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

Good morning. Thanks, everyone, for dialing in. Up next is Citizens Financial Group. We've got Don McCree, Vice Chair and Head of Commercial Banking. He's responsible for all aspects of Commercial Banking as well as Capital Markets and Treasury Management, two areas of focus for Citizens in recent years. Don has a few slides, and then we'll move to the virtual fireside chat format. [Operator Instructions] Don, thanks for joining. And let me turn it over to you.

Okay. Thanks, Matt, and thanks for everybody joining today virtually. It's a little strange to do one of these things over the phone, but it seems to be the world that we're in. I thought I'd make a few comments. We did send it on the slide deck. There's a disclaimer on Page 1, so just read the disclaimer. I'll talk a little bit about how we see things right now and then a few themes that we're focused on here at Citizens. I'd say, first and foremost, our attention is on helping our clients through this disruptive period. We're literally talking to every one of our clients weekly, very good dialogues, very good understanding of their situation. There have been a couple of big themes and waves that we've seen as we've gone through the last couple of months. The first was some pretty significant drawdowns of standby credit facilities by clients. And good news there is the -- lot of deposit activity that went along with that. Second thing was the arrival of the government programs and particularly PPP, which we spent a good month on here at Citizens, and we're getting the back end of that at this point. Third thing was a whole series of amendments and restructurings in the credit book that we're undertaking with our clients. And then most recently, we're starting to see a fair amount of balance sheet reconstruction from clients, which will be a theme that we think continues on through the next few weeks and months and quarters actually. Our second focus is obviously on credit. We did provide a lot of information on credit in our first quarter earnings call about 5 weeks ago that highlights our areas of focus. While clearly stressed, I think we have a very good handle on our credit book and individual flash points and subsector flashpoints. At the core of all our work is really deep liquidity analysis on a client-by-client basis to understand their available liquidity, their cash burn in various stages of disruption; what they need to do to repair themselves; or in a lot of cases, confidence that they're going to get through this quite well as we go through the next couple of months. And as I said, a lot of companies seem to be accessing new facilities right now, both new facilities and public market executions, which is building liquidity and increasing staying power from what might have been 3 or 4 quarters to 3 or 4 years and just getting in conservative mode. We think that's quite healthy. We actually feel quite good about how we've operated in this crisis and how we went into this crisis. I think -- just remember, for those of you who've been following us, we've been on a 5-year rebuild of this company. And we were set up in just an incredible way as we entered 2020. And our first quarter was quite strong around core activities of our business, like our Capital Markets activity. We've expanded our geography quite extensively. Well, that's tended to be with larger companies, which is serving us well through the crisis. We're really integrating well, which has led to real growth in terms of lead table performance and share gains. And our service quality, which we've been focused on, has really served us well as we've gone through the crisis. And we really have not missed a beat in terms of 100% operating capacity, a 100% ability to service our clients in our payments businesses and really, a massive efficiency gain that we've seen as we've gone through a virtual kind of setup for the company. So we feel quite good about how we've been operating and how we're going to continue to operate. And then the last thing I'll say is we maintain totally committed as an institution to our TOP programs and to our BSO programs. So those are moving ahead of pace, notwithstanding the disruptions, and we're hitting all of our milestones in those programs. We are going -- and I think you heard Bruce speak recently, you've heard us talk about a strategy refresh. We're doing a lot of work right now in terms of what does post-COVID mean, what are the opportunities, how can we build even greater efficiency and how can we take advantage of some new revenue streams that we see that might be available out there. I'll turn to Page 4 and just talk for a minute about what we're seeing out in the marketplace. We do -- as I said, we do see quite a bit of capital restructuring going on. So we see a lot of issuance in the high-grade markets, a lot of issuance in the high-yield market. We've got a few assignments where we're sourcing equity for clients, both large clients and midsized clients, public and private. So that's creating a decent amount of business flow. We're quite encouraged by the public markets and how significant the issuance have been. Obviously, the high-grade markets, you've seen record issuance for the last couple of months. And high yield has been quite active over the last month or so. So we think those are signs of health for the economy and for the markets going forward. We've been extraordinarily busy in our interest rate management businesses. We've seen a lot of client activity where clients are restructuring their hedges, building liquidity out of those restructurings. And we've seen spottier but reasonable activity in our foreign exchange hedging businesses, both as clients repatriate funds from overseas and hedge offshore expenses. So our markets businesses continued to perform quite well. I won't talk a lot about line draws until I get to the next slide, but our line draws were quite extensive. As we started the crisis, we have seen those dissipate a little bit and our outstanding have come down a bit. But those -- that trend has slowed a little bit also. The -- let me turn to Page 5 and talk a little bit about those line draws. We peaked out at about 50% utilization. We had -- and I think we said this at the -- on the earnings call, we had $7.2 billion of draws through the first quarter. We've kind of given back about $1 billion of that so far. It continues to trade down. There'll be puts and takes on this. We expect our outstandings to decline modestly as we go forward. But we are seeing increased inquiry on new money loans and some transactional activity that will offset any drawdowns of the lines. The line draws were actually quite high quality, 60% investment-grade. We are able to convert about 60% of those draws to deposits. And I think that those deposits came in at relatively attractive pricing. So while we're seeing NIM decline, it's more than offset by balances. And the NIM has been a little bit protected by some really strong deposit activity. On the on the government programs, we were quite active on PPP, as I said. We basically processed 24 years of loans in 30 days, which was quite consistent with the industry, I think. We did about 43,000 PPP loans across our client base. They were mostly to small businesses. 