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

Welcome to our second day of our 25th Annual Financial Institutions Conference. We are very pleased to have with us Citizens Financial Group. As many of you know, Citizens is the 12th largest bank in the United States with about $183 billion in assets. Its franchise covers 11 states. The company has about 17,000 employees and over 980 branches. The company is now trading just below book value. The company's dividend yield is about 3.6% and has a CET1 ratio of about 10%. The company has announced that it's planning to do a buyback or it's underway in the first quarter -- beginning in the first quarter of about $750 million. We're very pleased today to have with us John Woods, who's Vice Chairman and CFO of Citizens Financial Group. He's been here since February of 2019. And prior to that, he was Vice Chairman and CFO of Union Bank out in California. John, thank you very much for joining us today.

Yes, it's a pleasure, Gerard. Thanks for having me.

John, maybe we could start off with just what we've been through for the past year. I know this is an overused word, but it was unprecedented what we went through in our lifetimes last year. And maybe you could share with us what were some of the -- aside from the obvious pandemic being a surprise, but what were some of the surprises that you witnessed at Citizens? And how did the senior management team address the surprises that you all saw?

Yes. I mean, it's a good question. I mean I think the -- as you mentioned, the external -- the velocity of the events as they unfolded was really breathtaking. And when you think about the fact that back in the great financial crisis -- we tend to compare the 2. So back in the great financial crisis, I think we got a company line draws got up into the 40s. We -- and it took the better part of a year to get there. We got to 50% in a few weeks. We had consumer behavior completely shut down. And the government stimulus, both monitoring and fiscal, was really amazing. It was a tour de force to watch the several multiples of government support coming in, in a much shorter period of time compared to the great financial crisis back in 2008 and 2009. And pivoting to where -- our response to that. I mean, I think that I'm very proud to be able to say that our balance sheet strength was on display during this entire -- during the entire pandemic. From a liquidity standpoint, we doubled our contingent liquidity sources in a manner of a few short weeks and months all throughout 2012. I mean we started the pandemic with 10% CET1 capital. We doubled our credit reserves during the pandemic. And by the end, we were still at 10% CET1 capital. That was great to see to be able to illustrate and demonstrate the diversification of our revenue streams, drive record PPNR during that period. And then flipping over to our customer support. I mean, our PPP support of our business banking customers, we had to innovate to get that program up and going. We lend $5 billion in a short period of time, which we think supported over 540,000 jobs. And I'm particularly proud of our branch network and our branch colleagues. Unlike some others, our branch network was never more than 2% closed, meaning we were 98% open during the entire pandemic. That's just impressive in terms of our internal colleague response. And I'm just pretty proud, not only of Citizens, but the banking industry as a whole. I mean, back in the great financial crisis, there's a lot of those who would perceive that banks were part of the problem. But this time around, we were decidedly and definitively part of the solution. So I'm pretty proud of that.

Very good. Yes, it was a remarkable year. And as you just described, you guys responded quite successfully to this pandemic. Moving on to profitability for a moment, you've given out some guidelines in the past about targeted ROTCE levels of 14% to 16%. Can you share with us what kind of environment do you need to operate in to achieve those goals of an ROTCE number of 14% to 16%?

Sure. Yes, I think context is helpful here. It seems like forever ago, but back in 2019, pre-pandemic, we had gotten -- even in that environment, we had gotten to 13% ROTCE, which is just below that range that we were targeting. And so I think what we're expecting is, in order to achieve that goal, that there's a number of environments that would allow us to get to that 14% to 16% range. But what would be sort of down the middle of the fairway, if you will, is to have a reasonably steep yield curve, which is starting to happen. Some normalization of credit, sort of a -- and I think we mentioned in our earnings that we were expecting to try to get to a 55% or thereabouts efficiency ratio. And to have a GDP outcome that's sort of in the low to mid-single digits, you put all that together and we have, since our IPO, been endeavoring to grow revenues faster than growing expenses, even though we do want to continue to invest in our platforms, and that positive operating leverage is really the engine that has -- that will drive us to that medium-term outcome of 14% to 16%. And I'd like to highlight that I think we mentioned that it's our expectation that even in 2021, ex the mortgage comparables from 2020, which were phenomenal performance, ex those comparables that we expect to have positive operating leverage in 2021 when you think about it that way. So you think about it in a lot of ways as transitioning from the pandemic and from our mortgage comparables, and I think we get back to positive operating leverage that we've proven the ability to execute against post-IPO. We get back on that trajectory and that will deliver the outcome that we articulated in terms of ROTCE.

