2023-04-15 04:47:52 ET
Summary
- Citi delivered a stellar Q1 earnings report.
- Deposits are sticky.
- I expect Citi Banamex Mexico disposal announcement in the near term.
- Share buybacks are on the cards from July 2023.
- Citi is compelling value at less than 60 cents on the dollar.
In my prior article on Citigroup ( C ), I reflected back on Citi's Investor Day in Q1 2022 where it shared the bubble chart below:
The strategy outlined by Jane Fraser was very logical, it was all about growing the proportion of high-returning capital-light businesses of Services and Wealth and therefore attracting higher multiples and becoming a much more resilient and less volatile business model. It reminds me somewhat of the Morgan Stanley ( MS ) journey over the recent decade or so.
The Q1-2023 earnings report approximately 12 months later and the progress made is quite significant, especially when it comes to the Services division. It now comprises a much bigger share of the Citi Institutional and Corporate Group ("ICG") business.
On its investor day, Citi was targeting revenue growth of high single-digit for the Services division (comprising of Treasury and Trade Solutions ("TTS") and Security Services ("SS")). In reality, it delivered an astounding revenue growth of 29%. Clearly, a big part of it was driven by higher rates but fee revenues for TTS were also up ~13% year-on-year, suggesting the level of activity and volumes are also increasing. The good news is that both TTS and SS are rather stable annuity-like businesses and much less volatile than the Markets division and delivering 3x as measured by return on capital allocated.
It also appears that the combination of capital-light business Services and to a lesser extent Banking now form the bigger part of ICG by revenue. This, in time, should reflect in a higher valuation multiples.
How About The Global Wealth Business?
Citi's Global Wealth Management ("GWM") business is still not firing on all cylinders in spite of the significant investments made. The management team is attributing it to the difficult market conditions presenting currently.
As can be seen in the chart, revenue for GWM is down 9% year-on-year driven down by lower investment product revenue and the private bank deposits' repricing.
Underneath the bonnet, though, there seems to be much progress being made:
- Citi hired Andy Seig as the new Head of Wealth Management from Merrill Lynch Bank of America ( BAC ). Andy is a highly respected executive with vast experience in driving growth in the wealth management space
- Citi continues to leverage its retail network and generated over 13,000 Wealth referrals in the 1st quarter
- Other referrals take place through commercial banking relationships with owners of those enterprises
- Revenues in Asia were up ~20% on a sequential basis
- Client advisors are up 3% year-on-year
- Client acquisitions across the Wealth business are accelerating with Private Bank acquisitions up 62% and Wealth at Work 81%
It seems that Citi is well-positioned to capture material revenue upside once the macro environment recovers somewhat but investors should monitor this aspect closely. It is a key part of the investment thesis for Citi.
Mexico Sale
The disposal of Citi Banamex Mexico is absolutely key to the investment thesis. The sale should release a material amount of capital (up to ~$8 billion) as well as reduce the overall target capital requirements of Citi franchise as a whole.
In the Q1 earnings call, the management team maintained that they are pursuing dual paths of a direct sale or an IPO. Reading the tea leaves, however, it appears more likely that a sale is on the cards. There were several hints in the earnings call provided by CEO Jane Fraser including the following:
So, we are in a very active dialogue right now in Mexico . So, neither, Mark or I are going to comment in a lot of detail there. As you say, we are continuing to pursue a dual path, both the sale and an IPO. So, we will have an exit strategy either way. And we will take the path that is in the best interest of our shareholders.
From a negotiation perspective, Citi will clearly want to keep the IPO alternative on the table as a bargaining chip. However, a straight sale of Mexico will be much quicker and simpler to execute. I highly suspect an announcement of a sale will be forthcoming in the next month or two.
Deposits Are Sticky But Costly
Citi's deposits have grown by 2% year-on-year even when you take into account the 9% year-on-year reduction in legacy deposits:
Most of Citi's deposits are in the TTS business within ICG and are awfully sticky operational deposits. Though they are price-sensitive as corporate treasurers are typically quite interest-rate sensitive and thus cost of interest bearing deposits has gone up materially over the last 12 months.
As I predicted in my prior article , Citi benefited from deposits inflows to the tune of ~$30 billion as a result of recent banking crisis as confirmed by the CFO:
So, one, we did see inflows in the quarter associated with some of the sector turmoil. If you – we have looked at kind of deposit levels from, call it, March 7th, March 8th, through close to the end of March. And we certainly did see an uptick, call it, probably a little bit under $30 billion or so of inflows in that period of time with a good portion of that in our CCB, our commercial middle market client base.
Citi's CFO, Mark Mason, further commented on the stickiness of the deposits:
Most of these deposits are particularly sticky because they sit in operating accounts that are fully integrated into how our multinational clients run their businesses around the world from their payrolls, their supply chains, their cash and liquidity management. 80% of these deposits are with clients who use all three of our integrated services: payments and collections, liquidity management and working capital solutions. The data that we aggregate from these deposits and their related flows is fundamental to how our clients manage their efficiency, risk and compliance. And this greatly increases our deposit stickiness. It’s also why nearly 80% of these deposits are from client relationships that are 15 years old or more.
The CEO further commented that the deposits in TTS are very sticky and "it takes the root canal to extract us (i.e. Citi) from the operations of our clients".
Share Buybacks
Citi has ended the quarter with a CET1 ratio of 13.4% which is 140 basis points above its minimum capital requirements of 12%. This is an unusually large buffer but still Citi has not yet announced the resumption of share buybacks.
The key reasons for the continued suspension is capital headwinds from the sale of Mexico and uncertainties with the upcoming Fed CCAR stress tests that are due to be released in June 2023.
I fully expect Citi to resume share buybacks from July 2023, anything else would a very unpleasant surprise.
Final Thoughts
Citi is beginning to deliver solid proof points that the strategy is working. This is especially visible in the Services division that is printing ~30% year-on-year growth and is delivering ROE in the 30%s. The expectation is that both Banking and Wealth will start recording revenue gains as and when the macro environment improves somewhat.
However, the two key catalysts upcoming are the sale of Mexico and the Fed's CCAR results. Both these items should be resolved by the end of June 2023.
Buying back shares is an absolutely key part of the thesis, especially where the shares trade at less than 60 cents on the dollar. Also the expected reduction in the CET1 target to 11.5% to 12% as communicated in the Investor Day 2022, is absolutely crucial.
Citi currently operates at a 13.4% CET1 ratio. If it reduces its CET1 ratio to below 12%, the RoTCE should already comfortably exceed 10% in the current quarter. The new smaller and safer Citi should be able to operate with lower target capital ratios, all else being equal.
For further details see:
Citigroup Earnings: Mexico, Share Buybacks, And Deposits