My bullish call Citizen Financial (NYSE: CFG) hasn’t been among my most popular calls, but it continues to work as stocks are up over 15% since my last update, continuing to outperform regional bank peers as Citizens offers more benefits most to both the normalization of the economy and continued self-improvement efforts (efforts that seem to be at least partially underestimated by some investors).
I don’t like Citizens as much as I used to, but that’s only down to the outperformance of the stock price. I still think investors could get a long-term annualized return of close to 10% here, and that’s still quite attractive, especially as I see opportunities for beat and raise performance against my numbers . While weaker-than-expected loan growth and worse-than-expected deposit retention are two risks over the next year or two, it’s a name worth considering.
Second quarter results still under pressure
This uptrend contrasts somewhat with what was a lackluster set of results in the second quarter. While Citizens beat expected earnings by a healthy margin, the pace was driven by provisioning (reserve releases), not pre-provision earnings, and reserve releases aren’t going to elicit much sentiment at this point. versus revenue growth, loan growth, operating leverage, etc.
Revenue was down 8% year over year and 3% sequentially on an adjusted basis, missing expectations by a small margin. It should be noted that analysts (or investors) do not make the same adjustments on certain items, particularly on what constitutes “core” mortgage banking income and/or non-interest income. Therefore, your numbers may differ a bit.
Net interest income was down 3% year-over-year and slightly up sequentially, coming in around a penny lower than my expectations, with net interest margin down more than expected by 4 bps to 2.72% (and 16 bps from the level a year ago). . Again, loans and spreads were weaker than expected, but that’s not an uncommon issue this quarter.
Fee-based revenue was also weak, declining 18% YoY and 11% QoQ on a baseline basis and missing my expectations by about $0.03. Mortgage banking, which accounts for about 20% of non-interest revenue, was the main negative factor, and that doesn’t really surprise me (I had written earlier in the year that mortgage banking revenue were likely to fall for most banks). On a more positive note, there is continued progress in Citizens’ efforts to expand and grow its fee-generating businesses, with 33% growth in trust and wealth management, as well as recovery momentum in the cards sector (up 33% YoY and 16% qq).
Expenses were a little better than I expected (up 2% yoy and down 2% yoy), but core earnings before provisioning were still down 21% yoy yoy and 5% qoq, missing my expectations by almost $0.04/share. Taxes were also higher than I expected, and the pace against sell-side expectations was driven by the $213 million provisioning credit. Tangible book value per share increased nearly 4% sequentially.
Loans under pressure… but diversification and specialization are paying off
Although Citizens once again shed light on lending, another common theme this quarter across all banks, relative performance was not so bad. Excluding PPP loans, end-of-period loans were up almost 2%, with slight growth in commercial loans (vs. a 2.2% decline QoQ including PPP).
Citizens is benefiting from its diversified lending portfolio, with retail lending up nearly 3% year-over-year, including 7% quarter-over-quarter growth in mortgages, growth of nearly 4% in auto loans and a about 1% growth in student loans. However, yields are still under pressure (down 5 basis points year-on-year) and corporate line utilization is near record highs in the 30% as companies have strong cash balances and have been cautious with expansion plans (and/or limited access to work).
Compared to the other banks I have reviewed so far, Citizens management was perhaps the most optimistic about loan growth in 2H’21, with management expecting continued loan growth in the consumption (including student, auto, and point-of-sale financing) and “gradual” improvement in commercial lending.
It’s also worth noting again that Citizens has actively developed certain specialty lending verticals, including aerospace/defense, communications, restaurants and gaming, as well as retail categories such as point-of-sale financing. sales (targeting high income earners) and education. . With many banks actively reducing activity in these areas to control risk, Citizens could be on course for above-average loan growth and some market share growth over the next two years.
Watch spreads
Citizens has done a good job of closing the gap with its rivals when it comes to the cost of deposits. The increase in non-interest-bearing deposits that occurred during the pandemic contributed to this process, with total deposit costs falling a further 3 basis points quarter-on-quarter to 11 basis points. With interest-bearing deposit costs still somewhat elevated at 16 basis points, management appears optimistic (or perhaps optimistic) about its ability to keep low-cost deposits as the economy recovers, especially with management focusing on quality of service and scope of products/services to customers.
It should be noted, however, that Citizens is one of the most asset-sensitive banks in its weighting class. Management did not disclose its 100bp rate sensitivity (it should be in the 10-Q), but its Q1 sensitivity was 9.1%, more than double its peer group average. Management revealed that its sensitivity to a 200bp rate move was 10.7% (vs. 8.5% in Q1), so sensitivity is not decreasing. For investors unfamiliar with this metric, this essentially means Citizens has more net interest income on the upside if/when rates rise.
Also relevant to spreads and deposit costs, in late May Citizens announced the acquisition of 80 branches on the East Coast of HSBC (HSBC). With a deposit premium of only 2%, compared to a premium of 3.7% ANC (PNC) paid to BBVA (BBVA) for Compass and the 2.2% premium in the New York Community (NYCB)/flag star (FBC), Citizens pays an attractive price for $9 billion in low-cost deposits (average cost of 9 basis points) and “top-up” coverage between Boston and Philly (nearly two-thirds of deposits are in New York subway station).
I really like this deal, and while management has said they’re interested in further bank mergers and acquisitions at the right price, I don’t see too many deals like this as very likely.
Perspectives
I like the progress Citizens has made on its deposit costs, as well as growing its wealth management and capital advisory business. I also like the pre-provisioning earnings growth forecast in the second half on improving loan growth. All told, that would suggest good positioning for both revenue growth and positive operating leverage – two things the market really likes about banks.
Of course, I will necessarily mention that Citizens is starting from a lower base in terms of performance – Citizens has improved, but there was plenty of room for improvement from past performance levels.
I’m still looking for core long-term earnings growth of around 3%, but I see a path to growth of 4% or more if current initiatives work well. I don’t expect Citizens to ever have great ROE or ROTCE (or even “very good”), but it’s not essential for higher multiples if the business can generate improved growth (revenue, benefits, tangible book).
The essential
Based on discounted core earnings and the short-term ROTCE-driven P/TBV, I believe the Citizens should be trading between $40 and $50 today and offer investors a near double-digit annualized total return. . With relative valuation still attractive, progress in self-help initiatives, an improving economy, and even more room for improvement, I still like this stock for new investors.
