When Citigroup (C 3.06%) embarked on its strategy refresh last year to transform the bank into a more profitable and efficient organization, many wondered at the time what might happen to Banamex, a Mexican subsidiary that Citigroup bought in 2001 and one of the largest financial institutions in Mexico. Investors and analysts got their answer recently when Citigroup announced that it plans to exit or sell the consumer, small business, and middle-market banking operations of Banamex. The bank plans to maintain its institutional businesses in the country. With Banamex as profitable as it is, some may be wondering why Citigroup is planning to get rid of these businesses. Let's take a look.
Aligned with strategy
The portion of the business in Mexico that Citigroup is planning to sell or exit consists of $44 billion in assets. In 2021, the business generated nearly $4.7 billion in revenue and a net income of $1.1 billion. The business is supported by $4 billion of capital. If you think about Citigroup's full-year earnings in 2021 of nearly $22 billion, this portion of the business Citigroup is selling constitutes about 5% of the bank's total profits. The business is also generating a nearly 28% return on tangible common equity ($1.1B/$4B), which is very strong in the banking industry.
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However, keeping these operations would not really align with Citigroup's strategy refresh. One of CEO Jane Fraser's first moves, when she took over for Michael Corbat, was to announce that Citigroup would sell or wind down 13 global consumer franchises. The goal is to make the sprawling bank simpler and focus on Citigroup's higher-returning institutional businesses while doubling down on businesses that aren't as capital-intensive, like global wealth management. The only place where the bank looks like it will focus on retail banking in the near future is in the U.S. I think that makes sense, considering that Citigroup has a 4% deposit market share in its home country, a strong credit card business, and a well-known brand. As Fraser said on Citigroup's recent earnings call:
We took a clinical look at our franchise in Mexico, and we drew the hard conclusion that the noninstitutional businesses do not fit our new strategic direction. Now to be clear, these are terrific; they're scaled, high-returning franchises. But our strategic goal is to invest in businesses that are fully aligned with our core strengths and to simplify our firm.
Why the move could be beneficial
While the decision to sell likely wasn't easy, there is reason to believe it may make sense in the long term. First, it will help the bank get simpler. Because Citigroup is so global and operates so many unique businesses within banking, it has been harder for investors to analyze. It has also made risk mitigation more difficult. The public got a glimpse of regulatory issues at the bank in 2020 when regulators hit Citigroup with a $400 million fine and a consent order that told the bank to improve its internal controls at the bank pertaining to compliance, data, and risk management.
Getting out of Mexico and these other global consumer franchises will also help Citigroup improve its expense and capital structures. Like the other global consumer franchises Citigroup is selling, while Banamex is very profitable, it's not the most efficient. Based on the numbers provided by Citigroup, the operations being sold had an efficiency ratio of roughly 63% in 2020 and 68% in 2021. The efficiency ratio is a measure of a bank's expenses expressed as a percentage of total revenue, so lower is better. Large banks like Citigroup try to get their efficiency ratio below 60% typically. On Citigroup's recent earnings call, CFO Mark Mason said the sale might lower the bank's regulatory capital requirements.
Another positive is that the sale of the Banamex operations, as well as completion of the sales and exits of the other 13 global markets, is expected to free up significant capital. The 13 global markets consume $7 billion of capital, while the Banamex operations Citigroup is planning to sell consume about $4 billion of capital. The bank expects to free up at least $12 billion of capital through the sales and exits. It could even be more. With Banamex such a high-performing business, a sale of the business could reap a nice premium. Reuters reported that analysts believe Citigroup could get between $4 billion and $8 billion for the Banamex operations, and media outlets have reported that several banks and suitors are reportedly interested in the operations.
Citigroup will be able to use the $12 plus billion of freed capital for things like share repurchases, which are attractive at the bank's current low valuation. It can also invest in the bank's higher-returning businesses, address outstanding regulatory issues, and potentially build its U.S. retail business organically or inorganically.
Time for a change
The decision to get rid of these thriving businesses in Mexico likely was not easy, but the move seems to be in line with management's new strategy, frees up significant capital, and will make Citigroup much simpler. Make no mistake, there is work to do, including selling the units, and there could be some near-term pain from the revenue hole the sale will create. But Citigroup has now lagged behind its big-bank peers for quite some time. Its strategy has not worked for many years. It's clearly time for a change.
