Citizens Financial Group Inc (CFG) — Q1 2018 Earnings Call Transcript

Thanks so much, Kevin, and good morning, everybody. We really appreciate you joining us today. We're going to start things off with prepared remarks from our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, who will review our first quarter results, and then we'll open up the call for questions. We're really happy to have in the room with us today, Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking. In addition to our release, we have a presentation and financial supplement available at investor.citizensbank.com. I need to remind you that our comments today will include forward-looking statements, which are absolutely subject to risks and uncertainties. We provide information about the factors that may cause our results to differ materially from expectations in our SEC filings, including the Form 8-K we filed today. We also need to remind you that we utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and our earnings release materials. And with that, I'll hand over to Bruce.

Okay. Thanks, Ellen. Good morning, everyone, and thanks for joining our call today. We're pleased to report that we're off to a good start to 2018. We continue to deliver strong top line growth with 5.6% year-on-year revenue growth. We're also managing expenses effectively, resulting in positive operating leverage of 2.1%. Our ROTCE improved to 11.7% as we chart our course toward our new medium-term targets of 13% to 15%. We achieved year-on-year average loan and deposit growth of 3% in the first quarter and linked quarter spot and average loan growth of around 1%. Based on our pipelines, we feel this will pick up as the year progresses. Similarly, based on strong Capital Markets pipelines and the benefit of seasonality, we expect to see good fee growth in the second quarter. We continue to execute well on our strategic initiatives, building out our customer coverage and product capabilities while making critical investments in technology, our digital platform, data capabilities, and customer experience initiatives. We're finding new ways to streamline our processes and organization to become more efficient and to self-fund these investments. Our projects, TOP and BSO, are delivering consistent results, and we're working hard on the development of TOP V. Stay tuned for our July call for more details. We're making progress in building excellence in our capabilities and gaining external recognition for our progress. For example, we were named the #1 bank in the U.S. for customer experience by Temkin, and we were ranked Best Bank by Global Finance magazine in the Northeast and Great Lakes regions. There's certainly more work to do, but we're poised for a strong 2018. We have a good plan and a skilled leadership team that's executing well across the board, supported by an engaged and motivated colleague base. So with that, let me turn it over to our CFO, John Woods, who will take you through the numbers in more detail and provide you with some color.

Thanks, Bruce, and good morning, everyone. Let's get started with our first quarter results. We generated net income to common shareholders of $381 million, diluted EPS of $0.78, and ROTCE of 11.7%. Last year's first quarter and fourth quarter reported results were impacted by notable items largely related to tax matters. So to make it easier to see underlying trends, let's focus on our underlying results that exclude these items. Year-on-year growth in Q1 was very strong as we grew net income to common shareholders by 31% and EPS by 37%. This reflects our focus on driving positive operating leverage, which came in above 2%, along with favorable credit costs and a lower tax rate due to tax reform. Strong net interest income and a continued focus on expense discipline helped deliver an efficiency ratio improvement of 125 basis points to 60.4%. We also see the impact of our disciplined risk management on our credit quality metrics as we continue to drive improvement in the mix of the portfolio overall. Provision expense came in at $78 million for the quarter, a little lower than expected despite an $8 million build in the reserve. Nonperforming loans remained relatively stable at 78 basis points of loans. We actively managed our capital base, returning $283 million of capital to shareholders through higher dividends and share repurchases. Tangible book value per share increased 5% year-over-year to $27.24 and our CET1 ratio was a robust 11.2%. Taking a deeper look into NII and NIM, we delivered attractive and disciplined balance sheet growth, driving a 1% linked-quarter increase in NII. We've benefited from the earlier-than-anticipated move in 1-month LIBOR this quarter and a relatively steeper yield curve overall for much of the quarter. Approximately 75% of our sensitivity is associated with the short end of the curve. Our linked quarter net interest margin increased 8 basis points, reflecting improving earning asset yields given higher rates, and improved mix, which drove a 16 basis point improvement. Year-over-year, net interest margin improved 20 basis points, reflecting a 42 basis point benefit from earning assets, partially offset by a 22 basis point impact from funding costs. Our margin performance continues to benefit from our balance sheet optimization efforts, driving about 1/3 of our year-over-year NIM improvement. We're well positioned to capitalize on the rising rate environment with our asset sensitivity relatively stable at 5%. Turning to fees, on an underlying basis, non-interest income decreased 4% linked quarter reflecting an expected seasonal decline in service charges, as well as a reduction in mortgage banking fees and trust and investment services fees, largely related to the impact of long-term rates on product demand. In mortgage, our originations were down about 19%, in line with overall industry headwinds due to rates and a shift away from refi volume. We're making investments to grow our MSR portfolio and shift production toward more conforming volume. In wealth, investments are driving improvement in the mix of our fee-based sales. Capital Markets fees declined modestly from fourth quarter and first quarter, as there was a market fall-off in Middle Markets-indicated transactions. As a partial offset, we saw a pickup in debt and equity Capital Markets activity benefiting underwriting fees. Our Capital Markets pipeline is robust heading into the second quarter, including several deals that were originally targeted for the first quarter. Overall, the pipelines have improved significantly since the start of the year. Moving to expenses, on an underlying basis, expenses were up 3% linked quarter reflecting seasonally higher salaries and employee benefits. Year-on-year, our expenses were up 3% on an underlying basis as salaries and benefits expense were higher due to annual merit increases and increased stock-based compensation costs. We are disciplined on the expense front as we identify opportunities to streamline operations and enhance capabilities to serve customers.

