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

We are excited to, once again, have Citizens Financial. Citizens has done an outstanding job managing the current downturn, showcasing the changes that it's made in its business since the last downturn. That hasn't stopped Citizens from investing in its business, including upgrading its technology, continuing to develop a peer-leading consumer digital strategy and expanding its commercial footprint. More recently, it's been active on the acquisition front, with 4 deals in recent months that positioned the company well for the years ahead. Here to tell us more about the story is Chairman and CEO, Bruce Van Saun. Today's presentation is going to be a fireside chat. So Bruce, welcome. Happy to have you here once again.

Yes. It's my pleasure, Ryan.

Well, maybe to just start big picture. So you spent almost the last 2 years managing through the pandemic. And more recently, you shifted -- you've shifted back more towards a normal environment. You've engaged in a handful of M&A, as I highlighted. So as you sit here today, can you maybe just talk about how you feel the bank is positioned into 2022?

Yes. So I really like our positioning right now. So I think we weathered the pandemic well. And some of the things we had been investing in, in TOP 6 transformation, the top in terms of next-gen tech and moving our technology to the future going to digital-first business model, moving to agile ways of working, really moved us forward along the whole technology realm, which was important as we came through the pandemic. And so when I think about -- we shifted to offense in this year, 2021, and we really want to grow. I mean, I think, the key to successful business model is to be able to grow your top line, do it prudently, which, I think, we demonstrated an ability to do that since the IPO. But the reasons I'm excited on the consumer side, I think we have 4 major thrusts that should help us to deliver above-trend revenue growth. Those would be leveraging these acquisitions in New York metro. I think, at the moment, the deal pencils out well just on expense and funding synergies. We've held back the revenue synergies, but we picked up about 1 million customers who've been underserved by HSBC and investors. They don't have the breadth of product capabilities we have. So I think there's material upside there if we can do what we've done in Philadelphia and Boston and replicate that in New York. It will take some time, but I think not too long because we've got the formula down pretty well. Wealth is a business that we're, I think, pivoting to really have a strong leadership and an attractive business model. We have done one acquisition in Clarfeld to fit the ultra-high net worth side of the market, which has really got a lot of momentum. So I think if we can just move towards peer levels of penetration to the customers, that's another really big thing. Our point-of-sale finance business also is, I think, unique among peers. In fact, it's unique amongst all the players who are flooding the buy now, pay later space, and we can talk more on that later if you want to. So those are some of the major thrusts we have. And then on the commercial side, we've really scaled up the business. We've built up coverage and our product capabilities in sync. So now it's just a bigger business. We can cover mid-corporate companies, which are up to $3 billion in revenues very well. We have a lot of industry expertise. We've lined up M&A bankers and corporate finance bankers into those industry verticals. And so we're winning jump balls against all-comers, including the mega banks in that space. And the JMP acquisition gets us much deeper into health care, technology and financial services and brings an equities capability as well. So a lot to leverage on that. So if you just look at the positioning, we'll be able to pull across synergies in '22 from these acquisitions. The balance sheet is asset-sensitive. I think we have an ability to deliver above-peer loan growth but do it prudently. So I really like the positioning.

Bruce, maybe we'll get the less interesting part of the discussion out of the way here and maybe just talk about the near term. You gave guidance on a handful of items for the fourth quarter, including NII, broadly stable to slightly down. You gave some color on loan growth. Lot of moving pieces with PPP, stable fees and expenses. Maybe just give us a sense for how the quarter is progressing in terms of loan growth. And any other items and any early read on -- are you seeing any impact from the Omicron?

