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Citizens Financial: It’s time to make a choice between income and capital gains (NYSE: CFG)

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Citizen Financial (NYSE: CFG) is a bank headquartered in Rhode Island that serves customers in 11 states through 900 branches. The bank has recently strengthened its presence with the acquisition of 80 HSBC branches (HSBC) in New York, the mid-Atlantic region, and southeast Florida. This immediately increased the amount of deposits by more than $6 billion and will give Citizens Financial more firepower to continue its expansion. Keep in mind that this transaction was not completed until midway through the first quarter and that Citizens Financial’s first quarter results only include the contribution of HSBC assets from the day of closing. acquisition and that the second quarter of 2022 will be the first full quarter in which the HSBC assets will contribute to consolidated results.

Data by YCharts

A decent set of results in the first quarter of the year

In the first quarter of 2022, the bank reported total interest income of $1.21 billion, which is roughly unchanged from the first quarter of 2021. The 3% increase in net income interest was caused by lower interest charges: Despite the sharp increase in the amount of deposits, interest paid on deposits fell by 50% compared to the first quarter of the previous year.

income statement

Citizens Financial Investor Relations

The bank also saw its non-interest income decline while non-interest expense increased, resulting in net non-interest expense increasing from $476 million to $608 million. Excluding provisions for loan losses, pre-tax profit was $539 million, which was significantly lower than the $641 million generated in the first quarter of 2021. But there are two mitigating circumstances: the result of the first quarter of this year undoubtedly contained some transaction-related expenses that will not be recurring. And second, the acquisition of the HSBC branches only started contributing in the second half of the quarter.

The bank only had to set aside about $3 million in loan loss provisions, resulting in pre-tax income of $536 million and after-tax income of $420 million, of which $396 million were attributable to ordinary shareholders of Citizens Financial. That means EPS was $0.94 based on an average share count of 422.4 million shares. Keep in mind that the number of shares has increased and as of April 25 there were just over 495 million shares outstanding because after the end of the first quarter, Citizens Financial also finalized the acquisition of Investors Bancorp (ISBC) in a $3.5 billion cash and stock transaction.

Based on full-year guidance, Citizens expects its net interest income to grow 27-30% to $5.8 billion (+$1.4 billion), while net non-interest spending will increase by $550 million. While this will result in a very substantial increase in pre-tax income (+$750-900 million seems to be realistic), keep in mind that increasing the number of shares (almost +20%) will reduce the impact on EPS. And also keep in mind that CFG may need to record additional loan loss provisions after the loan book acquisitions are finalized.

Outlook 2022

Citizens Financial Investor Relations

Investors interested in Citizens Financial could take a look at preferred shares yielding above 6.25%

While I think CFG’s decision to acquire both banks is solid and will contribute to 2023 earnings, I don’t think we’ll see much improvement in 2022 as it always takes time to integrate new acquisitions into existing business structures. .

So longer term, I think CFG common stock could be attractive at the current level, as I expect EPS of $4.4 next year, which could easily rise towards $5/share. by 2024 based on higher interest rates and integration. of two new divisions. So for patient investors, I think CFG offers good upside potential.

And although the stock is currently yielding just under 4%, the bank also has two preferred stock issues outstanding for investors seeking income rather than capital gains.

The Series D preferred stock (CFG.D) is 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 redeemed by the company at $25 in April 2024. If not redeemed, the preferred dividend yield will become a yield variable based on the three-month period. LIBOR with a mark-up of 3.642%. Looking at the current yield on three-month Treasury bills (since LIBOR is no longer in general use) of 0.9%, it’s starting to look like the market is expecting either what CFG is calling these securities, either overestimating the yield curve or simply not being aware of preferred dividends starting to float from 2024. 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 it would be a return we haven’t seen since 2008.

I prefer to focus on Series E preferred shares (NYSE: CFG.PE). These have a fixed non-cumulative preferential dividend of 5% ($1.25 per year) and can be called from January 2025. These preferred shares are currently trading at $19.86 (the share price at the closing bell on Thursday), indicating a current yield of 6.3%. There is an opportunity to generate capital gains here as the preferred shares are trading around 20% below face value, but CFG obviously won’t call these securities if a 5% cost for the perpetual preferred shares continues to be good business. So I wouldn’t count on capital appreciation here, but investors can rest assured that the preferred dividend will be very well covered.

Investment thesis

The completion of the HSBC transaction during the first quarter and of Investors Bancorp at the start of the second quarter will make the second quarter report very interesting. I’m not expecting much because the higher number of shares and one-time expenses associated with the two acquisitions (not just legal fees and completion fees, but there will also be “streamlining” expenses ) will likely play a big role, but I’m looking forward to next year and 2024, it’s not hard to see CFG’s annual earnings surpassing $5/share (and that obviously could pave the way for further increases dividends).

Investors who are primarily interested in income rather than capital gains might start looking at preferred shares issued by Citizens Financial. The expanded earnings profile should further increase the preferred dividend coverage ratio, but it will be up to CFG to integrate the two newly acquired companies into the existing corporate structure.

I have no position in common stocks or preferred stocks, but I am watching with interest.