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

Good morning, everyone. Thank you for sitting in on the Citizens Financial Group fireside chat. As many of you know, Citizens has just over $217 billion in total assets. The company has 991 branches. And in the most recent period, it had a return on tangible common equity of about 11% and an ROA of about 75 basis points. And this was priced as of February 28, and you guys are trading at about 1.4x tangible. But in today's action, that's probably a little lower. So a better buying opportunity for folks. But to my immediate left is John Woods, who's the Vice Chair and Chief Financial Officer for Citizens Financial. John joined Citizens back in 2017. And prior to that, he was with MUFG out on the West Coast, which, as you know, owned Union Bank in California, which was subsequently sold to U.S. Bancorp. To his immediate left is Ted Swimmer, Head of Corporate Finance and Capital Markets. Ted has been with the bank since 2010. He headed up capital markets back then and has taken on more responsibility since that time. And prior to that time, Ted was down at Wachovia. And so with that, gentlemen, we have some questions that we'd like to ask, and we'll get some questions from the audience possibly a little later on. But maybe first, John, we were just talking briefly about this. Let's start with the environment. There's a lot of wildcards going on, a lot of crosscurrents with the new administration, what we heard last night with tariffs, the rate outlook. What are you hearing from your customers, both the consumers and the commercial customers? Are they on edge? Or what's the sense you're getting from them?

Yes, I'll start off, and Ted may jump in here a little bit. But yes, fascinating times. There's the competing narratives here where I think there is some expectation from management teams that the Trump administration would be pro-business and that regulations would be dialed back. And I think that we still believe that, that will be the case. And I think that's competing with the very near-term narrative of uncertainty. And broadly, that uncertainty encompasses the rate path and tariffs and where will growth go. So a little while ago, we were thinking, hey, maybe we're going to have some runaway inflation and the 10-year was close to 5. Now the 10-year is closer to 4, and we have -- now we have 3 or 4 cuts out there. So you've got these 2 competing forces broadly, and it's causing a bit of uncertainty. I think that management teams are digesting, I would say, is a good word to describe what they're doing, all of that uncertainty. And -- but I would say that the conditions for a rebound and a strong '25 remain. We've been below trend from a commercial activity perspective for a couple of years. And there's a significant amount of dry powder on the sidelines as a result. So a lot of capital around to be put to work. And we're seeing that in our pipelines. So conversations are still consistent with what we were saying in January, which is we really see activity building throughout the year, and that would be reflective of a very strong second half. I'll also add, from a tariff standpoint, that seems to be the topic of the day. We'll see how it plays out. And if they stay in place, there's a number of potential responses, right? We could have foreign manufacturers absorb some of the hit. We could have domestic manufacturers absorb some of the hit in margins or we could have it passed along to the consumer, right? It will probably be [ sum ] of all 3 occurring. But I'll hasten to add that our commercial customers have been through a lot over the last couple of years. And through the pandemic, they've really cleaned up their balance sheets, delevered. They've launched expense campaigns to preserve margin where possible. So I think that they've been hardened to some of these uncertainties and the resilience there, I think, is very good. So I would close it out on the commercial side, still consistent with picking up economic activity and -- as we had indicated, and we don't see any significant areas of concern on the commercial side. In consumer, I think it's -- we're hearing a lot of the soft data, right? I mean, the consumer sentiment and then how much of that is going to translate into the hard metrics like spending and we'll see where jobs goes this Friday. But I mean what we're seeing on the consumer side is a lot of stability for us. I'd say that there's probably building pressure on the lower end consumer, but we're a high prime lender and most of our customers on the consumer side are homeowners as well. And so those mortgage rates have created a fair -- a nice protective barrier against a lot of the price rises that renters may have felt. So we have predominantly high prime book with the majority of our customers as homeowners, and that really is translating to a level of stability on the consumer side. So those are some thoughts there.

Yes. No. And just speaking on the consumer side, you guys obviously have residential mortgage production. And if this 10-year continues to come down, to your point a moment ago, none of us were thinking refinancing business was going to come back with the 10-year going to 5. And now if it breaks down under 4 and not to say we'll go there. What -- are you guys hearing anything yet from your folks on the front lines about refinancing activity? Or is it too early for that?

