you can see the steady progress we are making against our financial targets. Since 3Q '13, our ROTCE has improved from 4.3% to 9.7%, which equates to 9% on an underlying basis. Our efficiency ratio has improved by 6% over that same time frame from 68% to 62%. And EPS continues on a very strong trajectory as well, more than doubling from $0.26 to $0.57 on an underlying basis.

Let's turn to our second quarter outlook on Slide 18. We expect to produce linked-quarter loan growth of around 1.5% on a period-end basis and 1% on an average basis. We continue to project full year loan growth to be within the 5.5% to 7% full year guidance range. We also expect net interest margin to continue to expand by about 3 to 4 basis points linked quarter, given the forward curve benefit. In noninterest income, we are expecting to see a sequential decrease given the strong first quarter results in capital markets. The Commercial activity pipelines have moderated somewhat as the market reassesses the political and economic outlook. We expect to keep expenses broadly stable in the second quarter with positive operating leverage and efficiency improving. We expect stable to slightly high provision, reflecting loan growth with relatively stable net charge-off levels. And finally, we expect to manage our CET1 ratio to around 11.1%, and we will manage the average LDR to around 97% to 98%. With regard to the full year 2017 outlook, we broadly reaffirm on the balance sheet and expense guidance that we previously provided but expect to come in at or above the high end of the range for NII and operating leverage.

To sum up, on Slide 19, our strong results this quarter demonstrate our ability to continue to improve how we run the bank. We have delivered well against our strategic initiatives that help us drive underlying revenue growth and carefully manage our expense base. We remain committed to being prudent capital allocators and enhancing our returns for shareholders. In the second half of the year, we will continue to focus on execution and making further progress for all stakeholders. With that, let me turn it back to Bruce.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [5]

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Thanks, John. Before we start the Q&A, let me turn it over to Brad for some brief words on a media article on our Checkup program. Brad?

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [6]

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Great. Thanks, Bruce. We have confidence in the Checkup program as an important part of our strategy to serve customers well and ultimately be better positioned to deepen relationships. We believe it's important to note that recent media coverage did not suggest customer harm nor have we identified any. Nevertheless, we have commenced a thorough review to determine whether there are any issues in delivery of the program. Our current expectation is that we are in a good position based on feedback and survey results we already have. Our surveys show that customers who go through the review are highly satisfied and most would recommend the Checkup to someone else. An engagement and organizational health index of our branches is up, customer alignment is up and turnover is down since we moved to this mode of interaction with our branch-based customers. However, we're open to things we learn from the review that we can adjust to become even better. So back to you, Bruce.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [7]

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Okay. Thanks, Brad. And with that, operator, we're ready to open it up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from John Pancari with Evercore.

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John G. Pancari, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [2]

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Could you update us on your updated thoughts on the ROTCE expectation at this point? I know you had a target of 10% medium term. You're certainly close to that now. So could you talk about where you expect that could go over the course of the next year and how soon you can be up towards your original targets when you spun off?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [3]

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Yes, sure. John, I have repeatedly not want to be drawn into putting a pin in the exact timing that we get to the 10%. What I would say is that we've made nice progress kind of consistently last year and now in the first quarter and we're getting closer. A lot will depend on, first, the environment and continued movement in interest rates, which provide some tailwind and then our continued ability to execute on our strategic initiatives. So I think we have momentum. I think we're, as you say, getting relatively close. So hopefully, it won't be too long, but what I would ultimately say is that once we get to that 10%, we won't be satisfied. We will look out. We'll be doing our strategic planning effort this summer, and we'll consider whether at the appropriate time if it's appropriate to raise that target even higher.

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John G. Pancari, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [4]

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Okay, all right. And then separately just around the auto business, I know you indicated outside of the SCUSA purchases ending that you are shrinking that portfolio. So could you talk about the rationale behind it and the magnitude of the shrinking we could expect? And then separately, any update on credit there? Is that influencing that decision?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [5]

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Yes, it's really, and John, you can add to what I say or Brad, but I think that the real reason is that we grew the auto book when there wasn't much happening on the consumer side. So there was very little demand for credit from consumers except in the auto arena. So we ramped up our own self-originations and we supplemented that with the SCUSA flow agreement, which got us into the prime space and in the super prime space and delivering quite poor returns. Our view was always that the runoff in auto was a bridge to hold us and deploy some capital until ultimately the consumer came back and, if you will, got his mojo back, his or her mojo back, and so we're seeing that now. We've seen increase in demand for personal unsecured and revolving credit, student lending, mortgages. And so as those other portfolios grow, there's less need to have the auto, and frankly the auto, now that our returns have lifted, is dilutive to our overall ROTCE and overall returns. So I think you'll see us -- we probably peaked at maybe $14 billion in total loans balances. I think that will probably be lower by about $1 billion, and I would expect that trend to continue into next year. I don't know, John or Brad?

