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

All right. Good morning, everyone. I'm Ken Zerbe, the midcap banks analyst at Morgan Stanley, and I want to welcome you to the 2020 Morgan Stanley Financials Conference. Now before we begin, I do need to tell you that for important disclosures, please read the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. So kicking off our conference this year, we have Brendan Coughlin, head of Consumer Banking from Citizens, and I'm really excited to have Brendan with us today. Now I also want to remind everyone before we begin that if you have any questions for Brendan, please submit the questions directly through the Morgan Stanley conference portal that you've dialed into. All right. With that, let me turn it over to Brendan for some prepared remarks, and then we're going to jump right into Q&A afterwards. Brendan?

Thanks, Ken. Appreciate it. And thanks, everybody, for joining today to this virtual conference. We also -- Citizens have some forward-looking disclosures on Page 2. So standard stuff. It's a -- I'm about 5 months into my job, and it's certainly been a different start than I imagined taking the reins here for the consumer bank at Citizens early in the year as rates have come down and we're all dealing with COVID and now the social issues of the day. I thought what I would do is give you a little bit of a reflection on my observations of the consumer bank, a little bit of where we're at, at the moment, and give you a forward-looking strategy around where we're expecting the consumer bank to go here over the coming quarters and years. Starting on Page 3, building a top-performing consumer bank, helping customers along life's journey. We are making very significant progress across a bunch of dimensions here at Citizens Bank, have very clear momentum against our peers. We certainly are helping our customers navigate today's challenges extremely well, and I'll share some of that with you, and have all eyes on credit at the moment. We have a very well-diversified portfolio on the consumer bank focused on prime and superprime, and it's presently holding up very well, given the current economic backdrop. And again, I will get into a little bit more of that in a minute. Customer behavior has certainly changed with COVID, and it's driving us to a very bold and new focus on digitization. And lastly, we are setting a long-term vision for Citizens to win in a digital-first world. Let me turn you to Page 4. I'm going to go relatively quickly through the first couple of pages because I do want to save a chunk of my prepared remark time on forward-looking strategy and how we're thinking about the bank going forward before we open it up for Q&A. Strong momentum. So let me just give you my early observations in a new seat here at Citizens. On the left side of the page here, we've got a very, very strong foundation here at Citizens, and we have achieved a lot over the last particularly 5 years since we've been a public company. We've achieved scale in mortgage, both organically as well through our acquisition of Franklin American. We're a top 15 bank-owned mortgage platform now in the U.S. Our wealth capabilities are expanding rapidly. These are 2 areas that we have leaned into heavily to drive an improved fee mix of our revenues over the last 5 years. And our Wealth business is growing substantially, both organically as well as supplemented by our acquisition of Clarfeld Advisors 18 months ago. We've made some significant investments already pre COVID in a national digital bank, with Citizens Access now topping $6 billion in deposits, and we're one of the first banks in the country to build a digital-only deposit platform. As you've heard from us, we've also invested heavily in innovation in some niche markets, including point-of-sale finance. We've got a 58% CAGR since 2016 and a very robust pipeline with aspirations for substantial growth in this space as we carve out a niche from an innovation perspective and disrupt a portion of the payments profit pool in the industry. And lastly but certainly not least, we've got a high-quality education lending business. I would say we've got one of the most diversified consumer lending platforms in the U.S. here certainly from a super regional bank standpoint. We're top 3 student lender nationally; $11 billion in the portfolio; a superprime credit profile with significant growth, 33%. Again, as I sit here 5 months in, I see enormous opportunities looking forward for this franchise. It's got incredible bones and incredible momentum, yet there's been an enormous amount of gas left in the tank for us to continue the story that you've come to know and appreciate from us over the last 5 years as we've turned the bank around, exited our turnaround phase and now aiming for excellence and build some real distinction for this franchise looking forward. I would bucket them in a couple of categories. First, we still have a lot of running room to improve our fee income percentage of revenues. I mentioned the progress we're having in mortgage and Wealth. There is still running room to be gained here. And particularly in the wealth management space, we've got a lot of focus on continuing our pace and momentum to drive up our mix of revenues to fee income. That's going to be a significant focus for us looking forward. Repositioning the balance sheet for higher returns. We've done a nice job of that over the last couple of years. We've got some real boutique, differentiated capabilities here at Citizens with student lending, with Merchant Finance. We want to continue to focus on driving risk-adjusted return improvements on the balance sheet on the asset side, potentially turning our eyes to originate, to distribute as well to drive some fee income as part of our differentiated lending capabilities. And on the deposit side, on the other side of the balance