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Should Value Investors Be Watching Citigroup?

By Bram Berkowitz - Feb 6, 2021 at 8:00AM

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The bank trades well below tangible book value, but it's in the process of correcting regulatory issues and refreshing its overall strategy.

Value investors typically look for stocks that are trading below their intrinsic value, and after a difficult 2020, Citigroup (C 8.05%) meets that criteria. Like nearly every other bank, it has been suffering due to the ultra-low-interest-rate environment and the higher credit costs that came with the coronavirus pandemic. But Citigroup also faced company-specific regulatory issues that sent its shares falling further than those of some of its peers.

Now, as the banking sector heads toward what could be a rebound this year and Citigroup makes progress on correcting those issues, it is certainly a stock value investors should be watching.

A year of recovery?

The best gauge of a bank's intrinsic value is its tangible book value, a metric that starts with the bank's equity -- assets minus liabilities -- and takes out intangibles that can be hard to accurately calculate. At Friday's prices, Citigroup trades around $63 per share -- about 85% of its tangible book value per share of $73.83 as of the end of the fourth quarter.

Citibank

Image source: Citigroup.

Citigroup's stock price fell by about 23% in 2020. As the coronavirus pandemic spread, Citi, like all banks, set aside large amounts of capital in loan-loss provisioning, anticipating that the economic crisis would lead to a wave of defaults on debt. Meanwhile, the Federal Reserve dropped the benchmark federal funds rate to zero. That helped stimulate the troubled economy, but it also squeezed the profit margins on bank loans.

As coronavirus vaccines get more widely distributed, the economy will hopefully begin to move back toward more normal conditions. Banks will still face challenges due to the low-interest-rate environment, but the yield on the 10-year U.S. Treasury has been rising, steepening the yield curve and therefore the spread between short-term and long-term debt. This typically benefits banks because they can borrow short-term money cheaply and lend it out at higher rates.

Additionally, banks expect credit costs to be materially lower in 2021. They also hope to be able to release some of the money they are currently reserving for loan losses back into their profits. Lastly, after halting stock buybacks for most of last year, Citigroup is resuming those this quarter, and may be able to accelerate share repurchases if the Fed removes certain restrictions later this year. All of this bodes well for Citigroup's profitability and its stock price.

Refreshing the bank's strategy

Another aspect that value investors should take note of is that the bank is finally beginning to correct longstanding internal issues and revamp its strategy -- addressing problems that have caused it to lag its peers on profitability for years.

Citigroup's results trailed the broader bank sector in 2020 largely due to issues that surfaced toward the end of the year. Federal regulators hit it with a $400 million civil penalty due to its failure to address inadequacies with its internal controls related to compliance, data, and risk management. They also imposed consent orders on Citigroup that require it to resolve its problems, and compel it to get regulatory approval before making large acquisitions.

Consent orders like this can take years to get removed, but at least the bank is beginning to do the necessary work. CFO Mark Mason previously said the bank spent $1 billion on correcting the issues in 2020 and anticipates increasing overall expenses by 2% to 3% in 2021, largely to continue building out the necessary infrastructure to get back into compliance with regulations. While those increased expenses will drag on the bank's profitability and efficiency in the near term, these are investments in technology and talent that will hopefully pay off for Citigroup in the long term.

Additionally, following the imposition of the consent orders last year, Michael Corbat retired as chief executive and was replaced by Jane Fraser, a 16-year veteran with the bank. On her first earnings call as CEO, Fraser said she and the rest of management are working on "refreshing our strategy" by "assessing which businesses can attain leading market positions in a much more digitized world." It remains to be seen exactly what the new strategy will look like, but I am sure Citigroup's frustrated shareholders will be pleased to see it trying something new.

A big opportunity

Trading at around 85% of tangible book value, Citigroup looks like a tremendous opportunity even though it may not have all the pieces in place yet for a rebound. Remember, Citigroup was the first modern megabank, and has 200 million customers in more than 160 countries. It also has plenty of capital right now to cushion it if the economy should take a turn for the worse.

Lower credit costs and stock repurchases should lead to improved earnings per share in 2021, while investments that will correct regulatory issues and a new strategy will hopefully create a better long-term outlook as well. It will be necessary to closely monitor how Fraser's plan to revamp the bank evolves, but with shares trading so cheap right now, value investors should definitely give serious consideration to Citigroup.

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