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [6]

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The only thing I would add is there was a specific question around is it in any way related to credit performance, the answer is no. Our credit performance has been strong, much -- right in line with our pricing expectations and our expectations. And to your point, it's all about the return on the business. It's not in any way related to the credit performance.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [7]

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Okay. Anything from you?

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [8]

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Yes, just getting back to the point about reallocating that capital to higher and better uses. I may have mentioned in my remarks that this generates higher risk-adjusted returns for us when we rotate that capital into those other Consumer businesses, so we're excited about that.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [9]

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Yes.

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Operator [10]

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

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David Eads, UBS Investment Bank, Research Division - Director and Equity Research Analyst [11]

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Welcome, John. Maybe starting with you, I think when you talked about kind of the strategic priorities, you started with opportunities for to optimize and improve on the funding side. I wanted to see if you can kind of give us a little more detail where you think opportunities might be there, whether it's on the Consumer side or Commercial side. And whether exactly how you think that's going to end up? What opportunities are going to be shaking out given the changes to the dynamics for deposit given higher rates?

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [12]

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Yes, thanks. And I think I would just talk about it on both sides and partnering with Don and Brad on this. In early days, there's been nice momentum in both of those businesses on funding. I'd say that we're entering into an environment here, which we'll all talk about rising rates and how we all operate in that environment. But looking forward, when you look at overall balance sheet, we're looking to remix and as we just talked about on the asset side, it’s a better use of that capital, we're constantly looking for better ways to fund that portfolio and that's part of our franchise. And we have some momentum there in terms of getting the right mix of Commercial and Consumer, so I think you'll see a bit more on the Commercial side and getting a better representation of Commercial deposits in our footprint. And there's also we've seen good control of deposit cost in the Consumer side. So like everybody, we're going constantly to look at that and look for ways to better fund the balance sheet.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [13]

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Brad, do you want to add some of the initiatives maybe that you have going on in Consumer, the targeting of -- the segmentation of the customer base, mining products and having data analytics to really tease out the products from -- with good offers to different segments of the base.

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [14]

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Yes, you bet. A couple things we've done. And I think we talked about this a little bit on last quarter's call. We have redesigned our value proposition for our Mass and Affluent consumers. I think we've got a much better value proposition to serve the needs of those customers. And we invested very heavily in analytics and really understanding our customer segments and how to reach them with very specific and targeted offers so that our offers are much less about putting broad offers out, if you will, across the entire branch base, but targeting the specific customers and specific customer sets. And we think that will really allow us to be much more efficient in driving lower-cost deposits.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [15]

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Yes, and Don, you're also looking to focus on where the opportunities are for deposits?

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Donald H. McCree, Citizens Financial Group, Inc. - Vice Chairman and Head of Commercial Banking Division [16]

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Yes, I mean, I think we've gotten materially more sophisticated with our deposit strategies over the last couple quarters and added staff and added specific programs and added an industry-based focus to where [ pooled ] deposits that are attractive and attractively priced are, so we’re very confident up there.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [17]

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And we'll start to emphasize some of the industry segments that have -- that are cash rich as opposed to kind of credit-needy. I think that’s part of the rotation that we're looking at as well.

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Donald H. McCree, Citizens Financial Group, Inc. - Vice Chairman and Head of Commercial Banking Division [18]

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Right.

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John G. Pancari, Evercore ISI, Research Division - Senior MD, Senior Equity Research Analyst and Fundamental Research Analyst [19]

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That's all very helpful. And maybe a separate question, obviously a really good quarter on the fee side. You talked about maybe a little bit of pullback on the capital markets. I'm curious, is -- should -- is the expectation that this step-up in the card fee line should be sustainable and kind of maybe fluctuating but broadly sustainable at this higher level?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [20]

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Yes, let me take that and then I'll go for my partners for color. But first off, with respect to capital markets, it really was an exceptionally strong quarter and I think it really shows that we've built some great capabilities. We had to move off of being a partner with RBS for many of these products, and we've now stood them up on our own. We've got really good teamwork going between coverage bankers and our product specialists. And we're making great traction and the market conditions were very favorable and I think we hit the ball out of the park. I think what we're cautioning is that we were at record levels when the capital markets fees were in the mid-30s very recently, we just hit a 48. I still think the numbers this year, the outlook is strong, but it's kind of capturing lightning in the bottle at this point for 48. But like I used to kid with Don and his team, when we were in the 20s, 30s, the new 20 and then we were in the 30s, 40s, the new 30, so I think we will continue to see as we build up our book of customers and continue to expand our capabilities that will push that number higher over time. On the cards side, what I would say is that, look, the renegotiations that we had with our core processing vendors creates a sustainable lift. There was some rewards expense adjustment in the quarter, which would not repeat, but that will be partially offset by seasonality in Q2. So I think we'll see a good percentage of this lift stick, but not all. So, Don, I don't know if you want to add color.

