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

Hi, everyone. This is Ryan Nash, the Regional Bank and Consumer Finance Analyst here at Goldman Sachs. Kicking it off for the regional banks and joining us for the sixth straight year, we are excited to once again have Citizens Financial. Citizens has done an outstanding job managing the current downturn as its countercyclical businesses such as mortgages have offset a challenging rate environment and a challenging credit backdrop. In addition, it's continued to drive expense discipline and operating efficiency through its top 6 program, which have recently added $100 million of pretax benefits too. Here to tell us more about the story, our Chairman and CEO, Bruce Van Saun. Today's presentation is going to be fireside chat. Just before we get started, you'll see on your screen, there's a place to submit questions. If you'd like to submit a question through the webcast, please do so, and we will try our best to ensure that gets addressed. So first up, Bruce, thank you once again for joining us at today's presentation.

My pleasure, Ryan, good to see you.

Great. And Bruce, maybe just to start big picture. You've spent the last 5-plus years repositioning the bank, expanding the product suite, upgrading technology and of course, improving returns. even so returns over 13% for a few quarters. However, we then saw rates get cut and then the onset of the pandemic, which have certainly weighed on the industry. So maybe with that as a backdrop, can you just talk about how you feel about the position of the bank as we look into 2021?

Yes. Sure, Ryan. Look, I think we've had a very strong year performance-wise in terms of delivering for all our stakeholders. We've taken care of our customers. We've kept our colleagues safe. We've impacted our communities. Our financials have held up well. We're in a good position with our regulators. So there were a lot of challenges thrown at us, but I think we've responded well. And we've kept our eye on the ball of what we're trying to achieve in terms of positioning the franchise well to continue to grow revenues, deliver operating leverage through time and improve that ROTCE to get back towards our medium-term targets of 14% to 16%. We clearly learned some things through the pandemic. We saw that the world is moving to digital embrace digital channels faster than ever before. There's a desire for more self-service on the part of customers for better customer experiences. So we had a chance as we went through the pandemic to step back and refresh our strategy, focus on how to accelerate our move to digital, kind of a digital-first mindset, end-to-end digital processes that are seamless and work better for customers. So that was part of the augmentation of the top program. I think we get a twofold benefit there, not only do we save expenses, but we also deliver better experience for customers. We've got some really great strategic initiatives going on in the consumer bank. One is kind of pulling our national businesses together and leveraging the Citizens Access digital platform. So we're excited about that. We have our point-of-sale platform that started with Apple, but is rapidly spread to a bunch of other marquee players and merchants which We have that well positioned to capture the growth we expect to see in point-of-sale finance. We've now assembled a full product line, both on consumer and commercials really deepen relationships. And get more cross-sell and make those relationships more productive for us. So very pleased with how we've come through this and feel that we're very well positioned for '21 and beyond.

Got It. Maybe before we get into some of the more interesting stuff, Bruce, you provided an outlook at 3Q earnings for the fourth quarter. I just wanted to see if there was any update to that, as you know, obviously, mortgage has remained strong, the curve has improved slightly, also any changes to the near-term credit expectations?

No. Look, we're going to finish the year strong. We feel good about how the quarter is going. So kind of right across the board when you think of revenues, expenses, credit, everything is tracking well. So feel good about the quarter. And also about the outlook for next year, which we'll cover in some detail when we get to our January earnings call.

Got it. Look, the environment today clearly isn't helping much, given all the uncertainty in the economy along with ZIRP. And if you read our economist forecast, short-term interest rates are going to be 0 for a while. Now in your -- in the first question, you talked about reaching a medium-term target of 14% to 16% over time. But clearly, that's going to be challenging in this kind of environment. However, can you generate EPS growth and return improvement? And can you maybe walk us through some of the strategies that you have in place to reach these goals?

