When Citizens Financial Group announced its 2006 results March 1, it focused on the positives: a 2-percent net income increase (actually 1.7 percent) over 2005 to $2.92 billion, with average loan growth of 10 percent and average deposit growth of 4 percent.
Chairman and CEO Lawrence K. Fish noted that “this was our 14th consecutive year of profit growth,” adding that Citizens was particularly pleased with its performance given the “continued interest rate margin pressure that is impacting the entire banking industry.”
But nationwide, the Federal Deposit Insurance Corporation had reported just days earlier, banks’ earnings grew by 8.8 percent in 2006 – five times Citizens’ growth. Locally, Citizens was outperformed by The Washington Trust Co., which grew its earnings 8.7 percent.
Look deeper and you’ll find a key reason why Citizens lagged behind: Despite its size – it’s the eighth-largest bank by deposits in the United States, with $106.8 billion as of Dec. 31 – Citizens operates more like a community bank than like a financial giant.
Interest rate trends have affected all of the industry, and last year, the average net interest margin declined to 3.31 percent from 3.52 percent, the lowest annual average since 1988, according to the FDIC. Banks still grew net interest income by an average of 3.7 percent, the FDIC said (Citizens’ actually dropped by 0.4 percent), but those that rely heavily on interest income did worse last year, in general, than those with more diversified income streams.
Banks with assets greater than $1 billion derived, on average, 57.1 percent of their net operating revenue from net interest income, the FDIC said. But for Citizens, it was 62.9 percent. And Citizens’ net interest margin was only 2.72 percent, down from 3 percent in 2005.
“As interest rates rose further and the U.S. yield curve inverted, low-cost checking and liquid savings deposits migrated to higher-cost deposit products,” the company explained in a news release. “Lower net interest margins more than offset the benefit of higher average loans and deposits, leaving net interest income marginally lower, at $3.84 billion.”
In an interview, Chief Financial Officer James B. Fitzgerald said the “competitive environment” to attract and retain deposits today “is more difficult than I can remember,” and that has created financial pressures for the company.
“We’re always interested in deposits, [but] we’ve been disciplined over the last year – and over the last 15 years,” he said. “But … the competitive environment is more challenging than it was three or four years ago … [so] we spend a lot of time on the product side trying to understand how best to attract customers, but also retain existing ones.”
Asked whether Citizens is considering fundamental changes in how it does business to try to boost profits, Fitzgerald wouldn’t go so far – but he did acknowledge that on a smaller scale, Citizens is expanding and diversifying its revenue base.
The 2006 figures show it. Citizens boosted its non-interest income by 9.2 percent to $2.27 billion, and increased non-interest income’s share of revenue from 35 to 37.1 percent.
In its earnings news release, Citizens attributed much of that gain to business and corporate non-interest income, which it said “rose strongly, with good results especially in foreign exchange, interest rate derivatives and cash management benefiting from increased activity with RBS Corporate Markets.”
Citizens is part of the Royal Bank of Scotland, and Fitzgerald said that partnerships with other RBS entities have been “very successful,” and “the future prospects are very strong.”
Industry trends also help. “More companies everywhere, including Rhode Island, are doing business overseas, so their needs for foreign exchange are greater than they were years ago,” Fitzgerald noted. That is particularly the case, he said, in cities such as Boston and Chicago.
In addition, Citizens has grown its debit card business aggressively, which yields profits through the accumulation of merchant transaction fees. Citizens said it has become the nation’s leading issuer of Paypass contactless debit cards, with 3.65 million cards issued. Last September, it also launched an “Everyday Rewards” program to encourage debit card use.
“There’s a very modest transaction fee with each transaction, and the theory is simple: The more convenient you make it, the more people use the card,” Fitzgerald said. “It’s an important revenue source for us. … We view it as a long-term important business for us.”
Citizens is also growing its credit card business – a major source of profits for Bank of America and other giants. The bank long had outsourced its credit card business, but in 2004, it began issuing its own, focusing on existing Citizens customers, Fitzgerald said.
Last year alone, Citizens increased its credit card customers by 20 percent and its average credit card loans by 19 percent. The base is small, Fitzgerald noted, so that’s not a big number, but “we’re very interested in growing it.”
On a related front, RBS Lynk, Citizens’ merchant acquiring business – and another partnership with its parent company – also achieved “significant growth,” the bank said, adding 11 percent more merchants and processing 40 percent more transactions than in 2005.
Fitzgerald said Citizens is interested primarily in “organic” growth in those areas at this point, but it’s also open to “opportunities for acquisition” that would expand those businesses.
Meanwhile, Citizens continues to grow more traditional revenue sources that, should interest rate trends shift, could lay the groundwork for stronger profits. Average loans and advances to customers grew by 10 percent, the bank said, while average corporate lending rose by 15 percent (excluding finance leases), reflecting the addition of new “midcorporate” customers and a 4-percent increase in total business customers, to 467,000. In personal lending, Citizens said it increased average mortgage and home equity lending by 14 percent.
Costs, meanwhile, have been held down, Citizens said, with only a 1-percent increase in 2006.
Looking ahead, Fitzgerald said Citizens believes its commercial business “is well-positioned to grow,” and the bank in general should do well in the long run.
“The environment has been very difficult in the last 18 months or so, and we do expect it to return to a more traditional environment at some point,” he said. “I think we feel very comfortable that when that does happen, we are very well positioned.”
And unlike many of its competitors, Citizens isn’t under pressure to keep pleasing shareholders quarter after quarter. RBS overall is doing fine, and Fitzgerald said “they’re very pleased with us.”
“They have a very good understanding of what the environment is,” he said. “The word they use is ‘headwinds’ that we’re facing.”
