S-1 1 d723158ds1.htm S-1 S-1

As filed with the Securities and Exchange Commission on May 12, 2014

Registration No. 333-          

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

CITIZENS FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   6021   05-0412693
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

One Citizens Plaza

Providence, RI 02903

(401) 456-7000

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Sheldon Goldfarb

Chief Legal Officer

Citizens Financial Group, Inc.

One Citizens Plaza

Providence, RI 02903

(401) 456-7000

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

 

 

Copies to:

 

Nicholas A. Kronfeld

Luigi L. De Ghenghi
Davis Polk & Wardwell LLP
450 Lexington Avenue
New York, New York 10017
(212) 450-4000

 

Leslie N. Silverman

Derek M. Bush

Cleary Gottlieb Steen & Hamilton LLP

One Liberty Plaza

New York, NY 10006

(212) 225-2000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to Be Registered

  Proposed
Maximum
Aggregate
Offering Price(1)(2)
  Amount of
Registration Fee

Common Stock, par value $0.01 per share

  $100,000,000   $12,880

 

 

(1)  Includes shares which the underwriters have the right to purchase to cover over-allotments.

 

(2)  Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Issued                     , 2014

                SHARES

 

LOGO

COMMON STOCK

 

 

The selling stockholders are offering             shares of common stock of Citizens Financial Group, Inc. We will not receive any of the proceeds from the sale of shares of common stock by the selling stockholders. This is our initial public offering and no public market exists for our shares. We anticipate that the initial public offering price will be between $         and $         per share.

We intend to apply to list our shares of common stock on             under the symbol “CFG.”

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 16.

 

 

PRICE $             A SHARE

 

 

 

      

Price to

Public

      

Underwriting
Discounts

and

Commissions

      

Proceeds to

Selling

Stockholders

 

Per Share

       $                               $                               $                       

Total

       $                               $                               $                       

The selling stockholders have granted the underwriters the right to purchase an additional              shares of common stock to cover over-allotments.

The underwriters expect to deliver the shares of common stock to purchasers on                     , 2014.

Neither the Securities and Exchange Commission (the “SEC”) nor any state securities commission has approved or disapproved of these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

Joint Global Coordinators

 

Morgan Stanley   Goldman, Sachs & Co.

 

 

 

Joint Bookrunner
J.P. Morgan

 


TABLE OF CONTENTS

 

 

 

     Page  

Prospectus Summary

     1   

The Offering

     11   

Summary Consolidated Financial and Other Data

     13   

Risk Factors

     16   

Special Note Regarding Forward-Looking Statements

     54   

Use of Proceeds

     56   

Dividend Policy

     57   

Capitalization

     59   

Dilution

     60   

Selected Consolidated Financial Data

     61   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     64   

Selected Statistical Information

     135   

Business

     149   

Regulation and Supervision

     169   
 

 

CERTAIN IMPORTANT INFORMATION

 

 

In this prospectus, “we,” “us,” “our” and “CFG” refer to Citizens Financial Group, Inc. together with its consolidated subsidiaries, “CBNA” means Citizens Bank, N.A., “CBPA” means Citizens Bank of Pennsylvania, “our banking subsidiaries” means CBNA and CBPA, “RBS” means The Royal Bank of Scotland Group plc and the “RBS Group” means RBS together with its subsidiaries (other than CFG). Unless otherwise noted, when we refer to our “peers” or “peer regional banks,” we refer to BB&T, Comerica, Fifth Third, KeyCorp, M&T, PNC, Regions, SunTrust and U.S. Bancorp. When we refer to our approximately 18,600 employees, we include the full-time equivalent of our approximately 18,400 full-time employees and 925 part-time employees, including employees on leave.

Unless otherwise indicated, the information presented in this prospectus includes the assets, liabilities, premises and employees associated with our Chicago retail branches. We reached an agreement in January 2014 to sell these branches to U.S. Bancorp along with certain assets and deposits, and expect to close the transaction in mid-2014. As of December 31, 2013, assets and liabilities associated with our Chicago retail branches were accounted for as assets and liabilities held for sale in our audited consolidated financial statements included in this prospectus.

We and the selling stockholders have not authorized anyone to provide any information other than that contained or incorporated by reference in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. The selling stockholders are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where such offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.

 

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Until            , 2014 (25 days after commencement of this offering), all dealers that effect transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

 

We have proprietary rights to trademarks, trade names and service marks appearing in this prospectus that are important to our business. This prospectus also contains additional trade names, trademarks and service marks belonging to the RBS Group. Solely for convenience, the trademarks, service marks and trade names referred to in this prospectus are without the ® and ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensors to these trademarks, service marks and trade names. All trademarks, service marks and trade names appearing in this prospectus are the property of their respective owners.

 

 

Within this prospectus, we reference certain industry and sector information and statistics. We have obtained this information and statistics from various independent third-party sources, including independent industry publications, reports by market research firms and other independent sources. Nothing in the data used or derived from third-party sources should be construed as advice. The SNL Financial LC, or SNL Financial, data included in this prospectus excludes all non-retail bank holding companies. The scope of “non-retail banks” is subject to the discretion of SNL Financial, but typically includes: industrial bank and non-depository trust charters, institutions with over 20% brokered deposits (of total deposits), institutions with over 20% credit card loans (of total loans) and institutions deemed not to broadly participate in the banking services market. Some data and other information are also based on our good faith estimates, which are derived from our review of internal surveys and independent sources. We believe that these external sources and estimates are reliable, but have not independently verified them.

 

 

Percentage changes, per share amounts, and ratios presented in this prospectus are calculated using whole dollars.

 

ii


PROSPECTUS SUMMARY

This summary highlights selected information contained elsewhere in this prospectus. This summary may not contain all of the information that you should consider before investing in our common stock. Therefore, you should read the entire prospectus carefully, including the section entitled “Risk Factors,” as well the consolidated financial statements and related notes included in this prospectus, before making an investment decision to invest in our common stock.

Company Overview

We are the 13th largest retail bank holding company in the United States according to SNL Financial with $122.2 billion of total assets as of December 31, 2013. Headquartered in Providence, Rhode Island, we deliver a broad range of retail and commercial banking products and services to approximately five million individuals, institutions and companies. Our approximately 18,600 employees strive to meet the financial needs of customers and prospects through approximately 1,370 branches and more than 3,500 ATMs operated in a 12-state footprint across the New England, Mid-Atlantic and Midwest regions and through our online, telephone and mobile banking platforms. We have over 80 retail and commercial non-branch offices located both in our geographic footprint and in five states and the District of Columbia outside our branch footprint. Our 12-state branch banking footprint contains approximately 34.6 million households and 3.6 million businesses according to SNL Financial.

As of December 31, 2013, including assets and liabilities classified as held for sale, we had loans of $87.1 billion, deposits of $92.2 billion and stockholders’ equity of $19.2 billion, and we generated revenues of $4.7 billion for the year ended December 31, 2013. We operate our business through two operating segments: Consumer Banking and Commercial Banking. As of December 31, 2013, the contributions of Consumer Banking and Commercial Banking to the loans in our operating segments were approximately 55% and 45%, respectively.

Consumer Banking serves retail customers and small businesses with annual revenues of up to $25 million. Consumer Banking products and services include deposit products, mortgage and home equity lending, student loans, auto financing, credit cards, business loans and wealth management and investment services. Product strengths and significant growth developments in Consumer Banking include:

 

    Home equity lines of credit (HELOCs): With $16.7 billion in HELOC loans outstanding as of December 31, 2013, we ranked sixth nationally according to SNL Financial;

 

    Auto financing: Through a network of over 5,900 automotive dealerships in 40 states, auto finance represented $9.2 billion of loans as of December 31, 2013, ranking 13th nationally among regulated depository institutions according to SNL Financial;

 

    Mortgage lending: We have grown in mortgage originations from an unranked position as of December 31, 2009, to 22nd among retail originators nationally as of December 31, 2013 according to Inside Mortgage Finance, originating $5.7 billion in mortgages in 2013; and

 

    Private student lending: We launched our education finance business in 2009 and have expanded to partner with over 1,100 higher education schools in all 50 states, which resulted in loan origination volume more than doubling to $253 million in 2013 from $112 million in 2010.

Commercial Banking primarily targets companies and institutions with annual revenues of $25 million to $2.0 billion. Commercial Banking offers a broad complement of financial products and solutions, including lending and leasing, trade financing, deposit and treasury management, foreign exchange and interest rate risk management, corporate finance and debt and equity capital markets

 

 

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capabilities. Product strengths and significant growth developments in Commercial Banking products include:

 

    Commercial and industrial loans: We generated a 12% compound annual growth rate in our commercial and industrial loan portfolio from year end 2009 through year end 2013. We believe this growth was driven by our ongoing commitment to high customer satisfaction as demonstrated by our number one rank in key client survey scores from Greenwich Associates compared to the top four competitors in our footprint, including Overall Capability of Relationship Managers and Overall Lead Client Satisfaction. We received 96% excellent or above average scores in these categories for the full year 2013;

 

    Capital markets: We have built out our capital markets capabilities over the past several years and now offer broader multifaceted financial solutions to meet our clients’ more sophisticated needs. These capabilities include developing expertise in areas like loan syndications which enhance our ability to meet the growing capital needs of clients while limiting balance sheet risk and better positioning us to compete for other banking products. Since 2010, we have completed 349 syndicated bookrunner transactions, including 152 lead-left roles;

 

    Franchise finance: Through our franchise finance business we provide financing to owners of franchised and chain restaurants, such as premier brands like McDonalds, Taco Bell, Applebee’s, Wendy’s and Dunkin Donuts, as well as convenience stores and gas stations on a national basis; and

 

    Commercial real estate: Following the recent cycle of real estate market stress, we took steps to reposition our commercial real estate (CRE) business, which represented $6.6 billion in loans at December 31, 2013, to enhance our focus on originating higher-quality assets in more attractive segments including institutional developers and real estate investment trusts (REITs).

The following table presents certain financial information for our segments as of and for the year ended December 31, 2013:

 

     As of and for the Year Ended December 31, 2013  
     Consumer
Banking
     Commercial
Banking
     Other(1)     Consolidated  
     (in millions)  

Total loans and leases and loans held for sale (average)

   $ 45,106       $ 34,647       $ 6,044      $ 85,797   

Total deposits and deposits held for sale (average)

     72,158         17,516         3,662        93,336   

Net interest income (expense)

     2,176         1,031         (149     3,058   

Noninterest income

     1,025         389         218        1,632   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total revenue

   $ 3,201       $ 1,420       $ 69      $ 4,690   

 

(1)  Includes the financial impact of non-core, liquidating loan portfolios and other non-core assets, our treasury activities, wholesale funding activities, securities portfolio, community development assets and other unallocated assets, liabilities, revenues, provision for credit losses and expenses not attributed to our Consumer Banking or Commercial Banking segments. For a description of non-core assets, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Analysis of Financial Condition—Non-Core Assets.”

History and Recent Strategic Initiatives

Our history dates back to High Street Bank, founded in 1828, which established Citizens Savings Bank in 1871. By 1981, we had grown to 29 branches in Rhode Island with approximately $1.0 billion

 

 

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of assets, and in 1988 we became a wholly owned subsidiary of the RBS Group. Over the following two decades, we grew substantially through a series of over 25 strategic bank acquisitions, including the purchase of the Bank of New York Mellon’s retail branch network in 2001, which included $14.4 billion in deposits, and the 2004 acquisition of Charter One, which had $41.3 billion in assets. These acquisitions greatly expanded our footprint throughout New England and into the Mid-Atlantic and the Midwest, transforming us from a local retail bank into one of the largest retail U.S. bank holding companies with nearly $170.0 billion in assets at the start of the global financial crisis.

Following this period of expansion and the subsequent global financial crisis, we took a number of decisive steps to begin repositioning and strengthening our business profile, including:

 

    Transformed business mix: Refocused our efforts to transform our business model toward a more balanced and diversified platform with a greater emphasis on higher growth, higher return businesses. As of December 31, 2013, we had expanded the contribution of Commercial Banking relative to Consumer Banking to approximately 45% and 55% of the loans in our operating segments, respectively, as compared to 36% and 64%, respectively, as of December 31, 2009;

 

    Improved deposit mix: Increased lower cost and more stable demand, checking, money market and savings accounts to 89% from 74% of total deposits at year end 2013 compared to 2009. This improvement in our core deposit funding mix, as well as our efforts to aggressively lower the rates paid on our time deposits, resulted in a more beneficial cost of total deposits, which decreased to 0.23% in 2013, from 1.32% in 2009;

 

    Reduced reliance on wholesale funding: Since the start of the financial crisis in 2009, we have aggressively worked to reduce the higher cost wholesale funding component of our balance sheet. We reduced wholesale borrowings from $23.7 billion as of December 31, 2009 to $8.4 billion as of December 31, 2013 and as of that date the balances were principally lower cost and more stable secured Federal Home Loan Bank and repurchase agreement borrowings;

 

    Improved strategic focus: Identified and began running down certain non-core assets deemed to be inconsistent with our strategic goals, generally as a result of geographic location, industry, product type or risk level. The non-core portfolio decreased to $3.8 billion at December 31, 2013 from $20.5 billion when it was designated on June 30, 2009;

 

    Optimized our geographic footprint: Exited certain geographies where we had underperforming market share positions and redeployed the capital into businesses with more attractive growth and return characteristics. In 2008, we sold 18 branches in the New York Adirondacks region, and in 2009, we sold our Indiana branch franchise, which consisted of 65 branches. In 2012, we sold 57 mostly in-store branches in Long Island and Westchester County, New York, and we have entered into an agreement to sell our 103 Chicago retail branches along with certain assets and deposits, which we expect to close in mid-2014. Additionally, we have routinely sought to optimize the branch footprint through a process of consolidation and rationalization, which has resulted in the closure of another 219 branches since 2009;

 

   

Refined our branch service delivery model: Proactively addressed evolving consumer preferences for banking interactions through expansion of alternative distribution channels. We have reduced our branch footprint while building out self-service channels through online and mobile banking and person-to-person payments. Our mobile banking channel has experienced rapid growth with a 33% increase in active mobile customers over the past year. We have continued to optimize the distribution network by migrating staffing in our branches

 

 

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toward a universal banker model, which involves training bankers to handle both teller and traditional banker functions, with a goal of further improving the efficiency of our network and allowing frontline employees to become more sales and solutions oriented; and

 

    Increased infrastructure investment: Invested more than $900 million in infrastructure and technology since 2009, with an additional $250 million planned for each of 2014 and 2015. These investments, intended to lower our costs and improve our customer experience, include significant programs to enhance our information technology resiliency, upgrade customer-facing technology and streamline operations. Significant investments included the 2013 launch of our new teller system, new commercial loan platform and new auto loan platform and the 2013 upgrade of the majority of our ATM network, including by equipping more than 1,600 ATMs with advanced deposit-taking functionality. These investments also involved spending to prepare for the planned rollout of our new mortgage platform.

These steps have helped provide a strong foundation for our ongoing transformation from a wholly owned subsidiary of a global financial group into a stand-alone U.S. regional bank. We have brought together a seasoned management team with an average of over 20 years of banking experience at large international financial institutions. The team was bolstered by the May 2013 announcement of Bruce Van Saun’s appointment as our Chairman and CEO. The team is focused on delivering improved returns, through implementation of growth and efficiency initiatives, along with a more disciplined allocation of capital and resources. This performance-driven culture is designed to enhance our competitiveness by rigorously analyzing the risk-return profiles of our diversified businesses and selectively investing in those that are well positioned to gain market share, improve efficiency and generate long-term growth and sustainable profitability. In prior years, many of our strategies around risk management, capital and investments were heavily influenced by our status as a subsidiary of a larger global financial institution.

Our Competitive Strengths

Our long operating history, through a range of challenging economic cycles, forms the basis for our competitive strengths. From our community bank roots, we bring a commitment to strong customer relationships, local service and an active involvement in the communities we serve. Our acquisitions enabled us to develop material scale in highly desirable markets and broad product capabilities. The actions taken since the global financial crisis have resulted in a business model with solid asset quality, a stable core deposit mix and a superior capital position. In particular, we believe that the following strengths differentiate us from our competitors and provide a strong foundation from which to execute our strategy to deliver enhanced growth, profitability and returns.

 

    Significant Scale with Strong Market Penetration in Attractive Geographic Markets: We believe our market share and scale in our footprint is central to our success and growth. With approximately 1,370 branches and 80 non-branch offices, more than 3,500 ATMs and approximately 18,600 employees, as well as our online, telephone and mobile banking platforms, we serve more than five million individuals, institutions and companies. As of June 30, 2013, we ranked second by deposit market share in the New England region1 and in the top five in nine of our key metropolitan statistical areas, or MSAs, including Boston, Providence, Philadelphia, Pittsburgh and Cleveland according to SNL Financial. We believe this strong market share in our core regions, which have relatively diverse economies and

 

1  The New England region consists of the states of Maine, New Hampshire, Vermont, Massachusetts, Rhode Island and Connecticut.

 

 

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affluent demographics, will help us achieve our long-term growth objectives. The following table sets forth information regarding our competitive position in our principal MSAs.

 

MSA

   Total
Branches
     Deposits
($ in Millions)
     Market
Rank(1)
     Market
Share
(%)(1)
 

Boston, MA

     212       $ 28,343         2         16.4

Philadelphia, PA

     188         17,012         4         8.1   

Providence, RI

     100         12,854         1         34.6   

Pittsburgh, PA

     131         7,130         2         8.8   

Detroit, MI

     95         4,563         6         4.6   

Cleveland, OH

     64         4,105         5         7.9   

Manchester, NH

     28         4,014         1         38.7   

Albany, NY

     29         1,590         4         7.1   

Buffalo, NY

     43         1,573         4         4.8   

Rochester, NY

     34         1,540         4         10.3   

 

  (1)  Source: FDIC, June 2013. Excludes “non-retail banks” as defined by SNL Financial. See “Certain Important Information.”

 

    Strong Customer Relationships: We focus on building strong customer relationships by delivering a consistent, high quality level of service supported by a wide range of products and services. We believe that we provide a distinctive customer experience characterized by the personal touch of a local bank with the product selection of a larger financial institution. Our Consumer Banking cross-sell efforts have improved to 4.9 products and services per retail household as of December 31, 2013 compared to 4.2 products and services as of December 31, 2009. Additionally, Consumer Banking improved overall customer satisfaction as measured by J.D. Power and Associates by 5% from 2012 to 2013, while the industry average score improved by 3% during the same period. Our ability to provide a unique customer experience is also evidenced by our Commercial Banking middle market team ranking among the top five in customer and lead bank penetration, with a 10% market penetration in our footprint based on Greenwich Associates’ research for 2013.

 

    Stable, Low-Cost Core Deposit Base: We have a strong funding profile, with $92.2 billion of total deposits (including deposits held for sale) as of December 31, 2013, consisting of 28% in noninterest bearing deposits and 72% in interest bearing deposits. Noninterest bearing deposits provide a lower-cost funding base, and we have grown this base to $26.0 billion at December 31, 2013, up from $19.0 billion at December 31, 2009. For the year ended December 31, 2013, our total average cost of deposits was 0.23%, down from 0.40% in 2012 and 1.32% in 2009.

 

    Superior Capital Position: We are among the most well-capitalized large regional banks in the United States, with a Tier 1 common equity ratio of 13.5% as of December 31, 2013, ranking highest among peer regional banks (listed under “Certain Important Information”), which had an average Tier 1 common equity ratio of 10.1% at that date according to SNL Financial. Our Tier 1 common equity ratio at December 31, 2013 under Basel III rules was 13.1% (fully phased-in basis). Our strong capital position provides us the financial flexibility to continue to invest in our businesses and execute our strategic growth initiatives. Through recent capital optimization efforts, we have sought to better align our Tier 1 capital base with peer regional banks, while maintaining a solid total capital position, by reducing Tier 1 capital and increasing Tier 2 capital. In 2014, we plan to continue our strategy of capital optimization by exchanging an additional $1.0 billion of Tier 1 common equity for other forms of capital, including Tier 2 subordinated debt. Pro forma for this exchange, our Tier 1 common equity ratio would have been 12.5% as of December 31, 2013.

 

 

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    Solid Asset Quality Throughout a Range of Credit Cycles: Our experienced credit risk professionals and conservative credit culture, combined with centralized processes and consistent underwriting standards across all business lines, have allowed us to maintain strong asset quality through a variety of business cycles. As a result, we weathered the global financial crisis better than our peers: for the two-year period ending December 31, 2009, net charge-offs averaged 1.63% of average loans compared to a peer average of 1.76% according to SNL Financial. More recently, the credit quality of our loan portfolio has continued to improve: nonperforming assets as a percentage of total assets were 1.20% compared to 1.55% as of December 31, 2013 and 2012, respectively. Net charge-offs declined substantially to 0.59% of average loans in the year ended December 31, 2013 versus 1.01% in the prior year. Our allowance for loan and lease losses was 1.42% of total loans at year end 2013. We believe the high quality of our loan portfolio provides us with significant capacity to prudently seek more attractive, higher yielding risk-adjusted returns while still maintaining appropriate risk discipline and solid asset quality.

 

    Experienced Management Team Supported by a High-Performing, Talented Workforce: Our leadership team of seasoned industry professionals is supported by a highly motivated, diverse set of managers and employees committed to delivering a strong customer value proposition. We have recently made selective additions to our management team and added key business line leaders, including the Head of Distribution and Head of Everyday Banking in Consumer Banking, as well as the Head of Technology Lending and Head of Loan Trading for Commercial Banking. Bruce Van Saun, who was announced as our Chairman and CEO in May 2013, has more than 30 years of financial services experience including four years as the RBS Group Finance Director. Earlier in his career, Mr. Van Saun held a number of senior positions at Bank of New York Mellon, Deutsche Bank, Wasserstein Perella Group and Kidder Peabody & Co. Our highly experienced and talented executive management team, whose members have more than 20 years of banking experience on average, provide strong leadership to deliver on our overall business objectives.

 

    Commitment to Communities: Community involvement is one of our principal values and we strive to contribute to a better quality of life by serving the communities across our footprint through employee volunteer efforts, a foundation that funds a range of non-profit organizations and executives that provide board leadership to community organizations. These efforts contribute to a culture that seeks to promote positive employee morale and provide differentiated brand awareness in the community relative to peer banks, while also making a positive difference within the communities we serve. Employee engagement increased during 2013 as highlighted by a 27% increase in employee volunteerism to more than 76,000 hours company-wide. In addition, employees serve on more than 440 community boards across our footprint. We believe our strong commitment to our communities provides a competitive advantage by strengthening customer relationships and increasing loyalty.

Business Strategy

Building on our core strengths, we intend to become a top-performing regional bank as viewed through the lenses of our five major stakeholders: customers, investors, regulators, colleagues and communities. We have identified a series of fundamental strategic initiatives designed to maximize the full potential of our business and drive sustainable growth and enhanced profitability. The core measure of our success in executing our strategic initiatives will be our ability to deliver higher Returns on Average Tangible Common Equity, or ROTCE. We aim for our strategic initiatives to increase our ROTCE from 5% in 2013, excluding our $4.4 billion goodwill impairment charge, to a target of greater than     % over

 

 

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the medium term.2 We plan to accomplish this goal through: (a) driving revenue growth in both the Consumer Banking and Commercial Banking segments; (b) enhancing cost reduction efforts across the company; (c) the benefit of a run-off in the non-core loan portfolio and pay-fixed interest rate swaps; (d) leveraging capital actions aimed at better aligning our capital structure with those of regional bank peers; and (e) the beneficial impact of a normalized rate environment on our asset-sensitive balance sheet. We also expect these efforts to result in a targeted efficiency ratio (noninterest expense divided by the sum of net interest income and noninterest income) in the                  range over the medium term.

 

    Revenue Growth: We are committed to generating profitable revenue growth in a disciplined manner by placing greater emphasis on reallocating resources toward businesses that will further increase and diversify our revenue base in order to deliver more attractive risk-adjusted returns to stockholders.

Increasing Loan Origination—We expect to prudently expand our balance sheet and drive increased loan origination volume. In our Consumer business we plan to hire more than                     sales professionals in mortgage, small business and auto finance over the medium term. In our Commercial business, we will continue to build out industry-focused teams, expand our origination efforts in mid-corporate with geographic expansion and grow in franchise finance.

Focus on Higher Return Assets—Given our scale, expertise and current geographic reach, we believe we are well positioned to further diversify our asset base by prudently seeking higher yielding risk-adjusted assets with a more balanced mix of commercial and consumer loans and appropriate risk discipline.

Driving Additional Fee Income—We also intend to transition to a more balanced revenue profile by taking steps to further grow our noninterest income through an expansion of our wealth management, capital markets and cash management services to reduce our overall reliance on net interest income.

Our objective is to increase our ROTCE in the medium term by approximately            to            basis points through these revenue growth initiatives.

 

    Cost Initiatives: We are focused on streamlining our processes and improving our cost structures. As a result of the initiative launched in late-2013 to improve efficiency and effectiveness, we expect to generate aggregate annualized expense savings of approximately $             million over the medium term. Noninterest expense savings from this initiative are expected to benefit ROTCE in the medium term by approximately                     to        basis points and to achieve a targeted efficiency ratio in the            range.2

 

    Run-off of Non-Core Portfolio and Existing Pay-Fixed Interest Rate Swaps: Credit trends in our non-core assets have continued to demonstrate improvement, as evidenced by lower levels of nonperforming loans and net charge-offs. Our proactive risk management efforts have helped reduce our non-core assets by 33% to $3.8 billion at year end 2013 from year end 2012, while net charge-offs in this portfolio decreased by 50% over the same timeframe. We expect these favorable trends to continue. In addition, we are running down pay-fixed interest rate swaps that we entered into to hedge fixed-rate assets. These swaps had a notional balance of $1.5 billion at December 31, 2013, compared to $3.7 billion at December 31, 2012. We expect these items to enhance ROTCE by        to        basis points in the medium term.

 

2  For information regarding the calculation of ROTCE and efficiency ratio, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Principal Components of Operations and Key Financial Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

 

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    Normalization of Tier 1 Common Equity Ratio: Given the robust level of common equity in our capital structure, we intend to continue to pursue various capital actions, subject to regulatory approval, that are expected to normalize our Tier 1 common equity ratio to a level that is more consistent with that of other peer regional banks. We expect lower levels of tangible common equity to facilitate a                 to                  basis point improvement to ROTCE over the medium term.

 

    Normalized Rate Environment: Net interest income growth has been challenged by the relatively persistent low interest rate environment. We remain well positioned for a rising rate environment, which would be beneficial to our net interest margin because our asset sensitive balance sheet would react favorably to an increase in both short-term and long-term rates. As of December 31, 2013, the estimated impact on our net interest income over the next twelve months based on a 200 basis point gradual increase in rates would be 6.8%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Governance and Quantitative and Qualitative Disclosures About Risk—Market Risk—Non-Trading Risk” for further details. The benefit to our net interest income from a gradually normalizing rate environment is expected to increase our ROTCE in the medium term by                 to                 basis points.

While our strategic plan and our ROTCE target and its components are presented with numerical specificity, and we believe such targets to be reasonable as of the date of this prospectus, given the uncertainties surrounding our assumptions, including possible regulatory restrictions on activities we intend to pursue, there are significant risks that these assumptions may not be realized and thus our goals may not be achieved. Accordingly, our actual results may differ from these targets and the differences may be material and adverse, particularly if actual events adversely differ from one or more of our key assumptions. We caution investors not to place undue reliance on any of these assumptions or targets. See “Note Regarding Forward-Looking Statements,” “Risk Factors” and “Business—Business Strategy.”

Customer Focus

In addition to the strategies outlined above, we strive to develop stronger and higher value customer relationships through an intense focus on delivering a differentiated experience across all of our distribution platforms, including our robust online, telephone and mobile banking platforms. We expect this focus to continue to drive improved customer loyalty across our businesses and distinguish us from our competitors. As an example of our approach, in January 2014, we launched our new One Deposit Checking product and our $5 Overdraft Pass offering, which exemplify our Consumer Banking’s new “Simple. Clear. Personal.” value proposition. We believe this approach will enable us to win, retain and expand customer relationships, as well as increase cross-sell and share of wallet penetration across our business segments.

Risks

An investment in shares of our common stock involves substantial risks and uncertainties that may adversely affect our business, financial condition and results of operations. Some of the more significant challenges and risks relating to an investment in our common stock include:

 

    We may not be able to successfully execute our strategic plan or achieve our performance targets.

 

   

Supervisory requirements and expectations, our need to make improvements and devote resources to various aspects of our controls, processes, policies and procedures, and any

 

 

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regulator-imposed limits on our activities, could limit our ability to implement our strategic plan, expand our business, improve our financial performance and make distributions to our stockholders.

 

    A continuation of the current low interest rate environment or subsequent movements in interest rates may have an adverse effect on our profitability.

 

    We could fail to attract or retain senior management, other key employees or members of our board of directors, which would adversely affect our business.

 

    The RBS Group will be our controlling stockholder and its interests may conflict with ours or yours in the future.

 

    RBS is 79.9% owned by the UK government and its interests may conflict with ours or yours in the future.

