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

Up next, and joining us for the eighth straight year, we're excited to once again have Citizens Financial. Citizens has done an outstanding job driving PPNR growth, integrating several transactions and managing the rate cycle thus far in a successful manner, all while continuing to upgrade and enhance its technology and build out its pure leading digital consumer strategy. Here to tell us more about how they're going to keep the momentum going is Chairman and CEO, Bruce Van Saun. Today's presentation is going to be a fireside chat.

So Bruce, thank you for joining us once again. Maybe just to start big picture- after managing through the pandemic, you spent a handful of months integrating deals and more recently moved back to execution mode while also benefiting from rising rates. So as you sit here today, maybe just talk about how you feel the bank is positioned as we head into 2023 to succeed.

I'd say I'm really excited about how we're positioned to finish out the year and then how we're set up to have a strong 2023. So clearly, there's some storm clouds forming over 2023 and we'll, I think, have to be prepared for what could come in terms of slowdown or mild recession. But, we certainly have focused on playing good defense first and foremost. So our capital is at near the top end of the range, we'll finish the year strong. Our liquidity and funding position, I think, are very, very strong. We've been selective on credit in the second half of the year. And I like our positioning overall and the diversity of our credit book and the prudent risk appetite that we've shown, so I think we're prepared for what could come. But, at the same time, really strong companies are always playing prudent offense. And so we've done some really significant things to better position the consumer bank over time for continued growth to focus on a few areas where I think we're unique and have a right to win. And then, on the commercial side, I think we've positioned ourselves with a full array of products focused on the right industry segments and market cap segments of the market where I think there's very few super regionals who can do everything we can do, and we can compete effectively head-to-head with the big banks. We're just kind of waiting for better market conditions on the commercial side for all that to manifest result. So one thing -- our returns are certainly moving up. And one thing we've been waiting for since the IPO is to move off the 0 bound of interest rates and get back into a more normal long-term level of short-term rates, which we're in now, and you can just see the value of our consumer deposit franchise is being reflected in terms of higher return on equity. We have, I think, a second kicker to that, ultimately, which is the fee machine that we've assembled on the commercial side is operating probably at 50% of where we were in the fourth quarter of last year. So last year, we did $185 million in revenue in Q4 in capital markets fees. We've been averaging 90% to 95% for the first 3 quarters of this year. So we're not firing on that cylinder, but I think that ultimately, the market conditions will stabilize. We're well positioned, and that should be another propellent to strong ROEs.

Yes, and it's nice, we got higher short-term rates. If you just get the curve less inverted, that would give me a nice little kicker. Bruce, you referenced returns. You posted a 17% return this quarter and even ex-OCI, you would have been on the high end of your targeted range. So looking ahead, 4Q is expected to be even higher than 3Q. So if we were to think about more normal equity levels, what type of returns do you think this franchise is capable of? And what are the drivers of the higher returns?

Yes. So it actually was 17.9%, not 17%. But, in any case, yes, we think we'll do even better in the fourth quarter. And what's basically propelled the ROTCE over time has been our commitment to positive operating leverage and growing our revenues faster than our expenses. The expense part is never easy, but I think our top programs are distinguishing in terms of how we run the bank, and we're constantly looking for ways to find more efficiencies to deploy new technologies, et cetera, to run the bank more efficiently. So then we'd free up the capacity to self-fund the investments in growth. So we're not shrinking our way to success. We're actually running a really good disciplined bank, and we're taking kind of the benefit of that and continuing to get the flywheel going with new investments that bring new customers and new revenue streams. So I think we-- that's the goal, to continue with that mindset, continue to do that. I mentioned getting off the 0 bound is a lift to ROTCE. That's been a big accelerant recently. And then I think, again, that the commercial side is currently underperforming its potential. So I think the combination of those 2 things lead me to believe that we should-- we're currently at the high end of our 14% to 16% medium-term target, if you back out the AOCI impacts. And we've hinted that we'll be refreshing that range come January on the earnings call. And I think we have the potential to stay in a level that's reasonably higher. We've done some nice hedging to kind of cushion any drop in rates if the Fed goes too far and then they have to bring rates down, stimulate the economy. We've locked in a pretty good corridor that should preserve that type of return on tangible equity.

