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

All right. Good morning, everybody. We're thrilled to have Citizens as our next presentation at our Morgan Stanley Financials Conference. With Citizens, we have John Woods, who's Vice Chairman and Chief Financial Officer. So John, thank you for being here.

Great to be here, Ken.

Great. Now before we begin, I do have to read these statements for important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. Yes. If you have any questions, please reach out to your Morgan Stanley sales representative. Great. All right. With that out of the way. So John, again, thanks for being here.

Why don't we just go straight into Q&A. Let me start off in terms of loan growth. I was hoping you could just provide a little thoughts on how loan growth has been trending in 2Q. I know Bruce previously said the loan growth was starting up a little bit slower than should ramp up towards the back half of the year. Like what are you most optimistic about growing over the next year or so, as the economy continues to reopen?

Yes. No, that's a really good question, and it's fundamental to how we're driving our revenues here. I mean, I'd say, I mean we're pretty encouraged. There's a significant amount of pent-up demand from the consumer side. And I think we're seeing that across a number of our revenue categories. We see that translating into growth in the second half of the year. Our discussions with our commercial clients are also very encouraging. We hear lots of inquiries about looking to invest and build inventories. And again, primarily, in the second half. In terms of categories that we like, I mean, I think, as you know, we have a very distinctive consumer lending business. Education refinance is an area that we see strengthen going forward. Mortgage and Auto have been doing quite well. And frankly, our unique capabilities in Citizens Pay, which I think will continue to create momentum on the retail side. When you flip over to Consumer -- I'm sorry, flip over to Commercial, we've been very pleased to see pipelines growing as we've been -- and building as we get through the second quarter. Frankly, pipelines, at this stage, are higher than they've been even compared to pre-pandemic. And we do expect utilization to begin to recover and increase in the second half, connecting back to the points I made earlier in terms of the discussions that we're hearing. In the near term, second quarter, we expect loans to be positive, we're going to see growth there. Spot will be higher than average. And those are the sort of the underpinnings of our optimism as we get into the second half.

And do you still expect to see 3% spot growth for the quarter?

Yes. So I mean, as you heard from Bruce, probably a little slower than anticipated. But again, we do have confidence in the spot outlook that we gave for the end of the year being mid- to high single digits. And so we're still optimistic that we're going to be able to achieve that goal, albeit with maybe a little bit slower uptake in 2Q, but still very strong momentum in the second half. And achieving that spot outlook for the year. That's how I would describe that.

Got it. Okay. And you did mention, I think, as Bruce had said it, the pickup towards the back half, like what's driving that?

Yes. As I've mentioned, I mean, I think the pipelines have stabilized, and we -- I'm sorry, utilization is stabilized, and pipelines are building. So we're just seeing very, very strong momentum in our -- the early read and outlook for commercial lending. As I said earlier, our conversations are -- have been extremely active. Our people are completely utilized in terms of their -- the conversations that they're having with our commercial clients, the inventories and receivables and CapEx, we think, are going to be areas of investment that we're hearing about from our customers. We're very encouraged. I mean, Education Refinance is an area of distinction for us that we see some areas of volume increase. And as you get into the summer in the later months, post-pandemic, our InSchool product is something that we see rebounding later in the year. Auto has been strong all along. Citizens Pay is an area of distinction. Then I'll add 1 other. For the first time in a number of years, we see our HELOC spot volumes looking to turn from a trading balances to actually increasing balances on a spot basis as you get into the end of the year, which is a unique capability that we've had for a long time. But along with the industry, we've seen declines there. But now we're seeing that start -- the outlook there to start to pick up. So those are some of the reasons why we have the optimism about the second half.

Okay. Great. Now I know you touched on loan growth but do you have any other updates that you'd like to provide for the quarter?

