Fitch Affirms Citizens Financial Group Inc.'s IDRs at 'BBB+/F2'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the Long- and Short-Term Issuer Default Ratings (IDRs) of Citizens Financial Group, Inc. (CFG) and its subsidiaries at 'BBB+' and 'F2', respectively. The Rating Outlook is Stable. CFG's Viability Rating (VR) has also been affirmed at 'bbb+'. CFG was last reviewed in committee on Aug. 18, 2016. There have been no material changes since then.

The rating action follows a periodic review of the large regional banking group, which includes BB&T Corporation (BBT), Capital One Finance Corporation (COF), Citizens Financial Group, Inc. (CFG), Comerica Incorporated (CMA), Fifth Third Bancorp (FITB), Huntington Bancshares Inc. (HBAN), Keycorp (KEY), M&T Bank Corporation (MTB), MUFG Americas Holding Corporation (MUAH), PNC Financial Services Group (PNC), Regions Financial Corporation (RF), SunTrust Banks Inc. (STI), US Bancorp (USB), Wells Fargo & Company (WFC), and Zions Bancorporation (ZION).

Company-specific rating rationales for the other banks are published separately, and for further discussion of the large regional bank sector in general, refer to the special report titled 'Large Regional Bank Periodic Review,' to be published shortly.

KEY RATING DRIVERS

IDRS, VRs AND SENIOR DEBT

The affirmation of CFG's IDR and VR is primarily supported by its solid capital profile. At June 30, 2016, CFG's Common Equity Tier 1 ratio under Basel III was 11.5%, around 70bps better than the large regional peer average. The company has a CET1 target of approximately 11%, which is considered appropriate given weaker capital generation capabilities relative to peers. Over the long term, Fitch expects that the large regionals banks will manage their CET1 to between 8% and 9.5%. Fitch expects CFG's capital ratios will also decrease over time, but believes the company will remain appropriately capitalized for its risk profile.

CFG's ratings also incorporate the company's clearly articulated and well-defined strategy, originally laid out in 2014. The bank continues to make progress towards meeting these initiatives. As an example, CFG now has a greater diversification between commercial and consumer loans, with a 48%/52% split, compared to 45%/55% a few years ago.

CFG also reported that the bank is on track with its TOP II expense initiative plan which is expected to deliver $95 million to $100 million in pre-tax earnings benefit in 2016, and recently announced a new TOP III efficiency program focused on expense, revenue, and tax initiatives. Roughly a third of the TOP III savings will come from staff reductions in non-revenue generating areas. CFG is targeting a 2017 pre-tax run-rate benefit of $90 million to $110 million from TOP III.

Upward ratings momentum for CFG will emerge over time as the company successfully executes on its strategic initiatives and improves its operating performance. Positively, quarterly ROA in the second quarter 2016 (2Q16) improved 13bps from a year ago.

Despite this improvement, CFG's earnings profile remains a key ratings constraint. CFG's reported ROA in 2Q16 was 69bps, well below the large regional peer median of approximately 100bps. CFG's profitability lags its large regional peers primarily due to lower loan yields, as well as lower relative fee income.

CFG's ability to align its fee revenue generation with those of its large regional peers remains a key strategic focus. Fitch notes that CFG has taken steps to improve this metric, including growing its capital markets and wealth management platforms. In mid-May, CFG rolled out commercial broker-dealer capabilities, which also aided growth in noninterest income from 1Q16. Fitch expects fee revenue as a percentage of total income to remain below the peer median at least over the near term. Following the recent movement on the long-end of the curve, it also appears likely that rates will remain lower longer, providing less hope for an earnings tailwind for asset-sensitive banks, like CFG.

Incorporated in today's rating action, Fitch notes that CFG has also significantly grown certain loan categories over the past couple of years, including CRE and student lending, amidst a competitive lending environment.

Some of the CRE loan growth is attributed to restrictions on CRE lending placed on the company in the past by its former parent, The Royal Bank of Scotland Group plc. The company is also trying to achieve a better balance in its loan mix, with less concentration in consumer loans. With 37% growth in CRE loans over the past two years as of June 30, 2016, the loan mix is more evenly balanced than in the past. However, this level of loan growth outpaced peers, and is in the context of relatively low economic growth. To date, credit quality in the CRE book remains manageable with less than 1% on non-accrual status, but warrants monitoring, given its growth.

Student lending continues to be an area of growth management intends to focus on. Fitch notes education lending balances are growing from smaller balances, and now comprise 5% of total loans. CFG offers both undergraduate primarily parent-guaranteed financing and graduate loan refinancing products. Credit risk remains benign. Fitch expects that loan losses will increase from their unsustainably low levels for CFG, and for the industry.

Automobile lending growth on average has also been strong, up 33% over the past two years, though it has slowed somewhat over the past 12 months. CFG has recently identified automobile lending as an area where it will reduce capital allocation, which Fitch views as prudent given the very competitive environment in the asset class. Average auto loan balances increased 1.3% in 2Q16. Through June 30, 2016, annualized net charge-offs remained modest at just 41bps in 2Q16.

