Citizens Financial: Time To Make A Choice Between Income And Capital Gains (NYSE:CFG)

Introduction

Citizens Financial (NYSE:CFG) is a bank headquartered in Rhode Island offering its services to its customers in 11 states through 900 branches. The bank recently expanded its presence with the acquisition of 80 branches of HSBC (HSBC) in New York City, the Mid-Atlantic region and Southeast Florida. This immediately increased the amount of deposits by in excess of $6B and will give Citizens financial more fire power to continue its expansion. Keep in mind this transaction was only completed halfway the first quarter and the Q1 results of Citizens Financial only include the contribution from the HSBC assets from the day the acquisition closed and Q2 2022 will be the first full quarter wherein the HSBC assets will be contributing to the consolidated results.

A Decent Set Of Results In The First Quarter Of The Year

In the first quarter of 2022, the bank reported a total interest income of $1.21B, which pretty much is a status quo compared to the first quarter of 2021. The 3% increase in the net interest income was caused by the lower interest expenses: Despite the strong increase in the amount of deposits, the interest paid on deposits fell by 50% compared to the first quarter of the previous year.

The bank also saw its non-interest income decrease while the non-interest expenses increased which resulted in an increase in the net non-interest expenses from $476M to $608M. Excluding the loan loss provisions, the pre-tax income was $539M which was substantially lower than the $641M generated in the first quarter of 2021. But there are two mitigating circumstances: the Q1 result of this year undoubtedly contained some transaction-related expenses which will be non-recurring. And secondly, the acquisition of the HSBC branches only started contributing in the second half of the quarter.

The bank only had to put about $3M aside in loan loss provisions which resulted in a $536M pre-tax income and an after-tax income of $420M, of which $396M was attributable to the common shareholders of Citizens Financial. This means the EPS was $0.94 based on an average share count of 422.4M shares. Keep in mind the share count increased and as of April 25 there were just over 495M shares outstanding as subsequent to the end of the first quarter, Citizens Financial also completed the acquisition of Investors Bancorp (ISBC) in a $3.5B cash and stock deal.

Based on the full-year guidance, Citizens expects its net interest income to increase by 27-30% to $5.8B (+$1.4B) while the net noninterest expenses will increase by $550M. While this will result in a very substantial increase in the pre-tax income (+$750-900M seems to be realistic) keep in mind the increased share count (almost +20%) will reduce the impact on the EPS. And also keep in mind that CFG may have to record some additional loan loss provisions after the completion of the loan book acquisitions.

Investors Interested In Citizens Financial Could Have A Look At The 6.25%+ Yielding Preferred Shares

While I think the decision by CFG to acquire both banks is solid and will contribute to the 2023 earnings, I don’t think we’ll see much of an uplift in 2022 as it always takes some time to incorporate new acquisitions in existing corporate structures.

So in the longer run, I think the common shares of CFG could be interesting at the current level as I’m expecting an EPS of $4.4 next year which could easily increase toward $5/share by 2024 based on the higher interest rates and the integration of two new divisions. So for patient investors, I think CFG offers an interesting potential on capital gains.

And while the stock is currently yielding just under 4%, the bank also has two issues of preferred shares outstanding for those investors looking for income rather than capital gains.

The D-series of the preferred shares (CFG.D) are currently trading above par at just over $26/share. These are non-cumulative preferred shares with an annual payout of $1.5875 per share and can be called by the company at $25 in April 2024. If they aren’t called, the preferred dividend yield will become a floating yield based on the three-month LIBOR with a 3.642% markup. Looking at the current three-month treasury yield (as the LIBOR is no longer in general use) of 0.9%, it’s starting to look like the market may be either expecting CFG to call these securities, overestimating the yield curve or simply not being aware of the preferred dividends starting to float from 2024 on. In order to achieve the same 6.35% yield on the principal amount, the three-month yield would have to increase to 2.7%. Not impossible but that would be a yield we haven’t seen since 2008.

I’d rather focus on the E-series of the preferred shares (NYSE:CFG.PE). These have a fixed non-cumulative preferred dividend of 5% ($1.25 per year) and can be call
ed from January 2025 on. These preferreds are currently trading at $19.86 (the share price at the closing bell on Thursday) indicating a current yield of 6.3%. There’s a possibility to generate capital gains here as the preferreds are trading about 20% below the par value but CFG will obviously not call these securities if a cost of 5% for perpetual preferred equity continues to be a good deal. So I wouldn’t count on capital appreciation here, but investors can rest assured the preferred dividend will be very well covered.

Investment Thesis

The completion of the HSBC transaction during Q1 and the Investors Bancorp at the beginning of Q2 will make the Q2 report very interesting. I’m not expecting much as the higher share count and one-time expenses related to both acquisitions (not just legal fees and completion fees, but there will also be some ‘rationalization’ expenses) will likely play an important role but looking forward to next year and 2024 it’s not difficult to see CFG’s full-year earnings come in at in excess of $5/share (and this could obviously pave the way for additional dividend increases).

Investors who are mainly interested in income instead of capital gains could start looking at the preferred shares issued by Citizens Financial. The expanded earnings profile should further increase the coverage ratio of the preferred dividends but it will be up to CFG to incorporate the two newly acquired companies in the existing corporate structure.

I have no position in either the common shares or the preferred shares, but I’m watching with interest.