Well, I mean, if you just round out the rest of revenue, the revenue aspects. I mean, I think from a net interest margin standpoint, we had some expectation that we'd see some cash drawing down and being deployed. But I think we're just like a lot of what you're seeing across the industry, we are seeing some pressure on in terms of cash levels growing, where instead of deposits leveling off we're still seeing deposit grow. So that's causing cash to actually remain elevated. So that will have an impact on net interest margin. But nevertheless, what we are seeing in the margin side of things is improvement in deposit costs. So we were at 20 basis points interest-bearing deposit costs last quarter. We're going to see that get down to mid teens this quarter. So another good, solid step down in deposit costs on our way to the rest of the -- as we look for the rest of the year, I think we mentioned that we would get into low teens. And I think our outlook there is to -- is for low teens are actually better on deposit costs. So we're very encouraged about that from a net interest margin standpoint. And so NII, overall, we expect to see that up from the first quarter. If you move on to fees, overall, we think that's going to be close to what we expected. I think we sit down high single digits. I just -- I think just a little bit more softness in mortgage from a margin standpoint, but we're seeing rebounding and strength in other categories. So in wealth, we're seeing very strong flows in wealth, strong flows in capital markets and a pretty sharp rebound in card fees to levels that exceed pre-pandemic, both in the debit and credit side. And so that's very positive to see. So overall, revenue stability outside of mortgage, which I think is well documented in terms of mortgage flows, but good revenue stability. And as we said, PPNR bottoming in the second quarter and increasing from here back to positive operating leverage on a sequential quarter basis, and then -- and that's really assisted by good performance and well-controlled expenses that offset some of the softness we're seeing in NII.

All right. Great. Now you mentioned deposit growth. It sounds like it's still really strong in second quarter. And before this quarter, I think you've raised like $25 billion or you brought in $25 billion in deposits. Last I checked, you were saying up $15 billion of cash. How do you decide when the right time to invest that cash is?

Yes. I mean, it's a good question. I'd say that we're -- I think at these levels, when you see what's happening with long-term rates, it's not something that we find very attractive to deploy a lot of that cash into the securities portfolio, for example. I think we're going to be pretty stable on our securities book from here on out as we -- for the next quarter or 2. But as it relates to -- really what we're looking for is to put that money to work for serving customers and clients. And really, the deployment of that cash is really being held, frankly, as dry powder to support all of the loan growth that we expect to drive into the second half. And we're seeing, as I mentioned earlier, we're seeing all this pipeline building and we're seeing this pent-up demand. And so our outlook here for the second half is that, that cash gets deployed into loan growth, in particular, on a spot basis. So that's really how we look at it. We don't see -- we have significant liquidity. So tying up all of that cash into the securities portfolio, maybe in a mortgage-backed security, given how tight spreads are there, it just doesn't have a great risk return profile. So we're going to keep our dry powder to support the loan growth in the later part of the year.

All right. Great. Now you did mention that I think you brought -- you're bringing your deposit cost down to the mid-teens, if I heard you correctly? How much further do you have to reduce your deposit costs from here or thereafter?

Yes. We still have a meaningful sort of tailwind from deposit costs. I think just stepping back for context and really as a emblematic of our franchise that we've been investing in over the years. So I mean, when we ended the last 0 rate environment, our interest-bearing deposit costs were 35 basis points. After years of getting being in a 0 rate environment. After really being in this 0 rate environment for maybe 1 year or a little bit more than a year, we're already down to 20 basis points last quarter. We're going to get to mid-teens this quarter. And we're going to get to low teens or even lower -- even better than that by the end of the year. So that's one of the tailwinds that -- and levers that we still have to pull. Much of that's being driven by the continued runoff of our CD book and continuing to sharpen our pricing and kind of in reflection of all of the investments we made in analytics over the years. And we've been growing noninterest-bearing deposits and DDA faster than our peers for the last several years as our investments and our capabilities have caught up and -- caught up to the pack and post-IPO. And so it's very exciting to see our deposit costs really converge and -- converge to where we need them to be.

All right. Last quarter, you added $7 billion of received fixed swaps. I know you took your asset sensitivity down by a couple hundred basis points. If the 10-year stays where it is, and that was kind of peaked in and it's down like around 150 or so. Like when would you add more swaps? I mean is it based on time? Is it based on the level of rates?