sheet, I would say we've been #1 in our peer set in driving low-cost deposit growth in the consumer franchise for some time now, and we have running room left to go. We believe that we have great momentum and we don't expect that to subside, which transcends the rate environment that we're in a bit, and I believe it's a bellwether for the future health of the franchise. Driving low-cost deposit growth means you've got sticky customers that will do more from you and cross-sell should improve. So we're focused heavily on that and believe that there's running room. And then lastly, a relentless focus on the expense base. I'm going to talk to you about digitization in a minute and what that means for our expense base and reinvesting in technology. Page 5 here. I'm going to go very quickly on 5 and 6. This is just the numbers behind our fee story. As you can see, significant growth in both the mortgage and the Wealth space. This was a critical strategy for us coming out of our IPO, and we've delivered very, very well here for our customers and our shareholders. This is a space we're very proud of. And as I mentioned, we believe we still have significant running room here to further improve the fee revenue mix of our consumer franchise. Largely, we'll be focused on a continuation of our growth story with mortgage and Wealth with a heavy lean into the Wealth business. On the next page, Page 6, you can see our balance sheet continues to grow healthy -- at a healthy clip, both on the asset side and the deposit side, both self-funding our growth at 5% annualized deposit and lending growth. On the lending side, we're remixing our portfolio to higher risk-adjusted returns as we focus on prime and superprime lending, and on the deposit side, again focused on low-cost DDA growth, which has been a leader in our peer set for our growth rate over the last couple of years and leveraging Citizens Access as another deposit lever for us to have cost-contained growth that keeps up with our lending innovation in the consumer bank. Turning to 7 and 8, navigating through the challenging times at the moment. We're very, very proud of the company's efforts around the PPP program. We will have secured almost $5 billion in funding for our small business and commercial clients. These numbers are enterprise numbers, both the consumer and commercial segments for us. We've got, I think, one of the lowest loan sizes in the peer set. You may have seen the SBA data that was released just 2 days ago publicly. And we're very proud about that. We've served small -- the true small business customer through the PPP program, leveraging the money for its intended purpose as part of the CARES Act. As you can see on the page here, we had about 25 folks that were working on this business prior to PPP. That scaled up to 1,500 over the course of just a couple of weeks. And it required a significant reengineering of our business processes, which was a great demonstration of our nimbleness and our past investments in digital that we could step up to the plate and do 24 years' worth of volume in just 30 days. So incredibly proud of the efforts, serving our communities and our customers. And certainly, we'll also have a positive financial outcome for the bank as well and all eyes on helping our customers now get through the forgiveness period of time, which, as you've all seen with the legislation changes, the country has now given some more flexibility for our customers to navigate through the next handful of months here with their PPP funding. Turning to Page 8. Our credit -- we're really stepping up to help our customers on the consumer side with their -- with our credit portfolios. As of the end of May, about 7% of our Consumer Banking loan portfolio is now in a forbearance status: 141,000 retail customers and 2,700 small business customers. The pace of customers entering forbearance has now dramatically slowed across all categories, consumer and small business. When you put the forbearance portfolio aside, the underlying delinquency trends in the nonforbearance portfolio is extraordinarily stable across all asset classes. And we've got incredible confidence at the moment in what we're seeing in our nonforbearance portfolio. Inside of the forbearance portfolio, we've got a 725 weighted average FICO. We have a meaningful percentage of these customers that are now all -- they're repaying us already. 20% or so of the portfolio, despite being in forbearance, continues to make full contractual payments to the bank, which is a great sign for the health of the portfolio. We believe that a meaningful percentage of our forbearance customers are engaging in taking forbearance as a safety net to navigate the unknown versus necessarily a sign of true distress for them. We are proactively reaching out to our customers now. Most of our customers are in 90-day forbearance disposition. We have the flexibility to offer another 90 days, but we're already seeing some customers come off of forbearance at a very slow clip. But the early signals are that a handful of our customers are now feeling like they're -- they've landed on their feet and they're starting to migrate through. So it's very, very early days here. We've got an enormous amount of attention on this and credit, but we are seeing some potential green shoot signs. On Page 9, you will have seen this slide before if you've been following the Citizens story. Our credit portfolio on the retail side is very well under control. We are a superprime and prime-plus lender. You can read some of the stats. 