Very good. And yes, we know from looking at many banks, the positive operating leverage focus is very important in achieving higher levels of profitability. And it's good to hear you highlight that positive operating leverage. You touched on, in your comments, the steepening yield curve. Maybe you can share with us, we all know, obviously, the yield curve has steepened, especially since the fall of last year. And just what kind of impact is that having on your business today? Any type of margin impact? And then second, John, not that the Fed is likely to raise short-term interest rates anytime soon. I believe the forward curve might be calling for 2 Fed fund rate increases in 2023. So if we were to see something accelerate, meaning they raise Fed funds sometime in '22 due to higher inflation expectations, can you share with us how the short end of the curve affects Citizens as well as this steepening we're seeing?

Yes, sure. I mean, as you know from our disclosures, we are meaningfully asset-sensitive, as the term goes. And so at the end of last year, it was in the neighborhood of 11% asset sensitivity. And that is -- that's contributed to by both the long end and the short end. So about most of it's short end, and I'll talk about that in a second. So about 55% of our sensitivity is due to the -- is due to our positioning to increased NII when rates rise. And so that leaves about 45% for the long end. And so NII is expected to be positively impacted by these moves that have happened as long as they are sustained. And so the main drivers of our long-end asset sensitivity is the front-book originations in our consumer lending businesses primarily and in their securities book, where we have fixed rate securities purchases as well as fixed rate lending that happens and the ability to lend at higher yields is really a big driver. I'd say that we also need to remind ourselves that there's a significant amount of premium that's on our balance sheet in the securities book as well as in our loan book. And as mortgage-related assets extend in their expected life, we'll amortize those premiums over longer periods of time. And so we'll have lower amortization that will occur when rates rise. I think the other couple of points I would make is that there's opportunities for hedging as well. On a dollar cost averaging basis, we will be hedgers over the cycle, where we see fixed swaps will be the typical tool that one would use to moderate asset sensitivity or monetize it as the term is over the cycle. And so we tend to dollar cost average our way into that. And so you could see some hedging, capturing some of those economics. And then just generally, the natural balance sheet dynamics as rates rise and as I mentioned earlier, mortgage-related assets will extend in duration and so asset sensitivity will moderate. But those are NII being positively impacted by all of those dynamics. And in part, net interest margins, of course, will be a big contributor to NII. So as I previously mentioned, under the prior kind of thinking that we had back in January, we did mention that net interest margin was likely to bottom somewhere in the 270 to 280 basis point range. And that we had had a sense that long-term rates would be at the -- around 130 to 140 basis points. But now with long-term rates tenure being higher than that, I suspect that we will bottom maybe at the upper end of that range, getting maybe 4 to 5 basis points of net interest margin lift from the steepening yield curve. And then lastly, on the long end, I would say that the fee construct for us has interest rate implications. So you see sort of a rotation out of the -- a slight rotation out of the mortgage business. I still think that mortgage will be extremely robust. But some rotation out of the refis into our NII economics so that overall revenues are still intact. And there are other fee categories that also are positive in a rising rate environment, such as wealth cap markets and others. So that's the long end, Gerard. Maybe I'll stop there and see if there's any questions about that before I move over to the short end.

Actually, maybe -- and we'll get into deposit and loan growth in a moment, John. But the influx into the industry last year of deposits was quite dramatic as you know for your own bank. Did that affect the -- how much did that affect, I should say, the positioning of the balance sheet to be more asset-sensitive in 2020 going into 2021 versus going into 2020?

