For some time now, my thesis on Citizen Financial (CFG) is about a bank that transforms from a permanent operational underperformer into a much better managed bank. Quarter after quarter and year after year, management continues to demonstrate that it believes in this potential for transformation. Now, as we head into 2022, Citizens looks well positioned for growth and loan sensitivity, and if management can sustain its focus on efficiency, competitiveness and quality, the upside could be significant.
In response to better quarters and better positioning for the future (including multiple recent acquisitions), my estimated long-term growth rate has increased, and with it my estimate of fair value. These stocks have continued to outperform since my last update (most on an annual basis, as rate expectations have risen), but I still see low double-digit annualized total return potential, making this a name well worth considering.
A healthy heartbeat
I calculate a base operating profit beat of $0.12/share for Citizens at Q4’21 (or more than 10%), and I was encouraged by how much that beat was pulled by the basic operations. Although lower provisioning expenses made a difference (around $0.06/share), as did higher taxes (a headwind of $0.03/share), Citizens saw a significant 0 beat, $10/share at the pre-funding line (numbers do not match exactly due to rounding).
Revenue was up less than 1% year-over-year, but closer to 4% quarter-over-quarter on a central basis, beating expectations by around 3% or around 0 $.10/share. Net interest income fell less than 1% yoy and 2% yoy, missing $0.02/share as the bank continued to face spread pressure (net interest margin in down 6bps yoy to 2.66% and 1bp below expectations). Fee revenue, however, was quite strong, rising 3% YoY and 16% QoQ on a basic basis and beating $0.12/share. Fee income was driven by exceptionally strong Capital Markets revenue (up 109% YoY and 156% YoY), which helped offset a 61% YoY decline and 30% QoQ in mortgage banking revenue.
Core operating expenses increased 4% YoY and 2% QoQ, broadly in line with expectations, but better on an efficiency ratio basis (58.7% vs. 59.5 % in Q3 and 60.2% estimated) due to revenue outperformance. Core earnings before provision fell 4% yoy, but rose 6% yoy and beat 8%, or $0.10/share.
Accelerating Loan Growth and Leverage
Part of my bullish thesis over the past six to nine months has been citizen leverage on loan growth as the economy began to recover. This is happening now and Citizens is already seeing encouraging loan growth, with management looking for better results through 2023.
Loans rose 5% q/q on a non-PPP end-of-period basis, beating expectations by nearly 2%. C&I loans were particularly strong, growing 9% on a non-PPP basis, while CRE loans were weaker than expected (down nearly 3%). Mortgages (up 6% EOP) were also stronger than expected, as were auto loans (up 20% yoy and 8% yoy).
Strong commercial lending was boosted by a range of activities, including corporate banking, subscription line financing (an alternative to call-on lending which is driving the growth of banks such as First Republic (FRC) and Signature (SBNY)) and asset-backed lending. Commercial line utilization is improving, up nearly 3% to 35% this quarter, but management warned deal funding was driving much of that – as the outlook of mergers and acquisitions in 2022 are still uncertain, I would still say it is less stable source of loan growth.
Looking to 2022, management expects high single-digit loan growth, and if it can do that, that should put Citizens in the better end of the average for loan growth over the course of the year. year. I would expect point-of-sale lending, an area that is getting a lot more attention and that banks love Regions (RF) have gained their way, would be a growth area to watch this year.
Citizen rate sensitivity is a more interesting topic and an area where I see some risk. While Citizen screens are quite sensitive to higher rates, there are a lot of moving parts to consider. Citizens do not historically have a high proportion of floating rate loans, but the Bancorp Investors (ISBC) should help some, and the bank does not have a particularly low loan-to-deposit ratio, but has acquired deposits from the HSBC (HSBC) should help. The HSBC deal also gives citizens a chance to reprice some more expensive financing.
Last but not least is the beta version of the repository; Historically, Citizens has been below average here, and I worry about higher than expected betas in this crunch cycle. Management believes, however, that it has a line of sight to reduce betas from previous cycles, as the company has focused on improving service quality in recent years and has expanded its product line to encourage depositors to stay with the bank.
Management has talked about their goal of 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 it can be a wise move with big rivals like M&T Bank (MTB) and Webster (WBS) are stepping up their game in the markets east/northeast of New York, and I also like the moves to expand the wealth management and capital markets business (including the JMP deal) .
Given progress in loan growth, allocation leverage, operating leverage, and fee-generating activity, not to mention M&A activity, I’ve raised my expectations for earnings quite significantly and my long-term core earnings growth rate goes from about 3.5% to 4.5. %. It’s a big swing, sure, but I think the improvements in the business can support it. Although returns on capital for shareholders are less spectacular for a few years, I think it makes sense to reinvest in the business.
Between discounted core earnings, ROTCE-based P/TBV (1.65x) and P/E (12x ’23 EPS), I think Citizens shares can and should trade closer to $60 in the near term. , and I see long double-digit annualized total return potential going forward at this level. I like Citizens’ focus on growing both its commercial lending (particularly for middle market and small business) and consumer lending (point-of-sale, education, and automotive) businesses, and I believe two years of double-digit pre-provision earnings growth can continue to drive industry-leading performance.