For several years now, management at the $183 billion-in-assets Citizens Financial Group in Rhode Island has hoped for a rerating of the bank's stock. A rerating simply means that investors are willing to pay a higher price for shares. Citizens' valuation has long trailed those of its peers, but is this lower valuation still warranted?

Perhaps a rerating is finally on the way. Let's take a look.

The lower valuation

Ever since it was spun off from the Royal Bank of Scotland in 2014, investors have been reluctant to buy the hype in Citizens, frequently assigning the stock a lower valuation than those of its peers. Here valuation refers to the bank's price-to-tangible-book-value ratio, which is a bank's current stock price divided by its equity minus goodwill and intangible assets.

Bank Price/Tangible Book Value*
Citizens Financial Group (CFG -1.28%) 138%
Fifth Third Bancorp (FITB -0.95%) 165%
KeyCorp (KEY -0.75%) 148%
M&T Bank (MTB -0.46%) 193%
Regions Financial (RF -1.13%) 179%
PNC Financial Services (PNC -1.25%) 184%
US Bancorp (USB -0.81%)  226%

Data source: Bank financial statements. *Ratio figure is based on closing stock prices on March 26.

There are certainly reasons why investors are assigning the bank a lower multiple. Citizens currently trails its two closest peers in terms of valuation -- Fifth Third and KeyCorp -- when you look at its deposit base, a key metric that bank investors watch. At the end of 2020, Citizens had a total cost of deposits of about 0.19% at the end of 2020. Meanwhile, Fifth Third and KeyCorp both had total costs of deposits of 0.08%.

Deposits are important, because the cheaper the deposit costs, the more profit banks can typically make on loans. Investors also want banks to have a sticky deposit base so that when interest rates rise, depositors don't leave the bank for higher yields elsewhere.

Picture of Citizens Bank branch.

Image source: Citizens Financial Group.

Citizens also trails Fifth Third and KeyCorp on a key credit quality metric called the net charge-off (NCO) ratio, which bank investors also watch closely. The bank's NCO ratio is a good measure of likely loan losses expressed as a percentage of total loans. Citizens had an NCO ratio of 0.61% at the end of 2020, while Fifth Third's was 0.47% and KeyCorp's was 0.53%, so all three have fairly similar NCOs. All three banks were also fairly similar in terms of their non-performing loans as a percentage of total loans, which shows how many loans are in danger of becoming charge-offs.

Citizens also had slightly worse profitability than Fifth Third and KeyCorp in 2020, but not by much. Citizens did, however, have a superior efficiency ratio -- expenses expressed as a percentage of revenue, so lower is better -- meaning it managed its expenses better in 2020.

What to get excited about

Citizens has some nice tailwinds going for it this year. In 2019, the bank began another efficiency program to find expenses it could eliminate and add revenue in order to increase its pre-tax profits. The bank had achieved about $300 million in pre-tax benefits at the end of 2020, but it expects to see another $125 million in pre-tax benefits by the end of this year. This will keep driving down Citizens' efficiency ratio, which is already better than Fifth Third and KeyCorp's. The bank has set a target of 55% for its efficiency ratio, which would be very strong for a bank of its size.

Citizens is also in the process of building out a national consumer bank. The bank has been growing its point-of-sale business, called Citizens Pay, and plans to build it out all over the country. The program essentially extends a digital line of credit that allows consumers to pay for products with fixed monthly payments. It also allows merchants to customize financing solutions in order to drive more sales and allows customers to use the same lines of credit for repeat purchases so they are not dealing with multiple credit applications or loans.

Citizens has been making headway with the program, gaining partnerships with retailers like Apple, Microsoft, and BJ's Wholesale. It also thinks it can grow the concept into the health and fitness verticals. On its recent earnings call, Citizens said it nearly tripled the non-Apple part of its point-of-sale portfolio. These loans have a high interest rate.

This is intriguing because it means there is the potential for Citizens to build its consumer bank into the kind of fintech model that has garnered high valuations from investors, who have favored companies like LendingClub, SoFi, Paypal, and others. Contrary to what many investors might believe, a large traditional bank like Citizens has more than enough resources and capabilities to build any kind of technology that a fintech can, not to mention the stability of a large banking operation behind it.

LendingClub and SoFi boast having (or soon reaching) 3 million members -- but Citizens Pay has served 5 million customers since its launch in 2015. There are some other banks doing point-of-sale lending, but Citizens has a great consumer product set to complement its point-of-sale operations, including home mortgages, student loans, and auto loans. It would be very exciting if Citizens could really integrate all of these consumer products under one umbrella and create a sleek digital experience. If it can build a machine that not only gets customers to use Citizens Pay for repeat purchases, but also cross-sells more traditional consumer products to customers, the bank could really stand apart from its peers and differentiate itself.

Will there be a rerating? 

Management has believed for a few years now that a rerating is warranted, and I certainly think one is coming. Given that a lot of the fundamentals in its business are roughly in line with or better than those of some of its peers, and the potential around the digital consumer national bank, I certainly think Citizens should trade at a valuation more in line with that of KeyCorp or Fifth Third.

Citizens' stock currently trades around $45 per share. If the bank were to trade between Fifth Third and KeyCorp's current valuations at, say, 156% of tangible book value, Citizens' stock would trade for about $51 per share. But again, I think Citizens would like to trade closer to some of its peers, and eventually closer to the middle of its peer group -- so in this case, I would watch where it trades relative to its peers, as opposed to just the stock price.