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

Good morning. Thank you for joining us for our fireside chat with Citizens Financial Group. I'm Gerard Cassidy from RBC Capital Markets. And with me today is Don McCree, who heads up -- he's Chairman of the Commercial Banking Division of Citizens Financial Group. As many of you probably know, Citizens is one of our largest regional banks, is the 13th largest bank in the United States with about $188 billion in total assets. The company has a market cap of approximately $19 billion and the stock trades at a slight discount to stated book value and has [Technical Difficulty] now of just about over 3%. As I mentioned, Don McCree is with us today, and he has joined Citizens back in 2015, and his responsibilities include the entire commercial and corporate banking division of Citizens. He joined them from JPMorgan Chase, where he spent over 30 years of his career with JPMorgan Chase. And so with that, Don, thank you so much for joining us today.

Great to be here. Thanks for the time.

You're welcome. Maybe we can open up with [Technical Difficulty]. Okay. I am having technical difficulty here with Don.

You're freezing.

Welcome back. We had a technical difficulty there but thank you for your patience. And once again, thank you, Don, for joining us. Maybe we can start off with a question about the broader macro environment. It looks like the worst of the pandemic is seemingly behind us but with that lingering labor and supply chain issues still seem to be here as well as the inflationary challenges that we're seeing as well as the expectation of higher interest rates. This -- this, of course, is all being now impacted by the conflict over in Ukraine with Russia and what it's doing to the commodity prices, particularly the price of oil. With that, what is the environment right now, Don, that you're seeing for the Commercial Banking business? And second, what are you hearing from your clients? And maybe you could share -- it's almost like a pre-Russian, Ukrainian conflict environment and then a post environment. But with that, I'll hand it over to you.

Yes. Why don't I start with the latter and talk a little bit about what we're seeing with clients. And it's certainly interesting times out in the marketplace right now. I would say, on Russia, Ukraine, it's probably a little bit too early. And I think what we're hearing from most clients is it just exacerbates some of the challenges that they've been facing to your point on supply chain and inflation. Interestingly, it's helped us a little bit on utilization because we've got some clients who have been prepositioning and ordering ahead in terms of bulking up on supplies to make whatever they are going to make. But the place we're seeing it the most, frankly, Gerard, is a little bit of pressure on margins. So any given client is going to be able to pass on labor cost and raw material costs, all of which are driving the inflationary environment to one degree over another. So it depends on strength of end marks and it depends on strength and size of the company. We don't see any real distress in the portfolio at this point, and then -- and companies are handling the situation fairly well. And what I've observed on that point is, as we went through COVID for the last 2 years, management teams got deadly serious about risk management. They adjusted their cost structures. They adjusted their balance sheets. They've built liquidity. And so they've almost are DEFCON 7 already in terms of managing through difficult times. So they went into the latest inflationary situation and now Russia and Ukraine more prepared than they were [ in ] prior cycles. And so I think that's been a generally good thing. So we're watching the portfolio, and we do extensive almost weekly reviews of what we're hearing from clients, and there's nothing out there that's particularly concerning to us at this split second. In terms of the macro environment, I mean, I think our view is that GDP growth has probably been down ticked a little bit. So if people were talking 3% to 4%, maybe you're talking in the 2-ish range. We don't think that we're going to tip into a recession. We're watching stagflation as a risk out there, but it's not our base case right now. And if you think about the macro drivers, you have high levels of liquidity, economic growth and relatively low interest rates, even if they're going to be higher. So those are good backdrops for most of our businesses. And then remember, and you started with this, we're a U.S. regional bank. So we don't have -- we have no exposures in Russia or Ukraine, we had no exposure in Europe. So it's really a U.S. economic story for us. And we think the backdrop of the U.S. economy is going to continue to be okay, although not as great as people thought it was going to be. And if we get -- we're expecting 6 -- 5, 6 hikes of interest rates this year, we don't think that's going to really cause people to derail. So maybe a little bit slower growth, but generally pretty good.