70% of the portfolio is a secured lending portfolio. Our CLTVs on the residential lending portfolios are very, very healthy. FICO scores across the board are very strong. Our response as COVID emerged was a significant tightening in new originations across many loan categories. In particular, personal lending, we tightened contracting origination stream by 90%. And so we felt that was very prudent as we watched the economic environment play out. But underlying in the portfolios that we do have, as I mentioned, delinquency is well under control. And we're -- although it's early days, we are pleased with what we're seeing in terms of the health of our portfolio so far. Let me turn to Page 10. Looking forward, as is well documented, I think the consumer is going to reemerge from COVID in a very different place in terms of behaviors. And it's going to encourage financial services institutions and consumer banks to dramatically accelerate their strategic investments in digital. What you see here on Page 10 is 2 things: One, on the left side of the page, a dramatic uptick in digital engagement from our customer base. Digital log-ins are up 20%, app downloads almost up 20%. And for the first time in the franchise history, in April and May, we took more deposits outside the branch than we did in the branch. We believe this is a trend that's here to stay. If you compare that to sort of the grocery stores and you're getting home delivery of groceries to your house, where you may have been trained to go to the supermarket every single week, you find it hard to believe that those consumers are now -- as they got trained on the convenience, will completely exit that convenience and go back to the grocery store every single week once safety concerns subside. We believe the same will play out in financial services that the consumer will have been encouraged out of a forcing function in the environment to engage digitally and will continue to engage that way. That means some very dramatic changes in how we think about our franchise going forward. The other point being made on this slide on Page 10 is on the top right chart is our debit transactions pre and post -- pre and current through COVID. You can see a dramatic drop as the environment got weaker. We dropped at 34% down year-over-year in debit transactions. You can see that steady, steady, steady improvement. And so while the economy is not out of the woods, while the banking system's not out of the woods, while our customers are not out of the woods, we are seeing some very encouraging return-to-life signs from our retail customer base, now just down 7% year-over-year in debit spending, which is a good sign as the economy reopens here over the next handful of weeks and months. Turning to Page 11 to give you a little bit of a forward-looking view into our strategy. We've got 4 pillars that we're announcing in consumer to reposition the bank to compete and win in a digital-first world. Number one, a full end-to-end digital transformation of our consumer base -- or of our consumer organization. A zero-based restructuring from a customer journey perspective and an acceleration of repositioning our distribution network to compete in a digital-first world. As you know, we've contracted, over the last 4 years, 15% of our retail distribution network, and about 30% has been transformed with investments to advisory centers. We expect that to accelerate as we make further investments in digital to streamline our expense base and bring our bank into the modern world as a digital-first organization. Secondly, national expansion. You've heard from us around our Citizens Access investment in deposits. We expect to integrate our national capabilities into a world-class national digital-first banking platform with a very compelling value proposition for target customers, bringing together the breadth of the bank into one offering nationally. And you'll hear a lot more from us on that, which will include the integration of our strategic choices that we've disclosed in the past: point-of-sale lending, business banking, national expansion and the expansion of Citizens Access to other products and services. On the third pillar, deepening relationships. While we've made great strides here over the last handful of years, opportunity remains to drive deeper and stickier relationships. We've made significant progress on our attrition and -- metrics and our primacy metrics in the consumer bank. Those have been what's driving our low-cost deposits growth over the last 5 years. As I mentioned, we believe there's a lot of gas left in the tank here to continue the progress of building deep primary banking relationships in the Mass Affluent and Affluent segments. So we'll continue to focus on here by being differentiated in the value we bring to the organization, focused on data analytics and deepening share of wallet, creating thick relationships. And last but not least, how we accelerate our financial progress through targeted structural changes, both with originate-to-distribute on the lending side to give ourselves some flexibility on the balance sheet and aspirations of driving some fee income through our lending business, accelerating the transition of our physical distribution and selectively focusing on M&A to bolster our desire to particularly grow in the fee space, with a focus on Wealth to really drive accelerated growth in the Wealth Management space. Lastly on Page 12, looking forward, I believe we've got an incredibly strong foundation at Citizens. We've transformed the bank and caught up to our peers in almost every dimension you can look at over the last 5 years since going public. We'll need to continue that. We've got a strong foundation to drive outsized performance versus our peers, and we believe the momentum we have will continue in so many different places. And we've outlined a bold vision for strategic growth to drive the next round of transformative repositioning of the consumer bank in a digital-first world. That will be our overwhelming focus over the next 2 years is to digitize the organization and continue to innovate and capitalize on some of the investments we've made in the past. So with that, Ken, let's open it up for questions.