Yes, it's a multifaceted analysis here. I mean, I think the -- we tend to look at -- most hedging gets done around the 5-year point on the curve. And it's interesting 5-year has held up a little bit better than 10-year. I think at least as of -- I think it's been in the 70s in terms of where the 5-year is. And even though the 10-year have come down by more than that. So what we tend to look at is really on a dollar cost averaging basis, where are we in the cycle? And so at the beginning of the cycle, we tend to have higher asset sensitivity and in terms of where we were last -- at the end of last year, we were close to 11%. At the end of last quarter, we got it down to around 8.5%. I'd tell you that given what's happening with deposit flows, et cetera, our asset sensitivity is actually rising again this quarter. So you're likely to see an increase in our asset sensitivity, given what's going on with all of the deposit flows that we have coming in. So we look at asset sensitivity. We look at where the 5-year is, and we look at where we are in the tightening cycle. By the end of the rate rise cycle, we expect to be in low single digits of -- up low single percentage digits of asset sensitivity. And we're at -- going to be at something that's closer to where we were at the end of last year. So there's a lot of hedging to do. But nevertheless, we'd like to see that 5-year a bit higher than where we are today before we come in for another dollar cost averaging round of hedging. But but there's a lot of -- there's significant hedging to do to get us to where we want to be as we get to the end of the cycle. So keep an eye on the 5-year, and that's really a signal for when we would come back in to do the next round of hedging.

Okay. Now the HSBC acquisition, does that change your asset sensitivity at all? And obviously, does it also change your expectation that NIM should bob around, it was 2.70% to 2.80% next year?

Yes. I mean, we're really pleased to be able to move forward with that acquisition. From an asset sensitivity standpoint, it does, net-net, increase our asset sensitivity, given the stable deposits at pretty low cost, single-digit cost of deposits. So we're excited to be able to to add that to the platform, like any franchise, having lots of liquidity and capital to deploy is representative of optionality down the line in terms of what we can do with those deposits. Those deposits will be NIM-accretive. And so we're excited about that. It increases the asset sensitivity, but it allows us lots of flexibility in terms of what we do on the asset side and how we manage our funding and continue to drive our deposit costs lower and lower. Now more strategically, on that acquisition, that's the financial aspects of it, which are quite good. More strategically, being able to enter attractive geographies that are, frankly, in our footprint, but haven't been well covered is very exciting and extremely efficient way to begin to connect our northeast franchise with our Mid-Atlantic franchise, there was not a significant amount of coverage in the areas that HSBC allows us to cover, particularly in the New York Metro area. We got north of 60 some branches there. But then there's also a thin network that we get in a very attractive Washington, D.C. Metro. And we had several branches in Southeast Florida, which adds to the wealth centers that we were already opening in Florida, on both the East and West Coast of Florida down there. So it was just a hand in glove acquisition for us and with significant financial benefits that accretive right out of the gate and significant strategic benefits, given where our footprint profile was before the deal.

Got it. And you mentioned the branch is actually kind of just thinking, how important was it to actually get the branches from the HSBC deal versus, say, the $9 billion of deposits. I mean, just given the fact that the industry is sort of moving sort of more a branch-light type structure?

Yes. I think they were both incredibly important. I still think that there's an important approach. I think we're going to look at certain geographies where we're going to be -- we're going to have branch coverage that's relatively dense. We're going to have certain geographies that we think we're going to cover in a branch-light way. And then we're going to have certain geographies that we are going to cover digitally without branches. And we do that now. We take deposits in all 50 states. Many of those just with a digital approach through our Citizens Access platform. And as you may know, the HSBC acquisition, we acquired a $3 billion of low-cost of digital deposits as well. So this was a really, really efficient way to help us cover New York in a way that we want to cover New York Metro, which is maybe more on the dense side of things as it relates to connecting our dense coverage in northeastern states and mid-Atlantic states. I mean, that's our approach that we want to pursue in the New York Metro. But -- and with a nice balance of branch-light in Washington, D.C. and Southeast Florida.

Are you willing to put any kind of numbers around the net interest income benefit that you might get just by having these new deposits in a rising rate environment?

No. I mean, it's a couple of things. I'd say, let me take a step back and say that more broadly, even without the HSBC acquisition, our previous range for net interest margin, you mentioned the 2.70% to 2.80%. That's actually improved. I mean we're going to be north of 2.80% going forward based upon our outlook and what's going on with the tailwinds of deposit costs, et cetera. So I'd say that we can update and improve our net interest margin outlook that would be north of 2.80% and maybe -- and then with HSBC, I think that would only support that a bit further. So without necessarily putting an exact range around it. I think we're pretty bullish on the improving profile of that interest margin compared to our previous guides.

No, that's a positive update. I appreciate it. I know HSBC was a rather unique situation. But if you could find another opportunity like that, is there any types of, now say, geographies that you'd be interested in expanding into?

