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

Continuing with this morning's track, very pleased to have Citizens Financial with us. [Operator Instructions] Next up, very pleased to have Bruce Van Saun, Chairman and Chief Executive Officer of Citizens Financial. This is the 18th year I've been doing this event at Barclays, and Bruce has been there at, at least, the majority of them I think and the only executive to actually be there representing 3 different institutions. So Bruce, thanks for coming back once again.

Okay. My pleasure, Jason. Always good to be with you. And good morning, everyone. It's a pleasure to present to you today even if it's virtual and not in person. Before I begin, I'd ask that you read this cautionary language at your convenience. So let me start off. I want to summarize 4 key points. The first is that our first half performance has been very solid in light of the COVID-19 disruption. We have -- our underlying PPNR was up 10% versus a year ago and our operating leverage was a robust 2.6%. We continue to build a stronger and more diversified business model that's really driving that performance, the second point. So we delivered very strong fee performance to offset pressure on NIM from the low-rate environment. And that goes back to a multiyear investment strategy we've had to expand our fee capabilities both through organic investments as well as some well-timed acquisitions. The third point is that we continue to protect our investment in things that we think are necessary for the future, that position us well for the future. And one of the ways we do that is through a relentless focus on expense efficiencies. We've had annual top programs, the most recent one was very significant; also working on how we allocate our capital on the balance sheet, and that's helped fuel that performance as well. And then the last point I would start off with is that we're doing all of this from a position of balance sheet strength. So we have a strong CET1 ratio, a strong allowance-to-loans ratio and very strong liquidity and funding metrics. Okay. I just want to refresh our story for those who might not be as familiar with it, but we have a very attractive franchise with strong market positions in many areas. First off, where we play in terms of the footprint GDP is very attractive, has a high degree of affluent households and also many different sized companies, from small businesses up to the large corporates. So very attractive overall. We have a TOP 5 deposit market share in 9 of 10 of the major MSAs that we serve, including the #2 deposit share in New England. We have leading positions in several lending areas, education, merchant finance, mortgage and home equity. And then also our commercial bank has really solidified a top league position. We're #6 in terms of overall middle-market lead and joint book runner. And so we've been investing in that and really building up the scale and capabilities in that area. Overall, we're focused on building a top-performing bank that can deliver attractive and sustainable long-term performance. And we're confident that we can continue to stay on that upward trajectory. And the confidence really rests on 3 main themes. One is we've demonstrated that we can be successful through all types of environments. And I think that rests on having a very strong and experienced Board and management team and great talent we've been able to attract to the bank. We also have I think demonstrated an ability to execute well, and that really drives out of having a customer-first approach to how we do business and then also that mindset of continuous improvement. We can always look for ways to run the bank better and serve customers better. And then we're committed to excellence in everything that we do. I think our enterprise-wide initiatives are very distinctive relative to peers and have certainly helped fuel our positive trajectory. And then I think some of the investments and innovation that you've seen from us around education, refinance loans or merchant point of sale, the national digital bank, we have that also in our DNA, that innovative capacity that stems from a growth mindset that we're constantly looking to find new ways to attract new customers to the bank or drive new revenue streams to keep the top line going and keep the bank healthy. We've had a number of multiyear investments across -- next slide, across consumer and commercial that have resulted in a stronger and more diversified business model. I'll just cover these very quickly. You're familiar with them, many of you are familiar with them. But on the consumer banking side, the merchant finance platform that Apple and now Microsoft and others, our partners on that platform; the first regional bank to come forth with a national digital bank in Citizens Access, an opportunity to leverage that further. We've really taken our mortgage business to the next level. So not only having absorbed and integrated the Franklin acquisition, but rapidly moving that business to really some great technology, digital -- front-end digital processes so we can scale up and take volume in these kind of periods and gain market share. We've consistently invested in the wealth business. We've added financial advisers, grown that by over 1/3, while also doing a very smart acquisition of Clarfeld, a high-end RIA focused on ultra-high net worth clients. And then on commercial banking, it's been mostly organic hiring experience, coverage bankers, corporate finance specialists. Some of our product areas, we've added some great talent from big shops, but also doing some acquisitions to gain an M&A capability, which is really important in terms of how we serve our clients. The results of all those efforts have been solid and delivered very strong results in the first half, which I'll just quickly walk through and head around the clock on this slide here. Our peer group is the 10 super regionals that are listed in our proxy. But effectively, in terms of revenue growth in the first half, we were about 6%; peers were about flat. NII, we were about stable; peers down 1.5%. Our fee income was up 22%; our peers, 2.5%. Here's one where the peers got us, 7.3% loan growth versus our 6.1%. But having said that, net interest margin, we were only down 24 basis points; peers down 37. And then our underlying operating leverage was a positive 2.6%; and for peers, it was a negative 1.9%. So really strong performance in light of COVID, but also relative to how our peers have performed. Next up is the fact that all these investments continue to drive our pre-provision profitability higher. If you look at this over time, and this is a PPNR-to-assets ratio that the Fed uses in DFAST. But on that basis, we started out at 2.7% back in 2015. We reached 3.8% in 2019. And the good news is that held through the first half of the year. With all the disruption and recession that was taking place, we still held a very robust level of PPNR. And if you look down at the bottom left on this slide, you can see some of the drivers there. We had to relever the balance sheet after we had trunk it under RBS ownership. We went about that prudently. That was a factor. We invested in capabilities, in our fee capabilities and targeted some acquisitions to diversify and grow revenues. And we had a relentless focus on the expense base, which through our TOP programs also helped drive positive operating leverage and improve our performance. Going forward, all those levers continue to be available to us. I think the fee business takes on added importance in a ZIRP environment. And so both continuing to invest organically and make sure we're actually delivering or enhancing our delivery, so where deepening relationships with customers becomes