The wheels have fallen off Citigroup's (C -1.89%) stock since its disappointing investor day earlier this year, when management announced new medium-term financial targets that failed to impress the market.
Things have only gotten worse with Russia's invasion of Ukraine, complicating the bank's previous decision to sell its consumer banking division in Russia and increasing the chance the bank takes a big charge on divesting the operation. With Citigroup set to report earnings later this week, here's one thing I'll be watching closely.
Will Citigroup be able to buy back more stock?
With investor day now in the past and the bank's transformation looking like a multiyear journey, Citigroup doesn't have a lot of near-term catalysts ahead. There are rising interest rates, and an end to the conflict in Ukraine would certainly help as well.
But other than those, the only big near-term catalyst I can see right now is if Citigroup could continue buying back stock this year while it is trading at beaten-down levels. The shares trade at less than 60% of Citi's tangible book value (TBV), or net worth, which creates an attractive opportunity to repurchase shares. Whenever banks repurchase shares when trading below TBV, the math works out so that the repurchases grow the bank's TBV, which banks trade relative to.
But the big question is if the bank will be able to repurchase more stock this year. Capital distributions at banks depend on a bank's regulatory capital requirements, the big one being the common equity tier 1 (CET1) capital ratio. That's a measure of a bank's core capital expressed as a percentage of its risk-weighted assets such as loans. Banks have minimum thresholds they must maintain as well as their own internal targets, so the capital for dividends and share repurchases comes from the excess capital they have above these CET1 targets and earnings each quarter.
Currently, Citigroup has a healthy 12.2% CET1 ratio, which is well above its current 10.5% requirement and also nicely above its 11.5% internal target. Citigroup had to halt share repurchases in the fourth quarter of 2021 to navigate around a new capital rule and then resumed those repurchases in the first quarter of this year. However, the bank might struggle to do any meaningful repurchases for the rest of 2021.
All about timing
One issue is that Chief Financial Officer Mark Mason said at Citigroup's investor day in March that the bank expects its CET1 requirements to rise at the start of 2023 (these regulatory requirements can change year to year), so the bank will have to increase CET1 to 12% CET1 by the end of 2022, not leaving a lot of excess capital.
Analysts on average are expecting Citigroup to generate about $13.6 billion in profit this year, but Citigroup has to cover its dividend, and there may be charges as the bank sells its international consumer banking divisions.
Last year, as part of its refresh strategy, Chief Executive Officer Jane Fraser announced the bank would sell 13 international consumer banking divisions that it deemed were inefficient and not scalable. The bank also earlier this year announced it would sell its very profitable consumer banking division in Mexico.
Some of these could result in significant charges. For instance, the bank's exit in South Korea resulted in a $1.2 billion hit to earnings before interest and taxes in the fourth quarter. Citigroup could face other charges from exits and has warned recently that it faces losing as much as $4 billion on its Russia operation.
The good news is that the sale of the 13 international markets will free up roughly $7 billion of capital, while the sale of Mexico will free up another $4 billion or $5 billion of capital. Additionally, dropping these markets could also reduce Citigroup's regulatory capital requirements over time, freeing up more capital.
Citigroup has sold and exited some of its international consumer banking divisions, but the sale of Mexico is much more complex and could take a little while to sort out. It's really all about timing and when the deals close, which is also complicated by the bank potentially having a higher CET1 ratio requirement next year.
Look for clues on the earnings call
Let's hope management will have an update about potential share repurchases on its earnings call later this week. If the bank could do more buybacks this year while it trades so far below TBV, that might spark a small rally in the stock.
Growing TBV would be extremely helpful in the long term because banks trade in relation to their TBV, so when TBV rises, it make it more likely that the stock price will follow suit.
While Citigroup has a lot of work to do, considering its peers trade well above TBV, with some near 200% of TBV, if Citigroup can show signs of some material progress, I am sure the stock can retrace back to 100% of TBV in the long term, so the higher that TBV is, the better for shareholders.