Citigroup (C 3.06%), which is a relatively new member of Warren Buffett and Berkshire Hathaway's large equities portfolio, recently announced that it is pausing share repurchases like many other large U.S. banks as it prepares for higher regulatory capital requirements. While understandable, the announcement is also likely frustrating for shareholders because Citigroup trades at a huge discount to its tangible book value (TBV), or net worth.
When banks repurchase stock trading below TBV, the math works out to raise TBV. This should be good because bank shares tend to trade relative to TBV. Considering how helpful repurchases would be right now, let's take a look at when Citigroup could be able to buy back stock again.
Look at capital levels
Banks are able to pay dividends and buy back stock with excess capital over their regulatory requirements. One way for investors to evaluate excess capital is by looking at a bank's common equity tier 1 (CET1) capital ratio, which measures a bank's core capital as a percentage of its risk-weighted assets such as loans.
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CET1 capital is replenished each quarter by retained earnings, but also gets depleted through dividends and repurchases -- as well as loan growth, because banks must set aside capital to reserve for loan losses. At the end of the second quarter, Citigroup had an 11.9% CET1 ratio, which is actually up from 11.4% in Q1.
But Citigroup is expecting to have a CET1 requirement of 12% in 2023 due to results from the Federal Reserve's annual stress testing and other capital charges. Banks usually keep a buffer over their regulatory requirement, and on the bank's recent earnings call, Citigroup's management team said the bank is planning to build its CET1 ratio to 13%. It's difficult to repurchase stock when you need to build capital. Citigroup expects to reach the 13% level by mid-2023.
Rapidly evolving situation
Citigroup is in the midst of a strategic transformation to achieve better returns for shareholders. One big part of this transformation is the bank's decision to sell 14 international consumer banking divisions, including its very profitable operation in Mexico called Citibanamex.
This will eventually free up a lot of capital. Citigroup's Chief Financial Officer Mark Mason has previously said that the sale of the 13 international consumer divisions excluding Mexico would free up $7 billion of capital. The bank closed the sale of its Australian consumer banking operations in the second quarter and has signed agreements to sell eight other consumer units. Citigroup also had to take a write-down on its subsidiary in Korea after it was unable to find a buyer. Mason said he expects the sales that close this year to free up about $3.5 billion of capital.
It's hard to say exactly when the sale of Citibanamex will happen, as it's going to be a lengthy process, but it too will free up a lot of capital, and media reports have suggested there are a number of interested buyers.
Banks have also been taking a capital hit in recent quarters due to the rising interest rates. These have resulted in unrealized losses on their bond portfolios, because as bond yields rise, bond prices fall. But as the bonds mature, those losses end up bleeding back to capital. Mason said on the bank's first-quarter earnings call that the maturity of bonds could add another $1 billion of capital by the end of this year.
In selling these consumer banking divisions, Citigroup is also becoming smaller and less risky, which could ultimately reduce its CET1 requirement next year. Citigroup will also be building capital through net income generation each quarter.
When will share repurchases start back up?
I don't think we will see any more repurchases this year, which is a shame considering the discount the stock trades at. But this is a situation that could definitely change quickly. Right now Citigroup more or less has a capital deficit, but it's going to build a lot of capital over the next year. Its capital requirements could also come down as it sells all of its international consumer units, essentially giving the bank a lot of excess capital.
I'd guess there is a chance the bank can start repurchasing stock again in the first half of 2023, depending on how things shake out. In the meantime, investors can enjoy Citigroup's 3.9% annual dividend yield, which makes it well worth waiting for the transformation to play out and for share repurchases to start back up again.
