It has not been an easy year for Citigroup (C 0.80%). The nation's third-largest bank by assets has seen its stock fall by 17.5% this year as of Thursday's close, trading at a significant discount to its tangible book value (TBV), or its net worth. Even though it's hired a new CEO, pledged to clean up regulatory issues, and launched a whole new transformation plan, investors have been reluctant to buy in.
So, when legendary investor Warren Buffett and his company, Berkshire Hathaway, recently disclosed that they had taken a stake in Citigroup, I viewed it as a huge victory for the struggling bank that came at just the right time. Here's why.
Failing to convince the market
For years, Citigroup has failed to generate returns in line with its peer group, which has led to the bank trading not only at a big discount to its peers but also to its TBV for large periods of time since the Great Recession. The bank is overly complex and has been difficult for the market to really analyze.
After a $400 million regulatory fine and cease-and-desist order from federal regulators in 2020 for failing to correct longstanding regulatory issues, Citigroup's former CEO, Michael Corbat, stepped down. Many believed Corbat had been forced out by disgruntled investors.
Citigroup elevated longtime executive Jane Fraser to take over as CEO early in 2021. Fraser got right to work, launching a strategy refresh that included a plan to sell the international consumer banking operations in 13 countries and double down in areas of strength, like investment banking and wealth management. Fraser would eventually make another difficult decision, announcing that the bank also plans to eventually sell Banamex, its very profitable consumer banking division in Mexico.
At times, there seemed to be real enthusiasm for the plan, and shares would bounce briefly. But some of the international sales have been more complex than anticipated and resulted in losses for the bank.
Furthermore, Citigroup had more exposure to Russia than its peers did, and investors were also not pleased when Citigroup paused share repurchases in the fourth quarter of 2021, due to new regulatory capital rules.
In February, at its highly anticipated investor day, where the bank laid out details of its long-term strategic vision, management said it is only targeting an 11% to 12% return on tangible common equity in the medium term, which is far below the medium- and long-term targets of its large bank peers.
Lastly, with rising expenses in 2021 and expense growth again this year, investors have realized that Citigroup's transformation might not be a quick fix. Difficult market conditions have not helped the cause, leading to continued pressure on the stock.
More than just a catalyst
Toward the end of March, Citigroup actually was downgraded by Wall Street due to a lack of near-term catalysts -- investor day had really been the bank's last big hope for a near-term push. So Berkshire's investment came as a nice surprise. The stock jumped nearly 7.5% the day after the news.
Buffett and Berkshire's investment is so much more than just a near-term bump for the stock, though. It's a sign that Citigroup, for the first time in a long time, might actually be on to something. After all, Citigroup has traded at big discounts to TBV many times over the last decade, and Buffett and Berkshire have never taken the bait. Why is this time different?
Citigroup is making the hard but seemingly right decisions in selling these international consumer banking operations. Some, like Korea, have been difficult to unwind and led to significant charges, but the sales will free up capital and make the bank simpler. Selling Banamex will also be a difficult and lengthy process because of how important the institution is in Mexico. It could also leave a revenue hole at the bank. Additionally, rising expenses have hurt Citigroup's performance and near-term outlook, but it seems that management is finally spending the necessary amount to correct regulatory issues that have dogged the bank for years.
From what I've seen, investors have had drastically different opinions over whether Citigroup actually has its act together this time around. Even though it's only a small percentage of Berkshire's portfolio, Buffett and Berkshire know the banking sector extremely well, so the fact they are investing in Citigroup for the first time in two decades is a huge validation for the bank and its somewhat new management team.