Yes. I'd say it's too early to tell. I mean, it takes a little while for that. You need a sustained decline in the mortgage rate typically for that to translate and there's lead times, as you know, for this, but for that to translate. And we're sitting in typically a seasonally down quarter on mortgage in any event. But if we have a sustained lower 10-year and if spreads cooperate as well, which they need to, I think, there's still capacity in the system. There's a lot of things that are going to have to happen. We're going to have to see the mortgage rate come down in sympathy with the 10-year on a sustained basis into the typical spring buying season. But the other side of it, we're going to need supply, right? And so that's been an issue as well. So there's a number of things that will have to contribute before we see that really taking off. But without a doubt, this is net positive to see the 10-year closer to 4 than otherwise.

What we are seeing, Gerard, is we are seeing a number of our corporate issuers go out to the market and refinance, a lot of them, and they're looking for a rate of under 4.25% on the 10-year. And now if that started to happen, we've seen an uptick of conversations with people going into the market, refinance their deals. We're seeing a lift of securitization deals come into the market because people are trying to take advantage of this lower rate that has been a positive in the last couple of weeks with the 10-year dropping.

Got it. Very good. In fact, maybe you can talk to when -- since Citizens has been public back in 2014, if I recall, the capital markets business has been building throughout that period. Obviously, you have been part of that growth. Can you share with us what differentiates Citizens Capital Markets today versus maybe when you first started, but also against your competitors today?

Sure. When we started, we always had a very good customer base. We had a very local middle market customer base. We had a decent mid-corporate customer base. But what we didn't have was a lot of products to sell these companies when they did transactions, when they did something transitional from an ownership perspective. We were kind of limited to basically lending with them, maybe putting on an interest rate swap or doing something of that nature. What we've done over the last 10 years, some of it organically, some of it inorganically is grow into a -- be able to fully transact with our customers over a number of different bases whether that be from an M&A perspective, we purchased 4 M&A specialty boutiques over the last couple of years. Over the last 7 years, we bought JMP, which is, obviously gets us into the equity business. And then we built out a number of industry verticals where we feel like we can penetrate with our customers and have the right to compete on every transaction they do. That has translated into us being depending on how you measure either 1 or 2 in the middle market league tables for sponsor-driven transactions. It's resulted in us being a top 10 middle-market M&A firm. And we continue to find ways to deploy our balance sheet to hopefully get more fees from the customer. I think we are an early adopter of the private capital -- into the private capital industry. When we started in 2013, 2014, we were trying to figure out how to increase the amount of customers we had. The private capital business was really just taking off at that point. And we embraced it. We did a lot on the subscription line business. We did a lot of lending to the direct lenders. And then of course, we build out our M&A capabilities and things of that nature. All that together really helped us embrace this and really run with the same. As the private capital universe has grown, so have we and it's really helped our capital markets and advisory business take off over the last couple of years.

Speaking on the private capital, the PE business as it's often referred to, sponsors obviously have portfolio companies, as we all know. And many of us are anticipating that there's going to be an opportunity for them to monetize those investments that they've had in those portfolios. But it's been kind of -- they've gotten off to a slow start, but what's holding it back do you think? Well, what do we need to see the really -- see that activity maybe pick up?

So I think things are somewhat skewed. Last year happened to be a record year for us on the M&A side. So I think the issue we have is with all of these -- with PE growing, we all believe that PE is going to -- that there should be more and more M&A. And I think we're a little bit skewed in that, last year was a decent year. It's just so much more could happen given how many more companies are now in private capital's hands. I think last year -- I think for the first time last year, we had financing markets that cooperated with the M&A environment. So in 2022, 2023, it was very, very hard for companies to borrow money at rates that they saw as being conducive to M&A. That changed last year. Supply and demand definitely went in the favor of the issuer versus the borrower. But we still had a mismatch of where companies have been bought in the 2020, 2021 generation of companies versus where they could sell now. I think we are starting to approach a point where that gap had narrowed. Now M&A does not do well in periods of high uncertainty. And I think right now, we're experiencing a position -- a period of slightly high uncertainty. I think we all expect that to even itself out over the foreseeable future and the M&A market really is lined up to be very aggressive, I think, in the second half of this year. Our pipelines are full. I mean we never had a bigger pipeline of M&A transactions right now. And they are really good transactions. So the good companies are now looking for an opportunity to sell. The private equity firms who have owned them are reaching their maturity point -- not the maturity point, but how long they generally want to hold the customer. And so they're looking for a market, and we have those engagements. They really started to pick up after the election. So when you have an M&A process, it generally takes from the start to the end somewhere between 6 and 9 months to transact, which is why we really think assuming that the macro environment settles down a little bit that the second half of the year should be a very strong year for M&A.

