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

Hi, everyone. Good afternoon. This is Brian Foran from Autonomous Research. We're delighted to have Citizens up for the next session. In preparing for this, I went back and read the primer I had written when Citizens was an IPO or a spin out, and it was pretty remarkable. I mean, the crux of the paper was really, can Citizens grow again? It has been a long tale period of deleveraging, and that was really the big strategic question. Just looking at some of the numbers since then, loans are up $30 billion round numbers and deposits are up $60 billion, which is effectively creating a pretty sizable regional bank from scratch organically. So I think they've answered the question at least over the long term. Citizens can grow again. And to talk about the outlook, we're delighted to have Bruce Van Saun, CEO, who, of course, has been leading the bank throughout that period. So Bruce, thanks again for joining us this year. Always a pleasure to have you at the conference.

Thanks.

Maybe to get started, sticking with that theme of growth. Clearly, the past 12, 15 months have almost in a way been a real-life stress test, and you and the bank have come through it in very good shape. We've really proved the benefit of investing in fee-based businesses of the growth in pre-provision earnings power you've put in place as well as coming through with good credit quality. As I talk to investors today, for you, as well as most regional banks, probably the #1 question is can loans grow again and when? You've previously talked about an inflection point as we move through this year, I'd love if we could just start there. What are you hearing when you talk to customers on the ground? What are you seeing when you look through your data? Are you on track on the loan growth side and how do you think that will play out over the next 12 to 24 months?

Sure. So 1 thing I would say to start off, Brian, is that we have probably a more diversified set of lending activities on the consumer side than our peers do. And so that's allowed us to consistently grow our consumer loans. And I think that's another thing that will be a point of distinction this year. So we have a big education refinance business, which is still doing nicely. The student in school business is a seasonal business that really picks up in the summer months. And so I think this will be a big year of kids going back to college. Some people sat out because of the pandemic. So expect to see a seasonal boost there. So student is in good shape. Auto has been strong for us. There's a need for -- as people reconsider how they want to live to more people going out and buying cars and the cost of cars is going up, given some supply shortages. And so the loans are a little bigger, so that's helping. And then our efforts in point-of-sale finance, we've been able to sign a bunch of marquee partners and that book is building and should continue to grow very nicely. So in addition to the typical things you'd see from peer groups like mortgage lending and credit cards, we have, I think, other points of distinction that serve as well. And I think as we looked in over the course of this year, we'll still get some growth in the second quarter, and then that will really pick up even more in the second half of the year. On the commercial side, over time, we've been able to grow a bit faster than peers, largely because we've been scaling up the commercial bank by going out and hiring coverage -- experienced coverage bankers who have pre-existing relationships. We have expanded geographically. We've expanded in industry verticals. And those relationship bankers tend to bring pre-existing relations over in time, which allows us to grow the book. So there's still opportunities from that to maybe grow a little faster than our peers, but we're also subject to many of the same factors that peers are referencing. So line utilization has been kind of near all-time lows. So for a while last year at the peak of the pandemic in the second quarter, they spiked to all-time highs. They've now gone to all-time lows, but they're stabilizing, and we're starting to see some signs that companies are interested in meeting the demand for their products and services and that will mean working capital investment and some CapEx investments. So I think you'll see stability in the second quarter and then starting to see growth in the second half of the year. And then our new origination pipelines where we're tied to either M&A activity or some of the new relationships we're going after, that pipeline is back to very good levels to pre-pandemic levels, whereas in the first quarter we were still at a relatively subdued pace. So how much of that we catch actually in Q2 and maybe not be that perceptible, but certainly as we look at the second half of the year, we would expect that to build. So we're still saying that the second half of the year, in particular, should bode well for good loan growth, which translates into the top line revenue growth, which allows to positive operating leverage, which has been the formula for us to drive up our ROCE over time.

And maybe while we're on the topic of balance sheet growth, you announced the HSBC acquisition recently. Maybe talk a little bit about what was attractive to you there, brings on some loans, probably more deposits, some branches, a little bit of market expansion? So what was compelling on that deal? And what do you see for the future of those customers coming in?