92% of them were to companies with 25 or less employees. So we feel good about the profile, and we feel good that our clients use the program in a way that it was constructed. The other thing that I mentioned is we're doing a lot of work around amendments to the portfolio. We've had about 1,000 clients come in and amend credit agreements. The vast majority of those are looking for increased debt baskets, which was largely driven by PPP and a lot of covenant relief, as companies need covenant waivers for a quarter or 2 as they get through the period of closure and into the period of reopening. So doing a lot of covenant relief work. Quite a small group, and I think it was 3% at quarter end, maybe a little bit higher now, have been around principal and interest actions, mostly principal where we pushed off a quarter or 2 of principal payments, a little bit less on the interest side. And we're tending to do that in a trade in a lot of places for those balance sheet restructurings that I talked about. So we'll give a client a little bit of principal relief if they go and put some junior capital into their capital structure. So all relatively healthy activity. Turning to credit for a minute on Slide 6. This is the slide that was in our deck at the earnings date. We called out about 11% of the portfolio that we said were in higher-risk sectors. We're working through all of those. I'd say we really don't have any material change in view on the individual sectors. A lot of them are continuing to perform okay. We think the contours of our credit portfolio give us some protection. So for example, in our foodservice area, 75% of our foodservice is fast and fast-casual concepts. Those are doing quite well. 60% of our retail portfolios are in things like gas stations and convenience stores, which are doing quite well. A lot of our energy portfolio is ABL and hedged, so protected against price declines and on and on. So continuing to work through it on an individual sector basis. I'd say a lot of this comes down to client selection. A lot of it comes down to structural protections. And a lot of it comes down to capital structures and loan to values, particularly in places like real estate where we're entering this crisis with a much more conservative setup than we entered the last crisis in '07 and '08. I do want to come back to the franchise for a second on Page 7. We have spent a lot of time really focused on building what we think is an excellent business model, very focused on becoming the lead bank for our clients. We've added enormous number of new clients in the last 5 years. We've also gained huge shares. I mean our Capital Markets business, our lead managed, content is up 95% in the last 5 years and 14% on a compounded 5-year growth. Our treasury services is up 5%, and our markets businesses is up 18% compounded over the last 5 years. There's a couple of slides in the appendix which goes through the detail of that. So we think our lead managed and co-managed content is -- has grown rapidly, and that's really helped us through the last several months in terms of the crisis. We feel like the connectivity with clients has been excellent, and they're turning to us to help them work through the crisis but also help them do things like restructure their balance sheets, which we think gives us a lot of hope in terms of the next few quarters and 2021 in terms of momentum on particularly our fee line. So our path has been very much build out our product sets, and we feel literally 100% complete in doing that. Second was build out our client sets, which was a geographic expansion to higher-growth parts of the country. You remember that we went into the Southeast a couple of years ago, Texas last year, and California last year. So very good traction in those markets with the corporates. And the other thing that we've been doing along the last, really, 3 years is a complete rebuild of our treasury services business. We've replatformed onto a state-of-the-art portal, which our clients use, which is now fully deployed, getting great utilization. We've built out significant new product sets in terms of real-time payments and integrated payables. Our sales lines are growing nicely. They're being offset right now a little bit by some volume deterioration, particularly in places like Merchant Services and card where volumes are down temporarily given the crisis, but the momentum is good. Don't forget, we bought another M&A firm called Trinity Capital in the first quarter. I don't know, fortuitously or not, but it's focused on restaurant restructurings and the restaurant industry. So we're seeing some nice flow out of Trinity, and that's been fully integrated under our platform. So from a starting standpoint 3 years ago, we've now got about 80 M&A professionals on the platform and a very good backlog of M&A transactions. A lot of those will be delayed a quarter or 2. But we feel quite strong about the advisory piece of our business. And then the last thing I'd say on this slide is I think we're integrating incredibly well. You've heard me talk before about being product-agnostic and solution-oriented. The client feedback we're getting is outstanding. The promoter scores we're getting in our operations units has been outstanding. And I just couldn't feel better about the momentum that's underlying the core franchise, notwithstanding the current disruption. Just a moment on Page 8, where we talk about our TOP programs and our BSO. Our TOP programs really surround a couple of different things. One is digitization. We think there's a big opportunity to build MIS-oriented digital delivery in our treasury services business, particularly for small companies. We're prototyping that right now and getting fantastic feedback. So that's things like cash flow forecasting and working capital efficiency, delivered off the back of AI-enabled analysis of our payment flows and then continued expansion on the TOP side into deeper industry orientation on a subsector basis. One of the things we did over the last 12 months is we really deepened across 13 different industry verticals, integrating corporate finance, M&A, sponsored business and coverage. And you'll see us doing more of that as we go through the next several quarters, and we're excited about that. And then optimization. One of the things that I've said before in general around optimization is this is really a move from net growth to more churn as we learn to grow our RORC (sic) [ ROIC ] and returns on our capital deployed and move under returning relationship off the balance sheet and refocus capital on new opportunities as we expand. And there'll be some continued repositioning of some parts of our franchise as we go through the next couple of quarters and couple of years. So I think to sum it all up, we're obviously in unique times. We actually think we're navigating through it reasonably well as we sit here today. I would say I'm more optimistic as I look at things today than I was 5 or 6 weeks ago when we talked about earnings. I think there's a powerful theme of reopening that's going on in the country right now. I think the government programs have proved effective to bridge people through the next, call it, 6 weeks to 12 weeks. We think the government has more firepower that they can actually deploy. We think the programs that have been deployed in the credit markets, for example, have buoyed the credit markets and created quite a constructive backdrop for issuance by companies who need to raise capital. The loan markets are coming back a little more slowly. And we've seen some institutional activity over the last, say, 3 to 4 weeks. A little bit less pro rata activity, but that seems to be opening up a little bit also. And we're kind of working through clients one by one and doing what we need to help them get through this period of disruption, and that's really our singular focus right now as we help our good clients kind of survive this disruptive period. We do think we're well positioned for the future. And we think we're highly optimistic about the ability to generate a reasonably strong earnings to offset any kind of credit bumps we have between now and full recovery for the economy. So Matt, why don't I leave it there? We can open it up to any questions that you have.