Yes, it was pretty significant. When you basically see, we had, call it, $10 billion to $15 billion of surge deposits, much of that coming in, in the DDA space and that creates basically some underpinning, if you will, on the liability side and that generates a lot of asset sensitivity in terms of how our models would consume that. And I'd say that in terms of the outlook for deposits, that is likely to be relatively sticky over 2021. I mean, if we did expect that when we talk about these -- we call these surge deposits that came from the unemployment benefits, stimulus payments, PPP and just balance parking behaviors, just reduced sort of consumer behaviors, there's a significant amount of surge there. And we expect that in 2021 that, that would moderate and somewhat dissipate at least a bit, even though we thought that a majority of it would stay around. But then we have new stimulus coming in. And so new stimulus basically appears to be adding and our outlook is that the deposit levels from these dynamics and from these sources are likely to be relatively flattish in 2021. Within that, we think we'll have some positive mix shift and our interest-bearing deposit costs are going to be down significantly in '21, but deposit levels are going to stay relatively elevated. And then we'll get into how we deploy all of that in terms of the asset side.

Very good. And then circling back to the short end of the curve, you're going to give us some color on what you see there in terms of should rates move higher at the short end.

Yes. I think I mentioned that the majority of our asset sensitivity comes from the short end, maybe about 55%. And it's due to all of the short-term -- the lending products that we have that are indexed to LIBOR and prime. I'd say that when and if the Fed begins to get lift off again, and maybe that's in the early 2023 as you're saying in some of the forwards, I mean I think deposit costs, the impact on us is a positive, overall. As I mentioned, they will see nice uplift in NII when and if that happens. And I think what we'll see is all of the immediate impact on the asset side where interest earnings will rise on our assets. But after a lag, as you know, there's a deposit lag dynamic, after some lag that may be a couple of quarters, maybe 2 to 4 quarters of lag, you can start to see lift off on deposit expenses. And we'll get into talking about deposit betas again. A couple of years ago, that's all we talked about. We don't talk about that anymore, but maybe a few years from now, we'll start talking about deposit betas again. And I'd say that our deposit betas in the last tightening cycle were in the neighborhood of 40 basis points or a little more. I think that something to keep in mind is that the maturation of our deposit mix and capabilities continues to contribute to what we expect will be lower deposit betas during the next tightening cycle compared to the last one for us as a platform, and we're excited to be able to demonstrate that given all of the investments we've been making in data and analytics and our deposit capabilities and our mix shift away from the higher beta deposit category. So those are the benefits and why we think rising short-term rates are, frankly, going to be a nice, real solid positive for us.

John, it's interesting you bring up deposit betas. I'm totally in your camp that they were very low in the last tightening cycle versus the prior tightening cycle. And in the next tightening cycle, whenever it comes, due to the incredible amounts of liquidity you and your peers have, I'm with you. I think the deposit betas come in even lower, which makes it even more profitable for the margin and for the banks as that deposit betas just don't kick in and then that widens the margin, which is -- would be very positive. And that's good to hear that you pointed that out. Thinking of deposits, you mentioned that you've had, obviously, the surge deposits. And if you put that off to the side for the moment, maybe can you talk about deposit growth? You were one of the first banks to roll out a digital product and so maybe you could talk about that and how that's going. And just deposits in general, what do you think it may look like over the next 12 months?

Yes. I mean I think that, as I mentioned, I mean, I think we've got some -- if you think about surge deposits, where we think that that's going to be somewhat stable and stickier over the next year. And that's really going to be flat. I think the other non-surge deposit dynamics are also about flat. And I would say that where that's -- where we would talk about that, at least for us, is that when you ended the last ZIRP cycle, if you will, about 15% of our deposits were in CDs. And it's emblematic of how our deposit platform had not yet matured. But as you get in towards the end of 2020, we had gotten that down to high single digits. By the end of '21, we're going to get that into low single digits. And so you're seeing a mix shift away from CDs and time and term deposits into DDA and low-cost money market and demand deposit accounts, et cetera. And so really, we're seeing surge deposits flattish, where a little bit of the runoff of the prior stimulus is offset by the new stimulus. And then in the non-surge deposits, you're seeing our mix shift away from CDs into growth of higher quality deposit growth in DDA, et cetera. So really flattish on both ends in terms of deposits going into the end of 2021.