Lots of things in there that we will certainly touch upon. So Bruce, before we talk about the potential of top 8- the first 5 to 6 years the bank was public were largely focused on self-help and improving returns. Then at some point, you pivoted and brought M&A back into the equation with the string of bank and nonbank deals. So I guess the question is what are the strategic priorities today? Is it all about execution? Or is it about adding fee capabilities, or do you have any broader aspirations?

Yes. Well, I think this year, you haven't really seen us do much of anything. We've done a couple of tiny deals-- it's been all about integrating the things, the big things that we did in 2021. So the New York metro play with HSBC and investors is a big investment on our part. It's, I'd say, a bet on ourselves that the type of banking that we bring to other major markets like Boston and Philadelphia and Pittsburgh, we can deliver that into New York. And even though New York is a heavily competed environment, that we can be successful with how we do our consumer banking and take a neighborhood approach and deliver solutions and be a trusted adviser of an individual's life journey. And then similarly, in the middle market, we go up against all the players in those big markets, and we do it very successfully. So now we have a bigger base to build on with those acquisitions. So I think that continues to be really job 1, is to get the deals that we've already done to really perform and to achieve their upside in terms of their revenue potential. I think the expense side of it is in the bag, the funding side of it is in the bag, but making sure that we are driving growth and account acquisition with new customers and deepening with existing customers, I think that's where we really need to succeed. I'd say we're selective on further acquisitions. We're very disciplined in terms of price. And so the spaces that we like to be bigger in, like wealth, we've done one acquisition really of any size, which was Clarfeld a few years back. It's working really, really well. We've looked at a lot of things, but again, we're disciplined on price. So we have huge investments in organic growth in wealth. It just takes longer. If we can accelerate that with an acquisition, we'll try to do it, but we don't feel that we have to rush out and do something and push aggressively on the numbers. And then I'd say there's still areas of interest- right now are around the payment space and deposit platforms. Deposits are king in this environment. So that's another place where we're kicking some tires, but it's very selective. We don't feel compelled. There's no product gaps remaining. There's no real geographic gaps in the footprint that we want to serve. So we can afford to be selective when it comes to inorganic.

So Bruce, you talked earlier about managing expenses, and the companies use the top programs as an annual exercise to promote continuous improvement, and they've allowed you to, as you said, to create investment capacity. Now, I know you're planning on unveiling something at 4Q. Maybe just a handful of questions on the topic. Can you maybe just talk broadly about what this is going to go after. I think you referenced organizational simplification, third-party spend. And second, will this be expense-focused again, which is what-- where I believe top 7 was? And I guess lastly, we're hopefully sitting here a couple of years from now, will we be talking about top 10 or top [indiscernible]?

Yes. So I'd say you hit on some of the hot buttons areas in top 8. Looking at the organization, looking at vendor contracts, looking at new technologies and embracing new technology and end-to-end processing digitally- those have been mainstays of the top programs and a lot of times, you're just taking those up a notch to the next level. And so I'd say that will be the focal point. We have, I'd say, generally a preference that at least 75% of the top program should be on the expense side. But it's interesting, we have one of the initiatives that we put into the last top program was our HELOC Fastline initiative, where we've reengineered the HELOC process so that we can-- currently we're doing, I'd say, I think, 20% of HELOC originations within 7 days and about 1/3 within 20 days. The average in the industry is about 50 days. And so we can pre-populate a lot of the information and create a very smooth customer experience in a product area that's often clunky and not a good customer experience. And as a result, we're now the #1 HELOC originator in the country, even though we're not in all the states in the country. So that is a combination of additional revenues, but also expenses because all the processing cost that goes in to originating those HELOCs, we've streamlined that and taken out a lot of the cost to originate. So some of these ideas, I'd just give you that as an example, kind of straddle revenues and expense at the same time.