Okay. Great. So a few high-level comments, and I guess the first one kind of follows on what you just said about feeling a little bit better than 5 or 6 weeks ago. Citizens, back in April on results, put out their economic assumptions for a V-shaped recovery. And I think that was more optimistic than most of your peers. But I felt like the tone was that you're preparing for it to be worse but that you were kind of more optimistic. So I guess the question is, why were you thinking about the V-shaped recovery then? And then is that still kind of your base case? I mean your comments today were upbeat but still somewhat balanced with respect to some of the risks out there.

Yes. I think it's going to be sector by sector. I think you're going to see some sectors go through a V recovery. You're going to see other sectors like hospitality, for example, take a little bit longer. So I think, in my mind, I would say it depends on your sector of the economy. I've certainly been encouraged by the tone around the country over the last week or 2 in terms of the speed to reopen. But it really is going to be virus-dependent, and we're just going to have to wait and see. I think we'll have a much better idea of where we think stand as we get to the end of the second quarter. We expect basically the economy to be struggling, as we all know, quite significantly in the second quarter. We'll have to see what the momentum looks like as we get into the end of the second quarter and into the third quarter. I do think we're not -- we don't have -- well, let's call it glasses on here. We're certainly focused very significantly on companies that are struggling and working through them through the disruption that we're having right now. And I think we did say in the first quarter that we were a little less optimistic on a full V as we were talking than we were when we put our materials together. So I'd say a slower recovery than we might have been projecting at the end of the -- when we put our materials together. But we do expect to see a decent recovery as we go through into the fourth quarter. And I don't know if it's a full V, a full U, an L, all the various paths. But we're just -- we're getting ready for all options right now.