 

    Our historical financial results are derived from our results as a wholly owned indirect subsidiary of RBS and reflect the benefit of the RBS Group’s purchasing power when procuring goods and services and therefore may not be representative of our results as a stand-alone company and may not be a reliable indicator of our future results.

 

    The RBS Group may face the risk of full nationalization or other resolution procedures under the Banking Act 2009, as amended by the UK Financial Services (Banking Reform) Act 2013, which could impact the RBS Group’s contractual arrangements with us or result in other material effects on us.

 

    Any deterioration in national economic conditions could have a material adverse effect on our business, financial condition and results of operations.

 

    We operate in an industry that is highly competitive, which could result in losing business or margin declines and have a material adverse effect on our business, financial condition and results of operations.

 

    Volatility in the global financial markets continued throughout 2013 as a result of the Eurozone crisis and any recurrence of such volatility could have a material adverse effect on our business, financial condition and results of operations.

 

    As a financial holding company and a bank holding company, we are subject to comprehensive regulation that could have a material adverse effect on our business, financial condition and results of operations.

 

    We may be unable to disclose some restrictions or limitations on our operations imposed by our regulators.

 

    We are subject to capital adequacy and liquidity standards, and if we fail to meet these standards, our business, financial condition and results of operations would be adversely affected.

 

    Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale, and RBS intends to sell its remaining beneficial ownership of our common stock, although the timing of such sale or sales remains uncertain.

 

    If RBS sells a controlling interest in our company to a third party in a private transaction, you may not realize any change-of-control premium on shares of our common stock and we may become subject to the control of a presently unknown third party.

 

 

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Other Information

We are subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). We are distinct from and independent of the RBS Group’s other businesses in the United States and have our own board of directors (“Board”) and executive management team. Our principal executive offices are located at One Citizens Plaza in Providence, Rhode Island, and our telephone number is (401) 456-7000.

 

 

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THE OFFERING

 

The offering

                common stock offered by the selling stockholders.

 

Common stock outstanding

                shares.

 

Option to purchase additional shares of common stock to cover over-allotments

                shares from the selling stockholders.

 

Voting rights

Each holder of our common stock will be entitled to one vote per share with respect to all matters on which stockholders generally are entitled to vote, except as otherwise required by law.

 

Use of proceeds

We will not receive any proceeds from sale of common stock in the offering; the selling stockholders will receive all of the proceeds from the sale of shares of our common stock.

 

Dividend policy

We intend to pay quarterly cash dividends on our common stock at an initial amount of approximately $         per share, although any declaration of dividends will be at the discretion of our Board and will depend on our financial condition, earnings, cash needs, regulatory constraints, capital requirements (including requirements of our subsidiaries) and any other factors that our Board deems relevant in making such a determination. Therefore, there can be no assurance that we will pay any dividends to holders of our common stock, or as to the amount of any such dividends.

 

  Dividends from our banking subsidiaries are the principal source of funds for the payment of dividends on our common stock. Our banking subsidiaries are subject to certain restrictions that may limit their ability to pay dividends to us. See “Dividend Policy” for more information.

 

Risk factors

See “Risk Factors” for a discussion of risks you should carefully consider before deciding to invest in our common stock.

 

Controlling stockholder

Prior to the completion of this offering, we are an indirect wholly owned subsidiary of RBS, and have been a part of the RBS Group’s consolidated business operations. Upon completion of this offering, RBS will beneficially own approximately         % of our outstanding shares of common stock (         % if the underwriters’ over-allotment option is exercised in full).

 

  For further information regarding our relationship with the RBS Group in the past and following the offering, see “Our Relationship With the RBS Group and Certain Other Related Party Transactions.”

 

Preemptive and other rights

Purchasers of the shares sold in this offering will not have any preemptive rights. Our common stock is not subject to redemption.

 

 

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Listing

We intend to apply to list our shares of common stock on             under the symbol “CFG.”

All share information, other than in historical financial results, reflects a 134,831.46-for-1 forward stock split to occur immediately prior to closing of this offering. Unless we specifically state otherwise, the information in this prospectus does not take into account the                 shares of common stock that may be granted under our equity compensation arrangements.

 

 

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SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA

We derived the summary consolidated operating data for the years ended December 31, 2013, 2012 and 2011 and the summary consolidated balance sheet data as of December 31, 2013 and 2012 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the summary consolidated balance sheet data as of December 31, 2011 from our consolidated financial statements, which are not included in this prospectus. Our historical results are not necessarily indicative of the results expected for any future period.

You should read the following summary consolidated financial data in conjunction with the sections of this prospectus entitled “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Selected Statistical Information” and our consolidated financial statements and the notes thereto included elsewhere in this prospectus.

 

     As of and for the Year Ended
December 31,
 
     2013     2012     2011  
     (dollars in millions, except per share amounts)  

Operating Data:

      

Net interest income

   $ 3,058      $ 3,227      $ 3,320   

Noninterest income

     1,632        1,667        1,711   
  

 

 

   

 

 

   

 

 

 

Total revenue

     4,690        4,894        5,031   

Provision for credit losses

     479        413        882   

Noninterest expense

     7,679        3,457        3,371   

Noninterest expense, excluding goodwill impairment(1)

     3,244        3,457        3,371   

(Loss) income before income tax (benefit) expense

     (3,468     1,024        778   

Income tax (benefit) expense

     (42     381        272   

Net (loss) income

     (3,426     643        506   

Net income, excluding goodwill impairment(1)

     654        643        506   

Net (loss) income per average common share—basic and diluted (pro forma)(unaudited)(2)

     (7.51     1.41        1.11   

Net (loss) income per average common share—basic and diluted (actual)

     (1,013,131.98     190,245.51        149,548.13   

Net income per average common share—basic and diluted, excluding goodwill impairment (pro forma)(unaudited)(1)(2)

     1.43        1.41        1.11   

Net income per average common share—basic and diluted, excluding goodwill impairment (actual)(1)

     193,122.25        190,245.51        149,548.13   

Other Operating Data:

      

Return on average common equity(3)

     (15.69 )%      2.69     2.19

Return on average common equity, excluding goodwill impairment(1)

     3.00     2.69     2.19

Return on average tangible common equity(1)

     (25.91 )%      4.86     4.18

Return on average tangible common equity, excluding goodwill impairment(1)

     4.95     4.86     4.18

Return on average total assets(4)

     (2.83 )%      0.50     0.39

Return on average total assets, excluding goodwill impairment(1)

     0.54     0.50     0.39

 

 

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     As of and for the Year Ended
December 31,
 
     2013     2012     2011  
     (dollars in millions, except per share amounts)  

Return on average total tangible assets(1)

     (3.05 )%      0.55     0.43

Return on average total tangible assets, excluding goodwill impairment(1)

     0.58     0.55     0.43

Efficiency ratio(1)

     163.73     70.64     67.00

Efficiency ratio, excluding goodwill impairment(1)

     69.17     70.64     67.00

Net interest margin(5)

     2.85     2.89     2.97

Balance Sheet Data:

      

Total assets

   $ 122,154      $ 127,053      $ 129,654   

Loans and leases(6)

     85,859        87,248        86,795   

Allowance for loan and lease losses

     1,221        1,255        1,698   

Total securities

     21,245        19,417        23,352   

Goodwill

     6,876        11,311        11,311   

Total liabilities

     102,958        102,924        106,261   

Deposits(7)

     86,903        95,148        92,888   

Federal funds purchased and securities sold under agreements to repurchase

     4,791        3,601        4,152   

Other short-term borrowed funds

     2,251        501        3,100   

Long-term borrowed funds

     1,405        694        3,242   

Stockholders’ equity

     19,196        24,129        23,393   

Other Balance Sheet Data:

      

Asset Quality Ratios:

      

Allowance for loan and lease losses as a percentage of total loans and leases

     1.42     1.44     1.96

Allowance for loan and lease losses as a percentage of nonperforming loans and leases

     86     67     95

Nonperforming loans and leases as a percentage of total loans and leases

     1.65     2.14     2.06

Capital ratios:

      

Tier 1 capital ratio(8)

     13.5     14.2     13.9

Total capital ratio(9)

     16.1     15.8     15.1

Tier 1 common equity ratio(10)

     13.5     13.9     13.3

Leverage ratio(11)

     11.6     12.1     11.6

 

(1)  These measures are not recognized under generally accepted accounting principles in the United States, or GAAP. For more information on the computation of these non-GAAP financial measures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Components of Operations and Key Performance Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

(2)  Pro forma basic and diluted earnings per share are unaudited and have been computed to give effect to the 134,831.46-for-1 forward stock split to occur immediately prior to the closing of this offering.

 

(3)  We define “Return on average common equity” as net income (loss) divided by average common equity.

 

(4)  We define “Return on average total assets” as net income (loss) divided by total average assets.

 

(5)  We define “Net interest margin” as net interest income divided by average total interest earning assets.

 

(6)  Excludes loans held for sale of $1,254 million, $646 million, and $564 million as of December 31, 2013, 2012, and 2011, respectively.

 

(7) Excludes deposits held for sale of $5,277 million at December 31, 2013.

 

(8)  We define “Tier 1 capital ratio” as Tier 1 capital balance divided by total risk-weighted assets as defined under Basel I.

 

 

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(9)  We define “Total capital ratio” as total capital balance divided by total risk-weighted assets as defined under Basel I.

 

(10)  We define “Tier 1 common equity ratio” as Tier 1 capital balance, minus preferred stock, divided by total risk-weighted assets as defined under Basel I.

 

(11)  We define “Leverage ratio” as Tier 1 capital balance divided by quarterly average total assets as defined under Basel I.

 

 

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RISK FACTORS

We are subject to a number of risks potentially impacting our business, financial condition, results of operations and cash flows. As a financial services organization, certain elements of risk are inherent in our transactions and operations and are present in the business decisions we make. We, therefore, encounter risk as part of the normal course of our business and we design risk management processes to help manage these risks. Our success is dependent on our ability to identify, understand and manage the risks presented by our business activities so that we can appropriately balance revenue generation and profitability. These risks include, but are not limited to, credit risk, market risks, liquidity risks, operational risks, model risks, technology, regulatory and legal risks and strategic and reputational risks. We discuss our principal risk management processes and, in appropriate places, related historical performance in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus.

You should carefully consider the following risk factors that may affect our business, future operating results and financial condition, as well as the other information set forth in this prospectus before making a decision to invest in our common stock. If any of the following risks actually occur, our business, financial condition or results of operations would likely be materially adversely affected. In such case, the trading price of our common stock would likely decline due to any of these risks, and you may lose all or part of your investment. The following risks are not the only risks we face. Additional risks that are not presently known or that we presently deem to be immaterial also could have a material adverse effect on our financial condition, results of operations and business.

Risks Related to Our Business

We may not be able to successfully execute our strategic plan or achieve our performance targets.

Our strategic plan, which we began to implement in the second half of 2013, involves five principal elements: (a) increasing revenue in both Consumer Banking and Commercial Banking; (b) enhancing cost reduction efforts across the company; (c) the benefit of a run-off in the non-core portfolio and pay-fixed interest rate swaps; (d) leveraging capital actions aimed at better aligning our capital structure with those of regional bank peers; and (e) the beneficial impact of a normalized rate environment on our asset-sensitive balance sheet. Our future success and the value of our stock will depend, in part, on our ability to effectively implement our strategic plan. There are risks and uncertainties, many of which are not within our control, associated with each element of our plan discussed further below.

In addition, certain of our key initiatives require regulatory approval, which may not be obtained on a timely basis, if at all. Moreover, even if we do obtain required regulatory approval, it may be conditioned on certain organizational changes, such as those discussed below, that could reduce the profitability of those initiatives.

Revenue Generation Component of Strategic Plan, Assumptions and Associated Risks. Our plans to increase revenue involve reallocating resources toward business that will further increase and diversify our revenue base, including by prudently growing higher-return earning assets, identifying and capitalizing on more fee income opportunities and selectively expanding our balance sheet through increased loan origination volume principally in mortgage, small business and auto. Our revenue growth plans are based on a number of assumptions, many of which involve factors that are outside our control. Our key assumptions include:

 

   

that we will be able to attract and retain the requisite number of skilled and qualified personnel required to increase our loan origination volume in mortgage, business banking, auto and wealth. The marketplace for skilled personnel is competitive, which means hiring, training and

 

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retaining skilled personnel is costly and challenging and we may not be able to increase the number of our loan professionals sufficiently to achieve our loan origination targets successfully;

 

    that we will be able to grow higher-return earning assets and increase fee income in part by means of increased management discipline, industry focus, expansion of target markets, focus on higher-return yielding assets and increased origination efforts;

 

    that we will be able to fund asset growth by growing deposits with our cost of funds increasing at a rate consistent with our expectations;

 

    that we will be able to successfully identify and purchase high-quality interest earning assets that perform over time in accordance with our projected models;

 

    that our expansion into specialized industries, as well as our efforts to expand nationally in the mid-corporate space, will not materially alter our risk profile from existing business operations in ways that our existing risk models cannot effectively or accurately model;

 

    that there will be no material change in competitive dynamics, including as a result of our seeking to increase market share and enter into new markets (as discussed below, we operate in a highly competitive industry and any change in our ability to retain deposits or attract new customers in line with our current expectations would adversely affect our ability to grow our revenue); and

 

    that software we have recently licensed and implemented throughout our business, including an automated loan origination platform, will function consistent with our expectations.

If one or more of our assumptions prove incorrect, we may not be able to successfully execute our strategic plan, we may never achieve our indicative performance targets and any shortfall may be material.

Cost Savings and Efficiency Component of Strategic Plan and Associated Risks. In order for us to execute our strategic plan successfully, we must implement a number of cost reduction and efficiency improvement initiatives, including streamlining processes, reducing redundancy and improving cost structures, which we believe will allow us to reduce overall expenses. There may be unanticipated difficulties in implementing our efficiency initiatives, and there can be no assurance that we will fully realize our target expense reductions, or be able to sustain any annual cost savings achieved by our efficiency initiative. Reducing costs may prove difficult in light of our efforts to establish and maintain our stand-alone operational and infrastructural capabilities as a banking institution fully separate from the RBS Group, including our rebranding efforts associated with our separation from the RBS Group. Reducing our structural costs may be difficult owing to our efforts to make organizational improvements in risk management and various policies and procedures in order to comply with new regulations and guidance from our regulators. In addition, any significant unanticipated or unusual charges, provisions or impairments, including as a result of any ongoing legal and regulatory proceedings or industry regulatory changes, would adversely affect our ability to reduce our cost structure in any particular period. If we are unable to reduce our cost structure as we anticipate, we may not be able to successfully execute our strategic plan, we may never achieve our indicative performance targets and any shortfall may be material.

Continued Reduction of Our Non-Core Assets. Non-core assets are primarily loans inconsistent with our strategic goals, generally as a result of geographic location, industry, product type or risk level. The portfolio has been actively managed since its designation on June 30, 2009. Since that time, we have reduced balances through collections by $8.8 billion, charged off $3.8 billion, transferred $2.8 billion back to the core portfolio and sold $1.2 billion. Our strategic plan includes assumptions that recent favorable trends with respect to our non-core assets will continue, including that the overall

 

17


credit quality of the portfolio will continue to improve. If the positive credit trends our non-core assets have experienced in recent periods do not continue, our ability to achieve the incremental performance targets we have identified might not be possible, which could prevent us from fulfilling our overall performance target.

Normalization of Our Tier 1 Common Equity Ratio. Our strategic plan requires us to complete capital initiatives that would result in a lower overall Tier 1 common equity ratio. Because our capital structure is subject to extensive regulatory scrutiny, including under the Federal Reserve Board’s Comprehensive Capital Analysis and Review, or CCAR, process, we may not able to consummate the capital initiatives required to bring our Tier 1 common equity ratio in line with our expectations. This could prevent us from achieving our ROTCE targets. For more information about risks relating to our ability to obtain the requisite approval from the Federal Reserve Board, see “—Supervisory requirements and expectations, our need to make improvements and devote resources to various aspects of our controls, processes, policies and procedures, and any regulator-imposed limits on our activities, could limit our ability to implement our strategic plan, expand our business, improve our financial performance and make capital distributions to our stockholders.”

Normalized Rate Environment. Net interest income growth has been challenged by the relatively persistent low interest rate environment. Our strategic plan includes assumptions about rising interest rates in the coming periods. In particular, our strategic plan assumes that interest rates will                 . We do not control interest rates and there is no guarantee that interest rates will rise consistent with our expectations. If the current low interest rate environment were to continue or if interest rates do not rise as much or as quickly as we expect, then we may not be able to achieve our ROTCE targets. For further information on how we may be affected by changes in interest rates, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Governance and Quantitative and Qualitative Disclosures About Risk—Market Risk.”

Supervisory requirements and expectations on us as a financial holding company and a bank holding company, our need to make improvements and devote resources to various aspects of our controls, processes, policies and procedures, and any regulator-imposed limits on our activities, could limit our ability to implement our strategic plan, expand our business, improve our financial performance and make capital distributions to our stockholders.

As a result of and in addition to new legislation aimed at regulatory reform, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and the increased capital and liquidity requirements introduced by the U.S. implementation of the Basel III framework, the federal banking agencies, such as the Federal Reserve Board, the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”), as well as the Consumer Financial Protection Bureau (“CFPB”), have taken a stricter approach to supervising and regulating financial institutions and financial products and services over which they exercise their respective supervisory authorities. We, our two banking subsidiaries and our products and services are all subject to greater supervisory scrutiny and enhanced supervisory requirements and expectations and face significant challenges in meeting them. We expect to continue to face greater supervisory scrutiny and enhanced supervisory requirements in the foreseeable future.

Our two banking subsidiaries are currently subject to consent orders issued by the OCC and the FDIC in connection with their findings of deceptive marketing and implementation of some of our checking account and funds transfer products and services. Among other things, the consent orders require us to remedy deficiencies and develop stronger compliance controls, policies and procedures. We have made progress and continue to make progress in addressing these requirements, but the consent orders remain in place and we are unable to predict when they may be terminated. Separately, CBNA is also making improvements to its compliance management systems, risk management and

 

18


deposit reconciliation practices in order to address deficiencies in those areas. CBPA is making improvements to address deficiencies in its compliance program, policies and procedures and anti-money laundering controls. These efforts require us to make investments in additional resources and systems and also require a significant commitment of managerial time and attention.

The OCC recently determined that CBNA currently does not meet the condition—namely, that CBNA must be both well-capitalized and well-managed, as those terms are defined in applicable regulations, based on certain minimum capital ratios and supervisory ratings, respectively—to own a financial subsidiary. A financial subsidiary is permitted to engage in a broader range of activities, similar to those of a financial holding company, than those permissible for a national bank. CBNA has two financial subsidiaries, CCO Investment Services Corp., a registered broker-dealer, and RBS Citizens Insurance Agency, Inc., a dormant entity. CBNA has entered into an agreement with the OCC (the “OCC Agreement”) pursuant to which it must develop a remediation plan, which must be submitted to the OCC, setting forth the specific actions it will take to bring itself back into compliance with the condition to own a financial subsidiary and the schedule for achieving that objective. Until CBNA satisfactorily addresses the deficiencies, it will be subject to restrictions on its ability to acquire control or hold an interest in any new financial subsidiary and to commence new activities in any existing financial subsidiary, without the prior consent of the OCC. If CBNA fails to remediate the deficiencies within 180 days from March 13, 2014, or such longer period as the OCC may permit, it may have to divest itself of its financial subsidiaries and comply with any additional limitations or conditions on its conduct as the OCC may impose.

In March 2014, the Federal Reserve Board objected on qualitative grounds to our capital plan submitted as part of the Comprehensive Capital Analysis and Review, or CCAR, process. In its public report entitled “Comprehensive Capital Analysis and Review 2014: Assessment Framework and Results,” the Federal Reserve Board cited significant deficiencies in our capital planning processes, including inadequate governance, weak internal controls and deficiencies in our practices for estimating revenues and losses under a stress scenario and for ensuring the appropriateness of loss estimates across our business lines in a specific stress scenario. Although the Federal Reserve Board acknowledged that bank holding companies such as ours that are new to the CCAR process are subject to different expectations, our weaknesses were considered serious enough to warrant the Federal Reserve Board’s objection based on its qualitative assessment of our capital planning process. As a result, we are not permitted to increase our capital distributions above 2013 levels and are required to resubmit our capital plan to the Federal Reserve Board, unless the Federal Reserve Board determines otherwise. If we resubmit our plan, we may determine that we need to modify our proposed capital distributions. In any event, we cannot assure you that the Federal Reserve Board will not object to any resubmitted plan or that, even if it does not object to it, our planned capital distributions will not be significantly modified.

In addition to all of the foregoing, as part of our and our banking subsidiaries’ regular examination process, from time to time we and our banking subsidiaries may become, and currently are, subject to prudential restrictions on our activities. The restrictions that apply to CBNA are described above. Similarly, under the Bank Holding Company Act of 1956 (the “Bank Holding Company Act”), we may not be able to engage in certain categories of new activities or acquire shares or control of other companies other than in connection with internal reorganizations.

In order to remedy all of these weaknesses and meet these significant regulatory and supervisory challenges, we need to make substantial improvements to our processes, systems and controls. We expect to continue to dedicate significant resources and managerial time and attention and to make significant investments in enhanced processes, systems and controls. This in turn may increase our operational costs and limit our ability to implement aspects of our strategic plan or otherwise pursue certain business opportunities. Moreover, if we are unsuccessful in remedying these weaknesses and meeting the enhanced supervisory requirements and expectations that apply to us and our banking subsidiaries, we could remain subject to existing restrictions or become subject to additional

 

19


restrictions on our activities, informal (non-public) or formal (public) supervisory actions or public enforcement actions. Any such actions or restrictions, if and in whatever manner imposed, would likely increase our costs and could limit our ability to implement our strategic plans and expand our business, and as a result could have a material adverse effect on our business, results of operations or financial condition.

A continuation of the current low interest rate environment or subsequent movements in interest rates may have an adverse effect on our profitability.

Historically, and in the near-to-medium term, we anticipate that net interest income will remain a significant component of our total revenue. This is due to the fact that a high percentage of our assets and liabilities have been and will likely continue to be in the form of interest bearing or interest-related instruments. Our net interest income was $3.1 billion for the year ended December 31, 2013 and $3.2 billion for the year ended December 31, 2012. Changes in interest rates can have a material effect on many areas of our business, including the following:

Net Interest Income. In recent years, it has been the policy of the Federal Reserve Board and the U.S. Treasury to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on securities we have purchased, and market rates on the loans we have originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest earning assets has decreased during the recent low interest rate environment. If a low interest rate environment persists, our net interest income may further decrease. This would be the case because our ability to lower our interest expense has been limited at these interest rate levels, while the average yield on our interest earning assets has continued to decrease. Moreover, if our floating rate interest earning assets do not reprice faster than our interest bearing liabilities, our net investment income could be adversely affected. If our net interest income further decreases, this could have an adverse effect on our profitability.

Deposit Costs. Our net interest margin would narrow if our cost of funding increases without a correlative increase in the interest we earn from loans and investments. Because we rely extensively on deposits to fund our operations, our cost of funding would increase if there is an increase in the interest rate we are required to pay our customers to retain their deposits. This could occur, for instance, if we are faced with competitive pressures to increase rates on deposits. In addition, if the interest rates we are required to pay for other sources of funding (for example, in the interbank or capital markets) increases, our cost of funding would increase. If any of the foregoing risks occurs, our net interest margin would narrow unless there was a correlative increase in the interest we earn from our loans and investments. Although our assets currently reprice faster than our liabilities (which would result in a benefit to net interest income as interest rates rise), the benefit from rising rates could be less than we assume, which may have an adverse effect on our profitability.

Loan Volume and Delinquency. Increases in interest rates may decrease customer demand for loans as the higher cost of obtaining credit may deter customers from new loans. Further, higher interest rates might also lead to an increased number of delinquent loans and defaults, which would impact the value of our loans.

Value of Our Mortgage Servicing Rights. As a residential mortgage servicer, we have a portfolio of mortgage servicing rights (“MSRs”). MSRs are subject to interest rate risk in that their fair value will fluctuate as a result of changes in the interest rate environment. When interest rates fall, borrowers are generally more likely to prepay their mortgage loans by refinancing them at a lower rate. As the likelihood of prepayment increases, the fair value of MSRs can decrease. Decrease in the fair value below the carrying value of MSRs will reduce earnings in the period in which the decrease occurs.

 

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We cannot control or predict with certainty changes in interest rates. Global, national, regional and local economic conditions, competitive pressures and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. Although we have policies and procedures designed to manage the risks associated with changes in market interest rates, as further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Governance,” changes in interest rates still may have an adverse effect on our profitability.

If our assumptions regarding borrower behavior are wrong or overall economic conditions are significantly different than we anticipate, then our risk mitigation may be insufficient to protect against interest rate risk and our net income would be adversely affected.

We could fail to attract, retain or motivate highly skilled and qualified personnel, including our senior management, other key employees or members of our Board, which could impair our ability to successfully execute our strategic plan and otherwise adversely affect our business.

A key cornerstone of our strategic plan involves the hiring of a large number of highly skilled and qualified personnel. Accordingly, our ability to implement our strategic plan and our future success depends on our ability to attract, retain and motivate highly skilled and qualified personnel, including our senior management and other key employees and directors, competitively with our peers. The marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, incentivizing and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place us at a significant competitive disadvantage and prevent us from successfully implementing our strategy, which could impair our ability to implement our strategic plan successfully, achieve our performance targets and otherwise have a material adverse effect on our business, financial condition and results of operations.

Governmental scrutiny with respect to matters relating to compensation and other business practices in the financial services industry has increased dramatically in the past several years and has resulted in more aggressive and intense regulatory supervision and the application and enforcement of more stringent standards. For example, in June 2010, the Federal Reserve Board and other federal banking regulators jointly issued comprehensive final guidance designed to ensure that incentive compensation policies do not undermine the safety and soundness of banking organizations by encouraging employees to take imprudent risks. The recent financial crisis and the current political and public sentiment regarding financial institutions has resulted in a significant amount of adverse press coverage, as well as adverse statements or charges by regulators and elected officials. Future legislation or regulation or government views on compensation may result in us altering compensation practices in ways that could adversely affect our ability to attract and retain talented employees.

In addition to complying with U.S. laws relating to compensation, we are also required to comply with United Kingdom (UK) and European Union (EU) remuneration requirements for so long as we remain subject to the supervision of the UK Prudential Regulatory Authority (PRA), which supervision will continue until the PRA determines that RBS Group ceases to control us. As a result of the implications of the EU Capital Requirements Directive IV (CRD IV), certain of our most senior employees, including our CEO, may not receive variable compensation in excess of 100% of fixed compensation (200% with shareholder approval) starting with performance year 2014. Because shareholder approval is not being sought by RBS, we anticipate that a 100% limitation will apply for 2014. We intend to maintain competitive total compensation levels for affected employees, although it is possible that the structure of our compensation packages may not be considered in line with our peers.

 

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Our ability to meet our obligations, and the cost of funds to do so, depend on our ability to access sources of liquidity and the particular sources available to us.

Liquidity risk is the risk that we will not be able to meet our obligations, including funding commitments, as they come due. This risk is inherent in our operations and can be heightened by a number of factors, including an over-reliance on a particular source of funding (including, for example, short-term and overnight funding), changes in credit ratings or market-wide phenomena such as market dislocation and major disasters. Like many banking groups, our reliance on customer deposits to meet a considerable portion of our funding has grown over recent years, and we continue to seek to increase the proportion of our funding represented by customer deposits. However, these deposits are subject to fluctuation due to certain factors outside our control, such as a loss of confidence by customers in us or the banking sector generally, increasing competitive pressures for retail or corporate customer deposits, changes in interest rates and returns on other investment classes, which could result in a significant outflow of deposits within a short period of time. To the extent that in the future there is heavy competition among U.S. banks for retail customer deposits, this competition may increase the cost of procuring new deposits and otherwise negatively affect our ability to grow our deposit base. An inability to grow, or any material decrease in, our deposits could have a material adverse effect on our ability to satisfy our liquidity needs.

In addition, volatility in the interbank funding market can negatively impact our ability to fund our operations. For example, funding in the interbank markets, a traditional source of unsecured short-term funding, was severely disrupted throughout the global economic and financial crisis. If market disruption or significant volatility returns to the interbank or wholesale funding market, our ability to access capital in these funding markets could be materially impaired. Additionally, other factors outside our control, such as an operational problem that affects third parties, could impair our ability to access capital markets or create an unforeseen outflow of cash or deposits. Our inability to access adequate funding, whether from bank deposits, the interbank funding market or capital markets, would constrain our ability to make new loans, to meet our existing lending commitments and ultimately jeopardize our overall liquidity and capitalization.

Maintaining a diverse and appropriate funding strategy for our assets consistent with our wider strategic plan remains challenging, and any tightening of credit markets could have a material adverse impact on us. In particular, there is a risk that corporate and financial institution counterparties may seek to reduce their credit exposures to banks and other financial institutions (for example, reflected in reductions in unsecured deposits supplied by these counterparties), which may cause funding from these sources to no longer be available. Under these circumstances, we may need to seek funds from alternative sources, potentially at higher costs than has previously been the case, or may be required to consider disposals of other assets not previously identified for disposal to reduce our funding commitments.