In terms of CFG's overall asset quality, its nonperforming assets are slightly higher than the large regional peer median, primarily attributed to large balances of residential mortgage and home equity problem assets. Despite higher problem asset balances, loan losses remain low, and in line with the peer median.

With regard to energy-related exposure, CFG's is modest at just 1.8% of total loans. However, Fitch notes its reserves are among the lowest of the peer group, while 77% of its energy portfolio is rated below investment grade. Partially offsetting this, CFG's forecasted loan losses under the Dodd-Frank severely adverse scenario were the fourth lowest of the peer group, and Fitch sees limited credit risk in the securities portfolio, with over 90% of the portfolio in either Treasury or Agency securities.

CFG's funding profile is roughly in line with peers, though does include a higher loan-to-deposit ratio. Fitch notes less reliance on short-term borrowings from a year ago, and demonstrated access to capital markets through several debt issuances since our last review. CFG maintains a strong presence in its core operating footprint, ranking in the top 3 for deposit market share in Rhode Island, New Hampshire, Massachusetts, and Pennsylvania.

Given the make-up of the large regional bank balance sheets, all 15 of the banks have relatively high liquidity subcomponents ratings, with an implied midpoint floor of 'a-' for these institutions. In addition to strong deposit market shares in their operating footprints, CFG, along with its peers, has multiple sources of funding, including issuance in the capital markets, FHLB advances, and brokered deposits.

Finally, as also reflected in the company's ratings, some legacy regulatory matters have yet to be resolved. Namely, the OCC determined that CBNA no longer meets the specific conditions to own a financial subsidiary, that the bank must be both well-capitalized and well-managed. Citizens Bank, NA (CBNA) was well-capitalized at June 30, 2016. CFG is in the process of remediating these findings, but there has not yet been a further update.

SUPPORT RATING

The IDRs and VRs do not incorporate any 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 of 'bbb+' while CFG's preferred stock is notched five levels below its VR. Subordinated debt is rated one notch below the VR for loss severity, reflecting below-average recoveries. Preferred stock is rated five notches below the VR, twice for loss severity, reflecting poor recoveries as the instruments can be converted to equity or written down well ahead of resolution. In addition, they are also notched down three times for non-performance risk, reflecting fully discretionary coupon omission.

These ratings are in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR.

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 DEBT

Fitch views CFG's VR as currently solidly situated, though we expect more ratings upside over the medium- to long-term than downside risk.

Positive rating momentum would be predicated on CFG improving profitability commensurate with higher-rated large regional peers, while maintaining disciplined growth and consistent underwriting standards.

CFG may also be upgraded with greater execution on its strategic priorities, along with greater seasoning in its recent loan growth without incurring outsized loan losses that exceed peer or industry averages.

Conversely, deterioration in asset quality or aggressively managing down capital 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, but that it will be maintained at generally above peer levels to compensate for lower capital generation capabilities.

It is not anticipated that CFG will pursue a large bank M&A transaction, but any individual transaction would be evaluated for its impact on the company's capital, and risk profile.

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.

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 as to the parent's ability to meet its obligations.

The rating actions are as follows:

Fitch has affirmed the following ratings:

Citizens Financial Group, Inc.

--Long-Term IDR at 'BBB+'; Outlook Stable;

--Short-Term IDR at 'F2';

--Viability rating at 'bbb+';

--Subordinated debt at 'BBB';

--Preferred stock at 'BB-';

--Senior debt at 'BBB+';

--Support rating at '5';

--Support rating floor at 'NF.'

Citizens Bank, NA

--Long-Term IDR at 'BBB+'; Outlook Stable;

--Short-Term IDR at 'F2';

--Viability rating at 'bbb+';

--Support rating at '5';

--Long-term deposits at 'A-';

--Senior unsecured at 'BBB+';

--Short-term deposits at 'F2';

--Support rating floor at 'NF.'

Citizens Bank of Pennsylvania

--Long-Term IDR at 'BBB+'; Outlook Stable;

--Short-Term IDR at 'F2';

--Viability rating at 'bbb+';

--Support rating at '5';

--Long-term deposits at 'A-';

--Short-term deposits at 'F2';

--Support rating floor at 'NF.'

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 15 Jul 2016)

https://www.fitchratings.com/site/re/884135

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012649

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Contacts

Fitch Ratings
Primary Analyst
Julie Solar
Senior Director
+1-312-368-5472
Fitch Ratings, Inc.
70 West Madison
Chicago, IL 60602
or
Secondary Analyst
Thuy Nguyen
Director
+1-212-908-0383
or
Committee Chairperson
Christopher Wolfe
Managing Director
+1-212-908-0771
or
Media Relations:
Hannah James, +1-646-582-4947
hannah.james@fitchratings.com