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

Next fireside chat. Citizens Financial is with us here. Many of you know John Woods to my immediate left, who is the Chief Financial Officer for Citizens. He joined back in 2017 as Executive Vice President and Chief Financial Officer. Prior to that, he was with Mitsubishi UFJ Financial, which was the old Union Bank, if I recall correctly. And obviously, he's well experienced as a senior executive at a number of institutions prior to that. Richard Stein is relatively new to Citizens. He's their Chief Risk Officer. He came in, in May of '23. Some of you might remember, Richard, when he was over at Fifth Third out of Cincinnati and another deeply experienced senior executive. Then I thank you for both of you for joining us. Some of you may not know, they're the 11th largest -- Citizens is the 11th largest bank now in the United States with assets of just over $220 billion. The company has a very strong CET1 ratio at 10.6% at the end of the fourth quarter. And the company has branches -- over 1,000 branches throughout New England and the Mid-Atlantic regions with organic growth as well as some acquisitions.

So with that, John, maybe we could start off with some questions about what you guys are seeing in the big picture, when you look into the details of the economy, it continues to be stronger than many of us expected that as recently as 3 or 4 months ago. And with that, do you think may happen for interest rates? What's the path of interest rates in an economy that looks like we're going to really have a soft -- potentially soft landing?

Yes. I mean, that's exactly right. I mean, the economy has been surprisingly resilient, right? I mean I think we had that blowout jobs report in January. Even after discounting for seasonal factors, still pretty impressive. So the labor market has been hanging in there very, very nicely. On the flip side of things, that kind of gives a little bit of angst to -- when you hear the Fed speak, basically making sure that they don't cut too early and ensuring that they don't make a policy mistake. So that's I'm sure part of how we want to think about how things will play out in 2024. That said, back in January, we thought that maybe we would get 4 or 5 cuts, you fast forward to today, it looks like maybe it's more like 3. So we have it kicking off sometime in June or July. And those 3 cuts, I think, will start us on the path towards kind of the down cycle, basically, rates normalizing, which I think would be very, very constructive broadly for the economy. As just kind of jumping into how that plays out in terms of conversations we're having with our customers, in the middle market space, there's a lot of encouraging signs starting to build with recession odds falling. When you take, hey, maybe we're likely at the end of the rate rising cycle and you've got recession odds falling pretty sharply. We're hearing a fair bit of optimism out of our customer set early in 2024, and we're seeing some momentum building as a result.

And in the middle market space, is it -- any geographic obviously, you have New England, you got the Mid-Atlantic, also some Midwest and you've got a corporate commercial book that's more national. Is there any particular areas that you're hearing more strength or less strength?

Yes. I'd say it's pretty broad-based across geographies. I'd say that what we're seeing is a pretty good uptake. The capital markets are open. So we're seeing opportunistic refinancing on the loan side. We're seeing opportunistic accessing the debt capital markets as well. And I'd say if I were to make a kind of carve out here, I'd say the upper middle market, maybe a little bit more active, mid-corporate, upper middle market, a little bit more active. I'd say that the other thing that's lagging a bit is utilization rates are down maybe a tad versus expectations, but can deal formation and conversations really picking up and pipelines look very good, so -- and very solid. And that connects back to our expectation, which we still feel good about of recovery in loan growth in the second half of '24.

Yes. When you look at expectations on potential rate cuts now in the middle of the year, and fewer rate cuts this year, how are you positioning now the bank in that kind of environment? And what does that do to your outlook for NII for '24 and beyond?