A reduction in our credit ratings, which are based on a number of factors, including the credit ratings of RBS or the RBS Group, could have a material adverse effect on our business, financial condition and results of operations.

Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings are based on a number of factors, including our financial strength. Other factors considered by rating agencies include the financial strength of and other factors relating to RBS and the RBS Group, as well as conditions affecting the financial services industry generally. Any downgrade in our ratings would likely increase our borrowing costs and could limit our access to capital markets and adversely affect our business. For example, a ratings downgrade could adversely affect our ability to sell or market in the capital markets certain of our securities, including subordinated debt, engage in certain longer-term and derivatives transactions and retain our customers, particularly corporate customers who need a minimum rating threshold in order

 

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to invest or deposit. In addition, under the terms of certain of our derivatives contracts, we may be required to maintain a minimum credit rating or have to post additional collateral or terminate such contracts. Any of these results of a rating downgrade could increase our cost of funding, reduce our liquidity and have adverse effects on our business, financial condition and results of operations.

Any downgrade in the credit rating of RBS, which will own     % of our stock after completion of this offering (or     % if the underwriters’ option to purchase additional shares of common stock is exercised in full), or the RBS Group may negatively impact the rating agencies’ evaluation of us and our business which could ultimately result in a downgrade of our credit ratings. The credit ratings of the RBS Group, along with a number of other European financial institutions, were downgraded during the course of 2011 and 2012 as part of the rating agencies’ review of systemic support assumptions incorporated into bank ratings and the likelihood, in the case of banks located in the United Kingdom, that the UK government is more likely in the future to make greater use of its regulatory tools to allow burden sharing among bank creditors. Rating agencies continue to evaluate the rating methodologies applicable to European banks, including the RBS Group, and any change in such methodologies could ultimately impact our credit ratings. Separately, adverse changes in the credit ratings of the United Kingdom could adversely affect the credit ratings of the RBS Group which may ultimately have an adverse impact on our credit ratings. In December 2012, Standard & Poor’s placed the United Kingdom’s AAA credit rating on credit watch, with negative outlook and, in February 2013, Moody’s downgraded the United Kingdom’s credit rating one notch to Aa1.

On November 29, 2011, Standard & Poor’s lowered its long-term debt rating of RBS to “A-” and, at the same time, lowered our long-term debt rating to “A.” On June 22, 2012, Moody’s downgraded the long-term bank deposit rating of our banking subsidiaries to A3 following its downgrade of RBS on June 21, 2012. On November 11, 2013, Standard & Poor’s lowered its ratings on 20 of CBNA’s letter of credit-backed U.S. public finance issues. This action followed Standard & Poor’s’ November 7, 2013 downgrade of the long-term debt of RBS to BBB+ and its simultaneous lowering of our long-term debt rating to BBB+. On November 3, 2013, Fitch downgraded our long-term debt rating to BBB+ following RBS’s announcement of its intention to fully divest us by 2016. Although Moody’s confirmed the long-term bank deposit rating of our banking subsidiaries on March 13, 2014, its ratings outlook is negative. On May 7, 2014, Standard & Poor’s lowered our stand-alone credit profile to “a-” from “a.” These ratings could be further downgraded as a result of a number of factors, such as our financial strength and economic conditions generally. The ratings could also be further downgraded due to RBS’s continued ownership interest in us, reflecting the potential adverse effects of challenges faced by the RBS Group, or in connection with our separation from the RBS Group, if the rating agencies perceive that we would not benefit from the support of the RBS Group. Any further reductions in our credit ratings or those of our banking subsidiaries could adversely affect our access to liquidity, our competitive position, increase our funding costs or otherwise have a material adverse effect on our business, financial condition and results of operations.

We are subject to certain risks related to originating and selling mortgages and we may be required to repurchase mortgage loans or indemnify mortgage loan purchasers, which could adversely impact our business, financial condition and results of operations.

We originate and often sell mortgage loans. When we sell mortgage loans, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our loan sale agreements require us to repurchase or substitute mortgage loans in the event of certain breaches of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Likewise, we are required to repurchase or substitute mortgage loans if we breach certain representations or warranties in connection with our securitizations, whether or not we were the

 

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originator of the loan. While in many cases we may have a remedy available against certain parties, often these may not be as broad as the remedies available to a purchaser of mortgage loans against us, and we face the further risk that such parties may not have the financial capacity to satisfy remedies that may be available to us. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover our losses from third parties. We have received repurchase and indemnity demands from purchasers in the past, which have resulted in an increase in the amount of losses for repurchases. In particular, between January 1, 2009 and December 31, 2013, we received approximately $119 million in repurchase demands and $89 million in indemnification payment requests in respect of loans originated, for the most part, since 2003. Of those claims presented, $64 million was paid to repurchase residential mortgage loans, and $25 million was incurred in indemnification costs to make investors whole. We repurchased mortgage loans totaling $35 million and $13 million for the year ended December 31, 2013 and 2012, respectively. We incurred indemnification costs of $12 million and $5 million for the year ended December 31, 2013 and 2012, respectively. We cannot estimate what the future level of repurchase demands will be or our ultimate exposure, and cannot give any assurance that the historical experience will or will not continue in the future. It is possible that the volume of repurchase demands will increase, which could have a material adverse effect on our business, financial condition and results of operations.

We face risks as a servicer of loans. We may be terminated as a servicer or master servicer, be required to repurchase a mortgage loan or reimburse investors for credit losses on a mortgage loan, or incur costs, liabilities, fines and other sanctions if we fail to satisfy our servicing obligations, including our obligations with respect to mortgage loan foreclosure actions.

We act as servicer or master servicer for mortgage loans included in securitizations and for unsecuritized mortgage loans owned by investors. As a servicer or master servicer for those loans, we have certain contractual obligations to the securitization trusts, investors or other third parties, including, in our capacity as a servicer, foreclosing on defaulted mortgage loans or, to the extent consistent with the applicable securitization or other investor agreement, considering alternatives to foreclosure (such as loan modifications, short sales and deed-in-lieu of foreclosures), and, in our capacity as a master servicer, overseeing the servicing of mortgage loans by the servicer. Generally, our servicing obligations as a servicer or master servicer described above are set by contract, for which we receive a contractual fee. However, the costs to perform contracted-for services has been increasing, which reduces our profitability. In addition, we serve as a servicer for government sponsored enterprises (GSEs) under servicing guides. The GSEs can amend their servicing guides, which can increase the scope or costs of the services we are required to perform without any corresponding increase in our servicing fee. Further, the CFPB has issued two regulations that amended the mortgage servicing provisions of Regulation Z and Regulation X, which became effective on January 10, 2014 and which may further increase the scope and costs of services we are required to perform, including as it relates to servicing loans that we own. In addition, there has been a significant increase in state laws that impose additional servicing requirements that increase the scope and cost of our servicing obligations.

If we commit a material breach of our obligations as servicer or master servicer, we may be subject to termination if the breach is not cured within a specified period of time following notice, which can generally be given by the securitization trustee or a specified percentage of security holders, causing us to lose servicing income. In addition, we may be required to indemnify the securitization trustee against losses from any failure by us, as a servicer or master servicer, to perform our servicing obligations or any act or omission on our part that involves willful misfeasance, bad faith or gross negligence. For certain investors and/or certain transactions, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit losses incurred on the loan as a remedy for servicing errors with respect to the loan. If we experience increased repurchase obligations

 

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because of claims that we did not satisfy our obligations as a servicer or master servicer, or increased loss severity on such repurchases, we may have to materially increase our repurchase reserve.

We rely on the mortgage secondary market and GSEs for some of our liquidity.

We sell most of the mortgage loans we originate to reduce our credit risk and to provide funding for additional loans. We rely on GSEs to purchase loans that meet their conforming loan requirements. Strategically, we may originate and hold nonconforming loans on-balance sheet for investment purposes, or from time to time, we will rely on other capital markets investors to purchase nonconforming loans (i.e., loans that do not meet GSE requirements). Since the onset of the global economic and financial crisis, investor demand for nonconforming loans has fallen sharply, increasing credit spreads and reducing the liquidity of those loans. In response to the reduced liquidity in the capital markets, we may retain more nonconforming loans, negatively impacting reserves, or we may originate fewer mortgages, which would negatively impact revenue. When we retain a loan not only do we keep the credit risk of the loan but we also do not receive any sale proceeds that could be used to generate new loans. However, we receive net interest margin as our income stream as loan payments are received on a monthly basis in lieu of sale proceeds. Depending on balance sheet capacity, a persistent lack of liquidity could limit our ability to fund and thus originate new mortgage loans, reducing the fees we earn from originating and servicing loans. In addition, we cannot provide assurance that GSEs will not materially limit their purchases of conforming loans due to capital constraints or change their criteria for conforming loans (e.g., maximum loan amount or borrower eligibility). We note that proposals have been presented to reform the housing finance market in the United States, including the role of the GSEs in the housing finance market. The extent and timing of any such regulatory reform regarding the housing finance market and the GSEs, as well as any effect on our business and financial results, are uncertain.

We are subject to increased risk of credit losses associated with HELOCs originated prior to the global financial and economic crisis.

During the years prior to the global financial and economic crisis, financial institutions, including us, originated a significant number of HELOCs. The terms of HELOCs generally provided for the deferral of borrowers’ obligations to begin to repay principal until a specified future date. As of December 31, 2013, approximately 39% of our $16.7 billion HELOC portfolio, representing $6.6 billion in drawn balances and $5.8 billion in undrawn balances, were subject to a payment reset between 2014 and 2017. This includes $500 million of balloon balances where payment in full of all outstanding indebtedness is due as of the reset date. Although we launched a program in September 2013 to manage the exposure by providing heightened outreach to borrowers, there remains a risk of increased credit losses as borrowers become obligated to make principal and interest payments. For further information regarding the expected HELOC payment shock, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors Affecting Our Business—HELOC Payment Shock.”

Our financial performance may be adversely affected by deteriorations in borrower credit quality, particularly in the New England, Mid-Atlantic and Midwest regions, where our operations are concentrated.

We have exposure to many different industries and risks arising from actual or perceived changes in credit quality and uncertainty over the recoverability of amounts due from borrowers is inherent in our businesses. For example, we have exposure to certain business sectors and geographic markets that were weakened by the global economic and financial crisis. Our exposure may be exacerbated by the geographic concentration of our operations, which are predominately located in the New England, Mid-Atlantic and Midwest regions. The credit quality of our borrowers may deteriorate for a number of

 

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reasons that are outside our control, including as a result of prevailing economic and market conditions and asset valuation. The trends and risks affecting borrower credit quality, particularly in the New England, Mid-Atlantic and Midwest regions, have caused, and in the future may cause, us to experience impairment charges, increased repurchase demands, higher costs, additional write-downs and losses and an inability to engage in routine funding transactions, which could have a material adverse effect on our business, financial condition and results of operations.

Our framework for managing risks may not be effective in mitigating risk and loss and our use of models presents risks to our risk management framework.

Our risk management framework is made up of various processes and strategies to manage our risk exposure. The framework to manage risk, including the framework’s underlying assumptions, may not be effective under all conditions and circumstances. If the risk management framework proves ineffective, we could suffer unexpected losses and could be materially adversely affected.

One of the main types of risks inherent in our business is credit risk. An important feature of our credit risk management system is to employ an internal credit risk control system through which we identify, measure, monitor and mitigate existing and emerging credit risk of our customers. As this process involves detailed analyses of the customer or credit risk, taking into account both quantitative and qualitative factors, it is subject to human error. In exercising their judgment, our employees may not always be able to assign an accurate credit rating to a customer or credit risk, which may result in our exposure to higher credit risks than indicated by our risk rating system.

In addition, we have undertaken a strategic initiative to enhance our credit policies and guidelines to address potential risks associated with particular industries or types of customers, as discussed in more detail under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management.” However, we may not be able to effectively implement these initiatives, or consistently follow and refine our credit risk management system. If any of the foregoing were to occur, it may result in an increase in the level of nonperforming loans and a higher risk exposure for us, which could have a material adverse effect on us.

Some of our tools and metrics for managing risk are based upon our use of observed historical market behavior. We rely on quantitative models to measure risks and to estimate certain financial values. Models may be used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting losses, assessing capital adequacy and calculating regulatory capital levels, as well as estimating the value of financial instruments and balance sheet items. Poorly designed or implemented models present the risk that our business decisions based on information incorporating such models will be adversely affected due to the inadequacy of that information. Moreover, our models may fail to predict future risk exposures if the information used in the model is incorrect, obsolete or not sufficiently comparable to actual events as they occur. We seek to incorporate appropriate historical data in our models, but the range of market values and behaviors reflected in any period of historical data is not at all times predictive of future developments in any particular period and the period of data we incorporate into our models may turn out to be inappropriate for the future period being modeled. In such case, our ability to manage risk would be limited and our risk exposure and losses could be significantly greater than our models indicated. For example, we experienced certain technical issues relating to our market risk measurement processes when we began incorporating trade level detail for foreign exchange contracts in 2013. Despite rigorous pilot testing of our processes, during the initial phase of implementation our processes failed to incorporate certain positions we maintained to offset client exposure, which led to an immaterial overstatement of foreign exchange currency rate risk positions during 2013 compared to our position at year end. We have adjusted our processes and have experienced no further issues. In addition, if existing or potential customers believe our risk management is inadequate, they could take

 

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their business elsewhere. This could harm our reputation as well as our revenues and profits. Finally, information we provide to our regulators based on poorly designed or implemented models could also be inaccurate or misleading. Some of the decisions that our regulators make, including those related to capital distributions to our stockholders, could be affected adversely due to their perception that the quality of the models used to generate the relevant information is insufficient.

The preparation of our financial statements requires the use of estimates that may vary from actual results. Particularly, various factors may cause our allowance for loan and lease losses to increase.

The preparation of consolidated financial statements in conformity with GAAP requires management to make significant estimates that affect the financial statements. Our most critical accounting estimate is the allowance for loan and lease losses. The allowance for loan and lease losses is a reserve established through a provision for loan and lease losses charged to expense and represents our estimate of losses within the existing portfolio of loans. The allowance is necessary to reserve for estimated loan and lease losses and risks inherent in the loan portfolio. The level of the allowance reflects our ongoing evaluation of industry concentrations, specific credit risks, loan and lease loss experience, current loan portfolio quality, present economic, political and regulatory conditions and incurred losses inherent in the current loan portfolio.

The determination of the appropriate level of the allowance for loan and lease losses inherently involves a degree of subjectivity and requires that we make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, the stagnation of certain economic indicators that we are more susceptible to, such as unemployment and real estate values, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside our control, may require an increase in the allowance for loan and lease losses. In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require an increase in the allowance for loan and lease losses or the recognition of further loan charge-offs, based on judgments that can differ from those of our own management. In addition, if charge-offs in future periods exceed the allowance for loan and lease losses—that is, if the allowance for loan and lease losses is inadequate—we will need additional loan and lease loss provisions to increase the allowance for loan and lease losses. Should such additional provisions become necessary, they would result in a decrease in net income and capital and may have a material adverse effect on us.

We could also sustain credit losses that are significantly higher than the amount of our allowance for loan and lease losses, and therefore have an adverse impact on earnings. Higher credit losses could arise for a variety of reasons. A severe downturn in the economy would generate increased charge-offs and a need for higher reserves. In particular, a severe decrease in housing prices or spike in unemployment would cause higher losses and a larger allowance for loan and lease losses, particularly in the residential real estate secured portfolios. Within the residential real estate portfolios, we have HELOCs for which the end of draw is happening over the next two years. If there is a spike in interest rates, these customers will not only have to deal with an increased or first time principal payment but also an increase in interest payments, potentially leading to larger losses and allowance for loan and lease losses. For more information about risks related to HELOCs, see “—We are subject to increased risk of credit losses associated with HELOCs originated prior to the global financial and economic crisis.” While we believe that our allowance for loan and lease losses was adequate on December 31, 2013, there is no assurance that it will be sufficient to cover all incurred loan and lease credit losses, particularly if economic conditions worsen. In the event of deterioration in economic conditions, we may be required to increase reserves in future periods, which would reduce our earnings.

 

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The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgments and estimates that may change over time or may ultimately not turn out to be accurate.

Under GAAP, we recognize at fair value: (i) financial instruments classified as held for trading or designated at fair value through profit or loss; (ii) financial assets classified as available for sale; and (iii) derivatives. Generally, to establish the fair value of these instruments, we rely on quoted market prices. If such market prices are not available, we rely on internal valuation models that utilize observable market data and/or independent third-party pricing. For example, observable market data may not be available for certain individual financial instruments or classes of financial instruments, such as venture capital investments. In such circumstances, we utilize complex internal valuation models to establish fair value; these models require us to make assumptions, judgments and estimates regarding matters that are inherently uncertain. When practical, we would supplement internal models using independent price verification in order to lessen the uncertainties in our models. These assumptions, judgments and estimates are periodically updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments may have a material adverse effect on our earnings and financial condition.

Operational risks are inherent in our businesses.

Our operations depend on our ability to process a very large number of transactions efficiently and accurately while complying with applicable laws and regulations. Operational risk and losses can result from internal and external fraud; errors by employees or third parties; failure to document transactions properly or to obtain proper authorization; failure to comply with applicable regulatory requirements and conduct of business rules; equipment failures, including those caused by natural disasters or by electrical, telecommunications or other essential utility outages; business continuity and data security system failures, including those caused by computer viruses, cyber-attacks or unforeseen problems encountered while implementing major new computer systems or upgrades to existing systems; or the inadequacy or failure of systems and controls, including those of our suppliers or counterparties. Although we have implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures, identifying and rectifying weaknesses in existing procedures and training staff, it is not possible to be certain that such actions have been or will be effective in controlling each of the operational risks faced by us. Any weakness in these systems or controls, or any breaches or alleged breaches of such laws or regulations, could result in increased regulatory supervision, enforcement actions and other disciplinary action, and have an adverse impact on our business, applicable authorizations and licenses, reputation and results of operations.

The financial services industry, including the banking sector, is undergoing rapid technological changes as a result of competition and changes in the legal and regulatory framework, and we may not be able to compete effectively as a result of these changes.

The financial services industry, including the banking sector, is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. In addition, new, unexpected technological changes could have a disruptive effect on the way banks offer products and services. We believe our success depends, to a great extent, on our ability to use technology to offer products and services that provide convenience to customers and to create additional efficiencies in our operations. However, we may not be able to, among other things, keep up with the rapid pace of technological changes, effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. As a result, our ability to compete effectively to attract or retain new business may be impaired, and our business, financial condition or results of operations may be adversely affected.

 

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In addition, changes in the legal and regulatory framework under which we operate require us to update our information systems to ensure compliance. Our need to review and evaluate the impact of ongoing rule proposals, final rules and implementation guidance from regulators further complicates the development and implementation of new information systems for our business. Also, recent regulatory guidance has focused on the need for financial institutions to perform increased due diligence and ongoing monitoring of third-party vendor relationships, thus increasing the scope of management involvement and decreasing the efficiency otherwise resulting from our relationships with third-party technology providers. Given the significant number of ongoing regulatory reform initiatives, it is possible that we incur higher than expected information technology costs in order to comply with current and impending regulations. See “—Supervisory requirements and expectations on us as a financial holding company and a bank holding company, our need to make improvements and devote resources to various aspects of our controls, processes, policies and procedures, and any regulator-imposed limits on our activities, could limit our ability to implement our strategic plan, expand our business, improve our financial performance and make capital distributions to our stockholders.”

Cyber-attacks, distributed denial of service attacks and other cyber-security matters, if successful, could adversely affect how we conduct our business.

We are under continuous threat of loss due to cyber-attacks, especially as we continue to expand customer capabilities to utilize the Internet and other remote channels to transact business. Two of the most significant cyber-attack risks that we face are e-fraud and loss of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds directly from customers’ or our accounts. We have been subject to a number of attacks historically. The attempts to breach sensitive customer data, such as account numbers and social security numbers, are less frequent but could present significant reputational, legal and regulatory costs to us if successful.

Recently, there has been a series of distributed denial of service attacks on financial services companies, including us. Distributed denial of service attacks are designed to saturate the targeted online network with excessive amounts of network traffic, resulting in slow response times, or in some cases, causing the site to be temporarily unavailable. Generally, these attacks are conducted to interrupt or suspend a company’s access to Internet service. The attacks can adversely affect the performance of a company’s website and in some instances prevent customers from accessing a company’s website. We are implementing certain technology protections such as Customer Profiling and Step-Up Authentication to be in compliance with the Federal Financial Institutions Examination Council (FFIEC) Authentication in Internet Banking Environment (AIBE) guidelines. However, cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks. In the event that a cyber-attack is successful, our business, financial condition or results of operations may be adversely affected.

We rely heavily on communications and information systems to conduct our business.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. Although we have established policies and procedures designed to prevent or limit the effect of the possible failure, interruption or security breach of our information systems, there can be no assurance that these policies and procedures will be successful and that any such failure, interruption or security breach will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failure, interruption or security breach of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability.

 

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We rely on third parties for the performance of a significant portion of our information technology.

We rely on third parties for the performance of a significant portion of our information technology functions and the provision of information technology and business process services. For example, (i) certain components and services relating to our online banking system rely on data communications networks operated by unaffiliated third parties, (ii) many of our applications are hosted or maintained by third parties, including our Commercial Loan System, which is hosted and maintained by Automated Financial Systems, Inc. and (iii) our core deposits system is maintained by Fidelity Information Services, Inc. The success of our business depends in part on the continuing ability of these (and other) third parties to perform these functions and services in a timely and satisfactory manner. If we experience a disruption in the provision of any functions or services performed by third parties, we may have difficulty in finding alternate providers on terms favorable to us and in reasonable timeframes. If these services are not performed in a satisfactory manner, we would not be able to serve our customers well. In either situation, our business could incur significant costs and be adversely affected.

We are exposed to reputational risk and the risk of damage to our brands and the brands of our affiliates, including the RBS Group.

Our success and results depend, in part, on our reputation and the strength of our brands. We are vulnerable to adverse market perception as we operate in an industry where integrity, customer trust and confidence are paramount. We are exposed to the risk that litigation, employee misconduct, operational failures, the outcome of regulatory or other investigations or actions, press speculation and negative publicity, among other factors, could damage our brands or reputation. Our brands and reputation could also be harmed if we sell products or services that do not perform as expected or customers’ expectations for the product are not satisfied.

Negative publicity could result, for example, from an allegation or determination that we have failed to comply with regulatory or legislative requirements, from failure in business continuity or performance of our information technology systems, loss of customer data or confidential information, fraudulent activities, unsatisfactory service and support levels or insufficient transparency or disclosure of information. Negative publicity adversely affecting our brands or reputation could also result from misconduct or malpractice by partners or other third parties with whom we have relationships. In particular, because of our relationship with the RBS Group, negative publicity about the RBS Group could have a negative effect on us. Adverse publicity, governmental scrutiny, any pending future investigations by regulators or law enforcement agencies involving us, any of our affiliates or the RBS Group can also have a negative impact on our reputation and business, which could adversely affect our results of operations.

Any damage to our brands or reputation could cause existing customers or other third parties to terminate their business relationships with us and potential customers or other third parties to be reluctant to do business with us. Such damage to our brands or reputation could cause disproportionate damage to our business, even if the negative publicity is factually inaccurate or unfounded. Furthermore, negative publicity could result in greater regulatory scrutiny and influence market or rating agencies’ perceptions of us, which could make it more difficult for us to maintain our credit rating. The occurrence of any of these events could have an adverse effect on our business, financial condition and results of operations.

We may be adversely affected by unpredictable catastrophic events or terrorist attacks and our business continuity and disaster recovery plans may not adequately protect us from serious disaster.

The occurrence of catastrophic events such as hurricanes, tropical storms, tornadoes and other large-scale catastrophes and terrorist attacks could adversely affect our business, financial condition or

 

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results of operations if a catastrophe rendered both our production data center in East Providence, Rhode Island, and our recovery data center in Medford, Massachusetts unusable. The distance between the data center locations (approximately 45 miles) provides diversity in resources, but not sufficient diversity in the event of a catastrophe as described above. Although we are building a new, out-of-region backup data center in North Carolina, scheduled for completion in 2015, we do not currently have a backup data center outside New England.

Our principal communications and information systems are housed in the East Providence primary datacenter and our operations are concentrated in the New England, Mid-Atlantic and Midwest regions. If a natural disaster, severe weather, power outage or other event were to occur in New England or if we were subject to a terrorist attack prior to the opening of the North Carolina recovery data center that prevented us from using all or a significant portion of our communications and information systems, damaged critical infrastructure or otherwise disrupted our operations, it may be difficult or, in certain cases, impossible for us to continue our business for a substantial period of time. Although we have implemented disaster recovery and business continuity plans, these plans may prove inadequate in the event of a disaster or similar event that seriously compromises our information systems. We may incur substantial expenses as a result of any limitations relating to our disaster recovery and business continuity plans, which, particularly when taken together with the geographic concentration of our operations, could have a material adverse effect on our business.

An inability to realize the value of our deferred tax assets could adversely affect operating results.

Our net deferred tax assets (“DTAs”) are subject to an evaluation of whether it is more likely than not that they will be realized for financial statement purposes. In making this determination, we consider all positive and negative evidence available, including the impact of recent operating results, as well as potential carryback of tax to prior years’ taxable income, reversals of existing taxable temporary differences, tax planning strategies and projected earnings within the statutory tax loss carryover period. We have determined that the DTAs are more likely than not to be realized at December 31, 2013 (except for $137 million related to state DTAs for which a valuation allowance was established). If we were to conclude that a significant portion of the DTAs were not more likely than not to be realized, the required valuation allowance could adversely affect our financial condition and results of operations.

We maintain a significant investment in projects that generate tax credits, which we may not be able to fully utilize.

At December 31, 2013, we maintained an investment of approximately $223 million in entities for which we receive allocations of tax credits, which we utilize to offset our taxable income. We earned $13 million in credits in 2012 and accrued $14 million in credits related to 2013, and as of December 31, 2013, we had a tax credit carryforward of approximately $54 million. Substantially all of these tax credits are related to development projects that are subject to ongoing compliance requirements over certain periods of time to fully realize their value. If these projects are not operated in full compliance with the required terms, the tax credits could be subject to recapture or restructuring. Any of these events could have a material adverse effect on our business, financial condition and results of operations.

We may have exposure to greater than anticipated tax liabilities.

The tax laws applicable to our business activities, including the laws of the United States and other jurisdictions, are subject to interpretation. The taxing authorities in the jurisdictions in which we operate may challenge our tax positions, which could increase our effective tax rate and harm our financial

 

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position and results of operations. In addition, our future income taxes could be adversely affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, or by changes in tax laws, regulations, or accounting principles. We are subject to regular review and audit by U.S. federal and state tax authorities. Any adverse outcome of such a review or audit could have a negative effect on our financial position and results of operations. In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment by management. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

If we are unable to implement and maintain effective internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may be negatively affected.

We are required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. As a subsidiary of RBS, we are currently subject to the requirements of the Sarbanes-Oxley Act, and as a U.S. bank holding company, we are also subject to the FDIC Part 363 Annual Report rules, which incorporates certain items from the Sarbanes-Oxley Act Section 404 into FDICIA requirements. In addition, beginning with our second annual report on Form 10-K, we will be required to furnish a report by management on the effectiveness of our internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act. Our independent registered public accounting firm is required to express an opinion as to the effectiveness of our internal control over financial reporting beginning with our second annual report on Form 10-K. The process of designing, implementing and testing the internal control over financial reporting required to comply with this obligation is time consuming, costly and complicated. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC, or other regulatory authorities, which could require additional financial and management resources.

We depend on the accuracy and completeness of information about clients and counterparties.

In deciding whether to extend credit or enter into other transactions with clients and counterparties, we rely on information furnished by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of such information is incorrect, then the creditworthiness of our clients and counterparties may be misrepresented, which would increase our credit risk and expose us to possible write-downs and losses.

We may not be able to successfully manage our intellectual property and may be subject to infringement claims.

We rely on a combination of owned and licensed trademarks, service marks, trade names, logos and other intellectual property rights. Third parties may challenge, invalidate, infringe or misappropriate our intellectual property, or such intellectual property may not be sufficient to provide us with

 

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competitive advantages, which could result in costly redesign efforts, discontinuance of certain services or other competitive harm. For example, words contained in our trademarks and trade names (including the word “Citizens”) are also found in the trade names of a significant number of third parties, including other banks. This has resulted in, and may in the future result in, challenges to our ability to use our trademarks and trade names in particular geographical areas or lines of business. Such challenges could impede our future expansion into new geographic areas or lines of business and could limit our ability to realize the full value of our trademarks and trade names. We may have to litigate to enforce or determine the scope and enforceability of our intellectual property rights, which is expensive, could cause a diversion of resources and may not prove successful. Existing use by others of trademarks and trade names that are similar to ours could limit our ability to challenge third parties when their use of such marks or names may cause consumer confusion, negatively affect consumers’ perception of our brand and products or dilute our brand identity. In addition, certain aspects of our business and our services rely on technologies licensed by third parties, and we may not be able to obtain or continue to obtain licenses and technologies from these third parties on reasonable terms or at all. The loss or diminution of our intellectual property protection or the inability to obtain third party intellectual property could harm our business and ability to compete.

