Royal Bank of Scotland's plans to sell a portion of its U.S. bank to outside investors seems to be on track, but the timeline has become less certain.

The $122 billion-asset RBS Citizens Financial in Providence, R.I., was recently the subject of acquisition rumors involving two Japanese megabanks. Also, its capital plan was rejected by the Federal Reserve Board as part of the Comprehensive Capital Analysis Review, or CCAR.

The following is a look at how the CCAR failure could influence the partial initial public offering and an assessment of how the bank's potential sale could play out, based on discussions with investment bankers, lawyers, analysts and others in the know.

What does the CCAR failure mean for a partial IPO for RBS Citizens?
RBS is planning to sell up to 25% of its U.S. bank's stock in the second half of 2014 through an initial public offering. The bank is not allowed to discuss the CCAR process, but a Royal Bank of Scotland spokesman said the company is still working toward the same broad timeline for the offering.

RBS has 90 days to resubmit its capital plan; the Fed would have another 75 days to respond. The bank's capital did well in the stress testing, but it failed because of qualitative reasons such as significant deficiencies in its planning process; inadequate governance and weak internal controls around the capital planning process.

The failure, observers say, has the potential to complicate the bank's path to the public offering in a couple ways. It could be a blow to perception of the bank's readiness to stand on its own. Bruce Van Saun, RBS Citizens' chief executive, has already enumerated the steps his team must make before the bank starts its independent life.

The reasons for the CCAR rejection perhaps suggest that more work must be done before RBS Citizens splits from its parent. To be fair to Van Saun, this isn't his first IPO. Prior to taking over RBS Citizens in October, he oversaw the partial IPO of Direct Line, a U.K. insurer RBS owned.

Another observer noted that RBS Citizens is overcapitalized, which could be a negative to IPO investors because of a drag on return on equity. It is unclear what capital ratio the bank is aiming to have at its IPO, but Van Saun said in announcing the CCAR rejection that the plan is to "normalize our capital structure through dividends and subordinated debt exchanges with our parent at the same pace as last year."

Ultimately, the Fed's rejection adds a layer of uncertainty that RBS will likely resolve before moving forward.

"It does throw some doubt on the timing and valuation on the IPO," says one observer. While the IPO remains doable, "it's just maybe later and at a lower valuation."

Is a sale more likely?
Maybe, but not necessarily. RBS has consistently said the IPO is the plan, but like any company, it would consider other options. A serious buyer might be able to get beyond the clandestine nature of the Fed's rejection in due diligence.

In theory, an acquisition would be priced higher than a public offering, but not necessarily in this case. Buyers are incredibly selective right now, and a deal for RBS Citizens would be a massive undertaking. Those forces could drive down the price.

But investors are enamored with banking right now, says Jeff Davis, a managing director at Mercer Capital, and they could buy into the IPO with an expectation of an industry related rise.

Another observer thinks the bank could fetch slightly above book value in an offering or sale. If true, a sale could prevail over a partial offering since it removes a lot of execution risk.

The British government owns 81% of RBS. Would it sell the U.S. bank for "slightly above" book value?
A discounted sale would make a lot of waves, but a premium, even a small one, should be fine. The British government wants RBS to boost its capital and focus on its U.K. business. Selling the bank would efficiently allow the company to repatriate the proceeds and reduce total risk-weighted assets, in effect boosting capital ratios and simplifying its business.

What would U.S. regulators think of a sale?
There haven't been any deals of this size in years, but regulators' treatment of smaller, but similar, deals suggest a heavily scrutinized process.

The largest deal from 2012 — the sale of Hudson City (HCBK) to M&T Bank (MTB) — is still pending following the discovery of compliance issues at M&T.

A foreign buyer would likely slow the process. Spain's Bankia agreed to sell City National Bank in Miami to Chile's Banco de Credito e Inversiones last May. The deal, initially expected to close by the end of 2013, still needs Fed approval.

Though a deal for RBS Citizens would face tough regulatory vetting, it is still doable, says Fernando Alonso, corporate partner and chairman of the Latin American practice group at Hunton & Williams.

"There's additional scrutiny and a great deal of care, but it is still an open environment," he says. "By no means is it shut off."

Are Japanese banks potentially interested in buying RBS Citizens?
Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group have considering bids, according to published reports. Sumitomo didn't return a call for comment; Mitsubishi declined to comment.

Their interest makes sense, though. While the U.S. economy is considered anemic at best these days, it is a smart long-term play for the Japanese banks given their nation's aging population and global conditions.

"The U.S. economy is still better than Europe and way less risky than China," says one person familiar with Japan's banks.

Sumitomo likely wants it more. Its retail banking presence in the United States is limited. It has a community bank in Los Angeles and a trust company in New Jersey. The company reportedly pursued Washington Mutual and Wachovia during the financial crisis. Those institutions went to JPMorgan Chase (JPM) and Wells Fargo (WFC), respectively.

Besides expanding in traditional banking, Sumitomo might also want RBS Citizens to comply with liquidity guidelines being implemented for foreign banks that do things like corporate and investment banking in the United States.

But Mitsubishi has the leg up. It already owns the $106 billion-asset Union Bank in San Francisco. Even though the retail franchises are on opposite sides of the country, there could be opportunities to cut back-office expenses.

Mitsubishi has a slight idea of what it takes for a global systemically important bank to get a deal approved by regulators. In 2012, Union bought the $6 billion-asset Pacific Capital. It was a relatively small deal, but one that provides some context.

"It could even be easier the second time around," says Juliana Balicka, an analyst at Keefe, Bruyette & Woods who covered Pacific Capital and who covers several Asian-American banks.

Could other banks have an interest?
Any large foreign bank that is looking to comply with the Fed guidelines could ponder it, but few would have the stomach or be in a position to go through the regulatory approval process.

Given its presence in the Northeast, Santander would be a logical buyer, but it is likely out because it also had its capital plan rejected by the Fed for qualitative reasons.

U.S. banks like U.S. Bancorp (USB) and PNC Financial (PNC) typically appear on lists of companies that could possibly get a deal done in a "no more big banks" environment, but RBS Citizens' profitability is not strong enough to entice those banks, Mercer's Davis says.

PNC's executives have said that acquisitions are not a focus for now. U.S. Bancorp is already buying RBS Citizens' Chicago branches, and Richard Davis, the Minneapolis company's CEO, says he is not interested in taking on the liabilities tied to buying another bank.

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