Yes, it's a really good question. I mean, I think the way -- so based on all of the uncertainty we saw at year-end, I mean, we've positioned ourselves basically neutral to rates or right around neutral. And as a result, we have offsetting forces that keep us within our range for 2024. So we indicated a decline of 6% to 9% in 2024. And that range is still good, and it's good across a number of rate outcomes. So whether we have 4 or 5 cuts, which we were thinking back in January or whether there's 3 cuts, which is what the market might be telling us today or if there are no cuts. I mean all of that is consistent with our original guidance in January. And so we feel really good about that for 2024. And when you think about what's going to happen outside of 2024, as we were mentioning, we have significant tailwinds as you get into the, call it, medium term, '25 through '27 range. I mean you'll see our swap portfolio runoff and the swap portfolio that's out there, if you have normalizing rates, those are 2 big tailwinds. We've got the noncore portfolio that we talked about running down. A number of our strategic initiatives are accretive to our net interest margin and our NII. And we were basically talking about the fact that our net interest margin over the medium term should get to 3.25 to 3.40, and we closed out the fourth quarter at 2.91. So you can see that we've got 40 to 50 basis points of net interest margin that we expect to deliver over the medium term. So 2024 is kind of within the realm of expectations and across a number of rate environments, our guide is still something that we expect to achieve. And when you get out into '25 and beyond, just a significant amount of tailwind that we would see from the net interest margin standpoint.

And when you talk about the tailwinds and some of the strategic actions you've taken in the wealth area for one, you have a targeted 16% to 18% return on tangible common equity. And is you're still comfortable with that over the medium term as based on what you're seeing?

Yes, very much so. I mean I'd hit it from 3 different places. So first, we're starting out on this journey to the 16% to 18% with an incredibly strong foundation from a balance sheet standpoint. We call that playing good defense. As you've heard Bruce and I talked about that in the past. But within that, we've got a capital level, whether it's unmarked or marked for securities losses in AFS we're near the top of the peer group. So that's an important place to start. Our liquidity levels are significantly above what would be required of a Category 1 bank from an LCR standpoint. So we're feeling very strong about that. And we like our rate positioning with -- so kind of like the foundation that we're building on is very solid. I think the second point I would throw out is, that allows you the opportunity to invest in a number of very unique strategic initiatives, and there's 3 of those, I'll highlight, the private bank. We had the formal launch in the fourth quarter. We got to over $1 billion, maybe $1.2 billion of deposits at the end of the fourth quarter. We're going to probably double that this quarter. I mean, just really strong trajectory there. So we'll get to around $2.5 billion of deposits with loan and AUM building in the private bank. New York Metro, we invested in this geography that we're all sitting in today. We did 2 acquisitions, HSBC and investors. Both platforms are growing well beyond our legacy branches from our other geographies. We're very excited about that. And in particular, HSBC, which got a head start on the ISBC in terms of data integration is now -- has -- is much more efficient and productive from the standpoint of customers per branch than even our legacy high-performing branches, extremely excited about that second initiative. And lastly, private capital. We've been investing in the private capital space for a very long time. We've been building capabilities, investing in coverage teams. And so as the secular kind of ongoing long-term shift to private capital being part of our lives, and part of the business going forward. We're extremely well positioned. So you wrap all of that together. And as -- and so where do we get the 16% to 18% when you think about the P&L, net interest income, huge tailwinds coming from net interest margin, as I mentioned earlier, 40 to 50 basis points. That's a big driver. Multiyear investments in fee capabilities that will have a compounding effect as you go -- as we head out into the medium term. We've had a history of being very disciplined on costs, and we're making investments in productivity and GenAI as you think about it. Credit should normalize back to the 35 to 40 basis points range from where we are today at 50. And all of this -- because of raving it back to the strong foundation, all of this across strong capital will allow us with our balance sheet optimization activities to be on this journey to still be returning capital along the way. So we'll be a rare capital return story as we migrate to achieving that 16% to 18%. So we're feeling quite bullish on that outlook for the medium term.

Very good. And Richard, I haven't forgot...

Let's keep going. I'll take another cup.

But John, you did bring up your strength in the LCR, your Category 1. So you might be the best to answer this question. There's expectations now because of what happened last year with Silicon Valley and the others that we're going to get more action from the Federal Reserve and another notice of proposed rulemaking on liquidity requirements. What's your thought -- I know the CFOs have talked to the Fed and stuff there. What are you thinking in terms of what new requirements may be on the horizon?