We may also be subject to costly litigation in the event our services infringe upon or otherwise violate a third party’s proprietary rights. Third parties may have, or may eventually be granted, intellectual property rights, including trademarks, that could be infringed by our services or other aspects of our business. Third parties have made, and may make, claims of infringement against us with respect to our services or business. As we rebrand CFG and our banking subsidiaries following the consummation of this offering and expand our business, the likelihood of receiving third party challenges or claims of infringement related to our intellectual property may increase. Any claim from third parties may result in a limitation on our ability to use the intellectual property subject to these claims. Even if we believe that intellectual property related claims are without merit, defending against such claims is time consuming and expensive and could result in the diversion of the time and attention of our management and employees. Claims of intellectual property infringement also might require us to redesign affected services, enter into costly settlement or license agreements, pay costly damage awards, or face a temporary or permanent injunction prohibiting us from marketing or selling certain of our services. Any intellectual property related dispute or litigation could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Our Separation from the RBS Group

RBS will be our controlling stockholder and its interests may conflict with ours or yours in the future.

Immediately following this offering, RBS will beneficially own approximately     % of our common stock (or     % if the underwriters’ option to purchase additional shares of common stock is exercised in full). As a result, the RBS Group will have significant power to control our affairs and policies including with respect to the election of directors (and through the election of directors the appointment of management), the entering into of mergers, sales of substantially all of our assets and other extraordinary transactions. In particular, under the separation and shareholder agreement that we intend to enter into with RBS in connection with this offering (the “Separation Agreement”), for so long as RBS maintains beneficial ownership of our outstanding stock in excess of certain thresholds, we will be required to obtain the consent of RBS to complete certain significant transactions, including change of control transactions, entrance into material joint ventures or similar corporate transactions, issuance of common stock (other than pursuant to our equity incentive plans), issuance or the guarantee of indebtedness in excess of certain thresholds, the termination of our Chief Executive Officer or Chief Financial Officer and certain other significant transactions. The interests of the RBS Group may not align with our or your interests and we may not be able to manage our business in a manner in your best interests, which could cause the price of our stock to decline.

 

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RBS is 79.9% owned by the UK government and its interests may conflict with ours or yours in the future.

Following placing and open offers in December 2008 and in April 2009, Her Majesty’s Treasury (“HM Treasury”) owned approximately 70.3% of the enlarged ordinary share capital of RBS. In December 2009, RBS issued a further £25.5 billion of new capital to HM Treasury. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary stockholders but are convertible into ordinary shares. Following the issuance of the B shares, HM Treasury’s holding of ordinary shares of the company remained at 70.3%, although its economic interest rose to 84.4%. As of March 31, 2014, HM Treasury held 63.5% of the voting rights in RBS and had an economic interest of 79.9%.

HM Treasury’s stockholder relationship with RBS is managed on its behalf by UK Financial Investments Limited (“UKFI”) and, although HM Treasury has indicated that it intends to respect the commercial decisions of RBS and that RBS will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury’s position as a majority stockholder (and UKFI’s position as manager of this stockholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over RBS. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority stockholder could give rise to conflict between the interests of HM Treasury and the interests of our stockholders, and RBS may make decisions impacting our operations and the value of our common stock based on UK policy imperatives rather than traditional stockholder economic considerations. We cannot accurately predict whether any restrictions and limitations imposed on RBS on account of HM Treasury’s ownership position, or the implementation of RBS’s restructuring plan agreed to with HM Treasury, will have a negative effect on our businesses and financial flexibility or result in conflicts between the interests of RBS and our interests. In addition, it is difficult for us to predict whether any changes to, or termination of, HM Treasury’s current relationship with RBS will have any effect on our business. We also note that we cannot predict the possible effect of RBS not satisfying its commitment to divest CFG as agreed with HM Treasury, for instance, by having a remaining ownership interest in CFG and its subsidiaries beyond any deadline agreed with HM Treasury.

Our historical financial results are derived from our results as a wholly owned indirect subsidiary of RBS and reflect the benefit of the RBS Group’s purchasing power when procuring goods and services, and therefore may not be representative of our results as a stand-alone company and may not be a reliable indicator of our future results.

Our business has benefited from the RBS Group’s purchasing power when procuring certain goods and services. As a stand-alone company, we may be unable to obtain such goods and services at comparable prices or on terms as favorable as those obtained prior to this offering, which could decrease our overall profitability. The historical information does not necessarily indicate what our results of operations, financial condition, cash flows or costs and expenses will be in the future, or that our costs as a stand-alone company will be similar. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Selected Consolidated Financial Data” and the notes to our audited consolidated financial statements included elsewhere in this prospectus.

The RBS Group and its UK bank subsidiaries are subject to the provisions of the UK Banking Act 2009, as amended by the UK Financial Services (Banking Reform) Act 2013, which includes special resolution powers including nationalization and bail-in.

Under the Banking Act 2009, substantial powers have been granted to UK banking regulators as part of a special resolution regime. These powers enable such regulators to deal with and stabilize certain deposit-taking UK incorporated institutions that are failing, or are likely to fail, to satisfy the “FSMA threshold conditions” (within the meaning of section 41 of the Financial Services and Markets

 

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Act 2000, or the “FSMA,” which are the conditions that a relevant entity must satisfy in order to obtain its authorization to perform regulated activities). The special resolution regime consists of three stabilization options: (i) transfer of all or part of the business of the relevant entity and/or the securities of the relevant entity to a private sector purchaser, (ii) transfer of all or part of the business of the relevant entity to a “bridge bank” wholly owned by the Bank of England and (iii) temporary public ownership (nationalization) of the relevant entity. If the UK regulators determine that the RBS Group has failed, or is likely to fail, to satisfy the FSMA threshold conditions, then HM Treasury could decide to take the RBS Group into temporary public ownership pursuant to the powers granted under the Banking Act 2009, and it may then take various actions in relation to any securities without the consent of holders of the securities. In each case, the UK banking regulators would have the authority to modify contractual arrangements of the RBS Group and disapply or modify laws (with possible retrospective effect) to enable their powers under UK law to be used effectively.

Among the changes introduced by the Financial Services (Banking Reform) Act 2013, the Banking Act 2009 was amended to insert a bail-in option as part of the powers of the UK regulators. This option will come into force on such date as shall be stipulated by HM Treasury (HM Treasury has indicated an intention to apply the bail-in provisions from January 1, 2015, which is ahead of the deadline of January 1, 2016 that is set out in the European Bank Recovery and Resolution Directive (“BRRD”)). The bail-in option will be introduced as an additional power available to the Bank of England to enable it to recapitalize a failed institution by allocating losses first to its shareholders and then to eligible unsecured creditors in a manner that seeks to respect the hierarchy of claims in liquidation. The bail-in option includes the power to cancel a liability, to modify the form of a liability (including the power to convert a liability from one form to another) or to provide that a contract under which the institution has a liability is to have effect as if a specified right had been exercised under it, each for the purposes of reducing, deferring or canceling the liabilities of the bank under resolution, as well as to transfer a liability. The Financial Services (Banking Reform) Act 2013 is consistent with the range of tools that European Member States will be required to make available to their resolution authorities under the BRRD, although some amendments are expected to the current UK bail-in provisions to ensure that they are fully compliant with the requirements of the BRRD.

If the UK regulators were to take such stabilization actions with respect to the RBS Group due to a failure, or likely failure, by the RBS Group to satisfy the FSMA threshold conditions, it could result in the creation, modification or canceling of certain of our contractual arrangements that we intend to enter into with the RBS Group prior to the completion of this offering, including the Transitional Services Agreement and Separation Agreement. In addition, the UK regulators could seek to impose additional obligations on us, including the provision of services to third parties who may purchase some or all of the RBS Group’s assets. The UK regulators could also materially modify the RBS Group’s restructuring efforts, including the acceleration of its disclosed intention to sell its remaining shares of our common stock. Any of these actions could have a material adverse effect on our business, contractual obligations and the value of our common stock.

Conflicts of interest and disputes may arise between the RBS Group and us that could be resolved in a manner unfavorable to us.

Questions relating to conflicts of interest and actual disputes may arise between the RBS Group and us in a number of areas relating to our past and ongoing relationships. Areas in which conflicts of interest or disputes between the RBS Group and us could arise include, but are not limited to, the following:

 

   

Competing business activities. The RBS Group is a large global banking and financial services group principally engaged in the business of providing banking and financial services. In the ordinary course of its business activities, the RBS Group may engage in activities where their interests conflict with our interests or those of our stockholders. Our

 

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amended and restated certificate of incorporation will provide that none of the RBS Group, any of its affiliates or any director who is not employed by us or his or her affiliates will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate. See “Description of Capital Stock.” The RBS Group also may pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. As a result, our future competitive position and growth potential could be adversely affected.

 

    Cross officerships, directorships and stock ownership. The ownership interests of our directors or executive officers in the common stock of RBS or service as a director or officer of both RBS and us could create, or appear to create, conflicts of interest when directors and executive officers are faced with decisions that could have different implications for the two companies. For example, these decisions could relate to (i) the nature, quality and cost of services rendered to us by the RBS Group, (ii) disagreement over the desirability of a potential business or acquisition opportunity or business plans, (iii) employee retention or recruiting or (iv) our dividend policy.

 

    Separation Agreement. We will enter into a Separation Agreement immediately prior to the completion of this offering that will govern the relationship between the RBS Group and us following this offering. The Separation Agreement will provide the RBS Group with certain governance rights over our business, as well as obligate us to comply with certain covenants including certain information rights, access privileges and confidentiality matters. Disagreements regarding the rights and obligations of the RBS Group or us under the Separation Agreement could create conflicts of interest for certain of our directors and officers, as well as actual disputes that may be resolved in a manner unfavorable to us. See “Our Relationship to the RBS Group and Certain Other Related Party Transactions—Separation Agreement.”

 

    Transitional Services Agreement. We will enter into a Transitional Services Agreement with the RBS Group for the continued provision of certain services by the RBS Group to us (including specified information technology, operations, compliance, business continuity, legal, human resources, back office and web services) and by us to the RBS Group. The services that are to be provided under the Transitional Services Agreement generally will continue to be provided until December 31, 2016, although certain services may have an earlier termination date or be terminated prior to that time upon the agreement of both parties. Interruptions to or problems with services provided under the Transitional Services Agreement could result in conflicts between us and the RBS Group that increase our costs both for the processing of business and the potential remediation of disputes. See “Our Relationship to the RBS Group and Certain Other Related Party Transactions—Transitional Services Agreement.”

 

   

Commercial Matters. In addition to the agreements that we intend to enter into as part of our separation from the RBS Group, we expect to continue certain of our commercial relationships with the RBS Group for which we intend to continue or enter into one or more commercial matters agreements. The principal commercial activities to be covered by such agreements include certain swap agreements and foreign exchange risk contracts with the RBS Group for the purpose of reducing our exposure to interest rate fluctuations or to meet the financing needs of our customers, as well as commercial referral arrangements related to debt capital markets, underwriting of loan syndications, commercial mortgage securitizations, asset finance and corporate credit card services. Despite our current expectation, there is no guarantee that the RBS Group will continue to provide such commercial services to us or that the prices at which they are willing to provide such services will remain consistent with historical periods. If the RBS Group were to terminate any of these arrangements, our financial results would be adversely affected. Moreover, disagreements may arise between us

 

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and the RBS Group regarding the provision or quality of any such services rendered, which may materially adversely affect this portion of our business. See “Our Relationship to the RBS Group and Certain Other Related Party Transactions—Commercial Matters.”

 

    Business opportunities. Our directors nominated by RBS and the RBS Group may have or make investments in other companies that may compete with us. Our Amended and Restated Certificate of Incorporation will provide that, to the fullest extent permitted by law, none of RBS or any of its affiliates or any director who is not employed by us or his or her affiliates will have any duty to refrain from (i) engaging in a corporate opportunity in the same or similar lines of business in which we or our affiliates now engage or propose to engage or (ii) otherwise competing with us or our affiliates. As a result of these charter provisions, our future competitive position and growth potential could be adversely affected. See “Description of Capital Stock.”

Our separation from the RBS Group could adversely affect our business and profitability due to the RBS Group’s recognizable brand and reputation.

Prior to the completion of this offering, as a wholly owned indirect subsidiary of RBS, we have marketed our products and services using the “RBS” brand name and logo. We believe the association with the RBS Group has provided us with preferred status among certain of our customers, vendors and other persons due to the RBS Group’s globally recognized brand, perceived high-quality products and services and strong capital base and financial strength.

Our separation from the RBS Group could adversely affect our ability to attract and retain customers, which could result in reduced sales of our products. In connection with this offering, although we expect to enter into a trademark license agreement pursuant to which we will be granted a limited license to use certain trademarks (including the daisywheel logo) for 10 years following the completion of the offering, we will be required under the agreement to remove the “RBS” brand name from all of our products and services by the time RBS beneficially owns less than     % of our outstanding common stock or upon the rollout of rebranding in a particular state (but in no event earlier than October 1, 2015). See “Our Relationship with the RBS Group and Certain Other Related Party Transactions—Trademark License Agreement.” After the consummation of this offering, we intend to change the legal names of any of our subsidiaries that continue to include “RBS” and to continue operational and legal work to rebrand CFG and its banking subsidiaries. The process of changing all marketing materials, operational materials, signage, systems, and legal entities containing “RBS” to our new brand name will take approximately 14 months and cost between $14 million and $16 million, excluding any incremental advertising and customer communication expenses. We expect to shift the majority of our advertising and marketing budget to our new brand progressively as the different legal entities complete their individual brand name changes; we expect the shift in advertising and marketing investment to begin no earlier than June 1, 2014 and to be completed no later than July 31, 2015. As a result of this rebranding, some of our existing customers may choose to stop doing business with us, which could increase customer withdrawals. In addition, other potential customers may decide not to purchase our products and services because we no longer will be a part of the RBS Group. We may also receive decreased referrals of business from the RBS Group. Our separation from the RBS Group could prompt some third parties to reprice, modify or terminate their distribution or vendor relationships with us. We cannot accurately predict the effect that our separation from the RBS Group will have on our business, customers or employees.

The risks relating to our separation from the RBS Group could materialize or evolve at any time, including:

 

    immediately upon the completion of this offering, when RBS’s beneficial ownership in our common stock will decrease to approximately     % (approximately     % if the underwriters’ option to purchase additional shares is exercised in full);

 

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    when RBS reduces its beneficial ownership in our common stock to a level below 50%; and

 

    when we cease using the “RBS” name or the daisywheel logo in our sales and marketing materials, particularly when we deliver notices to our distributors and customers that the names of some of our subsidiaries will change.

Any failure by us to successfully replicate or replace certain functions, systems and infrastructure provided by the RBS Group prior to this offering could have a material adverse effect on us.

We will need to replicate or replace certain functions, systems and infrastructure to which we will no longer have the same access after this offering, including services we will receive pursuant to the Transitional Services Agreement. We will also need to make infrastructure investments in order to operate without the same access to the RBS Group’s existing operational and administrative infrastructure. Any failure to successfully implement these initiatives or to do so in a timely manner could have an adverse effect on us.

The RBS Group currently performs or supports certain corporate functions for our operations, including investor relations, advertising and brand management, corporate audit, certain risk management functions, corporate insurance, corporate governance and other services. There is no assurance that, following the completion of this offering, these services will be sustained at the same levels as when we were receiving such services from the RBS Group or that we will obtain the same benefits. When we begin to operate these functions independently, if we do not have our own adequate systems and business functions in place, or are unable to obtain them from other providers, we may not be able to operate our business effectively or at comparable costs and our profitability may decline.

Also, we expect to make an investment of approximately $         million in our systems to complete the migration of technological services following our separation from the RBS Group. In particular, we will separate our shared global network and where services such as corporate risk, back office, audit and human resources are being provided by the RBS Group, we will establish those services for CFG. These initiatives may not be completed on the expected timetable or within the expected budget and may not provide the system functionality or performance levels required to support the current and future needs of our business. Further, the systems and services provided to us by the RBS Group under the Transitional Services Agreement will need to be replaced on or before the date of the expiration of the Transitional Services Agreement. The terms on which we purchase these new systems and services, or the functionality of the systems themselves, may be inferior to those of the systems provided by the RBS Group or those available elsewhere in the market and, in relation to third-party suppliers, may be on terms that are less favorable than the terms on which services were previously provided by third parties to the RBS Group, and from which we have historically benefited and will continue to benefit during the period of the Transitional Services Agreement. For more information regarding the Transition Services Agreement, see “Our Relationship with the RBS Group and Certain Other Related Party Transactions—Transitional Services Agreement.”

Any failure by the RBS Group to deliver the services to be provided under the Transitional Services Agreement could have a material adverse effect on our business, financial condition and results of operations.

In connection with our separation from the RBS Group, we intend to enter into a Transitional Services Agreement with the RBS Group for the continued provision of certain services to us for a specified period. Services provided for under the Transitional Services Agreement include certain information technology, operations, compliance, business continuity, legal, human resources, back office and web services. In particular, we will rely on the RBS Group to provide hosting, support and

 

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maintenance services that are critical to maintaining the level of support for the ongoing needs of our business. Although the majority of the systems run under the Transitional Services Agreement are independent of the RBS Group’s other systems, any technical problems occurring within the RBS Group could have an adverse effect on us. As with all of our systems, interruptions to or problems with our systems and services provided under the Transitional Services Agreement or as a result of migration from the RBS Group infrastructure could cause material damage to our business and reputation. If the RBS Group fails to provide or procure the services envisaged or provide them in a timely manner, it could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Our Industry

Any deterioration in national economic conditions could have a material adverse effect on our business, financial condition and results of operations.

Our business is affected by national economic conditions, as well as perceptions of those conditions and future economic prospects. Changes in such economic conditions are not predictable and cannot be controlled. Adverse economic conditions that could affect us include:

 

    reduced consumer spending;

 

    lower wage income levels;

 

    declines in the market value of residential or commercial real estate;

 

    inflation or deflation;

 

    fluctuations in the value of the U.S. dollar;

 

    volatility in short-term and long-term interest rates; and

 

    higher bankruptcy filings.

These scenarios could require us to charge off a higher percentage of loans and increase provision for credit losses, which would reduce our net income and otherwise have a material adverse effect on our business, financial condition and results of operations. For example, our business was significantly affected by the global economic and financial crisis that began in 2008. The falling home prices, increased rate of foreclosure and high levels of unemployment in the United States triggered significant write-downs by us and other financial institutions. These write-downs adversely impacted our financial results in material respects. Although the U.S. economy continues to recover, an interruption or reversal of this recovery would adversely affect the financial services industry and banking sector. In particular, although the ongoing general economic recovery has positively impacted the real estate market, the fundamentals within the real estate sector, including asset values, high vacancy rates and rent values, remain relatively weak compared to prior to the global economic and financial crisis. Should the recovery of real estate asset values, reduction in vacancies and improvement in rents be interrupted for an extended period of time, it could have a material adverse effect on our business, financial condition and results of operations.

We operate in an industry that is highly competitive, which could result in losing business or margin declines and have a material adverse effect on our business, financial condition and results of operations.

We operate in a highly competitive industry. The industry could become even more competitive as a result of reform of the financial services industry resulting from the Dodd-Frank Act and other legislative, regulatory and technological changes, as well as continued consolidation. We face

 

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aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services, including the following:

 

    Non-banking financial institutions. The ability of these institutions to offer services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures.

 

    Securities firms and insurance companies. These companies, if they elect to become financial holding companies, can offer virtually any type of financial service. This may significantly change the competitive environment in which we conduct our business.

 

    Competitors that have greater financial resources. Some of our larger competitors, including certain national and international banks that have a significant presence in our market area, may have greater capital and resources, higher lending limits and may offer products and services that we do not. We cannot predict the reaction of our customers and other third parties with respect to our financial or commercial strength relative to our competition, including our larger competitors.

As a result of these and other sources of competition, we could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect our profitability and business.

Volatility in the global financial markets continued throughout 2013 as a result of the Eurozone crisis and any recurrence of such volatility could have a material adverse effect on our business, financial condition and results of operations.

The effects of the Eurozone crisis, which began in late 2009 as part of the global economic and financial crisis, continued to impact the global financial markets throughout 2013. Numerous factors continued to fuel the Eurozone crisis, including continued high levels of government debt, the undercapitalization and liquidity problems of many banks in the Eurozone and relatively low levels of economic growth. These factors made it difficult or impossible for some countries in the Eurozone to repay or refinance their debt without the assistance of third parties. As a combination of austerity programs, debt write-downs and the European Central Bank’s commitment to restore financial stability to the Eurozone and the finalization of the primary European Stability Mechanism bailout fund, in 2013 interest rates began to fall and stock prices began to increase. Although these trends have helped to stabilize the effects of the Eurozone crisis, the underlying causes of the crisis have not been completely eliminated. Should the economic recovery in the United States be adversely impacted by a return in volatility in the global financial markets caused by a relapse in Eurozone crisis, loan and asset growth and liquidity conditions at U.S. financial institutions, including us, may deteriorate. Moreover, until RBS divests its interest in us, adverse trends in the Eurozone could increase investor concern or, even if not accurate, stimulate perceptions of funding difficulties for our business because RBS is based in the United Kingdom and has significant exposure to European economies. If any of these factors were to materialize, it could have a material adverse effect on our business, financial condition and results of operations.

Further downgrades to the U.S. government’s credit rating, or the credit rating of its securities, by one or more of the credit ratings agencies could have a material adverse effect on general economic conditions, as well as our operations, earnings and financial condition.

On August 5, 2011, Standard & Poor’s cut the U.S. government’s sovereign credit rating of long-term U.S. federal debt from AAA to AA+ while also keeping its outlook negative. Moody’s also lowered its outlook to “Negative” on August 2, 2011, and Fitch lowered its outlook to “Negative” on

 

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November 28, 2011. During 2013, both Moody’s and Standard & Poor’s revised their outlook from “Negative” to “Stable,” and on March 21, 2014, Fitch revised its outlook from “Negative” to “Stable.” Further downgrades of the U.S. government’s sovereign credit rating, and the perceived creditworthiness of U.S. government-related obligations, could impact our ability to obtain funding that is collateralized by affected instruments. Such downgrades could also affect the pricing of funding when it is available. A downgrade may also adversely affect the market value of such instruments. A downgrade of the sovereign credit ratings of the U.S. government or the credit ratings of related institutions, agencies or instrumentalities would significantly exacerbate the other risks to which we are subject and any related adverse effects on its business, financial condition and results of operations.

The conditions of other financial institutions or of the financial services industry could adversely affect our operations and financial conditions.

Financial services institutions that deal with each other are interconnected as a result of trading, investment, liquidity management, clearing, counterparty and other relationships. Within the financial services industry, the default by any one institution could lead to defaults by other institutions. Concerns about, or a default by, one institution could lead to significant liquidity problems and losses or defaults by other institutions, as the commercial and financial soundness of many financial institutions are closely related as a result of these credit, trading, clearing and other relationships. Even the perceived lack of creditworthiness of, or questions about, a counterparty may lead to market-wide liquidity problems and losses or defaults by various institutions. This systemic risk may adversely affect financial intermediaries, such as clearing agencies, banks and exchanges with which we interact on a daily basis, or key funding providers such as the Federal Home Loan Banks (“FHLBs”), any of which could have a material adverse effect on our access to liquidity or otherwise have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Regulations Governing Our Industry

As a financial holding company and a bank holding company, we are subject to comprehensive regulation that could have a material adverse effect on our business and results of operations.

As a financial holding company and a bank holding company, we are subject to comprehensive regulation, supervision and examination by the Federal Reserve Board. In addition, CBNA is subject to comprehensive regulation, supervision and examination by the OCC and CBPA is subject to comprehensive regulation, supervision and examination by the FDIC and the PA Banking Department. Our regulators supervise us through regular examinations and other means that allow the regulators to gauge management’s ability to identify, assess and control risk in all areas of operations in a safe and sound manner and to ensure compliance with laws and regulations. In the course of their supervision and examinations, our regulators may require improvements in various areas. If we are unable to implement and maintain any required actions in a timely and effective manner, we could become subject to informal (non-public) or formal (public) supervisory actions and public enforcement orders that could lead to significant restrictions on our existing business or on our ability to engage in any new business. Such forms of supervisory action could include, without limitation, written agreements, cease and desist orders, and consent orders and may, among other things, result in restrictions on our ability to pay dividends, requirements to increase capital, restrictions on our activities, the imposition of civil monetary penalties, and enforcement of such action through injunctions or restraining orders. We could also be required to dispose of certain assets and liabilities within a prescribed period. The terms of any such supervisory or enforcement action could have a material adverse effect on our business, financial condition and results of operations.

We are a bank holding company that has elected to become a financial holding company pursuant to the Bank Holding Company Act. As such, we are allowed to engage in certain financial activities in

 

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which a bank holding company is not otherwise permitted to engage. However, to maintain our financial holding company status, we (and all of our subsidiaries) must be “well capitalized” and “well managed.” If we cease to meet these capital and management requirements, there are many penalties we would be faced with, including (i) the Federal Reserve Board may impose limitations or conditions on the conduct of our activities, and (ii) we may not undertake any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the Federal Reserve Board. If a company does not return to compliance within 180 days, which period may be extended, the Federal Reserve Board may require divestiture of that company’s depository institutions.

We may be unable to disclose some restrictions or limitations on our operations imposed by our regulators.

From time to time, bank regulatory agencies take supervisory actions that restrict or limit a financial institution’s activities. In some instances, we are not permitted to publicly disclose these actions. In addition, as part of our regular examination process, our and our banking subsidiaries’ respective regulators may advise us or our banking subsidiaries to operate under various restrictions as a prudential matter. Such supervisory actions or restrictions, if and in whatever manner imposed, could have a material adverse effect on our business and results of operations; and, in certain instances, we may not be able to publicly disclose these matters.

The regulatory environment in which we operate could have a material adverse effect on our business and earnings.

We are heavily regulated by bank and other regulatory agencies at the federal and state levels. This regulatory oversight is established to protect depositors, the FDIC’s Deposit Insurance Fund, and the banking system as a whole, not security holders. Changes to statutes, regulations, rules or policies including the interpretation or implementation of statutes, regulations, rules or policies could affect us in substantial and unpredictable ways including limiting the types of financial services and other products we may offer, limiting our ability to pursue acquisitions and increasing the ability of third parties to offer competing financial services and products.

We are subject to capital adequacy and liquidity standards, and if we fail to meet these standards our financial condition and operations would be adversely affected.

We are subject to several capital adequacy and liquidity standards. To the extent that we are unable to meet these standards, our ability to make distributions of capital will be limited and we may be subject to additional supervisory actions and limitations on our activities. The capital adequacy and liquidity standards that we must meet include the following:

 

    Current capital requirements. Under regulatory capital adequacy guidelines and other regulatory requirements, CFG and its banking subsidiaries must meet guidelines that include quantitative measures of assets, liabilities and certain off-balance sheet items, subject to qualitative judgments by regulators about components of qualifying capital, risk weightings and other factors. We are regulated as a bank holding company and subject to consolidated regulatory capital requirements administered by the Federal Reserve. Our banking subsidiaries are subject to similar capital requirements, administered by the OCC in the case of CBNA and by the FDIC in the case of CBPA. Failure by us or one of our banking subsidiaries to maintain its status as “adequately capitalized” would lead to regulatory sanctions and limitations and could lead the federal banking agencies to take “prompt corrective action.” Furthermore, a failure by our banking subsidiaries to be “well capitalized” under applicable regulatory guidelines could lead to higher FDIC assessments.

 

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    Basel III. The U.S. Basel III final rule and provisions in the Dodd-Frank Act, including the Collins Amendment, will increase capital requirements for banking organizations such as us. Consistent with the Basel Committee’s Basel III capital framework, the U.S. Basel III final rule includes a new minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 4.5% and a Common Equity Tier 1 capital conservation buffer of greater than 2.5% of risk-weighted assets. We have established capital ratio targets that align with U.S. regulatory expectations under fully phased-in Basel III rules. Although we currently have capital ratios that exceed these minimum levels and a strategic plan to keep them at least at these levels, failure to maintain the capital conservation buffer would result in increasingly stringent restrictions on our ability to make dividend payments and other capital distributions and pay discretionary bonuses to executive officers. As to us, the U.S. Basel III final rule will phase in over time beginning on January 1, 2015, and will become fully effective on January 1, 2019.

