Being able to buy back stock is a key part of the Citigroup (C 1.88%) story right now, with the company currently undergoing a huge transformation and the stock trading at beaten-down levels. With Citigroup shares trading significantly below its tangible book value (TBV), or its net worth, any share repurchases right now would grow TBV. Considering bank stocks tend to trade relative to their TBV, a growing TBV tends to be beneficial long-term.
There have been questions in recent months about whether Citigroup, which has been buying back stock, will be able to continue to do so this year. Here's where things stand after its recently released first-quarter earnings report.
Citigroup has declining regulatory capital levels
Citigroup in the first quarter of 2022 returned $4 billion of capital to shareholders through share repurchases and dividends. But shareholders are unlikely to see the same level of buybacks in the remaining quarters of 2022 due to how the bank must manage its regulatory capital. All banks must hold regulatory capital to be able to absorb unexpected loan losses, while still being able to lend to individuals, families, and businesses during a severe economic downturn.
As a result, regulators require banks to maintain several regulatory capital ratios. A big one to watch is the common equity tier 1 (CET1) capital ratio, which measures a bank's core capital expressed as a percentage of its risk-weighted assets such as loans. Citigroup's required CET1 ratio this year is 10.5%, but management has an internal target of 11.5%. Citigroup must use capital above this 11.5% level and capital from future earnings to pay its dividend and fund share repurchases. Unfortunately, Citigroup's CET1 ratio came down a lot in the first quarter of 2022.
The trouble started in the fourth quarter of 2021 when a new regulatory capital rule, the standardized approach for counterparty credit risk (SA-CCR), changed the way banks calculated their exposure to derivative contracts, which inflated Citigroup's risk-weighted assets, the denominator in the CET1 calculation. That brought Citigroup's CET1 down from 12.2% to 11.8%. Then in the first quarter, Citigroup saw its CET1 further decline to 11.4% due to a range of factors including the capital returns it did in the quarter and unrealized losses on securities (AOCI), which all banks are dealing with due to higher interest rates and therefore higher bond yields.
Managing capital this year
An 11.4% CET1 ratio might have been sufficient to fund decent levels of share repurchases this year, considering Citigroup's projected earnings. But management now believes it needs to manage the CET1 ratio to a 12% target by the end of 2022 because its CET1 required ratio may be set to increase in 2023. That means Citigroup now needs to build capital. CFO Mark Mason said that equates to the bank adding about $7 billion to $8 billion to its current CET1 capital.
Mason said Citigroup plans to build capital from earnings generation this year, from deferred tax asset benefits, and from some of the AOCI losses benefiting capital as bonds the bank is invested in mature.
The last part of the equation is from divestitures. Last year, when CEO Jane Fraser took the reins of Citigroup, she immediately launched a strategy refresh. Part of this refresh involves the bank selling its consumer banking divisions in 14 international markets, largely because most of these units are inefficient and not big enough to adequately scale. Citigroup has so far announced the sale or the winding down of 10 of these units, a number of which Mason expects to close this year, releasing about $4 billion of capital. Then, of course, keep in mind Citigroup also has to cover common and preferred dividends.
Will there be more buybacks in 2022?
Mason said there would be a modest amount of share buybacks in the current quarter, the second quarter, which I found to be relatively good news because I didn't know if there'd be any. He also said some of the headwinds like losses from AOCI "bleed back in [to capital] over time." Given all of this, I would expect some modest buybacks in the back half of the year as well, with the potential for more once there is more clarity on interest rates, earnings, and Citigroup's 2023 capital requirements. The other good news is that the bank's 12% CET1 target is most likely temporary. Mason has previously said management wants to run the bank at an 11.5% CET1 capital ratio long-term and in selling the international consumer units, the bank could ultimately reduce its overall regulatory CET1 requirement. Ultimately, any buybacks the bank can do with the stock currently trading below TBV are huge and I'm hopeful buybacks will be much more aggressive in 2023.