10-Q 1 citizens10-qxq22018.htm 10-Q Document
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended
June 30, 2018

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From
(Not Applicable)
Commission File Number 001-36636
a5422139a7e5fcpreview620a15.jpg
(Exact name of the registrant as specified in its charter)
Delaware
 
05-0412693
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
One Citizens Plaza, Providence, RI 02903
(Address of principal executive offices, including zip code)
(401) 456-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.
[ü] Yes [ ] No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
[ü] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
[ü]
Accelerated filer
[ ]
Non-accelerated filer (Do not check if a smaller reporting company)
[ ]
Smaller reporting company
[ ]
 
 
Emerging growth company
[ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [ü] No
There were 475,946,441 shares of Registrant’s common stock ($0.01 par value) outstanding on August 1, 2018.




 
 
 
 
 
 
a5422139a7e5fcpreview620a15.jpg
 
 
 
 
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

CITIZENS FINANCIAL GROUP, INC.

 

GLOSSARY OF ACRONYMS AND TERMS
The following listing provides a comprehensive reference of common acronyms and terms we regularly use in our financial reporting:
AFS
 
Available for Sale
ALLL
 
Allowance for Loan and Lease Losses
AOCI
 
Accumulated Other Comprehensive Income (Loss)
ASU
 
Accounting Standards Update
ATM
 
Automated Teller Machine
Board of Directors
 
The Board of Directors of Citizens Financial Group, Inc.
bps
 
Basis Points
Capital Plan Rule
 
Federal Reserve’s Regulation Y Capital Plan Rule
CBNA
 
Citizens Bank, National Association
CBPA
 
Citizens Bank of Pennsylvania
CCAR
 
Comprehensive Capital Analysis and Review
CCB
 
Capital Conservation Buffer
CET1
 
Common Equity Tier 1
Citizens or CFG or the Company
 
Citizens Financial Group, Inc. and its Subsidiaries
CLTV
 
Combined Loan to Value
CMO
 
Collateralized Mortgage Obligation
DFAST
 
Dodd-Frank Act Stress Test
Dodd-Frank Act
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
EPS
 
Earnings Per Share
Exchange Act
 
The Securities Exchange Act of 1934
Fannie Mae (FNMA)
 
Federal National Mortgage Association
FDIA
 
Federal Deposit Insurance Act
FDIC
 
Federal Deposit Insurance Corporation
FHLB
 
Federal Home Loan Bank
FICO
 
Fair Isaac Corporation (credit rating)
FRB
 
Board of Governors of the Federal Reserve System and, as applicable, Federal Reserve Bank(s)

Freddie Mac (FHLMC)
 
Federal Home Loan Mortgage Corporation
FTP
 
Funds Transfer Pricing
GAAP
 
Accounting Principles Generally Accepted in the United States of America
Ginnie Mae (GNMA)
 
Government National Mortgage Association
HELOC
 
Home Equity Line of Credit
HTM
 
Held To Maturity
LCR
 
Liquidity Coverage Ratio
LIBOR
 
London Interbank Offered Rate
LIHTC
 
Low Income Housing Tax Credit
LTV
 
Loan to Value
MBS
 
Mortgage-Backed Securities
Mid-Atlantic
 
District of Columbia, Delaware, Maryland, New Jersey, New York, Pennsylvania, Virginia, and West Virginia
Midwest
 
Illinois, Indiana, Michigan, and Ohio
MD&A
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
MSRs
 
Mortgage Servicing Rights
New England
 
Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont
NM
 
Not meaningful

3

CITIZENS FINANCIAL GROUP, INC.

 

NSFR
 
Net Stable Funding Ratio
OCC
 
Office of the Comptroller of the Currency
OCI
 
Other Comprehensive Income (Loss)
Parent Company
 
Citizens Financial Group, Inc. (the Parent Company of Citizens Bank of Pennsylvania, Citizens Bank, National Association and other subsidiaries)
ROTCE
 
Return on Average Tangible Common Equity
RPA
 
Risk Participation Agreement
SBO
 
Serviced by Others portfolio
SEC
 
United States Securities and Exchange Commission
SVaR
 
Stressed Value at Risk
TDR
 
Troubled Debt Restructuring
VaR
 
Value at Risk
VIE
 
Variable Interest Entities




4

CITIZENS FINANCIAL GROUP, INC.

 

PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



5

CITIZENS FINANCIAL GROUP, INC.
FORWARD-LOOKING STATEMENTS



FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the Private Securities Litigation Reform Act of 1995. Statements regarding potential future share repurchases and future dividends are forward-looking statements. Also, any statement that does not describe historical or current facts is a forward-looking statement. These statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “goals,” “targets,” “initiatives,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would,” and “could.”

Forward-looking statements are based upon the current beliefs and expectations of management, and on information currently available to management. Our statements speak as of the date hereof, and we do not assume any obligation to update these statements or to update the reasons why actual results could differ from those contained in such statements in light of new information or future events. We caution you, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation:
Negative economic and political conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of nonperforming assets, charge-offs and provision expense;
The rate of growth in the economy and employment levels, as well as general business and economic conditions, and changes in the competitive environment;
Our ability to implement our business strategy, including the cost savings and efficiency components, and achieve our financial performance goals;
Our ability to meet heightened supervisory requirements and expectations;
Liabilities and business restrictions resulting from litigation and regulatory investigations;
Our capital and liquidity requirements (including under regulatory capital standards, such as the U.S. Basel III capital rules) and our ability to generate capital internally or raise capital on favorable terms;
The effect of changes in interest rates on our net interest income, net interest margin and our mortgage originations, mortgage servicing rights and mortgages held for sale;
Changes in interest rates and market liquidity, as well as the magnitude of such changes, which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets;
The effect of changes in the level of checking or savings account deposits on our funding costs and net interest margin;
Financial services reform and other current, pending or future legislation or regulation that could have a negative effect on our revenue and businesses, including the Dodd-Frank Act and other legislation and regulation relating to bank products and services;
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors or other service providers, including as a result of cyber-attacks; and
Management’s ability to identify and manage these and other risks.
In addition to the above factors, we also caution that the amount and timing of any future common stock dividends or share repurchases will depend on our financial condition, earnings, cash needs, regulatory constraints, capital requirements (including requirements of our subsidiaries), and any other factors that our Board of Directors deems relevant in making such a determination. Therefore, there can be no assurance that we will repurchase shares or pay any dividends to holders of our common stock, or as to the amount of any such repurchases or dividends.