Right. So I feel good about how the quarter is tracking overall. So feel good about broadly the PPNR guide, the credit guide. Credit continues to be in great shape. Things I would probably call out in the quarter, of note, is that I think we will track to the loan growth guide. So see that pulling through so far. And then also the capital markets business is pretty much on fire these days. So I feel really good about that. So there's always puts and takes, but generally feel very positive. I think Omicron it's not surprising to me. The market sold off big on a thin traded day going into a long weekend. It's like, why do I want to keep risk on over the period? And I think as the facts come out, a variant that is more transmissible typically would be less severe. And so I think that's starting to become the new base case assumption, which isn't all that at the end of the day. And we've learned how to cope with different variants and with the virus. It's going to be with us. It's more endemic than pandemic going forward. High vaccination rates. We just have to hope, really, the politicians don't muck things up. But if you take that wildcard off to the side, I think society, generally, is figuring out how to deal with this and get back to life as we knew it.

Maybe to pivot from that and start at the top of the house. You posted over a 14% return this quarter, albeit with very low credit costs. And you recently reiterated your goal of reaching 14% to 16% over time. However, the ISBC and HSBC transactions are expected to add, I think, 120 basis points to your return. So a 2-part question of what are the moving pieces to getting us to that 14% to 16%? And given your recent acquisitions, is it going to be better over time?

Yes. So if you go back to 2019, we were about 13% for the year. If you take out all the noise from the numbers, I'd say that's about where we are, if you could normalize for credit and some of the onetime things that happened over the course of the year, like PPP. So the formula of how we got from 5% to 13% was very basic, is grow your revenues faster than your expenses and that drives earnings growth and drives return on equity improvement. So that would be the goal for next year is to get back to that, and that will help push us into that 14% to 16%. And then as you say, the synergies are a big thing of that. So we kind of came into this year thinking play offense. Let's finally solve that New York Metro hole in the footprint and the synergies from that. If we end up in a lackluster year in 2022 because nothing happens on the rate front, at least we have something good to propel operating leverage, propel returns higher. So if we get a favorable environment, where the Fed is moving, the curve goes back to steepening, we're reaping some of the benefits of these organic initiatives and we're bringing the synergies across from these deals, certainly, getting into that 14% to 16% is a strong possibility for next year. And then the other thing I would say to you, are we going to move higher? My goal has always been take it one step at a time. So we were getting close to 10%, which was the goal coming out of the IPO. You said, "Are you going to raise it?" And so -- but let me get to 10% first, and then I'll raise it. So my view is let's get into the 14% to 16% and then we can figure out where do we go from here.

Yes. One of the things you said when you went from 5% to 10% is you wanted to grow revenues faster than expenses. And you've been able to do that for many years. You've created room for -- to make investments through your TOP programs. I think, obviously, the most recent one was transformational, largest to date. But you've been working on TOP 7. I was wondering, can you give us a sense for where the focus is going to be? How is it going to look revenue versus expense? And any parameters regarding how we should think about the size?

So yes, I mean TOP 6 was -- had an embedded traditional program, and then it had a transformational program, which we added to as we went into the pandemic, with a real focus on end-to-end digitization. So that kind of moved up to be about $400 million. That's on track. We've executed that really well. TOP 7, we've now been talking about with investors probably since the middle of the year. And I said I'd be ready, I think, to go out with something by the end of the year. So what we would expect is to be able to do another traditional size TOP program, which the goal would be exit run rate of about $100 million by the end of 2022. And the way we're going to do that is interesting, Ryan, is that we're really doubling back on places we've already been. So we're going to go look to spans and layer organizational streamlining. We're going to see if we can accelerate aspects of next-gen tech. We're going to work on refining our agile model, we call it, modern operating model. Go back on vendors and kind of look for another ounce of blood from our vendors. So I think it's important, with all the things that we have going on in the company, that we don't veer off and try to bite off more than we can chew. So we're going back to areas that we know well. It won't distract us from our big year of execution around the acquisitions, et cetera. So we feel a very high degree of comfort that we can go in, mine these areas and deliver that. And frankly, in a year when we're starting to see inflationary pressures around compensation, just being able to -- really happy that we started on that before all of that became evident that we were going to be in a little bit of a more inflationary environment with a war for talent that we'll have to manage through.

