Citigroup's ( C -1.85% ) third-quarter earnings results were fine, with the bank generating $2.15 in earnings per share on revenue of about $17.2 billion, both numbers that beat analysts' projections. However, those numbers failed to really excite investors who are still waiting for Citigroup to execute its new strategy under Chief Executive Officer Jane Fraser. One thing I was particularly disappointed in was the number of shares Citigroup repurchased in the quarter. Here's why.
They could have repurchased more
In the third quarter, Citigroup returned $4 billion of capital to shareholders, $3 billion of which was in the form of share repurchases. That was disappointing to me because the bank bought back $3 billion of stock in the second quarter at a time when the Federal Reserve had placed limits on large bank capital distributions. Those restrictions were no longer in place during the third quarter and Citigroup has plenty of capital, so it was unclear to me why the bank didn't increase its share repurchases.
Although many large banks are repurchasing shares right now, it is particularly advantageous to Citigroup, which is trading below tangible book value (TBV), the value of a bank if it were liquidated and a benchmark for valuing a bank's shares. When a bank repurchases shares while trading below TBV, the math works out so that both earnings per share and TBV increase. Because bank stocks are valued relative to their TBV, the stock price usually follows TBV. In other words, a higher tangible book value often leads to a higher share price. I think this is what could happen with Citigroup, because the bank does appear to have a solid rebuilding strategy in place. Citigroup traded below TBV for the entire third quarter and at one point was priced at just 84% of book value, among the lowest of the country's biggest banks.
Citigroup peers JPMorgan Chase ( JPM -0.59% ) and Bank of America ( BAC -1.89% ) trade near or above 200% of TBV, and even embattled Wells Fargo ( WFC -1.19% ) trades above TBV. The third quarter seemed like an ideal time for Citigroup to repurchase shares and I thought the bank would have bought back more stock than it did in the prior quarter.
The bank certainly had enough capital to repurchase more shares. One of the most important measures of capital is the common equity tier 1 (CET1) ratio, which is a measure of a bank's core capital expressed as a percentage of its risk-weighted assets. Citigroup management has said that it wants to target an 11.5% CET1 ratio, and that's the bank's internal target, not its actual regulatory requirement. The bank ended the quarter with an 11.7% CET1 capital ratio, so it had some room to use more capital to repurchase additional shares. Citigroup's capital is also replenished each quarter from retained earnings, and the bank is in the process of freeing up billions of more capital as it follows through on plans to exit and sell 13 global consumer franchises.
Wells Fargo bank analyst Mike Mayo on the company's second-quarter earnings call expressed his displeasure with management on the smaller repurchase amount.
The discount to book value is just getting greater and greater. Your discount versus peers has increased. Citi has worst-in-class returns, adjusted efficiency and stock market valuation. So why not a little change in that philosophy to more buybacks versus investing if you have such a great opportunity with your share price?
Still time to repurchase shares below TBV
The good news is that Citigroup still trades below TBV and may for a while, so there is still time for management to repurchase more discounted shares. CEO Fraser said on the earnings call that the bank is "deep in the second round of bids for the remaining exit markets," referring to the global consumer franchises the bank plans to sell. Announcing sales may give the bank confidence in its capital levels to step-up share repurchases. I still believe there is a great turnaround story in Citigroup, but investors are going to want to see more capital spent on buybacks this quarter.