Yes. I mean, I think, first, as we may have mentioned, I think we were at 117% or so. If you calculate our Category 1 LCR. There's a significant amount of cushion there for us to absorb even more onerous rules and still not need to build additional liquidity. But I guess what you could see coming would be sharpening the runoff assumption for different deposit categories. I mean you go back to the events of March of '23. And there were concerns about certain deposit classes that ran off faster than expected, right? And we all know what they are. And so I think you could probably see some of that getting tweaked. And I think a lot of us, certainly Citizens, we've leaned into that in '23 and '24, and we've sharpened even our own internal models and have increased runoff rates for areas of concern. So -- and that's part of the reason why we're at 117% based on the current Category 1 rules. I mean you might also -- of course, we have heard about the AFS marks, but there could be some focus on how the maturity as well. But broadly, we -- even on a marked basis, whether you have AFS or HTM, we're in a very solid place. And I think what it's pointing out is the interplay between capital and liquidity is incredibly important. Both of them are critical. And so even though your securities portfolio is primarily a liquidity driver, it also can create capital issues if it's not managed well. And we've been managing our securities portfolio to a shorter duration so that it is not only a falling deduction from a capital standpoint, but it's also a solid source of liquidity in times of uncertainty. So in any event, we'll see where it plays out, but we feel very well positioned for whatever one might come.

Good. Richard, obviously, new to Citizens, to Boston as well. And I don't know if you had talked like [ CAR ] yet, but a lots of. But anyway, can you share with us in these changing macro times we have, and obviously, we'll talk about commercial real estate a little bit in terms of what's going on there. But where have you been spending most of your time now at getting to know the bank? And what's on your agenda for risk as a option going forward?

Yes, it's an interesting time, as you say, it's also an exciting time for good risk managers. They'll find opportunities in these situations. I've been spending my time just trying to get to know the bank, right, looking at the risk framework, looking at the risk appetite and just meeting the people, looking at some really interesting business initiatives. John covered 3 of them, and I think they're really exciting for Citizens. I've had the luxury to with an extended transition with Malcolm Griggs, to travel around and meet people around the franchise, whether it's business leaders, colleagues, risk people and get to see what Citizens all about. And here's what I've learned. John said the word a couple of times, there's a great foundation here. There's a great risk foundation, cultural foundation at Citizens. And that starts with Bruce and the Board and runs through the management team. And it's not just a risk culture. There's a really interesting and vibrant culture at Citizens more broadly, and I'm excited to be part of it. I think for me, from an agenda standpoint, it really is supporting all the things that are great about Citizens maybe adding a little bit of new perspectives, but making sure that we have a best-in-class, highly respected risk culture that's going to strike the right balance of risk and return and drive shareholder value and importantly, position Citizens to support our customers in all environments and thrive through all cycles.

Very good. Now maybe getting down into some of the questions that we're all interested on commercial real estate. Citizens has been pretty forward about their commercial real estate exposure, the details that you gave us on office, for example, I believe you brought your loan loss reserve coverage up to about 10% of the office portfolio. Maybe you can share with us, what's your outlook in this area, your confidence in that this is manageable as we go forward. And maybe if you give us some ideas on how you might work with customers on extending loans and possibly what you think the maximum loss content is here?

