Citizens Financial Group, Inc. (CFG) Q3 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the Investors Bancorp Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. We’ll begin this morning’s call with the company’s standard forward-looking statement disclosure. On this call, representatives of Investors Bancorp, Inc. may make some forward-looking statements with respect to its financial position, results of operations and business. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond Investors Bancorp’s control, are difficult to predict and which can cause actual results to differ materially from those expressed or forecast in these forward-looking statements. In last night’s press release, the company included its safe harbor disclosure and refers you to that statement. That document is incorporated into this presentation. For a more complete discussion of the certain risks and uncertainties affecting Investors Bancorp, please see the sections entitled Risk Factors, Management Discussion and Analysis of Financial Conditions and Result of Operations set forth in Investors Bancorp’s filings with the SEC. Please note, this event is being recorded. And now I’d like to turn the call over to Kevin Cummings, Chairman and CEO of Investors Bancorp. Please go ahead.

Thanks, Gary, and good morning and welcome to the Investors Bancorp third quarter earnings conference call. Last night, the company reported in its press release, net income of $52 million or $0.20 per diluted share for the quarter ended September 30, 2019. This was versus $46.6 million or $0.18 per diluted share for the three months ended June 30, 2019, and $54 million or $0.19 per share for the three months ended September 30, 2018. For the nine months ended September 30, 2019, net income totaled $146.8 million or $0.55 per share compared to $169 million or $0.59 per diluted share for the nine months ended September 30, 2018. During the third quarter of 2019, we had $1.3 million of compensation expenses related to employee severance as we continue to redefine responsibilities in our branch system, and a $2 million charge related to the settlement of our shareholder litigation. Also included in that litigation settlement was a negative adjustment to our deferred tax assets for $1.3 million, which flowed through our tax provision for the quarter. As a result of these items, core earnings were $55.6 million or $0.21 per diluted share. Our net interest margin improved for the quarter by six basis points, from 2.47% to 2.53%, which reflects the impact of the July Fed cuts. During the quarter, we also closed down an interest rate swap put on the books of August of 2018 for $1 billion which gave us some insurance at that time for future anticipated interest rate increases. With the two rate cuts already in place and a third anticipated in the near future or in the fourth quarter, that decision will have a positive impact on our margin as we move into the fourth quarter of this year. Last year on this call for the third quarter, we indicated that our net interest margin forecast was a headwind. Today, with the September rate cut already in place and the potential for another this year, I would say that, that interest forecast currently is a tailwind for the bank. Either way, we will continue to leverage our capital and continue to diversify our loan portfolio. During the quarter, we grew C&I loans and construction loans $135 million while CRE and multifamily decreased approximately $287 million. With the yield curve flat to inverted during the period, we’ve decided to slow down our multifamily and CRE lending and focus on higher-yielding business lending. This lending drives a 50 basis points to 75 basis point improvement in yield and is more profitable at the margin. With all the noise related to New York multifamily regulation and the latter stages of the credit cycle, we believe that this is a good strategy to reduce our growth in CRE and multifamily, especially after the robust growth that we’ve experienced in the last five years. With respect to the recent changes in the New York City rental regulations, there appears to be a market reduction in market activity for New York multifamily relative to New Jersey and Pennsylvania. In our portfolio, refinances of non-New York properties have outpaced New York. It is likely that the benefits associated with the refinance in New York, especially our cash out, were greatly reduced by the market conditions relating to values and potential future revenues for New York multifamily. Also impacting this trend during the year was the decline in treasury rates during 2019, which allowed for the reset rates to be lower, which may have decreased the need to refinance. Despite this reduction in market activity though, there appears to be an active market for New York multifamily loans. The bank will continue to monitor the situation and we’ll see some reduction