And John, you've distinguished yourselves prior to the pandemic of having some better loan growth than your peer group. Can you share with us what the prospects are for loan growth? And obviously, tying in all this excess liquidity, we -- from the H.8 data that we look at weekly, loan demand -- ex PPP loans, loan demand doesn't really seem to be too robust at this time. Maybe can you share with us your outlook for loan growth at Citizens?

Yes. I think we mentioned that we would -- and we still -- we have not changed this outlook. I mean, we still believe that we are going to be in that approximately 2% average loan growth range over 2021. I think that that's really in reference or dependent upon 2 important dynamics. On the consumer side of things, we have a pretty diversified consumer lending business across a number of categories, whether that's mortgage or education, refinance, we've got the point-of-sale finance business and auto. Those will all contribute, we believe, to a robust 2021 by the time we get to the end of 2021. And something to remember in 2020, even though consumer loan growth was in the low single digits back then, we also had a number of loan sale transactions that we had executed in the student space and in mortgage. Absent those loan sales, it might have been mid-single-digit growth in 2020. So there is momentum and growth opportunity on the consumer side. So that's one dynamic. On the commercial side of things, we acknowledge that, with all of the stimulus, loan utilization has been really lower than we expected. It's lower than where we would expect it to be historically. And frankly, in the first quarter, it's taken a bit of a touch down compared to where we were at the end of 2021, I think, in line with industry trends. However, the sort of the opening the economy back up activity, and we would expect to see utilization rise and inventory building and receivable building as activity post-vaccination, post-opening really starts to occur in the second half of the year. So a combination of the ongoing strength in consumer and the fact that we believe that the second half will be very strong for commercial. And frankly, in the first quarter, we see incredibly strong pipelines building. Strongest pipelines that we've seen in over a year in the commercial side of our business. So you can sort of see this unfolding for a very strong second half. And -- but on average, coming back to about 2% for the year is our guidance that we still believe will occur.

So it sounds like, and maybe I'm being too optimistic, it could be more like a hockey stick in terms of growth in '21 for Citizens and possibly the industry when it comes to loan growth?

Yes. I mean 2H clearly better than 1H, although we still believe that we have some activity that you can see in 1H as well.

Great. Shifting over to credit. Obviously, credit is extremely important. It was an incredible year last year. If I recall correctly, you guys struggled a little bit in the third quarter with your credit, improved very nicely in the fourth quarter. Can you give us your views on what you see for credit quality in the upcoming year? And in particular, any commentary on loan loss reserve releasing, maybe negative loan loss provisions? Because your reserves, similar to your peers, could be quite a bit higher than needed if the credit net charge-offs remain low as they have so far for you and your peers.

Yes. I mean, I think as a headline, I mean, credit trends are very positive on both consumer and commercial, retail and commercial side of things. I mean, I think we do, nevertheless, keep an eye on areas of market concern that had the biggest impact on -- from the lockdowns coming out of the pandemic. So in CRE space, we still are keeping a close eye on retail and hospitality. And I think that just talking about that for a second, the onset of vaccinations and the easings of restrictions. And frankly, just improving liquidity could see some maybe green shoots, if you will, in the commercial credit area, particularly in CRE. So -- and then in terms of -- that will play out though -- that tends to play out over a longer period of time, so over multiple quarters and over the rest of '21 and into '22. In terms of C&I, casual dining and energy is an area that we've been focused on. But again, reopenings and stimulus are helping in the casual dining space. And when you look at energy prices rebounding nicely, that's giving a nice tailwind to the energy sector. So there's just a number of positive trends that we're tracking, and that's going to have a positive impact on expectations with respect to charge-offs, both in the near term and over 2021. So therefore, the second part of your question, what's going to happen with reserves. And I think it's -- we still -- we're coming into the end of the quarter, and we tend to focus on this at the very end of the quarter. So over the coming weeks, we're going to make these final decisions. So no final calls on this. But when you -- as you mentioned, our reserves are, call it, in the 220 basis point range. We started this whole cycle, when we adopted CECL, around 145 basis points. So we mentioned that, over time, we'd likely migrate back to something in that range or maybe even better. And so we thought that maybe as you were closing 2021 that maybe we could get to somewhere around the midpoint of that, and we were talking about that back in January. Things have only gotten better since then. So this is all to be decided in the future, but it's possible that you could see our reserve levels as you get to the end of '21, maybe even below the midpoint of where we started this whole thing in CECL back in adoption compared to where we were at the end of the fourth quarter. So you might see us even potentially a touch below the midpoint of that by the time you get to the end of '21.

