Citizens Financial Group (NYSE:CFG) recently announced it plans to purchase 80 branches from the U.S. division of HSBC as the London-based bank looks to exit U.S. retail banking and focus more on wealthy clients. Citizens is getting 66 branches in the New York City area, nine in the mid-Atlantic and Washington, D.C., area, and five in southeast Florida. The deal comes with $9 billion in deposits and $2.2 billion in loans, mostly residential mortgages. Let's take a look at why Citizens chose to pull the trigger on this deal.
Geography and balance sheet
There are several reasons this deal makes sense for Citizens. Citizens expects the deal to immediately boost earnings per share upon closing and result in an internal rate of return of 20% with no cost savings or revenue synergies baked in. The branch acquisition also fills in an important gap in the $187-billion-asset bank's geographic footprint: New York City. While the bank does have 111 branches in New York, most of them are upstate and not around the city, so this certainly fills in a missing piece. Also, I expect the bank will find opportunities to consolidate or close branches, which will eventually result in cost savings down the line.
Additionally, Citizens' purchase price of $180 million is only a 2% deposit premium, which represents the market value of the deposits. According to financial advisory services firm Mercer Capital, deposit premiums in branch deals averaged between 4.5% and 7.5% in 2019. Deposit premiums tend to come down in lower-rate environments when overall funding is cheaper, but even following the Great Recession, deposit premiums were still in the 2% to 4% range, so Citizens is getting a good deal. And the average cost of the $9 billion of deposits is just 0.09% interest, so these are cheap deposits.
The other thing the acquisition does is continue to help Citizens get more in line with peers. Ever since being spun off from the Royal Bank of Scotland in 2014, Citizens has received a lower valuation than its peers, as investors seemingly want Citizens to show them the strength of its business before going all in. Citizens has long desired a rerating. Because the acquisition is mostly of low-cost deposits, it will continue to lower Citizens' overall deposit costs and improve its funding mix. The addition of the deposits also lowers Citizens' loan-to-deposit ratio from 81% to 78%, meaning 78% of the bank's deposits will be deployed into loans. Now, I don't think Citizens exactly needs these new deposits to be able to handle loan demand in the near term, but it shows investors the bank now has more funding capacity for the long term like many of its peers.
Scaling the digital bank
Another big component of the deal is that 31% of the depositors Citizens is adding were acquired on HSBC's online platform, meaning they don't use a branch and are digital first. This is a very attractive proposition for Citizens' growing national consumer digital bank, Citizens Access, which is a key part of the bank's growth strategy. Citizens Access offers customers different kinds of online savings accounts and special mortgage rate discounts. Since 2018, Citizens has attracted about 72,000 Citizens Access accounts with $5.5 billion in deposits across all 50 states. Citizens believes that nearly half of the 800,000 accounts it is acquiring could be ripe for Citizens Access, allowing the company to increase the amount of customers and scale the digital consumer bank quickly.
Citizens also sees opportunities to sell these customers other consumer products, like mortgages, student loans, or the bank's growing point-of-sale business called Citizens Pay, which allows customers to use a line of credit for repeat retail purchases so they are not dealing with multiple credit applications or loans.
I do have some questions as to how easy all of these new HSBC customers will be to retain. HSBC is keeping its wealthy clients, so many of the customers Citizens is acquiring are not necessarily super wealthy or business banking customers that are serviced by the bank in other ways. These customers have smaller balances in their bank accounts. On one hand, this could make them a little harder to retain through the integration process -- after all, the 2% deposit premium does seem like a great deal for such cheap deposits in a market like New York City. On the other hand, this could create a ton of opportunity for Citizens because if the bank can retain them, it has a lot of great products it can cross-sell, as mentioned above.
A good opportunity
There are a lot of reasons to like this deal. It fills in a crucial gap in Citizens' geographic footprint, adds good liquidity to the balance sheet, and allows the bank to scale its national digital bank in what looks to be a big way. The pricing of the deal is also attractive and has proven to be a good way for Citizens to make a deal in the current environment. Because the bank doesn't have the highest valuation relative to others in the industry right now -- its stock traded a little under 1.6 times tangible book value at Wednesday's close -- it might have been more difficult for Citizens to do an all-stock deal that would have been financially attractive enough for investors. I plan to keep an eye on how many customers Citizens retains through the closing of the acquisition, but assuming it executes on this, this could turn into a strong move for the bank.