More information about factors that could cause actual results to differ materially from those described in the forward-looking statements can be found in the “Risk Factors” section in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2017.

6

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

INTRODUCTION
Citizens Financial Group, Inc. is one of the nation’s oldest and largest financial institutions with $155.4 billion in assets as of June 30, 2018. Our mission is to help our customers, colleagues and communities reach their potential. Headquartered in Providence, Rhode Island, we offer a broad range of retail and commercial banking products and services to individuals, small businesses, middle-market companies, large corporations and institutions. We help our customers reach their potential by listening to them and by understanding their needs in order to offer tailored advice, ideas and solutions. In Consumer Banking, we provide an integrated experience that includes mobile and online banking, a 24/7 customer contact center and the convenience of approximately 3,200 ATMs and approximately 1,150 branches in 11 states in the New England, Mid-Atlantic and Midwest regions. Consumer Banking products and services include a full range of banking, lending, savings, wealth management and small business offerings. In Commercial Banking, we offer corporate, institutional and not-for-profit clients a full range of wholesale banking products and services including lending and deposits, capital markets, treasury services, foreign exchange and interest rate products, and asset finance. More information is available at www.citizensbank.com.
The following MD&A is intended to assist readers in their analysis of the accompanying unaudited interim Consolidated Financial Statements and supplemental financial information. It should be read in conjunction with the unaudited interim Consolidated Financial Statements and Notes to the unaudited interim Consolidated Financial Statements in Item 1 of this Form 10-Q, as well as other information contained in this document and our Annual Report on Form 10-K for the year ended December 31, 2017.
Key Performance Metrics Used by Management and Non-GAAP Financial Measures
As a banking institution, we manage and evaluate various aspects of our results of operations and our financial condition. We evaluate the levels and trends of the line items included in our balance sheet and statement of operations, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against our own historical performance, our budgeted performance and the financial condition and performance of comparable banking institutions in our region and nationally.
The primary line items we use in our key performance metrics to manage and evaluate our statement of operations include net interest income, noninterest income, total revenue, provision for credit losses, noninterest expense, net income and net income available to common stockholders. The primary line items we use in our key performance metrics to manage and evaluate our balance sheet data include loans and leases, securities, allowance for credit losses, deposits, borrowed funds and derivatives.
We consider various measures when evaluating our performance and making day-to-day operating decisions, as well as evaluating capital utilization and adequacy, including:
Return on average common equity, which we define as annualized net income available to common stockholders divided by average common equity;
Return on average tangible common equity, which we define as annualized net income available to common stockholders divided by average common equity excluding average goodwill (net of related deferred tax liability) and average other intangibles;
Return on average total assets, which we define as annualized net income divided by average total assets;
Return on average total tangible assets, which we define as annualized net income divided by average total assets excluding average goodwill (net of related deferred tax liability) and average other intangibles;
Efficiency ratio, which we define as the ratio of our total noninterest expense to the sum of net interest income and total noninterest income. We measure our efficiency ratio to evaluate the efficiency of our operations as it helps us monitor how costs are changing compared to our income. A decrease in our efficiency ratio represents improvement;
Operating leverage, which we define as the percent change in total revenue, less the percent change in noninterest expense;
Net interest margin, which we calculate by dividing annualized net interest income for the period by average total interest-earning assets, is a key measure that we use to evaluate our net interest income; and
Common equity tier 1 capital ratio, represents CET1 capital divided by total risk-weighted assets as defined under U.S Basel III Standardized approach.
“Underlying” results, which are non-GAAP measures, exclude certain items, as applicable, that may occur in a reporting period which management does not consider indicative of on-going financial performance.

7

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

We believe these non-GAAP measures provide useful information to investors because these are among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions. In addition, we believe our “Underlying” results in any period reflect our operational performance in that period and, accordingly, it is useful to consider our GAAP results and our “Underlying” results together. We believe this presentation also increases comparability of period-to-period results.
Other companies may use similarly titled non-GAAP financial measures that are calculated differently from the way we calculate such measures. Accordingly, our non-GAAP financial measures may not be comparable to similar measures used by other companies. We caution investors not to place undue reliance on such non-GAAP measures, but instead to consider them with the most directly comparable GAAP measure. Non-GAAP financial measures have limitations as analytical tools, and should not be considered in isolation or as a substitute for our results as reported under GAAP.
Non-GAAP measures are denoted throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations” by the use of the term “Underlying” and/or are followed by an asterisk (*). For additional information regarding our non-GAAP financial measures and reconciliations, see “—Key Performance Metrics, Non-GAAP Financial Measures and Reconciliations,” included in this report.


8

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

FINANCIAL PERFORMANCE
Second Quarter 2018 compared with Second Quarter 2017 - Key Highlights
Second quarter 2018 net income of $425 million increased 34% from $318 million in second quarter 2017, with earnings per diluted common share of $0.88, up 40% from $0.63 per diluted common share in second quarter 2017. Second quarter 2018 ROTCE of 12.9% improved from 9.6% in second quarter 2017.
There were no notable items recorded in second quarter 2018 compared with a $26 million pre-tax impact related to impairments on aircraft lease assets in second quarter 2017, which reduced second quarter noninterest income by $11 million and increased noninterest expense by $15 million, and in addition to provision expense of $70 million, resulted in total credit-related costs of $96 million as detailed in the table below.
 
