For a good chunk of last year, the Federal Reserve banned share repurchases and put limits on dividend payouts in order to ensure that banks had plenty of capital to navigate through the uncertainties presented by the coronavirus pandemic. So, naturally, once those restrictions were lifted on June 30, most large banks announced their intentions to raise their dividends and ramp up share repurchases.
Citigroup (NYSE:C) was the only major bank not to announce a dividend increase. That was disappointing to the broader market, but the bank does appear to have a good reason for its decision.
Share repurchases are more important right now
Banks return capital to shareholders in two main ways: dividends and share repurchases. But right now Citigroup is in a position where share repurchases will maximize returns to investors. Last year, Citigroup ran into regulatory issues that included a $400 million consent order. The fine also came with consent orders from the U.S. Office of the Comptroller of the Currency, which regulates national banks, and the Federal Reserve, instructing Citigroup to improve its internal risks and controls. That, along with other troubles experienced during the pandemic, sent shares plummeting.
Although they have since rebounded, Citigroup still trades below tangible book value (TBV), which is a bank's common shareholder's equity minus intangible assets and goodwill. Essentially, TBV is a measure of what the bank would be worth if it were to be immediately liquidated. Banks typically trade in relation to their TBV, so a growing or declining TBV can greatly impact the stock price. Share repurchases are the most beneficial for a bank when they trade below TBV. Regardless of when banks do share repurchases, they are going to increase a bank's earnings per share (EPS) by decreasing the share count and giving the remaining shareholders a bigger portion of profits.
But when banks trade below tangible book value, the math works out so that share repurchases also grow TBV. When the share price is above TBV, share repurchases decrease TBV. With Citigroup currently trading at just 86% of TBV, this is a very unique opportunity for the bank to conduct share repurchases and maximize value. As analyst Mike Mayo said on the bank's earnings call, "so you should probably be selling ... your desk chairs and your silverware and anything you can to buy back your stock, I would think."
As a result, Citigroup will want to use most of its earnings and excess capital to repurchase as many shares as possible as opposed to paying out more dividends. Citigroup CFO Mark Mason said on the bank's recent earnings call that the bank has $4 billion of excess capital above the amount it wants to hold for regulatory purposes. Then the bank is planning to sell its consumer banking business in 13 global markets, which are supported by $7 billion of capital, so that will free up capital, and then of course the bank should continue to put up positive earnings results moving forward. Overall, this could equate to the bank buying back a lot of stock over this next year.
Already a strong dividend
The other reason Citigroup didn't feel the need to increase its dividend is because it is already paying out a strong dividend relative to its peers, even after their planned increases. Here is a comparison factoring in the planned dividend increases by other banks.
|JPMorgan Chase (NYSE:JPM)||2.6%|
|Bank of America (NYSE:BAC)||2.2%|
|Wells Fargo (NYSE:WFC)||1.8%|
Citigroup leads its peers on the dividend and posts an attractive yield at 3%. While it's true the bank's shares trade at a lower valuation compared to peers, even if Citigroup traded at an $80 share price, which is where it was prior to the pandemic, it would still have a 2.6% yield with its quarterly common dividend of $0.51, and that would still be at the top end of its peer group.
A good move
While I and the rest of the market probably would have liked to see Citigroup increase its dividend by a little bit just to appease the market, it still has a higher yield than its peers and an attractive dividend yield overall. Given how the math works, it makes much more sense for the bank to use capital to repurchase shares, which will grow EPS and TBV per share, and will prove beneficial for the stock long term. Not every bank makes the obvious decision to repurchase shares when they trade at or below TBV, so this is a good sign for shareholders that management sees the opportunity and is clearly taking advantage.