And maybe just to pick up on that, I mean, 2022 does have the potential to be a challenging year for the industry from an operating leverage perspective, just given the falloff of PPP. A lot of companies having swaps resetting, and you just referenced the potential for elevated inflation, which, I'm guessing, as we'll probably talk about later, will weigh on cost basis. You guys obviously have some idiosyncratic levers. So do you think you're in a position to commit to positive operating leverage in 2022? And whether you do or not, can we just talk about some of the key drivers?

Sure. So we really won't give our guidance until January, which is our custom. So I'm not going to go out there today and front-run that. But what I would say that, that clearly is the goal that we want to deliver that, and I think we can. I think we will get in a position where we can do that. And so you mentioned some of the negatives. PPP is a negative comparator. Swap runoff is something as well, maybe a little more normalization in the mortgage realm. So there's some things, for sure, that cut against that. But I think really strong loan growth. I mean, we -- as I said, we're tracking to aggressive numbers for Q4 that gives us a good jump-off point going into next year. I think, as the economy -- we should see 4% plus GDP growth, in my opinion, for next year. So I think that loan growth can hold up next year. I think the capital markets business, we'd still have very robust pipelines. There's $750 billion in private equity funds looking to get into the market. That's creating a lot of deal flow. That creates opportunities on the M&A front and on the financing front. And when we sell companies, what we're starting to see is that the selling family will take their proceeds and bring it over to Clarfeld to manage. So you get multiple bites at the -- at revenue streams with what we've put together. So we feel really good about that as well. And I think you can count on us to do a great job on expenses. So with TOP 7, with the synergies coming from the deals, I think we should be able to make that equation work. But stay tuned for January.

Sure. And you've referenced several times that it sounds like there's an increase -- in my opinion, increased degree of confidence on loan growth. You talked about the quarter progressing solidly and feel that you should be able to achieve above-average growth. When I think about what you've done more recently, you've had good growth in ABL, subscription finance and a couple of other areas. And as you're out, whether it's you or Don are out speaking with clients, are we seeing demand for credit picking up on the commercial side? Or are supply chain constraints still weighing in? If we are to see some of these constraints ease, what do you think it could mean for loan growth on the commercial side?

Yes. So I'd say, yes, we're starting to see the commercial had kind of stabilized, I would say, in Q2 and Q3. And I think now we're starting to see that lift a bit. So it's a combination of some of the things you already mentioned: subscription line, finance, asset-based lending. But even in our traditional corporate lending book, there is a lot of activity. We've had, for the year, probably the highest level of originations in Q2 and Q3 in our history. But that was offset, to some degree, by higher paydowns. So companies taking advantage of the open capital markets. And so part of what you're seeing is continued strong originations and a little less on the paydown front, which kind of gives you some net growth in your core area. And I think the line utilization, again, stabilized. Actually, it was up 50 basis points. We never talked about 50 basis points. But last quarter, when you can say 50 basis points, everybody is like popping champagne corks. So I think in Q4, you'll see that continue to traipse up. So it's going to be kind of a slow recovery, given some of the issues like supply chain and labor tightness aren't going away tomorrow, but I certainly think that's going to come back. And you can just do the math. If we got back -- if we're down at 31% line utilization, we used to be historically at 38%, there's a lot of loan growth built into that as we kind of move up that curve and some of those issues resolve themselves.

So I wanted to switch gears and talk about the consumer businesses. And maybe first, we'll start with loan growth just before we get into some of the initiatives. You guys have had outstanding growth in Citizens Pay, student and auto. So can you maybe just talk about what you see as the drivers of retail loan growth as we look ahead? And what are some of the areas that are poised to improve? And do you think this could be a source of upside for the company over the intermediate term?