Yes. So it really hit the sweet spot in a number of dimensions. So first off, $7 billion of net funding -- net deposit funding at 9 basis points, cost of funds is very attractive. And so I think that allows us to move our LDR more in line with the peer average. So as rates move up, we'll have more flexibility to manage our cost of funding and eliminate any differentials we've had over time. So we're excited about that. Secondly, it also gives us the wherewithal as we think we're going to have good loan growth opportunities to fund that loan growth and make a good spread, given the low-cost nature of those deposits. From a geographic standpoint, we've always had a gap from our New England franchise, kind of absent through Metro New York, and then it picks up in South Jersey, Philly, and then that starts the mid-Atlantic franchise. So starting to fill that in has always been a desire of ours, and the New York market is a very attractive market overall. We also pick up some locations pushing south a little bit in mid-Atlantic into the D.C. area. And then Florida is an important expansion market for us. We opened a wealth center in Palm Beach this year. We have another one opening later this year in Naples and then picking up 5 branches in Miami, 1 of which will turn into a wealth center, gives us access to some of the most important affluent areas in Florida. So excited by all those things. If that's not enough, then you also pick up the online business from HSBC, which has got probably 3x the number of customers on the deposit side that we do in Citizens Access. So it immediately brings more scale to our national banking ambitions, and it will, I think, accelerate some of the development that we have on the drawing board to be able to meet the time frame to bring those HSBC customers straight on to some of the new platforms and new services that we want to offer. So that's also a quite attractive aspect of the transaction.

That's great. And maybe turning to your fee-based businesses to round out the growth discussion. And if I could set mortgage aside for a second, obviously that's got some of its own dynamics right now. But in 2020, we really saw the benefits of many years of investing you had been doing, whether it's in capital markets, wealth management, other areas. As you look forward, where are you excited to continue to invest? Where is the incremental investment dollar going? And what do you see as the outlook for those non-mortgage fee-based businesses?

Yes. Probably top of the list, Brian, is capital markets, which has a lot of momentum at this point. So I think pound for pound, we've got as good a group of people in terms of capabilities as anybody in the peer group, hence we go toe to toe with the mega banks in the middle market and mid-corporate space and often win the mandates and do very well. So there, one of the keys has been adding the kind of debt capital markets capabilities and adding M&A capabilities. So if you went back at the time of the IPO, we were pretty much a one-trick pony with loan syndications as the core capability that we had. But we do so much more at this point, which has been great to see. And we're not done. I think there's -- we're building out verticals. And if we find other M&A shops that have the right cultural fit and we think we can plug-in and really leverage the relationships we have, we'd consider doing more there. I think our, what we call global markets, FX and interest rate hedging as well has very strong talent, very good capabilities. That will be a little bit episodic tied to loan originations and tied to market conditions, but we've seen that business grow consistently year after year and, again, compete very effectively against the mega banks in that space. Flipping over to the consumer side, I think the big area of opportunity for us is wealth. We've made a multiyear investment in improving our capabilities and growing the sales force and we've made an acquisition of Clarfeld to go after the ultra-high net worth and high net worth segment of the market. And I think we're on the cusp of really seeing productivity boost and deepening relationships with customers. So I expect an acceleration of revenue growth, given the investments that we've made. And we're also on the hunt there to see if we can find acquisitions that make sense. Pricing has been a stumbling block to some extent since we did Clarfeld, but we have our beat on a couple of the situations, and we'll see how things play out.

And then maybe coming back to mortgage, recognizing you probably -- I don't know if this is quite accurate, but you probably made about as much net income in mortgage the past couple of quarters as it took to buy the business. So a deal for the home runs and certainly want to recognize that. But it seems like some of the market data maybe is softening a little faster than I would have anticipated, spreads and purchase apps and refi apps, I don't know if you'd agree with that. But you've been very clear the business is going to normalize. This is no surprise in terms of where we're going. But in terms of the time to get there, what would you say is the state of play right now?

Yes. So I think the backdrop is still pretty good around originations. So if you just kind of look at multiyear trends of originations and the kind of spike that we saw in 2020, we're still going to have the second biggest origination effort in probably the past decade this year. So the market is moving a bit from a refi-oriented market, with a bigger mix of purchase, but it still feels pretty healthy to us. The headwind has really been on the margins in the business. So you've had all the industry participants kind of gear up and add capacity to meet the demand, and that's started to crimp the margins overall in the business. And so I think that's probably come down a little faster than we anticipated coming into the year. We called that out on our first quarter call and said that it's likely that we kind of hit the -- where we think will be the bottom in the second quarter of the year and stabilize. And so that puts a little pressure on things like positive operating leverage through the first half of the year. But then once that stabilizes, the other forces of loan growth and fee growth in the categories that I referenced should kick in. And you know we're going to do a good job of expenses, which gives us confidence that we can deliver positive operating leverage and grow PPNR nicely in the second half of the year.

Maybe turning to expenses, obviously, you've done a great job with the first 5 TOP initiatives, and you're well on your way to delivering on TOP 6. You gave us a lot of information detail on some of the things you're working on within that. If you were to highlight 1 or 2 things that you're really excited about that could really move the needle long-term coming out of those efforts, what are you most excited about in terms of the TOP program right now?

