Fitch Affirms Citizens Financial Group Inc.'s IDR at 'BBB+'; Outlook Remains Stable
CFG is an indirect subsidiary of the Royal Bank of Scotland Group plc (RBS), rated 'BBB+' by Fitch. Following last year's initial public offering (IPO), and subsequent stock repurchase activity, RBS' remaining ownership interest in CFG has declined to 20.9%. Reflecting the planned separation from RBS, to be completed by year-end (YE) 2016, and the diminishing ownership interest, Fitch has downgraded CFG's Support Rating to '5' from '2' indicating that support can no longer be relied upon. The downgrade in Support ratings had no impact on any of CFG's other ratings as its ratings are based on its stand-alone strength. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
VRs, IDRs and Senior Unsecured Debt
The affirmation of CFG's IDR and VR is driven by the entity's good capital profile, improving asset quality, and attractive deposit franchise in its core operating footprint. Fitch views favourably CFG's capital targets, including a Tier 1 common equity ratio of 11% over the near term. However, over the longer term Fitch expects capital will be managed lower given higher targeted pay-out goals, though the company plans to maintain a cushion over regulatory minimums until its performance is relatively in line with peers. Additionally, CFG's historical loan losses tend to track around the large regional peer averages, but asset quality has improved since the financial crisis.
CFG continues to report good capital ratios with Common Equity Tier 1 ratio of 11.8%, at the end of second quarter 2015 (2Q'15), down approximately 4 basis points (bps) on a linked-quarter basis due primarily to some balance sheet growth. This and other capital ratios compare favourably relative to large regional bank peer averages. As noted, Fitch expects CFG's capital ratios will decrease over time, but believes the company will remain appropriately capitalized for its risk profile.
CFG's asset quality continues to improve in terms of Fitch-calculated nonperforming assets (NPAs) and the steady run-off of non-core assets. CFG's Fitch-calculated NPA ratio at the end 1Q'15 was 2.16%, an improvement from 3.04% recorded at the YE2010. Though improved, CFG's NPAs, both including and excluding TDRs, are moderately higher than the large regional peer average, primarily attributed to large balances of residential mortgage and home equity problem assets, which have improved with higher home prices nationally, and are largely first lien secured.
Additionally, CFG's funding profile is considered somewhat weaker relative to large regional peer averages given a higher loan to deposit ratio, and higher portion of short-term borrowings. However, Fitch notes deposit costs hover around large regional peer averages, and CFG, since becoming public, has demonstrated successful access to the capital markets through recent debt raising activities.
It is also noteworthy that CFG maintains a strong presence in its core operating footprint, ranking in the top three for deposit market share in Rhode Island, New Hampshire, Massachusetts, and Pennsylvania. Such solid positioning in its operating footprint has transitioned into a favorable cost of funds relative to large regional peer averages.
CFG's strengths are primarily offset by its comparatively weaker earnings profile. CFG's reported return on assets (ROA) in 2Q'15 was 56bps, well below the large regional peer average of approximately 100bps. Profitability in the past has been impacted by the lack of investment in the franchise given issues at the parent company.
CFG's profitability continues to lag large regional peers due primarily to lower loan yields, as well as lower relative contribution from fee income lines of business. Further, fixed costs remain relatively high due to the company's sizable retail banking operations. Following CFG's 2014 IPO, management outlined a number of key initiatives aimed at improving profitability. Given the earnings differential between CFG and its large regional peers, Fitch expects CFG's earnings will not converge to peer averages over the near-to-medium term time horizon without a meaningful increase in short-term interest rates. Recent strategic objectives aimed at improving fee income may aid the company's earnings profile over time as well.
Fitch notes that CFG's balance sheet is fairly asset sensitive and well-positioned to aid earnings, should short-term interest rates meaningfully rise. Fitch expects that CFG may be well positioned under a rising rate scenario with a greater ability to manage its deposit costs given the make-up of the deposit footprint; however, there is still a great deal of uncertainty regarding depositor behaviour under higher rates.
As the company continues the process of separating from the Royal Bank of Scotland (rated 'BBB+'), its strategy has shifted. Going forward, CFG's strategy includes greater focus on expanding its consumer lending capabilities and continuing momentum in commercial lending noted above, while at the same time trying to improve efficiencies and enhance returns.
Fitch does not view CFG's separation from RBS as having a material impact on the company's franchise and profile. CFG's strategy historically relied more on the strength of its regional footprint, as opposed to cross selling into RBS' international clients in the U.S. Further, CFG branding remained distinct from RBS, and at times, its growth was curtailed by idiosyncratic issues at its parent.
SUPPORT RATING
Prior to the divesture, CFG's Support Rating was based on Institutional Support from RBS. Given the limited interest (20.9%) in CFG now owned by RBS, Fitch has changed the Support Rating from Institutional Support to Sovereign Support.