Great. All right. I do appreciate the remarks. I guess starting off, you had some good information on Page 8 about the forbearance or the loans that are in forbearance and the loans that are paying currently. And obviously, 20% is a pretty high number. But one of the issues that we struggle with is really trying to figure out what the ultimate loss content of -- on the loans are that are currently in forbearance like the guys -- the 80% that are not paying, right? One argument, obviously, is that it gives more -- people more time to get back on their feet, but the counter is that these are generally weaker customers who are probably more prone to loss. How do you think that ultimately plays out for the 80% that are not currently paying?

Yes. Ken, it's a great question. It's obviously a principal question that is -- we're working on here in the consumer bank at Citizens. It is early days. It's hard to have a declarative answer to that to know exactly where it's going to land. I would say as we've -- when we talked about this on the Q1 earnings call, the economic backdrop felt a little bit worse than it does right now as the reopening of the economy seems to be picking up some steam and some of the metrics we're looking at is showing a little bit more of a sign of a recovery on the consumer side. You saw the debit spend activity going up. There's some question around how sustainable is that with the stimulus payments and such, but we're seeing some green shoots. We've also done some work on the portfolio to look at income disruption on the forbearance book. And a meaningful percentage of that book does not appear to have income disruption. And it appears as if they raised their hands to go into the forbearance category out of an abundance of caution and as a safety net, as I described. And so while we don't know exactly the state of the economy -- what the state of the economy will be once the forbearance period ends and if it will recover to a place where the majority of these folks will land on their feet, we are seeing signs of positivity in the portfolio that's giving us some confidence that this is -- these are not all customers that can't pay us. And we -- and as I mentioned, not only are we seeing customers' cash flow but we're seeing customers raise their hand to reenter payments early. Lastly, I would say if the economy reopened slower than we're hoping, we also have the flexibility to offer another 90 days of forbearance, which would bring these customers through the October time period to give them more time to try to see if they can land on their feet. So look, all eyes on this, but I would say as the weeks go on, we're seeing more and more subtle signs of positivity than we are signs of negativity on this book.

Got you, okay. Now with so many people working from home and obviously, people are doing a lot more online, given your presentation, how does that change how you're thinking about your overall branch presence or the footprint?

Yes. Look, I am a buyer that brick-and-mortar will not die. Brick-and-mortar will be a part of our distribution strategy as long as I can see. I do think it will fundamentally change and be repositioned as an advisory center versus a transaction center. I don't think that's any different than what you've heard from us in the past around our branch network. I think what's happening now is a massive acceleration of the change. So pre COVID, it may have taken 3 to 5 years for our customers to demand -- vis-à-vis their behavior, to demand a different distribution model. That may take 12 to 18 months to 12 to 24 more months now. So what we're up to at Citizens is a rapid acceleration of our plans that we had already laid out. I -- while we don't have a destination state count for the number of branches that we will have, you can expect an acceleration of repositioning of our physical presence looking forward. But it needs to be combined with also an acceleration of our digital capabilities. We can't just pull our physical network down without replacing with world-class digital capabilities. So when I teed up one of our pillars as an end-to-end digital transformation of the bank, those 2 concepts are inherently linked. As we invest substantially in digitization, it allows us to reposition the branches as advisory centers because you can do a lot more transactional banking on your phone, and it allows us to thin out the network a little bit more. Customers are more willing to drive a few more miles to a branch when they're going there 2 to 3 times a year for a life event versus every Thursday to cash their check. And so you'll see a lot more detail from us here in the coming months on that initiative, including potential financial impacts. But that's the strategic mindset is a reinvestment substantially in digital and allow us to accelerate the repositioning of the branch network.