Sure. Well, I think in the near term, certainly, with ZIRP there's going to be some tough comps into next year, given that we have kind of higher rates earlier in 2020 that you're going to get a full-year effect of the lower rates on NII. And then we've had a tremendous surge in mortgage revenue, which I still think will be strong into next year, but probably the margins won't be as strong. And so those are things we have to contend with. But all in all, we know the levers we have to pull. We have to continue to find attractive loan growth to offset some of the pressure on margin, which right now is, I think, abating. We've seen -- we've taken most of the flows on that score. But we have to find smart loan growth. We should see a rebound in our other fee categories. So I think capital markets pipelines are building. Some of the consumer fees that have been affected by the pandemic, as the economy recovers, should bounce back. We know we have to do a great job on expenses. And hence, the upsizing of the top program. And I think we're probably second to none in the peer group in terms of consistently being able to find ways to find those efficiencies while funding the things we need to position us for the future. I think credit, the outlook is improving for credit next year. So where people thought peak charge-offs were going to be and the amount of reserves people needed to hold. I think that outlook is improving as as we see the recovery remains strong even with the COVID spike up, but likelihood of getting another stimulus bill plus the great progress on the health front is all boding well for the credit outlook next year. And as a result of those improvements, I think the capital positions for like the whole industry are back to pre pandemic CET 1 ratios. And so there's really in my opinion, there's not a big reason why the Fed should hold us back from returning that capital to shareholders, but we'll see if they remain cautious. But that's also part of the equation is to start the capital return process. So I'd say we're focused on '21 in terms of making sure we're solidly back in double-digit ROTCE territory, which I think is imminently achievable and feel confident about that. And then if we -- once we get through '21, we keep focused on that operating leverage. We'll continue to see revenue recovery, discipline on expenses, the same formula that brought us from 5% to 13% in terms of driving and delivering that operating leverage should push us higher. And obviously, it would certainly help a lot if the yield curve steepened and then we scot off a surge gives you the nice push into the mid-teens ROTCE. But at this point, we can't count on all of that. So we have to look for self-help. And I think 1 of the good things about us is we're never satisfied. We still have levers to pull to run this bank better, and we're going to find them and we're going to pull them.

Bruce, maybe to dig into some of the points that you highlighted, mortgage has been a major countercyclical business for you over the past 12 months. I think expectations are for rates to remain low. You mentioned that spreads may come in, in the coming quarters. But can you maybe just talk about 2 things: one, your expectations for the business in 2021? How do you think about taking share across the different verticals? And then second, and I think more importantly, you've talked about this business being bigger on the other side of COVID. Obviously, a lot of nonbanks are talking about taking market share there. Can you maybe just talk about your ability to take share when rates rise? What do you think the drivers of that will be?

Yes. Well, I think we've had a vision for how we wanted to participate in the mortgage business, and it starts with a strong retail channel that provides that product to our consumer customers. That's why we're in the business in the first instance. And we've been able to scale that business up nicely over time, and we've been -- had quite a bit of success. We've grown about 80 loan officers this year, plus we now have a virtual channel. That has grown by about 35 loan officers. We diversified into having corresponded in a wholesale customer base with the Franklin acquisition. And in both instances, we thought that as an independent, they weren't as ambitious and aggressive in terms of taking market share as they could have been with our ownership. And so we've seen tremendous share gains, particularly on the wholesale side, but also on the correspondent side this year. And we're cleansing the customers of less -- customer base of less active customers and really plugging in some very high potential customers on the front book. So really like what's happening there. Underpinning all of this focus on growth has been the investments that we've made in end-to-end digitization. We put a front-end digital application process in place through -- with a fintech partner called Blend. We're getting well over half of our apps come in through the digital channel now. So we've really streamlined and automated the business. So when the surge in volume took place, we were able to keep up with that, gained market share, not have to have a sneaker per gate to the extent that our peers did. And so we've kept our margins very high throughout this period. So it's been a well thought out plan of attack to get bigger in the business, to get scale in the business. The book that we have ServiceNow gives us servicing scale, and we have a nice MSR book. And as rates go up, we should make more money off that servicing stream with time. We also are positioned to benefit from going from a refi market to a purchase market. So we're focused on bringing in quality loan officers who actually operate well, have good relationships and perform well in a purchase environment. So you've seen the markets probably moved more towards a 70-30 split of refis to purchase this year. But our percentage across all our channel is probably more like 60-40. So we're already strong and oriented towards the purchase market.