in portfolio balances mainly due to our higher loan pricing and more conservative loan underwriting limiting loan proceeds. As we look out over the next 12 months, there does not appear to be any significant changes to the either economic or regulatory in the forecast that could reverse this trend in the short term. It is likely that refinancing transaction volume for New York multifamily will remain lower than in the past and will have – and specially in the – lower in the past compared to the last five years. Our asset quality improved for the quarter with the payoffs in July of a $30 million multifamily relationship in the Pennsylvania market. Our reserve to total loans remain flat at 1.05%, which compares favorably to our peers especially when you take into account the $14 billion of our portfolio where 64% is in the multifamily or residential portfolios, which historically have a lower credit loss history and other types of lending. During the quarter, we had a net charge-offs of $1.5 million versus a recovery of $221,000 in the second quarter. These charge-offs are principally due to one loan with a charge-off of $1.3 million on a multifamily property in New York City and Brooklyn, which is going through a transition to a condominium. We took a conservative view on this property by basing the valuation on net operating income as a rental and discounting net value by 25%. We believe we are in good position at its current value of $15 million at September 30 of this year. With respect to the remaining nonaccruals and other delinquencies 60- to 90-day category in commercial lending, there are a number of small credits with no individual loan greater than $3.3 million. With a coverage ratio of nonaccrual loans at 248%, we believe we are well-positioned at this point in the economic cycle. On the deposit side, we continue to see fierce competition for deposits in the New York/New Jersey market. Our cost of deposit decreased one basis point to 1.77% for the quarter versus last quarter. But the trend is improving as the cost of deposits were 1.73% for the month of September. During the quarter, we reorganized our retail branch teams by eliminating the assistant branch manager position, thereby eliminating 140 positions. We moved some of these positions to administrative functions at three regional centers, approximately 33 employees, to Brooklyn and Iselin and Robbinsville operating centers. In addition, we are creating more opportunities for our assistant managers by moving 28 of them to branch manager positions and another 40 to universal bankers. This change – this net change in staff was a reduction of headcount of 40 people. We continue to expand our business banking initiative and now have teams of 27 bankers with three more to hire, one in New York and two in South Jersey. Our North Jersey team is fully staffed, and we are moving into the markets with great enthusiasm and speed. We have stronger momentum with our advisory boards and have increased outreach to centers of influence in both New York City and Long Island. Yesterday, I spent the day on Long Island with the Gold Coast team, attending their board meetings. The board, along with their advisory board, will make up our new Long Island advisory team and is a very strong group who are entrepreneurial and have a very robust knowledge of the Long Island market. We are very excited to be working with this group and look forward to our meet-and-greet event with their top customers scheduled for mid-November. We expect to close on this transaction early in the first quarter of next year. During the quarter, the retail team entered into agreement with OnDeck, a fintech company, as part of a small business digital lending platform which will expand our small business lending and improve the customer service for loans under $1 million. We have an agreement with reworks where our New York City relationship managers have access to core loan businesses in that space also. We continue to expand our sales activities with lawyers and CPAs in New York City and Long Island, and have a coordinated effort engaging with the communities to expand our overall brand – to expand our brand across new target customers in the Lakewood deal and Brooklyn corridor. Our teams are working hard, and our sales activities are up during the previous year. With the implementation of Salesforce CRM system, we are managing this process diligently and adding resources to improve results. This is a critical part of our plan, and we need to execute and invest in our technology and the sales training of our staff, while being diligent to control our expenses. With some help from the Fed, with respect to rates, and sound cost control, we believe we are in a much better position for 2020 than last quarter. And with that good news, I’d like to pass the call over to Sean Burke, who will give some further commentary on operating results.

