Citizens Financial Group, Inc. (CFG) Earnings Call Transcript & Summary

We're going to get started. I assume some more people will come in as we begin our conversation here. Next up this afternoon, I have Citizens Financial Group with me. We're joined by John Woods, Citizens' CFO; and Ellen Taylor from IR. John, I believe you actually have a perfect record of joining us here each year, which we much appreciate. Last year, I put you in the hot seat to talk about maintaining independence on the heels of the SunTrust/BB&T merger, and it seems to me you've done a very good job as a stand-alone bank over the last year, building scale, gaining market share organically and through bolt-on acquisitions. So we're going to talk about M&A, again, because we're not going to completely rule that out. But let's start at the top with the macro, which seems to be the topic du jour. And let's talk about the macro environment a little bit.

So if I give you kind of where I'm coming from on the January call, you spoke to a moderately good economic backdrop with the fed on hold and a bias towards yield curve steepening, and we don't really have that right now. So how about I turn it over to you for that?

Sure. Yes, that's right. I mean I think our expectation at the time is probably pretty similar to others that there would be fed on hold with some slope on the back end of the curve, maybe even gaining a little bit more with the 10-year closer to 2 than 1, right? That was the thinking. Things have changed a lot in a month. I'd say it's early days, though. I mean it's still, I think, way too early to declare what things will be like for the rest of the year, number one. Number two, I would say also that we're in an environment where increasingly diversified business model will perform well. And in our case, I think that's true, whether it's in the lending space where we've been diversifying in Consumer and Commercial. That said, we may be passing the baton to the fee and the expense base. So on the fee side of things, we've done a number of bolt-ons, and we've been organically investing over the cycle, and that's been quite nice to see. And so as it relates to some of the offsets to the rate environment, I mean, mortgage is one that I would throw out there that, for us, now that we're at scale given our Franklin acquisition, has -- is something that we're really pleased to be able to see deliver a lot of benefit here. It's done it in 2019, and it's likely to do it again given what we're seeing in terms of applications in 2020. But -- and the last thing I'll mention is that the expense side of the equation, we've -- since the IPO, we've had completed 5 TOP programs. And there were some questions about whether we had anything left in the tank, and then we came in with a TOP 6 that was bigger than the recent ones that we've launched. So I mean, I think, just in summary, increasingly diversified business model, expense discipline and lots of levers in a down rate environment that we'll pull that will serve us well.

Okay. And in terms of kind of the environment and what you're watching, what you can listen to, what is most important right now as you kind of think day-to-day when you start to pull the levers on expense, for instance?

Yes. I mean I just -- I'll go back to some of the revenue levers and then touch on expenses. I mean I think on the revenue side of things, we're -- from a day-to-day standpoint, interest-bearing deposit costs, we've been doing, I think, quite a nice job over the last several quarters of, frankly, being at the front of the pack in terms of interest-bearing deposit cost decline. And we've improved and increased our investment in analytics and just operational excellence in that area over the last several years. And we had a lot of levers on that front. And we've got pretty efficient pricing mechanisms now that, from a day-to-day standpoint, that's something that we look at. We have commercial deposits that are higher beta. We have our Citizens Access platform, which is a higher beta platform. So that's true on the way up, but also on the way down. And so -- and we're executing against that real time, even as recently as this morning. Pricing changes in Citizens Access, I mean, that's something that we're looking at day-to-day. When you look at -- we're looking at day-to-day our fee income generation capabilities, not just in mortgage but also in capital markets. New issuance took a little bit of a pause this week, not surprising. But we -- the very, very near-term outlook, given our diversification there, loan syndications seem to be healthy. There's, as you might imagine, a fair bit of increase in debt capital markets activity with some of the people attempting to try to take advantage of this rate environment, which, hopefully, in the coming weeks, we'll see some of that coming back. But the diversification on the fee side, and all the levers that we pull, and from a lending standpoint, as I mentioned, more diversified there. I mean I'd hasten to add, it's not just a mortgage refi wave, it's also a student loan refi wave. And we're -- that's one of the businesses that we're also in, and we're seeing record flow in the student loan refinance space, which is also something that diversifies. And that's all in revenue. You flip over to the expense side of things, and we've got TOP 6 that has been launched. And there is a big transformation portion of TOP 6, but there's also the nuts and bolts BAU portion of TOP 6 that we are executing at on day-to-day. And so that's where our focus is in terms of trying to address the environment, and we feel like we've got lots of tools in the toolbox.