So Bruce, maybe one more strategic question before we...

And, by the way, your 10 and 12...I hope so. We'll see. Everybody jokes, it's like the fruit must be really high in the tree. They thought we were done after like top 3, but somehow we've always been able to keep going.

So Bruce, as we said, the top programs have allowed you to create capacity to invest across the franchise, whether it's been building out Citizens Access to the digital bank on the consumer side as well as expanding the commercial footprint and having broader consumer penetration. So I guess as you look ahead, given that everything is in place, as you talked about before, no product gaps, what are the big investments across the bank right now? And how have they changed over the last year or so?

Yes. So there's big investments, I would say, in enabling capabilities. So things like our next-gen tech and our digital-first agenda and our investment in data analytics. And so those are some of the foundation blocks that we keep investing in. I think in terms of business strategy, we've been-- we've tried to be ruthlessly disciplined in prioritizing the areas that we think have a lot of potential, and we think we have a right to win. So in consumer, there's probably 4 big ones. One is the New York Metro play. So we're putting a lot of investment in brand marketing and the technology conversions and putting our best people against that market opportunity. Citizens Pay is another one where I think we have a lot of running room, and we're gaining a lot of new business that I think will start to really ramp the balances, the deepening in wealth. So we've launched a number of -- Citizens Private Client, CitizensPlus -- there's a number of initiatives, I think that should really help us penetrate the opportunity with the existing customer base. And then our national expansion is the fourth one where we have a great digital platform that has been focused on deposits. We've moved that platform into the latest cloud-based FIS platform, and we're porting our other product capabilities so that we can be a full banker to some of the existing customers where we might just have a lending relationship or we have a deposit relationship, but we don't really serve as the primary bank for those customers. So lots of good stuff that's differentiating, I think, on our consumer bank. And then on the commercial bank, we've filled out all the product holes with some of the acquisitions that brought us M&A capabilities -- recently, equities, capital markets capabilities. We've built out the debt capital markets capabilities. And we've hired some great coverage bankers and we now are focused on the right regions around the country and the right industry verticals in the larger company space, the mid-corporate space, JMP brought us health care and technology focus and fintech focus. So I think we've aligned ourselves with the right opportunities with a full product set. And I think the last piece of that puzzle is we're very big on sponsor coverage and sponsors now own over half of the middle market companies in the country, and you need to be able to serve them well with M&A ideas. We have companies who want to sell every year -- that's kind of manna from heaven for the sponsor -- and then we get to finance those deals and provide services to those companies. So we'll continue to round that into shape. But, the nice thing about the commercial side is that the culture really works. It's a very collaborative culture focused on adding value to customer relationships. And at every touch point, the coverage bankers and the product folks are trying to come up with ideas to make a company more successful, and that's why we're so successful in gaining market share in that space.

Let's switch a little bit and talk about loan growth, maybe not so much about the near term. We'll get to that after. But, when you look ahead, C&I has been the focal point, where do you see-- what do you see driving commercial loan growth as we move into '23? Where do you see it heading? Are you tightening the portfolio? And what are the areas you see the best opportunities on the consumer side?