Very good. When you talk to clients, is there any second derivative risk that you're seeing with what's going on with the higher inflation, maybe with now with the price of oil where it sits our inflation numbers could be even higher. Do any of your customers think about how they could be affected in a -- not a direct way from Ukraine, of course, or Russia, but it's that second derivative of higher oil prices, higher inflation in general?

Yes, of course. I think it's all about commodity prices right now, and it [ spans the gamut ]. Talk about nickel, talk about oil, talk about now wheat and grains and the like, everything is going to be more expensive than it was. And I think people see that as a reality to operate in. So it's really that question of focusing on being able to pass those costs through and/or adjust their business models to absorb a slightly lower margin. And then there'll obviously be a continuation. And I think the war probably exacerbates this or certainly exacerbates the supply chain issues. And you've got a lot of companies that have redirected their supply chains, and we're seeing a lot in our treasury services business as companies are sourcing from different parts of the world. So there's been an adjustment that has resulted from supply chain disruption in COVID, which is going to continue in supply chain as a result of the Ukraine situation, if that continues for a period of time. So it's sourcing of goods and pricing of goods and then the ability to maintain margin. And as I said, it's also labor.

I thought your comments were very interesting in terms of what many of your customers have been through because of the pandemic and because of how they needed to operate their businesses, not that any of us knew this was coming with Ukraine and Russia and how terrible it is, but many companies may be better prepared to handle this event that has come out and can get through it maybe more effectively than if it happened in 2018 or '19?

Yes, I agree with you. And remember back at the -- so our view is this is not like the great recession. This is not like the pandemic. It's a different order of magnitude, at least for now, and hopefully, that continues. But if you go back to the beginnings of COVID, we had clients whose revenue lines went to 0 overnight. And we basically had 2 or 3 clients in our portfolio that ended up not making it. The rest [ were a ] lot of hard work by my teams, we were able to [ resuscitate ], obviously, the government and the liquification of the markets and the fiscal stimulus helped, but that was extreme. This is problematic. And I think people are well prepared to adjust to it.

Very good. Very helpful. Don, Citizens has made a number of acquisitions over the last few years. And in particular, they've added to your capabilities within your group. And you've got advisory capabilities now you recently added JMP, which closed in the fourth quarter of last year. What is your overall vision of bringing these businesses together?

Yes. So Gerard, it really goes back to -- and this is -- it really isn't a story from the last year and the acquisitions we did. Since I came really actually even before I came, since we IPO-ed, we've had a view in the corporate sectors of our business that we had to be a full-service provider for our clients. And we were a relatively narrow company 7 years ago, really with a very significant loan focus and very systematically over the last 7 years, we've been adding capabilities. So we started with syndicated lending, then we had our global markets businesses, and we began to add our securities businesses, so high yield, high grade ABS, then we added our M&A businesses. And of course, last year, it culminated with the acquisition of JMP, which gives us the equities and equity research capabilities. And our vision really is that in any cycle of the economy at any moment of any of our clients' life cycle, we need to be able to be there and be full service and help them accomplish whatever they need to accomplish. And I think it all came together last year, and you saw the fantastic results. We were in a good market, but the number of transactions where we were playing advisory roles and financing roles and hedging roles and wealth management roles, all rolled into individual transactions has been -- was very gratified. So we feel like we've executed a strategy that we have been building towards for 6, 7 years, and we feel that, that positions us incredibly well for the go-forward period. And we're gaining share. We're moving up the league tables, and we're getting great feedback from our clients. We are focused now on really 2 things that we want to also accelerate. One is we built a very good financial sponsor business and we serve financial sponsors in multiple ways. We sell them companies through our M&A divisions. We finance them through our leveraged finance divisions. We provide capital call lines. So we're touching them in many different ways, and we have a view that the financial sponsors are going to be the owners of a vast majority of particularly the middle market companies in this country, and we want to own that space. And you saw in the fourth quarter, we were #1 in leverage finance for sponsor-led transactions in the country. And we're building a very good reputation with the sponsors. The other thing that we're focused on now is off the back of JMP, we feel we're very well positioned to bank the new economy -- so JMP's focus as early-stage life science, early-stage fintech, early-stage technology, and we're going to build a suite of capabilities around JMP's business that allows us to engage with those companies as they mature and as they basically expand their businesses. So those would be 2 sub focuses against the broad capabilities focus we've had. The other thing that I'll just mention is in tandem with the capabilities strategy, we've been expanding nationally. So when I joined Citizens, we were really in New England and Mid-Atlantic bank. And you conclude pretty quickly that there's not a lot of corporate formation. There's not a lot of GDP growth in those markets. The good news is we're really deep and we're really penetrated. We've got great market shares. So those are our core businesses still we pushed into the Southeast in Florida and Texas and on to the West Coast aggressively over the last 5 years. And those are the -- probably the largest growth areas of our franchise right now. So capabilities built on the one hand and the client growth, on the other hand, has been really the 2-pronged strategy. And then, of course, the last piece of it, which is near and dear to everybody's heart right now is efficiency and expense control. And we've been able to take a lot of expense out of the company as we've grown and self-fund a lot of the growth.