Okay. So let's turn to the TOP 6 program and the strategic revenue initiatives that go alongside that as well. And I think it was last week, maybe 2 weeks ago, your Chief Information Officer, Mike Ruttledge, spoke at another conference about the technology aspects of the transformational program. Can we talk about, a, when you talk about recalibrating potentially on the expense side, let's talk about where you could cut versus moving forward because I would assume that what you don't want to do is stop the transformational initiative under Mike. Maybe you can expand on where you are, what you're doing and when you expect to see the efficiencies come out of that program.

Yes. It's a good question. I mean I'd say that the transformation is essential to who we are. I mean we've been on a journey towards becoming a top-performing bank, and this is part of what we're doing. And so on the -- in the transformation part of TOP 6 there's several levers we're pulling there. There's maybe 7 broad pillars of that transformation program. The top 3 or 4 of them are the next-gen tech, which is a cloud migration, an API-enabled workforce and approach to delivering change and transitioning from a highly outsourced project management-type shop to a highly in-sourced engineering shop, and that's really exciting to see where that's going. So we're going to keep that on the rails, that's our plan there. So aside of that, maybe next in line is what we're calling our modern operating model, which is a migration from traditional ways of working waterfall methodologies for delivering change to agile ways of working where we're going to organize ourselves in several hundred pods across the whole company, and that's happening over the next year. And you can see the benefits from each one of those starting to really kick in, in 2021. The earlier benefits are being seen in the next couple of initiatives. We have, what we're calling, our distribution customer interaction model, which is basically across the whole branch system, simplifying our job families across how we deliver mortgage and wealth products in our branches. And we were very siloed in our branches themselves. And so we're simplifying all those job families, and that's actually giving the twin benefit of better customer experience much more cheaply, and that's coming in, in 2020. We have a series of customer journeys, starting off in mortgage, help you buy a home, and really rearchitecting that experience from the customer back out. That's delivering expense benefits in the near term. And then all of the traditional levers like procurement and third-party spend, which I would have to describe ourselves over the last couple of years as being a bit more tactical -- tactically focused, but we've made a big investment in a strategically oriented procurement team that's delivering near-term benefits right here in 2020. The list goes on, and the levers that we have in that space are numerous. And it's exciting to be able to still have all of those levers to pull when we have this kind of environment. So big picture, it's yes, NII; loan growth will help offset; interest-bearing deposit focus, which we're getting quite good at, is going to help offset. But the baton will pass a bit to the fee space in the expense area, which we're excited about because that's what we've been doing. It's not like we've woken up to the challenge in the last couple of months, this is who we are as a company.

It wouldn't be fun if there wasn't a challenge, right?

Well, yes. I don't know, I'll take a couple of years off.

I hear you. So I mean also a part of this, I put it under the top umbrella in terms of the 2020-2021 outlook is the strategic revenue initiatives that you're speaking about, $40 million. And so let's turn to that for a minute, and whether or not -- I hate to even mention putting that spending at risk based on a slower revenue growth environment. Let's assume the fee revenue does pull weight against the NII headwind and that you continue to spend the $40 million to pursue the strategic revenue initiatives. Can you take us through kind of where the priorities are amongst that? And then we'll get into what would cause you to moderate the pace?