Got it. And sticking with private capital for a moment. Some of your competitors have done partnerships or joint ventures with private capital. What's your thoughts about that? And then also, how competitive is that environment where you do get into with the partnerships with the PE firms?

So we've -- I will say this with all candor. I think I get 3 calls a week from some private capital firm wanting to form a partnership. We talk to all the private capital firms on a regular basis, and we really struggle to want to get ourselves exclusive with one partner. We use private capital -- I mean private capital and regulated banks like ourselves are really frenemies when it comes to doing transactions. We need them. They need us, but we compete against each other. We talk to -- on a given day, we will talk to a capital provider on 6 or 7 different topics, whether it's lending to their direct lending fund, whether it's providing subscription line finance to them, whether it's selling our primary flow from the bank or the bond side to them, whether it's doing a swap or FX with one of their portfolio companies, whether it's our private banking customers talking about doing a partnership loan to them. So we're always in conversations with them. And the relationship is pretty symbiotic. The one place we do compete is on new leveraged originations. I think linking ourselves to one -- and we may ultimately choose to do it at some point if we see something beneficial. But we have contact and conversations with so many different financial -- with so many private capital providers, it's hard for us to go with just one of them. So we feel like the strategy has done us well. We continue to move up the lead tables. We continue to grow with -- have more product to show them that to limit ourselves to one has not been what we thought a great opportunity for us.

Coming back to the capital markets franchise in its entirety, not just private equity, what are the big opportunities that you see for Citizens over the next 3 to 5 years and how you can grow this business out?

So I think we're still in the second or third inning of what we're doing. We bought JMP in November of 2021. We bought DH Capital in 2022. DH Capital is the leading data center and infrastructure firm and M&A firm, we think, in the country. And then the markets were not incredibly cooperative for us for a period of time. And yet last year, we still had record years in our DCM and our M&A business. I think just having a good market in front of us for 2 to 3 years, we should see some very nice pickup in revenues. And then fulfilling the integration, I mean, we were -- a number of different firms coming together to think of ourselves as one Citizens and being able to cross-sell everything we have at once. And that now includes a private bank and have really built out treasury solution set that we've built over the last couple of years, all of that coming together. And then with our expansion in California and Florida and the expansion, the more customers we have at our fingertips now that we can do transactional and relationship business with. We think we're just beginning to build all of that out. And then finally, centralizing ourselves around 8 industry verticals where we have -- we can play from the equity side all the way down to the debt side, all the way down to the treasury solutions side, provide -- creating products for them in those industries, in those subsectors, I think, gives us a lot of upside in the near future.

Got it. Very good. John, coming back to you. Citizens has some real good ROTCE targets that you guys have laid out, 16% to 18%, which is very attractive for investors, of course. Can you share with us the path you're going to use to get there? And then how confident are you reaching it. But also, what are the risks that you have to keep an eye on as well?

Yes. I mean we have a very clear path. And it's one of the most exciting things I think about our story as you mentioned upfront, we're sitting around 11% ROTCE in the fourth quarter. And when you think about getting to 16% to 18%, the first contributor to that is really what's going on in the balance sheet. And that the balance sheet drivers are going to take us 400 to 500 basis points along this journey to 16% to 18%. And within that, that's primarily time-based. So as we have our terminated swaps running off, our noncore -- the negative carry on both of those terminated and noncore running off. That's the overwhelming majority of the balance sheet turnover that gets us to the low end of that 16% to 18%. It's basically time-based mechanical turnover. And so we're excited about that. To get into the range itself, it's the distinctive portfolio of strategic initiatives that we've launched across all of our businesses, and there's 200 to 300 basis points on top of that 400 to 500, that gets you into that range. And within that, we've -- that's where you find our private bank launch, which is going extremely well. We've got New York Metro, which is really building in terms of its momentum. We've got investments, as you heard from Ted, in the commercial business, building out California and Florida in terms of geographic expansion. And so the -- it's really right in front of us organically to see that transition to the 16% to 18%. I should hasten to add that the credit costs are expected to normalize from where we are now to the low to mid-30s, and that's also a contributor. So everything seems to be heading in that direction. It's basically organic execution. There are a range of economic environments that are consistent with the 16% to 18%. And so it's right in front of us. It's a clear path and even a wide range of interest rates would still be consistent with the 16% to 18%. But I mean, we're expecting generally supportive economic activity with GDP being in the -- around the 2% level from a real standpoint, and having an upper sloping yield curve with the Fed landing somewhere around 3.50%, which is what we published in January, which is frankly where they are right now in that range of 3.50% to 3.75%. So all of those things are highly consistent with a pretty direct path in 16% to 18%.

