In 2021, Citigroup (C 0.03%) was one of the few large banks that did not raise its dividend. It also caught shareholders off guard when it revealed that it had paused share repurchase in the fourth quarter of 2021 to deal with a new regulatory capital rule that just went into effect at the beginning of this year. Given these events, let's take a look at how Citigroup is planning to reward shareholders this year.
Repurchases to resume for now
Because Citigroup currently trades below its tangible book value (TBV), which is what a bank would be worth if it were liquidated, buying back stock is incredibly beneficial right now because the math works out so that repurchases grow TBV per share. A growing TBV is beneficial for banks because their stocks tend to trade relative to TBV, so when TBV grows, the stock price can often follow. This is likely why investors were so frustrated with Citigroup's announcement about its share repurchases.
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The rule, which is called the standardized approach for measuring counterparty credit risk (SA-CCR), changed the way banks calculate risk on their derivatives contracts. This effectively increased Citigroup's risk-weighted assets (RWAs), which include assets like loans. When RWAs go up, a bank is then faced with increasing regulatory capital to maintain required regulatory capital ratios. As a result, management decreased RWAs in Q4 and paused share repurchases to make sure its regulatory capital ratios were in line with where they needed to be.
The good news is management announced on its recent earnings call that the bank would resume share repurchases in the current quarter at a level similar to those seen in the second and third quarters of 2021, which was around $3 billion each quarter. I suspect the bank will be able to keep repurchasing shares for most of the year, although toward the end of the year, regulatory capital requirements may come into play and limit share repurchases for at least a time.
Regulatory capital constraints
Capital returns at banks are limited by their regulatory capital requirements. Although there are many capital ratios at banks, one of the main ones that regulators and investors watch is the common equity tier 1 (CET1) capital ratio. The CET1 ratio is a key regulatory ratio at banks and measures a bank's core capital expressed as a percentage of RWAs. If banks fall below their mandated CET1 ratios, which are set by the Federal Reserve, their capital returns such as share repurchases and dividends may be limited.
Citigroup's current CET1 requirement is 10.5%. But banks naturally have their own internal targets, which are above regulatory targets. Citigroup has been targeting a 11.5% CET1 ratio. However, there's a lot of moving pieces at the bank right now, given that Citigroup is currently in the middle of a strategy refresh that will see the bank sell or exit 13 global consumer banking franchises and the consumer, small business, and middle-market banking operations of its subsidiary in Mexico. Mason said that due to everything mentioned above, including the timing of business exits and the likelihood of higher regulatory capital requirements in 2023, the bank will likely need to manage to a 12% CET1 by the end of the year. A half percent might not sound like much, but it is when you are talking about tens and hundreds of billions of dollars.
After restructuring its RWAs and capital structure, Citigroup ended 2021 with a 12.2% CET1 ratio, not leaving a ton of room above the 12% level. The bank will be generating capital from earnings each quarter. The bank is also expected to free up at least $12 billion of capital once it sells and exits all of the consumer banking franchises. But this capital will likely be released at different times based on when sales and exits are completed. Ultimately, what this all means is that Citigroup should be able to repurchase stock for most of the year, but then it may need to pare back or potentially pause repurchases toward the end of this year when the 12% target comes more into play.
Given the 12% target toward the end of the year, I am also assuming that Citigroup will not raise its dividend this year. Maybe management does a very small increase because they haven't raised the dividend in two years now. But I would be fine with no increase, as I'd rather see the bank buy back stock while trading at this low valuation. The dividend is also at a good level right now. Even if Citigroup's stock were to rise back to its TBV per share at around $79, it would still have a nearly 2.6% yield.
Capital indicators
The situation is still fluid and could change before the end of the year. For instance, perhaps enough of the consumer sales are completed before 2023, freeing up the necessary capital to continue share repurchases through the end of the year. There's also the possibility of changes in capital regulation, which are fairly common in the banking industry. It's possible that large banks like Citigroup could get some kind of relief. Indeed, many of them have expressed a desire for looser regulation.
But as it stands today, investors can expect share repurchases for most of the year. It's possible that there'll be a pared-back repurchase or a pause in the second half of the year. It that happens, it's mostly likely to occur in the fourth quarter. I would expect little to no increase in the dividend this year.
