Citizens Financial Group Inc. has formed a subsidiary to provide subordinated debt financing for businesses with annual sales between $5 million and $100 million.

The subsidiary, Citizens Capital Inc., will finance management or employee buyouts, acquisitions, expansion and capital investment, and generational transfers.

The holding company subsidiary, managed by Robert E. Garrow and Gregory Mulligan, will offer mezzanine level financing for privately held companies located around its Boston headquarters.

Mr. Garrow said small business market has been underserved and represents an opportunity for the company to diversify beyond its base of residential mortgages.

"It's part of an effort to transform ourselves from primarily savings banks that we acquired to a full-service commercial bank," Mr. Garrow said.

Banking companies such as Providence, R.I.-based Citizens are forming financing subsidiaries to better compete with nonbank financial companies, which have recently made greater inroads into small-business financing.

Citizens, which has $4.3 billion of assets, will make hybrid debt and equity investments between $1 million and $10 million in companies that want to avoid going public.

"That market has not been served properly by commercial players trying to stretch into mezzanine or by equity players," Mr. Garrow said.

Mr. Garrow said a typical transaction would be a $3 million investment for five years with an 11% interest rate coupled with warrants to purchase shares of the company.

"Because we are part of a bank we have the flexibility not to take a cookie-cutter approach and worry about diluting the return on investment expected by investors," Mr. Garrow said.

The warrants make a deal safer for Citizens, but if exercised they would usually be immediately repurchased by the company or other investors.

Citizens Financial also plans to form a venture capital unit, called a small-business investment company, to make direct equity investments in young companies with high growth potential.

An increasing number of banks putting as much as 5% of their capital in small-business investment companies, which are licensed and regulated by the Small Business Administration.

The Bank Holding Company Act prohibits banks from owning more than 5% of the voting stock of another company, but through small-business investment companies they can hold up to 49%.

Mr. Garrow said he expects the small-business investment company's returns from its venture capital investments to range between 17% and 25%. Last year, the average return nationally for such companies was 8%.

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