For some time now, my thesis on Citizens Financial (CFG) has been about a bank that is transforming from a perennial operational underperformer into a much better-run bank. Quarter by quarter and year by year, management continues to build the case for believing in that transformative potential. Now, heading into 2022, Citizens looks well-positioned with respect to loan growth and sensitivity, and if management can execute on further efficiency, competitiveness, and quality drives, the upside could be meaningful.
In response to better quarters and better positioning for the future (including multiple recent acquisitions), my long-term core estimated growth rate has headed higher, and with that my fair value estimate. These shares have continued to outperform since my last update (most of that on a year-to-date basis, as rate expectations have headed higher), but I still see low double-digit annualized total return potential, making this a name well worth considering.
A Healthy Core Beat
I calculate a core operating earnings beat of $0.12/share for Citizens in Q4’21 (or more than 10%), and I was encouraged by the extent to which that beat was driven by core operations. While lower provisioning expense made a difference (about $0.06/share), as did higher taxes (a $0.03/share headwind), Citizens delivered a meaningful $0.10/share beat at the pre-provision line (the numbers don’t match up exactly due to rounding).
Revenue rose less than 1% year over year but closer to 4% quarter over quarter on a core basis, beating expectations by about 3% or around $0.10/share. Net interest income fell less than 1% yoy and fell 2% qoq, missing by $0.02/share as the bank continued to see spread pressure (net interest margin down 6bp qoq to 2.66% and 1bp short of expectations). Fee income, though, was quite strong, rising 3% yoy and 16% qoq on a core basis and beating by $0.12/share. Fee income was driven by unusually strong capital markets revenue (up 109% yoy and 156% qoq), helping offset a 61% yoy and 30% qoq decline in mortgage banking income.
Core operating expenses rose 4% yoy and 2% qoq, basically in line with expectations, but better on an efficiency ratio basis (58.7% vs. 59.5% in Q3 and 60.2% estimated) due to the revenue outperformance. Core pre-provision profits fell 4% yoy but rose 6% qoq and beat by 8%, or $0.10/share.
Accelerating Loan Growth And Spread Leverage
Part of my bullish thesis over the last six to nine months has been Citizens’ leverage to loan growth when the economy started to recover. That’s happening now and Citizens is already seeing encouraging loan growth, with management looking for better results into and through 2023.
Loans rose 5% qoq on an ex-PPP end-of-period basis, beating expectations by close to 2%. C&I lending was particularly strong, growing 9% on an ex-PPP basis, while CRE lending was weaker than expected (down close to 3%). Mortgage lending (up 6% EOP) was also stronger than expected, as was auto lending (up 20% yoy and 8% qoq).
Strong commercial lending has been driven by a range of businesses, including corporate banking, subscription line finance (an alternative to the capital call lending that drives a lot of growth for banks like First Republic (FRC) and Signature (SBNY)) and asset-backed lending. Commercial line utilization is improving, up almost 3% to 35% this quarter, but management did caution that deal financing was driving a lot of that – while the outlook for M&A in 2022 is still uncertain, I’d still argue this is a less stable source of loan growth.
Looking at 2022, management expects high single-digit loan growth, and if they can do it, that should have Citizens on the better end of average for loan growth in the year. I would expect point-of-sale lending, an area that’s getting a lot more attention and that banks like Regions (RF) have acquired their way into, would be an area of growth to watch this year.
Citizens’ rate sensitivity is a more interesting subject, and an area where I do see some risk. While Citizens screens as fairly sensitive to higher rates, there are a lot of moving parts to consider. Citizens doesn’t historically have a high proportion of floating rate loans, but the Investors Bancorp (ISBC) deal should help some, and the bank doesn’t have a particularly low loan/deposit ratio, but acquired deposits from the HSBC (HSBC) deal should help. The HSBC deal also gives Citizens a chance to reprice some more expensive funding.
Last and not least is deposit beta; historically Citizens has been below-average here, and I’m worried about higher than expected betas in this tightening cycle. Management believes they have a line-of-sight to lower betas than in prior cycles, though, as the company has been emphasizing improved service quality in recent years and expanding its range of products to encourage depositors to stay with the bank.
Management has been talking of their focus on building a premier banking franchise in the NY/NJ/Philly metro area, and I think they’ve definitely taken positive steps in that direction, including the HSBC and ISBC deals. I also think that may be a wise move with large rivals like M&T Bank (MTB) and Webster (WBS) stepping up their game in markets east/northeast of NYC, and I also like the moves made to build the wealth management and capital markets businesses (including the JMP deal).
Considering progress on loan growth, spread leverage, operating leverage, and fee-generating businesses, not to mention the M&A activity, I’ve boosted my earnings expectations pretty meaningfully and my long-term core earnings growth rate moves from around 3.5% to 4.5%. That’s a big swing, admittedly, but I think the improvements in the business can support it. While capital returns to shareholders will be less spectacular for a couple of years, I think reinvesting in the business makes sense.
The Bottom Line
Between discounted core earnings, ROTCE-driven P/TBV (1.65x), and P/E (12x ’23 EPS), I believe Citizens shares can and should trade closer to $60 in the near term, and I see double-digit long-term annualized total return potential at this level. I like Citizens’ focus on growing both its commercial lending business (especially middle-market and small business) and consumer lending (POS, education, and auto), and I think two years of double-digit pre-provision profit growth can continue to drive sector-beating performance.