Got it. And we were saying to investors that it's been 20 years since we've had the front end of the curve around 3.75%, 4% with a positive slope. Now we don't have it literally today, but we did. How powerful I mean that -- for net interest income for a lender, that kind of condition is pretty good.

Yes, it is. It's important. We're maturity transformers as banks do. We're intermediary in that regard. But I mean I don't think that is an absolute necessity for us to get to the 16% to 18%. I think as I mentioned, most of this transition is driven by the time-based runoff of terminated swaps and noncore, which gets us to the low end. And then there's execution that drives fees and drives activity that isn't highly dependent upon we must have a high -- an upward sloping yield curve. I mean that's the expectation. That's what we think would be supportive. But I think we get to 16% to 18%, even if it's a little flatter.

Got it. How -- you've laid out a very strong organic way of getting there. How does M&A play a role in reaching there? Is it part of it or it doesn't really matter?

Yes. Well, I mean, maybe I'll zoom out and talk about capital priorities, right? I think it fits in there and the top of that stack, as always, is the dividend, right? So that's basically where we are on that and looking for opportunities to grow that over time. So that's number one. And then right behind that is all the organic activities, and that's our focus, overwhelmingly. We are -- we have our work cut out for us with a very distinct portfolio of strategic initiatives, as I mentioned, across all 3 legs of our stool. The private bank which has been going extremely well, what we believe to be one of the best positioned commercial bank and a fully transformed consumer bank with low-cost deposits. So we're excited about all of that. I mean, as a sort of subset of organic, I think bolt-on M&A would be something that we would look to if it's capability enhancing, predominantly fee-based sort of bolt-ons. You heard from Ted regarding some of the things we've done in capital markets, but what we're doing in the wealth space and we would add payments to some of the categories of bolt-ons that we would find interesting. But I sort of think of that as supplementing organic activities. And kind of bank M&A is just not a priority at this point, and it's not a necessity. We've got an organic path here that's very exciting and very distinctive.

You touched on the capital in your answer. Can you guys give us your view of what's going on in Washington from the regulatory standpoint? How it appears things are changing, particularly with the stress test, I mean, your stress capital buffer appears to be -- it is higher than many of your peers. What are your thoughts about Basel III endgame, possibly being a lot softer or lighter than what was originally proposed in '23? What do you...

Yes, it feels like from a time standpoint, the stuff is likely to get pushed out. We still need a Vice Chair of supervision, likely gets pushed out to late '25 at the earliest, early '26 from a timing standpoint. And then even when it does come through, I think, the expectation is that we'll have an RWA neutral impact for a category 4 firm like ours almost certainly no real RWA impact. But our expectation, we are operating as if the AOCI deduction from capital is going to be something that we'll have to comply with. But I think that's already happened, right? We've been publishing it and I think the industry has been publishing it. I think that's true of a lot of the regulations, whether it's capital or liquidity. A lot of it's been pushed out. Upfront, I mentioned, we have a pro-business, lighter touch on regulation environment that I think is still intact. And we really don't see any real headwinds from that standpoint on our business. You mentioned SCB. The SCB for us is not frictional. I mean, at 12/31, we had a 10.8% CET1. And so SCB doesn't really drive the outcome. That said, we think it's unnecessarily and frankly, incorrectly high. But -- and I think the Fed is beginning to acknowledge that they've got some work to do primarily on their PPNR model. And it seems like there could be some work on that in '25. We're next up in June of '26 to participate. And it's -- there's a possibility that we may see some additional transparency and some fixes that may get put in place over the next year, which I think will be very positive to reducing the volatility and some of the head scratching that happens when some of the results come out, and it's hard to know what was really driving it based on the scenario that they published. So we're hopeful and optimistic that, that will continue to really not be a huge issue for us.

