Illustration: Andrew Archer
On October 18, Citizens Financial reported strong third-quarter results. For the first nine months of 2019, earnings per share came in 10% higher than for the same period in 2018, with revenues 7% higher.
As well as growing revenues, the firm has been buying back shares. Tangible book value per share was up 14% to $31.48, implying a modest premium in the share price of $35 on the day of the results, since rising to $38 as Euromoney went to press at the end of November for a premium of 1.2 times book.
The bank reported a return on tangible common equity for the first nine months of 12.7% on an efficiency ratio of 58.9%, with a return on assets of 1.1%.
This is all good, solid stuff from the 13th largest bank by assets in the US.
Most analysts had sharpened their pencils to note down any pointers on the outlook for net interest margins amid the Federal Reserve’s mid-cycle adjustment. But chief financial officer John Woods drew their attention to record fee income of nearly $500 million for the third quarter and $1.38 billion for the first nine months, up 18% on the first three quarters of 2018.
Citizens Financial has been on a mission to reduce its dependence on interest income, which still accounts for over 71% of revenue, down from 74% one year ago. On the commercial banking side, Citizens has been expanding in loan syndications and capital markets, as well as in global markets and is also building its capabilities in treasury management.
Thanks to a couple of recent bolt-on acquisitions it is also growing M&A fees, which were 11% higher than a year ago.
These strategic initiatives and others on the consumer side, in wealth management and mortgages, are being self-funded.
The bank has a 10.3% common equity tier-1 ratio, strong among its peers. It has nudged its loan-to-deposit ratio down to 94.5%, from 98% a year ago, by growing deposits faster than loans.
Chief executive Bruce Van Saun pointed to the bank’s strong credit metrics, with non-performing loans of just 0.67%, down from 0.73% in the third quarter of 2018 and a 159% coverage ratio, up from 149% one year ago.
Van Saun also noted an important anniversary for the bank, with the deadpan observation that: “It’s been quite a journey.”
Five years have passed since RBS, then still struggling to rebuild capital and assuage competition authorities in the wake of its crisis-era bailout, floated its US retail arm, Citizens Bank, on the New York Stock Exchange in September 2014.
It was one of the largest ever banking IPOs, bringing in $3 billion for RBS, which sold 25% of its stake in the Rhode Island-headquartered institution it had acquired in 1988.
The IPO was a key step for RBS in restructuring its finances and its business portfolio. But, for all its size, it did not feel like a landmark transaction at the time in Citizens’ home market.
Remember that many of the smaller banks already have a premium built into their share prices based on the possibility of them being taken over. You really do have to ask what is the point of paying a big premium for what may be yesterday’s model- Bruce Van Saun
The Citizens IPO was completely overshadowed by the $25 billion offering for Alibaba, which took place in the same month. That flotation only underlined that Citizens was an unproven recovery story being spun out of a troubled parent during an uncertain economic recovery into a banking market beset with new competitors.
During the roadshow it became evident that investors were not convinced of the capacity of a new Citizens management team to more than double its return on equity from under 5% to over 10% in the next few years.
The new team had good intentions. It was ambitious to grow the fee-earning side of the business, looking beyond the staple mid-market customers seeking bilateral credit and hoping to serve larger and better-quality corporates not just with loans but also premium offerings such as cash management, capital markets, interest-rate and FX hedging.
But the problem was that all these capabilities had been housed inside RBS, and Citizens would now lose access to them. The IPO was just the first step to a rapid and complete disposal.
Bookrunners Morgan Stanley and Goldman Sachs advised RBS to cut the price of the deal to the bottom of the indicated range. The whole market knew that RBS was under pressure to sell down below 50% by the end of 2016 to comply with conditions set on its bailout, to repay some of that injection of state funds and to improve its own ratios by deconsolidating the Citizens balance sheet.
It was not just the certainty of new supply that worried potential equity investors. It was not at all clear how Citizens might stand on its own feet outside the larger UK group.
Citizens had gone on a wild two-decade long acquisition spree under RBS ownership, acquiring 25 banks across New England, the Midwest and mid-Atlantic, growing from a small local retail bank in a small state, with just 29 branches and only $1 billion of assets at the start of the 1980s, into one of the largest US retail bank-holding companies.
By the start of the financial crisis it was running a $170 billion balance sheet.
In the immediate aftermath of the near collapse of RBS, Citizens had been forced to shrink. It exited certain geographies – Chicago, Indiana, Long Island and Westchester County – and started to transform its business. In the locations where it stayed put it now had to integrate IT systems among acquired banks – work that should have been done during its buying spree – and shift them onto unified operating platforms.