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Donald H. McCree, Citizens Financial Group, Inc. - Vice Chairman and Head of Commercial Banking Division [21]

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No, I think you're exactly right on capital markets. I mean, the only thing I'd add is that it is incredibly competitive out there right now and aggressive, so we're trying to maintain a level of discipline on the transactions we do. Highly encouraged by the quality of the franchise, and the transactions that we are doing, we're winning a disproportionate share of what we're seeing. So as you said, it's a function of activity in the market, discipline and then quality of franchise and I think we will continue to have strong quarters going forward. Our Treasury services business, just to mention that in my other fee line, has got tremendous momentum in it, and it's really led by card, which is growing at 30% to 40% a year, so that's the way to the future in terms of our Treasury business, so encouraged on both of them.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [22]

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Yes.

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [23]

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Really nothing to add, Bruce. I think you said it right.

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Operator [24]

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And our next question will come from Matt Burnell with Wells Fargo Securities.

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Matthew Hart Burnell, Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst [25]

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Maybe just focusing for a minute on commercial lending. What are the trends you're seeing there in terms of demand by size or maybe industry verticals? A couple of your competitors over the last few days have mentioned a growing demand in midmarket and maybe below midmarket relative to where it's been the last few quarters. Can you give us a little more color in terms of those trends and the utilization rates?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [26]

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Don, you want to take that?

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Donald H. McCree, Citizens Financial Group, Inc. - Vice Chairman and Head of Commercial Banking Division [27]

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I'd say utilization, just to start with that, it's up slightly, not in a material way. So we're seeing pretty standard utilization. Our pipelines in our midmarket business are actually quite strong. And the question is what closes and when does it close and how does demand continue to materialize? We saw quite robust kind of conversations and demands early in the year off the back of the change in administration. And I would say, given some of the uncertainty of delivery of some of those programs and potential delay into the back end of the year, it's moderated a little bit. But we're encouraged by what we're seeing in terms of pipeline growth and activity in conversations. I will say that it's been offset by 2 other factors. One is there's been very tremendous capital markets activity and in our mid-corporate and some of our Industry Vertical businesses, we've seen a lot of refinancings into the capital markets given the strength of the capital markets. You can see that in our fee lines as we capture some of that opportunity. And at the margin, we've gotten more disciplined on returns, so we're terming certain parts of the book to try to build better returning portfolios. So we've seen shrinking places like our leasing business, which has been offset by growth in other parts of our business. So I guess I'd summarize it by saying client activity is strong. We think the franchise is strong. We're adding a lot of new clients, so we're optimistic as we look out through the next several quarters. Whether it materializes in the second quarter or third quarter is a timing question that's in the back of my mind.

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Matthew Hart Burnell, Wells Fargo Securities, LLC, Research Division - Senior Financial Services Equity Analyst [28]

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And just staying on the idea of Commercial, you've mentioned a couple of times so far on this call about growing Commercial deposits prudently. And I'm curious, John, if you think that that's going to add to pressure in terms of deposit beta over the -- relative to what your prior expectations have been?

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [29]

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I think we have talked a little bit about how the funds are being deployed as well. You've heard on that a little bit earlier, we're putting that money to good use. We're making prudent decisions on the pricing side, and we have -- we're doing better on the loan yields side, so you've got to look at both sides of the balance sheet there when you talk about what we're doing with those funds. Sure, Commercial deposits have a bit higher beta than the Consumer deposits. But as you heard earlier from Don, we are underpenetrated on that side. We've got some very interesting things going on in the products front that will help to create some momentum on raising Commercial deposits. And we feel good about where that will go in terms of from a mix standpoint and how we will put that capital and liquidity to work.

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Operator [30]

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And our next question will come from Matt O'Connor with Deutsche Bank.