Well, I guess if we take sort of the expense piece and add it to the branch network, the changes that you talked about, if we think about like the individual branch, like a given branch, when you add in the digital component to it, is there room that you could actually reduce sort of per-branch expenses as you make them more advisory centers? Or is this just adding the digital on top of that?

Yes. No, there's -- yes, there's definitely room. So in the branch expense base repositioning, I would think about it twofold: one, less points of presence. That's going to thin out our expenses; two, for the points of presence that we have, they'll be less expensive to run. So instead of a 4,000-, 5,000-square-foot branch of the past with the marble and the 7 or 8 teller stations, you're going to shrink it down to approximately half the size, half the square footage. And we're -- it's not just about square footage, we're also redesigning the branches to be much more advisory-based. So when you're not doing transactions, you need significantly less space in the branch for teller stations, and you need more office space for a discussion about your retirement or a mortgage or a life event. That's -- we've been on that journey for the last couple of years. The pace of change and repositioning will accelerate on both of those dynamics: less points of presence, less square footage per point of presence and taking some of that money and reinvesting it in an acceleration of technology and digital.

All right, great. Now you've done a number of bolt-on acquisitions over the last several years. You did Franklin, Clarfeld, Trinity, et cetera. Can you just talk about the areas where you might consider additional bolt-on acquisitions in the consumer business that would further build out your capabilities?

Yes. I would say obviously, the present environment at the moment is challenged from an M&A perspective as companies are kind of trying to make sure they understand if we've hit bottom and where the outlook is going forward. But I would say we've got our head on a swivel for acquisitions that would advance our strategic agenda in a meaningful way. So in particular, the place that we're most focused is in the Wealth Management space. We've got incredible momentum on a percentage basis of outpacing the industry organically with Wealth growth, but that is a place in particular where if we could find the right deal at the right economics, that it would make a lot of sense for us to accelerate our growth in the Wealth Management business, drive up our percentage of revenue from fees and fill some real key capability gaps that we're building in the Wealth Management space to serve our customers better as we lean into the Mass Affluent and Affluent segments. So I would say that's our primary focus. But look, we have our head on a swivel for mid- to smaller sized bolt-on acquisitions that could significantly advance our strategy that we've articulated today. So if there's something in the technology or digital space that comes up that can really help us and it's cost effective, we'll consider that, too. But I would say the majority of our proactive efforts are in the Wealth space right now.

Got it. Understood, okay. And then maybe 1 or 2 last questions in the interest of time. In terms of mortgage banking, obviously, this has been an area of strength for Citizens this year, given both share gains and higher gain on sale margins. But how do you feel Citizens is positioned in mortgage banking once we come out of pandemic and things start to normalize again?

Well, I would answer that quickly in 2 ways. I think just the macro changes in the mortgage industry with a bit of a flight to quality, a lot of the nonbanks are having some real challenges at the moment and the banks are picking up some share. And I think Citizens is extraordinarily well positioned for the flight to quality and flight to safety. And you're seeing it play out in our numbers right now as we take some meaningful share gains and with the well-timed acquisition of Franklin and the organic growth that we had already been enjoying on the retail mortgage space. Uniquely to Citizens, I think this is a space where we've made a lot of investment. And even in the bank mortgage space, we believe we're taking share. We've made some investments to digitize the mortgage business. We have aspirations to integrate this business digitally into Citizens Access more medium term and take some share that way. This is a space where I think we have dramatically repositioned the franchise for growth and to be a leader in this industry over the long term. Wholesale and correspondent have some meaningful disruption in those verticals as well. And we, I think, remain extremely well positioned to continue to take share without using our balance sheet in a meaningful way and tie up capital so drive significant fee gains. So it's a space that we feel good about that we've made great strategic progress, and we think we're extremely well positioned looking forward to continue to compete well and take more share, independent of where the mortgage market is in terms of size and scale and interest rate environment.

All right. Perfect. All right, Brendan, I really appreciate your time, and I want to thank Citizens for being at the Morgan Stanley Financials Conference this year. So thank you very much.

Thanks very much, Ken.

And for all the people -- yes. And for all the people on the line, we have a 15-minute break and then we'll pick up with additional presentations at 8:45. So thank you very much, everyone.