2023-05-16 10:49:06 ET
Summary
- Citigroup has long been plagued by issues dating back to the great financial crisis.
- However, the recent regional banking crisis has proved a boon for large banks such as Citi.
- We believe the new vision of management is showing signs of success.
Background
Over the last forty years, one trend has remained un-bucked: the consolidation of commercial banking in the United States. According to the now-discontinued report on commercial banks in the U.S., the total number has dropped from more than 14,000 in 1984 to just over 4,000 in 2020.
This consolidation has had obvious winners and losers - the winnowing of local and regional banks over time, compounded by the 2008 great financial crisis ((GFC)), has created the phenomenon of Too Big To Fail institutions, which, for all intents and purposes, have the implicit backing of western governments.
Among those institutions, Citigroup ( C ), is unique. The bank was hit particularly hard by the GFC, and long-term shareholders whose positions predate the crisis have seen their positions remain depressed by over 80%.
This performance has lagged other TBTF institutions. On a total return basis over a 20-year timeframe, Bank of America ( BAC ) shareholders have had an 18% return, while JPMorgan ( JPM ) investors have had a stellar 670% return. Of course, students of history know this return is not a fluke - Citigroup was largely perceived to be the weakest of the TBTF banks, and itself narrowly escaped perishing in the crisis .
The most recent crisis in regional banks has, in our minds, only solidified the general position of TBTF institutions, and created an interesting situation for laggard Citigroup. Let's dive in.
Balance Sheet Strength
The regional banking crisis that brought down Silicon Valley Bank and others was, like bank runs of days past, a crisis of trust. Investors, spooked by declining values of held-to-maturity securities on the bank balance sheets as interest rates rose, fled to pull their deposits, which created a financial death spiral for some.
In this banking carnage, Citigroup emerged stronger. The bank reported its first quarter 2023 earnings in April, and there was little to nitpick across the board.
Revenues were up 12% year over year and, in a reflection of depositors' flight to large institutions from smaller ones, up 19% sequentially from Q4 2022. Management has done a good job of managing expenses at the bank, with overall operating expenses increasing only 1% year over year.
Importantly, the bank increased its Common Equity Tier 1 (CET1) ratio to 13.4% from 11% in Q1 2022. This is a great sign for Citigroup shareholders, as an improving CET1 ratio means that the bank (still shackled by regulators even after all these years) is now eligible to proceed with stock buybacks. Many investors were likely frustrated that executives declined to repurchase any shares during the first quarter, and stated on the Q1 earnings call that the decision to buy back shares would be evaluated on a "quarter by quarter basis."
While we can understand the impatience of long-suffering Citigroup shareholders, we believe that the rationale to hold off on buybacks makes good sense. The bank is currently in the process of streamlining its operations, divesting its Banamex unit for $7 billion to Grupo Mexico. While the deal has yet to be finalized and management was light on details on the earnings call, it is likely that the sale could affect the CET1 ratio in the near term - and the only thing worse than not repurchasing shares is repurchasing them and then having to stop again, which could rattle investor confidence.
Going forward, however, it is good to know that the bank is finally - finally - in a place where share repurchases are likely to begin by the end of 2023 or the beginning of 2024.
A further reflection of depositors' flight to size is the fact that, while a large number of smaller banks reported an overall decline in deposits, Citigroup posted average deposit gains.
Overall deposit growth to an average of $1.363 trillion in Q1 speaks to the leverage TBTF institutions wield in the minds of depositors during times of crisis.
A Question Of Value
It is perhaps not unsurprising given the issues discussed above (lack of share repurchases, a near-death GFC experience) that Citigroup trades at a significant discount to its book value and tangible book value.
In Q1, Citigroup posted a per-share book value of $96.59, and a tangible book value per share of $84.21 (see table referenced previously). As of this writing, Citigroup shares currently trade hands in the mid $40s.
Compared to its TBTF peers, Citigroup's value is clearly depressed.
On a tangible book value basis, Citigroup trades at 0.5x, while Bank of America sits at 1.2x and JPMorgan at 1.8x. There are generally accepted reasons for this disparity - Citigroup, for example, has had historically lower returns on equity than its peers. In April 2022 the bank was able to establish a win by having a decade-old regulatory sanction lifted , but it was only one of the regulatory issues facing the bank. Still outstanding, for example, is a 2020 regulatory consent order about the bank's internal controls. The resolution timeline for this consent order is, unfortunately, still murky.
While it may be tempting for investors to see the book-value discount at Citigroup, we believe that the gap exists for a reason and is not likely to close until the bank's regulatory woes abate and the bank successfully divests its Mexican banking operations.
The bright side to this, however, is that while the timeline isn't clear, it does seem that management is eager to put these issues behind them. The bank's leadership is relatively new (CEO Jane Fraser has been with the bank a little over a year) and, in our view, undoubtedly sees the same trapped value within the organization that shareholders do. It is our belief that, with time, the new leadership regime should be able to deliver on their strategic vision.
The Bottom Line
While some long-standing Citigroup shareholders may see it as a fool's errand to predict that the bank is finally on the verge of turning things around, we believe that the bank has made good progress on setting itself up for a return to its former glory. Risks to our thesis include new regulatory sanctions or consent orders, which are difficult to predict but cast a long shadow at financial institutions like Citigroup. We will continue to watch the bank closely and monitor management's progress, particularly the execution of share buybacks and the sale of the Banamex unit. However, after the bank posted strong operating results in Q1, we are cautiously bullish on the stock today.
For further details see:
Citigroup: Finally Turning The Corner?