When Citizens Financial Group (CFG -0.19%) went public in 2014, becoming the largest commercial bank to ever file an initial public offering, you would have been excused for thinking its future wasn't bright. But times have changed, and so have Citizens' prospects.

Two and a half years ago was an inopportune time to debut as one of the nation's biggest banks. Low interest rates and rising compliance costs made it hard for even elite banks to earn their costs of capital and create value for shareholders. On top of this, Citizens was in the midst of a turnaround, having been spun off from the Royal Bank of Scotland, which made mistakes in the lead-up to the financial crisis that have since cost Citizens' former parent company $58 billion in losses.

Bruce Van Saun, the Chairman and CEO of Citizens Financial Group.

Bruce Van Saun, the chairman and CEO of Citizens Financial Group. Image source: Citizens Financial Group.

Fast-forward to today, however, and Citizens' future looks much more promising. Interest rates are heading higher, and appear poised to continue doing so. Policymakers in Washington, D.C., have vowed to roll back onerous regulations enacted since the crisis. And Citizens' fundamental performance has improved across the board. Its profitability has nearly doubled, it's become more efficient, and its stock has handily outperformed the KBW Bank Index.

This isn't to say that Citizens is satisfied with where it is today, because it isn't. Chairman and CEO Bruce Van Saun's goal is to transform the $150 billion bank into one of the top-performing regional banks in the United States, along the likes of U.S. Bancorp and PNC Financial. This won't be easy, as formidable hurdles still lay in Citizens' path. But Van Saun was clear in a recent conversation that he thinks the Providence, Rhode Island-based bank is up to the task.

Turning the corner

"When I came over to Citizens in October 2013, our goal was to benchmark our performance against peers, start playing offense, and turn the company around," says Van Saun. "The plan was fairly straightforward and we've executed on it well. Our performance was initially behind our peers, but now we've pretty much caught up with them. We like to say now that we're turning the corner. We're moving out of our turnaround phase."

Citizens' performance last year corroborates Van Saun's optimism. The bank grew loans on a year-over-year basis by 7.7% compared to a 5.4% peer group average. Its revenues climbed even faster, rising 8.9% versus 5.4% for its average competitor. And its efficiency ratio, which measures the percent of revenue consumed by a bank's operating expenses, fell 376 basis points (bps), exceeding the 62 bps drop recorded by the typical bank in its peer group.

Things improved further in the first quarter of this year. Citizens finished with a 61.7% efficiency ratio, closing in on the 60% benchmark that most banks strive to achieve. Its return on tangible common equity came in at 9.68%, marking a substantial improvement over the first three months of last year, when it generated a 6.61% return on tangible common equity.

The net result is that Citizens is now on the verge of passing the 10% threshold that, as a general rule, distinguishes between banks that are earning their costs of capital, and thus creating value for shareholders, and those that aren't.

A chart showing Citizens Financial Group's stock performance compared to the KBW Bank Index.

Data source: YCharts.com. Chart by author.

The progress at Citizens stems in part from the fact that it had been undermanaged by RBS, which was forced by regulators to shrink and de-risk after the 2008 crisis. At one point, RBS went so far as to stop making commercial real estate loans, forcing Citizens to tell even long-standing customers at the time that it wasn't open for that kind of business. But that's no longer the case, says Van Saun, who flipped the sign around to say "shop open" after Citizens detached from RBS:

So we went out and recruited experienced commercial bankers, many of whom have relationships with companies that are above the middle market -- ones with more than $500 million in annual revenue.

To serve these companies you need industry expertise. So we set up a healthcare group, a technology group, an energy group. And we've been bringing over bankers who have strong relationships in these industries. When there's an opportunity to enter into a credit relationship with these companies, we're there to do so. Then we hopefully move over and become a more important bank for them.

Citizens has pursued a similar strategy in its consumer banking business. It jumped into education refinance loans, becoming one of the bigger players in that space. It's grown in the personal unsecured market by introducing a debt-consolidation product for people with high-interest credit card loans. It hired 200 new mortgage officers, increasing the bank's total to 550. And it introduced a new platinum status for customers who maintain higher balances and want more account features, fewer fees, better rates, and additional products and services.

Under Van Saun's watch, Citizens has also invested heavily in technology to improve the customer experience and navigate the unfolding institutional imperative in the financial services market. As the 58-year-old executive explained in his latest shareholder letter:

In digital technologies we are building next-generation experiences in key areas, including mobile, wealth advisory, lending and commercial services. We are focused on delivering a more consistent and integrated customer experience across all of our distribution channels. And to ensure that the technologies we deploy are relevant and valuable to our customers, we have invested in advanced analytical tools that give us real insight into each customer's needs.

In 2016, moreover, Citizens announced a partnership with SigFig, a financial technology company, or fintech, to roll out a robo-advisory service to the bank's wealth management clients. And the bank has "strategies in place to take advantage of further technology innovations, such as leveraging open applications and moving to a cloud-based infrastructure," wrote Van Saun. "You have to be judicious about where you're playing, and be innovative on the consumer side, but that's what's allowed us to grow," he told me.

