The Citizens Financial Group, Inc. (NYSE:CFG) posted earnings of $0.53 per share in the second quarter, up from $0.03 per share in the first quarter of 2020. Earnings will likely continue to recover in the second half of the year because the provision expense is likely to continue to decline. The loan loss reserve built in the first half of the year will likely cover most of the loan impairments that may arise in the year ahead. On the other hand, normalization of mortgage banking fees will likely limit the earnings recovery. For the full year, I’m expecting earnings to decline by 46% year over year to $2.04 per share. The June 2021 target price suggests a high upside from the current market price; therefore, I have a positive outlook on the stock for a holding period of one year. However, CFG’s high level of risk will likely keep the stock price subdued in the next two to three months; hence, I’m adopting a neutral rating on CFG for the near term.

Provisions Expense Likely to Decline from the First Half of the Year but Remain Above Normal

CFG posted a provision expense of $464 million in the second quarter, down from $600 million in the first quarter of 2020. The provision expense will likely continue to decline in the second half of the year because the first half’s reserve build appears high enough to cover most of the loan impairments that can arise in the year ahead. As mentioned in the second quarter’s investor presentation, the management incorporated GDP contraction of 33% and peak unemployment of 15% for the second quarter in its model to determine the allowances for loan losses. Further, the management assumed a gradual economic recovery in the second half of 2020. In my opinion, the assumption of a recovery this year is too optimistic; therefore, I’m expecting provisions expense in the year ahead to remain above normal.

Moreover, CFG has high exposure to COVID-19-sensitive loan segments, which will likely drive charge-offs in the year ahead. According to details given in the presentation, vulnerable commercial loan portfolios made up 11% of total loans, and vulnerable consumer loan segments made up 18% of total loans as of the end of the last quarter. The following table shows exposures to COVID-19-sensitive segments.Citizens Financial Group COVID-19 Sensitive Industries

Considering the macroeconomic assumptions and CFG’s exposure to vulnerable loan segments, I’m expecting the company to report provision expense of $1.5 billion in 2020, up from $393 million in 2019.

Net Interest Income Likely to Remain Stable

CFG’s loan balance declined by 1.7% quarter over quarter in the second quarter of the year. The decline will likely continue in the third quarter due to the COVID-19 pandemic and the resultant slowdown in business activity. Furthermore, the management mentioned in the presentation that it expects line utilization to decline in the third quarter, which will reduce loans. Moreover, the management expects a high percentage of the $4.7 billion Paycheck Protection Program loans on CFG’s books to get forgiven in the second half of the year, as mentioned in the presentation. The loan forgiveness will further reduce the loan balance in the year ahead. Consequently, I’m expecting CFG’s loans to decline by 0.5% in the third quarter. For the full year, I’m expecting loans to increase by 4.9% year over year, as shown in the table below.Citizens Financial Group Balance Sheet Forecast

CFG’s net interest margin, NIM, declined by 12bps in the second quarter due to the federal funds rate cuts in March. The NIM will likely decline some more in the second half of the year due to a lagged impact of the federal funds rate cuts. For the full year, I’m expecting NIM to decline by 22bps, as shown in the table below.Citizens Financial Group Net Interest Margin

The loan growth for the year will likely offset the NIM compression, leading to stable net interest income for this year. Consequently, I’m expecting the net interest income to increase by 0.6% year over year in 2020, which is in line with management’s guidance.

Normalization of Mortgage Banking Fees to Pressurize Earnings in the Second Half of 2020

CFG’s non-interest income surged by 19% quarter over quarter in the second quarter due to heightened mortgage banking fees. The sharp cut in interest rates acted as a catalyst for refinance activity, thereby driving mortgage banking fees. As I’m expecting interest rates to remain stable, the mortgage banking business will likely normalize in the second half of the year, which will pressurize earnings. On the other hand, the debit and credit card activity has substantially improved since the lifting of lockdowns, as mentioned in the conference call. Fees from cards will partially offset the impact of lower mortgage banking fees on non-interest income.

Earnings likely to Decline by 46%

Earnings will likely continue to improve in the third and fourth quarters of the year because the provision expense will likely decline from the first half’s level. On the other hand, the dip in non-interest income and the decline in NIM will likely pressurize earnings in the remainder of the year. For the full year, I’m expecting earnings to decline by 46% year over year to $2.04 per share. The following table shows my income statement estimates.Citizens Financial Group Income Forecast

Risks to Constrain the Stock Price in the Near Term

CFG has traded at an average price-to-book value ratio, P/B, of 0.76 in the past, as shown below.Citizens Financial Group Historical Price to Book

Multiplying the average P/B ratio with the forecast book value per share of $49.4 gives a target price of $37.4 for June 2021. The price target implies a 48.5% upside from CFG’s July 17 closing price. The following table shows the sensitivity of the target price to the P/B multiple.Citizens Financial Group Valuation Sensitivity

Apart from the upside, CFG also offers an attractive dividend yield of 6.2%. Despite the likelihood of an earnings decline, I’m not expecting a dividend cut because the earnings and dividend estimates suggest a payout ratio of 76%, which is manageable. Due to the high price upside and dividend yield, CFG appears to be a good investment for a holding period of a year.

However, for the next two to three months, the risks are likely to overshadow the attractive valuation. The uncertainties regarding the severity and duration of the COVID-19 pandemic have raised CFG’s riskiness. Moreover, the company’s high exposure to COVID-19-sensitive industries has increased the credit risk that it faces. Based on the risks, I’m adopting a neutral rating on CFG.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.





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