Is Citigroup the Best-Managed Large Bank in America?

Source: Hakan Dahlstrom Photography, republished under CC BY 2.0.

Is Citigroup, Inc. (C 0.26%) the best-managed bank in America? I'll save you the suspense: The answer is no. But it's better managed than the market believes, and for stock pickers, that's a valuable observation.

Want proof? Last Wednesday, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) jointly announced that Citi was the only bank among the top eight U.S. banks to receive a qualified approval from both regulators on its living will.

A living will -- "resolution plan" is the official term -- is a plan for winding down a too-big-to-fail institution in a manner that prevents a system-wide crisis.

That "win" clearly caught investors by surprise: Citi shares rose 5.6% on the day, versus a 3.8% gain for the KBW Bank Index (DJINDICES: ^BKX). (The entire sector got a lift from JPMorgan Chase's earnings that day.)

Who's the worst?
In the wake of the global financial crisis, too-big-to-fail banks have faced enormous skepticism on the part of the market, but none more so than Citi, and that's perfectly understandable. When former FDIC chairperson Sheila Bair was asked point blank in 2011 which bank was the worst, she answered:

"During the crisis I said Citigroup was a basket case, Merrill Lynch was a basket case. These thrifts, Countrywide, Golden West, WAMU [Washington Mutual], they were all in serious trouble."

Among that list, only Citi survived as an independent entity. The others failed or were acquired -- and gave their acquirers an expensive case of indigestion. Citi doesn't owe its survival to good luck: Chalk it up to the government's making two capital injections totaling $45 billion -- matched only by Bank of America Corp. -- and providing loss guarantees on a $306 billion pool of assets.

The "basket case" discount
Thus, over the past five years, Citi shares have traded at an average 33% discount to their peer group average price-to-book value multiple and a 12% discount on the basis of price-to-forward earnings, according to data from Bloomberg. The market left Citigroup for dead.

But institutions change, and 2016's Citigroup is a far different organization than 2008 Citigroup. Before becoming CEO, Michael Corbat oversaw the sale of 40 businesses and divested over $500 billion in assets at the head of Citi Holdings, the unit that houses the bank's non-core assets. The running total is now over 60 businesses and $700 billion in assets.

From worst to first
And there were clues that should have tipped investors off that Wednesday's success was completely plausible.

In March 2015, the Federal Reserve awarded Citigroup the cleanest pass on its capital return program among the top banks participating in the annual round of "stress tests."

That wasn't dumb luck: Citi had suffered an embarrassing failure on the same exercise a year earlier, prompting Corbat to stake his job on winning a pass in 2015. Now that's real motivation for you -- the kind that reverberates throughout the organization.

The bank then spent $180 million to improve its capital planning process. That had immediate benefits when it comes to drawing up a resolution plan, since the preferred resolution strategy under the Dodd-Frank Act is to recapitalize a bank's major operating subsidiaries before the failure of the parent company.

Going on page length alone (see the following table), it would appear that Citigroup's 2015 living will was the most explicit and comprehensive. In sum, Citi had put more care and effort into the exercise than its peers did.

Source: Federal Reserve.

I admit, though. that page length is a crude measure to infer the quality of the plan, particularly since these are the public summaries only. Some banks may simply have chosen to be more concise.

And the Fed and the FDIC did identify specific issues in Citi's plan that require improvement. However, these are qualified as "shortcomings" rather than the "deficiencies" found at the other banks that render a plan "not credible,"

From zombie to winner
For investors, what does this all mean? The greatest living will in the world doesn't ensure a bank is earning its cost of capital. Indeed, Citigroup is not currently earning its cost of equity, so it's no surprise the shares continue to trade at a discount to its book value and even to its tangible book value.

Still, this latest "win" for Citigroup is more proof that the bank is hugely improved under Corbat's leadership. I expect the improvements to continue and the gap with book value to narrow, and while the market caught a glimpse of this last Wednesday, I think it has yet to be fully reflected in the stock price.