Three Months Ended June 30,
 
2018
 
2017
(in millions)
Noninterest income
 
Noninterest expense
 
Credit-related costs
 
Net Income
 
Noninterest income
 
Noninterest expense
 
Credit-related costs
 
Net Income
Reported results (GAAP)

$388

 

$875

 

$85

 

$425

 

$370

 

$864

 

$70

 

$318

Less Notable items: Lease impairment credit-related costs

 

 

 

 
(11
)
 
15

 
(26
)
 

Underlying results* (non-GAAP)

$388

 

$875

 

$85

 

$425

 

$381

 

$849

 

$96

 

$318


* Comparison to second quarter 2017 Underlying results are before a pre-tax $26 million impact related to impairments on aircraft lease assets which, reduced noninterest income by $11 million and increased noninterest expense by $15 million and, in addition to provision expense of $70 million, resulted in total credit-related costs of $96 million. Where there is a reference to “Underlying” results in a paragraph, all measures that follow these references are on the same basis when applicable. For more information on the computation of key performance metrics and non-GAAP financial measures, see “—Introduction — Key Performance Metrics Used By Management and Non-GAAP Financial Measures” and “—Key Performance Metrics, Non-GAAP Financial Measures and Reconciliations.”

Net income available to common stockholders of $425 million increased $107 million, or 34%, compared to $318 million in second quarter 2017, led by 8% revenue growth, with 9% growth in net interest income and noninterest income growth of 5%, and a 14% reduction in income tax expense largely related to the December 2017 Tax Legislation.
On an Underlying basis,* excluding the impact of second quarter 2017 aircraft lease impairments, revenue increased 7% with 2% growth in noninterest income.
Total revenue of $1.5 billion increased $113 million, or 8%, driven by strength in both net interest income and noninterest income. On an Underlying basis,* total revenue increased 7%.
Net interest income of $1.1 billion increased $95 million, or 9%, compared to $1.0 billion in second quarter 2017, driven by a 21 basis point improvement in net interest margin and 3% average loan growth.
Net interest margin of 3.18% increased by 21 basis points, compared to 2.97% in second quarter 2017, reflecting higher interest-earning asset yields tied to higher short-term interest rates and improvement in loan mix towards higher-return categories, partially offset by higher deposit and funding costs.
Average loans and leases of $112.9 billion increased $3.7 billion, or 3%, from $109.1 billion in second quarter 2017, reflecting a $1.7 billion increase in retail loans and a $2.1 billion increase in commercial loans and leases.
Average deposits of $115.1 billion increased $4.4 billion, or 4%, from $110.8 billion in second quarter 2017, reflecting strength in term, checking with interest, savings and demand deposits.
Noninterest income of $388 million increased $18 million, or 5%, from second quarter 2017, including the $11 million impact of second quarter 2017 aircraft lease impairments.
On an Underlying basis,* noninterest income increased $7 million, or 2%, driven by higher foreign exchange and interest rate products income and trust and investment services fees.
Noninterest expense of $875 million increased $11 million, or 1%, compared to $864 million in second quarter 2017, which included the $15 million impact of second quarter 2017 aircraft lease impairments.

9

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

On an Underlying basis,* noninterest expense increased 3%, driven by higher salaries and employee benefits costs and outside services expense, largely tied to continuing investment to drive top-line growth. Results also reflect lower other expense due to a reduction in insurance expense.
Strong focus on top-line growth and expense management helped drive positive operating leverage of 7.0% and a 4.0% improvement in the efficiency ratio.
On an Underlying basis,* excluding the impact of second quarter 2017 aircraft lease impairments, operating leverage was 4.3% and the efficiency ratio improved 2.4% to 58.0%.
ROTCE of 12.9% improved from 9.6%.
Tangible book value per common share improved 4% to $27.67. Fully diluted average common shares outstanding decreased 4%, or 21.3 million shares.
Provision for credit losses of $85 million increased $15 million, or 21%, from $70 million in second quarter 2017.
On an Underlying basis,* including the second quarter 2017 aircraft lease impairments of $26 million, total credit-related costs improved $11 million from $96 million.
The effective income tax rate decreased to 22.6% from 31.1% in second quarter 2017, primarily driven by the impact of tax reform.
Net charge-offs of $76 million remained relatively stable compared to second quarter 2017. The ALLL of $1.3 billion increased $17 million compared to December 31, 2017. ALLL to total loans and leases of 1.10% as of June 30, 2018 compared with 1.12% as of December 31, 2017. ALLL to nonperforming loans and leases ratio of 148% as of June 30, 2018, compared with 142% as of December 31, 2017.
First Half 2018 compared with First Half 2017 - Key Highlights
First half 2018 net income of $813 million increased 27% from $638 million in first half 2017, with earnings per diluted common share of $1.65, up 33% from $1.24 per diluted common share in first half 2017. First half 2018 ROTCE of 12.3% improved from 9.6% in first half 2017.
There were no notable items recorded in first half 2018 compared with a first half 2017 $23 million benefit related to the settlement of certain state tax matters as well as a $26 million pre-tax impact related to impairments on aircraft lease assets, which reduced first half 2017 noninterest income by $11 million and increased noninterest expense by $15 million, and in addition to provision expense of $166 million, resulted in total credit-related costs of $192 million as detailed in the table below.
 
Six Months Ended June 30,
 
2018
 
2017
(in millions)
Noninterest income
 
Noninterest expense
 
Credit-related costs
 
Income tax expense
 
Net Income
 
Noninterest income
 
Noninterest expense
 
Credit-related costs
 
Income tax expense
 
Net Income
Reported results (GAAP)

$759

 

$1,758

 

$163

 

$237

 

$813

 

$749

 

$1,718

 

$166

 

$258

 

$638

Less: Notable items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lease impairment credit-related costs

 

 

 

 

 
(11
)
 
15

 
(26
)
 

 

Settlement of certain state tax matters

 

 

 

 

 

 

 

 
(23
)
 
23

Total Notable items

$—

 

$—

 

$—

 

$—

 

$—

 

($11
)
 

$15

 

($26
)
 

($23
)
 

$23

Underlying results* (non-GAAP)

$759

 

$1,758

 

$163

 

$237

 

$813

 

$760

 

$1,703

 

$192

 

$281

 

$615

* “Underlying” results, as applicable, exclude a first quarter 2017 $23 million benefit related to the settlement of certain state tax matters and are before a pre-tax $26 million impact related to impairments on aircraft lease assets which, reduced noninterest income by $11 million and increased noninterest expense by $15 million and, in addition to provision expense of $166 million, resulted in total credit-related costs of $192 million. Where there is a reference to “Underlying” results in a paragraph, all measures that follow these references are on the same basis when applicable. For more information on the computation of key performance metrics and non-GAAP financial measures, see “—Introduction — Key Performance Metrics Used By Management and Non-GAAP Financial Measures” and “—Key Performance Metrics, Non-GAAP Financial Measures and Reconciliations.”