Very good. Very helpful. Can you share with us -- you touched on it in your comments, -- the fourth quarter, the capital markets revenue line for Citizens as well as some of your peers was extraordinary. Maybe can you break out what you saw in the advisory business versus the ECM or DCM business? And how sustainable is that I would assume that elevated level that you're not expecting, obviously, to be repeated in the first quarter, even in normal times, first quarter numbers tend to be lower than the fourth quarter in certain product sets. But maybe you could share with us some color on how you see this business developing in 2022?

Yes. I'll answer it this way. There's 2 things that we focused on -- multiple things we focused on as we think about the different parts of our capital markets businesses. One is diversification -- so I'll take you back -- I won't talk about the fourth quarter, but if you go back to the beginning of the pandemic in 2020, what was really, really rolling was the high-yield market as a lot of companies went to the high-yield market, liquefied their balance sheet, tons of issue, and we made a lot of money in the high-yield market. And we made relatively limited amount of money in the loan syndication market because the sponsors were less active because there was uncertainty in terms of the economic environment, that completely flipped in 2021. [ Saw ] huge sponsor activity, huge loan syndication activity, a little bit of a less active bond market. So even within the capital markets, one of the things we think we have now is a little bit of a hedge based on what the market environment is. So some years equity is going to be busy. Some years, bonds are going to be busy. Some years, loans are going to be busy. So as I look at '22, we continue to be quite optimistic. Our pipelines are really strong. So our M&A pipeline is about where it was at this time last year. Our high-yield pipeline is higher than it's ever been right now. And our loan syndications pipeline is reasonably strong also. We've actually syndicated a lot of deals in the last 6 weeks or so, but rebuilding a loan syndications pipeline. So -- and the high-yield pipeline is being driven by all the bonds that I just mentioned that were issued 2 years ago and which have 2-year no calls on them. So everybody wants to come back and refinance those. So it's a matter of market receptivity and when we can execute against the pipeline. We've had very, very, very few transactions go away as a result of the environment. We've had a lot of push in terms of timing because nobody wants to execute right now. So we think, again, back to what we think we've built we're highly optimistic on it being sustainable and our ability to generate a pretty strong fee stream, and we want to add to it. The one thing I didn't mention is we bought a relatively small company called Willamette, which is a valuation services business, which is very annuity like. It's like treasury services, and we want to build out that business. So that brings us into -- we were very small in that through one of our M&A shops. It doubles our size and the valuation business, and that's going quite well right now also. So we feel good about the pipelines. First quarter will be a little bit lower than what we thought, but it's going to be, okay, in terms of what we see. And the other thing I will mention is given the current environment, Gerard, is -- we have -- the first thing I look at when we get market disruption like this is, do we have bridge loans or un-syndicated transactions on our books, we have none. We've sold everything, and we're completely clean from a risk standpoint. So we don't have downside risk in terms of potential marks as we sit here today.

