Citizens Financial, the Royal Bank of Scotland’s retail arm in the US, has filed for an initial public offering (IPO).
The timeline, number of shares to be offered, and price range for the proposed listing have yet to be determined, although Citizens is expected to float before the end of the year.
Yet despite the lack of detail, some are spying an opportunity akin to the Royal Mail privatisation on these shores last year. On the first day of that company’s public life, its shares closed 38% higher than their sale price – equivalent to a £750 million instant rerating. They have not crashed below the offer price yet.
The National Audit Office has reported that the government ‘could have achieved better value for the taxpayer’ in the deal. ‘It conceded price tension for certainty that the transaction would be completed, by setting a cautious low end of the price range.’ There was an unspoken sense that the government wanted to get its planned series of asset sales off to a good start, ahead of the trickier divestments of stakes in RBS and Lloyds – not to mention more leftfield candidates such as Urenco or the student loan book.
For Peter Hahn, a senior lecturer at Cass Business School and a former senior adviser at the Bank of England, the same principles could now be guiding the floatation of Citizens.
‘As a forced seller, RBS and UK taxpayers will also be desperate for an IPO share price bounce to help ease future sales,’ he argued. RBS now has a tier one capital ratio of 9.4%, which it hopes to raise to 11% by the end of 2015 through such disposals. After Citizens, Williams & Glyn is likely to be the next division floated.
Hahn speculated that the management team within Citizens could also dampen the offer price. ‘A selling shareholder always wants the highest price, which usually conflicts with the IPO management who are likely to get massive share incentive packages and want the lowest IPO price for the maximum potential gain,’ he explained.
‘Only hindsight will offer a view of whether local management – perhaps – hid some good stuff from the seller, a very tough call for a foreign board or shareholder governance pre-IPO.’
Trade or invest?
Beyond any short-term spike in the share price, though, is Citizens worth owning for the longer term? Earlier this year the Federal Reserve relayed that it had ‘identified deficiencies in RBS Citizens’s practices for estimating revenue and losses under a stress scenario and for ensuring the appropriateness of loss estimates across business lines given a specific stress scenario’.
But this was based on modelling rather than capital adequacy: Citizens boasts a tier one ratio of 13.5%, the highest in its peer group of US banks, and it has been paying dividends to RBS.
On the other hand, in the calendar year 2013 Citizens posted a net loss of $3.4 billion (£2 billion) – although that was due to a one-off goodwill impairment charge of $4.4 billion (£2.6 billion), which it attributed to the sluggish US economy. Excluding that, the bank’s full-year return on equity was 4.95%, up from 4.86% in 2012. Its net interest margin of 2.85% lags the peer group average of more than 3%.
Ian Gordon, head of banks research at Investec, is not impressed by those numbers and is therefore not enthused about Citizens as a long-term investment.
‘It is not a new company, so we have clear visibility of the weak operating story,’ he stated. ‘In simple terms we are talking about a bank with a cost-income ratio of around 70% and a return on equity in the low single digits, and no obvious transformation of those metrics.’
Gordon therefore regards it as unlikely that the IPO will represent a bargain opportunity. ‘There is no obvious reason from the outside why it should be materially mispriced.’ He would not be drawn on the possibility that there are subtle reasons from the inside for any mispricing, such as those alluded to by Hahn.
Pau Morilla-Giner, chief investment officer at London & Capital, sits somewhere between them. He does expect Citizens to be listed cheaply. ‘There is a high likelihood that RBS will have to take a discount in terms of valuation. Why? RBS has notoriously failed to find a suitable strategic buyer, which was the preferred option. This sends a powerful message to the market.’
But equally Morilla-Giner believes that the discount will be justified. ‘Expect downward pressure to Citizens even after the IPO is over,’ he warned. ‘We would not rush in.’
Morilla-Giner is sceptical for the longer term too. 'It is clear to us how difficult it is for large regionals like Citizens to find a comparative advantage versus smaller players or larger banks.
'Banks like Citizens rely on traditional deposit taking and loan origination to make money, and the low interest rates that have prevailed since the financial crisis have cut into their profits. Midsize banks either have to make risky loans that other banks wouldn’t or underprice their loans to attract businesses from other banks. None of these are attractive to investors in the current market climate.'