Like its parent, Citizens had become too dependent on wholesale funding and now had to build deposits instead, ideally low-cost and stable retail deposits in checking, savings and money-market accounts. That required it to invest in technology for the retail bank even while striving to cut costs.
It also needed to change the composition of its assets, getting out of riskier loan types and reducing exposure to now non-core industries while finding new sources of loan growth instead in segments such as mortgages, home equity loans, student loans (where it specializes in refinancing once students have jobs and improved their credit profiles) and auto loans.
It has also developed a specialization in merchant finance, for example providing loans to consumers buying iPhones. At the end of October this year, Citizens announced a new consumer finance package for Microsoft’s newly launched Xbox All Access programme, which will be delivered to customers buying through Amazon. It may yet be a new model for consumer finance, bringing together manufacturer, lender and retailer.
Even five years on from its IPO, Citizens Financial still faces questions over its loan growth in these newer segments and worries that through negative selection – lending to borrowers that more established and experienced banks have turned down – it may be acquiring earnings today while storing up trouble for the years ahead.
It’s one of those ritual questions in earnings calls and analyst presentations, and the pat answer is that, for all this supposedly rapid loan growth, the bank’s balance sheet, at just over $161 billion today, is still smaller than at its peak 12 years ago.
In the spring of 2014, and still under RBS ownership, Citizens had failed the Federal Reserve stress test. This did not make headline news. Citigroup also failed, creating an anxious few weeks for Citi’s still-new chief executive Michael Corbat. And Citizens had company in the shape of HSBC and Deutsche Bank. But investors remembered this during the IPO pitch, even though Citizens added to its capital before the flotation.
Large bank IPOs are rare. Trade sales are the usual choice for sellers. But even though RBS’s advisers were supposed to be running a dual-tack process and rumours sometimes surfaced of potential interest from Asian and even Canadian banks, no offers ever became public.
One of the biggest IPOs in the history of banking only went ahead because the seller had no other choice. It was not a promising start.
Citizens is thus a case study in banking recovery in the US. How has it done, after such an uncertain debut? Euromoney asks Van Saun.
Van Saun has had a storied career. As the financial crisis hit, he was chief financial officer and vice-chairman of Bank of New York Mellon and renowned for having steered those two predecessor banks through their merger. In 2009, then-RBS chief executive Stephen Hester recruited him to be his chief financial officer through the now state-owned bank’s post-bailout turnaround.
The hire of a big-name US banker seemed like something of a coup. Van Saun toiled for four years in London, until RBS asked him to become head of its US subsidiary in 2013 and get it into shape for its coming flotation. This gave him the prospect of finally becoming chief executive of a large bank, one which by then had assets of $120 billion.
What did he find?
“The good news was that Citizens had a very decent footprint covering 25% of US GDP and quite an affluent part of the country with a good mix of businesses,” Van Saun says. “But in getting it back on its feet RBS had had to shrink its assets, and that didn’t leave much money for investment in new capabilities. The raw material was there, but we hadn’t been seizing our opportunities.”
Bruce Van Saun
The decision to go for an IPO rather than a trade sale was pivotal in reinvigorating the bank and, in the first instance, its leadership.
Citizens would have to present itself as a growth story, a vigorous entity. This would be a big change from running a division of a large international bank, where executives essentially had to keep the lights on and not mess up. There would be much more pressure to perform and intense scrutiny over delivery against promised targets.
Of the 11 original members of the executive committee reporting to Van Saun when he first arrived in Rhode Island, only two remain today. He jokes that he regularly reassures them that still being there shows they have made the grade. Nine have been brought in.
Van Saun recalls hiring Donald McCree, a 30-year veteran of JPMorgan and one of Jamie Dimon’s top lieutenants, to head commercial banking.
“Don had decided to leave JPMorgan and take some time before his next move, perhaps setting up his own hedge fund,” says Van Saun. “So I had a brief chance to intercept him. I pointed out that Citizens was not going to be sold to another bank. Going public, it would be a new company, and that would give us a white canvas that we could paint. Didn’t that sound a very rewarding chance at that point in our careers?”
RBS sold Citizens at close to book value. Investors may have reasoned that it would eventually be acquired anyway – and many presumably still think that. But the new leadership team now had the chance to build something.
Its growth in commercial banking, a much smaller part of the Citizens story when Van Saun first arrived than it is today, is telling.
Van Saun says that when he arrived: “We had a good corporate customer base, but weighted towards mid-market companies with between $25 million to $500 million in annual turnover. We wanted to target what we call mid-corporates, with $500 million to $3 billion in annual revenues. And while we did have coverage of some of these companies, it was not at all systematic.”