 

    Capital Plans. We are required to submit an annual capital plan to the Federal Reserve Board. The capital plan must include an assessment of our expected uses and sources of capital over a forward-looking planning horizon of at least nine quarters, a detailed description of our process for assessing capital adequacy, our capital policy, and a discussion of any expected changes to our business plan that are likely to have a material impact on our capital adequacy or liquidity. Based on a qualitative and quantitative assessment, including a supervisory stress test conducted as part of the CCAR process, the Federal Reserve Board will either object to our capital plan, in whole or in part, or provide a notice of non-objection to us by March 31 of a calendar year. If the Federal Reserve Board objects to a capital plan, we may not make any capital distribution other than those with respect to which the Federal Reserve Board has indicated its non-objection. Although we were permitted to continue capital actions at a level consistent with those executed in 2013, the Federal Reserve Board objected to certain qualitative aspects of our 2014 capital plan and we will be required to resubmit our plan unless the Federal Reserve Board determines otherwise.

 

    Stress Tests. In addition to capital planning, we and our banking subsidiaries are subject to capital stress testing requirements imposed by the Dodd-Frank Act that will likely require us to hold more capital than the minimum requirements applicable to us. The stress testing requirements are designed to show that we can meet our capital requirements even under stressed economic conditions.

 

    Liquidity Coverage Ratio. The federal banking regulators also evaluate our liquidity as part of the supervisory process. In October 2013, the U.S. federal banking regulators issued the Notice of Proposed Rulemaking (NPR) for the U.S. implementation of the Liquidity Coverage Ratio (“LCR”). This NPR included a modified version of the Basel Committee’s Liquidity Coverage Ratio (“LCR”) in the United States, which would apply to large bank holding companies such as us. As compared to the Basel Committee’s version of the LCR, the modified version of the LCR includes a narrower definition of high-quality liquid assets, different prescribed cash inflow and outflow assumptions for certain types of instruments and transactions and a shorter phase-in schedule that begins on January 1, 2015, and ends on January 1, 2017.

See the “Regulation and Supervision” section of this prospectus for further discussion of the capital adequacy and liquidity standards to which we are subject.

We could be required to act as a “source of strength” to our banking subsidiaries, which would have a material adverse effect on our business, financial condition and results of operations.

Federal Reserve Board policy historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as

 

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a statutory requirement. This support may be required by the Federal Reserve Board at times when we might otherwise determine not to provide it or when doing so is not otherwise in the interests of CFG or our stockholders or creditors, and may include one or more of the following:

 

    Any extensions of credit from us to our banking subsidiaries that are included in the relevant bank’s capital would be subordinate in right of payment to depositors and certain other indebtedness of such subsidiary banks.

 

    In the event of a bank holding company’s bankruptcy, any commitment that the bank holding company had been required to make to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

    In certain circumstances one of our banking subsidiaries could be assessed for losses incurred by the other. In addition, in the event of impairment of the capital stock of one of our banking subsidiaries, we, as our banking subsidiary’s stockholder, could be required to pay such deficiency.

We depend on our banking subsidiaries for most of our revenue, and restrictions on dividends and other distributions by our banking subsidiaries could affect our liquidity and ability to fulfill our obligations.

As a bank holding company, we are a separate and distinct legal entity from our banking subsidiaries: CBNA and CBPA. We typically receive substantially all of our revenue from dividends from our banking subsidiaries. These dividends are the principal source of funds to pay dividends on our equity and interest and principal on our debt. Various federal and/or state laws and regulations, as well as regulatory expectations, limit the amount of dividends that our banking subsidiaries may pay. For example:

 

    CBNA is required by federal law to obtain the prior approval of the OCC for the payment of cash dividends if they exceed prescribed limits;

 

    CBNA may pay dividends only to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation).

 

    CBPA may only pay dividends out of accumulated net earnings and may not be declared unless surplus (retained earnings) is at least equal to contributed capital.

 

    Neither CBNA nor CBPA may pay a dividend if, in the opinion of the applicable federal regulatory agency, either is engaged in or is about to engage in an unsafe or unsound practice, which would include a dividend payment that would reduce either bank’s capital to an inadequate level.

Currently, as a result of the goodwill impairment recognized by CBNA in the second quarter of 2013, CBNA must request specific approval from the OCC before executing capital distributions. This requirement will be in place through the fourth quarter of 2015. Limitations on our ability to receive dividends from our banking subsidiaries could have a material adverse effect on our liquidity and ability to pay dividends on our equity, as well as interest and principal on our debt.

In addition, on February 18, 2014, the Federal Reserve Board approved a final rule implementing certain enhanced prudential standards for bank holding companies with $50 billion or more in total consolidated assets. The rules will subject a foreign banking organization with at least $50 billion in non-branch U.S. assets as of June 30, 2015 to various requirements, including a requirement to establish by July 1, 2016 a U.S. intermediate holding company (an “IHC”) to hold all of the foreign banking organization’s interests in U.S. companies which it controls for U.S. bank regulatory purposes. An IHC will have to comply with U.S. risk-based capital, leverage, liquidity and risk-management

 

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requirements, as well as other regulations. Although the timing of our separation from the RBS Group is uncertain, the RBS Group will be subject to the enhanced prudential standards for foreign banking organizations, including the requirement to create an IHC, owing in part to the fact that we are an indirect subsidiary of RBS. If we become a subsidiary of the RBS Group IHC, even if we receive dividends from our banking subsidiaries, our ability to pay dividends or make capital distributions could be constrained by the IHC’s capital requirements, which will be affected by any interests that it holds in other of the RBS Group’s U.S. companies.

We are and may be subject to regulatory actions that may have a material impact on our business.

We are involved, from time to time, in reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding our business. These regulatory actions involve, among other matters, accounting and operational matters, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief that may require changes to our business or otherwise materially impact our business. For example, in April 2013, our banking subsidiaries consented to the issuance of orders by the OCC and the FDIC (the “Consent Orders”). In the Consent Orders (which are publicly available and will remain in effect until terminated by the regulators), our banking subsidiaries neither admitted nor denied the regulators’ findings that they had engaged in deceptive marketing and implementation of the bank’s overdraft protection program, checking rewards programs and stop-payment process for pre-authorized recurring electronic fund transfers. Under the Consent Orders, our banking subsidiaries paid a total of $10 million in civil monetary penalties and are required to (i) develop plans to provide restitution to affected customers (the amount of which is anticipated to be approximately $8 million), (ii) cease and desist any operations in violation of Section 5 of the Federal Trade Commission Act, and (iii) submit to the regulators’ periodic written progress reports regarding compliance with the Consent Orders. For more information regarding ongoing significant regulatory actions in which we are involved, see “Business—Legal and Regulatory Proceedings.”

In regulatory actions, such as those referred to above, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount of any loss. We cannot predict with certainty if, how or when such proceedings will be resolved or what the eventual fine, penalty or other relief, conditions or restrictions, if any, may be, particularly for actions that are in their early stages of investigation. Adverse regulatory actions could have a material adverse effect on our business, financial condition and results of operations.

We are and may be subject to litigation that may have a material impact on our business.

Our operations are diverse and complex and we operate in legal and regulatory environments that expose us to potentially significant litigation risk. In the normal course of business, we have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with our activities as a financial services institution, including with respect to unfair or deceptive business practices and mis-selling of certain products. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the entities that would otherwise be the primary defendants in such cases are bankrupt or in financial distress. We currently have, among others, pending legal actions alleging violations under the Fair Labor Standards Act and certain state fair wage laws. Moreover, a number of recent judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or

 

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its other creditors or stockholders. This could increase the amount of private litigation to which we are subject. For more information regarding ongoing significant legal proceedings in which we are involved, see “Business—Legal and Regulatory Proceedings.”

In disputes and legal proceedings, such as those referred to above, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount of any loss. We cannot predict with certainty if, how or when such proceedings will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for proceedings that are in their early stages of development or where plaintiffs seek substantial or indeterminate damages. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, determination of issues related to class certification and the calculation of damages and by addressing novel or unsettled legal questions relevant to the proceedings in question, before a loss or additional loss or range of loss or additional loss can be reasonably estimated for any proceeding. Adverse judgments in litigation or adverse regulatory actions could have a material adverse effect on our business, financial condition and results of operations.

The Dodd-Frank Act has changed and will likely continue to substantially change the legal and regulatory framework under which we operate our business.

On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which has changed and will likely continue to substantially change the legal and regulatory framework under which we operate. The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial-services industry, addressing, among other things, (i) systemic risk, (ii) capital adequacy, (iii) consumer financial protection, (iv) interchange fees and (v) mortgage lending practices. A significant number of the provisions of the Dodd-Frank Act still require extensive rulemaking and interpretation by regulatory authorities. In several cases, authorities have extended implementation periods and delayed effective dates. Accordingly, in many respects the ultimate impact of the Dodd-Frank Act and its effects on the U.S. financial system and on us will not be known for an extended period of time.

The following are some of the current provisions of the Dodd-Frank Act that may affect our operations:

 

    Creation of the CFPB with centralized authority for consumer protection in the banking industry.

 

    New limitations on federal preemption.

 

    Application of heightened capital, liquidity, single counterparty credit limits, stress testing, risk management and other enhanced prudential standards.

 

    Changes to the assessment base for deposit insurance premiums.

 

    Creation of a new framework for the regulation of over-the-counter derivatives and new regulations for the securitization market and the strengthening of the regulatory oversight of securities and capital markets by the SEC.

Some of these and other major changes under the Dodd-Frank Act could materially impact the profitability of our business, the value of assets we hold or the collateral available for coverage under our loans, require changes to our business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk.

 

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The Dodd-Frank Act’s provisions and related rules that restrict bank interchange fees may negatively impact our revenues and earnings.

Pursuant to the Dodd-Frank Act, the Federal Reserve Board adopted rules effective October 1, 2011, limiting the interchange fees that may be charged with respect to electronic debit transactions. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other credit card companies and card-issuing banks for processing electronic payment transactions. Since taking effect, these limitations have reduced our debit card interchange revenues and have created meaningful compliance costs. Additional limits may further reduce our debit card interchange revenues and create additional compliance costs. In July 2013, a decision by a Washington D.C. District Court judge invalidated the Federal Reserve Board’s interchange rule, ruling in favor of a group of retailers who argued that the new, lower interchange fees had been inappropriately set too high by the Federal Reserve Board. The Federal Reserve Board has successfully appealed the decision but it is uncertain whether the group of retailers will further appeal. If the rule were to be revised so that interchange fees were even lower, it would further adversely impact our noninterest income.

The CFPB’s residential mortgage regulations could adversely affect our business, financial condition or results of operations.

The CFPB finalized a number of significant rules that will impact nearly every aspect of the life cycle of a residential mortgage. These rules implement the Dodd-Frank Act amendments to the Equal Credit Opportunity Act, the Truth in Lending Act and the Real Estate Settlement Procedures Act. The final rules require banks to, among other things: (i) develop and implement procedures to ensure compliance with a new “reasonable ability to repay” test and identify whether a loan meets a new definition for a “qualified mortgage,” (ii) implement new or revised disclosures, policies and procedures for servicing mortgages including, but not limited to, early intervention with delinquent borrowers and specific loss mitigation procedures for loans secured by a borrower’s principal residence, (iii) comply with additional restrictions on mortgage loan originator compensation, and (iv) comply with new disclosure requirements and standards for appraisals and escrow accounts maintained for “higher priced mortgage loans.” These new rules create operational and strategic challenges for us, as we are both a mortgage originator and a servicer. For example, business models for cost, pricing, delivery, compensation and risk management will need to be reevaluated and potentially revised, perhaps substantially. Additionally, programming changes and enhancements to systems will be necessary to comply with the new rules. We also expect additional rulemaking affecting our residential mortgage business to be forthcoming. These rules and any other new regulatory requirements promulgated by the CFPB and state regulatory authorities could require changes to our business, in addition to the changes we have been required to make thus far. Such changes would result in increased compliance costs and potential changes to our product offerings, which would have an adverse effect on the revenue derived from such business.

The Dodd-Frank Act’s consumer protection regulations could adversely affect our business, financial condition or results of operations.

The Federal Reserve Board enacted consumer protection regulations related to automated overdraft payment programs offered by financial institutions. Prior to the enactment of these regulations, our overdraft and insufficient funds fees represented a significant amount of noninterest fees. Since taking effect on July 1, 2010, the fees received by us for automated overdraft payment services have decreased, thereby adversely impacting our noninterest income. Complying with these regulations has resulted in increased operational costs for us, which may continue to rise. The actual impact of these regulations in future periods could vary due to a variety of factors, including changes in customer behavior, economic conditions and other factors, which could adversely affect our business, financial condition or results of operations.

 

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The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The CFPB is authorized to engage in consumer financial education, track consumer complaints, request data and promote the availability of financial services to underserved consumers and communities. We expect increased oversight of financial services products by the CFPB, which are likely to affect our operations. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices (“UDAAP”). The review of products and practices to prevent UDAAP is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties.

In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations, and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief and/or monetary penalties. The Dodd-Frank Act and accompanying regulations, including regulations to be promulgated by the CFPB, are being phased in over time, and while some regulations have been promulgated, many others have not yet been proposed or finalized. We cannot predict the terms of all of the final regulations, their intended consequences or how such regulations will affect us or our industry.

The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.

Compliance with anti-money laundering and anti-terrorism financing rules involve significant cost and effort.

We are subject to rules and regulations regarding money laundering and the financing of terrorism. Monitoring compliance with anti-money laundering and anti-terrorism financing rules can put a significant financial burden on banks and other financial institutions and poses significant technical challenges. Although we believe our current policies and procedures are sufficient to comply with applicable rules and regulations, we cannot guarantee that our anti-money laundering and anti-terrorism financing policies and procedures completely prevent situations of money laundering or terrorism financing. Any such failure events may have severe consequences, including sanctions, fines and reputational consequences, which could have a material adverse effect on our business, financial condition or results of operations.

We may become subject to more stringent regulatory requirements and activity restrictions, or have to restructure, if the Federal Reserve Board and FDIC determine that our resolution plan is not credible.

Federal Reserve Board and FDIC regulations require bank holding companies with more than $50 billion in assets to submit resolution plans that, in the event of material financial distress or failure, establish the rapid, orderly and systemically safe liquidation of the company under the U.S. Bankruptcy Code. Insured depository institutions with more than $50 billion in assets must submit to the FDIC a resolution plan whereby they can be resolved in a manner that is orderly and that ensures that

 

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depositors will receive access to insured funds within certain required timeframes. If the Federal Reserve Board and the FDIC jointly determine that a company’s resolution plan is not credible, and the company fails to cure the deficiencies in a timely manner, then the Federal Reserve Board and the FDIC may jointly impose on the company, or on any of its subsidiaries, more stringent capital, leverage or liquidity requirements or restrictions on growth, activities, or operations, or require the divestment of certain assets or operations. If the Federal Reserve Board and the FDIC determine that our resolution plan is not credible or would not facilitate our orderly resolution under the U.S. Bankruptcy Code, we could become subject to more stringent regulatory requirements or business restrictions, or have to divest certain of our assets or businesses. Any such measures could have a material adverse effect on our business, financial condition or results of operations.

Risks Related to our Common Stock

Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale, and RBS has committed to sell its remaining beneficial ownership of our common stock, although the timing of such sale or sales remains uncertain.

The sale of substantial amounts of shares of our common stock in the public market, or the perception that such sales could occur, could harm the prevailing market price of common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. Upon completion of this offering we will have a total of             outstanding shares of common stock. Of the outstanding shares, the             shares sold in this offering (or             shares if the underwriters exercise their option to purchase additional shares in full) will be freely tradable without restriction or further registration under the Securities Act, except that any shares held by our affiliates, as that term is defined under Rule 144 of the Securities Act, may be sold only in compliance with the limitations described in “Shares Eligible for Future Sale.”

The remaining             shares outstanding and the             shares of common stock held indirectly by the selling stockholders, subsidiaries of RBS, and management, respectively, after this offering, will be subject to certain restrictions on resale. We, our officers, directors and the selling stockholders that will collectively own             shares following this offering (or             shares if the underwriters exercise their option to purchase additional shares in full), will sign lock-up agreements with the underwriters that will, subject to certain customary exceptions, restrict the sale of the shares of our common stock held by them for 180 days following the date of this prospectus, subject to extension in the case of an earnings release or material news or a material event relating to us.             may, in its sole discretion, release all or any portion of the shares of common stock subject to lock-up agreements. See “Underwriting” for a description of these lock-up agreements.

Upon the expiration of the lock-up agreements described above, all of such shares will be eligible for resale in a public market, subject, in the case of shares held by our affiliates, to volume, manner of sale and other limitations under Rule 144. We expect that the selling stockholders and other members of the RBS Group will be considered an affiliate 180 days after this offering based on their expected share ownership (consisting of             shares, or             shares if the underwriters exercise their option to purchase additional shares in full), as well as their veto and board nomination rights under the Separation Agreement we intend to enter into with RBS prior to the completion of this offering. However, commencing 180 days following this offering, RBS will have the right, subject to certain exceptions and conditions, to require us to register its shares of common stock under the Securities Act, and it will have the right to participate in future registrations of securities by us. Registration of any of these outstanding shares of common stock would result in such shares becoming freely tradable without compliance with Rule 144 upon effectiveness of the registration statement. See “Shares Eligible for Future Sale.”

 

49


As restrictions on resale end, the market price of our shares of common stock could drop significantly as RBS has publicly stated its intent to sell its remaining shares in the short to medium term. The RBS Group, which is currently controlled by the UK government, is undertaking a restructuring plan to facilitate its eventual privatization. As part of its obligations under the European Commission’s State Aid Amendment Decision of April 9, 2014, RBS has committed to dispose of its remaining ownership of our common stock by December 31, 2016, with an automatic 12-month extension depending on market conditions. RBS’s current intention for disposal of its remaining ownership of our common stock is to sell, over time, such remaining shares in a series of tranches, subject to market conditions and the terms of the lock-up provisions discussed above. The timing and manner of the sale of RBS’s remaining ownership of our common stock remains uncertain, and we have no control over the manner in which RBS may seek to divest such remaining shares. RBS could elect to sell its common stock in a number of different ways, including in a number of tranches via future registrations or, alternatively, by the sale of all or a significant tranche of such remaining shares to a single third-party purchaser. Any such sale would impact the price of our shares of common stock and there can be no guarantee that the price at which RBS is willing to sell its remaining shares will be at a level that our Board would be prepared to recommend to holders of our common stock or that you determine adequately values our shares of common stock.

In addition, these factors could also make it more difficult for us to raise additional funds through future offerings of our shares of common stock or other securities.

If RBS sells a controlling interest in our company to a third party in a private transaction, you may not realize any change-of-control premium on shares of our common stock and we may become subject to the control of a presently unknown third party.

Following the completion of this offering, RBS will continue to beneficially own a significant equity interest of our company. RBS will have the ability, should it choose to do so, to sell some or all of its shares of our common stock in a privately negotiated transaction, which, if sufficient in size, could result in a change of control of our company.

The ability of RBS to privately sell its shares of our common stock, with no requirement for a concurrent offer to be made to acquire all of the shares of our outstanding common stock that will be publicly traded hereafter, could prevent you from realizing any change-of-control premium on your shares of our common stock that may otherwise accrue to RBS on its private sale of our common stock. Additionally, if RBS privately sells its significant equity interest in our company, we may become subject to the control of a presently unknown third party. Such third party may have conflicts of interest with those of other stockholders. In addition, if RBS sells a controlling interest in our company to a third party, RBS may terminate the license agreement and other transitional arrangements, and our other commercial agreements and relationships could be impacted, all of which may adversely affect our ability to run our business as described in this prospectus and may have a material adverse effect on our business, operating results and financial condition.

There is no prior public market for our common stock and one may not develop.

Prior to this offering, there has not been a public trading market for our common stock. An active trading market may not develop or be sustained after this offering. If an active trading market does not develop, you may have difficulty selling your shares of common stock at an attractive price, or at all. The initial public offering price for our common stock sold in this offering will be determined by negotiations among the selling stockholders and the underwriters. This price may not be indicative of the price at which our common stock will trade after this offering. The market price of our common stock may decline below the initial offering price, and you may not be able to sell your common stock at or above the price you paid in this offering, or at all.

 

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Our stock price may be volatile, and you could lose all or part of your investment as a result.

You should consider an investment in our common stock to be risky, and you should invest in our common stock only if you can withstand a significant loss and wide fluctuation in the market value of your investment. The market price of our common stock could be subject to wide fluctuations in response to, among other things, the factors described in this “Risk Factors” section, and other factors, some of which are beyond our control. These factors include:

 

    quarterly variations in our results of operations or the quarterly financial results of companies perceived to be similar to us;

 

    changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;

 

    our announcements or our competitors’ announcements regarding new products or services, enhancements, significant contracts, acquisitions or strategic investments;

 

    fluctuations in the market valuations of companies perceived by investors to be comparable to us;

 

    future sales of our common stock;

 

    additions or departures of members of our senior management or other key personnel;

 

    changes in industry conditions or perceptions; and

 

    changes in applicable laws, rules or regulations and other dynamics.

Furthermore, the stock markets have experienced price and volume fluctuations that have affected and continue to affect the market price of equity securities of many companies. These fluctuations have often been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, interest rate changes or international currency fluctuations, may negatively affect the market price of our common stock.

If any of the foregoing occurs, it could cause our stock price to fall and may expose us to securities class action litigation that, even if unsuccessful, could be costly to defend and a distraction to management.

We may not pay cash dividends on our common stock.

Although we intend to pay dividends to our stockholders, we have no obligation to do so and may change our dividend policy at any time without notice to our stockholders. Holders of our common stock are only entitled to receive such cash dividends as our Board may declare out of funds legally available for such payments. Any decision to declare and pay dividends will be dependent on a variety of factors, including our financial condition, earnings, legal requirements and other factors that our Board deems relevant, as well as obtaining applicable regulatory consents and approvals as described under “Regulation and Supervision,” including the CCAR process. In addition, our ability to pay dividends may be limited by covenants of any future indebtedness we or our subsidiaries incur. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it. In addition, since we are a holding company with no significant assets other than the capital stock of our banking subsidiaries, we depend upon dividends from our banking subsidiaries for substantially all of our income. Accordingly, our ability to pay dividends depends primarily upon the receipt of dividends or other capital distributions from our banking subsidiaries. The ability of our banking subsidiaries to pay dividends to us is subject to, among other things, their earnings, financial condition and need for funds, as well as federal and state

 

51


governmental policies and regulations applicable to us and our banking subsidiaries, which limit the amount that may be paid as dividends without prior regulatory approval. See “—We depend on our banking subsidiaries for most of our revenue, and restrictions on dividends and other distributions by our banking subsidiaries could affect our liquidity and ability to fulfill our obligations” and “Regulation and Supervision.”

You will incur immediate and substantial dilution in the net tangible book value of the shares you purchase in this offering.

The initial public offering price is likely to be substantially higher than the net tangible book value per share of our common stock based on the total value of our tangible assets less our total liabilities divided by our shares of common stock outstanding immediately following this offering. Therefore, if you purchase common stock in this offering, you will experience immediate and substantial dilution in net tangible book per share value after completion of this offering. To the extent outstanding options to purchase our common stock are exercised, there will be further dilution. See the section entitled “Dilution.”

“Anti-takeover” provisions and the regulations to which we are subject may make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to stockholders.

We are a bank holding company incorporated in the state of Delaware. Anti-takeover provisions in Delaware law and our amended and restated certificate of incorporation and amended and restated bylaws, as well as regulatory approvals that would be required under federal law, could make it more difficult for a third party to take control of us and may prevent stockholders from receiving a premium for their shares of our common stock. These provisions could adversely affect the market price of our common stock and could reduce the amount that stockholders might get if we are sold.

These provisions include the following, some of which may only become effective when RBS no longer owns shares of our common stock representing at least         % of our issued and outstanding capital stock:

 

    the sole ability of our Board to fill a director vacancy on our Board;

 

    advance notice requirements for stockholder proposals and director nominations;

 

    provisions limiting the stockholders’ ability to call special meetings of stockholders, to require special meetings of stockholders to be called and to take action by written consent;

 

    the approval of holders of at least         % of the shares entitled to vote generally to amend, alter, change or repeal specified provisions, including those relating to actions by written consent of stockholders, calling of special meetings of stockholders, business combinations and amendment of our amended and restated certificate of incorporation and amended and restated bylaws;

 

    the required approval of holders of at least         % of the shares entitled to vote at an election of the directors to remove directors, which removal may only be for cause; and

 

    the ability of our Board to designate the terms of and issue new series of preferred stock without stockholder approval, which could be used, among other things, to institute a rights plan that would have the effect of significantly diluting the stock ownership of a potential hostile acquirer, likely preventing acquisitions that have not been approved by our Board.

See the section entitled “Description of Our Capital Stock—Anti-Takeover Effects of Some Provisions.” We believe these provisions protect our stockholders from coercive or otherwise unfair

 

52


takeover tactics by requiring potential acquirers to negotiate with our Board and by providing our Board with more time to assess any acquisition proposal. However, these provisions apply even if the offer may be determined to be beneficial by some stockholders and could delay or prevent an acquisition that our Board determines is not in our best interest and that of our stockholders.

Furthermore, banking laws impose notice, approval and ongoing regulatory requirements on any stockholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. These laws include the Bank Holding Company Act and the Change in Bank Control Act. These laws could delay or prevent an acquisition.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We have made statements under the captions “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and in other sections of this prospectus that are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” the negative of these terms and other comparable terminology. These forward-looking statements may relate to our financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to expected earnings levels, the adequacy of the allowance for credit losses, delinquency trends, market risk and the impact of interest rate changes, capital market conditions, capital composition and adequacy and liquidity, the effect of legal proceedings and new accounting standards on our financial condition and results of operations. Forward-looking statements are not guarantees of future performance, are based on management’s current expectations and, by their nature, involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond our control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements, including those factors discussed under the caption entitled “Risk Factors.” You should specifically consider the numerous risks outlined under “Risk Factors.” Other factors that might cause such a difference include, but are not limited to:

 

    the rate of growth in the economy and employment levels, as well as general business and economic conditions;

 

    changes in interest rates and market liquidity, as well as the magnitude of such changes, which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets;

 

    changes in federal bank regulatory and supervisory policies, including required levels of capital;

 

    the impact of the Dodd-Frank Act on our businesses, business practices and costs of operations;

 

    the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets in the markets in which our borrowers are located;

 

    competition in the financial services industry; and

 

    legislative, tax, accounting or regulatory changes.

Other possible events or factors that could cause results or performance to differ materially from those expressed in such forward-looking statements include the following:

 

    negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of nonperforming assets, charge-offs and provision for credit losses;

 

    adverse movements and volatility in debt and equity capital markets;

 

    changes in market rates and prices, which may adversely impact the value of financial assets and liabilities;

 

    liabilities resulting from litigation and regulatory investigations;

 

    our ability to grow our core businesses;

 

    decisions to downsize, sell or close units or otherwise change our business mix; and

 

    management’s ability to identify and manage these and other risks.

 

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Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. We are under no duty to update any of these forward-looking statements after the date of this prospectus to conform to our prior statements as to actual results or revised expectations.

 

55


USE OF PROCEEDS

The selling stockholders are selling all of the shares of common stock in this offering and we will not receive any proceeds from the sale of the common stock in the offering.

 

56


DIVIDEND POLICY

We intend to pay quarterly cash dividends on our common stock at an initial amount of approximately $             per share. Any declaration of dividends will be at the discretion of our Board and will depend on our financial condition, earnings, cash needs, regulatory constraints, capital requirements (including requirements of our subsidiaries) and any other factors that our Board deems relevant in making such a determination. Therefore, there can be no assurance that we will pay any dividends to holders of our common stock, or as to the amount of any such dividends. See “Our Relationship with the RBS Group and Certain Other Related Party Transactions” for further information regarding capital distributions.

Dividend payments to our stockholders are subject to the oversight, regulatory policies and requirements of the Federal Reserve Board, including requirements to maintain adequate capital above regulatory minima. As described in the section entitled “Regulation and Supervision,” dividends generally may only be paid or made under a capital plan as to which the Federal Reserve Board has not objected, including in respect of the CCAR process. In March 2014, the Federal Reserve Board objected on qualitative grounds to our capital plan submitted as part of the CCAR process. In its public report entitled “Comprehensive Capital Analysis and Review 2014: Assessment Framework and Results,” the Federal Reserve Board cited significant deficiencies in our capital planning processes, including inadequate governance, weak internal controls and deficiencies in our practices for estimating revenues and losses under a stress scenario and for ensuring the appropriateness of loss estimates across our business lines in a specific stress scenario. Although the Federal Reserve Board acknowledged that bank holding companies such as ours that are new to the CCAR process are subject to different expectations, our weaknesses were considered serious enough to warrant the Federal Reserve Board’s objection based on its qualitative assessment of our capital planning process. As a result, we are not permitted to increase our capital distributions above 2013 levels and are required to resubmit our capital plan to the Federal Reserve Board, unless the Federal Reserve Board determines otherwise. If we resubmit our plan, we may determine that we need to modify our proposed capital distributions. In any event, we cannot assure you that the Federal Reserve Board will not object to any resubmitted plan or that, even if it does not object to it, our planned capital distributions will not be significantly modified.

