Citigroup's Strategic Direction Finally Makes Sense
Summary
- Citi's new CEO is not wasting any time in restructuring the firm.
- The strategic direction appears sound and confidence is building around the execution.
- The disposal of the Asian and EMEA consumer divisions has been announced and there is more to come.
- Is Citigroup finally investible?
As articulated in my prior Seeking Alpha articles (see one such example here), Citigroup (NYSE:C) has been a trading position for me and not a long-term investment. My trading strategy is simply to buy (and leverage up) when it trades at a deep discount to tangible book value ("TBV") and sell when it nears TBV.
It has been a very profitable strategy and fortunately Mr. Market gives away these gifts periodically (e.g. 2016, 2018, and 2020). It seems that every time the global economy sneezes, Citi ends up catching the flu.
Citigroup is not JPMorgan (JPM) to state the obvious. The main differences include:
1) Citigroup’s sprawling global consumer bank and largely monoline presence in the U.S. (mainly credit cards) versus JPM's large-scale and multi-product U.S. consumer footprint.
2) Citigroup has some obvious gaps in the investment bank (namely sub-scale equities trading business) compared to JPM's top 2 positions in practically all important verticals. This, however, is rather fixable and partially offset by Citi’s dominating Trade and Transaction Services (“TTS”) division which is widely seen as Citi’s crown jewel.
3) Citi has a chequered history of long-standing operational failures. As highlighted by the recent Fed’s Consent Order, Citi has deep-seated issues relating to its data systems and compliance processes. Citi is notoriously complex to manage and its current technology stack is evidently not robust enough given its systemic importance and global footprint. Citi is currently embarking on a multi-year and multi-billion transformation to address these deficiencies. Whilst JPM's operational resilience and efficiency are clearly best-in-class and is never starved of investment.
In summary, the above factors largely explain why Citi trades at below TBV and JPM is trading at above 2x TBV.
Citi's new CEO, Jane Fraser, has repeatedly articulated her desire to close the valuation gap with its peers. To achieve this, it is clear that the strategy must be radically transformed and execution needs to become a lot better.
Evidently, Ms. Fraser does not seem to waste any time since taking on the helm at Citi, but more on this later.
The strategic imperative
I have been advocating a strategic overhaul for several years now and been publishing my work right here on Seeking Alpha.
My thesis is simple. I always believed that the Global Consumer Bank strategy is fundamentally flawed. Citi has sub-scale operations in a large number of markets and is clearly a disadvantaged owner of these franchises given its global systemically important bank ("GSIB") status and the requirement to adhere to gold plated U.S. standards of capital adequacy, laws, and regulations. Consumer banking, after all, is all about scale.
As such, I articulated a strong view that Citi needs to sell its Asian and Mexican consumer operations (ex wealth management locations), grow organically and inorganically in the home market of North America, invest in certain parts of the investment bank (i.e. Equities trading), and return capital to shareholders.
Jane is not wasting any time
During the first quarter, Citi announced the disposal of 13 Asian and EMEA consumer operations and the intention to refocus on 4 wealth locations (Singapore, Hong Kong, United Arab Emirates, and London).
Incidentally, this is also the first time that Citi breaks down the financials for these jurisdictions and it completely validated my thesis. These operations are grossly inefficient and deliver, at best, low single-digit RoTCE. As a point of reference, the regional Asian banks typically operate with efficiency ratios in the low 40s compared to Citi in the 60s and 70s. Citi is clearly a disadvantaged owner and should be able to dispose of these at or around book value. The rationale for selling is compelling as Citi should be able to extract approximately book value for grossly underperforming assets.
Sell Mexico?
My view is that eventually Mexico should and will be sold. It is a completely different proposition to the Asian consumer franchises given that is very much a scale operation. However, it is a mass-market proposition in an emerging market jurisdiction that doesn't comfortably sit in a U.S.-domiciled GSIB bank. Banamex Mexico can be sold at the appropriate time, for multiple of TBV.
So far, Ms. Fraser has been non-committal on Mexico:
And then in terms of Mexico, look, Mexico is a scaled franchise. When I compare Mexico to our Asian consumer franchises, they really benefit from their scale. The returns are good. And there's a lot of upside potential there. The investments in digitization have really paid off. So, while the country is going through a very challenging time at the moment, there's a lot to like in the franchise over the longer term. And I know, we'll give you a better sense of the strategy there as we carry on the strategy refresh work, but a lot to like.
Clearly, a decision has not been formally made and I do not expect Jane to say anything different at this stage. Ultimately, this comes back to what kind of a bank Citi wants to be. My view is unequivocal, Citi is a disadvantaged owner of this asset. The math is also straightforward, sell Mexico for a multiple of book value and buy back shares at a discount to book. Citi is also likely to benefit from lower capital requirements as it reduces complexity, cross-border connectivity, and severe forecasted CCAR losses.