Net income available to common stockholders of $806 million increased $175 million, or 28%, compared to $631 million in first half 2017.
On an Underlying basis,* net income available to common stockholders increased by 33%, led by 6% revenue growth with 9% growth in net interest income, given 3% average loan growth and a 20 basis

10

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

point increase in net interest margin. First half 2017 results included a $23 million benefit, or $0.05 per diluted common share, related to the settlement of certain state tax matters.
Total revenue of $3.0 billion increased $191 million, or 7%, driven by strong net interest income growth:
Net interest income of $2.2 billion increased $181 million, or 9%, compared to $2.0 billion in first half 2017, driven by a 20 basis point improvement in net interest margin and 3% average loan growth.
Net interest margin of 3.17% increased 20 basis points, compared to 2.97% in first half 2017, reflecting higher interest-earning asset yields tied to higher short-term interest rates and improving loan mix towards higher-return categories, partially offset by higher deposit and funding costs.
Average loans and leases of $112.0 billion increased $3.4 billion, or 3%, from $108.6 billion in first half 2017, reflecting a $2.1 billion increase in retail loans and a $1.3 billion increase in commercial loans and leases.
Average deposits of $114.3 billion increased $3.9 billion, or 4%, from $110.4 billion in first half 2017, reflecting strength in term, checking with interest, savings and demand deposits.
Noninterest income of $759 million increased $10 million, or 1%, from first half 2017, which included the $11 million impact of second quarter 2017 aircraft lease impairments.
On an Underlying basis,* noninterest income decreased $1 million from $760 million in first half 2017, driven by a decrease in capital market fees and other income, partially offset by higher foreign exchange and interest rate products income and trust and investment services fees.
Noninterest expense of $1.8 billion increased $40 million, or 2%, compared to $1.7 billion in first half 2017, which included the $15 million impact of second quarter 2017 aircraft lease impairments.
On an Underlying basis,* noninterest expense increased 3%, driven by higher salaries and employee benefits cost, higher outside services expense, largely tied to continuing investment to drive top-line growth, partially offset by lower other expense due to a reduction in insurance expense.
Generated positive operating leverage of 4.6%, a 2.6% improvement in the efficiency ratio to 59.2% and ROTCE of 12.3%, despite the impact of continued investing to drive future growth.
On an Underlying basis,* operating leverage was 3.2%, efficiency ratio improved 1.9% from 61.0% in first half 2017 and ROTCE increased 3.0% from 9.3%.
Return on average common equity was 8.2% compared to 6.5% for first half 2017.
On an Underlying basis,* return on average common equity improved 2.0% from 6.3% for first half 2017.
Diluted earnings per common share increased $0.41, or 33%.
On an Underlying basis,* diluted earnings per share increased $0.46, or 39%.
Tangible book value per common share improved 4% to $27.67. Fully diluted average common shares outstanding decreased by 21.7 million shares.
Provision for credit losses of $163 million decreased $3 million, or 2%, from $166 million.
On an Underlying basis,* total credit-related costs decreased $29 million, or 15%, from $192 million in first half 2017, driven primarily by the $26 million impact of aircraft lease impairments in first half 2017.
The effective income tax rate decreased to 22.6% from 28.8% in first half 2017, primarily driven by the impact of tax reform, partially offset by the prior year settlement of certain state tax matters.
On an Underlying basis,* the effective income tax rate decreased from 31.3% to 22.6%, primarily due to the impact of tax reform.
Net charge-offs of $146 million decreased $16 million, or 10%, from $162 million in first half 2017. The ALLL of $1.3 billion increased $17 million compared to December 31, 2017. ALLL to total loans and leases of 1.10% as of June 30, 2018 compared with 1.12% as of December 31, 2017. ALLL to nonperforming loans and leases ratio of 148% as of June 30, 2018, compared with 142% as of December 31, 2017.


11

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

SELECTED CONSOLIDATED FINANCIAL DATA
The summary Consolidated Operating Data for the three and six months ended June 30, 2018 and 2017 and the summary Consolidated Balance Sheet data as of June 30, 2018 and December 31, 2017 are derived from our unaudited interim Consolidated Financial Statements, included in Part I, Item 1 — Financial Statements of this report. Our historical results are not necessarily indicative of the results expected for any future period.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(dollars in millions, except per-share amounts)
  2018

 
  2017

 
2018
 
2017
OPERATING DATA:
 
 
 
 
 
 
 
Net interest income

$1,121

 

$1,026

 

$2,212

 

$2,031

Noninterest income
388

 
370

 
759

 
749

Total revenue
1,509

 
1,396

 
2,971

 
2,780

Provision for credit losses
85

 
70

 
163

 
166

Noninterest expense
875

 
864

 
1,758

 
1,718

Income before income tax expense
549

 
462

 
1,050

 
896

Income tax expense
124

 
144

 
237

 
258

Net income

$425

 

$318

 

$813

 

$638

Net income available to common stockholders

$425

 

$318

 

$806

 

$631

Net income per common share - basic

$0.88

 

$0.63

 

$1.66

 

$1.24

Net income per common share - diluted

$0.88

 

$0.63

 

$1.65

 

$1.24

OTHER OPERATING DATA:
 
 
 
 
 
 
 
Return on average common equity
8.65
%
 
6.48
%
 
8.24
%
 
6.50
%
Return on average tangible common equity
12.93

 
9.57

 
12.32

 
9.62

Return on average total assets
1.11

 
0.85

 
1.08

 
0.86

Return on average total tangible assets
1.16

 
0.89

 
1.12

 
0.90

Efficiency ratio
57.95

 
61.94

 
59.17

 
61.81

Operating leverage
6.96

 
4.76

 
4.56

 
5.79

Net interest margin
3.18

 
2.97

 
3.17

 
2.97

Effective income tax rate
22.58

 
31.13

 
22.55

 
28.82





12

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

(dollars in millions)
June 30,
2018
 
December 31,
2017
BALANCE SHEET DATA:
 