We are a legal entity separate and distinct from our banking subsidiaries and other subsidiaries. Our principal source of liquidity is dividends from CBNA and CBPA. Various federal and state statutes and regulations limit the amount of dividends that may be paid to us by our banking subsidiaries without regulatory consent.

In particular, dividends payable by CBNA, as a national bank subsidiary, are limited to the lesser of the amounts calculated under a “recent earnings” test and an “undivided profits” test. Under the recent earnings test, a dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current year’s net income combined with the retained net income of the two preceding years, less any required transfers to surplus, unless the national bank obtains the approval of the OCC. Under the undivided profits test, a dividend may be paid only to the extent that retained net profits (as defined and interpreted by regulation), including the portion transferred to surplus, exceed bad debts (as defined by regulation). CBNA is currently required to seek the OCC’s approval prior to paying any dividends to us, and we are not able to predict when CBNA will be able to pay dividends to us without the OCC’s approval.

With respect to CBPA, the PA Code states, in part, that dividends may be declared and paid only out of accumulated net earnings and may not be declared unless surplus (retained earnings) is at least equal to contributed capital.

 

57


In addition, with respect to both CBNA and CBPA, if, in the opinion of the applicable federal regulatory agency, a depository institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the regulator may require, after notice and hearing, that the bank cease and desist from such practice. The OCC and the FDIC have indicated that the payment of dividends would constitute an unsafe and unsound practice if the payment would reduce a depository institution’s capital to an inadequate level.

Moreover, under the Federal Deposit Insurance Act (“FDIA”), an insured depository institution may not pay any dividends if the institution is undercapitalized or if the payment of the dividend would cause the institution to become undercapitalized. In addition, the federal bank regulatory agencies have issued policy statements which provide that FDIC-insured depository institutions and their holding companies should generally pay dividends only out of their current operating earnings.

During the year ended December 31, 2013, we declared and paid the following cash dividends, by quarter:

 

Year Ended December 31, 2013

   Aggregate Cash
Dividend
 
     (in millions)  

1st Quarter

   $ 40   

2nd Quarter

     388 (1) 

3rd Quarter

     383 (1) 

4th Quarter

     374 (1) 
  

 

 

 

Total

   $ 1,185   
  

 

 

 

 

(1)  Includes special common dividends to RBS. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Capital.”

During the year ended December 31, 2012, we declared and paid the following cash dividends, by quarter:

 

Year Ended December 31, 2012

   Aggregate Cash
Dividend
 
     (in millions)  

1st Quarter

   $   

2nd Quarter

     40   

3rd Quarter

     55   

4th Quarter

     55   
  

 

 

 

Total

   $ 150   
  

 

 

 

During the year ended December 31, 2011, we did not declare or pay any dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2013. The selling stockholders are selling all of the shares of common stock in this offering and we will not receive any proceeds from the sale of the shares. This table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and notes included elsewhere in this prospectus.

 

     December 31, 2013  
     Actual  
     (in millions)  

Debt:

  

Short-term borrowed funds:

  

Federal funds purchased

   $ 689   

Securities sold under agreements to repurchase

     4,102   

Other short-term borrowed funds

     2,251   
  

 

 

 

Total short-term borrowed funds

   $ 7,042   
  

 

 

 

Long-term borrowed funds:

  

Citizens Financial Group, Inc.

  

4.150% fixed subordinated debt, due 2022

   $ 350   

5.158% fixed-to-floating subordinated debt, (LIBOR + 3.56%) callable, due 2023(1)

     333   

4.771% fixed subordinated debt, due 2023(1)

     333   

4.691% fixed subordinated debt, due 2024(1)

     334   
  

 

 

 
     1,350   

Banking Subsidiaries

  

Federal Home Loan Advances due through 2033

     25   

Other

     30   
  

 

 

 
     55   
  

 

 

 

Total long-term borrowed funds

   $ 1,405   
  

 

 

 

Total debt

   $ 8,447   
  

 

 

 

Stockholders’ equity:

  

Preferred Stock

   $   

Common Stock

       

Additional paid-in capital

     18,609   

Retained earnings

     1,235   

Accumulated other comprehensive loss

     (648
  

 

 

 

Total stockholders’ equity

   $ 19,196   
  

 

 

 

Total capitalization

   $ 27,643   
  

 

 

 

 

(1)  Intercompany borrowed funds with the RBS Group. See “Our Relationship with the RBS Group and Certain Other Related Party Transactions—Other” and Note 18 “Related Party Transactions” to our audited consolidated financial statements included elsewhere in this prospectus.

 

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DILUTION

Our consolidated net tangible book value as of December 31, 2013 was $         or $         per share of common stock. Consolidated net tangible book value per share represents consolidated tangible assets, less consolidated liabilities, divided by the aggregate number of shares of common stock outstanding. Our consolidated net tangible book value per share will not be affected by the sale of shares of common stock in this offering. Dilution per share represents the difference between the price per share to be paid by new investors for the shares of common stock sold in this offering and the consolidated net tangible book value per share. The price per share to the public of the shares of common stock in this offering exceeds the consolidated net tangible book value per share prior to the offering. Therefore, purchasers of shares of common stock in the offering will realize immediate and substantial dilution in the consolidated net tangible book value of $         per share. The following table illustrates this per share dilution:

 

Assumed initial public offering price

   $                

Consolidated net tangible book value per share as of December 31, 2013

   $     
  

 

 

 

Dilution per share to new investors

   $     
  

 

 

 

The following table sets forth as of                 , 2014 the number of shares of common stock purchased, the total consideration paid, or to be paid, and the average price per share paid, or to be paid, by existing stockholders and by the new investors, at an assumed initial public offering price of $         per share, the midpoint of the range set forth on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and offering expenses payable by us:

 

     Shares Purchased     Total Consideration     Average
Price
Per Share
 
     Number    Percent     Amount      Percent    

Existing stockholders

                       $                          $                

New Investors

               $                                     $     
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

Total

        100   $           100   $     
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

Sales by the selling stockholders in this offering will reduce the number of shares held by existing stockholders to                 or approximately     % of the total shares of common stock outstanding after the offering, or to             shares or approximately     % of the total shares of common stock outstanding after the offering if the option to purchase additional shares is exercised in full, and will increase the number of shares to be purchased by new investors to                 or approximately     % of the total shares of common stock outstanding after the offering, or to             shares or approximately     % of the total shares of common stock outstanding after the offering if the option to purchase additional shares is exercised in full, of the total shares of common stock outstanding after the offering.

The foregoing tables assume no exercise of the underwriters’ over-allotment option or of outstanding stock options after             . At             ,             shares of common stock underlying performance-based restricted stock units were outstanding. To the extent these restricted stock units vest, there may be further dilution to new investors. See “Compensation Discussion and Analysis” and our audited consolidated financial statements included elsewhere in this prospectus.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

We derived the selected consolidated statement of operations data for the years ended December 31, 2013, 2012 and 2011 and the selected consolidated balance sheet data as of December 31, 2013 and 2012 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the selected consolidated statement of operations data for the years ended December 31, 2010 and 2009 and the selected consolidated balance sheet data as of December 31, 2011, 2010 and 2009 from our consolidated financial statements, which are not included in this prospectus. Our historical results are not necessarily indicative of the results expected for any future period.

You should read the following selected consolidated financial data in conjunction with the sections of this prospectus entitled “Summary Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Selected Statistical Information” and our consolidated financial statements and notes thereto included elsewhere in this prospectus.

 

    As of and for the Year Ended December 31,  
    2013     2012     2011     2010     2009  
    (dollars in millions, except per share amounts)  

Operating Data:

         

Net interest income

  $ 3,058      $ 3,227      $ 3,320      $ 3,345      $ 3,419   

Noninterest income

    1,632        1,667        1,711        1,733        1,666   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    4,690        4,894        5,031        5,078        5,085   

Provision for credit losses

    479        413        882        1,644        2,783   

Noninterest expense

    7,679        3,457        3,371        3,483        3,495   

Noninterest expense, excluding goodwill impairment(1)

    3,244        3,457        3,371        3,483        3,495   

(Loss) income before income tax (benefit) expense

    (3,468     1,024        778        (49     (1,193

Income tax (benefit) expense

    (42     381        272        (61     (420

Net (loss) income

    (3,426     643        506        11        (740

Net income (loss), excluding goodwill impairment(1)

    654        643        506        11        (740

Net (loss) income per average common share—basic and diluted (pro forma)
(unaudited)(2)

    (7.51     1.41        1.11        0.03        (1.62

Net (loss) income per average common share—basic and diluted (actual)

    (1,013,131.98     190,245.51        149,548.13        3,378.92        (218,808.05

Net income (loss) per average common share—basic and diluted, excluding goodwill impairment (pro forma)
(unaudited)(1)(2)

    1.43        1.41        1.11        0.03        (1.62

Net income (loss) per average common share—basic and diluted, excluding goodwill impairment (actual)(1)

    193,122.25        190,245.51        149,548.13        3,378.92        (218,808.05

 

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    As of and for the Year Ended December 31,  
    2013     2012     2011     2010     2009  
    (dollars in millions, except per share amounts)  

Other Operating Data:

         

Return on average common equity(3)

    (15.69 )%      2.69     2.19     0.05     (3.77 )% 

Return on average common equity, excluding goodwill impairment(1)

    3.00     2.69     2.19     0.05     (3.77 )% 

Return on average tangible common equity(1)

    (25.91 )%      4.86     4.18     0.11     (9.56 )% 

Return on average tangible common equity, excluding goodwill impairment(1)

    4.95     4.86     4.18     0.11     (9.56 )% 

Return on average total assets(4)

    (2.83 )%      0.50     0.39     0.01     (0.47 )% 

Return on average total assets, excluding goodwill impairment(1)

    0.54     0.50     0.39     0.01     (0.47 )% 

Return on average total tangible assets(1)

    (3.05 )%      0.55     0.43     0.01     (0.51 )% 

Return on average total tangible assets, excluding goodwill impairment(1)

    0.58     0.55     0.43     0.01     (0.51 )% 

Efficiency ratio(1)

    163.73     70.64     67.00     68.59     68.73

Efficiency ratio, excluding goodwill impairment(1)

    69.17     70.64     67.00     68.59     68.73

Net interest margin(5)

    2.85     2.89     2.97     2.78     2.49

Balance Sheet Data:

         

Total assets

  $ 122,154      $ 127,053      $ 129,654      $ 129,689      $ 147,681   

Loans and leases(6)

    85,859        87,248        86,795        87,022        95,080   

Allowance for loan and lease losses

    1,221        1,255        1,698        2,005        2,209   

Total securities

    21,245        19,417        23,352        21,802        28,161   

Goodwill

    6,876        11,311        11,311        11,311        11,709   

Total liabilities

    102,958        102,924        106,261        106,995        125,405   

Deposits(7)

    86,903        95,148        92,888        92,155        98,053   

Federal funds purchased and securities sold under agreements to repurchase

    4,791        3,601        4,152        5,112        5,222   

Other short-term borrowed funds

    2,251        501        3,100        1,930        11,373   

Long-term borrowed funds

    1,405        694        3,242        5,854        7,135   

Total stockholders’ equity

    19,196        24,129        23,393        22,694        22,276   

Other Balance Sheet Data:

         

Asset Quality Ratios:

         

Allowance for loan and lease losses as a percentage of total loans and leases

    1.42     1.44     1.96     2.30     2.32

Allowance for loan and lease losses as a percentage of nonperforming loans and leases

    86     67     95     85     101

Nonperforming loans and leases as a percentage of total loans and leases

    1.65     2.14     2.06     2.71     2.31

Capital ratios:

         

Tier 1 capital ratio(8)

    13.5     14.2     13.9     13.0     11.6

Total capital ratio(9)

    16.1     15.8     15.1     14.4     13.0

Tier 1 common equity ratio(10)

    13.5     13.9     13.3     12.5     11.1

Leverage ratio(11)

    11.6     12.1     11.6     10.4     8.7

 

(1)  These measures are non-GAAP financial measures. For more information on the computation of these non-GAAP financial measures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Components of Operations and Key Performance Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

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(2)  Pro forma basic and diluted earnings per share are unaudited and have been computed to give effect to the 134,831.46-for-1 forward stock split to occur immediately prior to the closing of this offering.

 

(3)  We define “Return on average common equity” as net income (loss) divided by average common equity.

 

(4)  We define “Return on average total assets” as net income (loss) divided by average total assets.

 

(5) We define “Net interest margin” as net interest income divided by average total interest earning assets.

 

(6)  Excludes loans held for sale of $1,254 million, $646 million, $564 million, $716 million, and $456 million as of December 31, 2013, 2012, 2011, 2010, and 2009, respectively.

 

(7)  Excludes deposits held for sale of $5,277 million at December 31, 2013.

 

(8)  We define “Tier 1 capital ratio” as Tier 1 capital balance divided by total risk-weighted assets as defined under Basel I.

 

(9)  We define “Total capital ratio” as total capital balance divided by total risk-weighted assets as defined under Basel I.

 

(10)  We define “Tier 1 common equity ratio” as Tier 1 capital balance, minus preferred stock, divided by total risk-weighted assets as defined under Basel I.

 

(11)  We define “Leverage ratio” as Tier 1 capital balance divided by quarterly average total assets as defined under Basel I.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

This section contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including, without limitation, those set forth in “Special Note Regarding Forward-Looking Statements” and “Risk Factors” and the matters set forth in this prospectus generally. The following discussion is based on, and should be read in conjunction with, our audited consolidated financial statements and related notes included elsewhere in this prospectus, as well as “Summary Consolidated Financial and Other Data,” “Selected Consolidated Financial Data” and the other financial information included elsewhere in this prospectus.

Overview

We are the 13th largest retail bank holding company in the United States according to SNL Financial with $122.2 billion of total assets as of December 31, 2013. Headquartered in Providence, Rhode Island, we deliver a broad range of retail and commercial banking products and services to approximately five million individuals, institutions and companies. Our approximately 18,600 employees strive to meet the financial needs of customers and prospects through approximately 1,370 branches and more than 3,500 ATMs operated in a 12-state footprint across the New England, Mid-Atlantic and Midwest regions and through our online, telephone and mobile banking platforms. We have over 80 retail and commercial non-branch offices located both in our geographic footprint and in five states and the District of Columbia outside our branch footprint. Our 12-state branch banking footprint contains approximately 34.6 million households and 3.6 million businesses according to SNL Financial. We conduct our banking operations through our two wholly owned banking subsidiaries, CBNA and CBPA.

We operate our business through two operating segments: Consumer Banking and Commercial Banking. Consumer Banking accounted for $45.1 billion and $46.5 billion, or approximately 53% of our average loan and lease balances (including loans held for sale) as of both December 31, 2013 and 2012. Consumer Banking serves retail customers and small businesses with annual revenues of up to $25 million through a network that as of December 31, 2013 included approximately 1,370 branches operated in a 12-state footprint across the New England, Mid-Atlantic and Midwest regions, as well as online, telephone and mobile banking platforms. Our Consumer Banking products and services include deposit products, mortgage and home equity lending, student loans, auto financing, credit cards, business loans and wealth management and investment services.

Commercial Banking accounted for $34.6 billion and $32.5 billion, or approximately 40% and approximately 37%, of our average loan and lease balances (including loans held for sale) as of December 31, 2013 and 2012, respectively. Commercial Banking primarily targets companies and institutions with annual revenues of $25 million to $2.0 billion. Commercial Banking offers a broad complement of financial products and solutions, including lending and leasing, trade financing, deposit and treasury management, foreign exchange and interest rate risk management, corporate finance and debt and equity capital markets capabilities.

As of December 31, 2013 and 2012 we had $3.8 billion and $5.7 billion, respectively, of non-core asset balances, which are included in Other along with our treasury function, securities portfolio, wholesale funding activities, goodwill, community development assets and other unallocated assets, liabilities, revenues, provision for credit losses and expenses not attributed to Consumer Banking or Commercial Banking. Non-core assets are primarily loans inconsistent with our strategic goals, generally as a result of geographic location, industry, product type or risk level. We have actively managed these loans down since they were designated as non-core on June 30, 2009, and the

 

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portfolio decreased a further 33% as of December 31, 2013 compared to December 31, 2012. The largest component of our non-core portfolio is our home equity products serviced by others portfolio (a portion of which we now service internally).

Recent Events

In January 2014, we announced an agreement to sell certain assets and deposits associated with our Chicago-area retail branches, small business relationships and select middle market relationships to U.S. Bancorp. This agreement included 103 branches with $5.3 billion of deposits and $1.1 billion in loans as of December 31, 2013. We intend to redeploy the sale proceeds to higher return businesses. This transaction is subject to regulatory approval and is anticipated to close in mid-2014.

Key Factors Affecting Our Business

Macro-economic conditions

Our business is affected by national, regional and local economic conditions, as well as the perception of those conditions and future economic prospects. The significant macro-economic factors that impact our business are: the U.S. and global economic landscapes, unemployment rates, the housing markets and interest rates.

The U.S. economic landscape continued to improve modestly in 2013, with nominal GDP growth averaging 2.6% for the year. Similarly gradual improvement in international economic growth occurred, with the recession in Europe finally ending in the second half of the year. Despite the improving picture in the Eurozone and periphery countries, continued slowing growth in China provided an offsetting influence. The U.S. unemployment rate dropped to 6.7% at year end 2013 from 7.9% at year end 2012. The improvement was driven by a decrease in the labor force participation rate, which declined to its lowest level in over 35 years. The housing market continued to strengthen in 2013, as demonstrated by continued price increases, favorable shifts in supply and demand and some encouraging signs from certain homebuilding activities, such as a general increase in housing permits and a rise in new home sales. The Federal Reserve Board maintained very accomodative monetary policy conditions through a zero to 25 basis point Federal Funds target at the short end of the curve, and quantitative easing programs designed to reduce longer tenor rates. Although interest rates remain relatively low, an increase in mortgage rates from 2012 to 2013 negatively impacted 2013 refinance applications industry wide. See “—Interest rates” below for further discussion of the impact of interest rates on our results.

Credit trends

Credit trends improved during 2013 compared to 2012 largely driven by the improvement in the macro-economic factors discussed above. The improvement in credit trends led to an improvement in our net charge-offs for the year ended December 31, 2013, which decreased $374 million, or 43%, to $501 million, compared to $875 million for the year ended December 31, 2012. The net charge-offs as a percentage of total average loans improved to 0.59% for the year ended December 31, 2013, compared to 1.01% for the year ended December 31, 2012.

Interest rates

Net interest income is our largest source of revenue and is the difference between the interest earned on interest earning assets (usually loans and investment securities) and the interest expense incurred in connection with interest bearing liabilities (usually deposits and borrowings). The level of net interest income is primarily a function of the average balance of interest earning assets, the average balance of interest bearing liabilities and the spread between the contractual yield on such

 

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assets and the contractual cost of such liabilities. These factors are influenced by both the pricing and mix of interest earning assets and interest bearing liabilities which, in turn, are impacted by external factors such as local economic conditions, competition for loans and deposits, the monetary policy of the Federal Reserve Board and market interest rates. For further discussion, refer to “—Risk Governance and Quantitative and Qualitative Disclosures About Risk—Market Risk—Non-Trading Risk.”

The cost of our deposits and short-term wholesale borrowings is largely based on short-term interest rates, which are primarily driven by the Federal Reserve Board’s actions. However, the yields generated by our loans and securities are typically driven by short-term and long-term interest rates, which are set by the market, or, at times by the Federal Reserve Board’s actions. The level of net interest income is therefore influenced by movements in such interest rates and the pace at which such movements occur. In 2013, short-term and long-term interest rates remained at very low levels by historical standards, with many benchmark rates, such as the federal funds rate and one- and three-month LIBOR, near zero. Further declines in the yield curve or a decline in longer-term yields relative to short-term yields (a flatter yield curve) would have an adverse impact on our net interest margin and net interest income. The low interest rate environment has compressed our net interest margin in recent periods.

During 2013, the Federal Reserve Board maintained a highly accommodative monetary policy, and indicated that this policy would remain in effect for a considerable time after its asset purchase program ends and the economic recovery strengthens. In December 2013, the Federal Reserve Board announced it would begin tapering the pace of asset purchases by $10 billion (from $85 billion per month to $75 billion per month) in January 2014, with the expectation that the pace of purchases will continue to drop throughout 2014.

Regulatory trends

We are subject to extensive regulation and supervision, which continues to evolve as the legal and regulatory framework governing our operations continues to change. The current operating environment also has heightened regulatory expectations around many regulations including consumer compliance, the Bank Secrecy Act, and anti-money laundering compliance and increased internal audit activities. As a result of these heightened expectations, we expect to incur additional costs for additional compliance personnel or professional fees associated with advisors and consultants.

Dodd-Frank regulation

As described further under “Regulation and Supervision,” we are subject to a variety of laws and regulations, including the Dodd-Frank Act. The Dodd-Frank Act is complex, and many aspects of it are subject to final rulemaking that will take effect over several years. The Dodd-Frank Act will continue to impact our earnings through fee reductions, higher costs, and imposition of new restrictions on us. The Dodd-Frank Act may also continue to have a material adverse impact on the value of certain assets and liabilities held on our balance sheet. The ultimate impact of the Dodd-Frank Act on our business will depend on regulatory interpretation and rulemaking as well as the success of any of our actions to mitigate the negative impacts of certain provisions. Key parts of the Dodd-Frank Act that will specifically impact our business are the repeal of a previous prohibition against payment of interest on demand deposits, which became effective in July 2011, and the introduction of a stress-testing and capital planning framework developed by the Federal Reserve Board, known as the comprehensive capital analysis and review, or “CCAR.”

Repeal of the prohibition on depository institutions paying interest on demand deposits

We began offering interest bearing corporate checking accounts after the 2011 repeal of the prohibition on depository institutions paying interest on demand deposits. Currently, industry-wide

 

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interest rates for this product are very low and thus far the impact of the repeal has not had a significant effect on our results. However, market rates could increase more significantly in the future. If we need to pay higher interest rates on checking accounts to maintain current clients or attract new clients, our interest expense would increase, perhaps materially. Furthermore, if we fail to offer interest rates at a sufficient level to retain demand deposits, our core deposits may be reduced, which would require us to obtain funding in other ways or limit potential future asset growth.

Comprehensive Capital Analysis and Review (CCAR)

CCAR is an annual exercise by the Federal Reserve Board to ensure that the largest bank holding companies have sufficient capital to continue operations throughout times of economic and financial stress and robust, forward-looking capital planning processes that account for their unique risks.

As part of CCAR, the Federal Reserve Board evaluates institutions’ capital adequacy, internal capital adequacy assessment processes and their plans to make capital distributions, such as dividend payments or stock repurchases. In March 2014, the Federal Reserve Board objected on qualitative grounds to our capital plan submitted as part of the CCAR process. In addition to modifications we may be required to make in connection with our proposed capital distributions, we may incur additional expenses in connection with the CCAR process that would affect our profitability and results of operations. For further information regarding the CCAR process, see “Dividend Policy” and “Regulation and Supervision.”

Basel III final rules applicable to us and our banking subsidiaries

In July 2013, the Federal Reserve Board, OCC, and FDIC issued the U.S. Basel III final rules. The final rule implements the Basel III capital framework and certain provisions of the Dodd-Frank Act, including the Collins Amendment. See “Regulation and Supervision – Capital” for further information. Certain aspects of the final rules, such as the new minimum capital ratios, will become effective on January 1, 2015. In order to comply with the new capital requirements, we established capital ratio targets that meet or exceed U.S. regulatory expectations under fully phased-in Basel III rules, and as a result our capital requirements were increased.

HELOC Payment Shock

Recent attention has been given by regulators, rating agencies, and the general press regarding the potential for increased exposure to credit losses associated with HELOCs that were originated during the period of rapid home price appreciation between 2003 and 2007. Industry-wide, many of the HELOCs originated during this timeframe were structured with an extended interest-only payment period followed by a requirement to convert to a higher payment amount that would begin fully amortizing both principal and interest beginning at a certain date in the future. As of December 31, 2013, approximately 39% of our $16.7 billion HELOC portfolio, or $6.6 billion in drawn balances, and $5.8 billion in undrawn balances, were subject to a payment reset or balloon payment between 2014 and 2017 (including $500 million in balloon balances since a portion of this portfolio was originally structured with a 10-year interest only draw period followed by a conversion to an amortizing principal and interest paydown).

To help manage this exposure, in September 2013, we launched a comprehensive program designed to provide heightened customer outreach in order to inform, educate, and assist customers through the reset process as well as to offer alternative financing and forbearance options. Early results indicate that our efforts to assist customers at risk of default have successfully reduced delinquency and charge-off rates compared to our original expectations.

 

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As of December 31, 2013, for the $668 million of our HELOC portfolio that was originally structured with a reset period in 2013, 93% of the balances were refinanced, paid off or were current on payments, 5% were past due and 2% had been charged off. $898 million of our HELOC portfolio is scheduled to reset in 2014. Factors that reduce our future expectations for charge-off risk for the portion of our HELOC portfolio subject to reset periods in the future include improved loan-to-value ratios resulting from continued home price appreciation, stable portfolio credit score profiles, and more robust loss mitigation efforts.

Factors Affecting Comparability of Our Results

Goodwill

During the 19-year period from 1988 to 2007, we completed a series of over 25 acquisitions of other financial institutions and financial assets and liabilities. We accounted for these types of business combinations using the acquisition method of accounting. Under this accounting method, the acquired company’s net assets are recorded at fair value at the date of acquisition, and the difference between the purchase price and the fair value of the net assets acquired is recorded as goodwill.

Under relevant accounting guidance, we are required to review goodwill for impairment annually, or more frequently if events or circumstances indicate that the fair value of any of our business units might be less than its carrying value. The valuation of goodwill is dependent on forward-looking expectations related to the performance of the U.S. economy and our associated financial performance.

The prolonged delay in the full recovery of the U.S. economy, and the impact of that delay on our earnings expectations, prompted us to record a $4.4 billion pre-tax ($4.1 billion after tax) goodwill impairment as of June 30, 2013 related to our Consumer Banking reporting unit. For segment reporting purposes, the impairment charge is reflected in Other.

Although the U.S. economy has demonstrated signs of recovery, notably improvements in unemployment and housing, the pace and extent of recovery in these indicators, as well as in overall gross domestic product, have lagged behind previous expectations. The impact of the slow recovery is most evident in Consumer Banking. The forecasted lower economic growth for the United States, coupled with increasing costs of complying with the new regulatory framework in the financial industry, resulted in a deceleration of expected growth for Consumer Banking’s future income, which resulted in our recording of a goodwill impairment charge during the second quarter of 2013. We have recorded goodwill impairment charges in the past and any further impairment to our goodwill could materially affect our results in any given period. As of December 31, 2013, we had a carrying value of goodwill of $6.9 billion compared to $11.3 billion as of December 31, 2012. For additional information regarding our goodwill impairment testing, see Note 1 “Significant Accounting Policies” and Note 8 “Goodwill” to our audited consolidated financial statements included elsewhere in this prospectus.

Investment in the business

We regularly incur expenses associated with investments in our infrastructure, and, since January 2009, we have invested more than $900 million in infrastructure and technology, with an additional $250 million planned for each of 2014 and 2015. These investments, which are designed to lower our costs and improve our customer experience, include significant programs to enhance our resiliency, upgrade customer-facing technology and streamline operations. Recent significant investments included the 2013 launch of our new teller system, new commercial loan platform and new auto loan platform and the 2013 upgrade of the majority of our ATM network, including equipping more than 1,600 ATMs with advanced deposit-taking functionality. These investments also involved spending to prepare for the planned rollout of our new mortgage platform. We expect that these investments will increase our long-term overall efficiency and add to our capacity to increase revenue.

 

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Operating expenses to operate as a fully independent public company

Following the completion of this offering and as part of our transition to a stand-alone company, we expect to incur one-time expenses of approximately $51 million, including branding initiatives, as well as ongoing incremental expenses of approximately $34 million per year. We expect these ongoing costs will include higher local charges associated with exiting worldwide vendor relationships and incremental expenses to support information technology, compliance, regulatory and risk infrastructure that are necessary to enable us to operate as a fully stand-alone public company. For additional information on the planned separation from the RBS Group, see “Our Relationship with the RBS Group and Certain Other Related Party Transactions.”

Principal Components of Operations and Key Performance Metrics Used By Management

As a banking institution, we manage and evaluate various aspects of both our results of operations and our financial condition. We evaluate the levels and trends of the line items included in our balance sheet and statement of operations, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against our own historical performance, our budgeted performance and the financial condition and performance of comparable banking institutions in our region and nationally.

The primary line items we use in our key performance metrics to manage and evaluate our statement of operations include net interest income, noninterest income, total revenue, provision for credit losses, noninterest expense and net (loss) income. The primary line items we use in our key performance metrics to manage and evaluate our balance sheet data include loans and leases, total securities, allowance for loan and lease losses, deposits, borrowed funds and derivatives.

