Pressed for time and want to analyze a bank like a pro quickly? Let me show you how. I will be using Citizens Financial Group (CFG) as an example to explain the process.

Basics

Banks fundamentally differ from nonbanks. Banks will take on liability if they can find financial assets to invest in that yield a higher return than the cost of the liability. Also, while nonbanks can operate with negative equity and few long-term assets, banking supervision requires maintaining a certain level of equity. Hence, analyzing banks is fundamentally different from analyzing nonbanks. This makes it challenging for retail investors.

Key Metrics

Professional bank analysts use a plethora of metrics to analyze banks. The list is so long that it becomes overwhelming. Here are the important ones I use.

Return on Risk Weighted Assets

What are the benefits of RoRWA?

• Due to the risk weighting of assets, RoRWA allows for a like-for-like comparison of banks irrespective of asset mix.

• Excludes the impact of taxation in various jurisdictions.

• Excludes one-time charges in banks.

• As one can see, banks with higher RoRWA are assigned a higher P/B. Making RoRWA a very valuable metric. Note: C has other regulatory issues, and thus, C is assigned a lower P/B. However, the market assigning a higher P/B to JPM, MS, and GS makes complete sense.

• Rule of thumb: Ideally, one should invest in banks with RoRWA greater than 2% if no other issues—like what is publicly known at C—exist.

• CFG has a lot of improving to do.

Modified ROA and Cost of Liabilities

Here is a cool trick. If a bank’s modified ROA falls below the cost of liabilities, the bank is pretty much in big trouble. Let’s calculate this for CFG. The numbers are in millions other than percentages.

Net Interest Margin After Risk Costs

This metric tells us how much an increase in net charge-offs will cause issues for a bank. For instance, CFG’s net charge-offs for 2024 were 0.52% (10K PDF Page 53), and its NIM was 2.84% (10K PDF Page 43). Hence, CFG’s NIM after Risk Costs was 2.32%. Put another way, charge-offs will need to increase by four and a half times (2.32 / 0.52) for CFG to have issues.

Noninterest Income

CFG’s noninterest income is 30.6% of total revenues. On the surface, it may look like CFG is well-diversified. However, the noninterest income fees are tied to the loans. Capital market fees are only 6.3% of total revenues. It is always prudent to check the breakdown of noninterest income. Why?

This income will help provide a buffer during a momentary run on deposits. That said, CFG is a bank, basically performing a bank’s core function. Noninterest income becomes important for the big boys. Refer to 2024 10K PDF page 144 for a breakdown of CFG’s noninterest income.

Loan-to-Deposit Ratio

For CFG, the loan-to-deposit ratio is 81.1%. This implies that CFG has 18.9% of customer deposits available to make other loans. Hence, CFG has enough lower cost deposits available to make new loans.

Basel III Risk-Based Capital and Leverage Ratios

As you might have guessed, a lot of new regulations and metrics were put in place after the GFC under Basel III. The conundrum for regulators is which ratio to fix: Common Equity Tier 1 (CET 1) or Leverage Ratio?

CFG’s RWA/Total Assets is 152%. WOAH!!! Anything over 70% is pretty darn risky. CFG has huge amounts of risk on its books.

As the metric is greater than 33%, the focus should be on the CET1 ratio; simplistically, they need to hold more capital.

CFG is mandated to keep its CET1 ratio above 9.0% to be able to distribute capital. CFG’s CET1 ratio is 10.8%—increased from 10.6% from 2023. See what they focused on fixing? Also, CFG’s subsidiary CBNA is mandated to keep its CET1 ratio above 7.0%. CBNA’s CET1 ratio is 12.3%—increased from 11.3% from 2023.

Simplistically, the dividends are safe for now.

Valuing CFG

1. Return on Equity (ROE) = 6.2% or Growth / (1 - Payout Ratio).

2. Normalized Net Income = Book Value of Equity x ROE = 24,254 × 0.062 = 1,504 million.

3. Value of Equity = (Expected Dividends Next Year) / (Cost of Equity - Stable Growth Rate) OR
   = (Net Income * Payout Ratio) / (Cost of Equity - Stable Growth Rate)
   = (1,509 × 0.55) / (0.09 - 0.03) = 13,833 million.

4. The current Market Cap is 17,790 million. Hence, this makes CFG overvalued by 22%.

I leave it up to you to play around with the assumptions like payout ratio, cost of equity, and stable growth rate. As you change the assumptions, the value of equity will change and thus will the interpretation of overvaluation or undervaluation.

Circling back to RoRWA. CFG’s RoRWA of 0.57% is abysmal. As a retail investor, you would have just stopped there and moved along. As we saw along the way, CFG has taken on too much risk, and based on my assumptions, it is overvalued.

See, I promised you would get to cover all the bases pretty quickly without being a rockstar banking analyst.

Random Thoughts

• I wrote an email to the board of TSCO in good faith on Friday morning, highlighting my concerns about the issues I highlighted in my Wednesday article and then the Beneish M-Score boomshell. I didn’t want to give the media or short sellers a chance to create a circus. I gave them a heads-up on what I had discovered. Now, it is for the board to decide what they want to do. Unlike short sellers, I don’t take positions before publishing an article. Governance rules here are strict, and you can check them out in the “About Us” page.

• A subscriber recently wrote to me and said she liked two of my articles from last year. I know they were “reading comprehension and accounting” cool. Check them out.

  • WING. (Free). Down 50% since I warned.

  • CAVA. (Paywall). Down 48% since I warned.

• Come on, boys and girls, if you can pay $9 for a dozen eggs, you sure can afford $30 per month for my premium stuff.