- Details are leaking relating to Citigroup's refreshed strategy under the new CEO.
- Pivoting to wealth management in Asia has already been communicated.
- Shedding off some global consumer business is on the cards.
- Will new CEO Jane Fraiser able to fix this perennially underperforming bank?
- In my view, the litmus test is the sale or retention of the Mexico consumer bank.
As many of my readers would know, I have been arguing for several years now that Citigroup's (NYSE:C) business model is seriously flawed and an urgent strategic overhaul is required. For me, Citi, in recent years, has been a trading position as opposed to long-term investment. Of course, I would not refuse a trade when Mr. Market gifts it at a fraction of the tangible book, but I will quickly sell when it reaches above tangible book. As further context, this article summarises my playbook for trading Citi.
The problem child is quite clearly Citi's sprawling and inefficient Global Consumer Bank ("GCB") division. If anything, the key reason for investing in Citi is the wide moat of Citi's investment and institutional bank otherwise known as the Institutional Client Group ("ICG").
The good news for the long-suffering shareholders of Citi is that changes appear to be on the horizon. These have been summarised in this Wall Street Journal article noting of course that these are "informed" leaks and not necessarily the final say.
The new CEO, Jane Fraser, is now in the box seat and has promised to take a "dispassionate" review of the Bank's strategy anchored by what she wants Citi to look like as opposed to being solely driven by near-term financial metrics. Based on the WSJ article (as well as this Bloomberg article), Citi is looking to dispose of a number of consumer bank franchises in Asia but is inclined to retain the large Mexico operations of Citibanamex.
That is certainly progress - but will this be enough to move the dial on the investment case?
The problem with Citi's current strategy
A global consumer bank is effectively a misnomer.
Consumer banks by their nature are domestic beasts and the foremost important factor for success is having sufficient scale. There are close to zero synergies in a global consumer bank aside from perhaps a shared services function and a common IT platform. This is especially true where you are a U.S. globally systemically important bank ("GSIB") that is subject to much higher capital requirements, liquidity constraints, and U.S. gold standards of regulatory laws, practices, and regulations.
Citi's does not disclose a breakdown of its consumer franchises' financials but the below slide on consumer credit provided is a good proxy for the size of operations:
Most of these operations are sub-scale in their respective markets and Citi is a disadvantaged owner of these assets compared with local or regional banking franchises. This is especially true in markets such as Korea and Australia that are highly competitive and are dominated by local giants.
In the context of a wealth management pivot, I can see why retaining Hong Kong and Singapore makes a lot of sense. These locations typically serve affluent and ultra-high-net-worth individuals and families in Asia (such as China, Malaysia, and Indonesia). So I fully expect Citi to retain the full banking franchises in these locations and serve the Asian region.
A recent Barron's article highlights that regional peers in Asia and Latin America's stand-alone valuation are currently at ~1.3-1.4x tangible book value. Given the substantial synergies that will benefit a buyer, the sale price, in my view, should translate to closer to 2x tangible book or above. Given Citi trades at ~0.9x tangible book. It is simple maths, if you can sell your assets for 2x tangible book and buyback shares less than the book value, that is hugely accretive.
Mexico is the key question
All the articles referenced above suggest that the Mexico franchise is not likely to be sold. The reasons provided are that Citibanamex has a "wonderful scale" and otherwise any disposal "would be costly because the unit is tied to a chunk of goodwill on the balance sheet".
I find this "explanation" somewhat disingenuous. Goodwill is a non-cash item that doesn't impact tangible book or capital ratios. In simple terms, it does not really matter from an investment thesis perspective - it is just an accounting entry.
This excuse reminds me of Mr. Corbat's assertion several years back when asked about the cost/benefit of selling Mexico. The response back then was that even if it sold it and generated capital, the Fed may not allow excess capital to return to shareholders.
Then as now, I would categorize and attribute these types of explanations to the "disingenuous" bucket. Citi's management certainly knows better.
Ms. Fraiser is right though, about the Citibanamex franchise, it has sufficient scale in Mexico which is an attractive long-term market. However, a dispassionate view also suggests the Citi, a U.S. GSIB bank, is a disadvantaged owner of this franchise. Citi management knows that it doesn't fare well in the CCAR stress tests (Citi's binding constraint) due to much higher loss severity outcomes and potential conduct-related risks accentuated by differing standards of corporate governance matters in emerging markets.
In my view, Citi should monetize this asset and reinvest the proceeds in the U.S. franchise and buybacks of shares.
The equities trading business
Citi's corporate and investment bank is a fantastic and leading business with a wide moat that is second only to JPM's operations. A key reason why it trails JPM is Citi's subscale equities trading franchise. Citi is exceptionally strong in FICC (a consistent top 2 player globally) but far behind its peers (at 5 or 6 spot on the league table) in equities trading. A key reason for the underperformance is the lack of investment in the equities infrastructure and IT systems at a monumental time in the industry where the equities business was transformed due to the electronification of trading. Citi's management was too distracted by its other problems to allocate investment dollars to this business.
Mr. Corbat tried to frantically catch up in the last 2 to 3 years but was only partially successful. Citi can either follow the Deutsche Bank (DB) path and exit equities trading altogether (Citi is currently probably only marginally profitable or loss-making) or alternatively invest substantial dollars in systems, people and infrastructure to climb up the rankings.
The current indication (as per the WSJ article) is that equities trading is here to stay. Management is highlighting the equities trading is very valuable to client relationships even if investors are not able to see it. That may be true and in fact, that was the exact rationale articulated by DB executives when first resisted the idea of exiting equities trading. DB has gone ahead and exited equities trading and found out that the connectivity to other clients' business is very small.
Nonetheless, I agree with Citi's management position on equities trading. Given the breadth and depth of Citi's client relationships, there is no reason why Citi shouldn't be a consistent top 5 equities trading franchise. I see it as primarily attributable to an investment decision and execution matter as opposed to an unsolvable strategic issue.
The first step in solving Citi's strategic issues is to recognize there is a problem. There has been good progress on acknowledging that and steps to address it are in motion to fix that problem. Pivoting to capital-light wealth management in Asia is absolutely the right strategy. So is shedding sub-scale global consumer businesses and investing in equities trading.
However, Ms. Jane Fraser needs to decide and clearly articulate to stakeholders what kind of a bank Citi wants to be.
If Citi wants to become more like JPM (and benefit from the valuation associated with it), then Citi needs to seriously scale up in the U.S. beyond a credit-card-led business. This may also mean participating in inorganic acquisitions as well in the U.S. at some point in the future.
Citi of the future could be a top-tier corporate and investment bank, a wealth management powerhouse in Asia, and a full-service, scale U.S. consumer bank.
However, the "price" it will need to pay, to release resources and appease regulatory requirements, is parting ways with Citi's Mexico franchise.
Mexico is the litmus test in my view for Citi's restructure.
This article was written by
Analyst’s Disclosure: I am/we are long C, BAC, JPM, DB. 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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