Yes. So I think the places that we've seen growth, we've seen growth in mortgage. We've seen growth in auto. We've seen growth in student. I think they should continue to show good traction. Obviously, with low rates, there's still the pricing-sensitive sectors like mortgage, student loan refinancing are attractive. And the government kind of moratorium on the repayment of federal loans ends on January 31 so that could be a boost to student loan refinancing. Auto market continues to be hot. And prices for used autos are going up, and you're kind of seeing new car prices also higher. And so just the size of the loans is bigger. So you're seeing loan growth there in auto. Interestingly, we've seen a flex point in home equity line of credit, which we're actually growing the loan balances now. So that's a new potential driver. And then the whole kind of unsecured area paced by point-of-sale finance, very excited about that. So we have about 25 relationships. We focus at the high end of the market on bigger, more comprehensive programs, with the demanding partners that we're able to satisfy, which is really good. We have another 10 in the pipeline. And these wins, they actually scale up at a moderate pace. They don't just -- you don't just turn on the spigot and see the uptake on the loans. So I think there's a lot of growth that's built in from the things that we've already won, that are in the scaling process and then the new stuff we bring, and we'll just continue to feed that. So feel good about all those areas.

Maybe just digging on the consumer initiatives a little bit further. I think the team recently highlighted that the retail and consumer initiative strategies could have over $1 billion in possible revenue growth over an intermediate time frame. That's almost 20% of the company's revenues. Can you maybe just highlight for us what are some of the main areas that are going to be driving this? And over what time frame do you think this is achievable?

Yes. So I mentioned the 3 already in my opening answer to your question. So I do think that the New York Metro is big. The wealth opportunity is big, point-of-sale is big. The one I didn't focus on was the national expansion. So we have our digital bank Citizens Access that we're adding to when we bought the HSBC operations. They have an online bank as well, which probably has 3x the size of our own customer base. So what we've been busy doing is trying to figure out how do we take the foundation we have with Citizens Access and add our other national lending products to create value proposition for a targeted segment of the national customer base, where we think we have a right to win and where we can be competitive. Because the last thing we want to do is go out and say we're here around the country when, certainly, there's plenty of banks all over the country. So what is it that we can do that's unique, where we're already successful? And where we're focused in our own footprint has been in mass affluent young professionals, and they're digital savvy. We have a great lead product with student loan refinancing. We provide wealth advice. We can do the whole mortgage when they buy their first home. And so that's a value proposition that's allowed us to gain market share in our own footprint. And we also think we'll be able to replicate that, over time, with the national expansion strategy. So what that $1 billion that Brendan referenced at the recent conference was like, over a period of 5 years, we should take our natural run rate and tilt it up so that we could generate faster run rate as these initiatives come through.

Bruce, maybe to just build on that, you mentioned expanding the national digital bank. You've talked about, through a branch-light strategy, which, combined with your -- the dense part of your -- represents the 3-pronged strategy that you guys have rolled out. Can you maybe just talk about what your vision is for your distribution over the next 18 to 24 months? And it feels like, also, given the convergence between Citizens Access and the core platform, there should be some cost leverage from a tech perspective. Can you maybe just expand on this, where you see this going?

Yes, sure. So I'd say, so far, Citizens Access was just -- has just been digital-only without branches. What I like about the HSBC deal is that we did half a dozen branches in the Miami area. We get about 8 to 10 branches in the Washington -- Greater Washington, D.C. area. So that allows us to start to experiment as to, if we go digital first and we have a thin branch network, can we really gain share and gain primacy? Because it's a little interesting. People say, "Well, you're going so hard in a digital direction. Why did you stop and decide you needed 200 branches in the New York Metro region?" Which, if you actually look at gaining primacy and having -- owning the relationship of a bank customer, they value having branches. And so we didn't think we could attack the New York market without that factor. So as we move around the country, the question is, how much branch presence is necessary? And you're seeing other banks experiment with that. I know Chase has come into a number of markets, and they're actually a little on the heavier side than some of the other players like PNC and U.S. Bank, who were coming in with a lighter strategy. So it's going to be really interesting to see how that plays out over the next 5 years, but we're now poised and in position to try to optimize that.