 
 
Total assets

$155,431

 

$152,336

Loans held for sale, at fair value
521

 
497

Other loans held for sale
189

 
221

Loans and leases
113,407

 
110,617

Allowance for loan and lease losses
(1,253
)
 
(1,236
)
Total securities
25,513

 
25,733

Goodwill
6,887

 
6,887

Total liabilities
134,964

 
132,066

Total deposits
117,073

 
115,089

Federal funds purchased and securities sold under agreements to repurchase
326

 
815

Other short-term borrowed funds
1,499

 
1,856

Long-term borrowed funds
13,641

 
11,765

Total stockholders’ equity
20,467

 
20,270

OTHER BALANCE SHEET DATA:
 
 
 
Asset Quality Ratios:
 
 
 
Allowance for loan and lease losses as a percentage of total loans and leases
1.10
%
 
1.12
%
Allowance for loan and lease losses as a percentage of nonperforming loans and leases
148.20

 
141.96

Nonperforming loans and leases as a percentage of total loans and leases
0.75

 
0.79

Capital Ratios:
 
 
 
CET1 capital ratio (1)
11.2
%
 
11.2
%
Tier 1 capital ratio (2)
11.6

 
11.4

Total capital ratio (3)
13.8

 
13.9

Tier 1 leverage ratio (4)
10.2

 
10.0

(1) “Common equity tier 1 capital ratio” represents CET1 capital divided by total risk-weighted assets as defined under U.S. Basel III Standardized approach.
(2) “Tier 1 capital ratio” is tier 1 capital, which includes CET1 capital plus non-cumulative perpetual preferred equity that qualifies as additional tier 1 capital,
divided by total risk-weighted assets as defined under U.S. Basel III Standardized approach.
(3) “Total capital ratio” is total capital divided by total risk-weighted assets as defined under U.S. Basel III Standardized approach.
(4) “Tier 1 leverage ratio” is tier 1 capital divided by quarterly average total assets as defined under U.S. Basel III Standardized approach.




13

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

RESULTS OF OPERATIONS
 
Net Income
Net income totaled $425 million, up $107 million, or 34%, from $318 million in second quarter 2017. Net income of $813 million increased $175 million, or 27%, from $638 million in first half 2017. The following table presents the significant components of our net income:
 
Three Months Ended June 30,
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
(dollars in millions)
2018

 
2017

 
Change

 
Percent

 
2018

 
2017

 
Change
 
Percent

Operating Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income

$1,121

 

$1,026

 

$95

 
9
%
 

$2,212

 

$2,031

 

$181

 
9
%
Noninterest income
388

 
370

 
18

 
5

 
759

 
749

 
10

 
1

Total revenue
1,509

 
1,396

 
113

 
8

 
2,971

 
2,780

 
191

 
7

Provision for credit losses
85

 
70

 
15

 
21

 
163

 
166

 
(3
)
 
(2
)
Noninterest expense
875

 
864

 
11

 
1

 
1,758

 
1,718

 
40

 
2

Income before income tax expense
549

 
462

 
87

 
19

 
1,050

 
896

 
154

 
17

Income tax expense
124

 
144

 
(20
)
 
(14
)
 
237

 
258

 
(21
)
 
(8
)
Net income

$425

 

$318

 

$107

 
34

 

$813

 

$638

 

$175

 
27

Net income available to common stockholders

$425

 

$318

 

$107

 
34
%
 

$806

 

$631

 

$175

 
28
%
Return on average common equity
8.65
%
 
6.48
%
 
217
 bps
 
 
 
8.24
%
 
6.50
%
 
174
 bps
 
 
Return on average tangible common equity 
12.93
%
 
9.57
%
 
336
 bps
 
 
 
12.32
%
 
9.62
%
 
270
 bps
 
 
Net Interest Income
Net interest income is our largest source of revenue and is the difference between the interest earned on interest-earning assets (usually loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (usually deposits and borrowings). The level of net interest income is primarily a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities and the spread between the effective yield on such assets and the effective cost of such liabilities. These factors are influenced by the pricing and mix of interest-earning assets and interest-bearing liabilities which, in turn, are impacted by external factors such as local economic conditions, competition for loans and deposits, the monetary policy of the FRB and market interest rates. For further discussion, refer to “—Market Risk — Non-Trading Risk,” included in this report and “—Risk Governance” as described in our Annual Report on Form 10-K for the year ended December 31, 2017.
 

14

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

The following table presents the major components of net interest income and net interest margin:
 
Three Months Ended June 30,
 
 
2018
 
2017
 
Change
(dollars in millions)
Average
Balances
Income/
Expense
Yields/
Rates
 
Average
Balances
Income/
Expense
Yields/
Rates
 
Average
Balances
Yields/
Rates
Assets
 
 
 
 
 
 
 
 
 
 
Interest-bearing cash and due from banks and deposits in banks

$1,801


$8

1.77
%
 

$2,081


$5

0.88
%
 

($280
)
89 bps
Taxable investment securities
25,197

165

2.62

 
25,732

154

2.39

 
(535
)
23

Non-taxable investment securities
6


2.60

 
7


2.60

 
(1
)

Total investment securities
25,203

165

2.62

 
25,739

154

2.39

 
(536
)
23

Commercial
39,399

405

4.07

 
37,846

326

3.40

 
1,553

67

Commercial real estate
12,071

134

4.39

 
11,086

97

3.47

 
985

92

Leases
3,073

21

2.69

 
3,557

22

2.50

 
(484
)
19

Total commercial loans and leases
54,543

560

4.06

 
52,489

445

3.35

 
2,054

71

Residential mortgages
17,488

156

3.57

 
15,646

140

3.57

 
1,842


Home equity loans
1,252

18

5.91

 
1,668

24

5.74

 
(416
)
17

Home equity lines of credit
13,112

144

4.40

 
13,765

126

3.68

 
(653
)
72

Home equity loans serviced by others
480

9

7.23

 
668

11

7.12

 
(188
)
11

Home equity lines of credit serviced by others
130

1

3.62

 
188

2

4.24

 
(58
)
(62
)
Automobile
12,657

113

3.60

 
13,574

110

3.23

 
(917
)
37

Education
8,374

119

5.71

 
7,490

98

5.26

 
884

45

Credit cards
1,854

50

10.74

 
1,693

45

10.71

 
161

3

Other retail
2,966

60

8.10

 
1,959

39

8.01

 
1,007

9

Total retail loans
58,313

670

4.61

 
56,651

595

4.21

 
1,662

40

Total loans and leases
112,856

1,230

4.34

 
109,140

1,040

3.80

 
3,716

54

Loans held for sale, at fair value
470

5

4.15

 
465

4

3.60

 
5

55

Other loans held for sale
195

3

6.38

 
162

2

5.51

 
33

87

Interest-earning assets
140,525

1,411

4.00

 
137,587

1,205

3.49

 
2,938

51

Allowance for loan and lease losses
(1,246
)
 