really important. We'll still keep an eye open for acquisitions that we can find that are attractive and make sense. We'll also continue that relentless focus on the expense base, which also takes heightened importance given the low-rate environment. The fee capabilities, it's interesting. We really had a targeted approach as to where we thought we needed to grow and where there were opportunities to grow and we had a right to win. So on the consumer side, that focused on mortgage banking and wealth, the trust and investment services line. On the commercial side, it was capital markets and then also FX and interest rate products, so basically global markets hedging. And if you look at the graph in the center, interestingly, both the growth in consumer across those businesses and the growth in commercial across those feature businesses averaged about 18% over the past 5 years. And so that helped drive overall fee performance to an attractive growth level. And we'll continue to drive that growth, and we'll continue to seek to do more for our customers. One thing that I'm not sure we're getting full credit from the market on is the growth in our mortgage business and our mortgage revenues, which, actually, to us, is an attractive business. And we have kind of done some analyses to look at how does the mortgage revenue, which some people may perceive to be volatile, fit in with -- and as a diversifier to other revenue sources. And so it's true that it's diversifying against low rates. It's also true that it's diversifying against other fees, particularly capital markets fees. So this little slide looks at 2 time periods. One is the past 6 years since the IPO, and the other one goes back 12 years, another 6 years beyond that. And says, what would be the standard deviation of our revenues, the fee revenues in -- if we had the current business mix all the way back to those time periods versus what we actually reported? And you can see there that actually, today's business mix is less volatile with the bigger mortgage presence in the revenue mix than if we didn't have that. So anyway, just something to note. And at the bottom of the page, you can see kind of the history of how we built up those capabilities to achieve that result. I'm going to shift gears here now and look ahead to the next couple of years. And I think what's on many investors' minds is how are banks going to operate successfully in the ZIRP environment. And not just a similar ZIRP environment to what we saw past 2010 to 2015 or '16, but back then, you had a much steeper yield curve, you still had the 10-year at 175 or higher. Now we barely see a day when the 10-year gets over 75 basis points. So that clearly represents some headwind to the revenue picture, and it's likely to stay with us for some time. So we still think it's possible to achieve EPS growth and ROTCE improvement. But to do that, we're going to have to be very focused on executing well across a number of dimensions. And all those dimensions here are listed on this slide. I'm going to take each one and turn in the next section of the presentation. So let's start off first with using loan and deposit growth to help protect NII in that ZIRP environment. And what I would say there is that historically, we've had a good track record of finding niche areas or finding ways to grow the loan book in a prudent fashion that we find some running room in areas that deliver good risk-adjusted returns. So on the consumer side, that's been education, refinance, merchant finance is also where underweight mortgages, and we've grown mortgages on the book as well. We've had a very disciplined risk appetite on consumer, and we stay focused at super prime and prime quality borrowers. And then on commercial, we've really been able to grow the book as we've added coverage bankers who bring relationships over to us. And we've found opportunities to grow in slightly bigger end of the market in mid-corporates, companies with $500 million in revenues to $3 billion in revenues. And oftentimes, we need industry specialists. We've hired corporate finance bankers who can really know how to cover companies in those areas, and we've married that to geographic expansion as well. So we think there's still opportunities to find loan growth. And obviously, that will pick up as the economy strengthens. I would say one last thing here, too, is that even with that relatively fast releveraging since the IPO date, our average credit quality in both the consumer book and on the commercial book has improved when you look at that. And we've shown slides like -- that demonstrate that in the past. On the deposit side, really, part of the challenge for us has been to grow out the ability to attract low-cost deposits on the consumer side up the DDA percentage. We've been successful in doing that. In fact, we've had top of peer set performance in DDA growth over the last several years, and that really rests on our investment in data analytics, personalization and targeted customer offerings around mass affluent customer base. On the commercial side, that's been also broadening out our capabilities around operational deposits and having new offerings such as escrow counts and things like that. So there's still more room to run there, but changing that mix to -- and we can be a little selective now. We have plenty of deposits. And so trying to work down that overall cost of deposits is really, really important. Next up in protecting NII is what we've done in terms of balance sheet optimization and also our net interest margin management. If you look at some of the BSO actions that are listed here, I won't go through all of them, but we're growing attractive front book areas and we're reducing areas that are not as attractive; and then on the liability side, again, focusing on those lower-cost categories. And importantly, the launch of Citizens Access gave us a lot of flexibility in terms of how we price for deposits. So that was really a milestone in our ability to bring down our overall cost of deposits. And going forward, we think we'll continue to use some of those same plays in the playbook. We'll focus on commercial relationships and eliminating low-return relationships over time. A new play that we have in the playbook on the consumer side is starting to work towards an originate to distribute model. As we indicated in the second quarter call, we've now completed the sale of $900 million of student loans and we're able to achieve a nice gain on that. So you get some fee income plus you can retain the servicing. So that's further fee income, so you can convert what was balance sheet income and capital usage to some fee orientation. And then also on the bottom of the page, NIM management, we continue to see opportunities around pricing given the significant strength we have in the deposits right now. We have, for example, $3.5 billion of CDs maturing in the second half of '20, which gives us a real opportunity to price down. We've done some very good hedging. And so that's helped sustain that NIM performance. That's the good news. The bad news about hedge is they roll off over time. And right now, the ability to extend is not very attractive, but we'll hopefully see some opportunities as the economy strengthens potentially to put some hedges back in place. Next up is -- next lever is going to be fee growth. So I already spoke quite a bit about fee growth, but we still think there's very positive forward view on where fees can go. I think there's a general feeling that the mortgage business is heavily refi-dependent. And over time, that will normalize and it may normalize quickly. We actually think at these interest rates, there's still quite a bit of benefit to households and quite a bit of -- quite a number