Thank you, Kevin. Net interest margin was 2.53%, an increase of six basis points from the prior quarter. Higher asset yields, higher prepayment fees and stable deposit costs drove the improvement. The provision for loan losses was negative $2.5 million for the quarter and provision was impacted by improved credit quality metrics, including the level of nonaccrual loans, coupled with the decline in our loan portfolio balances. Our allowance remains robust and our credit and allowance ratios remain amongst the strongest in our peer group. Our allowance to nonaccrual loans coverage ratio was 248%, and our allowance as a percent of loans was 1.05% at September 30. Noninterest income totaled $14.8 million for the quarter, an increase of $2.1 million from the prior quarter on a core basis. The increase was attributable primarily to the success of our customer swap program. Noninterest expenses totaled $108.7 million, included in the expense total for the quarter was $3.3 million of compensation expenses related to employee severance and our shareholder litigation settlement. In addition, professional fees were elevated by approximately $2 million due to enhancements made to our commercial treasury management and online banking products as well as cost to improve our risk management process efficiency. Absent these items, noninterest expenses were relatively consistent quarter-over-quarter. Our effective tax rate was 28.8%, fairly consistent with the prior quarter. Now I’d like to turn it back over to Kevin for any concluding remarks.

Good. Thanks, Sean. I have been out on the road recently with shareholders and potential in California and Boston. It is clear to us that we need to continue our transition through a commercial bank and enhance our transition from a trip to a full service bank. We need to work smarter and more efficiently, and I emphasize more efficiently, to maintain our strong risk and credit culture while improving our operating matrices. There is a strong focus here at the bank on our culture and investors that is focused on driving shareholder value. We certainly are not satisfied with our results, but are dedicated to making the changes, and change is difficult sometimes, but necessary to improve our returns with the goal of a 10% return on equity by the end of 2021. We have a plan and we are a different bank that wants to make a difference with its employees, our customers and the communities that we serve. And if we continue to serve these groups, our shareholders and owners, you, will be rewarded. There is strong momentum going into the fourth quarter in 2020. It’s a different feel at the price, especially after being out of the BSA order, but we need to execute on our plans, execute on our strategy with both the retail and commercial customers. We feel pretty good about the quarter, and I think we are moving forward with tremendous opportunity in the marketplace for a bank our size. We thank you for your support. And now I’d like to turn the call over to for some questions. Thank you very much.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mark Fitzgibbon with Sandler O’Neill + Partners. Please go ahead.

Hey guys, good morning.

Good morning, Mark.

Sean, I’m wondering, with all the cost associated with those projects you did this quarter, treasury management, online banking and risk, will those costs all be out in the fourth quarter? And should we assume an operating expense run rate of around $120 million?

We expect it to return to a more normalized level, Mark. So I would play guide around the $105 million area is more appropriate, plus or minus $1 million.

Okay. And then secondly, I wondered if you could share with us the size of the C&I pipeline and maybe what the average rate on that is.

Yes. Mark. It’s Domenick. The C&I pipeline is about $900 million and has an average yield of about 480.

Okay. And then are we likely to see more negative provisions in coming quarters? Or we’re getting to the end of that, would you say?

It really does depend on asset quality and loan growth. And this quarter, we benefited from the fact that loan balances were down, as Kevin alluded to, the strategy about allowing lower-yielding multifamily, commercial real estate and residential loans running off and associated high cost funding that goes along with that. So as that trended down, so did our allowance.

Okay.

And then Mark, I’d just like to add, like I mentioned, the pipeline, the 60 to 90 pipeline; it doesn't seem like any major loans around on the horizon in that time. Like I said, there's no loan margin in $3.3 million.

Okay. And then if I'm reading the tea leaves properly, it looks like your margin's going to be up significantly in the fourth quarter. Can you help us get a sense of how much that is and how future rate cuts will impact the margin in 2020?

Sure. There are some moving pieces there, but regardless of the Fed cuts in October, we expect margin will trend higher in the fourth quarter, Mark, driven by lower deposit costs and our emphasis on higher-yielding commercial loans. We forecast the margin to expand around five basis points in the fourth quarter.

And that’s exclusive of prepayment penalties?

I think that’s regardless of what happens to prepayment penalties. It is a wild card, but the guidance that I gave, I think we're being relatively conservative when it comes to prepayment penalty.

Mark, just a point to add to what Sean's comments were. Approximately 25% of our deposits are tied to the Fed fund's index. So, the fourth quarter will result in a full quarter of benefit, if you will, for the two rate cuts that have occurred in July and in September.

Thank you.

Mark, just a clarification point. I think you were asking our core margin. So the guidance I was giving is a core margin lift to primarily, as Domenick and Kevin described, improvements related to deposit costs or a trend downward in deposit costs and also our continued remix of the balance sheet to higher-yielding commercial loans.

Thank you.

The next question is from Laurie Hunsicker with Compass Point. Please go ahead.

Yes. Hi, good morning. Really like to see your margin expansion. I was wondering if you could help us, do you have a margin for the month of September just so that we get a snapshot look at where you currently are?

We do not, Laurie.

Okay.