Maybe to just round out the discussion on the consumer strategy. So you've outlined the goal of doubling Citizens Pay over the next 4 years. I think you even talked about tripling the number of customers. You just mentioned 10 additional partners in the pipeline. Can you maybe just talk about how you're competing in the buy now, pay later arena, given that I think mostly it's a relatively unleveled playing field then? How are you able to generate good customer acquisition returns under this platform?

Yes. So what I'd say, the point of distinction is that we're very focused on bigger relationships and comprehensive solutions as to how they raise their sales, hit their sales targets, hit the deepening that they want with their customers. So this is multichannel. It's very great customer experience, very good technology. And the product is somewhat unique in that it's really an installment feature in a kind of line of credit format, which allows you to have your customer have repeat purchases under the facility. So it's not the same as the buy now, pay later, pay in 4, which is really pitched as an alternative to debit and credit at the checkout register. This is something where we can help bring our customers, if they have a Citizens Pay line, to merchants, but also work with merchants to avail themselves of a very flexible and unique product capability. And all of the consulting that kind of goes with that as to how they achieve their sales objectives.

So we're at just about 10 minutes left. So I wanted to shift gears and talk about acquisitions. And you guys announced the acquisition of ISBC. Their loan book was largely mortgage and commercial real estate. And I think you've noted that you expect it to look different down the road. So can you maybe just talk about your expectations for that loan book? Will there be strategic runoff? Can you outpace the declines? And second, given your much more in-depth product suite, how big of an opportunity do you think revenue synergies can be from this part of the footprint?

Yes. Right. So what I would say there is that the loan book is somewhat different than the composition of our loan book, but it's battle-tested and it's performed well over time. So the loss through the cycle that investors had has been better than our peer average, even though there's a fair amount of multifamily there, which tends to be kind of the least risky class in commercial real estate. So we'll go from being underweight in commercial real estate to being modestly overweight, the peer median. I think what you'll see is we'll probably not grow as fast in commercial real estate. I don't think we have to offload anything and create a drag on our loan growth. But we should be able to grow faster in areas like consumer and in traditional corporate and in the subscription line business that allows to, over time, commercial real estates to become a smaller percentage of the total loan book. So that's how we think about it. And I do think that, with investors, that revenue opportunity is very sizable because they're not offering the consumer loan product capability. They really have a smallish wealth offering. And so there's a lot of things that we can scale up on the revenue side, and that's part of that $1 billion of kind of revenue pool that we see to grow and if we can get that equation right. And same thing with HSBC. I put them in the same bucket. We're basically managing as one project, New York Metro. There's 2 separate technology conversions, but the approach in terms of how we're coming to market is across both operations.

So you recently closed the JMP acquisition, and I think you received shareholder approval for ISBC. Can you maybe just give us an update on how the deals are progressing? And any other updates or milestones to be aware of?

Yes. So JMP and Willamette have both closed, and so they're operating as part of Citizens here in the fourth quarter, which is great. We'll have some modest technology conversions over time, but we can operate as it is for a while. We have the regulatory approval on HSBC. And so the targeted close for that one is mid-February, over President's weekend. And so everything is tracking well towards that date. Investors, we've -- we're in the regulatory approval process. And we're behind -- when people say that some of these deals are getting slow walked, we're not off any schedule because we came after some of the ones that came earlier. So my hope is we can move through that process. I don't think it's a very controversial acquisition. There's much really to object to. And we've had a targeted date of April 1 on that. So we're still reasonably optimistic that we should get all the approvals in hand. And the planning around that has gone really, really well. So one of the things we really liked about investors is their culture is very similar: focus on the customer, focus on the community. So we've had great level of coordination between our team and their teams.

I put this one similar to the return question of asking your question before we've even achieved finishing the last one. But what is the appetite for further deals from here, whether it's bank or nonbank? And -- or are you on the sidelines for a period of time as you integrate these transactions?