There were clear reasons to target these customers. First, they tend to be higher-quality credits than mid-market companies to lend to. Second, they want much more from their banks than business accounts and loans.
“They have much bigger wallets for financial services and want much more than bilateral lines of credit,” says Van Saun. “They want loan syndications. They will pay for access to capital markets, bonds and M&A and the whole cash management service, including handling operating cash, providing trade finance and then, related to that, FX and interest rate hedging.”
However, even when Citizens had presented the front-office face to corporations requiring these services, most of this business was handled by the global markets division of RBS. Citizens would need to invest in its own product capabilities and do this sophisticated business itself. Van Saun claims Citizens has managed to do this.
“We have hired in mostly people that have worked at the US mega banks or super-regionals,” he says. “We now have one of the best pound-for-pound FX and rates hedging businesses in the market and can do more for these mid-corporate customers today than we did as part of RBS. We bring a lot of intellectual firepower around options trading and in tailored research on their key currency pairs, and are now at the point where we can win jump-balls even against the mega-banks like JPMorgan and Bank of America in competing for their business.”
Its smaller relative size and closer proximity to customers presumably helps here. Citizens can have its most senior people working with mid-corporates, while their equivalents at JPMorgan, Bank of America and Citi will mostly deal with the largest multinational corporations. The most senior executives at those banks won’t devote too much attention to a $1 million interest rate swap for a large regional company.
“You cannot cover mid-corporates just with generalist local bankers,” says Van Saun. “You need industry experts who know their sectors nationally.
“But certainly, local knowledge helps you win corporate customers. Your bankers go to the same chambers of commerce meetings as their executives, pull for the same local sports teams and all that. However, if you lack product capability, these companies can soon outgrow their local banks. We want to be able to tell them: ‘You need us in your facilities now that you’re growing more internationally, need more complex cash management and FX hedging.”
Competition for this kind of business is intensifying. Sit down with the top executives of the largest US banks and they will all talk about putting more bankers in second-tier US cities beyond the largest regional business capitals. Even Goldman is targeting the middle market now.
And it’s not just banks. While Citizens is proud of its achievements in arranging syndicated loans for its target corporate customers – typically ranking anywhere from fifth to eighth in league tables, while ranking 13th by asset size – it is having to work increasingly hard to protect what should be its natural turf.
“As well as competition from the mega banks, we also face increasing competition from non-banks in lending,” says Van Saun. “A lot of the big private equity firms have set up large credit funds that are bidding for market share. If a borrower is looking for a $150 million term loan, a regional bank like ourselves might typically suggest a syndicated facility with maybe three other banks. But the credit funds will say they can take down the whole loan, sometimes at lower terms and often with looser covenants. A lot of customers will be open to that.”
Citizens has been around for 190 years. It has served some companies through several generations of family ownership. So, it has cards to play, especially given prevailing economic uncertainty. US bankers tend to agree that the economy remains in good shape and that more interest rate cuts are now unlikely. But anecdotal evidence suggests that the animal spirits of executives of mid-size companies have been more affected by trade tensions than those of their larger peers. They are more cautious.
“We can point out that we are a relationship-oriented institution,” says Van Saun. “We can provide cash flow-based lending, but also asset-based lending, which may become useful to companies in a downturn. It is not clear how some of these large credit funds will behave in tougher times.”
Central to all these efforts to wring revenues from larger corporates is the cash-management business.
As it tidied up after years of acquisitions and subsequent retreats, Citizens upgraded these capabilities in the year before Van Saun took over as head of the bank. That left it with a good cash-management platform for smaller mid-market customers, but one that did not work so well for larger mid-corporates. And so management decided that it must re-platform once again.
Today, two thirds of the bank’s corporate customers have transitioned onto accessOPTIMA, Citizens’ new real-time treasury management platform with migration due to complete by the end of this year.
“There is a lot of change coming to payments, and we knew we had to up our game,” Van Saun explains. “It is a once-opaque area becoming increasingly transparent. There was a time when customers didn’t know what FX spreads were being taken by custody banks, for example. Now you can see that on a screen. We have built a payments hub to optimize our customers’ cash-flow streams and, for example, help them to decide when it is better to pay for a fast payment, or OK to rely on ACH [automated clearing house].”
Citizens is working with a cloud-based vendor and hopes that new technology will help it provide customers with cash-management services that make their lives easier.
“It used to be that most banks went with the largest technology vendors for cash-management systems and then had to keep in step with each version upgrade, and so did not do too much customization for fear of being left behind,” Van Saun says. “Now, banks might run these hubs more like software-as-a-service, with a core platform that remains current but that can also accommodate particular bells and whistles. So, our payments hub will figure out how best to route customers’ payments while also giving them customized data reports or other specific add-ons.”