Sure. You guys have talked about your medium-term net interest margin being between 3.25% and 3.5%. Can you share with us what gets you there? I assume some of the terminated swaps will be part of that, of course. And then if the Fed just stays pat and doesn't move from here, how does that influence your thinking on that margin?

Sure. Yes. I mean so this margin is connected to the ROTCE story, where most of our progression to 16% and 18% is actually coming from the margin side of the house. So we were at 2.87% in the fourth quarter. We have 38 basis points of time-based tailwinds, which just come in mechanically over the next -- over the medium term and that's from noncore and terminated swaps. So that gets you -- that math gets you to 3.25% which is at the low end of our range. The range itself was constructed predominantly based on where the Fed may end up. And so 3% Fed is consistent with a 3.25% NIM for us. So that anchors the low end. 4% Fed is consistent with a 3.50% NIM for us. And that's the biggest drivers where the Fed comes out in the short end. The long end matters. It's not as big of a driver, but really, the short end is where that range was constructed. And so out the window if the Fed is ultimately going to get to 3.50% or 3.75% that would be middle of the range. So the other drivers, I'd say the other things that will contribute the deposit betas, we are expecting a low to mid-50s deposit beta. So if that's a little higher, we'll be more upper end of the range or little lower end of the range and balance sheet mix, which has stabilized and to slightly improving over time. Your final question about what happens if the Fed doesn't move at all? That's a net positive for us. We would be, all else equal, above the upper end of the range with -- we're asset sensitive out the window, we're asset sensitive here in the fourth quarter and in the first quarter with some growing asset sensitivity over time with opportunities to balance that. I mean, I think we have a nice balance of a road map here where in order to see this happening along the way, we indicated that in the fourth quarter of '25, we'll get to 3.05% to 3.10%. And that's also intact, and that's our expectation even with the out the window rates that you're seeing is that we expect to achieve the 3.05% to 3.10% by the end of '25, which is also important to seeing our net interest income rise. And wrapping it all together, 2025 is going to be, for us, a very strong operating leverage year of 150 basis points, strong revenues coming from fees and net interest income. But I think what we're demonstrating here is delivery along the way to a pretty exciting medium-term outcome.

Bringing it to near term with the quarter, I know we're only 2 months beyond -- going into the third month of the first quarter. How is it shaping up for you guys relative to your expectations? Any update you'd like to give us?

Yes. So maybe I'll start with the balance sheet. Things playing out as expected. We're seeing some early loan growth in C&I could be inventory building. We're getting in front of tariffs and things like that, but that was to be expected, and we're seeing some growth in the private bank. That is -- so core loan growth. That's being offset by noncore runoff that, again, exactly as expected in terms of the quarter playing out on the loan side. Deposits, this is typically a seasonally down quarter for deposits that also playing out just as we expected. January, you typically see the dip, in February you see the recovery. It's exactly what we've seen. So deposit recoveries in February, and the outlook for deposits is right where we were thinking it would be for the end of the quarter. We flip over to the P&L. So P&L trends playing out broadly as expected. So that's both with respect to the components of PPNR as well as credit, where we said that credit would likely see a moderate decline and charge-offs. And we're seeing that play out with stability in consumer and seeing commercial coming down in the quarter. So feeling right on schedule in 2025 for a nice delivery, as I mentioned earlier.

Yes. Ted, coming back to M&A. Do you think M&A begets M&A, meaning if we start to see some high-profile deals in the next 3 months, is that, in your experience, bring others to the table saying, you know what, we better get moving.

And we have started to see some in the first quarter. Some -- we saw American Axle make an acquisition. We saw Columbus McKinnon just make an acquisition. There have been some activity. It has not been to the pace that we thought it would necessarily be. But yes, to your direct question, there is no doubt in my mind that when we start seeing some of these transactions get complete, it will accelerate. And I think it will start opening it up for some of the -- I think we're seeing the A companies have transactions right now. I think we'll start seeing some of the A- and B+ companies find a buyer or 2 because people are going to be afraid to miss out on the wave. It just hasn't happened quite yet.

Got it. And I see we're in the red zone, which means we're finished with time. Please join me in a round of applause thanking the gentleman for coming to the conference.