Citigroup: The Only Big Bank I Wouldn't Buy

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About: Citigroup Inc. (C), Includes: BAC, JPM, USB, WFC
by: Marcello Pinto
Summary

Citigroup's low return on equity and low return on assets put it at the bottom of its peer group. The bank trades at a significant discount, but so it should.

Citigroup is still provisioning massive amounts for loan losses, benefits, and claims, which reflects a lack of lending discipline and a less than prudent culture.

Capital ratios are higher than before and loan growth is strong, though the bank still looks vulnerable to another economic downturn. International exposure is an additional risk.

Loan losses are at a low in the economic cycle, yet the bank is still taking write-offs. If the economy takes a downturn, things could get a lot worse.

Citigroup (C) is by far the cheapest big bank in the United States. It is significantly cheaper in terms of both price-to-earnings and price-to-book ratios. However, there's a reason: The bank comes with more risk than the others. The company earns below 1% on assets and earns less than a 10% return on equity. This is substantially less than the top tier banks such as Wells Fargo (WFC) and US Bancorp (USB).

There are a couple of key factors that investors need to be aware of. Firstly, Citigroup is by far the most internationally exposed bank: 53% of their deposit base is international. JPMorgan (JPM) only has 18% of their base as international deposits. Bank of America (BAC) is 6%. Citibank's exposure to emerging markets that are not going as well as the United States right now means that they are vulnerable to a lot of risk that other big banks are not.

Secondly, Citibank has a lot of legacy assets on their balance sheet. These are toxic assets which have been causing them large losses over the years. The bank is in much better shape than before, but these toxic assets are still present. Finally, the bank has almost certainly the most risk appetite of all of the major US banks.

A History of getting in trouble

In 2008, Citibank was in far worse shape than its big bank peers. The company would absolutely have gone bankrupt without government funding. The company's market capitalization fell from $300 billion to $6 billion that year and shares have not fully recovered ever since.

It’s because Citigroup remains the most global of the big banks, and those operations keep collecting scandals. Here is a list of scandals that have plagued the list:

These aren’t the worst of it. The worst of it involves an Australian bank, ANZ, which hired Citigroup, JPMorgan and Deutsche Bank AG (USA) (NYSE:DB) to run a $1.9 billion stock underwriting in 2015. Australia has brought criminal charges against the stock last year.

Recently, the company faces losses of as much as $180 million on loans made to an Asian hedge fund whose foreign-exchange wagers went awry, prompting board-level discussions and a business shakeup. Citigroup said also it had increased balances from prime brokerage clients by 40 percent since 2014 and noted its revenue growth in the business doubled that of its Wall Street peers.

Citibank's international operations, while they can be a source of continuous growth for the company, have also bought about massive challenges.

Beware of just looking at capital ratios

While Citibank is unquestionably better capitalized than ever before, the bank has failed a number of stress tests in the past, as recently as 2013. Tier 1 Capital is well in excess of 10%, but this does not tell the full story.

Citigroup’s allowance for loan losses was $12.3 billion at quarter end, or 1.81% of total loans, compared to $12.4 billion, or 1.86% of total loans. This is an order of magnitude higher than its peers at Wells Fargo or USB that have write-offs between 0.30%-0.50%. There are a number of major red flags in the Annual Report. For example, there was an episodic loss in derivatives of approximately $130 million related to a single client event in the prior year.

The bank simply does not have a culture of caution and prudence, which I believe is the worst kind of attitude to have for a financial institution. History has a tendency to repeat itself in banking and I would not be surprised at all if Citibank got into severe trouble in the future.

Moreover, Citibank's lack of focus on its core business which is taking in deposits, means that the company is more likely to have asymmetrical risk characteristics. The focus on equity trading, opening brokerage accounts, credit cards and derivatives means that the company is likely to get into trouble at some point.

Interestingly, if you look at Berkshire Hathaway's portfolio, the company owns massive stakes in all of the Big Four banks, except for one- Citigroup. Despite trading for the lowest multiple of tangible book value of any of the big four banks and historically, the lowest P/E ratio, Warren Buffett has never seen this as a value play.

A Brighter Future for the Bank's Investors

One piece of positive news for the bank's investors has been Citibank's more aggressive capital program. The company is returning $22.0 billion to shareholders and dividends are increasing from $0.32 to $0.45 a share. With these capital programs in 2017, 2018 and 2019, the company will have returned a total of $60 billion, which is very impressive for a company of this size.

Naturally, Citibank will also benefit from higher interest rates and the recent fiscal tax stimulus. The bank also has a decent efficiency ratio which indicates that the company is improving its financial performance.

Source: Quarterly Report

Summary

Citibank is cheap for a reason. The bank is simply much lower quality than most of its peers. I would not recommend acquiring shares at these prices, given that there is almost no margin of safety.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.