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Richard Lee Dodds, Deutsche Bank AG, Research Division - Research Associate [31]

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This is actually Ricky Dodds from Matt's team. Just a quick question on the build out in wealth and mortgage. It seems to be going pretty well and appreciate the update and the press release. Just wondering if you could give a little more color on sort of what's left to do there? And how you think you guys are doing on the build versus maybe your initial expectations?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [32]

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Brad, you want to take that?

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [33]

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Sure. I would say, we're feeling pretty good about both of those areas. I will start with mortgage. We’re up 22 LOs this quarter, up 125 year-on-year. I think the key for us has been, we feel really good about the progress we're making in turning our operations around. So we've really seen improvement in our customer satisfaction operations, which has allowed us to recruit loan officers and retain loan officers. Obviously the entire industry is seeing a little bit of slowdown in terms of demand. But all in all, we feel good and the progress that we're making with hiring our loan officers had been in more conforming geographies as well, which will help drive fee income. So we feel very good about that. I'd say on the wealth side, it was a good quarter for us, and we feel good about the progress we're making. We continue to see improved growth. We talked about it last quarter. One of the things that slowed our trajectory a little bit in growing fee income was a movement from, toward managed money, fee-based products and we're seeing that trend continue, but we feel like we've sort of crossed over that threshold where we're not yet at that sustainable source of fee income and so continuing to have good success and good progress. And I would say, maybe to your question about how do we feel against our original projections, we feel like we're pretty much on track there.

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [34]

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Well, I'd say, it's probably taken us longer to get here.

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [35]

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Taken us longer...

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John F. Woods, Citizens Financial Group, Inc. - CFO and EVP [36]

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But we have made some, I'd say, slight adjustments in the mortgage to make sure we're focusing on the conforming geographies and make sure we get fulfillment and servicing where it needs to be. And in wealth, I think we're just building it the right way, putting the right products in place. We're putting the right customer segmentation and delivery mechanisms in place. We've got the robo-advisory now up and running this quarter. So I'm really excited about really where both businesses are today and the outlook, although I'd say to be fair, it's taken us a little long to get there.

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Richard Lee Dodds, Deutsche Bank AG, Research Division - Research Associate [37]

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Okay, great. And just a quick one on occupancy cost this quarter. It looks like you called out about $5 million in branch rationalization or upgrade cost. Wonder if you can give a little color on that. And then, is that something we should expect going forward as you continue to sort of make improvements to your footprint?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [38]

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Yes, there's probably of that increase, I think it was maybe 3 or 4 was related to the branch charges. But what we're focused on here is what we call -- refer to as branch transformation, which is to take a look at all our branches and try to figure out how to reconfigure them. So in most instances, we don't need as much space as we have, so we want to reduce the overall square footage in the branches, and we want to take what was space dedicated to transactions and the remaining space should have more private rooms for conversations, so we can deliver advice to our customers, and we can also use the floor area, the entrance room for putting in some very sophisticated machines that people can do a lot of the banking that require tellers right on those machines. We're probably looking at a 10-year time line based on our lease expiries to get to all our branches and we're kind of in the early stages of that. So initially, you'll see the charges for the refurbs exceed what we get in terms of the back book of lower rent from the restructured branches. But as time goes by, that becomes a nice driver because ultimately, we'll be driving the occupancy expense lower and because of the less square footage, and that will swamp the cost of a handful of branches each quarter getting refurbished. So anyway, that's what you saw in Q1.

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Operator [39]

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(Operator Instructions) And we'll go to the line to Vivek Juneja with JPMorgan.

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Vivek Juneja, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [40]

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I wanted to talk a little bit about reserves, reserve levels for your loan portfolio, obviously credit's been very good, but how are you thinking about reserves to loans have come down a little further to 113 and where do you see that leveling out?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [41]

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Look, we're comfortable with where that is, Vivek, and I think it partly reflects the shift in some of the portfolios that you've seen. You've seen some runoff of some of the legacy poor assets serviced by other home equity portfolio being replaced with very high prime and super-prime consumer assets, which has been an upgrade. And I think in the Commercial side, you're seeing growth in the kind of Mid-corporate space, which tend to be higher rated credits. So I think it's really just an overall function of the decisions we're making in terms of how we play and where we play. If you look at the coverage ratios of things like NPLs, that continues to go up. And I think we're up to 118 on that basis. So overall, I think we're probably getting to a point where you won't see significant further reductions from that 113. But ultimately, if we keep working down the book of NPAs, you might see that number continue to improve somewhat. The other thing I'd say that's quite interesting is while we're focused on getting higher yields, and we're also improving the risk-adjusted returns on our loan book, we're seeing that our stress-test losses are actually reducing because of some of the impacts that I described of running off these legacy portfolios and putting really good quality back on the books. So you kind of have the hat trick in effect: better yields, better risk-adjusted returns and lower stress losses, which is really great to see.

