2023-10-17 10:06:37 ET
Summary
- Citigroup reported solid Q3 results, but the stock remains near its 52-week lows due to concerns about a potential recession and higher capital requirements.
- The bank has already embedded loss reserves for a recession and is divesting noncore businesses to reduce capital requirements.
- Management expects a big improvement in 2024 and is confident in achieving its medium-term return on tangible common equity target of 11-12%.
Citigroup ( C ) delivered a solid Q3, but the stock continues to languish near its 52-week lows. The bear thesis revolves around fears of a potential recession, higher future capital requirements, and really the lingering fears stemming from the "banking crisis." A recession has been predicted for well over a year now and Citigroup already has loss reserves embedded with a recessionary scenario, so even the realization of a recession will be very manageable. Management has been successful in divesting large noncore businesses that will ultimately reduce capital requirements, and I expect them to make business adjustments, which reduces the likely regulatory increases, such as utilizing securitization to get risk off the balance sheet. All the banks are pretty unified in negotiating these requirements down, as they seem quite draconian and duplicative. The "banking crisis" revolved around a few fringe banks that grew deposits at accelerated rates, while creating severe duration mismatches that were hugely irresponsible given the noncore deposit nature that characterized these banks. Citigroup is on the other end of things with a highly diversified and strongly operational deposit base and a balance sheet that isn't plagued with a huge percentage of low-rate long duration investments. 2023 should be a trough year for the bank as operating cost growth will have peaked, and I'd expect a big rally in 2024 as the company shows major improvement.
Citigroup has long traded at a discount to its peers, which have mostly traded at premiums to tangible book value. Every year or so, there has been a crisis such as Brexit, or the oil price plunge, that has caused the stock to drop to very depressed levels of around .6x tangible book value. Historically, those have been attractive buying opportunities, as the stock has tended to rally towards book value, offering attractive investment/trading returns. Over the last year-plus however, Citigroup really has not had that type of convergence with tangible book value. I think a big part of that is that management didn't show the required urgency that investors feel seeing their investments decline. They have increased costs dramatically to deal with consent orders and modernize the company, and then they were unable to complete the sale of the Mexican consumer business after quite a long process. Investment Banking results across the industry have been muted outside of trading, due to higher rates reducing bond and equity issuances, along with advisory revenues. These issues are temporary, however. Citigroup will emerge through the other side of the tunnel and there is simply no reason the stock can't converge with its growing tangible book value per share, as its ROTCE gets back to double digits.
On October 13th, Citigroup reported $3.5B of net income, an EPS of $1.63, and an ROTCE of 7.7%. Revenues were up 10% to $20.1B, ex-divestitures, and all key five businesses posted revenue growth. Embedded in these results are divestiture-related impacts of approximately $214MM after tax, primarily driven by the Taiwan consumer business sale, so excluding these items, EPS was $1.52 and the ROTCE was 7.2%. TTS was up 12% YoY, generating the highest revenue quarter in over a decade, with half the result of business growth and the other half attributed to rates. Security Services posted revenue growth of 16% and through taking market share, the company has now grown its AUC and AUA by over $2 trillion in the last year. Markets revenues were up 10% YoY, bolstered by rates and currencies having the best quarter in 10 years, and commodities, which benefitted from the volatility we saw. Equities were down slightly, but prime balances have grown YTD. Banking revenues were up 17% YOY. Investment Banking revenues were up 34%, off a very low base as some decent-sized deals got to the finish line. U.S. Personal Banking was up 13%, as card revenues were strong in both the branded and retail services portfolios.
Expenses were up 6% to $13.5B on transformation, risk and controls, etc., while the cost of credit was approximately $1.8B, up 35% YoY, driven by continued normalization in credit losses. As of the end of Q3, Citigroup had over $20B in total reserves with a reserve-to-funded ratio of approximately 2.7%. Despite higher credit costs and massively elevated spending to meet regulatory requirements and modernize the infrastructure, Citi has posted an ROTCE of 8.3% YTD. U.S. Cards are reserved at 7.8%, and Cards represent 45% of loans in PBWM, with 80% of that being to customers with FICO scores of 680 or higher. Both Branded Cards and Retail Services NCL rates are still below pre-Covid levels but are normalizing, and remember, pre-Covid was a good credit environment in its own right.
In the ICG portfolio, approximately 85% of total exposure is investment grade. Internationally, 90% is investment grade or exposure to multinational clients and their subsidiaries. Corporate non-accrual loans increased by $490MM but remain at just 68 bps of total corporate loans, with a reserve to funded loan ratio of roughly 1%. Citigroup has $65B of commercial real estate lending exposure in its $2.4T balance sheet, of which 86% is investment grade. The bank has a total reserve to funded loan ratio of 1.4%. Underpinning the $20B of reserves is a current scenario of an unemployment rate of 5%, including a downside scenario with an average unemployment rate of roughly 7%, which is obviously far higher than current levels. The technology spend in the quarter was $3B, up 8%, driven by investments in product development, platform enhancements, and improving the client experience.