It's this combination of factors, combined with Van Saun himself, that has caught the attention of industry observers. "I like Citizens a lot," says veteran bank analyst Richard Bove, pointing to Citizens' capital levels, strategic relationships with companies like SigFig, and risk discipline. "And I think Van Saun is top quality," Bove continued. "He's an excellent banker."

The path to top performance

Even though Citizens has made considerable progress since going public in 2014, plenty of obstacles remain on its journey to emerge as a top-performing regional bank.

In the first case, loan growth across the industry has decelerated. Loans on commercial bank balance sheets have increased over the past two years by 8%. Starting at the end of 2016, however, the rate has steadily dropped. Recent data from the Federal Reserve shows that total loans at commercial banks expanded only 4.1% in March compared to the same month last year.

A line chart showing the trend in loan expansion at commercial banks.

Data source: Federal Reserve. Chart by author.

Moreover, while rising interest rates will increase the yield on loans and fixed-income securities, which will be especially beneficial to asset-sensitive banks like Citizens, higher rates may also eventually cause depositors to look elsewhere to improve on the rates offered by checking and savings accounts. "If [banks] continue to keep money at zero and slightly higher rates, they are likely to be severely criticized," noted Bove in a recent note to clients. "These banks are going to lose deposits. They are going to be forced by market conditions to raise rates. If they choose not to do this, they will lose hundreds of billions in deposits."

This is an important issue for Citizens. "The one thing we have to focus on is that, while we have plenty of capital, our loan-to-deposit ratio ended the first quarter at 97%," says Van Saun. "So if we're going to grow loans at a good clip, we need to continue growing deposits as well, because we fund each dollar in loan growth with a dollar of deposit growth. And we want to find those deposits in a cost-effective manner."

Citizens' credit rating also serves as a headwind. It ranks in the middle of its peer group in this regard, thanks principally to its condition upon its spinoff from RBS. This acts as a signal to corporate customers who have become more discerning over the past decade about the banks they partner with. Just as importantly, a lower credit rating increases a bank's cost of funds, not unlike how a person with a lower credit score must pay a higher interest rate on their mortgage.


Credit Rating (Standard & Poor's Long-Term Senior Debt)

U.S. Bancorp


PNC Financial




Citizens Financial


Fifth Third Bank


SunTrust Banks


Regions Financial


Data source: Company filings.

The good news is that Citizens' credit rating should improve with time. The bank is more than adequately capitalized, has plenty of liquidity, and, barring missteps, should see its profitability rise as interest rates climb and the bank's strategic initiatives gain momentum.

Van Saun also emphasized that Citizens is working with the ratings agencies to bolster its score:

We've been in active dialogue with the ratings agencies about making sure they understand our plan and the progress we've made. They've taken comfort in our fortress balance sheet and I think the reason our rating isn't where we'd like it at this point is that our earnings levels have been lower than peers. That gap is rapidly diminishing, but the ratings agencies tend to look more out of the rearview mirror than the front windshield. So we'll need to have a more sustained level of improved operations at the current level to get us a better rating.

Finally, not unlike a handful of other banks that have been accused of questionable practices in the wake of Wells Fargo's (WFC -0.39%) fake-account scandal, The Wall Street Journal alleged at the end of March that employees at Citizens fabricated information about the number of appointments they scheduled and held with customers under the bank's customer service initiative, Citizens Checkup. "For a week or so, I had my bankers [try to make] real appointments. No one was picking up the phone," a former branch manager told the Journal. "So we put random people's names down and said, 'We have an appointment.'"

It's important to appreciate that the allegations against Citizens are different both qualitatively and quantitatively from Wells Fargo's unsavory sales practices. The latter amounted to an outright fraud that was perpetrated against millions of Wells Fargo customers over a decade and a half, if not longer. By contrast, Citizens' program was only rolled out in February 2016. And while it's not good if the initiative inadvertently incentivized illicit behavior, setting up fake appointments is far less egregious than opening fraudulent accounts for customers and then retaliating against employees who brought the scandal to the attention of their superiors, as was the case at Wells Fargo.

Furthermore, unlike Wells Fargo, the allegations against Citizens remain just that. Aside from the inevitable wave of class action lawsuits filed against the bank by attorneys seeking to pad their own pockets, it's telling that there haven't been additional media reports confirming the claims. That contrasts sharply with Wells Fargo, which has been under a constant barrage of corroborating media reports for eight months.

"We have a full review going on to see if there's ways to sharpen how we've implemented the program," says Van Saun. "But it's a great program and it's here to stay. It's not scandalous. It's actually something that I think is very admirable and it's a great way to up our game in terms of knowing our customers and having more interaction with them."

The investment thesis

While no stock is a guaranteed home run, Citizens' future looks bright.

Its shares give investors an opportunity to profit from an improving economic and regulatory environment, as well as the bank's ongoing efforts to bolster its efficiency and profitability. It's also well positioned to grow through acquisitions, giving it a leg up on the nation's megabanks, three of which control over 10% of domestic deposits each and are thus legally prohibited from acquiring other depository institutions. And the icing on the cake is that Citizens is one of the few big bank stocks that trade for less than book value -- currently, for a 6% discount.

The onus remains on Citizens to grow in a responsible manner and to successfully navigate the digital divide confronting banks today. But assuming it does so, current and prospective investors in the bank could benefit handsomely.