Citizens Financial Chief Favors a Different Kind of M&A

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It would seem very tempting for Citizens Financial Group in Providence, R.I., to pursue an acquisition.

After all, growth prospects are tight for all banks, rivals such as BB&T and KeyCorp are expanding in the Northeast through M&A, and the $138.2 billion-asset Citizens can spread its wings now that it is several months fully separated from its former parent company, Royal Bank of Scotland.

But Chairman and Chief Executive Bruce Van Saun put the kibosh on that suggestion Friday. The bank will continue to plug away at its turnaround plan, spend its money on recruiting lending talent, and steer clear of deals this year, he told analysts.

"We are still a work in progress," Van Saun said. "It would be a mistake to get distracted and start running off [doing deals]. I think once the bank is running better and achieves some of that potential [growth] organically, then we can start to look at the possibility. [We] want to dip our toe in the water gradually before we run out and do anything big."

Van Saun is sticking with his game plan of hiring more commercial, middle-market and mortgage loan officers to deliver stronger revenues. As a result expenses are likely to rise 2.5% to 3% this year. Investors reacted by sending Citizens' stock down roughly 3% to $20.66 a share.

Scott Siefers, a principal at Sandler O'Neill, said the stock dip is a function of the outlook on expenses and a rise in overall credit costs.

Citizens' provision for credit losses rose 26% to $91 million in the fourth quarter compared with a year earlier. The majority of the provision reflects a reserve build in excess of net chargeoffs.

"It's prudent and it's not reflective of any credit issues, but it will cost money," Siefers said.

Citizens seems less exposed to a drop in oil prices compared with its peers. The bank has not disclosed the amount of reserves it is holding against its energy portfolio. With a total energy book of just $1.6 billion, roughly $700 million of its portfolio is in two areas vulnerable to swings in oil prices - oil-reserve-based lending and loans to oil-field-services companies.

"We're adequately reserved," Van Saun said in an interview after his conference call with analysts. "We have a lot of small loans to a number of borrowers and we've been diligent in how we've underwritten those and in how we've structured those loans, particularly in reserve-based lending."

Citizens also laid out in some detail in supplemental materials the impact of any rate hikes in the year ahead. With the current market turmoil, a rate hike seems less likely, which could mean further expense-cutting.

"It would be much easier for the market to digest higher expenses if the rate outlook were more accommodating," Siefers said. "Even though they're doing a great job controlling what they can, on loan growth and fees, it would be easier to absorb higher costs if the [net interest] margin was expanding more meaningfully."

The December rate hike created a $40 million to $50 million "tailwind," for the bank, Van Saun said in the interview.

"If we don't get that second tailwind, we'll find ways to grow loans a little faster or offset it on the NIM."

Citizens has done plenty of heavy lifting by getting its risk profile, expense base and capital base in order, but the bank's profitability is still below where the bank would like it to be, Siefers said.

Citizens reported an 8% jump in fourth-quarter profit to $221 million, or 42 cents a share, compared with a year earlier. Revenue rose 2% to $1.2 billion. Citizens' net interest income rose 4% to $870 million. Net interest margin rose one basis point to 2.77%.

Its noninterest expense of $810 million was 2% lower than a year earlier but modestly higher than in the third quarter due to costs associated with its efficiency initiatives.

The bank achieved strong loan and fee growth year over year.

Total loans and leases rose 7% from a year earlier, to $52.7 million. Noninterest income also rose 7% to $362 million, driven by higher service charges and fees. However, capital markets fees plummeted 29% to $15 million.

"We had expected to do even better but the leverage credit markets became challenged during [the fourth quarter], disrupting some of our capital markets pipeline," Van Saun said.

On the consumer side, Van Saun said in an interview that the bank has had a strong response to a student loan refinance product, though in November it introduced loan-modification options for qualified students who are struggling to make payments.

The bank also has high expectations for its wealth management business after hiring John Bahnken, a former executive at Bank of the West and Bank of America, as president of the division in October.

Citizens was largely a neglected franchise when its parent RBS had to pare back after the financial crisis, whittling down the bank's assets and exposure to real estate.

The bank had been in a downsizing mode for several years before Van Saun, the former chief financial officer of RBS, took over in 2013 with a growth strategy and turnaround plan. The bank reported its first stand-alone earnings in the third quarter of 2014 following a partial initial public offering that year. It became a fully independent, publicly traded company in November.

"We continue to focus on putting our capital to work," Van Saun said. "If we do that and keep net interest margins stable to improving, we'll get good revenue growth, and the key is to have a nice spread and deliver that operating leverage."

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