Net interest income declined by $72MM, but excluding markets, NII increased by $332MM, driven by growth in PBWM as loan growth and higher loan spreads pull through. Average loans were up 1%, mostly on Cards, retail banking, and TTS. Average deposits were down 2%, driven by Services, as non-operational deposit outflows came as expected. NIM increased by 1 basis point. Citi has a $1.3T deposit base diversified across regions, industries, customers, and account types. $782B of deposits are of an institutional and operational nature and span across 90 countries. These are complemented by $416B of U.S. Personal Banking and global wealth deposits. Citi ended the quarter with $569B of HQLA and total liquidity resources of $937B. Tangible book value per share is up 8% YoY, standing at $86.90.
Citigroup ended the quarter with a CET1 ratio of 13.5%, which is $14B above the regulatory minimum and still includes a 100-bps internal management buffer. During Q3, Citigroup returned $1.5B to shareholders through dividends and common stock buybacks. As I've reiterated over and over talking about Citigroup, there is nothing management can do to create shareholder value more than stock buybacks. It is encouraging that management also signaled that it would make modest buybacks in Q4, while still building capital to meet potentially more stringent regulatory requirements.
In the quarter, Citigroup closed on the sale of its Taiwan consumer business, which was the second largest of the Asia consumer divestitures. Earlier last week, the company announced it would sell its consumer wealth portfolio in China to HSBC, which includes roughly $2.6B in AUM and $1B of deposits. In Q4, Citi should close the sale of its Indonesia consumer business. The sales process has also begun again in Poland, and Citi should have the Mexico consumer business separated next year, with an IPO to follow in 2025. These are big dispositions that should lower the risk profile and complexity of Citigroup. Most of these will free up capital, some of which can be used to buy back stock at these ridiculous prices.
While 2023 has been a year of massive investment into the business to modernize and improve processes, management has now laid the groundwork for a very large organizational restructuring, which should help bring the cost curve down materially. The changes will eliminate layers and complexity within the business making the five core business leaders accountable directly to the CEO. The actions taken will eliminate over 15% of the regional and functional roles at the top two layers of the company while getting rid of 60 committees. In January, we will get more details about specific numbers, but hopefully, Citigroup will show some pretty dramatic progress on improving operating leverage, from the current elevated cost structure.
Management continues to expect full year revenues of $78 to $79B, excluding 2023 divestiture-related impacts. Net interest income expectations were slightly higher at just above $475B, excluding markets. Expense guidance continues to be approximately $54B, ex-divestitures, and the FDIC special assessment. Net credit losses should continue to normalize. Citigroup is executing its strategy and producing topline revenue growth of 5% YTD. Management is confident that it is on pace to achieve its medium-term ROTCE target of 11-12%.
Citigroup is a very large and systematically important bank. The biggest risks are events such as a world war, or other global catastrophes such as pandemic-inspired lockdowns. The fact that regulatory agencies are once again demanding increased capital for the big banks, despite a clear track record of having more than sufficient capital as exemplified through every crisis since 2008, is very disappointing. Investors are rightfully fed up with the stock, as am I, but the obviousness of the value is too much for me to sell. Price is what you pay, and value is what you get. Tangible book value per share will rapidly increase to above $90 per share, as soon as Citi gets serious on stock buybacks. I've never seen the stock so cheap when it is printing $15-$20B a year in net income on a consistent basis.
At a recent price of $40.95, Citigroup trades at an absurdly low 47% of tangible book value per share. Is the bank losing money? No, it has generated EPS of $6.35 per share over the trailing twelve months, which would put the P/E at less than 6.5x, offering an earnings yield of 15.7%. While costs have been embarrassingly high as the company has dealt with various consent orders and modernization, the inflection point of improvement begins in earnest next year. CECL accounting has front-loaded loan loss reserves and recessionary scenarios are included in current estimates. The ICG benefits from heightened volatility and provides a nice hedge in a weakening environment. Investment banking revenues have been weaker over the last 7 quarters, but there are signs of green shoots and history has shown that these downturns don't last much longer than 7 quarters, as companies must issue debt and equity to meet their capital needs. Citigroup has made major progress in divesting international consumer businesses and is emerging as a simpler company. Management is finally starting to understand that they must buy back stock given this incredible disconnect between price and intrinsic value, and if they lean into that, I'd expect the stock price to recover much more rapidly. I believe Citigroup will ultimately trade above $80 per share, which would still be a discount to tangible book value, as the company gets closer to a double-digit ROTCE, and investors can pocket the 5% plus yield in the interim. Citigroup has been an immensely disappointing investment, but the fundamentals do not warrant the current price.
For further details see:
Citigroup Offering 15.7% Earnings Yield And 47% Of Tangible Book Value