Yes, I'd say in commercial, we're still-- we're probably being very disciplined right now because there was a lot of pullback in the market and many borrowers came back to the bank syndication market. Even the biggest banks, I think, were kind of closed shop after Labor Day. So that presents some opportunities. But we're into relationship banking, and so we're going to be selective and make sure that those folks value us as a relationship bank, if they're new to bank opportunities and that their business model and their credit standing is really strong going into potentially a storm. So I think we'll see some growth there because the economy is still doing okay, and there's still, I think, folks borrowing money to expand or to do deals, but it's probably tapering a little bit as we kind of go through this year and we look out into next year. There's still some specific areas, such as- subscription line finance is another area where some of the peers are backing away. And so private equity firms still have a desire to grow those lines. So I think you'll see some growth there. I think it will be selective, but certainly still the engine of our loan growth, I'd say, will be more on the commercial side, but, again, being selective. I think on the consumer side, what we're seeing is a very good rotation that is part of our balance sheet optimization, where we're taking capital away from auto, which has been, I think, probably the lowest returning activity that is a little bit opportunistic for us. It's a place to park loans in a 2-year duration type portfolio. And then when better things come along, you can extract the capital up. So that probably ran up to $14 billion, and it's on its way down to mid-single digits, which is freeing up capital and it's releasing pressure on deposit growth, which in this environment, you don't want to be out there-- bid for the marginal deposit. You want to be managing your deposit betas. So that's kind of a big call at the top of the house. Similarly on mortgage, I think we're being much more disciplined in terms of using our balance sheet only to support relationships where we have opportunity to cross-sell, and get the wealth, cross-sell and other things. And so I think we're trying to slow the growth of investment in the mortgage portfolio. And I think student has some choppiness that won't be the big grower that it's been in the past. What's picking up in place of that really is HELOCs as I mentioned, I think we've built a great mouse trap, and many folks have equity value in their home that's certainly expanded. They have locked in a low-cost mortgage so they don't want to move. And so how do I tap into that value either to make a home improvement or use that money for other purposes. I think we have some nice tailwind there in HELOCs. Then I mentioned also in Citizens Pay, I think we're at a point of inflection where we could start to see some faster growth there. So net-net of that is that's positive for our ROTCE to see growth in those other 2 areas and less investment in things like auto and mortgage.

So you referenced deposits a couple of times. I know you said deposits are king, managing deposits. I mean you're one of the few banks that's actually growing deposits at this point, largely on the retail side. Maybe just talk a little bit about the strategies to grow deposits. How are you approaching this? And as you think about deposits and deposit betas, the goal of this cycle was to be more aligned with the [indiscernible], can you maybe just talk a little bit about how that's progressing relative to your expectations.

Yes, I think we're doing a really good job. And for a while, we were building out certain new capabilities in deposit gathering. And I'd say we were, kind of, on a moderate pace of completing those investments given all the other things we're investing in, because everybody was awash in liquidity. Then all of a sudden, the script flipped a cycle-- let's complete and accelerate some of those investments. So we have broader capabilities on the commercial side and on the consumer side to really have a better opportunity to go out and grow the deposit base and take advantage of natural opportunities where I think we were underpenetrated in terms of our share of wallet on deposits. So the whole customer-facing sales force is now not as focused on loans. They're focused on deposits. We're incented to bring in deposits, and we're asking for the order, and we make a new loan, we want to make sure we're getting the deposits in. And so I think part of that is, again, our growth being a bank that had plenty of things to fix and get better at, which you could view as a criticism, but you could also view it as a real positive because if you can go attack those things and capture the opportunity, that's going to propel better performance. So I think we're feeling good about our ability to have a favorable deposit outlook. We're not immune from the things that you're going to see rotation out of noninterest-bearing into interest-bearing as rates skyrocket and people wake up and see those opportunities. But overall, I'd say we're doing a good job and the deposit betas are tracking where we want them to be. I think you'll see when we get to the Fed final destination that our deposit betas are going to look very similar to peer group.

Bruce, maybe to just think a little bit near term, you guys have given guidance on a handful of items that pertain to 4Q. We've gotten a couple of updates from others. Maybe just give us an update on how the quarter is progressing and any trends that you wanted to comment on?

Yes, I would just simply say we're satisfied with the guidance that we gave in the third quarter. So I don't think there's anything particularly noteworthy in terms of our performance. We're doing what we thought we'd do in terms of the major categories. There's always little puts-and-takes, but we feel good about achieving the guidance that we gave in Q3.