Well, I mean, I think, first and foremost, I mean, I'd say organic deployment of capital is our primary goal. I mean, we really -- when we think about capital deployment. We talk about the waterfall of what we reserve that capital for. Organic is clearly at the top of that priority list in Pyramid. Supporting the dividend is also at the top of our priority list. And then as you look at other opportunities. I mean, I think fee-based and bolt-on acquisitions are really also an area of emphasis and we've done quite well there. If there were opportunities to look at other depositories, where it was both financially and strategically compelling, we'd sort of have to do that on behalf of their shareholders. Now the geographies in the Northeast and the Mid-Atlantic are where our dense branch network exists. And that's an area of interest if something was compelling. But I mean, I think that, now you really got to go back to the top of the pyramid in terms of organic deployment of capital as being the primary goals from here on out.

Great. Maybe switching gears to Citizens Access. Obviously, Citizens Access was a great way for you to grow deposits without kind of raising the deposit cost of your entire portfolio. But in this environment, where rate is 0, kind of not really needed to that extent. Like what role does Citizens Access play for you guys in a 0 interest rate environment?

Yes. I mean, I think Citizens Access phase -- the early stages of that investment in the rate environment that we were in were served to accelerate the goals that we had in our footprint -- branch deposit raising business, and to really just kind of focus all of our efforts in footprint, in deepening with customers. And so we took some of the funding pressures off of the branch network. And that worked extremely well. But that was always just the first stage of what the -- and it was very financially oriented early on. But the gleam in our eye from the beginning was to transition this into a strategic approach to serving customers nationally. And so really, the next step in that is going to be in the second half of this year, where we broadened the product set for Citizens Access and first out of the gate in the -- in that effort will be to create mortgage capability and Education Refinance capability and a checking product. We hope to have that in place by the end of the year. And so you would have checking, savings, CDs, mortgages and Education Refinance. And then when you get into 2022, we're going to continue to broaden the product set for that platform. And when you get into next year, you're talking about on the product roadmap is to add wealth capabilities with Citizens Pay and point-of-sale capabilities are going to be added to the platform and down the line, home equity, et cetera. So we really -- we're planning to create a digital bank. And the early days of focusing on of high-yield savings account are really sort of on the cusp of being behind us. This is a truly diversified digital bank that we're planning to create, and we're extremely excited about it strategically.

That's great. Now moving to, I guess, fees or bolt-on acquisitions, like you guys have been very vocal about wanting to do additional fee-based acquisitions. What are your priorities there?

Yes. I mean, I think we -- our priorities from a strategic standpoint, are to serve our customers in a profitable way. And we want to -- when we focus on a fee category, we want to get to scale in that category. So mortgage was an area of an emphasis for us. And so we endeavored to get to scale there, and we've been able to do that. We've -- I'd say, the capital markets and M&A advisory has been an area that is important to us as part of our life cycle approach on the commercial side of our business. And so we've been really driving scale there, a number of acquisitions in M&A advisory that we've been pleased to be able to integrate. What's left on the roadmap really is, I'd say, primarily is in the wealth space. I mean, we started that journey with Clarfeld. Very excited to be able to integrate that organization into the fold being able to serve ultra-high net worth and high net worth individuals and that connectivity to our Commercial business, our middle market and mid-corporate businesses has been going extremely well. That said, we're not at scale and wealth. But we're going to be remaining -- we always remained financially disciplined. And so the pricing has kind of gotten away from us a little bit in the wealth side. So we're going to pick our spots and continue to focus on trying to get to wealth -- get to scale and wealth, continue to build in capital markets where we can. And those are really the areas of emphasis on the fee side.

In wealth, I mean, is there a certain type of product or capability or so? What are you searching for in wealth that would be most valuable to Citizens?

Yes. I mean, I think that being able to support the mass affluent and affluent customers that we target on their life's journey. And it's really the financial planning capabilities that would support that is the underpinning of what we're trying to create. So that's our emphasis. And it's really -- we have a target life cycled approach, not only on the Commercial side, but also on our Consumer businesses and being able to sort of drive and support our customers achieving their potential over their life's journey is what we're trying to create. So personal financial planning is the emphasis.

All right. Now, just staying with fees, overdraft, in particular, I think there has been a lot of discussion or hearing more and more talk about banks probably should rely a little bit less on overdraft fees. Do you think that's a risk that investors really need to be worried about at this point? And what could the magnitude be?