of households, I'd say, the majority of households are still in the money in terms of having a refi opportunity. There's also capacity constraints on the ability to handle that. So that bodes well for margins continuing to stay at attractive levels. And then underlying our business, we basically have some very ambitious goals in terms of scaling up all of our distribution channels, the loan officer channel, the correspondent, the wholesale channels, where I think we have great offerings and ability to gain market share, continue to gain market share. So I think the outlook for mortgage is probably better than people think at this point. I'll just skip down in the interest of time to global capital markets. And here, I think we've built a top-class operation that can compete well with any super regional and then also with the mega banks when they come down into our space to cover our sized companies. And there's a building opportunity, I think. There's a lot of capital on the sidelines looking to go to work out of private equity funds or distress funds. And so we think we can help intermediate that to make advisory fees and then also financing fees. So I look forward to that. Next up is I've talked some already. I'm going to just flip here. We talked already about our TOP programs, but they've clearly been instrumental in our ability to deliver positive operating leverage and drive ROTCE improvement. The good news is that everything we launched is still on track to hit that $300 million to $325 million run rate by the end of '21. There's some puts and takes given the environment. So it won't be the exact same blueprint that we drew up, but we're still on track to deliver that. And what we've been working on, on over the past couple of months has been ways to upsize that program and expand it. And the principal opportunity there, you can see the box in the middle of the page lists several of them. But really moving on towards enhanced digital capabilities and doing digitization on an end-to-end basis, really, to me, is a very attractive opportunity that can meaningfully augment the size of the program. Why don't we flip to the next slide and I thought digitization on its own merited further comment. But clearly, the pandemic has accelerated this whole move towards digital. So it's essential that banks continue to invest here. We have a new digital consumer platform that's rolling out. The mobile is in phased rollout right now and online by the end of the year. So we're pleased with that. And then on the commercial side, we've launched a global cash management platform that's very oriented around digital access to information that was fully implemented by the end of last year. So I feel that we're making the right investments, and the next frontier is really working on back end -- front-to-back or end-to-end, however you want to say it, digitization, which just streamlines processes, moves from the old way of working to the new way of doing things, offers customers better experience, offers customers an ability to self-serve. So their experience goes up while we gain additional efficiencies. Next up is continuing to invest strategically. So with some pressure on the net interest margin, there won't be potentially as much capital to invest. We'll have to be careful about where we invest, but we want to prioritize things that actually help position us well for the medium term. So much of the work around technology, around digitization goes to the top of the list. But also backing some of these strategic initiatives where we can have breakout revenue performance over the next 3 to 5 years, that stays high on the list as well. So some of those items on the consumer side, national expansion with Citizens Access and pulling together some of our lending businesses, to us, seems very attractive. Our merchant point-of-sale platform, we can add additional merchants to that. We can also go direct to consumer and give them different ways to purchase going forward, and then a real focus on deepening relationships and upping the value proposition we have for our targeted customer segments. And then on the commercial side, continuing to leverage growth in coverage bankers while also investing in additional product capabilities. That's been the formula that's taken us a long way, and there's still room to run in that model. Just next up is normalizing credit costs. So clearly, we will -- CECL accelerated the provision bills. And so as we look forward, we'll still see charge-offs going up, but provisioning should come down, and it should turn into a positive driver around earnings once the macro view improves. So looking forward to that. Next slide here is on -- while we're on the topic of credit, it probably makes sense just to pause and talk a bit about forbearance and trends that we're seeing in the book. So when you look at the commercial side, really, there's nothing that's been surprising since our earnings call in terms of any credit migrations or trends in forbearance. The areas of concern the industries most affected by COVID is really where we continue to stay focused. And if there's any issues, it will really be contained to there. But good news is the deferrals have trended down from about 3% in May, down to 1.8% in August, and I think there's further momentum around that as we see the benefits of stimulus and reopenings start to have positive impacts on our customers. On the consumer side, we're still seeing broadly stable trends in delinquency for accounts that are not in forbearance. In fact, they're actually favorable. They're doing very well. And then the pace of new forbearance requests continues to slow dramatically. And down at the bottom, you can see that we had about 6% of our customers in forbearance at June 30. That's down to about 4.5% as of the end of August, and that trend continues to accelerate downward movements. So looking good there. Lastly, the lever that's important always remains our capital management. And I think here, we feel very good about the strength of the capital position, the capital position plus reserves plus PPNR generation leaves us feeling good about capital overall. And so our top objective, we're going to protect the dividend. We feel good about that. We will look to support loan growth as we see it. So I think that's really important to have our capital supporting customers and customer needs and driving operating leverage, as we discussed. Also, we've had some well-timed acquisitions. If we can find more, we'd like to do that. And then we'd like to get share repurchases back in the mix at some point depending on what the other opportunities are for deployment of that capital. So I'm going to summarize here and just say that, overall, we feel good about how we've navigated 2020's challenges. We feel that we're positioned to leave the crisis with positive momentum. While the ZIRP environment poses some challenges, we do feel that we've demonstrated an ability to operate effectively in any environment historically and that we will be able to achieve EPS and ROTCE improvement, but it will require strong execution across a number of dimensions, having that growth mindset, building out those fee capabilities and having that relentless focus on the expense base. We'll also look to capitalize on opportunities we see coming out of the pandemic, whether it's moving digital more aggressively or whether it's finding areas to invest where we can find some and drive some top line revenue growth and customer acquisition. So in short, to summarize, we're confident that we can manage through the current environment and resume progress towards becoming a top-performing regional bank. So that's my prepared remarks. And Jason, I'm happy to open it up for questions.