Which is very important because those marks can be very damaging. That is for sure.

Yes. Okay.

When you look at the pipelines, and you highlighted that they're strong and some deals have been pushed out because of market conditions, we certainly see that in the ECM business, you probably look at the [ geologic data ] that comes out, and it's down dramatically from a year ago, which first quarter of '21, of course, was very strong due to the strength of the [ SPACs in ] the IPO market. What metrics are you guys looking at to see what's going to bring those pipelines that you mentioned that have been pushed out a bit, what brings them to actually new transactions? What do you think -- what conditions are you guys monitoring to say, okay, now they're coming back, but we're going to start doing it. Can you share with us some of the metrics.

I think it's less level of the market and more less volatility. So I think what you need to see is the volatility to calm down. And then our view is people will find relative value and they'll begin to execute. And again, the -- there's going to be -- there's some positive trade against [go to ] high yield as opposed to ECM -- there's some very, very expensive high-yield debt out there. And even with spreads flowing out and high yield backing up, it's going to be advantageous to refinance the other thing, and then I'll come back to ECM. The other thing is, if you think about it, it could actually benefit lending -- so if the capital markets get a little bit more expensive or stay a little bit more volatile, it could spill over into the loan markets. And with everybody searching for loan growth, it could be a little bit of a positive for loan growth that could result from this. We're seeing it a little bit at the margin right now, and we're wondering whether that could accelerate depending on clients' needs and actual requirements to finance. The opportunistic refinancing is probably on the sideline for a little bit until things calm down. But I think to me, it's really about volatility coming down. When you see the market going up and down 2%, 3% a day, it's just nobody is going to step into that.

Great. It's interesting on the loan growth because -- as you recall, the [ H8 ] data after having a very healthy, strong December, [ they ] finish off the year, the rate of loan growth has slowed into the first - this is pre the conflict starting over in Ukraine. But it's interesting that you bring up the volatility in the capital markets could actually, like you said, lead to more loan growth. In fact, when you look out over the next 3 to 6 months or so or through the end of the year, what's your -- what are you envisioning for loan growth for the traditional commercial loan books that you manage?

Yes. So we're tracking a little bit better than the H8 right now. We'll have a pretty good average -- average loan growth for the quarter. We'll have a little bit of spot loan growth for the quarter. We're seeing utilization tick up interesting. We've been going up by about 0.5 point a quarter, and that's continuing. Our laggard on utilization continues to be the C&I portfolio. So real estate utilization has been relatively flat, what we call market utilization, which is really capital call lines and ABS has been quite strong and continues to be quite strong and C&I is beginning to tick up. And some of that has to do with a little bit of the working capital build that I talk about. Some of that's due to a little bit of expansion activity that we're seeing in certain companies. So we think we still feel good about loan growth for the year. And we feel like we're trending well. Activity levels are extremely high. Our teams are out with clients across the board. We're on airplanes, we're calling. We're getting a lot of really, really good feedback from clients about coming [ out ] of the pandemic and how they see their businesses. We're actually adding new clients. We've added 20 new clients already this year, which doesn't sound like a lot, but we're 2 months in. And then there's a lot of uncertainty to be adding clients. That's just a net positive. We have a lot more in the pipeline. So I think the backdrop for loan growth, we continue to be confident.

Got it. Coming back to what you just mentioned about the uptick in line utilization that you're seeing can you point out or share with us what's considered normal for line utilization? And where are you relative to what you would consider to be a satisfactory level?