Yes. So I'd say the transformational element of TOP 6. So you may recall, TOP 6, we had a traditional program plus a transformational program and kind of the cornerstone of the transformational effort was called next-gen tech, or NGT, which basically was lifting our technology ecosystem and positioning it into the future. So moving our infrastructure to the cloud, changing the way we develop applications to an agile approach and basically create -- streamlining the architecture, creating more robust platforms that are open architecture, and we can cook into APIs. And so there's a lot of change to make the overall technology complex fit for the future, more adaptable, easy to change and to kind of innovate off of these platforms. And so we're on the path towards getting that right, and I think that unlocks a lot of great things, innovation, responsiveness to customer needs, speed to market and lower costs. So that, to me, is kind of the most salient aspect of the whole program. There's another element we added in last year as we went through the pandemic, which is the world is moving digital very quickly. Customer preference for digital is accelerating. And so how do we make this a digital-first bank? How do we look at end-to-end digitization from the first customer touch point to the back end of a transaction, and can we streamline all of that, digitize it, offer more self-service for our customers. And so that's another effort that I think is really kind of have a lasting impact at a lower cost and improved customer satisfaction, it will take out paper. So excited about that one as well.

And then going back to the consumer lending businesses, I mean, you hit it upfront that you do have a different tilt, a different mix than most banks, much less credit card, some more on the student lending, the merchant point of sale. That Citizens Pay business in particular, I find, is: one, investors with the growth in buy now pay later with some pretty eye popping market caps from stand-alone companies and competitors are really focusing on your business quite a bit more. Take us through what you've built there and what you see as the growth outlook because you were very early on that trend?

Yes. And I'd say the point-of-sale finance is sometimes seen as equivalent to buy now pay later. It's not really one and the same. And so there's what we focus on is working with our partners in terms of how to help them achieve their sales objectives. And so we have a number of approaches that offer different products and services and twists on different kind of lending arrangements to help the customer meet their goals. And I think that's why we've been successful. We haven't -- we haven't tried to go broad and go mass and to pick up a significant customer base in terms of quantity. What we focused on is the marquee iconic platforms where we can bring our kind of focus on the customer, focus on their customer, client experience, focus on great technology that's scalable that can handle volumes like when Apple does their launch of their new phones, we can keep up with the demand and still not degrade and offer great customer experience. So I think we've built some things that we can take around to some of the bigger players in consumer electronics and retail and home improvement. We're trying to stay focused on a few verticals and really the bigger program opportunities. So BJ's being the latest one, BJ's Wholesale Club that we won. So excited by that, and we take on some of these folks with the big market caps. And I think our approach oftentimes is successful just because of the breadth of our thinking and our capabilities.

Let's shift gears a little bit to credit quality. I kind of chuckle myself. It was only 6 months ago, everyone was freaking out about your exposure to 2 malls. So is there a third mall in there and oh my gosh, now we're sitting there at charge-off levels that we haven't seen even pre-pandemic in a long time. I guess, increasingly, the tone of investor questions is prodding around the argument for stronger for longer for charge-offs to remain low in '22, even '23. If the customer came through the pandemic and didn't have a problem, why would they have a problem going forward? How do you think about that? Are there any worry spots left on your list? And when people prod you around stronger for longer on the credit outlook, what are some of the upside and downside risks you'd be watching?

Yes. So I guess if you take a longer-term historical perspective, banks talk about what their through the cycle charge-off rate is going to be. And then maybe 8 years out of 10, you're south of that. So you're better than what that through the cycle average is. And then there's 2 years when you have a recession and your charge-offs spike, and then that results in a higher average than you'd normally see. So I think it's very realistic that we had the spike last year, and we're kind of on the glide path down. We'll be pretty close to probably below through the cycle levels already this year, but back to kind of what we had pre-pandemic, and that could be a sustainable level. If the economy stays healthy, you can see yourself operating at something we called out 35 to 45 basis points this year. But if you went back from the time of the IPO, we were probably in a 25 to low 30s type of basis point charge-off range. So I don't see anything in the consumer portfolios, people coming off forbearance, all the things that people initially worried about hasn't panned out and the charge-offs on the consumer side are lower than they were pre-pandemic, at least for a while with all this stimulation cash floating around. I think that will continue. There's no problem building up that has to correct at some point that we're going to hit a wall. I think we'll just slowly migrate back to charge-off levels over time that are kind of approaching more normal times. And in the commercial side as well, we're seeing the companies weathered the storm of weaker credits. And those most affected by the pandemic, we took our pain on that. But most of the businesses now are playing offense and seeing demand for their products and revenues rise and are thinking about how to shift to offense. So there's not a huge -- we're still monitoring the sectors that were most affected by the pandemic, but even those are showing nice smart improvement. So I think it's a pretty positive picture when you think out the next couple of years for sure.

