While there is still uncertainty heading into the winter, the banking sector, like most of the market, seems to have shaken off the significant rise in COVID-19 cases, hopeful that an effective vaccine will soon be ready for the public. With that in mind, it's a good time to look for opportunities in the banking sector, which is still down on the year, before more catalysts like a second stimulus bill drive stocks higher. One regional bank that looks like it has opportunity is Citizens Financial Group (NYSE:CFG), a $180 billion large-asset regional bank based in Providence, Rhode Island. Here's why.

Trading low with solid fundamentals

After the recent rebound in the banking sector, Citizens Financial was recently trading at about 110% of tangible book value. But even at that level, the bank was still trailing all of its peer banks in terms of valuation.

Bank Price/Tangible Book Value
Citizens Financial Group 110%
Fifth Third Bancorp (NASDAQ:FITB) 118%
KeyCorp (NYSE:KEY) 119%
U.S. Bancorp (NYSE:USB) 124%
Regions Financial (NYSE:RF) 139%
M&T Bank Corp (NYSE:MTB) 159%
PNC Financial Services Group (NYSE:PNC) 161%

Source: Bank financial statements.

While the lower valuation is not a complete surprise considering Citizens went through a major corporate change just over five years ago, I still think the bank has enough going for it to warrant a higher valuation for a few reasons.

Through the first nine months of the year, Citizens Financial generated roughly $2.2 billion in pre-provision net revenue, which is total revenue before accounting for credit costs. This was 11% higher than the same time period in 2019. That's stronger growth than any of the banks in Citizens' peer group and an impressive achievement in an ultra low-rate environment with very little commercial loan demand.

The interior of a Citizens Bank with a flight of stairs leading to the main floor.

Image source: Citizens Bank.

The main reason for this is because of Citizens' acquisition of the assets of Franklin American Mortgage Company in 2018. The move significantly grew Citizens' mortgage-servicing and origination operations; more importantly, it served as a hedge in the low-rate environment that struck in March when the Federal Reserve lowered its benchmark lending rate to practically zero. The lower rates set off a wave of refinancing activity, which Citizens capitalized on with its improved mortgage business. Mortgage banking fees at the bank in the third quarter of 2020 more than doubled from the third quarter of 2019 .

While refinancing activity won't stay this hot forever, Citizens CEO Bruce Van Saun said on the company's third-quarter earnings call that he thinks the refinancing business can stay strong in 2021. He added that the bank is well positioned to take advantage of the market when more people start buying homes. That's important because it's still hard to say when commercial loan demand will start to pick up to sufficient levels again.

Citizens Bank has also been strong on the expense front. Its efficiency ratio, a measure of a bank's expenses expressed as a percentage of revenue (lower is better), was 55.2% in the third quarter and 57.3% for the first nine months of 2020. That is the best among its peer group. Management has also said it is going to continue to focus on efficiency initiatives in 2021.

The credit question

Some investors may still have credit-quality questions with the bank. The origin of Citizens Bank dates back to the 1800s, but in 1988, it was acquired by the Royal Bank of Scotland (RBS). After the Great Recession (2007-2009), RBS would eventually spin it off. Then Citizens did another initial public offering (IPO) at the end of 2014. When I spoke to Van Saun not too long ago, he said that, after the IPO, the bank was underleveraged and had to grow the balance sheet. Whenever a bank grows quickly, investors and analysts are always going to be concerned about credit during a downturn.

Currently, the bank has a higher amount of non-accrual loans than its peers. Typically, those are loans that haven't received a payment from the borrower in at least 90 days. Non-accrual loans as a percentage of total loans at the end of the third quarter were 1.03%, up more than 63% from a year ago. Citizens also took a similar credit provision (money set aside for potential future loan losses) in the third quarter as it did in the second quarter, which is a slightly different route from most of the industry.

But net charge-offs (debt unlikely to be collected) were stable through the third quarter, and management expects to see non-accrual loans decline and to release reserves in the fourth quarter. That means the bank must feel good about its credit position. This could in fact be a big opportunity for Citizens to show that it has lent prudently.

Prospects for 2021

Although credit should still be watched carefully, Citizens appears to have some good tailwinds heading into 2021, including a strong mortgage business and continuing improvement to its efficiency. The bank will also likely look to buy back stock should regulators allow large banks to do so. If Citizens can come out of the coronavirus pandemic with its credit quality intact, that could give investors the confidence they need to come up with a valuation similar to or even above some of its peers.