CFG's Support Rating has been downgraded to '5' from '2' reflecting the view that support can no longer be relied upon. The IDRs and VRs do not incorporate any support. Fitch has assigned a Support Rating Floor of 'No Floor' as the company's support rating is now based on Sovereign Support, and no longer considered Institutional Support. In Fitch's view, CFG is not systemically important and therefore, the probability of support is unlikely.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
CFG's subordinated debt is notched one level below its VR. CFG's preferred stock is notched five levels below its VR. These ratings are in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles. Thus, these ratings have been affirmed due to the affirmation of the VR. CFG's subordinated debt is notched two times from the VR for loss severity, and two times for non-performance. Conversely, CFG's preferred stock is notched two times from the VR for loss severity, and three times for non-performance.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The uninsured deposit ratings of Citizens Bank, N.A. and Citizens Bank of Pennsylvania are rated one notch higher than CFG's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
HOLDING COMPANY
The IDR and VR of CFG are equalized with its two operating companies, Citizens Bank, N.A. and Citizens Bank of Pennsylvania, reflecting its role as a bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries.
RATING SENSITIVITIES
VR, IDRs and Senior Unsecured Debt
Fitch views CFG's VR as currently well-situated at their current levels, and likely to remain as such over the near term.
Going forward, positive rating momentum could emerge should management continue to execute on its strategic initiatives and enhance its franchise in key markets and products. The key to this would be whether execution of these strategies results in improved profitability commensurate with higher rated peers. Coupled with strategic execution and improved profitability, positive rating momentum would incorporate an expectation that CFG maintains sound asset quality and solid capital levels, consistent with higher rated peers.
Negative rating action could arise should medium- to long-term earnings remain below peer averages. An inability by management at CFG to align the company's earnings profile with large regional averages would suggest a lack of execution and, thus, present negative rating pressure. Fitch believes CFG's earnings are likely to remain below peer averages over the near term, which is why the ratings are more sensitive to longer-term factors. In addition, Fitch views CFG's capital levels as a relative rating strength, therefore, any a material reduction in capital levels which is not offset by internal capital generation would be a negative rating sensitivity.
Additionally, deterioration in asset quality or aggressive reductions in capital ratios are factors that could lead to negative ratings pressure. Current ratings reflect Fitch's view that there will continue to be some declines in CFG's capital profile, though that it will be maintained at generally above peer levels to compensate for lower capital generation capabilities.
Although CFG passed its most recent CCAR and DFAST reviews, Fitch notes the company did fail its initial CCAR review during 2014 based on qualitative factors, and thus its ratings are sensitive should it not pass either quantitatively or qualitatively.
SUPPORT
Since CFG's Support and Support Rating Floors are now '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings for CFG and its operating companies' subordinated debt and preferred stock are sensitive to any change to CFG's VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The long-and short-term deposit ratings for Citizens Bank, N.A. and Citizens Bank of Pennsylvania are sensitive to any change to CFG's long- and short-term IDR.
SUBSIDIARY AND AFFILIATED COMPANIES
The IDRs and VRs of Citizens, N.A. and Citizens Bank of Pennsylvania are equal to those of CFG, therefore they are broadly sensitive to the same considerations that might affect CFG's IDR and VR.
HOLDING COMPANY
Fitch could notch the holding company's ratings from the operating companies if holding company liquidity were to deteriorate materially, and raise concerns relative to the parent's ability to meet its obligations.
Fitch has taken the following rating actions:
Citizens Financial Group, Inc.
--Long-term IDR affirmed at 'BBB+'; Outlook Stable;
--Short-term IDR affirmed at 'F2';
--Viability rating affirmed at 'bbb+';
--Subordinated debt affirmed at 'BBB';
--Preferred stock affirmed at 'BB-';
--Support rating downgraded to '5' from '2'.
--Support rating floor assigned at 'NF.'
Citizens, NA
--Long-term IDR affirmed at 'BBB+'; Outlook Stable;
--Short-term IDR affirmed at 'F2';
--Viability rating affirmed at 'bbb+';
--Support rating downgraded to '5' from '2';
--Long-term deposits affirmed at 'A-';
--Senior unsecured affirmed at 'BBB+';
--Short-term deposits affirmed at 'F2';
--Support rating floor assigned at 'NF.'
Citizens Bank of Pennsylvania
--Long-term IDR affirmed at 'BBB+'; Outlook Stable;
--Short-term IDR affirmed at 'F2';
--Viability rating affirmed at 'bbb+';
--Support rating downgraded to '5' from '2';
--Long-term deposits affirmed at 'A-';
--Short-term deposits affirmed at 'F2';
--Support rating floor assigned at 'NF.'
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