Business Context and Reporting Period
Citizens Financial Group, Inc. is a bank holding company operating through Citizens Bank, N.A. and Citizens Bank of Pennsylvania. Its two segments are Consumer Banking and Commercial Banking. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, with balance-sheet comparisons to December 31, 2013.
The company completed its initial public offering on September 29, 2014, after its common stock began trading on the New York Stock Exchange on September 24, 2014. RBS Group remained the majority shareholder. The filing also reflects the June 2014 sale of 103 Illinois branches, related deposits and selected loans.
Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net interest income | $820 million, up 6% | $2.461 billion, up 8% |
| Noninterest income | $341 million, down 11% | $1.339 billion, up 7% |
| Total revenue | $1.161 billion, up 1% | $3.800 billion, up 8% |
| Provision for credit losses | $77 million, down 47% | $247 million, down 29% |
| Noninterest expense | $810 million, up 3% | $2.568 billion, down 63% |
| Net income | $189 million, or $0.34 diluted EPS | $668 million, or $1.19 diluted EPS |
| Net interest margin | 2.77% | 2.84% |
The nine-month 2013 comparison includes a $4.435 billion pretax goodwill impairment charge, which materially distorts reported year-over-year expense and earnings. Excluding goodwill impairment, restructuring charges and special items, nine-month 2014 net income was $573 million versus $502 million in 2013. Third-quarter 2014 adjusted net income, excluding restructuring charges and special items, was $202 million versus $144 million.
- Total assets were $131.341 billion, up from $122.154 billion at December 31, 2013.
- Loans and leases were $90.749 billion, up 6%; growth was concentrated in commercial loans, residential mortgages and auto loans.
- Deposits were $93.463 billion, up 8%, while total short-term borrowings increased to $11.899 billion from $7.042 billion.
- Long-term borrowed funds were $2.062 billion, versus $1.405 billion at year-end 2013.
- Stockholders’ equity was $19.383 billion. Accumulated other comprehensive loss improved to $435 million from $648 million.
- Cash and cash equivalents ended at $2.889 billion. Operating activities provided $1.2 billion, investing activities used $7.4 billion, and financing activities provided $6.3 billion.
- Regulatory capital remained strong: Tier 1 capital ratio was 12.9%, total risk-based capital ratio was 16.1%, and leverage ratio was 10.9%. Pro forma Basel III Tier 1 and common equity Tier 1 ratios were each 12.5%.
Material Changes Versus Prior Comparable Period
- Net income increased $45 million, or 31%, in the third quarter, primarily from higher net interest income and lower credit-loss provision.
- Net income for the nine months increased from a $3.578 billion loss to $668 million, largely because the prior-year period included the goodwill impairment. On an adjusted basis, earnings increased 14%.
- Net interest income benefited from loan and securities growth, lower deposit costs and reduced hedging costs, but loan yields and the net interest margin remained under pressure from the low-rate environment.
- Noninterest income declined in the third quarter because of lower securities gains, service charges and card fees. Nine-month noninterest income benefited from the $288 million pretax gain on the Chicago divestiture; excluding that gain, it declined 16%.
- Credit quality improved. Nine-month net charge-offs fell to $243 million from $386 million, the annualized net charge-off rate declined to 0.37% from 0.61%, and nonperforming loans declined to $1.079 billion from $1.416 billion.
- The allowance for loan and lease losses was $1.201 billion, or 1.32% of loans, compared with 1.42% at year-end 2013. Total allowance for credit losses, including unfunded commitments, was $1.264 billion.
- Consumer Banking nine-month net income decreased 32% to $130 million, while Commercial Banking net income increased 8% to $421 million.
- The company incurred $90 million of restructuring costs during the first nine months and disclosed approximately $121 million of expected total restructuring costs through December 31, 2015. It expected an additional $35 million to $45 million during the remainder of 2014.
Guidance, Outlook, Commentary, Risks and Unusual Items
- No formal earnings or revenue guidance is provided. Management stated that results for interim periods are not necessarily indicative of full-year results.
- Management expected credit charge-off rates to increase modestly in 2015 and 2016 but remain below 2013 levels as recovery opportunities diminish, housing prices stabilize and non-core portfolios run off.
- Management identified the persistent low-interest-rate environment, declining loan yields, deposit pricing floors and interest-rate sensitivity as pressures on net interest income and margins. The balance sheet was described as asset-sensitive, with modeled net interest income benefiting from rising rates.
- Approximately $5.0 billion of drawn HELOC balances and $4.1 billion of undrawn balances were subject to payment resets or balloon payments between October 2014 and December 2017. Management reported favorable early performance from its borrower-outreach and modification program.
- The company had $26.0 billion of unused secured borrowing capacity, including unencumbered securities, FHLB capacity and Federal Reserve discount-window capacity. Unencumbered liquid securities totaled $13.1 billion and available FHLB capacity was approximately $3.5 billion.
- The Federal Reserve objected to the company’s 2014 CCAR capital plan on qualitative grounds. The company could not increase capital distributions above 2013 levels until a new plan was approved. CBNA also required OCC approval for capital distributions through the fourth quarter of 2015 and was subject to remediation requirements related to its financial subsidiaries.
- Material contingencies included consumer-product regulatory matters, possible additional restitution, TCPA and LIBOR litigation, a foreclosure-related investigation, and mortgage repurchase and indemnification demands. Management could not estimate ultimate exposure beyond recorded provisions but did not expect these matters, in aggregate, to have a material adverse effect.
- The company disclosed $55.333 billion of undrawn credit commitments and total off-balance-sheet commitments of $58.077 billion at September 30, 2014.
- Subsequent to quarter-end, on October 8, 2014, the company issued $334 million of subordinated notes and repurchased 14,297,761 common shares from RBS Group for $334 million, or $23.36 per share.
Investor Verification Points
- Reconcile reported earnings with adjusted earnings, particularly the Chicago divestiture gain, restructuring and separation costs, regulatory charges and other special items.
- Assess whether loan growth, especially auto and commercial lending, is generating acceptable risk-adjusted returns as loan yields remain compressed.
- Monitor HELOC payment resets, non-core home-equity performance, TDRs, delinquencies and the adequacy of the allowance for credit losses.
- Verify the sustainability of deposit growth and the effect of increased short-term and subordinated borrowing on funding costs and liquidity.
- Track CCAR and Basel III outcomes, OCC remediation, subsidiary dividend capacity and restrictions on future capital distributions.
- Evaluate ongoing legal, regulatory, mortgage-repurchase and consumer-restition exposures, including matters for which ultimate losses remain uncertain.
- Review the transition from RBS-provided systems and services, including operational, compliance, market-risk and technology infrastructure dependencies.