Got it. Maybe to ask, I know every CEO's favorite question to answer. And I know last month, you guys gave guidance or talked about the NIM bottoming in 2022, somewhere in the 270 to 280 range. And I think that assumed a mid-1s 10-year. Can you maybe just talk about what that looks like in a world where rates actually don't end up moving from current levels. Can you maybe just talk about some of the leverage you have, whether it's liquidity deployment, optimization of underwriting across certain products or maybe any remixing? And what do you think it will take for us to start to see core NII growing?

Yes. Well, we're affecting all of those things that you just mentioned, Ryan. So regardless of where the rate curve is going, there's opportunities for us to just optimize our balance sheet. So we've had an effort called BSO balance sheet optimization for a number of years. There's a consistent effort to look at where we're originating front book loans. And can we tilt that towards places where we're getting better risk-adjusted returns. All positively impact rods, but also positively impact NIM. And I think you've seen us do that quite effectively and impactfully on the consumer side. We're also moving into verticals on the commercial side, where we think there's a little more spread and a little better ability to penetrate and get more cross sell. So -- but it's not quite as impactful on NII on the commercial side as it has been on the consumer side. One of the additional things that we've done on consumer is we're exploring the capacity to have an originate to distribute model. So we've had a number of mortgage loan sales over time. But recently, this year, we also had a student loan sale of almost $1 billion of loans which was a very powerful transaction. We recorded a gain. We released capital and we released CECL reserves, which were kind of overstated, I think, because of the way CECL works, and these were long duration loans with about a 15-year average life. So we can now put that in the playbook and optimize on balance sheet versus off balance sheet, and we retain the servicing. So we'd also be building up fee income stream from doing that in the plans for next year, we'd like to do an auto CLN. And so we now have an ability across all 3 asset classes, mortgage and student and auto to have that toggle switch between on balance sheet and off balance sheet. We're also very focused on the deposit and the cost side of the equation. And you can see over time, we've really brought down the gap in deposit costs from us versus our peers, which I think was somewhat historical artifact of the way RBS accumulated the franchise, and it was more a thrift like base that focused on rate as an enticement to bring customers in. And I think over time, we've developed really good value propositions and much more segmented marketing approach that allows us to offer a full range of services and take less emphasis on price. So we've been able to price down our deposits. And certainly, that's turbocharged an environment now where the whole market is awash in liquidity, and we can be more aggressive in terms of how we're pricing. So that's another big lever that I think will help give us confidence in our ability to bottom out NIM regardless of what's happening in the kind of longer end of the curve.

Bruce, you mentioned you and the industry is awash in liquidity. I think one of the things we'd all like to see is some of that being used for some loan growth. And if you think about how things have gone over the course of the year, we had a defense of draws, then we had PPP serve as a bridge for many. And -- but there's obviously still a lot of uncertainty out there, particularly on both the corporate and the consumer side. So can you maybe just talk about, as you are talking or Zooming with corporates, what's the appetite to borrow into next year? And then second, on the consumer side, can you maybe just talk about what parts of the lending portfolio you're most excited about into next year that you think could be sources of growth even outside of the macro coming back?