Yes. So overall and really in C&I, which is where I'm mostly focused on right now, normal is like 37%, 38% utilization. We peaked out at over 50 at the beginning of COVID, when everybody drew their lines. We're probably 6, 7 points below that right now in terms of the C&I. So we've got 6 or 7 ticks to actually go on the C&I side. And we don't see any reason that line utilization from a historic trending kind of basis. And there's been a reset. We just -- we think it's a moment in time. But we still got -- as you know, we've still got enormous levels of deposits in the system and sitting on balance sheet. So some of that has to be spent down before you get the final leg and the loan utilization.

In fact, you answered what I was going to ask you about what will drive that utilization higher. So the liquidity of the customers' balance sheets as is [ shown ] down as they grow their business, obviously, seems to be factors that will drive that utilization higher.

Right. And going back to where we started, in terms of the risk of the current environment, we're reasonably happy that people have high levels of liquidity right now. So at this split second, I'd be focused on risk as much as loan growth.

Aside from the liquidity on the utilization lines, when you talk about the C&I numbers growing, is it more driven by your customers need to finance their inventories or receivables or is it their expansion plans? What are some of the fundamental factors that drive that utilization rate higher?

We're seeing some expansion, some, not a ton yet. I still think CEOs are cautious having lived through the last couple of years and the current environment will make them a little more cautious. So it's really working capital. It's 2 things. It's commodity prices, which are driving working capital levels a little bit higher. So if you look at ABL utilization or you look at commodity-linked companies and financing their inventories, that's a little more expensive right now. And then there's a little bit of this stockpiling of goods because supply chains have been a little bit disruptive. So I would say it's really around working capital and really around inventories as opposed to receivables.

Yes. I don't know if you don't want to comment on this, feel free not to comment. We all see this inventory issue when we drive by our local automobile dealerships, the lots are more than half empty. They haven't been rebuilt yet. And when you look at it from a macro standpoint, and you talk to the economists, it seems like they claim that the big inventory problems, the supply chain problems in this country are primarily in the auto sector and many of the other sectors don't have as much of an issue. Do your customers outside the auto sector, are you hearing from them that they've gotten through the supply chain issues? Or are there still some challenges for them, too?

I think they're still struggling. I think it's broader than the auto sector. I mean the auto sector is really about the chips, right? And now it's kind of [ nickel ] for nonfossil fuel vehicles, EVs, and that's the topic that people are talking about right now. But it really depends on what products you need as input products. So it's a little bit broader. I think it's extreme in the auto industry, but that's why [ they're doing ]. They've done a little bit of supply chain adjustment, a little bit of the stockpiling to make sure that they have inputs that they could actually deliver to their order books.

Very good. Pivoting a little bit over to commercial real estate. It was an incredible year in the United States for the commercial real estate markets. I believe it was a recon year of transactions approximately $800 billion, I think, traded in 2021. What do you see for the growth in your commercial real estate area and Citizens?

So I'll talk pre-investors because when we close the investors deal, we'll take a big hike in our overall real estate business. But what we're seeing is exactly what you said, Gerard is we've had pretty good originations. And we're open for business in a couple of sectors and not that opened in other sectors. So we've seen a lot of activity in the industrial sector. So I think warehouses. We've seen a lot of activity in purpose-built office. So big corporate wants to build office space. We did a transaction for Amazon, which is public, where they built a new office in Boston, and we financed the office against a lease from Amazon. We've seen a lot of activity in the life sciences area. There's just unending demand for life sciences. So those are the areas where we're really focused. In our overall office portfolio, it's actually holding up really well. We're not adding to it. We're watching the back-to-work phenomenon and in hospitality and retail, we're basically not adding to exposures at this point. So we've had a fair amount of origination. But to your point, what we've seen is twofold in terms of offsets. One is there's been a fair amount of refinancing long term for the agencies and with the insurance companies of the portfolio, trying to get ahead of interest rate increases. And then the second thing is we've seen enormous M&A activity. So we've seen a lot of the owners of our real estate sell the properties. And in fact, some things that we had in the classified bucket were sold for very high prices. So it's actually been helpful in terms of some of our credit statistics. So we're projecting flat to a little bit up in the real estate business, but I would think flattish. And when we add -- we're about to double our real estate portfolio when we close the Investors transaction. So -- and that's a very diversifying acquisition. It was no overlap at all in the 2 real estate businesses. So we'll be holding it relatively flat.