Yes. I think that has to be job 1, which is really just focused on just kind of good execution. And my view on these transactions, for 4 years after the IPO, we didn't do any deals. We had a lot of fixing to do. We had the foundation in place so the bank was running better. And then we put our toe in the water, and we bought a small M&A shop with like $15 million in revenue since the first act. So -- but then when you do that successfully, you earn the right to do the next one. And so you walk before you run. So we've just done gradually bigger deals that fit the strategy. I'd like to say they get us farther down the track faster. And they've all proven to be good from a strategic standpoint and good from a financial standpoint. So we're highly disciplined. A little bit opportunistic when HSBC came on the market that allowed us to finally attack the New York Metro hole that we're pondering how are we going to do that, and then we could [ carry ] that with investors. So there's nothing really burning at this point that we need to do. I'd say wealth is an area where we kind of need to do a deal or 2 to get more scale into wealth. But again, that's a seller's market. That's not a buyer's market, which is why you haven't seen us do a whole lot because we're disciplined. So yes. So focus will be on integration. We'll continue to be opportunistic if we see things that really work from a street strategy, culture and financial standpoint. But we're not turning into a serial deal machine to try to get our growth. We have plenty of things going on the organic side that we're going to stay focused on.

Bruce, you mentioned earlier the hope for higher interest rates. And a lot of different banks have taken different approaches to managing their asset sensitivity. You guys have been taking it down a little bit, adding some derivatives. It will come down a little with ISBC, but then some of the other deals could out bring it back up. So can you maybe just talk about how you're approaching asset sensitivity? Are you going to manage it down further? Also, can you maybe just remind us of the split between the long end and short end? And I think one thing that could make Citizens differentiated this time is how the deposit base evolve. What are your expectations for deposit base this time relative to the last time [ interest ]?

So I think we -- there was probably more notoriety about the swaps we put on last quarter that probably was merited because every bank is adjusting its position, either through investing in securities or investing in swaps. And so we had drifted up. The kind of gauge we look at is the impact of a gradual rise of 200 basis points, and that had moved up to close to 12%. And we put some swaps on opportunistically when the 5-year moved up. We put some swaps on that -- brought that back down to around 10%, which is still a very asset-sensitive position. And so over time, the primary move of your asset sensitivity down is just natural. As rates move up, your deposit betas start low and then they move up later in the cycle, and so your asset sensitivity moves down. So we'll continue to be opportunistic and -- but again, I like that position. We like having a coiled spring that when -- this is the same position. We had a 7% asset sensitivity at the time of the IPO and everybody thought we were hugely asset-sensitive. So today, we have 10%. So we do think that the Fed is going to be forced to move. And rates are going to move back up, and that's going to be very valuable in terms of net interest margin and net interest income. What was it, did you have a second part of that?

Yes, about deposits.

Deposits, yes. So -- and I also think that's something we're really proud of. We've closed down the gap on -- so cost of funding versus peers. That was something that was historical. And it's partly how was Citizens assembled, the purchase of a lot of thrifts and roll-up of thrifts, and so leading with rate. We've moved the value prop so that we're leading with our full range of services. And so we've grown noninterest-bearing deposits. And so I really like the composition that we have of the deposit base, and I think we'll be able to have a lower beta because of that as we move through the cycle.

We're getting closer on the time here, but I want to see if I could sneak in 1 or 2 last questions. So Bruce, you've had a target of 9.75% to 10% on CET1, you're above 10% at 10.3%, although the deals will consume about 30 basis points. And when I look, your target still remains above a lot of companies in the peer group. Now you've had a really strong downturn. You've been public over 6 years now. I recognize that you have to go through a handful of integrations. But what do we need to see for you to bring the capital levels closer to that 9% to 9.5%, where we've seen many of your peers are targeting at this point?

Well, there's really no reason that we have to stay a little bit higher, given our performance through the last pandemic period. And all the stress testing shows that our credit losses should be no worse than our peer median and the super regional peers. I do think we're generally a little bit prudent and a little bit conservative. Still being relatively new, still a little bit of a show-me story and earning the trust from stakeholders. So over time, I think we can bring that down. We probably just need a little more of a track record before we do that.

Great. Well, we are out of time, but everyone, please join me in thanking Bruce.