Net interest income

Net interest income is the difference between the interest earned on interest earning assets (usually loans and investment securities) and the interest expense incurred in connection with interest bearing liabilities (usually deposits and borrowings). The level of net interest income is primarily a function of the average balance of interest earning assets, the average balance of interest bearing liabilities and the spread between the contractual yield on such assets and the contractual cost of such liabilities. Net interest income is impacted by the relative mix of interest earning assets and interest bearing liabilities, movements in market interest rates, levels of nonperforming assets and pricing pressure from competitors. The mix of interest earning assets is influenced by loan demand and by management’s continual assessment of the rate of return and relative risk associated with various classes of earning assets.

The mix of interest bearing liabilities is influenced by management’s assessment of the need for lower cost funding sources weighed against relationships with customers and growth requirements and is impacted by competition for deposits in our market and the availability and pricing of other sources of funds.

Noninterest income

The primary components of our noninterest income are service charges and fees, card fees, trust and investment services revenue and securities gains, net.

Total revenue

Total revenue is the sum of our net interest income and our noninterest income.

 

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Provision for credit losses

The provision for credit losses is the amount of expense that, based on our judgment, is required to maintain the allowance for credit losses at an adequate level to absorb probable losses inherent in the loan portfolio at the balance sheet date and that, in management’s judgment, is appropriate under relevant accounting guidance. The provision for credit losses includes the provision for loan and lease losses as well as the provision for unfunded commitments. The determination of the amount of the allowance is complex and involves a high degree of judgment and subjectivity. For additional information regarding the provision for credit losses, see “—Critical Accounting Estimates—Allowance for Credit Losses” and Note 1 and Note 5 to our audited consolidated financial statements included elsewhere in this prospectus.

Noninterest expense

Noninterest expense includes salary and employee benefits, outside services, occupancy expense, equipment expense, goodwill impairment, and other operating expenses.

Net (loss) income

We evaluate our net income based on measures including return on average common equity, return on average total assets, return on average tangible common equity and efficiency ratio.

Loans and leases

We classify our loans and leases pursuant to the following classes: commercial, commercial real estate, leases, residential (including residential mortgages and home equity loans and lines of credit), home equity products serviced by others (including certain purchased home equity loans and lines of credit), other secured retail (including automobile loans and other installment loans), and unsecured retail (including student loans and credit card).

Loans are reported at the amount of their outstanding principal, net of charge-offs, unearned income, deferred loan origination fees and costs and unamortized premiums or discounts (on purchased loans). Deferred loan origination fees and costs and purchase discounts and premiums are amortized as an adjustment of yield over the life of the loan, using the level yield interest method. Unamortized amounts remaining upon prepayment or sale are recorded as interest income or gain (loss) on sale, respectively. Credit card receivables include billed and uncollected interest and fees.

Leases are classified at the inception of the lease by type. Lease receivables, including leveraged leases, are reported at the aggregate of lease payments receivable and estimated residual values, net of unearned and deferred income, including unamortized investment credits. Lease residual values are reviewed at least annually for other-than-temporary impairment, with valuation adjustments recognized currently against noninterest income. Leveraged leases are reported net of non-recourse debt. Unearned income is recognized to yield a level rate of return on the net investment in the leases.

Mortgage loans held for sale are carried at fair value. Other loans held for sale primarily include loans relating to our Chicago branch network and are carried at the lower of cost or fair value.

Securities

Our securities portfolio is managed to seek return while maintaining prudent levels of quality, market risk and liquidity. Investments in debt and equity securities are carried in four portfolios: available for sale, held to maturity, trading account assets and other investment securities. We determine the appropriate classification at the time of purchase. Securities in our available for sale

 

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portfolio will be held for indefinite periods of time and may be sold in response to changes in interest rates, changes in prepayment risk or other factors relevant to our asset and liability strategy. Securities in our available for sale portfolio are carried at fair value, with unrealized gains and losses reported in other comprehensive income, or OCI, as a separate component of stockholders’ equity, net of taxes. Securities are classified as held to maturity because we have the ability and intent to hold the securities to maturity, and are carried at amortized cost. Debt and equity securities that are bought and held principally for the purpose of being sold in the near term are classified as trading account assets and are carried at fair value. Realized and unrealized gains and losses on such assets are reported in noninterest income. Other investment securities are comprised mainly of FHLB stock and Federal Reserve Bank stock, which are carried at cost.

Allowance for credit losses

Our estimate of probable losses in the loan and lease portfolios is recorded in the allowance for loan and lease losses and the reserve for unfunded lending commitments. Together these are referred to as the allowance for credit losses. We evaluate the adequacy of the allowance for credit losses using the following ratios: allowance for loan and lease losses as a percentage of total loans and leases; allowance for loan and lease losses as a percentage of nonperforming loans and leases; and nonperforming loans and leases as a percentage of total loans and leases. For additional information, see “—Critical Accounting Estimates—Allowance for Credit Losses” and Note 1 “Significant Account Policies” and Note 5 “Allowance for Credit Losses, Nonperforming Assets and Concentrations of Credit Risk” to our audited consolidated financial statements included elsewhere in this prospectus.

Deposits

Our deposits include on demand checking, checking with interest, regular savings accounts, money market accounts and term deposits. As of December 31, 2013, total deposits were $86.9 billion.

Borrowed funds

Our total short-term borrowed funds include federal funds purchased, securities sold under agreement to repurchase and FHLB borrowings. As of December 31, 2013, total short-term borrowed funds were $7.0 billion. Our total short-term borrowed funds are offset by $1.4 billion in average excess reserves held at Federal Reserve Banks as of December 31, 2013.

Our long-term borrowed funds include $350 million of fixed rate subordinated debt held by external parties and $1.0 billion of subordinated debt held by the RBS Group. For additional information, see “Our Relationship with the RBS Group and Certain Other Related Party Transactions.”

Derivatives

Historically, we have used pay-fixed interest rate swaps to synthetically lengthen liabilities, offsetting duration in fixed-rate assets. With our material prepayment of fixed-rate mortgages and home equity loans since 2008, these swaps were no longer needed and have been terminated or allowed to run off, resulting in a reduction in the notional balance of these swaps from $3.7 billion as of December 31, 2012 to $1.5 billion as of December 31, 2013. We use receive-fixed swaps to minimize the exposure to variability in the interest cash flows on our floating rate assets. As of December 31, 2013, a notional amount of $4.0 billion receive-fixed swaps had been executed. The assets and liabilities recorded for derivatives designated as hedges reflect the market value of these hedge instruments.

We also sell interest rate swaps and foreign exchange forwards to commercial customers. Offsetting swap and forward agreements are simultaneously transacted to minimize our market risk

 

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associated with the customer derivative products. The assets and liabilities recorded for derivatives not designated as hedges reflect the market value of these transactions.

Key Performance Metrics and Non-GAAP Financial Measures

We consider various measures when evaluating our performance and making day-to-day operating decisions, as well as evaluating capital utilization and adequacy, including:

 

    Return on average common equity, which we define as net income (loss) divided by average common equity;

 

    Return on average tangible common equity, which we define as net income (loss) divided by the difference of average common equity excluding average goodwill, net of the deferred tax liability, and average other intangibles;

 

    Return on average total assets, which we define as net income (loss) divided by average total assets;

 

    Return on average total tangible assets, which we define as net income (loss) divided by average total assets excluding average goodwill, net of the deferred tax liability, and average other intangibles;

 

    Efficiency ratio, which we define as the ratio of our total noninterest expense to the sum of net interest income and total noninterest income. We measure our efficiency ratio to evaluate the efficiency of our operations as it helps us monitor how costs are changing compared to our income. A decrease in our efficiency ratio represents improvement; and

 

    Net interest margin, which we calculate by dividing annualized net interest income for the period by average total interest earning assets, is a key measure that we use to evaluate our net interest income.

Certain of the above financial measures, including return on average tangible common equity, return on average total tangible assets and the efficiency ratio are not recognized under GAAP. In addition, we present noninterest expense, net income (loss), return on average total tangible assets, return on average tangible common equity, return on average common equity, return on average total assets, and efficiency ratio, net of the $4.4 billion pre-tax ($4.1 billion after tax) goodwill impairment we incurred for the quarter ended June 30, 2013. We believe these measures provide useful information to investors because these are among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions. In addition, we believe goodwill impairment in any period does not reflect the operational performance of the business in that period, and, accordingly, it is useful to consider these line items with and without goodwill impairment. This presentation also increases comparability of period-to-period results.

We also consider pro forma capital ratios defined by banking regulators but not effective at each period end to be non-GAAP financial measures. Since analysts and banking regulators may assess our capital adequacy using these pro forma ratios, we believe they are useful to provide investors the ability to assess its capital adequacy on the same basis. Other companies may use similarly titled non-GAAP financial measures that are calculated differently from the way we calculate such measures. Accordingly, our non-GAAP financial measures may not be comparable to similar measures used by other companies.

 

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The following table reconciles non-GAAP financial measures to GAAP:

 

        As of and for the Year Ended December 31,  
   

Ref.

  2013     2012     2011     2010     2009  
        (dollars in millions, except per share amounts)  

Noninterest expense, excluding goodwill impairment:

           

Noninterest expense (GAAP)

  A   $ 7,679      $ 3,457      $ 3,371      $ 3,483      $ 3,495   

Less: Goodwill impairment (GAAP)

      4,435                               
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense, excluding goodwill impairment (non-GAAP)

  B   $ 3,244      $ 3,457      $ 3,371      $ 3,483      $ 3,495   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income, excluding goodwill impairment:

           

Net (loss) income (GAAP)

  C   $ (3,426   $ 643      $ 506      $ 11      $ (740

Add: Goodwill impairment, net of income tax benefit (GAAP)

      4,080                               
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss), excluding goodwill impairment (non-GAAP)

  D   $ 654      $ 643      $ 506      $ 11      $ (740
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average common equity, excluding goodwill impairment:

           

Average common equity (GAAP)

  E   $ 21,834      $ 23,938      $ 23,137      $ 22,425      $ 19,604   

Return on average common equity, excluding goodwill impairment (non-GAAP)

  D/E     3.00     2.69     2.19     0.05     (3.77 )% 

Return on average tangible common equity, excluding goodwill impairment:

           

Average common equity (GAAP)

  E   $ 21,834      $ 23,938      $ 23,137      $ 22,425      $ 19,604   

Less: Average goodwill (GAAP)

      9,063        11,311        11,311        11,674        11,709   

Average other intangibles (GAAP)

      9        12        15        19        205   

Add: Average deferred tax liabilities related to goodwill (GAAP)

      459        617        295        27        52   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average tangible common equity (non-GAAP)

  F   $ 13,221      $ 13,232      $ 12,106      $ 10,759      $ 7,742   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average tangible common equity (non-GAAP)

  C/F     (25.91 )%      4.86     4.18     0.10     (9.56 )% 

Return on average tangible common equity, excluding goodwill impairment (non-GAAP)

  D/F     4.95     4.86     4.18     0.10     (9.56 )% 

Return on average total assets, excluding goodwill impairment:

           

Average total assets (GAAP)

  G   $ 120,866      $ 127,666      $ 128,344      $ 138,253      $ 156,272   

Return on average total assets, excluding goodwill impairment (non-GAAP)

  D/G     0.54     0.50     0.39     0.01     (0.47 )% 

Return on average total tangible assets, excluding goodwill impairment:

           

Average total assets (GAAP)

  G   $ 120,866      $ 127,666      $ 128,344      $ 138,253      $ 156,272   

Less: Average goodwill (GAAP)

      9,063        11,311        11,311        11,674        11,709   

Average other intangibles (GAAP)

      9        12        15        19        205   

Add: Average deferred tax liabilities related to goodwill (GAAP)

      459        617        295        27        52   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average tangible assets (non-GAAP)

  H   $ 112,253      $ 116,960      $ 117,313      $ 126,587      $ 144,410   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average total tangible assets (non-GAAP)

  C/H     (3.05 )%      0.55     0.43     0.01     (0.51 )% 

Return on average total tangible assets, excluding goodwill impairment (non-GAAP)

  D/H     0.58     0.55     0.43     0.01     (0.51 )% 

Efficiency ratio, excluding goodwill impairment:

           

Net interest income (GAAP)

    $ 3,058      $ 3,227      $ 3,320      $ 3,345      $ 3,419   

Noninterest income (GAAP)

      1,632        1,667        1,711        1,733        1,666   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue (GAAP)

  I   $ 4,690      $ 4,894      $ 5,031      $ 5,078      $ 5,085   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency ratio (non-GAAP)

  A/I     163.73     70.64     67.00     68.59     68.73

Efficiency ratio, excluding goodwill impairment (non-GAAP)

  B/I     69.17     70.64     67.00     68.59     68.73

 

73


        As of and for the Year Ended December 31,  
   

Ref.

  2013     2012     2011     2010     2009  
        (dollars in millions, except per share amounts)  

Net income (loss) per average common share – basic and diluted, excluding goodwill impairment:

           

Average common shares outstanding—basic and diluted (pro forma)

  L     456,000,000        456,000,000        456,000,000        456,000,000        456,000,000   

Average common shares outstanding—basic and diluted (actual)

  M     3,382        3,382        3,382        3,382        3,382   

Net income (loss) per average common share—basic and diluted, excluding goodwill impairment (pro forma)(unaudited)

  D/L     1.43        1.41        1.11        0.03        (1.62

Net income (loss) per average common share—basic and diluted, excluding goodwill impairment (actual)

  D/M     193,122.25        190,245.51        149,548.13        3,378.92        (218,808.05

Pro forma Basel III common equity Tier 1 capital ratio:

           

Tier 1 common capital (regulatory)

    $ 13,301           

Less: Change in DTA and other threshold deductions (GAAP)

      6           
   

 

 

         

Basel III common equity Tier 1 (non-GAAP)

  J   $ 13,295           
   

 

 

         

Risk-weighted assets (regulatory)

    $ 98,634           

Add: Net change in credit and other risk weighted assets (GAAP)

      2,687           
   

 

 

         

Basel III risk-weighted assets (non-GAAP)

  K   $ 101,321           
   

 

 

         

Pro forma Basel III common equity Tier 1 capital ratio (non-GAAP)

  J/K     13.1        

Pro forma Basel III Tier 1 capital ratio:

           

Basel III common equity Tier 1 (non-GAAP)

  J   $ 13,295           

Add: Trust preferred and minority interest (GAAP)

                
   

 

 

         

Basel III Tier 1 capital (non-GAAP)

  N   $ 13,295           
   

 

 

         

Pro forma Basel III Tier 1 capital ratio (non-GAAP)

  N/K     13.1        

Pro forma Basel III total capital ratio:

           

Total Tier 2 common capital (regulatory)

    $ 2,584           

Add: Excess allowance for loan and lease losses (GAAP)

      27           
   

 

 

         

Basel III common equity Tier 2 (non-GAAP)

  O   $ 2,611           
   

 

 

         

Pro forma Basel III total capital (non-GAAP)

  O+J   $ 15,906           
   

 

 

         

Pro forma Basel III total capital ratio (non-GAAP)

  (O+J)/K     15.7        

Pro forma Basel III leverage ratio:

           

Quarterly average assets (GAAP)

    $ 120,705           

Less: Goodwill (GAAP)

      6,876           

Restricted core capital elements (regulatory)(1)

      17           

Add: Deferred tax liability related to goodwill (GAAP)

      351           

Other comprehensive income pension adjustments (GAAP)

      259           
   

 

 

         

Basel III adjusted average assets (non-GAAP)

  P   $ 114,422           
   

 

 

         

Pro forma leverage ratio (non-GAAP)

  P/J     11.6        

 

(1)  Restricted core capital elements include other intangibles, intangible mortgage servicing assets, and disallowed mortgage servicing assets.

 

74


        As of and for the Year Ended December 31,  
        2013     2012     2011  
   

Ref.

  Consumer
Banking
    Commercial
Banking
    Other     Consolidated     Consumer
Banking
    Commercial
Banking
    Other     Consolidated     Consumer
Banking
    Commercial
Banking
    Other     Consolidated  
        (dollars in millions)  

Net (loss) income, excluding goodwill impairment:

                         

Net (loss) income (GAAP)

  A   $ 242      $ 514      $ (4,182   $ (3,426   $ 185      $ 453      $ 5      $ 643      $ 265      $ 373      $ (132   $ 506   

Add: Goodwill impairment, net of income tax benefit (GAAP)

                    4,080        4,080                                                           
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income, excluding goodwill impairment (non-
GAAP)

  B   $ 242      $ 514      $ (102   $ 654      $ 185      $ 453      $ 5      $ 643      $ 265      $ 373      $ (132   $ 506   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency ratio:

                         

Total revenue (GAAP)

  C   $ 3,201      $ 1,420      $ 69      $ 4,690      $ 3,384      $ 1,385      $ 125      $ 4,894      $ 3,332      $ 1,272      $ 427      $ 5,031   

Noninterest expense (GAAP)

  D   $ 2,522      $ 635      $ 4,522      $ 7,679      $ 2,691      $ 625      $ 141      $ 3,457      $ 2,524      $ 605      $ 242      $ 3,371   

Less: Goodwill impairment (GAAP)

                    4,435        4,435                                                           
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense, excluding goodwill impairment (non-
GAAP)

  E   $ 2,522      $ 635      $ 87      $ 3,244      $ 2,691      $ 625      $ 141      $ 3,457      $ 2,524      $ 605      $ 242      $ 3,371   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency ratio (non-GAAP)

  D/C     78.76     44.66     NM        163.73     79.45     45.22     NM        70.64     75.78     47.55     NM        67.00

Efficiency ratio, excluding goodwill impairment (non-GAAP)

  E/C     78.76     44.66     NM        69.17        79.45     45.22     NM        70.64     75.78     47.55     NM        67.00

Return on average total tangible assets:

                         

Average total assets
(GAAP)

    $ 46,465      $ 35,229      $ 39,172      $ 120,866      $ 47,824      $ 33,474      $ 46,368      $ 127,666      $ 46,071      $ 29,800      $ 52,473      $ 128,344   

Less: Average goodwill (GAAP)

                    9,063        9,063                      11,311        11,311                      11,311        11,311   

Average other intangibles (GAAP)

                    9        9                      12        12                      15        15   

Add: Average deferred tax liabilities related to goodwill (GAAP)

                    459        459                      617        617                      295        295   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average total tangible assets (non-
GAAP)

  F   $ 46,465      $ 35,229      $ 30,559      $ 112,253      $ 47,824      $ 33,474      $ 35,662      $ 116,960      $ 46,071      $ 29,800      $ 41,442      $ 117,313   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average total tangible assets (non-
GAAP)

  A/F     0.52     1.46     NM        (3.05 )%      0.39     1.35     NM        0.55     0.57     1.25     NM        0.43

 

75


        As of and for the Year Ended December 31,  
        2013     2012     2011  
   

Ref.

  Consumer
Banking
    Commercial
Banking
    Other     Consolidated     Consumer
Banking
    Commercial
Banking
    Other     Consolidated     Consumer
Banking
    Commercial
Banking
    Other     Consolidated  
        (dollars in millions)  

Return on average total tangible assets, excluding goodwill impairment (non-GAAP)

  B/F     0.52     1.46     NM        0.58     0.39     1.35     NM        0.55     0.57     1.25     NM        0.43

Return on average tangible common equity:

                         

Average common equity (GAAP)(1)

    $ 4,395      $ 3,897      $ 13,542      $ 21,834      $ 3,813      $ 3,626      $ 16,499      $ 23,938      $ 3,423      $ 3,452      $ 16,262      $ 23,137   

Less: Average goodwill (GAAP)

                    9,063        9,063                      11,311        11,311                      11,311        11,311   

Average other intangibles (GAAP)

                    9        9                      12        12                      15        15   

Add: Average deferred tax liabilities related to goodwill (GAAP)

                    459        459                      617        617                      295        295   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average tangible common equity (non-GAAP)(1)

  G   $ 4,395      $ 3,897      $ 4,929      $ 13,221      $ 3,813      $ 3,626      $ 5,793      $ 13,232      $ 3,423      $ 3,452      $ 5,231      $ 12,106   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average tangible common equity (non-GAAP)(1)

  A/G     5.48     13.20     NM        (25.91 )%      4.89     12.45     NM        4.86     7.71     10.81     NM        4.18

Return on average tangible common equity, excluding goodwill impairment (non-GAAP)(1)

  B/G     5.48     13.20     NM        4.95     4.89     12.45     NM        4.86     7.71     10.81     NM        4.18

 

(1)  Operating segments are allocated capital on a risk-adjusted basis considering economic and regulatory capital requirements. We approximate that regulatory capital is equivalent to a sustainable target level for common equity Tier 1 and then allocate that approximation to the segments based on economic capital.

 

76


Financial Highlights

For the year ended December 31, 2013:

 

    we recorded a $4.4 billion pre-tax ($4.1 billion after tax) goodwill impairment charge that resulted in a $3.4 billion net loss;

 

    excluding the impact of the goodwill impairment charge and $26 million ($17 million after tax) in restructuring charges in 2013 and a net $158 million of pre-tax ($125 million after tax) unusual items in 2012, net income decreased $97 million, or 13%, from 2012. 2013 restructuring charges related to our implementation of a new branch image capture system on the teller line which automated several key processes within the branch network, and our decision to close certain branches, which resulted in lease termination costs and other fixed asset write-offs. Unusual expenses in 2012 included a $138 million ($87 million after tax) litigation settlement related to overdraft protection, a $77 million ($49 million after tax) settlement of defined benefit pension plan obligations to vested former employees, a $25 million charge associated with a state tax settlement, and a $23 million ($15 million after tax) loss on sale of a commercial real estate portfolio, offset by a $75 million ($48 million after tax) gain on sale of VISA, Inc. Class B shares and a net $5 million ($3 million after tax) reversal of prior restructuring charges;

 

    net interest margin was 2.85% compared to 2.89% in 2012, driven by declining yields on investment securities, auto loans, and commercial and consumer real estate-secured loans;

 

    net interest income decreased $169 million, or 5%, to $3.1 billion compared to $3.2 billion in 2012, largely reflecting the effect of the continued low-rate environment which reduced loan yields and deposit spreads. Income from loans and leases decreased $204 million driven by the effect of lower interest rates and lower portfolio balances, principally in consumer real estate secured loans. Interest expense on deposits declined reflecting a decrease in total deposits and an improvement in the mix as we reduced our reliance on higher cost certificates of deposit and money market balances. Average earning assets decreased 4% as an increase in commercial loans was more than offset by declines in the investment portfolio and the consumer real estate secured portfolio, including a $947 million decrease in our non-core consumer real estate secured portfolio;

 

    noninterest income decreased $35 million, or 2%, to $1.6 billion compared to $1.7 billion in 2012, which included a net benefit of $52 million in unusual items. Excluding the unusual items, noninterest income increased $17 million largely as higher securities gains, net, other services income, other income and trust and investment services revenue was partially offset by lower mortgage banking and card fee income. 2012 unusual items included the $75 million gain on sale of our VISA, Inc. Class B shares and a $23 million loss on the sale of a commercial real estate portfolio;

 

    noninterest expense of $7.7 billion included a $4.4 billion goodwill impairment charge recorded in the second quarter of 2013 and a $26 million net restructuring charge. Noninterest expense in 2012 included a $138 million litigation settlement related to overdraft protection and a $77 million defined benefit pension plan obligation charge paid to vested former employees as a single lump sum payment, partially offset by a net $5 million reversal of prior restructuring charges. Excluding these unusual items, noninterest expense in 2013 decreased $29 million, or 1%, compared to 2012, largely due to lower other operating expense and salaries and employee benefits partially offset by higher amortization of software;

 

    excluding the impact of the $4.4 billion pre-tax ($4.1 billion after tax) goodwill impairment charge, our return on average tangible common equity improved to 4.95% from 4.86% in 2012;

 

    average loans and leases of $85.4 billion decreased $1.6 billion, or 2%, from $87.0 billion in 2012, as commercial loan growth was more than offset by a decrease in our retail loan portfolio, which included a $1.2 billion decrease in the non-core retail loan portfolio;

 

77


    average interest-bearing deposits of $67.9 billion were flat compared to 2012 as growth in low cost deposits such as interest checking and money market and savings deposits, was offset by lower term deposits;

 

    our capital ratios continued to be well above regulatory requirements: our total capital ratio increased to 16.1% from 15.8% in 2012, and our Tier 1 capital ratio was 13.5% compared to 14.2% in 2012 as a result of our plan to rebalance our capital structure;

 

    net charge-offs declined $374 million from 2012 to $501 million and provision for credit losses totaled $479 million, up 16% from $413 million in 2012. The allowance for credit losses totaled $1.3 billion as of December 31, 2013, down $35 million, or 3%, reflecting continued improvement in overall credit quality from 2012; and

 

    net (loss) income per average common share, basic and diluted, on a pro forma basis to give effect to the 134,831.46-for-1 forward stock split to occur immediately prior to the closing of this offering, was ($7.51) compared to $1.41 in 2012. Net (loss) income per average common share, basic and diluted, on an actual basis was ($1,013,131.98) in 2013 compared with $190,245.51 in 2012. Net income per average common share, basic and diluted, excluding goodwill impairment, on a pro forma basis to give effect to the 134,831.46-for-1 forward stock split to occur immediately prior to the closing of this offering, was $1.43. Net income per average common share, basic and diluted, excluding goodwill impairment, on an actual basis was $193,122.25 in 2013.

Results of Operations—Year Ended December 31, 2013 Compared with Year Ended December 31, 2012

Net Income (Loss)

We reported a net loss of $3.4 billion for the year ended December 31, 2013, after recording a goodwill impairment charge of $4.1 billion after tax in the second quarter of 2013 and $26 million ($17 million after tax) in restructuring charges. Excluding the goodwill impairment and restructuring charges above and a net $158 million of pre-tax unusual items in 2012, net income decreased $97 million, or 13%, from 2012, largely driven by the effect of the relatively persistent low interest rate environment on net interest income and a reduction in fee income, driven by continued pressure from regulatory changes and lower mortgage banking fees. Results also reflected increased provision for credit losses and lower noninterest expense, excluding goodwill impairment.

The restructuring charges in 2013 related to our implementation of a new branch image capture system on the teller line which automated several key processes within the branch network, and our decision to close certain branches, which resulted in lease termination costs and other fixed asset write-offs. Unusual expenses in 2012 included a $138 million ($87 million after tax) overdraft litigation settlement, a $77 million ($49 million after tax) settlement of defined benefit pension plan obligation to vested former employees, a $25 million charge related to a state tax settlement and a $23 million ($15 million after tax) loss on sale of a commercial real estate portfolio, offset by a $75 million ($48 million

 

78


after tax) gain on sale of our VISA, Inc. Class B shares and a net $5 million ($3 million after tax) reversal of prior restructuring charges.