Let's move on and discuss the balance sheet. On Page 9, we continue to grow our balance sheet while expanding our NIM. Total average and spot loans were up 1% on a linked-quarter basis and 3% year-over-year, with core loan growth rates slightly higher. We grew the average core retail portfolio 5% year-over-year, with expansion in residential mortgages and higher risk-adjusted return categories like education. This growth was partially offset by planned reductions in auto portfolio due to high levels of payoffs in line with industry trends. On Page 10, looking at the funding side, we saw a 6.5 basis point sequential quarter increase in our cost of deposits, reflecting the impact of higher rates. Year-over-year, our cost of funds was up 25 basis points, reflecting deposit cost increases of 20 basis points. Our deposit betas remain in line with our overall expectations given where we are in the rate cycle. We've seen some increased competition for deposits, but for the most part, deposit costs have been well-behaved. We're continuing to invest in analytics and improve our targeting through digital and direct mail offerings on the consumer side. Next, let's discuss credit quality.

Overall credit quality remains strong, reflecting the mix shift towards high-quality, lower-risk retail loans and a relatively clean position in the commercial book. The nonperforming loan ratio improved slightly to 78 basis points of loans linked quarter, while improving 19 basis points year-over-year. Provision for credit losses of $78 million was $8 million above charge-offs. Despite this reserve build, the provision was down compared to the fourth quarter and year ago, reflecting improvement in overall credit quality. On Page 12, we maintain robust capital and liquidity positions. We ended the quarter with a CET1 ratio of 11.2%. This quarter we repurchased 3.9 million shares, returning $283 million to common shareholders, consistent with our strategy.

On Page 13, we are progressing against our strategic initiatives. We have highlighted some of our efficiencies achieved through TOP programs, delivering significant results that allow us to self-fund our capabilities and drive continuous improvement. For Q2, we expect average loan growth to come in at about 1.5% and NIM to be up modestly. We anticipate mid-single-digit noninterest income pickup from seasonally lower first quarter levels, and we aim to keep expenses stable with positive operating leverage. To sum up, we've delivered solid results in Q1, and our balance sheet remains robust across capital, liquidity, and credit positions. We're committed to continuous improvement and innovation, positioning ourselves well to become a top-performing bank. We're positive about our outlook for the second quarter and reiterate our broad full year 2018 guidance.