Well, I think from a maximum loss content, we've expressed that in our reserves at 10.2%. And that's based on our current assumptions, the current outlook. We've been through the portfolio in extensive detail, and commercial real estate is not something that snuck up on us. The team started working on this at a detailed level in the fall of '22. When they started to see rates rise, you started to see some interesting trends in vacancy and return-to-office. So been doing a ton of work name by name. I think you just have to understand, general office is going to be a medium-term problem. It is and this really goes to the way these workouts are. The workouts are building-by-building, borrower-by-borrower, situation-by-situation as someone'd say, in real estate location, location, location. We're trying to be as supportive as we can. We're trying to find the optimal outcome for our borrowers in these buildings. We want to make sure the buildings are full. Full buildings are much easier to deal with than empty buildings, right? So if that means a little concession here or there to ensure that a lease gets extended or the borrower has some money to do some tenant improvements to extend leases. That's what we're doing. And so we think this is certainly going to be a problem from a loss and a charge-off standpoint through '24 and into '25. We think it probably peaks towards the end of '24, maybe into '25. But it's going to be a medium-term problem that we're going to have to deal with. Back to the 10.2%, that's a really severe scenario. That's a scenario that looks like the great financial crisis. That's a 1 in 5 default rate and a 50% loss rate. That's not how we get there, but that's kind of how the math works. So it's a really severe scenario. And so we feel comfortable where we're reserved.

And what's interesting is -- I believe this is true for you folks as well that the origination loan to values are in that 50% to 60%. Property values fall 30% or 40%. The actual loss content to your point, I'm just...

It's not 50%, right? I think the other thing to remember is our general office portfolio is 70% suburban. So while that doesn't mean they're out of the woods, that has a different dynamic than central business district office.

And diversified geographically many different suburban kind of locations.

Correct. Moving to the other asset class that's receiving a ton of attention lately is multifamily, as you know. And maybe you can walk us through the contours of your portfolio? And how do you expect it to play out?

Multifamily is a different dynamic because vacancies are still really low, particularly if you think about those of you that live in New York City, it's a 2% vacancy rate in New York City. The other thing to remember when you think about multifamily, building permits are down 20% year-over-year, down 30% in New York. So we view this as a temporary issue. Look, absolutely, there's some pressure with higher rates and higher operating costs, but we view those as transient. It's going to impact some near-term cash flow situations. But the structural shortage in housing, the continued drive in housing formation means that we think there's still tailwinds in multifamily. The reality is asking rents did moderate a little bit in '22 into '23. They're starting to pick up in the Midwest and the Northeast. So feel good about the portfolio. It's diversified geographically, mostly within our footprint. Average loan size is about $6 million. So it's been -- it's diversified from loan size, and we've been through every piece of collateral in every unit. I know rent-regulated is a question that people want to know about. If you're going to be in a metro area, you're going to have rent regulated. 44% of the apartments in New York are rent-regulated, 16,000 are rent controlled. We have virtually no rent controlled exposure at all. And even rent-regulated, you get 3% rental inflation or asking price. So we think it's a timing issue as we go through. $2.8 billion in New York, most of the maturities are beyond 2026. And again, the rent-regulated piece is not material.

Yes. One area that we just don't see a lot of focus on credit is the commercial loan book, C&I, commercial and industrial loans. What are you guys seeing there? What are some of the trends that are developing? Or is it still a real strong book?

It's still a strong book. I think you still have pressure with higher input costs, whether wages, material cost inflation has come down, but input costs are still high. But at the same time, most C&I customers continue to be able to push price. And so that's being pushed through to the consumer, hence, the strength in the economy. So there's a little bit of one-off. If somebody has trouble dealing with the timing differences of cost and revenue changes. But for the most part, there's nothing -- we're not seeing anything material, just the normal pressure of just dealing with the transition. So it's in good shape.

And when you think about commercial, we also have leveraged loans, and they're holding -- you look at all the industry data, and they're holding in there very well.

They're holding in. Remember, with a leverage loan and sponsor selection is important, and that's one of the things that Citizens is really good at. They're making -- they've got a lot of capital at risk. They get -- they support these businesses not only with capital, but intellectual capital support, right, their network. So yes, they're performing as good or better than we expected. It doesn't mean that there's not some rate pressure. But from an operating standpoint, there continues to be strength.