 

     Year Ended December 31,     Change from
2013-2012
 
         2013             2012        
     (dollars in millions)     (%)  

Operating Data:

        

Net interest income

   $ 3,058      $ 3,227      $ (169     (5 )% 

Noninterest income

     1,632        1,667        (35     (2
  

 

 

   

 

 

   

 

 

   

Total revenue

     4,690        4,894        (204     (4

Provision for credit losses

     479        413        66        16   

Noninterest expense

     7,679        3,457        4,222        122   

Noninterest expense, excluding goodwill impairment(1)

     3,244        3,457        (213     (6

(Loss) income before income tax (benefit) expense

     (3,468     1,024        (4,492     (439

Income tax (benefit) expense

     (42     381        (423     (111

Net (loss) income

     (3,426     643        (4,069     (633

Net income, excluding goodwill impairment(1)

     654        643        11        2   

Return on average tangible common equity(1)

     (25.91 )%      4.86     NM          

Return on average tangible common equity, excluding goodwill impairment(1)

     4.95     4.86     9 bps          

 

(1)  These are non-GAAP financial measures. For more information on the computation of these non-GAAP financial measures, see “—Principal Components of Operations and Key Performance Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

Net Interest Income

The following table shows the major components of net interest income and net interest margin:

 

    Year Ended December 31,     Change
from
2013-2012
 
  2013     2012    
    Average
Balances
    Income/
Expense
    Yields/
Rates
    Average
Balances
    Income/
Expense
    Yields/
Rates
    Average
Balances
    Yields/
Rates
 
    (dollars in millions)  

Assets

               

Taxable investment securities

  $ 21,340      $ 488        2.29   $ 23,592      $ 622        2.64   $ (2,252     (35 )bps 

Non-taxable investment securities

    12               2.66        40        2        4.32        (28     (166
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total investment securities

    21,352        488        2.29        23,632        624        2.64        (2,280     (35

Commercial

    28,654        900        3.10        27,273        849        3.07        1,381        3   

Commercial real estate

    6,568        178        2.67        7,063        196        2.72        (495     (5

Leases

    3,463        105        3.05        3,216        112        3.48        247        (43
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total commercial

    38,685        1,183        3.02        37,552        1,157        3.04        1,133        (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Home equity lines of credit

    17,105        485        2.83        17,745        497        2.80        (640     3   

Residential mortgage

    9,104        360        3.96        9,551        413        4.32        (447     (36

Home equity loans

    6,330        361        5.71        8,176        481        5.88        (1,846     (17

Automobile

    8,857        235        2.65        8,276        273        3.30        581        (65

Student and other installment loans

    3,655        202        5.52        4,040        218        5.38        (385     14   

Credit cards

    1,669        175        10.46        1,634        166        10.15        35        31   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total retail

    46,720        1,818        3.89        49,422        2,048        4.14        (2,702     (25
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total loans and leases

    85,405        3,001        3.50        86,974        3,205        3.67        (1,569     (17

 

79


    Year Ended December 31,     Change
from
2013-2012
 
  2013     2012    
    Average
Balances
    Income/
Expense
    Yields/
Rates
    Average
Balances
    Income/
Expense
    Yields/
Rates
    Average
Balances
    Yields/
Rates
 
    (dollars in millions)  

Loans held for sale

  $ 392      $ 12        3.07   $ 538      $ 17        3.10   $ (146     (3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Interest earning assets

    107,149        3,501        3.25        111,144        3,846        3.45        (3,995     (20

Allowance for loan and lease losses

    (1,219         (1,506         287     

Goodwill

    9,437            11,323            (1,886  

Other noninterest earning assets

    5,499            6,705            (1,206  
 

 

 

       

 

 

       

 

 

   

Total noninterest earning assets

    13,717            16,522            (2,805  
 

 

 

       

 

 

       

 

 

   

Total assets

  $ 120,866          $ 127,666          $ (6,800  
 

 

 

       

 

 

       

 

 

   

Liabilities and Stockholders’ Equity

               

Checking with interest

  $ 14,096      $ 8        0.06      $ 13,522      $ 10        0.08      $ 574        (2

Money market & savings

    42,575        105        0.25        41,249        121        0.29        1,326        (4

Term deposits

    11,266        103        0.91        13,534        244        1.80        (2,268     (89
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total interest bearing deposits

    67,937        216        0.32        68,305        375        0.55        (368     (23

Federal funds purchased and securities sold under agreements to repurchase(1)

    2,400        192        7.89        2,716        119        4.31        (316     358   

Other short-term borrowed funds

    251        4        1.64        3,026        101        3.27        (2,775     (163

Long-term borrowed funds

    778        31        3.93        1,976        24        1.20        (1,198     273   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total borrowed funds

    3,429        227        6.53        7,718        244        3.11        (4,289     342   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total interest bearing liabilities

    71,366        443        0.61        76,023        619        0.80        (4,657     (19

Total demand deposits

    25,399            25,053            346     

Other liabilities

    2,267            2,652            (385  

Stockholders’ equity

    21,834            23,938            (2,104  
 

 

 

       

 

 

       

 

 

   

Total liabilities and stockholders’ equity

  $ 120,866          $ 127,666          $ (6,800  
 

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Interest rate spread

        2.64            2.65       
   

 

 

   

 

 

     

 

 

   

 

 

     

Net interest income

    $ 3,058          $ 3,227        $ (169  
   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Net interest margin

        2.85         2.89       (4 )bps 
     

 

 

       

 

 

     

 

 

 

 

(1)  Balances are net of certain short-term receivables associated with reverse repurchase agreements. Interest expense includes the full cost of the repurchase agreements and certain hedging costs. The rate on federal funds purchased is elevated due to the impact from pay-fixed interest rate swaps that are scheduled to run off by the end of 2015. See “—Analysis of Financial Condition—Derivatives” for further information.

 

80


Net interest income of $3.1 billion in 2013 decreased $169 million, or 5%, from $3.2 billion in 2012, and reflected a four basis point decline in net interest margin to 2.85%. The decrease in net interest income was driven by a reduction in earning asset yields given the relatively persistent low rate environment as well as a decrease in loan and securities portfolio balances, which were partially offset by a reduction in pay fixed swap costs and improved deposit spreads. Average interest earning assets decreased $4.0 billion driven by a $2.9 billion decrease in consumer real estate secured portfolios, a $2.3 billion decrease in the investment securities portfolio and a $385 million decrease in student and other installment loans, which were partially offset by a $1.1 billion increase in total commercial loans and a $581 million increase in auto loans.

The four basis point decrease in net interest margin reflected the effect of the relatively persistent low rate environment, which led to a decline in earning asset yields that outpaced our ability to reduce the cost of interest bearing liabilities. The decline in earning asset yields reflected continued prepayment of higher yielding consumer real estate secured loans as well as the contractual amortization of higher yield portfolios, which were entered into in higher interest rate environments. In addition, intense industry-wide competition for loans compressed spreads on new originations and resulted in downward pressure on loan yields. To a lesser extent, rates on interest bearing deposits also declined compared to 2012. Industry wide, net interest margins experienced downward pressure as higher rate loan and securities balances ran off and deposit rates approached floors where they cannot be reduced further.

The net yield on average interest earning assets decreased 20 basis points to 3.25% in 2013 from 3.45% in 2012, reflecting a 17 basis point decline in the loan and lease portfolio yield and a 35 basis point decline in the investment portfolio yield from 2012. The decline in average yields largely reflected the effect of the continued low-rate environment as new loans and securities were issued at lower rates and prepayment speeds on higher rate fixed assets in the portfolio increased. Investment portfolio income of $488 million decreased $136 million, or 22%, from 2012, and the yield on the portfolio declined 35 basis points to 2.29%. These results were impacted by our strategic decision to slow down reinvestment activity in the first half of 2013, given extremely low levels of market rates.

Our total interest bearing deposit costs in 2013 decreased $159 million, or 42%, from $375 million in 2012 and reflected a 23 basis point decrease in the rate paid on deposits to 0.32% from 0.55% in 2012. The rates paid on term deposits declined to 0.91% from 1.80% in 2012. As a result of the historically low interest rate environment, many deposit products have hit pricing floors at or near zero, limiting further rate reductions and thus compressing margin. The total cost of borrowed funds increased to 6.53% from 3.11% in 2012 due to additional subordinated debt issued in 2013 and the full expense impact of the subordinated debt issued in 2012.

 

81


Noninterest Income

The following table details the significant components of our noninterest income for the periods indicated:

 

     Year Ended
December 31,
     Change from
2013-2012
 
     2013      2012     
     (dollars in millions)      ($)     (%)  

Service charges and fees

   $ 640       $ 704       $ (64     (9 )% 

Card fees

     234         249         (15     (6

Mortgage banking fees

     153         189         (36     (19

Trust and investment services fees

     149         131         18        14   

Foreign exchange and trade finance fees

     97         105         (8     (8

Capital markets fees

     53         52         1        2   

Bank-owned life insurance income

     50         51         (1     (2

Securities gains, net

     144         95         49        52   

Other income(1)

     112         91         21        23   
  

 

 

    

 

 

    

 

 

   

Total noninterest income

   $ 1,632       $ 1,667       $ (35     (2 )% 
  

 

 

    

 

 

    

 

 

   

 

(1)  Includes net impairment losses on available for sale securities recognized in earnings and other income.

Total noninterest income of $1.6 billion in 2013 decreased 2%, or $35 million, from 2012 largely as higher securities gains, net, other income and trust and investment services fees were more than offset by lower service charges and fees, mortgage banking fees and card fees. Service charges and fees of $640 million decreased 9% largely on lower account volume. Mortgage banking fees of $153 million decreased $36 million, or 19%, from $189 million in 2012. The decrease was primarily driven by lower loan sale gains reflecting the decision to retain more loans on our balance sheet, which was partially offset by higher mortgage servicing rights valuations. Card fees of $234 million declined $15 million, or 6%, compared to $249 million in 2012 driven by lower transaction volumes. Net gains on the sale of securities of $144 million increased $49 million, or 52%, from $95 million in 2012 primarily reflecting the sale of higher yielding investment securities. We do not expect to record comparable securities gains, net, in the coming years. Other income of $112 million increased $21 million, or 23%, from 2012 primarily due to a $75 million gain on the sale of Visa Class B shares offset by a $23 million loss on the sale of a commercial real estate portfolio recorded in 2012. Excluding the Visa gain and the loss on commercial real estate, other income increased $73 million driven by higher derivatives income, leasing income, and a gain on sale of warrants.

Provision for Credit Losses

Provision for credit losses of $479 million in 2013 increased $66 million, or 16%, from $413 million in 2012, despite a $374 million decline in net charge-offs. The increase in the provision for credit losses reflects growth in the commercial loan portfolio and recognition of incremental loss exposure related to expected HELOC payment shock. Additionally, while overall credit quality continued to improve in 2013, the rate of improvement slowed relative to 2012. As a result, 2013 provision for credit losses included a release of $22 million from the allowance for credit losses (the amount by which net charge-offs exceeded the provision), compared with a release of $462 million in 2012. For further information regarding the expected HELOC payment shock, see “—Key Factors Affecting Our Business—HELOC Payment Shock” in this section.

 

82


Noninterest Expense

The following table displays the significant components of our noninterest expense for the periods indicated:

 

     Year Ended
December 31,
     Change from
2013-2012
 
     2013      2012     
     (dollars in millions)      ($)     (%)  

Salaries and employee benefits

   $ 1,652       $ 1,743       $ (91     (5 )% 

Outside services

     360         339         21        6   

Occupancy

     327         310         17        5   

Equipment expense

     275         279         (4     (1

Amortization of software

     102         77         25        32   

Goodwill impairment

     4,435                 4,435        NM   

Other operating expense

     528         709         (181     (26
  

 

 

    

 

 

    

 

 

   

Total noninterest expense

   $ 7,679       $ 3,457       $ 4,222        122
  

 

 

    

 

 

    

 

 

   

Noninterest expense of $7.7 billion in 2013 increased $4.2 billion from $3.5 billion in 2012 and included a second quarter $4.4 billion goodwill impairment charge as described below. Excluding the goodwill impairment, noninterest expense of $3.2 billion declined $213 million, or 6%, from $3.5 billion in 2012. Results in 2012 included a $138 million litigation settlement related to overdraft protection and a $77 million settlement of defined benefit pension plan obligations to vested former employees, partially offset by a net $5 million reversal of prior restructuring charges. Excluding these unusual items and a $26 million restructuring charge in 2013, noninterest expense decreased $29 million, or 1%, driven by lower other operating expense and salaries and employee benefits.

In the second quarter of 2013, we recorded a $4.4 billion goodwill impairment charge driven by a deceleration of the expected future earnings associated with our Consumer Banking reporting unit as compared to our prior expectations. Although the U.S. economy has demonstrated signs of recovery, including notable improvements in unemployment and housing, the pace and extent of recovery in these indicators, as well as in overall gross domestic product, have lagged behind previous expectations and interest rates have remained at or near historically low levels for a protracted period of time. Lower economic growth rates for the United States, coupled with increased costs to comply with the new regulatory framework in the financial services industry, resulted in a deceleration of the expected growth rate for future earnings associated with the Consumer Banking reporting unit, which caused us to record a goodwill impairment charge during the second quarter of 2013. For segment reporting purposes, the impairment charge is reflected in Other, and the remaining carrying value of goodwill totaled $6.9 billion as of December 31, 2013. See Note 8 “Goodwill” to our audited consolidated financial statements included elsewhere in this prospectus for further information.

Provision for Income Taxes

In 2013, we recorded an income tax benefit of $42 million compared to $381 million of income tax expense in 2012. The effective tax rates for the years ended December 31, 2013 and 2012 were 1% and 37%, respectively. The decrease in the effective rate was mainly due to the tax rate impact of the goodwill impairment in calculating our income tax benefit as well as the effect of a $25 million charge related to a state tax settlement in 2012. Goodwill not deductible for tax purposes accounted for 78.4% of the total goodwill impairment charge and generated a reduction of 35% in our effective tax rate for the year ended December 31, 2013. During 2012, we recorded a state tax settlement charge for the years 2003 through 2008 related to our real estate investment trust and various passive investment companies. For further discussion of our tax settlement in 2012, see Note 14 “Income Taxes” to our audited consolidated financial statements included elsewhere in this prospectus.

 

83


Business Segments

The following table presents certain financial data of our business segments for the year ended December 31, 2013:

 

    As of and for
Year Ended December 31, 2013
 
    Consumer
Banking
    Commercial
Banking
    Other(4)     Consolidated  
    (dollars in millions)  

Net interest income (expense)

  $ 2,176      $ 1,031      $ (149   $ 3,058   

Noninterest income

    1,025        389        218        1,632   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    3,201        1,420        69        4,690   

Noninterest expense

    2,522        635        4,522        7,679   
 

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before provision for credit losses

    679        785        (4,453     (2,989

Provision for credit losses

    308        (7     178        479   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income tax expense

    371        792        (4,631     (3,468

Income tax expense (benefit)

    129        278        (449     (42
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 242      $ 514      $ (4,182   $ (3,426
 

 

 

   

 

 

   

 

 

   

 

 

 

Loans and leases and loans held for sale (period- end)(1)

  $ 45,019      $ 36,155      $ 5,939      $ 87,113   

Average Balances:

       

Total assets

  $ 46,465      $ 35,229      $ 39,172      $ 120,866   

Loans and leases and loans held for sale(1)

    45,106        34,647        6,044        85,797   

Deposits and deposits held for sale

    72,158        17,516        3,662        93,336   

Interest earning assets

    45,135        34,771        27,243        107,149   

Key Metrics:

       

Net interest margin

    4.82     2.97     NM        2.85

Efficiency ratio(2)

    78.76     44.66     NM        163.73

Efficiency ratio, excluding goodwill impairment(2)

    78.76     44.66     NM        69.17

Average loans to average deposits ratio

    62.51     197.80     NM        91.92

Return on average total tangible assets(2)

    0.52     1.46     NM        (3.05 )% 

Return on average total tangible assets, excluding goodwill impairment(2)

    0.52     1.46     NM        0.58

Return on average tangible common equity(2)(3)

    5.48     13.20     NM        (25.91 )% 

Return on average tangible common equity, excluding goodwill impairment(2)(3)

    5.48     13.20     NM        4.95

 

(1)  Loans held for sale refer to mortgage loans held for sale recorded in the Consumer Banking segment, as well as the loans relating to the sale of our Chicago branch network, which are recorded in both the Consumer Banking and Commercial Banking segments.

 

(2)  These are non-GAAP financial measures. For more information on the computation of these non-GAAP financial measures, see “—Principal Components of Operations and Key Performance Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

(3)  Operating segments are allocated capital on a risk-adjusted basis considering economic and regulatory capital requirements. We approximate that regulatory capital is equivalent to a sustainable target level for common equity Tier 1 and then allocate that approximation to the segments based on economic capital.

 

(4)  Includes the financial impact of non-core, liquidating loan portfolios and other non-core assets, our treasury activities, wholesale funding activities, securities portfolio, community development assets and other unallocated assets, liabilities, revenues, provision for credit losses, and expenses not attributed to our Consumer Banking or Commercial Banking segments. For a description of non-core assets, see “—Analysis of Financial Condition—Non-Core Assets”.

 

84


We operate our business through two operating segments: Consumer Banking and Commercial Banking. Segment results are derived from our business line profitability reporting systems by specifically attributing managed balance sheet assets, deposits, and other liabilities and their related income or expense. Residual assets and liabilities not attributed to Consumer Banking and Commercial Banking are attributed to Other.

Other includes our treasury function, securities portfolio, wholesale funding activities, goodwill and goodwill impairment, community development assets and other unallocated assets, liabilities, revenues, provision for credit losses and expenses not attributed to Consumer Banking or Commercial Banking. Other also includes our non-core assets. Non-core assets are primarily loans inconsistent with our strategic goals, generally as a result of geographic location, industry, product type or risk level. The non-core portfolio totaled $3.8 billion as of December 31, 2013, down 33% from December 31, 2012. The largest component of our non-core portfolio is our home equity products currently or formerly services by other firms portfolio.

Our capital levels are evaluated and managed centrally; however, capital is allocated to the operating segments to support evaluation of business performance. Operating segments are allocated capital on a risk-adjusted basis considering economic and regulatory capital requirements. We approximate that regulatory capital is equivalent to a sustainable target level for common equity Tier 1 and then allocate that approximation to the segments based on economic capital. Interest income and expense is determined based on the assets and liabilities managed by the business segment. Because funding and asset liability management is a central function, funds transfer-pricing methodologies are utilized to allocate a cost of funds used, or credit for the funds provided, to all business segment assets, liabilities and capital, respectively, using a matched funding concept. The residual effect on net interest income of asset/liability management, including the residual net interest income related to the funds transfer pricing process, is included in Other.

Provision for credit losses is allocated to each business segment based on actual net charge-offs that have been recognized by the business segment. The difference between the consolidated provision for credit losses and the business segments’ net charge-offs is reflected in Other.

Noninterest income and expense directly managed by each business segment, including fees, service charges, salaries and benefits, and other direct revenues and costs are accounted for within each segment’s financial results in a manner similar to the consolidated financial statements. Occupancy costs are allocated based on utilization of facilities by the business segment. Generally, operating losses are charged to the business segment when the loss event is realized in a manner similar to a loan charge-off. Noninterest expenses incurred by centrally managed operations or business segments that directly support another business segment’s operations are charged to the applicable business segment based on its utilization of those services.

Income taxes are assessed to each business segment at a standard tax rate with the residual tax expense or benefit to arrive at the consolidated effective tax rate included in Other.

Developing and applying methodologies used to allocate items among the business segments is a dynamic process. Accordingly, financial results may be revised periodically as management systems are enhanced, methods of evaluating performance or product lines change, or our organizational structure changes.

 

85


Consumer Banking

 

     As of and for the
Year Ended
December 31,
             
     2013     2012     Change     Percent  
     (dollars in millions)     (%)  

Net interest income

   $ 2,176      $ 2,197      $ (21)        (1)

Noninterest income

     1,025        1,187        (162)        (14)   
  

 

 

   

 

 

   

 

 

   

Total revenue

     3,201        3,384        (183)        (5)   

Noninterest expense

     2,522        2,691        (169)        (6)   
  

 

 

   

 

 

   

 

 

   

Profit before provision for credit losses

     679        693        (14)        (2)   

Provision for credit losses

     308        408        (100)        (24)   
  

 

 

   

 

 

   

 

 

   

Income before income tax expense

     371        285        86        30   

Income tax expense

     129        100        29        29   
  

 

 

   

 

 

   

 

 

   

Net income

   $ 242      $ 185      $ 57        31   
  

 

 

   

 

 

   

 

 

   

Loans and leases and loans held for sale (period-end)

   $ 45,019      $ 46,289      $ (1,270)        (3)   

Average Balances:

        

Total assets

   $ 46,465      $ 47,824      $ (1,359)        (3)   

Loans and leases and loans held for sale(3)

     45,106        46,455        (1,349)        (3)   

Deposits and deposits held for sale

     72,158        70,812        1,346        2   

Interest earning assets

     45,135        46,479        (1,344)        (3)   

Key Metrics:

        

Net interest margin

     4.82     4.73     9 bps        

Efficiency ratio(1)

     78.76     79.45     (69) bps        

Average loans to average deposits ratio

     62.51     65.60     (309) bps        

Return on average total tangible assets(1)

     0.52     0.39     13 bps        

Return on average tangible common equity(1)(2)

     5.48     4.89     59 bps        

 

(1)  These are non-GAAP financial measures. For more information on the computation of these non-GAAP financial measures, see “—Principal Components of Operations and Key Performance Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

(2)  Operating segments are allocated capital on a risk-adjusted basis considering economic and regulatory capital requirements. We approximate that regulatory capital is equivalent to a sustainable target level for common equity Tier 1 and then allocate that approximation to the segments based on economic capital.

 

(3)  Loans held for sale include mortgage loans held for sale and loans relating to the sale of our Chicago branch network.

Consumer Banking net income of $242 million in 2013 increased $57 million, or 31%, from 2012 as a 5% decrease in revenue was more than offset by a 6% decrease in noninterest expense and a $100 million decrease in provision for credit losses. 2012 unusual items included a $75 million ($48 million after tax) benefit in revenue relating to a gain on the sale of Visa class B shares and a $138 million ($87 million after tax) settlement charge in noninterest expense associated with overdraft litigation. Excluding these items, net income increased $18 million as the benefit of lower provision for credit losses and continued expense discipline more than offset the lower revenue reflecting continued pressure from the relatively persistent low rate environment as well as the impact of regulatory changes on service charges and card fees.

Net interest income of $2.2 billion in 2013 declined $21 million, or 1%, largely driven by a 3% decrease in earning assets and a reduction in deposit spreads. The average loan portfolio declined $1.3 billion to $45.1 billion, driven by a $1.8 billion decrease in home equity balances given industry-wide higher levels of mortgage refinance activity. In 2013, we originated $5.7 billion in mortgages compared

 

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with $7.9 billion in 2012. We sold 67% of 2013 originations compared to 70% in 2012. Average deposits grew 2% to $72.2 billion reflecting a $3.0 billion increase in money market deposits, partially offset by a $2.4 billion decrease in certificates of deposit.

Noninterest income of $1.0 billion decreased $162 million, or 14%, from 2012, which included the benefit of the $75 million gain on the sale of Visa class B shares. Excluding this gain, noninterest income decreased $87 million driven by a $53 million decrease in service charges and a $36 million decrease in mortgage banking fees. The decrease in mortgage banking fees reflected a $2.2 billion decrease in origination volumes as well as lower gains on the sale of mortgages as secondary market spreads narrowed. Gains on sale of mortgages decreased $77 million and volume related fees declined $28 million, partially offset by the recovery of mortgage servicing rights valuations and lower amortization expense.

Noninterest expense of $2.5 billion decreased $169 million, or 6%, from 2012, which included the $138 million overdraft settlement. Excluding this settlement charge, noninterest expense decreased $31 million driven by lower salaries and benefits and branch related costs partially offset by higher commissions expense.

Provision for credit losses of $308 million decreased $100 million, or 24%, from 2012, largely reflecting the benefit of decreased charge-offs in the residential real estate secured portfolio as well as general improvement in the credit environment.

Commercial Banking

 

     As of and for the
Year Ended
December 31,
             
     2013     2012     Change     Percent  
     (dollars in millions)     (%)  

Net interest income

   $ 1,031      $ 1,036      $ (5       

Noninterest income

     389        349        40        11
  

 

 

   

 

 

   

 

 

   

Total revenue

     1,420        1,385        35        3   

Noninterest expense

     635        625        10        2   
  

 

 

   

 

 

   

 

 

   

Profit before provision for credit losses

     785        760        25        3   

Provision for credit losses

     (7     63        (70     (111
  

 

 

   

 

 

   

 

 

   

Income before income tax expense

     792        697        95        14   

Income tax expense

     278        244        34        14   
  

 

 

   

 

 

   

 

 

   

Net income

   $ 514      $ 453      $ 61        13   
  

 

 

   

 

 

   

 

 

   

Loans and leases and loans held for sale (period-end)

   $ 36,155      $ 34,384      $ 1,771        5   

Average Balances:

        

Total assets

   $ 35,229      $ 33,474      $ 1,755        5   

Loans and leases and loans held for sale(3)

     34,647        32,499        2,148        7   

Deposits and deposits held for sale

     17,516        17,650        (134     (1

Interest earning assets

     34,771        32,600        2,171        7   

Key Metrics:

        

Net interest margin

     2.97     3.18     (21 ) bps        

Efficiency ratio(1)

     44.66     45.22     (56 ) bps        

Average loans to average deposits ratio

     197.80     184.13     1,367   bps        

Return on average total tangible assets(1)

     1.46     1.35     11   bps        

Return on average tangible common equity(1)(2)

     13.20     12.45     75   bps        

 

(1)  These are non-GAAP financial measures. For more information on the computation of these non-GAAP financial measures, see “—Principal Components of Operations and Key Financial Metrics Used By Management—Key Performance Metrics and Non-GAAP Financial Measures.”

 

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(2)  Operating segments are allocated capital on a risk-adjusted basis considering economic and regulatory capital requirements. We approximate that regulatory capital is equivalent to a sustainable target level for common equity Tier 1 and then allocate that approximation to the segments based on economic capital.

 

(3)  Loans held for sale include loans relating to the sale of our Chicago branch network.

Commercial Banking net income of $514 million in 2013 increased $61 million, or 13%, from $453 million in 2012 driven by growth in noninterest income and continued improvement in credit quality. Total revenue rose 3% reflecting an 11% increase in noninterest income and relatively flat net interest income.

Net interest income of $1.0 billion in 2013 remained relatively flat with the prior year as the benefit of loan growth of 7%, largely in middle market, mid-corporate, and franchise lending, was offset by a 21 basis point decline in net interest margin given the relatively persistent low-rate environment.

Noninterest income of $389 million in 2013 increased $40 million, or 11%, from 2012, largely due to higher interest rate products and leasing income, which was partially offset by lower foreign exchange and trade finance fees.

Noninterest expense of $635 million in 2013 increased $10 million, driven by higher salary and benefits cost as well as continued investment in technology and risk management.

Average loans and leases increased $2.1 billion, or 7%, in 2013 due to strong new loan origination activity particularly in the second half of 2013 in commercial finance. Average deposit balances were relatively flat at $17.5 billion despite a $256 million increase in noninterest bearing demand deposits.

Provision for credit losses in 2013 reflected a net recovery of $7 million on prior charge-offs, compared with an expense of $63 million in 2012, as overall credit quality continued to improve.

Other

 

     As of and for the
Year Ended December 31,
       
     2013     2012     Change     Percent  
     (dollars in millions)     (%)  

Net interest (expense)

   $ (149   $ (6   $ (143     NM   

Noninterest income

     218        131        87        66
  

 

 

   

 

 

   

 

 

   

Total revenue

     69        125        (56     (45

Noninterest expense

     4,522        141        4,381        NM   
  

 

 

   

 

 

   

 

 

   

(Loss) before provision for credit losses

     (4,453     (16     (4,437     NM   

Provision for credit losses

     178        (58     236        406   
  

 

 

   

 

 

   

 

 

   

(Loss) income before income tax (benefit) expense

     (4,631     42        (4,673     NM   

Income tax (benefit) expense

     (449     37        (486     NM   
  

 

 

   

 

 

   

 

 

   

Net (loss) income

   $ (4,182   $ 5      $ (4,187     NM   
  

 

 

   

 

 

   

 

 

   

Loans and leases and loans held for sale (period-end)

   $ 5,939      $ 7,221      $ (1,282     (18

Average Balances:

        

Total assets

   $ 39,172      $ 46,368      $ (7,196     (16

Loans and leases and loans held for sale

     6,044        8,558        (2,514     (29

Deposits and deposits held for sale

     3,662        4,896        (1,234     (25

Interest earning assets

     27,243        32,065        (4,822     (15

 

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A net loss of $4.2 billion was recorded for the year ended December 31, 2013, which included a pre-tax goodwill impairment charge of $4.4 billion. Excluding the goodwill impairment, the net loss was $102 million compared with net income of $5 million in 2012. 2013 results reflected the benefit of higher noninterest income and lower noninterest expense, which was more than offset by higher provision for credit losses and a reduction in net interest income. Total revenue of $69 million in 2013 decreased by $56 million, or 45%, from $125 million in 2012.

Net interest income in 2013 decreased $143 million to a loss of $149 million compared to a loss of $6 million in 2012. The decrease was driven by lower average investment portfolio balances of $2.3 billion, a $2.2 billion decrease in average non-core loan balances and a decrease in residual net interest income related to funds transfer pricing, which was partially offset by the benefit of interest rate swaps used for hedging assets and liabilities.

Noninterest income of $218 million in 2013 increased $87 million, or 66%, from $131 million in 2012, which included a $23 million loss on sale of non-core loans. Noninterest income in 2013 also included higher net gains on sale of securities available for sale of $65 million.

The provision for credit losses within Other mainly represents the residual change in the consolidated allowance for credit losses after attributing the respective net charge-offs to the Consumer and Commercial segments. It also includes net charge-offs related to the non-core portfolio. The provision totaled $178 million in 2013, and was an increase of $236 million from a negative provision of $58 million in 2012. Non-core net charge-offs were $195 million and $393 million in 2013 and 2012, respectively, resulting from improved credit quality and continued run-off in the portfolio. 2013 provision for credit losses included a release of $22 million from the allowance for credit losses (the amount by which net charge-offs exceeded the provision), compared with a release of $462 million in 2012.

Noninterest expense of $4.5 billion increased $4.4 billion from $141 million in 2012 and included a $4.4 billion goodwill impairment charge. Noninterest expense, excluding goodwill impairment, of $87 million in 2013 decreased $54 million, or 38%, from $141 million in 2012. 2013 results included $26 million of restructuring charges, and 2012 results included a $77 million settlement of defined benefit pension plan obligations to vested former employees, partially offset by a net $5 million reversal of prior restructuring charges.

Total assets include $2.1 billion and $4.8 billion of goodwill related to the Consumer Banking and Commercial Banking reporting units, respectively. For further information regarding the reconciliation of segment results to GAAP results, see Note 24 “Business Segments” to our audited consolidated financial statements included elsewhere in this prospectus.

Results of Operations—Year Ended December 31, 2012 Compared with Year Ended December 31, 2011

Net Income

2012 net income of $643 million increased $137 million, or 27%, from $506 million in 2011, reflecting a $469 million decrease in provision for credit losses and the benefit of a $75 million ($48 million after tax) gain on the sale of VISA, Inc. Class B shares and a net $5 million ($3 million after tax) reversal of prior restructuring processes, partially offset by a $138 million ($87 million after tax) litigation settlement related to overdraft protection, a