CFG - The Recovery Of Citizens Financial Group

2023-08-15 18:39:07 ET

Summary

• Year-to-date, Citizens Financial Group has underperformed the S&P 500 and the S&P Regional Bank Select Industry Index.
• The company has undertaken strategic initiatives, including growth in private banking and balance sheet optimization, that may uncover value for skeptical investors.
• Target: $42 per share.

Investors should buy shares of Citizens Financial Group ( CFG ).

Recent bank failures have cast a shadow across the regional banking industry, and Citizens has not been immune to this trend. Down 22% year to date, the firm has significantly underperformed the S&P 500 and the S&P Regional Bank Select Industry Index. As the defunct Silicon Valley Bank ( OTCPK:SIVBQ ) and Signature Bank have become household names, investor confidence in firms such as Citizens, KeyCorp ( KEY ), and Fifth Third Bancorp ( FITB ) has fallen.

The future is quite challenging to predict, and there is likely some truth to Eugene Fama and Ken French's Efficient Market Hypothesis regarding the market's ability to discount public information. However, there are several catalysts that could uncover value and alter the market's perception of Citizens as a dead-end stock.

Strategic Catalysts

Citizens has undertaken a number of strategic initiatives that may generate accretive value for the firm:

1. Citizens Private Bank

The firm has emphasized growth in its private banking service portfolio over the past few years . Throughout 2022 and 2023, Citizens opened private banking centers in Boston, Palm Beach, New York, and San Franscisco. The firm projects that this service line will be profitable by FY2025 and that the Private Bank will have ~$10 billion AUM by early 2026. Should this become a viable service line, Citizens should experience EPS growth.

2. Balance Sheet Optimization

Given the interest rate risks highlighted during the fall of Silicon Valley Bank, Citizens has made a special effort to reduce risk on its balance sheet. The firm's current working capital management plan includes reducing wholesale funding, focusing on consumer deposit growth, and remixing its loan portfolio. Unfortunately, Citizens has not shown much progress towards reallocating its portfolio of available-for-sale securities. Long-dated agency mortgage-backed securities compose the majority of the firm's investment portfolio. Citizens does not make any distinction regarding whether these are commercial MBS or residential MBS, and the firm has taken quite a few unrealized losses on its held-to-maturity MBS portfolio. This has definitely played a part in depressing the firm's share price. If Citizens can effectively rebalance these securities to prevent future liquidity concerns, the share price should rise.

3. M&A Activity

Citizens has undertaken several strategic financial acquisitions over the past few years. The firm has built its capital markets team through the 2019 acquisition of Bowstring Advisors (Atlanta-based M&A), the 2020 acquisition of Trinity Capital (Los Angeles-based M&A), the 2021 acquisition of JMP (San Fransisco-based M&A), and 2022 acquisition of DH Capital (New York-based M&A). These companies have created a network for Citizens to provide full-service debt and equity underwriting. In addition, Citizens acquired HSBC Bank USA in 2021 to increase its consumer banking footprint in the greater New York City area.

Citizens has shown a willingness to pursue strategic acquisitions in the past, and additional accretive M&A activity could improve the firm's stock price. Citizens has cash, but lacks the necessary financing in the current high-interest rate environment. This poses substantial headwinds towards any blockbuster acquisitions, but Citizens could pursue a merger with a firm such as M&T Bank Corporation ( MTB ) or PNC Financial Services Group ( PNC ). This would be similar to the creation of Truist Financial Corporation ( TFC ) via the 2019 merger between BB&T and Suntrust. However, the Citizens merger would hopefully take lessons from problems encountered during the Truist merger.

The proposed merger would optimally create a strong branch network for the new firm to be the premier Northeastern regional bank. This new firm would also be able to consolidate capital markets and private banking services to establish differentiated product lines.

Banking, like many other industries, has shown a trend towards consolidation over the past few decades. Many smaller banks have been de facto takeover targets with larger banks such as JPMorgan Chase & Company ( JPM ) or Wells Fargo & Company ( WFC ) waiting for them to collapse so that they can buy them for pennies on the dollar. Examples include Wachovia in 2008, Washington Mutual in 2008, and First Republic Bank in 2023. The sharks have been circling Citizens since March, and the firm should seek out new defenses for the next liquidity crisis.

Valuation

Companies in different industries require distinct valuation methods. While a discounted cash flow model may be appropriate for firms in high-growth industries, banks are generally valued based on balance sheet multiples. Issues with U.S. GAAP accounting are partially to blame for this distinction, but this is remedied by the fact that the majority of a bank's assets are carried on the balance sheet at their fair values. Therefore, Citizens was valued through a combination of a peer group price to tangible book value multiple and a dividend discount model.

Several considerations were made when selecting an appropriate peer group for Citizens. Market capitalization based on each firm's share price multiplied by shares outstanding was the main criteria applied to potential comparable companies. Moreover, the geographic distribution, total deposits, and number of branches were also considered. A selected peer group of First Citizens BancShares ( FCNCA ), Regions Financial Corporation ( RF ), M&T Bank Corporation ( MTB ), Huntington Bancshares ( HBAN ), Fifth Third Bancorp ( FITB ), and KeyCorp ( KEY ) was created. This seems to be an appropriate peer group given the similarities in each firm's business model and strategic objectives.

S&P Capital IQ provided relevant net interest margin, return on assets, tier 1 capital, and price to tangible book value data. Moreover, the average and median of these values for the peer group was calculated to provide a good relative comparison to Citizens. The results indicate that Citizens is reasonably undervalued. The 1.5 times price to tangible book value peer multiple implies that Citizens is worth $46 per share instead of $31. However, multiples valuation alone is not sufficient to prove whether a firm is fairly valued since forming a peer group is quite subjective.

A dividend discount model was used to find the firm's intrinsic value. Citizens has a history of paying dividends to shareholders, and these cash flows were used to value the firm. The inspiration for using a DDM was taken from David B. Moore, a CFA with Marathon Capital Holdings in San Diego, California. Mr. Moore published a guide on valuing community banks whereby he argues the merits of using a DDM to price bank stocks.

Based on the firm's future discounted dividends, Citizens has an intrinsic value of $42 per equity share. This can be further amended to a target range of $35 to $49 per share, which implies significant upside. With respect to assumptions included in the base-case model, a 9.5% discount rate was used in addition to earnings and dividends estimates taken from CapIQ. Moreover, a second stage growth rate of 1% was used along with a terminal price to earnings ratio of 10.5. Please remember that these are estimates and are meant to illustrate a reasonable base case that does not consider a significantly negative or positive event.

Investment Summary

Citizens has been battered throughout 2023. Much of this has been justified given the perilous nature of regional banks. However, a remarkable value opportunity lurks below this dark surface. Should Citizens capitalize on its strategic growth opportunities, the firm could reassure investors who have been content to place it at a steep discount relative to its peers.

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