 
 
(1,223
)
 
 
 
(23
)
 
Goodwill
6,887

 
 
 
6,882

 
 
 
5

 
Other noninterest-earning assets
7,087

 
 
 
6,632

 
 
 
455

 
Total assets

$153,253

 
 
 

$149,878

 
 
 

$3,375

 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
Checking with interest

$22,185


$34

0.61
%
 

$21,751


$20

0.36
%
 

$434

25 bps
Money market accounts
36,396

79

0.87

 
36,912

45

0.49

 
(516
)
38
Regular savings
9,889

1

0.05

 
9,458

1

0.04

 
431

1
Term deposits
17,838

67

1.50

 
15,148

36

0.97

 
2,690

53
Total interest-bearing deposits
86,308

181

0.84

 
83,269

102

0.49

 
3,039

35
Federal funds purchased and securities sold under agreements to repurchase (1)
504

1

0.73

 
808


0.37

 
(304
)
36
Other short-term borrowed funds
1,677

14

3.48

 
2,275

7

1.23

 
(598
)
225
Long-term borrowed funds
13,394

94

2.77

 
13,647

70

2.05

 
(253
)
72
Total borrowed funds
15,575

109

2.78

 
16,730

77

1.86

 
(1,155
)
92
Total interest-bearing liabilities
101,883

290

1.14

 
99,999

179

0.72

 
1,884

42
Demand deposits
28,834

 
 
 
27,521

 
 
 
1,313

 
Other liabilities
2,433

 
 
 
2,452

 
 
 
(19
)
 
Total liabilities
133,150

 
 
 
129,972

 
 
 
3,178

 
Stockholders’ equity
20,103

 
 
 
19,906

 
 
 
197

 
Total liabilities and stockholders’ equity

$153,253

 
 
 

$149,878

 
 
 

$3,375

 
Interest rate spread
 
 
2.87
%
 
 
 
2.77
%
 
 
10
Net interest income
 

$1,121

 
 
 

$1,026

 
 
 
 
Net interest margin
 
 
3.18
%
 
 
 
2.97
%
 
 
21 bps
Memo: Total deposits (interest-bearing and demand)

$115,142


$181

0.63
%
 

$110,790


$102

0.37
%
 

$4,352

26 bps
(1) Balances are net of certain short-term receivables associated with reverse repurchase agreements, as applicable. Interest expense includes the full cost of the repurchase agreements and certain hedging costs. See “—Analysis of Financial Condition — Derivatives” for further information.

Net interest income of $1.1 billion increased $95 million, or 9%, compared to $1.0 billion in second quarter 2017, reflecting 3% average loan growth and a 21 basis point improvement in net interest margin.
Average interest-earning assets of $140.5 billion increased $2.9 billion, or 2%, from second quarter 2017, driven by a $2.1 billion increase in average commercial loans and leases and a $1.7 billion increase in average retail

15

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

loans, partially offset by a $816 million decrease in average investments and interest-bearing cash and due from banks and deposits in banks. Commercial loan growth was driven by strength in commercial and commercial real estate. Retail loan growth was driven by strength in residential mortgage, other retail, education and credit cards.
Average deposits of $115.1 billion increased $4.4 billion from second quarter 2017, reflecting growth in term deposits, checking with interest, savings and demand deposits. Total interest-bearing deposit costs of $181 million increased $79 million, or 77%, from $102 million in second quarter 2017, primarily due to the impact of rising rates and a shift in mix.
Average total borrowed funds of $15.6 billion decreased $1.2 billion from second quarter 2017, reflecting a decrease in other short-term borrowed funds, federal funds purchased and repurchase agreements and long-term borrowed funds. Total borrowed funds costs of $109 million increased $32 million from second quarter 2017. The total borrowed funds yield of 2.78% increased 92 basis points from 1.86% in second quarter 2017 due to the rise in benchmark interest rates and a mix shift to long-term borrowed funds.
Net interest margin of 3.18% increased 21 basis points compared to 2.97% in second quarter 2017, driven by higher interest-earning asset yields given higher interest rates and continued mix shift towards higher-yielding assets, partially offset by higher deposit and funding costs. Average interest-earning asset yields of 4.00% increased 51 basis points from 3.49% in second quarter 2017, while average interest-bearing liability costs of 1.14% increased 42 basis points from 0.72% in second quarter 2017.

16

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

 
Six Months Ended June 30,
 
 
2018
 
2017
 
Change
(dollars in millions)
Average
Balances
Income/
Expense
Yields/
Rates
 
Average
Balances
Income/
Expense
Yields/
Rates
 
Average
Balances
Yields/
Rates
Assets
 
 
 
 
 
 
 
 
 
 
Interest-bearing cash and due from banks and deposits in banks

$1,622


$14

1.70
%
 

$2,023


$8

0.76
%
 

($401
)
94 bps
Taxable investment securities
25,315

333

2.63

 
25,760

314

2.44

 
(445
)
19

Non-taxable investment securities
6


2.60

 
8


2.60

 
(2
)