That's very good insights, I really appreciate that. It's going to be interesting because there's, as you well know, the federal reserve on managing your capital once we get to the full stress capital buffer construct, there won't be any restrictions on how much share -- how many shares of bank and buyback and you can increase your dividends as long as your CET1 ratio, common equity Tier 1 ratio, exceeds, of course, the required level. But in the meantime, you do have this income restriction, which I know you're well aware of. So it's going to be interesting for us investors to see how the second quarter or how these loan loss reserve releases play out in the first half of the year because, of course, that will affect income. Speaking of which, John, can you share with us your targeted and remind us your targeted CET1 ratio, where you guys are comfortable in managing your bank? And then just your view on the excess capital that you continue to build due to the ongoing profitability of your organization. How do you take care of and redeploy that excess capital on a go-forward basis?

Yes, just to get into that. So our -- as you may know, our target capital is of range, and we've got it at 9.75% to 10%. And just for context, as I get into my other conversations, as I mentioned earlier, we ended 2019 with a 10% CET1 ratio, but our -- pre-CECL, our credit reserves were, call it, somewhere around 1.1% or in that range. And you zoom past to where we ended up 12/31/2020, so a year later, we were still at 10%, but we had doubled the credit reserves outstanding. So you have to view those together, I think, in particular, when you feel like you're getting to -- getting some clarity and some transparency around to where you think credit losses may come in, you have to look at those together. And so when we think about capital deployment, as we expect provisions to basically be lower than charge-offs, not just in the fourth quarter but going forward here in 2021, when we think about how we would deploy that capital, and it's a cascading sort of prioritization. First, we want to support our dividend. It's important that we have a return to our shareholders that are reliable and that they can count on the fact that we're going to support that dividend over time. So that's at the top of our list. But then we quickly pivot to deploying capital in ways where we can generate returns that exceed our cost of capital. And that would -- that's in organic ways primarily. I'd say that bolt-on acquisitions are a fast follower to what we find very attractive, and we've demonstrated, I think, the ability to deploy capital very prudently in fee-based acquisitions in the past. And so that's part of the construct of deploying capital in a way that is -- would give strong economic returns to our shareholders. And then I think the other aspect of this, and if we're unable to deploy that capital profitably, that's when we get into share buybacks. And that's something that we would do on an ongoing basis as we assess our opportunities organically and in the fee-based arena.

Now John, if -- obviously, we both know your bank and the other big banks go through stress tests every year. Any commentary or color on what you're thinking about with this year's stress test? The economic, obviously, scenarios have been put out there for you -- for all you guys to review.

Yes. I think that -- I think we're transitioning from the resubmission at the end of 2020. This is an opt-in year for Citizens. We're going to be evaluating the pros and cons of opting in, in the coming weeks in consultation with our Board. But with respect to us, in particular, through the passage of time, we've been able to demonstrate very solid and positive results in the Fed model for credit. And so we've felt very good about the fact that even in the resubmission, we ended up with credit results that were better than median with respect to peers. On the flip side, I think that the Fed's models are taking a while to burn in all of the changes that we've made since the IPO. We're a completely different company today than we were on the IPO. And every year that goes by, when we demonstrate our PPNR strength, that gets incorporated into the Fed model, and that will gradually improve our results on the PPNR side of things as well. So we feel pretty good about how we would fare in any Fed test, and we'll see that play itself out over time.

That's a great wrap-up, John. Unfortunately, I have -- would love to continue the conversation, but we're up against the clock. And -- but I'm very pleased that you joined us for our conference this year. I really appreciate it. And thank you so much, and have a wonderful day.

Yes, thank you. Glad to speak with you.

Okay. Take care.