Yes. I mean maybe the last part first. I would say, I think that's right. We want to protect that spend. We think that the whole point of this in our journey of building a top-performing bank is being able to invest organically, and from time to time inorganically, to improve capabilities. Our TOP programs are organized and architected to achieve a dual benefit. One is to keep us on our profitability trajectory that we think would be appropriate for our investor base and our shareholder base, but secondly, to provide the resources to invest over the medium term so that we're constantly investing in new profit pools and feeding that innovative culture that we want to be able to support. So the base case is that we're going to protect that spend. And sure, if things -- it remains a lever. It's one that is not binary. It's not all or nothing. We have ways to pace that spend. We have ways to stretch things out. We have ways to achieve those goals more cheaply and manage the time frame and possibly chipping off a little bit of scope. But I think you could -- you'll see that we'll balance that and it won't be all or nothing. We'll be investing for the medium and long term in 2020 under almost any environment that we can imagine. That said, so what are we investing in? So I think what we're investing in is in our -- we're a big believer in the digital space. So Citizens Access, our customer behaviors tell us that there's a significant demand for a fully digital bank offering. Many of the digital banks out there have maybe 1 of the 2 or 3 legs of the stool, which create a full digital bank, I'm maybe oversimplifying here, but you take deposits, you make loans and you provide services for a fee. And our thinking is not very complicated, but it's -- in theory, but it's very hard to do in practice, which is to create a full digital bank where it's not just savings and CDs, but it's also checking transaction accounts, debit, bill pay, and bundling that with our unique consumer lending capabilities, which are unique. We're one of the most diversified consumer lenders in the United States, whether you're talking about a regional bank or one of the top banks. We're in almost -- we're in a variety of spaces, some banks, which are not. I mean we're in home equity and mortgage, we're in student, we're in auto, we're in merchant finance. And if you look at that whole portfolio, and -- it's unique in terms of that diversification. So we -- and much of it is digitally oriented, and therefore, it lends itself to that second leg of the stool for a digital bank. And then the third is exploring ways to provide services for a fee, and we were one of the early regional banks in the wealth space in terms of robo advisory digital capabilities. There are other fee-based services that we're looking at, but that's one of the big areas that we're looking at. I think going up the segmentation here, one step into, call it, small business and business banking, we believe that there's a similar demand that hasn't been well served in that space. And so looking at a way to create a platform that serves that customer segment. And I think we want to acknowledge that there's lots of overlap. Many of our consumer customers are actually small business owners as well. So when we provide that service for them as individuals, we want to be there for them also in their small business needs also. And then I would -- and you can keep that going, right, into the lower middle market, et cetera, which we have some interest in. And then lastly, we have the point-of-sale space, which is -- where there's a lot of change. But we're one of the leaders in this space. We're in merchant point-of-sale finance where we have our Apple products that we partner with Apple on. We now have the Microsoft Xbox product that we're on. We're in the home alarm system, ADT, and we have others coming. And we have -- we also finance telethons and other products. So we have a very unique lead in merchant finance space, and we're looking to take that lead and convert it into a disruptive point-of-sale offering that interfaces with the consumer directly and positions us as facilitating responsible spending. So that's the area of strategic investment that we're looking at in 2020. It's very exciting, and we want to protect it, and we think we can, given how we've paired it with our stock program.

So to the degree we can bring this then to the bottom line or kind of the mid-bottom line on positive operating leverage, let's talk about whether or not you can and should drive positive operating leverage in 2020 depending on the variance of the headwinds that you face from the yield curve because you can, right? I mean you can.

Yes. I mean I think that, that's the question, and it's a balancing act. I mean I think when you go back to our guide for 2020, it was constructed in a way that would produce positive operating leverage. And so like any plan, when you launch it, there is going to be puts and takes throughout the year across all of the areas and the line items on the revenue side, expenses and whatever or what have you. So original expectation and balancing act was, "Let's go ahead and achieve positive operating leverage, but let's still invest for the medium term." And we'll -- and that remains our goal is to achieve both of those. We'll keep a close eye on circumstances as they unfold. But that remains our goal. And I think that's the appropriate goal for us over the longer term is to balance our financials where we want to achieve that trajectory of financial performance but also continue to invest for the long term.

Okay. Fair enough. And let's just circle back on balance sheet optimization for a minute because we talked about the deposit pricing and all that you've kind of learned through Citizens Access and in terms of the beta and the ability to exercise beta in that portfolio. But there are several legs to the stool of balance sheet optimization for you and you've been at this now for a few years, but I gather there's still a little bit more left in the tank on this one.