Got it. So maybe to just spend a little bit more time on the impact of rising rates. So you're expecting the margin to reach 3.5%, and you've added lots of protection such that you expect the margin to remain above 3.25% through 3.24% even if the Fed begins to cut. Can you maintain the 3.50% margin while the Fed is in a 5% range? And maybe can you just talk high level about how you and the team manage the balance sheet and controlling deposit betas in this ever-evolving environment. And what are the biggest risks that you're concerned about in terms of preserving these margins?

Yes. It's a good and complicated question, and it's a complicated topic, yes. But, I think one of the things we tried to bring out in the third quarter call was that we still benefit even-- folks think that we're getting to peak NIM and the Fed's gone too fast or too high and that ultimately, the curve bends at some point. But, given the kind of mix we have on our balance sheet, our asset betas are still higher than the deposit betas. And we have our interest fees that are being invested in higher yielding fixed loans and securities at this point. So we think that we can continue to see expansion of our NIM in 2023, although it will be at a lower pace of expansion than what we've seen. And you can see that if you go through the quarters of this year, it was big in the early part of the year, and it's still pretty good chunks of advance. But it's starting to slow, and that will continue through 2023. One of the things that's important for banks is we operate in a kind of a risk framework where we try to protect against tail risk either direction. So you're constantly evaluating hedges and how to lock in your positioning so that you don't end up-- if unforeseen things happens and tail risk happens that you see a calamitous impact to your P&L or your equity. So I think we've done a good job, maybe started a little early, but you're following your framework. And I think now we said there's a [indiscernible] of around 3.50% to 3.25% down if the Fed has to cut a couple hundred basis points because they went too far, we're trying to lock in these return on tangible equity in a corridor that leaves us at a healthy ROTCE and above the current targets. So we feel pretty good about that. And certainly, if the Fed has to go appreciably higher with big jumps because it turns out they're way behind the curve, then you'll probably see even faster deposit migration. So there's wildcards out there that could kind of upset the pretty picture that we're painting. But I'd say for most of the scenarios that you can envision, we feel like we're in pretty darn good shape at this point.

Bruce, maybe to talk a little bit about credit. You used the words 'potential storm' twice. Hopefully, it's just going to be a drizzle, not a major storm. But clearly, the markets have been worried about a recession, yet your credit has obviously been very strong. Maybe just talk about expectations, some of the things that you've put in place to prepare for what feels like an inevitable downturn? And what are some of the strategies that you put in place to manage through that type of environment?

Yes. So I would say, first off, if you look at our growth, and I know this has been a concern of investors is that we had to re-lever the balance sheet after our IPO, and we grew loans pretty fast. If you actually look at where we focused on our loan growth, it was in very selective areas. And over time, our credit risk rating of the consumer portfolio and the commercial portfolio have both increased. So we've actually improved the credit quality while we've grown the loan book. And so I think investors may be waiting for a test like, okay, well, the pandemic wasn't necessarily a fair test because the government came in and saved the day. So go through a recession and show us that you-- your performance will match what you're saying and what your statistics say. So I think we're prepared and feeling good about that. So I would just say, structurally, our back book is in very, very good shape- good diversification and very super prime and high prime focus on consumer and moving to bigger companies in corporate, which tend to be more diversified and better credits. In terms of the front book and originations, again, you're looking at the higher-risk individual customer segments and doing some tightening selectively. Same thing on the corporate side and commercial real estate, you're pretty much pencils down on office and some of the areas that are the ones to worry about. So I think we've taken the steps on the front book to be very disciplined in this environment.

Maybe just to expand on a couple of the last points that you made. You've talked about margins getting squeezed on the corporate side. Obviously, we have inflation out there. Maybe just talk a little bit more about what are the parts of the portfolio that you're monitoring most, whether it's office CRE or the leverage book and what are the key areas that you're watching on the consumer side? And what are some of the leading indicators you're looking for?