All in all, the rationale for the disposal of Mexico remains compelling.
What about the U.S.?
The key valuation difference between Citi and the likes of Bank of America (BAC) and JPM is the latter banks' large U.S. consumer presence. Simply put, Citi does not generate the same risk-adjusted returns as its U.S. peers. The only way to solve this is by growing the U.S. presence in a capital-light and accretive way.
Ms. Fraser seems to concur on that point as well:
Look, the US is our home market, we have to get it right. It's a great franchise in terms of brand, the client base that we have around the country. We certainly see upside potential in wealth, as we've been talking about. We have a large cards business where the pandemic has accelerated the cross-sell of our broader banking proposition. And I think, the broader theme of digitization, we have very high-quality clients in and out of footprints. And they've been very digitally engaged and that's only increased. Some 50% of the new accounts this quarter in the retail bank were acquired digitally and about 75% of our clients, for example, are digitally engaged already. And we have tremendous partnerships. So I think we've got terrific assets and building blocks. But as you said, the work is going on right now on the strategy refresh. And we're looking forward to coming back to you in reasonably short order when we've done the work and have the plan on what actions we will take. We're looking longer run. And for now, partnerships are going to be very important, but we'd love to do inorganic moves if they make sense for our shareholders and for us further down the line. But at the moment, we'll focus on partnerships.
Realistically, to expand inorganically in the U.S., Citi will need to obtain regulatory buy-in. This will certainly depend on a positive resolution of the Fed's Consent Orders, but disposing of Mexico operations would also facilitate such a move on several levels including investment capacity, lower risk and complexity, and reduced capital surcharges.
Is Citi Finally Investible?
So far so good. The strategic direction appears absolutely sound and progress is rapid. The pivot to wealth management in Asia, investment in ICG as well as scaling up of the U.S. consumer bank all appear to be part of a coherent and sensible strategy.
However, it is all about execution as well and the jury is still out on this matter. For example, the wealth management space in Asia, whilst very lucrative, is also highly competitive with the likes of HSBC (HSBC), Credit Suisse (CS), UBS (UBS), boutique private banks as well as local/regional players all vying for the same affluent and high-net-worth clientele. Citi, whilst well-positioned, will still need sublime execution to succeed in this space.
At the moment, I am keeping an open mind and retaining a "bullish" rating on Citi largely due to undemanding valuation. I will likely upgrade my rating to "very bullish" should one or more of the following take place:
- Citi announces the disposal of Banamex Mexico
- Tangible progress on resolving the Consent Order's matters
- Inorganic acquisition in the U.S.
Final thoughts
In 3 years from now, the 'future' Citi could look very different. It could comprise a leading corporate and investment bank, a global wealth management franchise, and a large-scale multi-product consumer bank in the U.S. that is digitally led and bolstered by inorganic acquisitions.
Citi could easily pay for this by the disposal of Asian and Mexican consumer franchises and still deploy some of the proceeds towards share buybacks and dividends.
This version of Citi should require lower capital targets (estimate at ~10.5 percent compared with current 11.5 percent), be safer, and much less complex to manage. It should also deliver RoTCE in the high-teens or above warranting a valuation in line with its peers.
Assuming a TBV of ~$85 in three years' time, an appropriate valuation on the "future" Citi could be somewhere around $150.
For me, the litmus test is the strategic decision regarding Mexico. Citi has to make a tough and brave decision on what it wants to be in a few years' time. In the last decade or so, being perceived as an emerging markets bank clearly did not help their cause.
This article was written by
Analyst’s Disclosure: I am/we are long C, BAC, JPM. 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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Comments (14)
There are a number of reasons, primarily the Fed’s soft guidance. When crisis/recession happen (ie see recent pandemic), the banks can switch off the buybacks temporarily but keep the dividend going. In other words, the dividends (on the face of it) are sustainable throughout the economic cycle. Longer term, all else being equal, one would expect the dividend to grow CAGR at 10-15 percent (mix of lower share count and profit growth as well as utilisation of DTA).
The elephant in the room is the needed systemic upgrades. Great amounts of money and time spent over the years but little to no improvement at an operational level. I see Jane as the leader capable of completing the needed upgrades and getting off the merry go round. Fingers crossed.
It is at least couple of years away but the steps along the way are really important.
In terms of banks to buy, deposits franchise are prob most complimentary. I don’t think Citi needs to double down on credit cards either.
Deposits and wealth management are prob the areas to focus on and strengthen further. Shrink first than grow is the right strategy