Yes. The consumer has been healthy across the board, except for the lower FICO score consumers seem to be struggling as a kind of a conundrum with the low unemployment rate and seeing the way the charge-offs are moving in that cohort, if you will. Maybe can you share with us what you're seeing in your consumer portfolio and what the outlook is?

We're seeing the same national trends. So renters have more pressure, right, for the reasons we just talked about with rental increases. FICO is rank ordering by pressure, income -- pressure in the consumers rank ordering by income. What you remember about the Citizens book is 3/4 of the book of the consumer book is secured, whether it's mortgage, HELOC or auto, right? So that's a different loss profile. The rest of the book, and it really has to go with how we go to market and a relationship marketing offer mostly through financial centers, we get 2/3 of our customers are also homeowners on the unsecured side. So while there's been some normalization, we're not seeing the same fanning that other people are seeing. We're seeing it move back to the 2019 trend. But part of that is because it's homeowners, higher income, generally, a little bit older cohort. And we feel really good about where that trend is going.

John, coming back to you with some final questions here. Maybe what are you thinking about the quarter? And are there any update you'd like to share with us on the quarter?

Yes. Feeling good about the quarter. There's puts and takes as always. As I mentioned earlier, maybe a tad lower on loan utilization than this than expected. But that's being offset by a little bit better trends on the net interest margin line. So I mean NII expectations are holding in where we had them back in January. Fees, same view their capital markets and broadly on track, seeing a fair bit of uptake on the loan and bond side, like I mentioned earlier, lot of opportunistic accessing the bond market earlier this quarter. And in the M&A space, really, really nice momentum building as we get through the end as we get into the last month of the quarter. Expenses, well controlled and as we expected it, credit coming in with no surprises. We also mentioned that we would be considering being in the market and buying back stock this quarter, and we're on track to complete $300 million as anticipated. So broadly on track, puts and takes, but expect to hit that guide.

When you look at the capital markets business, some of the regional banks have developed some strength in this area, and you certainly are one of the ones that have built up the strength. What do you run into as your competitors? Because I assume you're not going head-to-head with the very large capital market players. That's occasionally, you might, but that's -- who are your primary competitors?

Yes, I'm not going to give any commercials for any of my peers right now. But we compete with the large regional, super regional space, but also the Category 1 group. We will have -- in our different geographies, we compete with them across all of our products. It's not just in capital markets where we've developed capabilities that are well beyond what you might see a bank of our size being able to have expertise that would be, call it, Category 1 level expertise and punching way above our weight in the capital market space. But that's true across a number of our businesses, right? And we compete against the large banks in our -- in New York. Our growth rates are fantastic on our legacy HSBC and investors businesses. So that's a retail kind of where you might you might say it might be harder for us to compete with the larger banks. But whether it's in Boston, Philadelphia, New York and the Northeast or now in our expansion markets on the West Coast in San Francisco or in Southeast Florida, we are competing against all banks no matter what the size is.

Yes. Aside from commercial real estate questions. The other topic that everybody focuses on is deposit betas and what's going on with rates. So John, maybe you can share with us, if you look at your deposit betas, what you think if it's higher for longer, where your terminal beta will be? And then any migration assumptions that you tie in from noninterest-bearing maybe it's interest-bearing. And then secondly, when rate start -- when Fed fund rates start to come down, what do you think that deposit betas will be for your organization?