Bruce, thank you. That was a very good and comprehensive strategic overview. And clearly, looking at a lot of opportunities for citizens to differentiate themselves. [Operator Instructions] Bruce we have about 10 minutes remaining, and I already have a lot of questions in my inbox I guess relating more to kind of the near-term outlook. But maybe to start with the first, you talked to net interest income up modestly in the third quarter. Some of that included the PPP benefit in NIM. Now that's like more of a 4Q event. Can you just talk to kind of the near-term NII trajectory and kind of ex PPP, can you still keep the NIM broadly stable given the current rate backdrop?

Yes. What I would say there, Jason, is that we had made certain assumptions around the PPP forgiveness. And really, it was the -- and we got in position to be an efficient leader in terms of how forgiveness was processed. We invested in a platform with 1 of the big 4 firms. And then the SBA, when we went to test, basically put the brakes on and said, we're not quite ready, and there's political discussion about can we have blanket forgiveness under certain loan sizes. So all of that means that the forgiveness will push out into 4Q and 1Q. And so I think we will not hit the NII guidance largely because of that. Having said that, if I look at revenues overall, I think we're in really good shape to a good performance this quarter on revenues because, in large part, the mortgage business has been very strong, stronger than we expected. And then capital markets also has seen some uptick in activity as well. So revenue picture, overall good, probably a bit short on NII.

