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Can Hester arrest Citizens' sale?

by Laura Board In London  |  Published February 26, 2013 at 3:23 PM
The U.K.'s Royal Bank of Scotland Group plc is seen likely to bow to the inevitable Thursday, Feb. 28, and pave the way for a separation of Providence, R.I.-based RBS Citizens Financial Group Inc., with the unit's planned partial initial public offering potentially morphing into an outright sale in coming months.

News outlets have reported that RBS announced plans to sell up to 25% of Citizens via an IPO within two years. Neither the Edinburgh institution nor UK Financial Investments Ltd., which manages the government's 83% stake in RBS, would comment, though a person familiar with the situation confirmed several strategic announcements will accompany the lender's full-year earnings report Thursday. These may also include plans to set in motion a late 2014 selloff of a small part of the government's RBS shareholding, and a further downsizing of its investment banking operations.

RBS chief executive Stephen Hester (pictured) didn't originally envisage a future without Citizens as he reshaped the sprawling global institution into a retail and commercial lender focused on both the U.K. and the U.S. But he has caved to pressure from Prime Minister David Cameron's government to accelerate a restructuring he began in February 2009 following a £45.5 billion ($68.9 billion) state bailout. Hester has already shed £318 billion of funded balance sheet assets, but Cameron, while he was traveling last week in India, called on the executive to act faster. And Chancellor of the Exchequer George Osborne told parliament Monday that RBS management now agrees with him that it should become a U.K.-focused retail and commercial lender.

Talk of the partial IPO "is the clearest signal so far that this business will not be part of the 'core' RBS going forward," noted Credit Suisse Group analyst Carla Antunes-Silva.

Citizens has more than 1,400 branches in 12 mainly Eastern states, about 3,900 automated teller machines, around 18,950 employees and $132 billion of assets. It ranks No. 9 in the U.S. by branches and No. 13 by deposits, which amounted to $97 billion as of Sept. 30. Nine-month operating profit was £554 million.

The appearance of any sizeable U.S. retail bank on the block is likely to generate some excitement in the still-fragmented consumer banking market. Potential bidders may include Pittsburgh's PNC Financial Services Group Inc., U.S. Bancorp of Minneapolis or Toronto's TD Bank Group, which operates in the U.S. down the Eastern seaboard and in December expanded its U.S. operations with the $668 million purchase of fund manager Epoch Holding Corp.

All three banks declined to comment.

A full disposal of Citizens would seriously narrow Royal Bank of Scotland's horizons. But it would at least allow Royal Bank to recognize any gain on the disposal in a way it couldn't when a minority stake is ceded. In that scenario, Ian Gordon of Investec plc noted that the Edinburgh seller would sustain a 3% to 4% decline in earnings without getting anything back, because of International Financial Reporting Standards accounting rules.

Whether it's worth RBS's while to sell depends on whether Citizens has by then completed a turnaround to improve weak returns and cut costs. Its 8.1% return on equity in the nine months ended September, though up from 5.7% a year earlier, compares with 23.5% at RBS's U.K. retail banking division and is lower than all of RBS units apart from Ulster Bank.

Until it has improved those returns it is likely to be sold at a discount to its roughly $17 billion book value, possibly even less than the $10.5 billion that Citizens paid for Charter One Financial Inc., of Ohio, in 2004.

One London analyst sees the long lead-in time as a partial victory for Hester's management team.

"Within two years Citizens' ROE will have built quite well and should be enough to justify a premium to book value," he said. "This could be an elegant solution that marries management expectations on valuation and potentially fixes government concerns over a potential capital shortfall at RBS."

The problem is that by announcing the IPO plans now, RBS will likely attract bid interest long before the division is in good shape to sell. If that happens, Hester will need nerves of steel to withstand further political bullying.

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Tags: David Cameron | George Osborne | PNC Financial Services Group Inc. | RBS Citizens Financial Group Inc. | Royal Bank of Scotland Group plc | Stephen Hester | TD Bank Group | U.S. Bancorp of Minneapolis | UK Financial Investments Ltd.

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