Very good. You touched on the liquidity of your customers with deposits and Bruce has touched on for your organization, the total deposit beta is what you guys Bruce and John, for that matter, about what they could be in this cycle because of the liquidity throughout the banking system. But within your specific line of business, commercial, what kind of deposit betas are you planning to see when the Fed -- let's assume the Fed does still continue to raise rates this year 3 times to 5 times over the next 6 to 12 months. What do you think will the commercial bank or commercial deposits do in terms of deposit betas?

I think it's probably relatively consistent with John and Bruce's comments. I think they said [ a third ] better than prior. So we're kind of using that as a guideline. I think the important thing, obviously, deposit pricing will go up when rates go up. But I think the important thing that I think about is we have completely recast our deposit businesses. We didn't have a deposit specialist 5 years ago. I've now got 5 in the commercial division and the expertise around managing deposits and working with corporates is at a totally different level. And then we've also tried to innovate and build a bunch of things in our deposit activities, which we think are going to make those deposits stickier. And we've seen very, very little upward pressure so far. Of course, rates aren't rising yet. But if anything, we're able to drive deposit costs a little bit down. And our DDA content is at about 42%, 43% probably versus 37 pre-pandemic. So it's skewing away from interest-bearing, which is helping the cost of funds. And we think that we're going to be able to hold the price pretty strongly, at least for the foreseeable future.

We'll try to squeeze one last question, and we're coming up upon the end of the conversation here. Maybe you can just give us some color on how you're going to approach the Metro New York marketplace, the HSBC acquisition, obviously closed in February, and investors expected to close fairly soon here. And maybe you can give us some color on how you're approaching -- how you will approach that market.

Yes. We're really excited about it. In fact, I was walking down my main street in my town of Rye, New York this weekend. It's a Citizens branch, which has never been a Citizens branch before. So I kind of had it firsthand. So first and foremost, what I've said -- I don't know if I've ever talked to you about this Gerard, but I've said as I expand around the country, I don't want to grow the middle market business in new markets, unless I have people who've been in those markets for a long period of time because I'm very worried about adverse selection in the mid-market sector. So what do we get with investors, we get a seasoned group of middle market bankers and real estate bankers that have been operating in the New York region for years. I was at a client in with our 20 largest clients last Thursday, great clients. I'm really encouraged to have the Citizens products. Investors [ is very narrow type ] of community bank with basically a lending product. So when we bring in all our suite of products, we expand the relationships and become more valuable to the clients. We also think it's a platform that we can grow off of. So we have a very small New York Metro business. We have 2 corporate bankers and 2 middle-market bankers. So we expand that by tenfold with the investors acquisition. And then importantly, we get grant and we're going to have huge amounts of branch presence in the New York Metro area. We're going to have advertising. And so the Citizens name, we'll get a lot of support to it. So it feels -- when I started, I talked about our franchise being New England and the Mid-Atlantic and we call the New York Metro, the hole in the donut, which we're filling in kind of overnight with these 2 acquisitions. So I'm really optimistic. We've got an expense base that we want to churn and aim at different parts of the market. We can do that. It doesn't have to be de novo funding. So there's lots of things to like about it. And we're more encouraged as every week goes by and march towards closing.

Well, great. And Don, I really appreciate you coming on today and talking to us about the commercial business, some great insights. Really I'm pleased that you're here, and thank you so much for joining us.

Thanks for the time, and thanks for all the support.