Yes. I mean, I think, well, you've seen overdraft fees actually decline. As part of all the liquidity that exists or that came into the system during the pandemic and with a lot of our consumers being pretty flush with cash, given stimulus checks and the support that -- other support that's come through the fiscal side. I think that you've seen a lot of that come out of the system already and kind of come down to a lower level. And I think that said, it is a service that we provide. And many of our customers understand that product extremely well. And we meet them in their time of need from time to time when that's important to them. That said, I think it's an area that we're going to look at and evaluate and analyze whether there are tweaks that we can make to those practices over time to align with what expectations are of our customers and our other stakeholders.

Great. Moving to the TOP program. I mean TOP has been awesome, right? It's been one of the key drivers of how you've actually been able to get better than peer operating leverage over the last several years. Can you just talk about where the trend -- you understand the transformational part of the TOP program. Like how is that progressing? And what do you still have to do before that's complete?

Yes. We've been really, really pleased with the trajectory of our TOP 6 transformation program. As you may recall, I mean, we set out to transform on a number of dimensions. Our branch distribution model has been completed. I mean, we've migrated away from sort of the generalist approach to serving our customers, and we've really been able to invest in specialized advice across all of the capability stripes that are important to our customers when they interact with us through our branch model. So that's been completed. Our next-gen technology part of TOP 6 transformation has been -- the -- has been -- a big phase of that has been completed. We've in-sourced all of our engineering capabilities, which is important to creating an engineering culture in our company. And so that's been completed. We've also migrated to our agile ways of working in agile pods, hundreds of agile pods across the company. I think what remains is in the next-gen tech journey is migrating all of our applications to the cloud. So that remains and also was continued tailwind in terms of simplifying and advancing our infrastructure from a technology standpoint. And maturing our agile approach to being innovative and bringing products to market very quickly. I should say, though, that even as we begin to bring our 2-year TOP 6 program, which was unique in terms of the 2-year profile to a close, where we're going to achieve north of $400 million of run rate saves, which has been phenomenal, there's still lots left to accomplish on the expense side of things. And there's no lack of focus and energy and momentum on being able to continue to get back to the TOP programs for us. And whether it's branded as TOP or not, there's still lots of expense energy and opportunity that we have left to accomplish.

All right. And in terms of your 14% to 16% ROTCE targets, like what actions can Citizens take that would actually be -- the most meaningful actions that will get you closer to your target aside from away from higher rates, of course?

Yes. I think what has got us this far, we're going to continue to -- you may recall back, pre-pandemic, we had already gotten to 13% ROTCE. And what drove all of that was our continued focus and commitment to positive operating leverage, overtime. And that's really what the focus is, is continuing to have a commitment to positive operating leverage, which we're getting back to. And as we mentioned, in the second half of 2021 on a sequential quarter basis, getting to positive operating leverage, focusing on the areas of distinction that we have in terms of revenue generation, the distinctive investments we've made in Commercial -- I'm sorry, in Consumer Lending, the investments that we've made across our geographies and verticals in commercial. All of the fee income diversification and build, overtime, is coming to fruition. I mentioned just a few moments ago, the ongoing commitment and opportunity left in managing expenses. All of that comes together in the positive operating leverage outlook that will allow us to get to -- and why we're optimistic that we can get to our ROTCE range over the medium term.

All right. Perfect. I know we have...

And I can -- I should add. And it's interesting how times have changed where we often don't get credit questions. But I think that is part of that longer-term deal. I mean, I think that we've done just a phenomenal job of managing credit overtime. But -- and I maybe earlier neglected to update on the credit side of things. We mentioned that in the second quarter, credit would be in the 30 to 40 basis point range, and that for the full year, we'd be 35 to 45 basis points. I think we can update that to something that we expect to be at the low end of that range, as we've been getting through the quarter, we just continue to see great performance in terms of charge-offs on both commercial and retail and maybe even -- maybe more sharply in commercial, but even with -- on the retail side, which was already in great shape is continuing to decline. And that's also part of the ROTCE journey that we're talking about is as we exit the pandemic and as we've continue to focus in that area, our credit performance has been quite good. And just like our deposit costs converging to peers, our credit costs are also looking quite strong. And wanted to add that to the overall journey. It's such an important part of our ROTCE journey is how well we're managing credit as well.

I don't think I could ask anything else that would end us on a more positive note than that. So why don't we wrap it up here, looks like we're right on time. John, thank you so much. I really appreciate your time today. So thank you.

Been a pleasure, Ken. Been a pleasure. Good to see you and we'll talk, again, soon.