Yes. So I would say, obviously, office is subject to what-- how hybrid work and return to office plays out. And so...

[indiscernible]

Yes, you're back. So I hope everybody follows your kind of framework because that would be good for bank credit overall, if everybody goes back to work. But yes, I'd say we're watching office, and there's different kinds of office. So there's life sciences, there's office built for high investment-grade company credit like we have at Amazon and the Seaport, there's suburban office, and so you're really looking at the sliver that's kind of Class B and Class C and older buildings that are going to be harder to let in a shrinking demand for office space. Leveraged lending, I'd say we're watching that. But again, we have very low granular hold positions. I think our average position is $12 million and so I'm not as worried about that. We're also looking at the non-profit space, which also in a downturn-- is an area that you can see some brushfires but nothing dramatic at this point. So those would probably be the areas on the commercial side. Then in consumer, I'd say what's been remarkable to me is that we thought we'd see a much faster migration back to pre-pandemic levels of delinquencies and NPAs and it's just not happening. So the consumer still flush with a lot of cash and the migration is happening much slower. So there's nothing really at this point that jumps out. We're looking at-- in the auto, that used car prices are coming down a bit, but that's-- they're still way up where they were from a year ago. So I don't think that's a big worry at the moment.

Two more questions, Bruce, that I'd like to hit on. So you referenced earlier, you spent years building out the fee income capability, some organically, but largely through acquisition. You talked about capital markets not operating at -- because of cyclical issues -- full capacity. Maybe talk about how the fee income businesses are positioned for '23, what do you think could be the areas of bright spot? And what about the areas that are facing headwinds and how are you managing them?

Yes. So I'd say I think the big upside is in commercial, and I think we could potentially have a bounce back year in capital markets, and we've built a machine and it's powering and ready to go. So I'm excited about that. Some of the other fee areas that we sell to customers' cash management. We've made some really nice investments in cash management capabilities and I think our sales growth this year is the best it's ever been. And our FX and derivatives with all the volatility in the markets, we've got some great people there, and that's also-- has continued momentum heading into next year. So the kind of areas-- and I think wealth, too, is an area that we've had the market correct a bit this year, which has hurt the fee performance a little bit, but still all the sales performance and the productivity of our FAs continues to tick higher. So we feel good about that. We probably -- on a year-over-year comparison -- we've been making changes to consumer service charges and so we'll get the full effect of that. But, in fact, growing households is an offset to that. So I think that's tracking a little better than what we modeled. And then, mortgage is probably near-- I've said on the calls, it's pretty close to washed-out levels and servicing has picked up the slack when production is way off. I think you're seeing capacity leave the industry right now and therefore, I think you'll see some margin reflating next year. So you might see-- start to see us tip up a bit next year, but it won't be dramatic.

Maybe one question to round it out Bruce. I think you talked about resuming buybacks in 4Q, yet capital is still expected to remain on the high end of your 9.5% to 10% targeted range. Maybe just talk about how you plan to manage capital in this type of environment, how do you prioritize? And are you thinking about letting the capital build until the uncertainty passes?

Well, I'd say we've done that. So operating at the high end of our range and at a gap to peers, I think we don't have to be a whole lot higher than the 10% that-- we're going to end the year close to that or at that. And dividend, maintaining a strong and growing dividend is at the top of the charts and supporting balance sheet growth that is consistent with our strategy is kind of next on the list. And I think our stock is very attractive to take excess capital and be buying our stock back. So we're happy that we're doing that in the fourth quarter, and we would expect to be doing that next year. And if we see any deals that we bench against, well, how does this deal-- has a strategic advantage, but financially, does it offer the same rough TBV earn back that a buyback would-- we go through that discipline. So we see some good deals, we'll do some good deals. But absent that, we'll continue to buy back our stock.

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