We don’t have that in front of us. And I think the point we were trying to make that Kevin was alluding to is that this quarter, we benefited more from prepayment fees. We saw deposit cost inflect. We're slightly down. And we expect to see deposit cost trend even lower going into the fourth quarter.

Sure. And just to close the lid on what Mark was asking. So your core margin extra prepays was 245. So we should think about that in the 250 range with everything sort of adjusted for the fourth quarter. Is that correct?

it sounds about right, Laurie.

Okay. And then can you just help us in terms of your deposit, because we've seen those come down nicely, particularly savings. What sort of cuts are you making in various categories? What's on the docket? How should we think about that?

Laurie, I think the primary cut were in our online accounts. We had approximately $350 million there at a rate of $250 million. Those are down to $190 million. We've lowered all of our CD rates. And as I said, we have – a significant portion of this deposit were tied to Fed funds, which is benefiting the cost of funds also.

Okay, great. And then can you just give us an update on your muni deposits, where those balances are and what that cost is running?

It’s about $4 billion and cost was running, as of September 30, at just under 2%.

Okay, Great. And then just a quick line item on the income statement. Sean, it looked like the BOLI income was a little outsized. So, is there something nonrecurring in that?

A little bit, there was a small debt benefit that we picked up in the quarter of I think…

Around, what, 300 or something?

Maybe, 100,000 or 200,000, but it sounds about right.

Okay, great. And then just generally, Kevin, I wondered if you could comment on your view of M&A as we look forward in this post-CECL world, how you're approaching it and what your thoughts are, what changes. Thank you so much.

We’re certainly focused on the Gold Coast transaction. We filed the S-4 this week. And I think we continue to look at situations, but we've continued to be mindful of where our stock is trading at and the opportunities that allows us to execute on it. I think there's a lot of discussion and activity in the marketplace. We have opportunities to look at a lot of things, but we're going to be very prudent in our approach and mindful of tangible book value dilution. I don't think anything has changed at the organization, but I think it's – we're pretty consistent on that message, and we'll continue to execute on the Gold Coast deal and – because of the opportunities that, that provides us.

Great. Thanks for taking my questions.

The next question comes from Steven Duong with RBC Capital Markets. Please go ahead. Mr. Duong, your line is open or not hearing perhaps you muted on yours.

So, I’m just jumping on a little late, I apologize if my questions have already been asked. But just leaving prepayment income aside, how should loan yield hold up in the fourth quarter under an October rate cut scenario?

They should hold up well, Steve. I'm looking at the average loan yield that – for C&I and CRE, and it's north of 4.25%. So, 4.25% is where we are on multifamily and CRE, and about 4.75% on multifamily – I'm sorry, on C&I.

Great. Appreciate the color on that, just on your FHLB borrowings, do you have – what's sort of the re-pricing opportunity in 2020 and the cost that we're looking at?

Steve, there is an opportunity for us to re-price those at lower levels. I'd say the bigger opportunity that I'd highlight remains with respect to our broker deposits and our CD book. There's significant savings there as those re-price. The average life of the brokered CD book and our retail CDs is inside of a year and probably closer to six months on average, and we're going to see a tremendous amount of re-pricing, on average, what we see re-pricing, is around that – currently around the 230 area, and we believe that it will re-price down to around the 180 area.

That’s very nice to hear. Yes. So then basically, the borrowings would just be an additional potential tailwind on top of that. And then just moving on to your expenses. Are you guys pretty much done with the consulting type of professional fees? Or is there still more to come?

Yes. The consulting fees are done for the year. We think we were pretty specific on what we use the money for, and we've – those expenses were one-time. We will see some additional expense reductions in the fourth quarter. And we had a change in employee account. We've reduced headcount. And that will happen – that will be reflected in the fourth quarter.

Got it. And somewhere, your advertising promotional expense, is this essentially a good run rate to end the year?

No. It’s elevated this quarter. So, Steve, we estimate that approximately $2 million of expense of advertising and professional fees will be taken out.

Got it, got it. Yes, I apologize for that, I meant to say X those. And then just lastly, your share repurchase opportunity, have you guys sized up what you're looking at for 2020?