And just maybe talk to -- in terms of loan growth has kind of been another topic, clearly seeing a decline in line utilization. So commercial under pressure. There's been pockets of strength in consumer and some of the places you play. Maybe talk to what you're seeing there.

Yes. I'd say it's about what we called out. So when you factor off the line draws coming down and some of the temporal impacts, the underlying we thought would be broadly stable, maybe off slightly. And I think that's about where it is. So there's no real big surprises on the volume side.

Okay. And then I guess given the shift in revenue mix this quarter with maybe the income a bit better than expected, NII a bit worse, how does that I guess play out into kind of near-term expense outlook of up low single digits? Has that kind of come under a bit more pressure given there tends to be more costs associated with fee income? Or just how do you think about that?

No. Look, I -- you're trying to get me to update my whole guidance, which I don't like to do intra-quarter. But in any case, I do think we've done a great job on expenses historically. So even if there's a mix shift that there's some compensation related to the mortgage revenues, we're constantly working for ways to accelerate some of the cost efficiencies. And so I feel good about what the expense outlook is at this point.

Got you. Maybe kind of longer term on expenses. When you're talking about the TOP program, you highlighted you still expected to get there in totality, although the puts and takes were maybe a bit different. I guess did you find some new opportunities with respect to COVID that kind of goes into TOP? And then there's other initiatives you can kind of table and pick up next year and ultimately, that program can kind of grow in scale and scope in a post-COVID world? Or just how should we think about that?

Yes. So what I would say there, Jason, as you remember, the TOP program had a traditional element and a transformational element. And the program across both has revenue elements as well as cost reduction elements. And so I think because of the COVID period, some of the revenue ability to get sales and further penetration into the customer base was pushed out a little bit. So we had to make up for that. And really, on the traditional side, we have just new ideas about how to manage the expense base, and we'll make up for it probably with a little of a shift towards expenses as opposed to -- as a way to offset some of the slightly lower revenues that we had initially envisioned.