Good question. I'd say it's not too dissimilar to what we're doing on expenses. I mean we've been at expenses for half a decade, and we're going to be at expensive for the better part of the next decade, that's just our job. And I think balance sheet optimization is also in a similar category. We're going to be at this for years and years and years to come. And I think what's unique about us is that I think we've got maybe more to untangle there than maybe most. So therefore, the opportunity is quite large. Couple of examples. What I talked to you about on the deposit side of things, that remains big picture, increasing the percentage of our deposits that are -- can be found in the DDA space. We've been a leader over the last several years in terms of DDA growth, that continues to be the case. So we're looking to close the gap there. That takes years to do, right? And so -- but we're really happy with our performance. We've been at the front of the pack in terms of that. So that's big picture, and then I already talked about this in interest-bearing deposits, how that's getting reoptimized. On the asset side of things, there's some things that we have there, too. I think we've begun a program to sell off maybe some lower customer value mortgages over the last couple of quarters, and so that's something that we're optimizing. We have a large mortgage book on balance sheet. And so we're trying to figure out where we can cross-sell and where we can't and where we can. We're saying, "Okay. Let's go ahead and find ways to reallocate that capital." We also have a large auto book. That auto book, there are ways to possibly improve the capital charge for auto books, and that's something that you might see over the -- in this year, as we're looking for ways to reduce the capital that auto produces and elevate the returns for the auto book. And then I think student is another place where we may be looking at an originate-to-distribute model that hasn't been in place in the past. We've been an originator, but we're getting up to the point where the on-balance sheet is about where we might want it to be. We have more appetite -- we have appetite for more. But our origination capabilities are quite good and quite strong, and this is where you can convert and balance out, originate to distribute where you keep the customer relationship but reduce the balance sheet exposure to that customer. And all of a sudden, the returns across all 3 of those businesses by cross-selling mortgage, by reducing the capital charge in auto and by originate to distribute in the student, all of a sudden, we have a very large part of our balance sheet basically being elevated from a return standpoint. That's just Consumer. Then we have Commercial, right? There's a whole another...

You're freeing up a lot of capital, but I'm going to ask you what you're going to do with it in a minute. But keep going on with that.

Yes. Maybe just a couple more seconds on Commercial. Commercial has been optimizing its portfolio as well, and we're balancing our middle market and mid-corporate exposure. That's a risk/return play that's been going on over the last couple of years. We've been balancing across geographies where we've launched our Southeast program at region, and that's gone quite well. And we launched our west region just more recently, and that's got some great early returns also. So you're seeing the diversification and optimization, call it, horizontally, but -- and vertically within the C&I book, we're spending a long -- spending a lot of time focusing on that bottom quintile and doing the same thing we're doing in mortgage. If there's -- if we haven't had a lot of cross-sell and it doesn't look the prospects are that great, we're looking to recycle that capital. And so the engines for all of that are not plateauing and slowing down on BSO, they're revving and the momentum is building in BSO. It takes a little while to get things going. But we're now -- I think we have the whole company focused on this in the right way, so you could see us continuing to build momentum in BSO in the near term.

Okay. So to the degree that you are optimizing the use of capital and doing it increasingly surgically and aggressively here. And you like your glide path, I'll give you that. Your stock is quite cheap for you to buy back and perhaps go down the glide path a little bit further at this moment. So I'm curious where your appetite is. I know you did a small acquisition about a week or 2 weeks ago of Trinity Capital, and we can talk about how that fits in. But what's the appetite for acquisitions? What's the determination to maybe move a little bit faster down that glide path on capital?

Yes. Sure. When -- I think we've -- it hasn't changed much. Maybe the numbers have changed a little bit, but our focus is building a bank and putting capital to work in ways that are going to be accretive for shareholders. And when we can do deals that generate economic value-added in excess of cost of capital and for which the integration is relatively straightforward in a bolt-on, we think that's a better use of capital, notwithstanding what's going on with earn backs, than elevating our buyback. We're building a bank here and we're building capabilities, and we're putting capital to work in a way that is value-added for shareholders. That's good, and that'll provide benefits across the whole platform. So that's our main goal. That said, we do -- we acknowledge that earn backs have come down in terms of the buyback program. So to me, that just raises the bar for M&A transactions that we would do. It doesn't close us out, it just raises the bar and really make sure that what we do is highly strategic and highly accretive and that we're putting that capital to work in a way that stands the test of what the earn backs would be on the buyback. And so yes, and we -- and each of the ones that we've done, we think, has met that test.

Okay. I want to circle back to M&A in a minute, but staying on the balance sheet optimization for a second here. In a CECL world, and how much is the implementation of CECL influencing what you're doing with balance sheet optimization and where your appetite is potentially for different loan categories?