The $185 billion asset Citizens Financial Group (CFG -0.75%), based in Rhode Island, posted disappointing second-quarter results, generating diluted earnings per share (EPS) of $1.46 on total revenue of $1.61 billion. EPS beat expectations by $0.37, but missed slightly on revenue. However, EPS would have missed expectations had Citizens not released $291 million of reserve capital previously set aside for pandemic-related loan losses but not used because of an improving macroeconomic outlook.

What was most disappointing about the report was the lighter-than-expected loan growth, despite the bank's somewhat unique consumer loan mix that had been expected to produce above-industry-average loan growth in the current market conditions.

Despite the underwhelming numbers, there is still reason to believe Citizens can outperform over the next several quarters. Here's why.

Outside of Citizens Financial Group branch.

Image source: Citizens Financial Group.

Disappointing results, but positive signs

Citizens' average loan balances and period-end loans balances barely moved from the first quarter of the year. If you exclude Paycheck Protection Program (PPP) loans, period-end loans grew 1.8% from the sequential quarter.

However, last quarter management had guided for 1.5% to 2% of loan growth in the second quarter, and it did not specifically say anything about excluding PPP loans in its guidance. Citizens Financial CEO Bruce Van Saun said on the bank's most recent earnings call that pay downs on PPP loans and other commercial loans offset solid levels of originations.

Material loan growth has been underwhelming across the banking industry in the most recent quarter. But Citizens' main differentiator is its unique consumer loan mix, which includes mortgage, home equity, auto lending, student loan refinancing, and point-of-sale (POS) lending. This unique set of verticals should have benefited in a more outsize way than the industry in the second quarter because the consumer is driving a lot of the economic recovery right now.

Favorable developments in the quarter

Management said the consumer lending portfolio reported record originations in the quarter, growing period-end total consumer loan balances 3% from the first quarter. Period-end loan balances from the sequential quarter jumped 7% specifically in residential mortgage, 4% in auto, 1% in student loan refinancing, and negative 3% in POS, so there was some favorable movement. Van Saun said he remains optimistic about the back half of the year: "Looking out to the second half, we believe we will see a pickup in loan growth, particularly on the consumer side in student, point-of-sale finance, and auto. In commercial, we should start to see gradual growth in line utilization off of low levels along with the pickup in deal-related financings."

In January, management guided for period-end loan growth in the mid- to high-single-digit percentages in 2021, with acceleration in the back half of the year, so it's not great to see the bank missing guidance in Q2. Mid-single-digit percentage growth still looks very possible, with high-single-digit growth looking more like a reach right now. Management also said it paused share repurchases in the second quarter in part to prepare for accelerating loan growth, and management has guided for period-end loan balances to grow 2% to 3% in the third quarter.

Aside from lending, Citizens continued to bring down its deposit costs in the quarter and generated record revenue in its capital markets and wealth management fee income business lines. Citizens expects total fee income to be up 2% to 4% in the third quarter, with improvement in mortgage banking, which cooled off substantially in the second quarter. Credit quality remained excellent, with management forecasting minimal losses for the year.

Citizens also got more asset sensitive in the quarter, meaning that when interest rates go up, more of its assets will reprice higher than its liabilities. A gradual 2% hike in interest rates would result in an additional 10.7% of net interest income over a one-year period (roughly 9% when you factor in Citizens' recently announced acquisition of Investors Bancorp (ISBC)).

A good entry point

Despite disappointing loan growth in Q2, mid-single-digit loan growth on the year still looks to be very achievable. If Citizens can hit the top end of the mid-single-digit range or get to the high-single-digit percentage range, it will likely outperform peers on loan growth. There were some good signs in the consumer portfolio, so I'm not ruling it out just yet.

Citizens also recently announced two acquisitions in the last two months -- one of 80 U.S. HSBC Holdings branches and the other of Investors Bancorp ($27 billion in assets) in New Jersey. Along with the recent pullback on share prices over the last month, investors have the potential to buy shares of Citizens at roughly 125% of tangible book value (TBV), which is a bank's equity minus goodwill and intangible assets, or a look at what a bank would be worth if it were to be immediately liquidated. That's a good entry point on a bank moving in the right direction.