In the very beginning of your comments, you mentioned that Citizens was going through a strategy refresh. It sounds like it's very early in that process, but maybe give us a sense of some of the things that you're looking at as part of that.

Yes. I'd say at the company, we think we learned a lot off the last 2 months. And one of the things we learned, for example, is the power of virtual and the power of digital. So I think one of the things that is going to go through the entire company is how do we take what might have been a multiyear digital journey and accelerate it. So I think on our strategic front, we're probably not doing anything that we weren't already thinking of. We're just trying to do it much faster than we already were. And if you take PPP as a learning, we were able to do things in a period of a week that would have taken us months and years to do in our old operating model. So we were highly encouraged by the engineering pivot we've undertaken in our technology units. We were very encouraged by the ability to use APIs to extend our franchise, for example. On my side, we've been very encouraged on our ability to engage with clients digitally. So we're pulling some of those thoughts forward. And as I said, industries is an increasingly important theme as we try to differentiate. So I think our process on that is we're hard at work pulling together our thoughts. We're going to sit down as a management team broadly in kind of the beginning of the third quarter, and we'll probably go to the Board in the beginning -- end of the third quarter or early fourth quarter. So I would just say, stay tuned to what we're saying on that. We'll have a lot more to talk about as we get through the next couple of months and quarters. But we're quite excited about what we see as the opportunities.

I guess specific to the clients within the commercial bank, how are these customers thinking different long term? Maybe it's too early because, obviously, the focus right now is just getting through the downturn. And you talked about the reconstruction of the balance sheet and restructuring. But are they thinking strategically different yet? And how can you be in position to help them in those conversations and thoughts?

I think they're starting to. I think that you'll see us go in a couple of ways from what I'm seeing. One is, let's hunker down and figure out what our situation is, how are we impacted. Some companies aren't impacted at all. Some people are benefiting from this. Other people are impacted quite significantly or having to take cost-cutting actions and change of businesses temporarily or maybe permanently. So we're probably getting to the back end of that. Let's kind of figure out how it's going to impact our individual businesses. Now we're turning to a phase, which I think is -- I'll use balance sheet reconstruction. It may be -- we've got to shrink or dispose of certain pieces of our business. We've got to go raise some third-party junior capital. We may have an opportunity to go entertain an M&A transaction if we are benefiting from the current environment. So we do expect there to be a restructuring wave, a capital-raising wave and an M&A wave, all of which we think we're well positioned to benefit from given the products we build. And I think we're seeing a lot of our midsized companies, meaning the middle market, really engaging with us on helping to analyze their situation and help them figure out where they want to take their companies on the back end of this. So I'm quite encouraged by the depth of relationship and, really, the depth of individual banker dialogue with our clients. So even if a company has experienced extreme distress, we feel like we're way ahead of it. So there's not a lot of surprises that we're seeing out there, the things that we've identified that will be an issue at the end of the second quarter, the end of the third quarter, and we've got time to work through those. So we think our set of products sets up quite well for what we see different clients needing through this. So remember, we've got a big asset-based finance team. We've got a big restructuring team. And we've spun our M&A teams, for example, into these equity capital-raising opportunities. So we're using resources which might be temporarily quiet to work on other things that they have expertise in.

And shifting to credit quality. You mentioned today and you alluded to it back in April as well, but about 3% of your clients needed some deferrals or kind of payment help at the end of the first quarter. It's slightly higher now. I think back in April, you said, if you look out at 2 or 3 quarters, depending on the pace of the rebound, it could be another 20%, 25%, in addition to the roughly 3%. Are those still good estimates? And any updated thoughts on the way you framed that a couple of weeks ago?

Yes. I think those are probably pretty decent. We're probably talking to more clients right now on the question of can -- will we give them a deferral. It's interesting. We've seen some clients that don't need a deferral that have decided that they want a deferral because it's a nice thing to have, which we're not doing. And then we're seeing companies and sectors which continue to be pretty much shut down, looking to engage in those conversations. So again, I think it depends on the pace of recovery and the pace of reopening by individual companies. But our bias is, we're trying to do it where we think it's appropriate because we want to help companies live through this. Our bias is to do more on the principal side, so give a company a quarter or 2 holiday on principal and push it out to the back end of a loan agreement as opposed to give them interest holidays. But in some cases, we've done both. I can think of one where we basically said to a client, and this just gives you an example of the kind of thing negotiation we'll have is, we'll give you a year of principal and interest holiday if you go and raise $1 billion of junior capital in the marketplace. And that's a condition of that holiday, and the company did well in excess of that. So it's hard to generalize on these things because every situation is bespoke. It will depend on what a collateral position might be. It will depend on real underlying situation. But if there's true cash flow distress, we don't want to throw a company into default that we think is going to come out the back end when we see a recovery. So I would say the 3% could go to 5%, 6%, even higher than that, over the next couple of quarters, depending on the pace of recovering. But it's not something we're spending an enormous amount of time really worrying about.