Yes. Sure, Ryan. So on the corporate side, I'd say, obviously, in the early part of the pandemic, the race was on to build liquidity and just play defense. And so we did see the draws. We did see the investment-grade market open up first and then the high-yield market, people can access the bond market to bigger companies. So much of that borrowing was defensive in nature or locking in lower rates and looking to refinance or prefinance upcoming maturities. I think as we get more visibility and confidence in economic recovery, we're starting to see companies think about playing offense is they're an acquisition they'd like to do how fast can they add capacity and when we'll -- if it's a manufacturing company, will that make sense? And so I think you'll start to see a turn in line draws and start to see people borrowing money for what I would refer to as offensive purposes. I think a big thing that we're seeing is the accumulation of investment capacity in various investment vehicles like PE funds, there's a huge desire to put money to work, and we're starting to see an uptick in M&A and M&A pipelines. And usually, that bodes well for transactional flows and lending opportunities. So I think one thing we saw in the last sort environment that Fed HA data for corporate loans was about 8% growth when the economy was growing like 1.8% that whole period. The reason that happens is because smart players take advantage of low cost funding, and they put more leverage on their companies. They do equity recaps, and we saw a lot of that. And the -- if rates go up, it actually could increase the sense that the tax shield on having leverage is more valuable. So we're pretty optimistic and bullish that those factors as the economy stays strong, you'll see a lot of money flowing in from smart investors and people taking advantage of low rates to borrow money, that's effectively what the Fed is trying to accomplish. So on the consumer side, there, I think we have a very strong position because we're probably more diversified than any of our super regional peers in terms of all of the venues we play in, in terms of our lending channels. And so we've had, I think, a strong year in mortgage this year. We've still had a good year in student in spite of some of the forbearance that the government put around student lending, there's opportunities with lower rates for education refinance loans for people to lock in lower rates in the -- on the private side of the market. So we've seen some growth there. And then our merchant finance business, the point-of-sale finance business, I'm very excited about that. Industry reports estimate that point-of-sale finance for the next 5 years is going to grow at a 19% clip, and credit card is only going to grow at a 4% clip. And so I think we've built something that really works to be a disruptor to point-of-sale finance with some very great products that work well for some of the marquee merchants today. So I think there's a lot of upside there as well. So those would be the areas I'd call out. And I'd say, very, very pleased with our diversification and our ability to capture borrowing even in an environment that you're seeing revolving credit balances lower, and so some other firms are having trouble getting balances growing. I think we have enough sales up that we should be able to catch some NIM.

Got it. Maybe, Bruce switching gears a little bit. So you announced top 6 last year, which was slated to deliver $300 million to $325 million in gross pretax pickup. You recently upsized it by $100 million by year-end 2021. Can you maybe just talk about how you're progressing with the plan as well as some of the upside -- some of the drivers of the upsizing? And do you think this is enough to drive positive operating leverage over both the short and intermediate term?

Yes. I feel really good about the foundational top 6 program that was announced in the middle of last year. We're hitting all our markers. All our work streams are delivering in spite of the challenges of the year. So the -- probably the 2 most important initiatives under the initial form of the top 6 transformation, one was called Next-gen Tech, which is where we're lifting our technology ecosystem to face the future. And the second is modern operating model, which is reorienting the way we manage change in the bank to be an agile format where business folks and technologists and the staff functions work together to affect that change, and that's all been going exceptionally well. The new things that we added on really relate to what I mentioned earlier in terms of the world going digital and going faster. So how do we gin up an effort to really push for end-to-end digitization and change the way we're running the bank. So we have that set up with some great leaders focused on how to do that. We've set up our work streams. I feel good about that. We also kind of embedded and that upsizing is moved towards virtual. So can we make certain force is more productive by hubbing them and then using the virtual channels. And for example, our business bankers covering small companies could maybe drive around and do 3 appointments in a day. And if they're in a centralized location, they can do 10 client calls in a day. And be -- and get very good feedback from the customers from being able to engage that way. So we're looking at that. And then another element there is what we're calling war on paper. is that probably $25 million to $30 million prize, if we can just get rid of some of that paper. And it's also good for the environment. So it's ecologically friendly. So that's another thing that we're very focused on. And just in terms of how that plays into operating leverage, as I mentioned earlier, that I think the comps for next year early is going to be a little bit of a challenge, but that's ultimately our goal. The only way that ROTCE goes up is to get back towards delivering that operating leverage, where we're growing revenues and some of the strategic investments that I mentioned are designed to keep our revenue top line growth rate strong. We want to kind of outperform peers on the top line, which does allow us the flywheel moves faster, and we can reinvest in continuing to keep that upward trajectory. But certainly in 2021, we're going to be very, very disciplined on the expense side.