Okay. So just kind of playing that out. So in the first quarter, just some observations we're seeing very, very solid stabilization. We've had a lot of deposit migration as an industry. We were part of that. But we look at it in the context of noninterest-bearing migrating to interest-bearing. We're seeing that stabilize in the first quarter and flattening out. And that's really nice to see. We're on the -- in the category of low cost migrating to higher cost, that has been declining and decelerating as well. So all of that is great. And in the context of overall deposit levels were pretty flat in the quarter, even though when you look at the window being flat with a quarter that's typically seasonally down. We're having very strong kind of resilience in the deposit portfolio, which feels really good. As we look forward to our terminal deposit betas, we mentioned that we would -- we should end this cycle in the low 50s. Back in January, we said that, and that was expecting the first cut to come in May or June and maybe we'll have 4 or 5. Even as you kind of fast forward and say, okay, maybe then the first cut doesn't come until June or July, and there's only going to be 3. We still think we're going to -- it will be a little higher, but still in the low 50s for our terminal beta on the -- in this up cycle. Flipping around to the down cycle, which is the other part of your question. In the down cycle, we mentioned that if we got 4 or 5 cuts, we would get to 35% to 40%. But that builds. You don't get the 35% to 40% on the first cut. That kind of builds and compounds to that fourth or fifth. And so we still think that 35% to 40% is about right once we get to the fourth or fifth. But if you end up at somewhere in the neighborhood of 3, you'll have somewhere halfway between 0 and 35% and 40%. So maybe 25-ish on the down, if you get into that 2, 3 level. And then that will be building as cuts continue to 35% to 40%. But the resilience and diversification of our deposit platform that we've been investing in for -- ever since the IPO is really playing out here. I mean we're -- in the last rate rising cycle, we actually -- we lagged peers. We might have had one of the higher terminal deposit betas versus in the peer set. But when you look at where we're playing now, in 2023, our deposit beta for the year was below the median, which was great to see. And then we're right there in the pack in terms of delivering a strong deposit beta with our products and investments that we've made over the years. So feeling very good about how that will drive our profitability for years to come.

Great. We're running out of time, but one last question. Maybe your thoughts on the CCAR scenarios, Richard, obviously, it's new for you here versus where you were working before. Possibly both of you can give us some color here. And then just your thoughts quickly on when you think Basel III end game may finally be here and obviously, the impact of a bank like yours is far different than some of the money centers.

Yes, I'll start off. I mean, we were in the test last year, CCAR 2023 because of our acquisitions in the past. And so 2023 scenario was significantly more severe than 2022, as I recall. So we have gone through it, and we have kind of a sense for where the Fed models will place us with that more severe scenario. And when you look at the scenario in 2024, it's pretty similar to '23. And therefore, I mean I think you could expect some stability in our results coming out of CCAR, again, with puts and takes across and who knows, these are -- this is a black box in terms of the Fed model. But I think there's some stability there. I think possibly some banks that haven't yet -- that were in the '22 cycle, but not '23, will have a little bit of a convergence given the fact that they'll get reset to a more severe scenario. And from that standpoint, we feel that this is going to be just fine in terms of the outcome that we expect out of CCAR.

I agree. John, I agree. I mean, I think the way you look at the different win last year and this year, the scenario is very similar.

Yes. What are your guys' views on the exploratory part of it? I know they're not going to announce individual bank net, but what do you think about that?

Yes. I mean I think it will be fine. I mean I think that when we poke around and try to reverse model the exploratory scenarios. We end up with adequate capital across all of them. And there's -- I think in the main scenario, we're getting back down to something that's very low in terms of rates. So the exploratory scenarios are trying to poke at what would happen if rates a lot higher. And the way we model it, given our rate positioning being about neutral. And technically, our position -- we do have a net floating position that actually ends up with higher net interest income in a rising rate environment. That tends to get offset by deposit migration, but generally very well balanced, whether we end up with a higher rate scenario or a lower rate scenario. So we're feeling pretty good about that. You asked about Basel III, but I'm glad to give you the answer on that. On Basel III, I mean, we'll see where it plays out. But we're operating as if it's already kind of a final rule in terms of how we're managing the securities portfolio primarily. When it comes to RWA, we really aren't that impacted by the RWA aspects of it. And in particular, if the operational aspects of RWA get dropped, there's potentially a benefit in RWA side. So we'll see how it plays out, but we're operating as if it's already a rule and therefore, don't feel like it's going to be much of an impact to us at all if and when it comes into that.

Super. With that, please join me in a round of applause thanking Richard and John.