Like this idea that your normalized losses is really 8 years below and 2 years above. I remember my first boss in the business used to put it, you hit normal losses twice. Once on the way up and once on the way down. So you never actually have normal losses at a moment in time. I guess one potential outcrop of that is around competition. If credit is good, if everyone is desperate for loan growth, does competition build in the system, whether it's price or structure or lending terms? What are you seeing there and what's your outlook? Do you think the industry can hold the line a little bit or is that a worry spot in your mind that competition will build, the longer credit stays low?

Yes. So I would say on the consumer side, we're not seeing any particularly excessive competition on spreads. And so we've been able to hold the spreads to a large degree on the consumer side. On the commercial side, I think, year-to-date, we've probably seen a bit more froth and competition on spreads because everybody's scuffling to get some loan growth. I do think that, that abates as the liquidity build on some of these companies receipts and businesses start to play offense and start to need to invest, it will just create a bigger pie and more lending opportunities. And so hopefully, that adjusts as we look out into the second half of the year, but it's been pretty intense in the first half of the year. And I think the antidote to that for folks like us is you got to do a good job on your deposits. So if you're getting squeezed a little bit on your loan yields then you got to go back and be aggressive on your deposit pricing, and the good news there is that we're so flushed with cash and deposits that you can do that.

Maybe extending on that, I mean the balance sheet overall is probably in as good a shape as it's ever been. You've got CET1 capital north of 10%. Your loan-to-deposit ratio, I think, will be below 80% once HSBC is folded in. When you look around where are the opportunities to deploy cash and capital and where does it make sense to kind of hold back a little bit of dry powder?

Sure. So I'd say the first thing we do when we think about where a direct capital -- let's put the dividend aside. We've got to make sure we're maintaining a good dividend payout ratio, but supporting the organic growth and positioning of the business is making sure we can fund the loan growth that we see in front of us. And I do think we're going to have some very attractive loan growth levels in the second half of the year. We have plenty of cash to support it on the liquidity side, and we have -- we're operating above our CET1 capital targets. And so we have plenty of capital to do that as well. So that's really job 1. I would say these fee-based acquisitions also are attractive to us. I think we've done a good job of finding things that work. That we're able to lever the relationships that we have and bring additional capabilities to the company. So we're not done there, and we'll continue to look at that. And then the deals like HSBC, which used 24 basis points of our CET1 when it closes, I think those make a lot of sense as well because there is certainly today opportunities to fill in your footprint and strengthen your footprint, which this HSBC opportunity does. I think there's the potential to look beyond that and see are there other little pockets where you can do something smart, but I haven't wanted to get out over our skis on overcommitting any of that to kind of whole bank acquisitions. You've got to walk before you run. You have to earn your stripes and it's a long journey. And so I think the HSBC gives us an opportunity to demonstrate that we have what it takes to execute a transaction like that and be smart about it. And if there's other situations that develop, a lot of the smaller banks are under pressure, given what you see in terms of the need to go to digital business models to upgrade their technology revenue pressure to some extent with low rates. So there might be things that fall in our lap that we can look at that we can do that make strategic sense and the numbers work, but that's not our highest priority. We've got a lot of organic growth to fund it. We have these fee-based bolt-on deals, which would be higher on the list at this point.

And maybe I want to come back to the consolidation point for you in the industry. But before I do it's striking to me that over the past maybe 5 years, you and a handful of your peers have been able to do acquisitions in the capital markets and wealth space, also team lift out, hires and really execute on it successfully. I mean it felt like for years and years and years, it was almost a truism that if a bank bought a capital markets team, they lose, right? It just wasn't going to work. What in your mind has changed? Why today is that such a successful strategy, whereas maybe 10, 15, 20 years ago, it was less successful, let's call it?

Well, I think banks have a very broad and deep customer base. And so when you think about smaller M&A boutiques to be able to tap into those, it's very competitive out there. And so if they align with a bank that allows them to operate somewhat autonomously and keep their culture, but get enough insight of the company that they can leverage those relationships and see more flow, it's a win-win for them and for us. I think it's similar on the wealth deals to some extent as well that banks have broader capabilities and balance sheets and so they can offer if you're just an RIA shop and you're providing asset allocation advice. If you come on to a bank platform, you can also now offer mortgages or secured loans against portfolios and things. And so having that broader capability and then we also have a big customer base that they can cross-market to and get leads. And so to kind of get going on a faster growth trajectory is something that a bank can offer to those shops. So I think many of these firms -- and the one thing, Brian, that's a truism that I've seen my whole career. Once you do a print in a space, then people take notice and then you start getting the inbounds. And so when we do our first M&A boutique, Citizens is looking at that space, and let's see how that goes. And the first one goes well, and then you start to have other folks say, "Hey, we'd like to have a chat with you because we see that you know how to do this, and it's been a very successful strategy." And so that's what you want to get going. You want the flywheel to be going so you start to see more opportunities.