I was just wondering if you could talk a bit more about the fee revenues. We're seeing it in some other banks as well, but just some softness across a number of categories. You were pretty clear about Capital Markets pipeline being strong and bouncing nicely in Q2, but just some of the other categories were also a little bit soft, and I'm wondering what that says about the underlying activity among the customer base.

Sure. I would say probably the disappointments in Q1 were really in Capital Markets, where a number of transactions pushed from Q1 to Q2. We saw seasonal slowness at the start of the year, and although things seemed to pick up nicely in March, we didn’t get everything done. So that bodes well for a quite positive outlook in Q2 in Capital Markets. The mortgage business also faced general market softness with a shift away from refinancing due to rising rates. Most other lines were quite impacted by seasonality. We expect service charges and fees will rise in Q2 due to this seasonal benefit. So we anticipate better performance moving forward.

That's right, and as we approach the end of the quarter, our Capital Markets pipeline looks much better heading into the second quarter. We also mentioned some seasonal impacts. In the mortgage sector, although we had a down quarter, we are seeing improvement in our conforming mix that we expect will bode well going forward.

That's helpful. Also, when we look at the deposits, the noninterest-bearing demand deposits continue to grow, year-over-year, despite some seasonality. I'm wondering if you could talk about how your mix is different or whether you think it’s more granular why you're still able to grow free deposits in this higher rate environment?

We have been investing in this over the last couple of years. On the deposit side, our recent results reflect our deposit initiatives taking hold. We're seeing traction on the consumer side through our data investments and improved targeting. Our promotional approach has shifted to attract more stable deposits at competitive rates. We’re very pleased with this improvement, and these investments will continue.

I think the big thing has been the improvement in analytics and targeted offerings. We've also signaled for several quarters our focus on the Mass Affluent and Affluent customer base through our redesigned product suite. We're seeing positive traction from that.

Can you just talk about how you think about accelerating capital return, if we do get SIFI reform, and has your thinking changed at all over recent quarters?

We're more optimistic that we can move down our glide path a little faster overall. We’ve been measured in our approach to bringing capital down as a new public company. We targeted a glide path of 40 to 50 basis points this year. As you know, we previously stated that our aim was to reach a range of 10.7% to 10.9%. Our earnings have exceeded expectations, and with the new proposal for the stress capital buffer, we believe there will be more flexibility to provide additional capital returns throughout the year.

We've indicated that flexibility will come in '19 and into '20. We're supportive of the changes that the new framework proposed by the Fed has laid out. It's all very positive for us moving forward.

Regarding asset quality, are there areas of your portfolio that you're concerned about or watching more closely?

There's nothing in delinquencies or roll rates that gives us pause on the consumer side. On the commercial side, we have a net recovery position. We keep an eye on the casual dining segment but expect it to behave well overall. We're in a great position with our credit quality.

Yes, we see improvements in our 30- to 90-day delinquencies both quarter-over-quarter and year-over-year. Our credit metrics are strong, and we are well-positioned overall.

Can you provide insights into your relative cumulative betas for deposits across your retail, commercial, and wealth segments?

We see cumulative betas for commercial in the 70% to 75% range, while for consumer, it's closer to 35% to 40%. Overall, our cumulative beta stands around 60% through this tightening cycle.

We're optimistic about our financial outlook. Our strategy to optimize our offerings and maintain disciplined expense management will position us as a strong competitor even in a challenging environment.

Can you share guidance for net interest income for the full year? How do you see this evolving?

We're holding to our guidelines, expecting trends to support upper bounds in NII as we also expect loan growth. Overall, we don't plan to reforecast our full-year guidance but feel comfortable with what we projected earlier.

Given the opportunities, do you see acquisitions being a part of your future strategy?

We're primarily focused on enhancing our capabilities in areas like Capital Markets and consumer offerings. While we’re open to pursuing fintech partnerships, acquiring depositaries isn't currently on our agenda.

Thank you, everyone, for your participation. We truly appreciate your interest and support. We're off to a good start and maintain a positive outlook for 2018. Have a good day.