What can an investor say about Citigroup (C)? The company has been through the wringer and cost many investors a substantial amount of money. Over the last ten years, we have witnessed the transformation of this behemoth from global financial services to investment bank wannabe to zombie and back to global financial services. Maybe we should call it a boomerang bank, it has come right back to where it started.
To many investors, Citigroup is synonymous with pariah due to the pain inflicted upon them by outsized risks and lack of governance. These factors translated into this:
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Not a happy chart for many. Pariah? Perhaps. Phoenix? Maybe. One thing is for certain, Citigroup has underperformed their peers [Bank of America (BAC), JP Morgan Chase (JPM) and Wells Fargo (WFC)] and the catalyst for outperformance has not yet surfaced.
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So how does an investor position this bank that has essentially flatlined? Better yet, how does one invest in the bank with an income objective? Two words: preferred stock.
Background
Many might remember In February 2009, Citigroup announced the suspension of dividends on certain non-cumulative preferred (C-P, C-M and C-I) as the securities were converted into equity in an effort to raise tangible common equity and capital requirements. A little over a year and a half later (October 20, 2010), Citigroup reinstated the dividends on the preferred shares. A tumultuous ride, to say the least.
Current Situation
Those days are behind us now, and Citigroup has turned the corner. As of March 31, 2012 Citigroup had the following profile:
- Basel I Tier 1 common ratio of 12.4%,
- Basel III Tier 1 common ratio of 7.2%(2), expect to exceed 8% by year end,
- $906B in deposits,
- $29B of loan loss reserves, 4.5% of total loans,
- Net interest margin of 2.90%,
- Citi Holdings (bad bank) assets down to $209B or 12% of Citicorp, and
- $4.1B net funded exposure to Spain, $1.2B net funded exposure to Greece.
Basically, the bank is in decent shape and is no longer fearing for its life. It has done an admirable job changing direction (admittedly with billions of support from their Uncle Sam). Bottom line: the bank is "investable" or, put differently, investors can position the bank within their portfolios should they find it compelling.
The Opportunity
The problem for income investors, is that Citigroup's common stock yields only 15bps, and it does not seem that they will be allowed to raise it in the near future (although based on their metrics, they could increase it prudently). This is where preferred stock and trust preferred securities (TruPS) enter the picture.
The following is a list of Citigroup's preferred stock and trust preferred securities (not including enhanced TruPS):
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Graphically, the preferred have done the following:
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TruPS vs. Preferred Stock
The difference between the TruPS and preferred stock, is that TruPS are cumulative (junior subordinated debt is in the trust) which is why payments were not stopped in 2009.
As well, the key fact that has been driving the TruPS market is the ability of a bank to redeem their Trups if there is a regulatory capital event. A regulatory capital even is, essentially, any change in the regulatory treatment of instruments that are considered Tier ! capital (such as TruPS).
TruPS are in the sights of the various regulatory bodies and it is believed that they will no longer qualify as Tier 1 capital. As the Citigroup TruPS (with the exception of the fixed to float Series N) are currently callable anyway, this is not a significant factor.
Bottom line: Investors can position Citigroup Preferred stock and/or TruPS to generate income from this turnaround bank. There are a number of ways to position these, but I prefer the Series F (C-M). Buying both the C-Z and C-M helps average out returns should there be a call on either/both position. (I intend to swap out of my Citigroup V (C-V) into the C-Z/C-M pair after this article is published). If you believe the equity is going to picj up steam, you can pair the preferred with longer dated calls and let some of the preferred income pay for the calls. As well, you can hedge by using some of the income from the preferreds to pay for longer dated puts.
Disclosure: I am long C.
Additional disclosure: Long C-Vs. This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.