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Vivek Juneja, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [42]

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Okay, great. You basically segued into my next question, which was CCAR. Can you talk a little bit about how you're thinking about that? And given your continued very strong capital levels, your plans for how you're thinking about capital return and capital deployment?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [43]

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Sure. And again, we've been, I think, very consistent and predictable that we've been on a glide path that we want to have strong returns of capital to shareholders and strong loan growth. The fact that we were birthed from RBS with a high capital ratio has allowed us that flexibility. We're coming closer and closer to where peers are, but we still have, I think, relatively high rates. So yes, I think you could expect more of the same in terms of our approach this year. When I think about what we want to do with capital, certainly, increasing the dividend; you saw us raise the dividend and the payout ratio is going up. We'd like that to continue, and we'll also want to continue to fund loan growth as a high priority, and then when we have excess, we'll use that to repurchase the shares. So that's it in a nutshell.

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Vivek Juneja, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [44]

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And are you still targeting, Bruce, as you look out what's kind of the target capital ratios other than me putting words in your mouth, let me just give that to what are you thinking where you would like to run with that?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [45]

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Well, we haven't really freshened that view. As you recall, when we did the IPO roadshow, we said we wanted to bring it down to around 11%. I think last year, we came from 11.7% to 11.2%-ish. So the glide path the past couple of years has been down 50 basis points or so. I think we'll cross over the 11% this year and still have a differential to peers, so I think this continued glide path can continue not only this year but into next year and so we'll stay tuned on that. We'll probably post you on that sometime the middle of the year.

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Operator [46]

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And our next question will come from Scott Valentin with Compass Point.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD and Research Analyst [47]

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Just on the unsecured portion of loan origination, just wondering, I know you guys use a combination of partnerships and, I guess, internal initiatives. Just wondering over time, if you plan to internalize all that or will partnerships remain a key component to driving that unsecured loan growth, consumer loan growth?

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [48]

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Let me start, and Brad can add some color on this. But clearly, we've had -- I think, we've taken the view that to grow our card portfolio is challenging because the payback period for actually growing that book takes some time. And so there were better uses of expense dollars to grow other portfolios. One of the things when we looked at the unsecured space and struck up the partnership with Apple was that the returns are accretive much faster, so we were able to make an investment to build the capabilities to support Apple. But then as the balances come on the books, we're not paying for 0 balance transfers and heavy marketing expenses. So we like that aspect about the program and the risk-adjusted returns on that portfolio are very good from our standpoint. We have, because of that, being partnered with an iconic company like Apple, we've had other reverse inquiries, and we've actually gone out and solicited some. So we've got 2 new partnerships set up that will gain some traction as the year goes by. One is with Vivint, a smart-alarm company, and the other is with HP, and they're -- stay tuned because there could be more in the works. So we like that capability that we've developed and partnering with real class companies and so that, I think, will be a growth feature going forward. We've also determined that there is an opportunity much the way with the Ed Refi lending product that we can offer attractive proposition to borrowers who are carrying high-cost debt. There’s other customers of ours who may be carrying multiple revolving credit balances who can consolidate that into an unsecured line of credit. And so we introduced our PERL product last year, and that has real traction too. So I think you'll probably see a combination of the 2. You'll see some direct mailing and branch offers to our customers on the PERL product and then married to an overall trust on the partnership side. So, Brad, you want to add to that?

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Brad L. Conner, Citizens Financial Group, Inc. - Vice Chairman of Consumer Banking, Vice Chairman of Citizens Bank and Head of Consumer Banking for Citizens Bank [49]

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Not much to add, Bruce, other than I think you said it right. I mean, we have a very, very high-quality list of other potential partners that have reached out to us. We think we have a unique capability and we think we can continue to expand there with a very attractive set of customers. I will just point out too that Vivint is a very good commercial bank customer of Don's, and we think this is also a way to build great synergy between the consumer and the commercial bank, and we will continue to look for those opportunities as well.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [50]

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Great.

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Operator [51]

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And there are no further questions in queue at this time. I'll turn it back over to Mr. Van Saun for closing remarks.

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Bruce W. Van Saun, Citizens Financial Group, Inc. - Chairman and CEO [52]

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Okay. Well, thanks again, everyone, for dialing in today. We really appreciate your interest. As I said in the press release, I think we're really firing well on all cylinders, remain very confident in our full year outlook. Thanks again, and have a good day.

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Operator [53]

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