Not absent the Gold Coast deal. So what I'd say is we're expecting the Gold Coast deal to close in the first quarter, and we have communicated our desire to repurchase the stock equal to the stock that we're issuing in connection with the transaction. So outside of that, what I would say is we do remain committed to buying back our stock especially at these levels, and we'll continue to buy back at these levels. And we'll have more to report in terms of guidance on the fourth quarter call.

All right. I appreciate the color, guys. Thanks, again.

The next question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.

This is actually Timur Braziler filling in for Jared. Appreciate all the color on New York multifamily. I'm just wondering, as we've been in this environment now for a couple of months, are the thoughts still that this is mainly going to be a volume-type impact? Or has there been any change in thoughts around the potential for credit risk?

Tim, I'm not sure of your question. Are you asking if we're going to continue to see our multifamily portfolio decline?

Just in the broader environment, is it still just a risk of volume going lower in this environment? Or has the environment shifted such that there's credit at risk as well?

I think you're always going to be – this is Kevin, I think you're always going to be looking at the credit, and it's always going to be an issue. But there are other factors that impact that, is rising rates, the reset value. Right now, it's been benign, because treasury rates went down, people could reset and not have to go out and get an appraisal. So we really haven't seen – we haven't done – we've done very little refi in the New York market over the course of this past year. So because of the interest rates, they just reset and they don't go out and get an appraisal in that type of situation. If you look at where we are today, I think a big issue in the CRE space is property taxes. I mean, if that impacts your net cash flow, that certainly will be a credit event if property taxes go up. So with the facts and circumstances that we know today and the way things are – our borrowers are reacting to the change in regulation, it's to be seen. And we don't think there's a credit event on the horizon at this point in time. But if some other factors should change where all of a sudden, the resets make the NOIs more difficult or – and the cash flows change, that could have an impact, property taxes could have an impact. But the majority of our bias and our overall exposure to this is not that significant. Of the $8 billion that we have in New York City – in the – $8 billion in multifamily, we're looking at possibly $800,000 to $1 million in exposure in this space that our borrowers would be impacted.

Okay. That’s helpful.

What I would just add out to what Kevin pointed out on the credit front is that the shape of the yield curve also has something to do with it in the sense that in order to be in that market, you need to be somewhere between 3 and 3/8 and 3 1/2. That's what the latest color is showing. We're at 3 5/8, and so it's a deliberate attempt to reduce the asset, because of the spread implications, right. With the yield curve being inverted as it is, it's dilutive to NIM. So, we're being very careful about those types of assets coming on the balance sheet.

Okay. And as we think about that portfolio, is the third quarter level of decline a good run rate going forward? Or should we see balances accelerate and declining in future quarters?

Yes. I think that our objective is to keep the balance sheet steady. So, I'm not sure if it will continue to decline. I can tell you that we have lowered rates over the last few weeks. We've got the benefit of the lower cost on the liability side, so that's given us a little bit more opportunity to be more competitive in that market. But we're going to be very careful about the volume of loans in the multifamily book coming on because quite frankly, we want to increase the portion of C&I loans on the balance sheet just in our transition to a commercial bank.

All right. And then looking at the total loan book, is there expectation that other categories like C&I are going to be able to offset the declining multifamily portfolio?

To some degree, at this point, I would say that it's not a one-for-one request between multi and C&I, but we're going through a number of new hires, and we expect that we can build up to that level. Also, we have expanded some aspects of commercial real estate lending like non-multifamily assets and construction assets. So we think with those two categories and C&I, that we can pretty much fill the gap or fill up the negative of the multifamily amortization and payoffs.

Okay. And then just one last one from me, where do you see the capital ratio shaking out in the 10% return on equity guide for 2021?

In terms of a tangible common ratio, we have talked about an 8.5% to 9% into a common equity ratio to tangible assets.

Okay. Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Okay. Well, I want to thank you for participating on the call today. Again, we feel it's been a strong quarter. We're at an inflection point with respect to our net interest margin. I guess that's one of the advantages of being an outlier, being a liability-sensitive organization. But we're still on that journey to continue to evolve into a full-service commercial bank. Our credit is strong. Our capital is strong. We've declared a dividend of $0.11, and we continue to make improvements in our infrastructure, our technology and our risk management. I want to thank you for participating on the call, and I look forward to seeing you out and about on the road. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.