What Should Citizens Financial Investors Keep Their Eyes On?

If an investor were to look at Citizens Financial Group's (CFG 1.57%) recent performance, it'd be tempting to conclude that the bank has nothing to worry about, as both its profitability and efficiency are going in the right direction at a rapid clip. Yet there remain a number of potential issues that investors in the Providence, Rhode Island-based bank should keep their eyes on.

In this segment of Industry Focus: Financials, The Motley Fool's Gaby Lapera and contributor John Maxfield dig into three such areas in particular.

A full transcript follows the video.

This video was recorded on May 26, 2017.

John Maxfield: Right now the bank industry is going through a very significant shift toward digital banking. So, the banks that are going to survive into the future, 10-50 years down the road, have got to navigate this digital transformation effectively in order to make it. So, keep in mind that that's a really important context. There are a number of different ways and technologies that a bank needs to pursue in order to navigate the digital divide, one of which is just having an effective digital app, a presence online, an effective digital app that provides really good customer experience, that's something that Citizens has invested in. Another thing is cloud computing. Cloud computing reduces the costs of storing customer data and accessing that data and using it for analytical purposes to grow your business in the future. There's also another thing that Citizens Financial has gotten into more recently, in fact, I was just talking to the head of their wealth management recently about this, they are pushing into the robo advisory space, which is basically an algorithmic program that manages your investments, and these things are just blowing up. You have Wealthfront, Betterment, Schwab has gone into the space, Vanguard has gone into the space, Bank of America is coming into the space, everyone is moving into the space because it's such an inexpensive way to serve these customers. It's also getting into big data analytics, that's something that Bruce Van Saun noted in his most recent letter. Big data analytics, what that allows you to do is look across your customer base, determine which customers have the right products and which don't, and then make a tailored pitch to those customers who don't have the right products but maybe need an additional one, and tease out why that would help them financially. It's a multifront war that banks are fighting, and Citizens is on the vanguard of that.

Gaby Lapera: Question for you, because, you're right, banks are trying to deal with all these things and update their services to match this digital world. Do you think that Citizens is trying to get into too much at once? Or do you think this really makes sense for them?

Maxfield: I think, as they would say in contract law, time is of the essence. With the millennial generation that has grown up with technology in their pocket, and they expect that experience, to be able to do whatever they want on their phone, and when you add on top of that the high switching costs that have traditionally been in the banking space, now, switching costs could change going forward, but assuming that they don't, if they don't change, if these banks are not providing these top-notch digital products to these millennials, they will just go elsewhere and they'll just stay at those banks forever. So, these investments have to be made right now. It's a non-optional thing for banks. To a certain extent, it would be nice if a bank like Citizens didn't have to throw so much money at these things simultaneously. But I don't think that's an option for them.

Lapera: OK, totally fair. That brings me to my next point, which is, they're investing all this money, they're growing, their story is, in theory, a turnaround story, they're on the upswing. But if someone is thinking about investing in this bank, there are some things they probably want to watch out for. For me, we were talking earlier about the rapid loan growth. That's something that I would want to keep an eye on to make sure that doesn't change from "We have a lot of room to grow in this area" to "Our underwriting processes are slowly getting worse and worse and worse."

Maxfield: Right. And just because I think Citizens Financial is on the right track, and it looks to me like everything is going well, and it looks to me like given the fact that their stock is trading below book value and their trajectory of their earnings and growth, that it looks like a compelling opportunity to me -- I will tell you that the one thing that I learned last year when that Wells Fargo scandal came out is that you're never sure. That really shocked me, that Wells Fargo scandal. I had an immense amount of respect for John Stumpf, and the way they ran that bank, and the way they'd run that bank for 160 years. You can never know for sure with these institutions. So, that should always stay in the back of people's minds, whether it's JPMorgan Chase, even with a guy as incredible as Jamie Dimon, or whether that's Wells Fargo or Citigroup. You should always be suspicious, and innately have that in the back of your head.

Lapera: Yeah. We should rename this show The Paranoid Investor. [laughs]

Maxfield: [laughs] Exactly. Only the paranoid investors survive. I think that's what Andy Grove, the former Intel CEO, that was his philosophy.

Lapera: What were you going to say, though, the other thing?

Maxfield: The other thing, Gaby, you and I talked about this earlier, Citizens Financial has had some bumps in the road. The most recent bump in the road concerns its so-called Citizens checkup program. The Citizens checkup program is pretty basic. What Citizens wants its employees to do is reach out to their customers. Citizens is now investing in this data analytics program. Now they want to reach out to these customers whose portfolio of financial products may not be ideal for these individuals. We all accumulate a new account here and a new account there, and then you get to 40 and you're like, "Why do I have all these random accounts? $15 here, $10 here, I thought this was a good idea but I could really use this or that." Basically, what Citizens Financial wants its employees to do is reach out to these customers, set up appointments to either call them on the phone or come into a branch, and have a "financial checkup," kind of like a doctor checkup. The problem that Citizens Financial employees ran into, allegedly, according to an article in The Wall Street Journal from earlier this year, is that they couldn't either get ahold -- because we all know what sales calls are like, because that's basically how someone would interpret these --

Lapera: Yeah, I would definitely hang up on that.

Maxfield: Exactly. Or you wouldn't pick up the phone, right?

Lapera: No, not at all.

Maxfield: So, the problem they ran into was everybody was doing that. So, they're being told, "Make all these appointments," but they were having problems. Again, these are all allegations from The Wall Street Journal, so keep that in mind, these are just allegations. So, what these employees allege, and I think there are roughly a dozen employees that were used as sources for this story, what they alleged is that they would then, to make sure they kept their jobs, they would make up these fake appointments and say someone came in, or hadn't come in, or had cancelled, or whatever it was. So, they were inflating the number of appointments that they actually had. That's not a good thing. So, No. 1, I think we need to be clear, that is not a good thing. But, let me say this. If you compare those allegations at Citizens to what happened at Wells Fargo, which is the natural analogy that anyone is going to draw right now, there's two points to make. No. 1, in the wake of the Wells Fargo scandal, it was a deluge of information in the media from other Wells Fargo employees who came out and said, "Not only were we doing this, and all these other people were doing it and all these other people were doing it," and leak and leak and leak came out about it, but also, Wells Fargo was mistreating its employees at the same time, by firing them, or demoting them, or in some way impacting their employment in a negative way because they tried to bring the scandal to light. That just hasn't been the case at Citizens. After that initial Wall Street Journal article, you haven't seen anything in the media about this. Which leads me to believe that this was not even close to as widespread as the Wells Fargo scandal.

Lapera: Yeah. And honestly, making up that I made a meeting with someone is very different from opening a fake account in their name and having people be potentially charged fees because they don't know this account exists. But, there is something to think about there, and something to keep an eye on. Just keep an eye on the story, A, and B, when stuff like this happens, regulatory bodies tend to start taking more interest in your bank, which can lead to increased cost. The CFPB, the Consumer Financial Protection Bureau, may have a couple tentacles out there looking at Citizens Financial, and that's something that you want to watch in the future.