So Bruce, you had mentioned as part of the top 6, there's a lot of work going on to transform the digital applications of the company. I think digital logins were up almost 20%, app downloads are up double digits and non-branch transactions are increasing. And I think you recently upgraded your app and your online banking. So can you maybe just talk about what you're seeing across the customer base, how much of this do you think is truly secular versus environmental? And then what does this mean for branches going forward? And what are the lessons learned from this downturn in terms of accelerating the pace of digital engagement?

Yes. Well, I think the digital experience is here to stay, and you only have to look at how shopping is getting done, moving to online and how -- when people get back to flying, you buy your tickets and you don't even have to go to a counter, you can just click your phone and get walk onto a plane. So I think the comfort level with using your phone to do a lot of navigation through purchases is here to stay or use it as an aid to check your balances or conduct some basic transactions. So once you've taken a picture of a check and you don't have to get in your car and drive to the bank, why would you ever do anything different. So we think that's here to stay, and that has implications for the overall distribution effort, it means you have to get better at digital sales, how do you make connections with your customers. How do you promote your brand, the top of the funnel advertising and your marketing has to reorient towards a digital approach. So we're working through all of that. It is still a fact though that our most satisfied customers value all the channels and having the capacity to use all channels. So the most satisfied customers still go into the branch on occasion. They'd like to call the contact center if they have a question, they need an answer. And then they like to use the digital tools. So our goal is to make that seamless and to kind of, ultimately, over time, pull more cost out of the physical channel and -- so we can reinvest that into our digital channels. I think we've done a good job of that so far. We're probably in the last 5 years, down about 15% in terms of our branch count. And I think we also had an effort underway to transform the branches to make them less transaction centers and make them really nice in advice centers with private offices and overall a smaller need for space. So if we had a yesteryear branch was 4,500 square feet, a new branch can be 2,000 to 2,500 feet just configured differently. So we're about 5 years through a 10-year program on that. So that's ongoing. But we should be able to continue to thin and you'll hear more about that when we report in January.

So we made it almost 30 minutes without talking about credit. And Bruce, you were aggressive early on in terms of identifying high-risk exposures. You've built a lot of reserves. And you recently noted you think commercial losses are close to peaking. Maybe can you just talk about what you're seeing in the portfolio, What is giving you confidence that this is going to happen? And I think more near-term oriented, you talked about 4Q earlier, not to be too short-term oriented, but are you still feeling good about releasing the reserves in the near term? And do you think we're on a path back to more normalized reserves by the end of 2021?

Yes. So I feel very confident in how we will perform, even with all the uncertainty, the uncertainty is slowly dissipating. But we knew coming into this crisis that we had been very disciplined in terms of how we re-levered our balance sheet. We had a very pristine, safe risk appetite in the consumer side. All of our exposures, basically super prime and high prime, and it's diversified across a number of lending books. And then on the commercial side, we had been moving upmarket and growing the mid-corporate sized customer base, which is basically companies with $500 million to $3 billion in sales, faster than the middle market book, which is $25 million to $500 million, and those tend to be better credits. So if you look over the last 5 years, our average FICO scores on the consumer book were higher. And also the average rating on our corporate book was higher. And then when you look at how those portfolios stress tested with the Fed, we were always kind of around the median or slightly better than the median performance. So I recognize that there was some concern at how fast we had grown the credit -- the overall loan book over the 5 years, 5, 6 years since the IPO, but we were confident that we have been prudent and that we just -- some folks on my team would say, gosh, what we need is a good recession, so we can prove it. I was like be careful what you wish for. We actually don't want that. But now here we are in improving ground. And if we maybe a show me stock, but it's really important that we come through this with good relative credit performance. And I think that's going to happen. So we had, I think, good visibility into the fourth quarter that we just had a couple of tall trees hit us in the third quarter. But we're starting to see improvement in credit class trends, NPA trends, the things that are coming into watch of first basically dried up industries of market concern, where we had 10% on heightened watch. We had downgraded to only 5% of the book with the third quarter earnings document. So we certainly feel that there is certainly pain. There's pain in the sectors most affected by the pandemic and the lockdowns. But other than that, we're seeing good credit quality because we've been disciplined in terms of how we play the game and how we've grown the book. And similarly, on the consumer side, we've had very positive developments. we're seeing charge-offs and delinquencies at almost all-time lows. We've had forbearance take up, hit the mid-7s. It's down closer to 2% today. So there's that hard-core residual folks, most affected by the pandemic that we have to monitor and find solutions for, and we'll end up having some charge-offs there. But again, I think the credit quality is very high, and I think we'll come through this strongly on the consumer side as well. So I do think the investor community and the analyst community has been overly conservative with the outlook, and they're kind of refreshing that. And I think that will continue to happen. I think that as long as we don't see something unexpected occur, I think the '21 credit numbers for all banks, and including ourselves, will be better than people are expecting at this point.

