It hasn't been the greatest year for Citigroup (C 1.34%). One look at the performance of the stock, down 27% year to date, will tell you that. Part of it is due to macro forces -- primarily the pandemic, which hurt the economy, which in turn affected banks as they rely on GDP growth, spending, and loans to make profits. Historically low interest rates, in the 0% to 0.25% range, due to the economy and pandemic also affected banks' ability to generate interest income on loans.
But Citigroup also had its own internal issues to deal with. One was a financial and legal entanglement where a Citigroup employee mistakenly sent $900 million to the wrong company, which Citigroup sued to get back. In October, the Federal Reserve Board and Office of the Comptroller of the Currency also fined Citigroup $400 million for "unsafe or unsound banking practices for its long-standing failure to establish effective risk management and data governance programs and internal controls."
As a result, Citigroup did not perform as well as some of its peers. The issues may lead some investors to wonder if Citigroup's difficulties will extend into the new year.
Breaking the glass ceiling
Citigroup, the nation's fourth-largest bank with $1.6 trillion in assets, begins the new year with a new CEO, Jane Fraser, the first woman ever to lead a large Wall Street bank. Fraser was appointed in September to replace Michael Corbat, who is retiring in February. Fraser will take over a bank that should be in better shape from a risk standpoint than it was in 2020.
For example, the risk of a potentially costly internal glitch, like the error where an employee sent money to the wrong lender, or even fraud, is reduced by corrective measures that Citigroup has established. "We have thus redoubled our efforts and have made transforming our risk and control environment a strategic priority," company officials said in a statement released in October. The company will invest over $1 billion to improve internal controls and hired a chief administrative officer to oversee the efforts and centralize its management. As Citigroup said: "The entire management team is committed to achieving operational excellence and a best-in-class risk and control environment."
However, a major risk to banks, interest rates, remains. Interest rates are key to a bank's growth, because banks earn a good portion of their revenue from interest income on loans. The federal funds rate is currently in the 0% to 0.25% range, and the Federal Reserve said in September that it likely wouldn't raise it until 2023 as the economy recovers. That means that interest income will still be challenged.
But the good news is that the economy is expected to rebound in 2021. Goldman Sachs economists said in November that the GDP should return to pre-pandemic levels by mid-2021, buoyed by the rollout of the COVID-19 vaccines. This will be good for banks like Citigroup because when the economy is growing, more people are working, spending, taking out loans, and paying off debt. This would have the effect of increasing loan activities for banks, as well as reducing the provision for credit allowance that they set aside for defaults.
A recent study by The Deloitte Center for Financial Services said the U.S. banking industry will have to provision for $318 billion in net loan losses from 2020 to 2022. Through the second quarter, the top 100 banks had already set aside $103.4 billion, so it is safe to say more than half of that $318 billion will already have been provisioned by the start of 2021. That, in turn, means that these provisions should be lower over the next two years.
A less risky proposition
Another indicator that Citigroup faces less risk heading into 2021 is that its capital position remains strong. As of the end of the third quarter, the bank had a common equity tier 1 ratio of 11.8%, which is a measure of a bank's solvency and capital strength. It is up from 11.6% a year ago, which means it has weathered the worst of the crisis in good financial shape.
Its book value per share has actually gone up 4% year over year through the pandemic, to $84 per share. That means the intrinsic value of its assets has increased, even though the stock price has dropped to $58 per share. That makes it a good value, because the market should recognize its value and push the price back up.
When you put all of these factors together, Citigroup will be a less risky stock going forward. While the next few months, even quarters, could be rocky, Citigroup, as one of the largest banks in the world, will be a good long-term investment coming out of the recession.