Over the last two months, Citizens Financial Group (CFG 1.88%) has been opportunistic on the acquisition front, making not one, but two significant depository purchases. First, Citizens announced it was buying 80 branches from HSBC Holdings. Then the bank wheeled around and acquired the $27-billion-asset Investors Bancorp, based in New Jersey, its largest acquisition since Citizens spun off from the Royal Bank of Scotland in 2015.

While the two deals may seem unrelated, Citizens actually used the acquisition of the HSBC branches to make the purchase of Investors Bancorp possible. Let me explain.

A one-two punch

Citizens Financial is a $185-billion-asset bank based in Rhode Island whose branch footprint largely extends from New England through the mid-Atlantic, with branches in the Midwest. But Citizens never had a presence in the New York metropolitan area or much of a presence in New Jersey.

In June, the bank announced plans to acquire 80 branches -- 66 of them in New York -- from the U.S. banking franchise of HSBC, which came with $9 billion of cheap deposits and about $2.2 billion of loans. Sixty-six of those branches were in New York City. It was a good deal for Citizens because the 80 HSBC branches only had a roughly 24% loan-to-deposit ratio, meaning only 24% of the deposits Citizens is acquiring have been deployed into loans. The deposits also only had a total deposit interest cost of 0.09%. This gives Citizens added liquidity and helps further bring down the bank's total deposit costs. Citizens only paid a 2% deposit premium in the deal, which represents the market value of the deposits. Additionally, 400,000 customers from HSBC were online-only customers, which presents a good opportunity for Citizens to onboard those customers to its national digital consumer bank, Citizens Access, and grow that customer base substantially.

Three people across from three people preparing to shake hands.

Image source: Getty Images.

Then most recently, Citizens announced it plans to acquire Investors Bancorp, with 234 branches largely spread out in New York City, New Jersey, and Philadelphia. The key difference between Investors and HSBC is that Investors has very little liquidity and higher deposit costs. Investors has a 108% loan-to-deposit ratio and much higher deposit interest costs of 0.34%. Citizens CFO John Woods said the "opportunistic HSBC acquisition really fueled the ability" to do the deal for Investors, which makes sense, because adding Investors alone would have increased deposit costs and reduced liquidity at Citizens. But HSBC really helps offset the impact of adding Investors.

Currently, Citizens has a 0.11% cost of deposits and an 81% loan-to-deposit ratio. Following the integration of both HSBC and Investors, the pro forma bank's loan-to-deposit ratio will remain the same and the bank's cost of deposits will only move up to 0.13%. So, Citizens will essentially maintains its overall profile, while being able to fill a key hole in its geographic footprint by adding 196 branches in the New York Metro market from both Investors and HSBC, and giving the bank a top 10 deposit market share in the wealthy market practically overnight. Citizens also gains the No. 7 deposit market share position in New Jersey with its acquisition of Investors.

Looking beyond the numbers

Citizens plans to purchase Investors in a deal valued at $3.5 billion. The consideration was paid for in 90% stock and 10% cash. The purchase price values Investors at 130% to its tangible book value (TBV), which is a bank's equity minus its intangible assets and goodwill, or what a bank would be worth if it were to be immediately liquidated. 

The market didn't love the deal, and it's easy to see why -- it's going to dilute Citizens shareholders. Usually, when one bank acquires another, it's a bank with a higher valuation buying out a bank with a lower valuation. But when the valuation gap is minimal or inverse, it is usually going to result in TBV dilution. Because Citizens recently traded at 124% of TBV, which isn't a very strong valuation, and it paid a price equivalent to 130% to TBV for Investors, its TBV will be diluted by about 2.6%, which will take the bank roughly 2.5 years to earn back. 

But only paying 130% TBV for Investors is still a very reasonable price, and I think it's going to be worth it. Getting into the New York metro area is meaningful, considering it represents about 5% of the country's gross domestic product and includes 2.5% of the U.S. population. And the HSBC deal really helps because, as mentioned above, it enables Citizens to purchase Investors without eroding its cost of deposits and loan-to-deposit ratio. Citizens will be able to strip out 30% of Investors' expense base, and there will likely be cost savings in the 80-branch HSBC footprint as well. Once the cost savings are realized, both HSBC and Investors will boost earnings at the combined bank by 8.8% in 2023. Citizens will also have new markets for organic growth, as well as the ability to cross-sell its more diverse set of lending and fee income products.

A creative approach

The big takeaway here is that Citizens used a creative approach to grow strategically. By acquiring Investors alone, not only would the deal have diluted TBV, but it would have hurt the bank's profile in terms of deposits and liquidity, which investors watch carefully. HSBC helped maintain Citizens' overall profile, which it has worked hard to build over the last several years. Now Citizens is in new key markets, it has the scale to hit the ground running, and it can grow organically as well as through cross-selling -- all of which should bode well for the bank.