Total investment securities
25,321

333

2.63

 
25,768

314

2.44

 
(447
)
19

Commercial
38,683

762

3.92

 
37,682

638

3.36

 
1,001

56

Commercial real estate
11,812

253

4.25

 
10,955

184

3.34

 
857

91

Leases
3,093

41

2.65

 
3,626

45

2.49

 
(533
)
16

Total commercial loans and leases
53,588

1,056

3.92

 
52,263

867

3.30

 
1,325

62

Residential mortgages
17,326

309

3.56

 
15,466

276

3.56

 
1,860


Home equity loans
1,297

37

5.83

 
1,730

49

5.70

 
(433
)
13

Home equity lines of credit
13,232

282

4.30

 
13,860

244

3.55

 
(628
)
75

Home equity loans serviced by others
500

18

7.28

 
693

24

7.07

 
(193
)
21

Home equity lines of credit serviced by others
136

2

3.81

 
198

4

3.98

 
(62
)
(17
)
Automobile
12,835

225

3.53

 
13,672

217

3.20

 
(837
)
33

Education
8,329

233

5.65

 
7,165

186

5.25

 
1,164

40

Credit cards
1,841

98

10.72

 
1,679

91

10.93

 
162

(21
)
Other retail
2,906

116

8.04

 
1,880

74

7.98

 
1,026

6

Total retail loans
58,402

1,320

4.55

 
56,343

1,165

4.16

 
2,059

39

Total loans and leases
111,990

2,376

4.25

 
108,606

2,032

3.75

 
3,384

50

Loans held for sale, at fair value
445

9

4.01

 
487

8

3.45

 
(42
)
56

Other loans held for sale
225

7

6.29

 
118

3

5.86

 
107

43

Interest-earning assets
139,603

2,739

3.93

 
137,002

2,365

3.46

 
2,601

47

Allowance for loan and lease losses
(1,241
)
 
 
 
(1,229
)
 
 
 
(12
)
 
Goodwill
6,887

 
 
 
6,879

 
 
 
8

 
Other noninterest-earning assets
7,144

 
 
 
6,683

 
 
 
461

 
Total assets

$152,393

 
 
 

$149,335



 
 

$3,058

 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
Checking with interest

$21,927


$60

0.55
%
 

$21,228


$33

0.31
%
 

$699

24 bps
Money market accounts
36,738

144

0.79

 
37,390

86

0.46

 
(652
)
33
Regular savings
9,759

2

0.05

 
9,285

2

0.04

 
474

1
Term deposits
17,174

120

1.41

 
14,663

67

0.93

 
2,511

48
Total interest-bearing deposits
85,598

326

0.77

 
82,566

188

0.46

 
3,032

31
Federal funds purchased and securities sold under agreements to repurchase (1)
574

2

0.70

 
845

1

0.30

 
(271
)
40
Other short-term borrowed funds
1,579

23

2.99

 
2,617

15

1.13

 
(1,038
)
186
Long-term borrowed funds
13,471

176

2.60

 
13,033

130

2.00

 
438

60
Total borrowed funds
15,624

201

2.57

 
16,495

146

1.77

 
(871
)
80
Total interest-bearing liabilities
101,222

527

1.05

 
99,061

334

0.68

 
2,161

37
Demand deposits
28,690

 
 
 
27,808

 
 
 
882


Other liabilities
2,440

 
 
 
2,659

 
 
 
(219
)

Total liabilities
132,352

 
 
 
129,528

 
 
 
2,824


Stockholders’ equity
20,041

 
 
 
19,807

 
 
 
234


Total liabilities and stockholders’ equity

$152,393

 
 
 

$149,335

 
 
 

$3,058


Interest rate spread
 
 
2.88
%
 
 
 
2.78
%
 
 
10
Net interest income
 

$2,212

 
 
 

$2,031

 
 
 

Net interest margin
 
 
3.17
%
 
 
 
2.97
%
 
 
20 bps
Memo: Total deposits (interest-bearing and demand)

$114,288


$326

0.57
%
 

$110,374


$188

0.34
%
 

$3,914

23 bps
(1) Balances are net of certain short-term receivables associated with reverse repurchase agreements, as applicable. Interest expense includes the full cost of the repurchase agreements and certain hedging costs. See “—Analysis of Financial Condition — Derivatives” for further information.

Net interest income of $2.2 billion increased $181 million, or 9%, compared to $2.0 billion in first half 2017, reflecting 3% average loan growth and a 20 basis point improvement in net interest margin.
Average interest-earning assets of $139.6 billion increased $2.6 billion, or 2%, from first half 2017, driven by a $1.3 billion increase in average commercial loans and leases and a $2.1 billion increase in average retail loans, partially offset by an $848 million decrease in average investments and interest-bearing cash and due from banks

17

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

and deposits in banks. Commercial loan growth was driven by commercial and commercial real estate. Retail loan growth was driven by residential mortgage, education and other retail.
Average deposits of $114.3 billion increased $3.9 billion from first half 2017, reflecting growth in term deposits, checking with interest, savings and demand deposits. Total interest-bearing deposit costs of $326 million increased $138 million, or 73%, from $188 million in first half 2017, primarily due to rising rates and a shift in mix toward commercial deposits.
Average total borrowed funds of $15.6 billion decreased $871 million from first half 2017, reflecting a decrease in other short-term borrowed funds and a decrease in federal funds purchased and repurchase agreements, partially offset by an increase in long-term borrowed funds, primarily senior debt. Total borrowed funds costs of $201 million increased $55 million from first half 2017. The total borrowed funds cost of 2.57% increased 80 basis points from 1.77% in first half 2017 due to an increase in long-term rates and a mix shift to long-term senior debt.
Net interest margin of 3.17% increased 20 basis points compared to 2.97% in first half 2017, driven by higher interest-earning asset yields given higher interest rates and continued mix shift toward higher-yielding assets. These results were partially offset by the impact of higher deposit and funding costs. Average interest-earning asset yields of 3.93% increased 47 basis points from 3.46% in first half 2017, while average interest-bearing liability costs of 1.05% increased 37 basis points from 0.68% in first half 2017.
Noninterest Income
The following table presents the significant components of our noninterest income:
 
Three Months Ended June 30,
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
(in millions)
2018

 
2017

 
Change

 
Percent

 
2018

 
2017

 
Change

 
Percent

Service charges and fees

$127

 

$129

 

($2
)
 
(2
%)
 

