Citigroup: Look For Capital Return Catalyst

| About: Citigroup Inc. (C)

Summary

Citigroup passes the 2016 stress test with flying colors.

The bank stock took a huge hit due to Brexit.

The bank is perfectly aligned to announce a big capital return increase as the stock hits recent lows.

Despite strong CCAR results, Citigroup (NYSE:C) ended down over 9% and is trading near recent lows around $40 due to Brexit. In essence, the bank is doing what it can but external events continue hammering the stock whether justified or not.

Source: Citigroup presentation

The Brexit results might impact some growth and earnings expectations as interest rate hikes are now likely off the board for a while. The stock was exceptionally cheap prior to the massive sell off on Friday and the capital return approvals could provide a good boost for the following reasons.

CCAR Results

The Federal Reserve released the stress test results for 33 large banks on Thursday night. The results were better this year after banks have had several years to fine tune the results on the annual test.

The WSJ provided a quick synapse of the results for the big banks that included a combined $195 billion total loss on aggregate losses of $526 billion, an average of $5.9 billion per bank. The total losses were better than the average of $7.6 billion last year.

The article listed the following summary for Citigroup.

Citigroup listed the following internal projections based on the severely adverse scenario under the stress test. Most notably, the bank stressed the business to a higher level than the Fed with a common equity Tier 1 ratio of 8.5%, lower than the 9.2% from the Fed.

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Capital Returns

The end result is that Citigroup has tons of excess capital. The common equity Tier 1 ratio would still sit at 9.2% according to the Fed under a scenario where unemployment doubled to 10%. The minimum requirement is 4.5% leaving tons of excess capital in an extremely negative economic outcome that may never happen, or at least in the 21st century.

For 2015, the Fed approved Citigroup repurchasing $7.8 billion in stock and a $0.05 quarter dividend back last March. In total, the bank was approved to return roughly $8.4 billion to shareholders. The bank repurchased $6.5 billion of stock over the last four quarters.

C Stock Buybacks (Quarterly) Chart

With even higher capital ratios this year, Citigroup should be able to increase the capital returns. The payout ratio sat in the mid-30s last year and the bank has the potential to generate excess capital due to high DTAs.

Analysts Dick Bove of Raferty Capital Markets and Tom Brown of Second Curve Capital both went on CNBC stating expectations of much higher payout ratios. The suggestion is that Citigroup is likely to double the dividend and possibly make a big bump to the stock buybacks.

While the analysts agreed on payout ratios approaching 100% for the industry, the reality doesn't seem to suggest that Citigroup moves much beyond a stock buyback of $10 billion this year. The boost though would allow the bank to repurchase nearly 8.5% of the outstanding shares based on the ending market cap of $118 billion.

Hopefully, the bank will utilize a strategy that takes advantage of the stock trading at tangible book value as well as dramatically increasing the dividend. As mentioned by the analysts, solid utility stocks with 4% dividend yields trade at multiples double that of banks like Citigroup.

The key being that Citigroup could even get to a 10% stock buyback that will automatically increase the EPS by a similar amount even if income growth stalls as the government turns banks into financial utilities. The bank though will hopefully double the dividend.

Takeaway

While the market focuses on Brexit, the large drop in Citigroup plays perfectly into the banks plans for a larger capital returns. The bank can turn strong stress test results into larger capital returns. The stock remains significantly undervalued.

Disclosure: I am/we are long C.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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