Bruce, there continues to be a debate around scale in the industry. We now have several banks that are over $500 million in assets. The bank hasn't done the whole bank acquisition since coming public. However, as we move through the cycle, the valuation improves and the risk of the recession comes down, does that at all change your view of whole bank M&A? Or is the focus still more on bolt-on capabilities?

Yes. Look, I think scale is a 2-sided coin. And the banks that are going through big mergers they'll have some scale benefits once they get integrated. But while they're going through integration, they have to focus on how to put very big technology complexes together, which could keep them on the back foot for all the change that's happening. I think we have enough size and scale to certainly pursue our strategy and to compete effectively and we compete against the bigger peers and the super regionals and against the megabanks, and we win business on a regular basis. So that focus on the customer we have and then being disciplined and having good technology people and being able to execute and prioritize well really matters. So having said that, acquisitions have been important to us. Without Franklin, we wouldn't be having the year that we're enjoying now. So I think it was smart once we started to get the bank in position where we could have confidence we could go out and execute acquisitions and execute well. That we went and did that. And so we've brought in a wealth manager. We've brought a mortgage upscaling opportunity or some M&A shops in to help what we can do for our commercial customers. And we'll still have that on our list. We'll still have transactions in the wealth space or in the M&A space, the fee-based deals to broaden our capabilities will be at the top of the list. I'd say we're open for business to look at other things. We've looked at some of the portfolios that are rumored to be on the market by 1 particularly large bank is going through quite a bit of restructuring. And I think it always makes sense to kick the tires and try to say as part of PSO, if we bring in this business and this portfolio, what would have to go out and how would that change the franchise. Is it positive benefit overall, and can we get something at a good price. I think you could extend that and say, if there's banks that are struggling and the valuation is attractive, but they have some real value, could we do that. Could we now -- do we have enough maturity as a company? Have we fixed the company sufficiently that we could go take a look at some things. I think we could. But again, we're going to be very cautious, and we're going to only do things like Franklin that makes sense for our shareholders. So we will not reach and stretch for things. We I think, have a great plan to grow organically. And then I think we have a proven ability to go find some of these fee-based deals that are going to be accretive to our shareholders.

Bruce, we got about 30 seconds to go here, maybe I'll squeeze in one last question. You talked about rebuilding the capital back to pre-pandemic levels. You said you want to get back into repurchase. Can you maybe just talk about the priorities for capital return? And you've laid out a target of 9.5% -- 9.75% to 10% given how resilient earnings have been? Where do you think capital could go over time?

Yes. So I have to be really fast to my answer. But maintaining the dividend, it was always at the top of our list. I think we've demonstrated that, that is eminently achievable. We want to grow the balance sheet organically, support our customers. That would probably be number two. Number 3 would be smart M&A to the extent we can deploy capital and good rates of return, particularly in this low rate environment, that's certainly attractive. And then I would like to -- if we're unsuccessful in either loan growth or in acquisitions, we'd like to buy back our stock because we think it's a very attractive buy at the current valuation.

Got it. Well, on behalf of myself and all the investors just want to say thanks for taking the time today. Have a great holiday season, and go Giants.

All right. Yes.

Thank you.

Thanks, Ryan. Buh-bye.

Bye.