$251

 

$254

 

($3
)
 
(1
%)
Card fees
60

 
59

 
1

 
2

 
121

 
119

 
2

 
2

Capital markets fees
48

 
51

 
(3
)
 
(6
)
 
87

 
99

 
(12
)
 
(12
)
Trust and investment services fees
43

 
39

 
4

 
10

 
83

 
78

 
5

 
6

Letter of credit and loan fees
32

 
31

 
1

 
3

 
62

 
60

 
2

 
3

Foreign exchange and interest rate products
34

 
26

 
8

 
31

 
61

 
53

 
8

 
15

Mortgage banking fees
27

 
30

 
(3
)
 
(10
)
 
52

 
53

 
(1
)
 
(2
)
Securities gains, net
2

 
3

 
(1
)
 
(33
)
 
10

 
7

 
3

 
43

Other income (1)
15

 
2

 
13

 
NM

 
32

 
26

 
6

 
23

Noninterest income(2)

$388

 

$370

 

$18

 
5
%
 

$759

 

$749

 

$10

 
1
%
(1) Includes net securities impairment losses on debt securities available for sale recognized in earnings, bank-owned life insurance income and other income. Amounts for the three and six months ended June 30, 2017 include $11 million of finance lease impairment charges.
(2) 2018 noninterest income amounts reflect the adoption of ASU 2014-09, Revenue From Contracts With Customers (Topic 606).

Noninterest income of $388 million increased $18 million, or 5%, from second quarter 2017. Excluding the impact of 2017 finance lease impairments, Underlying noninterest income* increased $7 million, or 2%, reflecting growth in foreign exchange and interest rate product and trust and investment services fees partially offset by lower mortgage banking fees, driven by a reduction in loan sale gains, as well as a reduction in service charges and fees and capital markets fees.
Noninterest income of $759 million increased $10 million, or 1%, from first half 2017. Excluding the impact of 2017 finance lease impairments, Underlying noninterest income* decreased $1 million, driven by lower capital markets fees, primarily reflecting seasonality and an overall market reduction in middle market loan syndication activity. These lower capital markets fees and other income were offset by growth in foreign exchange and interest rate products and trust and investment services fees.
    

18

CITIZENS FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS

Provision for Credit Losses
The provision for credit losses of $85 million increased $15 million, or 21%, from $70 million in second quarter 2017, reflecting strategic growth in high-quality commercial and retail assets. Second quarter 2018 results reflected a $9 million reserve build, compared to a $5 million reserve release in second quarter 2017, largely due to the loan growth experienced in second quarter 2018. Second quarter 2018 net charge-offs of $76 million were stable with second quarter 2017, primarily reflecting lower commercial losses but moderately higher retail losses. On an Underlying basis,* total credit-related costs, which include the impact of second quarter 2017 aircraft lease impairments, decreased $11 million.
The provision for credit losses of $163 million decreased $3 million compared to $166 million in first half 2017, reflecting lower net charge-offs, partially offset by a higher reserve build. First half 2018 results reflected a $17 million reserve build, compared to a $4 million reserve build in first half 2017, largely due to loan growth. Net charge-offs for first half 2018 of $146 million were $16 million lower than first half 2017, due to lower commercial losses, partially offset by slightly higher retail losses. On an Underlying basis,* total credit-related costs decreased $29 million due to the impact of second quarter 2017 aircraft lease impairments.
The provision for loan and lease losses is the result of a detailed analysis performed to estimate an appropriate and adequate ALLL. The total provision for credit losses includes the provision for loan and lease losses as well as the provision for unfunded commitments. Refer to “—Analysis of Financial Condition — Allowance for Credit Losses and Nonperforming Assets” for more information.
Noninterest Expense
The following table presents the significant components of our noninterest expense:
 
Three Months Ended June 30,
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
(in millions)
2018

 
2017

 
Change

 
Percent

 
2018

 
2017

 
Change

 
Percent

Salaries and employee benefits(1)

$453

 

$432

 

$21

 
5
%
 

$923

 

$878

 

$45

 
5
%
Outside services
106

 
96

 
10

 
10

 
205

 
187

 
18

 
10

Occupancy
79

 
79

 

 

 
160

 
161

 
(1
)
 
(1
)
Equipment expense
64

 
64

 

 

 
131

 
131

 

 

Amortization of software
46

 
45

 
1

 
2

 
92

 
89

 
3

 
3

Other operating expense(1)(2)
127

 
148

 
(21
)
 
(14
)
 
247

 
272

 
(25
)
 
(9
)
Noninterest expense

$875

 

$864

 

$11

 
1
%
 

$1,758

 

$1,718

 

$40

 
2
%
(1) Salaries and employee benefits and other operating expense amounts reflect the impact of the adoption of ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.
(2) Amounts for the three and six months ended June 30, 2017 include $15 million of operating lease impairment charges.

Noninterest expense of $875 million increased $11 million, or 1%, from second quarter 2017. Excluding the impact of 2017 operating lease impairment charges, Underlying noninterest expense* increased $26 million, or 3%, driven by higher salaries and employee benefits, largely tied to continuing investments to drive growth, as well as higher outside services tied to strategic growth and efficiency initiatives, partially offset by lower other operating expense.
Noninterest expense of $1.8 billion increased $40 million, or 2%, from first half 2017. Excluding the impact of 2017 operating lease impairment charges, Underlying noninterest expense* increased $55 million, or 3%, compared to first half 2017, reflecting higher salaries and employee benefits, driven by higher revenue-based incentives and merit increases, as well as higher outside services expense, given investment in strategic initiatives, partially offset by lower other operating expense.
Income Tax Expense
Income tax expense was $124 million and $144 million in second quarter 2018 and 2017, respectively. Our effective tax rates in second quarter 2018 and 2017 were 22.6% and 31.1%, respectively. The decrease in the effective income tax rate was primarily driven by the impact of tax reform.
Income tax expense was $237 million and $258 million in first half 2018 and 2017, respectively. Our effective tax rates in first half 2018 and 2017 were 22.6% and 28.8%, respectively. The decrease in the effective income tax rate was primarily driven by the impact of tax reform, partially offset by the prior-year settlement of certa