So of course, the key question on asset quality is what do -- how does all this translate into charge-offs within commercial and the timing of it? Because, obviously, credit was very benign in the first quarter, at least from a charge-off perspective. So any thoughts on, first, the timing of when we'll start seeing a material increase? And then any guesstimates on the level of charge-offs, either for Citizens or for the overall industry within the commercial banking?

Yes. We put up the big reserves at the first quarter. We're looking now and we'll make a decision for the second quarter, whether we want to add to any of that. I think you'll see probably slightly higher charge-offs in the second quarter. But we don't see a massive spike out there right now. We said third and fourth quarter, you could see them build a little bit. But again, it's going to depend on the path of recovery and, really, the individual credits. So I think that's what I'll say on that for now. We'll really know more in the next 5 or 6 weeks when we start to do bring downs on the overall book.

Okay. And then shifting to some of the business lines. You talked about converting about 60% of the line draws to deposits. What's the opportunity to keep these deposits longer term? And obviously, the big upgrade of your treasury management platform is done. Does that help keep those deposits, now that they're in the door, give you a better chance to keeping the longer term?

Yes. Sorry about that. It's interesting that even though we've seen a little bit of drawdown on loan levels, we're holding our deposit levels quite strong, and they're actually continuing to rise. So we're using the opportunity to aggressively reprice and try to bring down the cost of deposits. So I think the deposit book feels quite good to me right now, and we don't really expect that to change as we go through the next couple of quarters. There's a few things that could affect that. If companies -- remember, we got a bunch of deposits as a result of PPP, kind of probably $1 billion-ish or so as it relates to the commercial bank. We have a bunch of deposits coming with the line draws. As companies go through extended periods of disruption, you could see those begin to draw down as companies use them to fund operations. So that will be a little bit of our offset to some net growth. But we feel pretty good. And it's hard to know what's coming from the government. So there's clearly a lot of unspent programmatic treasury money that continues to be on the sideline. And depending how that's pushed into the economy -- let's say, the states get a big a big pot of money from the government, some of that could end up on bank's balance sheets as company -- as they tend to be a little more risk-averse and want to put it in the banking system. So there's some puts and takes here that are pretty hard to kind of completely calibrate, but we're feeling pretty stable on commercial deposits. And then to your point, on the treasury platform, we've got a couple of things. One is we're pushing out a liquidity portal also, which will be deposits plus other investments where we'll have a lot more connectivity with clients across their overall investment book of business, which should help us manage future deposits. And we are seeing new business growth on the treasury side, some of which will result in higher depository business. And that will depend on how we toggle at any point in time between the fee lines and the deposit lines in terms of how we want to guide clients to pay us on that treasury business. So you'll see it in one or the other but not both. And that will be a decision that we manage based on where we see the best economics.

We're almost out of time here, but I do want to sneak in a question about repricing on the asset side, which obviously helps piece to get the outlook on the net interest margin. The deposit repricing, I think it's been a positive for you, it sounds like, and I think for the overall industry. On the asset side, we have seen LIBOR rates finally come down, which I think is what's the base rate for most of the commercial loans. I realize there might be a lag, but I would assume that is NIM-dilutive as we think about 2Q and 3Q.

Yes. We're being hurt by lower LIBOR rates on -- we're getting a little bit of pickup on spread because the banks are pricing a little better for risk given the environment we're in. And if you see where spreads in the public markets are, they kind of really widened out and probably have retrenched about 50% or a little bit more at this point. So at least when we're talking to clients, we're able to come in a little bit more spread. But it's not totally offsetting what we've given up on LIBOR. So asset NIM is down and will continue to be down. So we expect -- I mean, the broad picture for the commercial business is, we expect kind of stable to slightly declining NIM to be offset by higher levels of balance sheets. So NII looks okay right now.

Okay. Well, let's leave it at that. Don, thanks so much for joining. And that's the end of this session.

All right. Matt, thank you very much, and thanks, everybody, for joining.