Given the increasing competition from large banks and non-banks for its target corporate customers, Citizens has performed well in core areas such as cash management, lending, capital markets and global markets. It has also built new revenue streams.
The bank had no M&A business when Van Saun arrived. Today, it has 65 M&A professionals who are all, it seems, flat-out busy.
It has built this advisory capability on top of the Citizens Capital Markets broker-dealer platform, first established in 2016, through acquisitions of M&A boutiques.
In 2017, Citizens acquired Western Reserve Partners, an advisory firm based in Cleveland Ohio with a focus on middle-market clients, which had expertise in industrials, business services, consumer, healthcare, real estate and technology.
The bank continued to hire M&A bankers and industry coverage experts and then, in February this year, it acquired Bowstring Advisors, an Atlanta-based advisory firm with an industry focus complementary to Western Reserve.
McCree emphasizes the importance of this acquisition: “The addition of the highly regarded Bowstring team more than doubles our M&A advisory business with deep knowledge in key industry sectors such as healthcare, technology and business services, while strengthening our coverage nationally and further enhancing our ability to deliver for our clients.”
The mention of a national ambition was very deliberate. Van Saun tells Euromoney that Citizens could do with another one or two such acquisitions – if ones can be found that line up with its industry verticals.
In Boston in November, CFO Woods outlined this plan to bank analysts: “Our aspiration is to grow fees as a proportion of overall revenue from 30% today up to 40% – and that’s hard to do organically. We continue to focus on bolt-on acquisitions.”
He offered the usual provisos: “We are pretty disciplined. We do a lot of shopping before we buy anything.”
Our aspiration is to grow fees as a proportion of overall revenue from 30% today up to 40% – and that’s hard to do organically. We continue to focus on bolt-on acquisitions- John Woods
The bank needs to see a good cultural fit with the partners of any advisory firm willing to sell at a reasonable price. But it is not done yet.
As talk turns to M&A, it is inevitable to ask what role Citizens Financial might play beyond such small bolt-on acquisitions.
It is a very different bank today than the one that launched its IPO in 2014. Citizens has impressed customers, as seen not just in league tables but also net promoter scores. In 2019, it ranked fourth in the JD Power home-mortgage satisfaction survey, up from 10th in 2018 – a still quite new business that it has built organically.
The bank makes all the right noises about investing in digital technology for consumers and turning branches into advisory centres.
Investors are also seeing the benefit in a return on equity above 12.5%, while the shares have put on more than 75% in five years, from an IPO price of $21.5 up to $38 in mid November 2019.
Citizens has been a classic self-help story. Earnings calls tend to focus on its so-called TOP programmes. TOP stands for ‘tapping our potential’, and these annual programmes target cost-cutting and redeployment of a portion of such savings into initiatives to build revenues.
Right now, it is into TOP 6, a two-year project targeting a $300 million to $325 million pre-tax run-rate benefit by the end of 2021.
Woods told analysts: “We are targeting transformational change with technology, re-organizing thousands of people into small, agile pods and moving away from being a waterfall company with migration to the cloud and agile development.”
That’s nice. But investors have been thinking about other things, ever since February when BB&T and SunTrust announced a merger of equals that would, if it goes through, create a bank with $442 billion of assets, the sixth largest in the country. It will be the biggest bank M&A deal in the US since the financial crisis.
Van Saun remembers the day well: “Every bank CEO’s phones suddenly lit up as the investment bankers who had been asleep for years woke up and told us: ‘This affects you, let us come in and show you our chess board for potential moves.’”
The deal will create three super regional banks in the US, with from $400 billion to $470 billion in balance sheets in US Bancorp, PNC and the newly combined bank, which is to be called, for reasons that Euromoney can’t quite follow, Truist.
Beneath them will be a range of banks with balance sheets of between $140 billion to $175 billion, of which Citizens is one with a certain momentum.
“We cannot spend more than JPMorgan or Bank of America on technology or brand,” says Van Saun. “So the question becomes are we capable and nimble enough to compete at scale.”
Having seen at first hand the challenges of making a large merger work between Bank of New York and Mellon Financial, Van Saun does not sound keen to repeat the experience.
“While I do see more consolidation coming among smaller financial institutions, I don’t think our investors would welcome the idea of us buying another sizeable deposit-taking bank. Remember that many of the smaller banks already have a premium built into their share prices based on the possibility of them being taken over. You really do have to ask what is the point of paying a big premium for what may be yesterday’s model.”
Never say never, of course, and if Citizens itself becomes subject to an offer rather than making one, its management and board would have to consider the best interest of shareholders.
For now, Van Saun says: “We can build more franchise value organically.”