Early in 2021, when new Chief Executive Officer Jane Fraser took the reins at Citigroup (C -0.32%), she quickly began to overhaul the bank's strategy, which for years produced lackluster returns and disappointment for shareholders.
In perhaps the biggest move, Citigroup said that it planned to sell most of its international consumer banking units, including a large portion (consumer, small business, and middle-market banking) of its very profitable division in Mexico, Citibanamex.
The goal is for the bank to focus on its more profitable wealth management, investment banking, and payments businesses while making the bank simpler and more efficient from an operational and capital standpoint. Furthermore, the bank has to get into compliance with a consent order from regulators that will require it to invest in modernizing its systems.
Citigroup also said at its investor day event earlier this year that it set a goal for return on tangible common equity (ROTCE) in the medium term. Let's take a look at how the bank's multiyear transformation plan is progressing in light of its third-quarter earnings report.
Consumer banking sales
Citigroup initially announced plans to exit 13 international consumer banking units and is well underway in the process. The process has not always been smooth and at times has resulted in charges, like with its Korean consumer bank, which Citigroup was unable to sell and had to wind down.
Image source: Getty Images.
But at the end of the third quarter, Citigroup had signed agreements to sell nine of its international consumer units. So far it has closed on the sales of its Australian and Philippines units. Before the year is done, Citigroup expects to complete the sales of its consumer units in Thailand, Malaysia, and Bahrain. Vietnam, India, Taiwan, and Indonesia should all conclude sometime in 2023.
These nine sales along with Korea and Citigroup's planned exit from Russia, which should be completed next year, will free up about $6 billion of capital. There's another $4 billion of capital to be freed up with units that have not yet been sold in Mexico, Poland, and China. Citigroup also announced in September that the bank will wind down its small retail bank in the U.K., which is not likely to have a huge impact on capital.
Citigroup Chief Financial Officer Mark Mason expects the five closed sales in 2022 to release more than $3 billion of capital. So you can expect at least another $3 billion of freed capital in 2023. Then the big question is really how successful Citigroup is in selling Citibanamex, which is a complex transaction because it's one of the largest banks in Mexico. As such, the bank will need to work closely on the process with the Mexican government.
However, Citibanamex has been incredibly profitable. In 2021, the division generated more than a 27% ROTCE, so many analysts are expecting the division to fetch a premium, somewhere in the range of $7 billion or $8 billion, but, again, it will be a complex transaction.
Boosting financial returns and regulatory issues
Citigroup said at its investor day event that its goal is to deliver an 11% to 12% ROTCE over the next three to five years. Through the first three quarters of the year, Citigroup had a 9.9% ROTCE and in the third quarter the bank turned in an 8.2% ROTCE.
However, Citigroup is currently benefiting from higher interest rates and a very benign credit environment. Next year, conditions are expected to worsen and Citigroup could also see its deposit costs rise.
In 2020, the bank got hit with a $400 million fine and a consent order from regulators telling the bank to fix companywide controls related to data, compliance, and risk management. These issues were on full display when Citigroup earlier that year accidentally wired $900 million to the wrong parties due to a manual error and out-of-date software. The funds were eventually returned after a court battle. A report from Reuters in September did say Citigroup had submitted a multiyear plan to regulators for how to address these issues, so the bank might be making some progress on that front.
But all of this has led to expense growth this year. The bank now has 10,000 employees working on the transformation alone. Management expects expenses to be 7% to 8% higher this year, excluding costs related to the sale of international consumer banking units. While not official, based on Mason's recent comments you can likely expect to see Citigroup's expenses rise again next year, which will obviously continue to be a drag on earnings.
Where is the bank in the transformation?
I think the bank is making progress and doing everything it can to move quickly on the transformation but it does still seem like there is a lot more work to do.
That said, there are some potential catalysts to look out for in 2023, including the resumption of share repurchases and the sale of the Mexico division.
The good news is that the stock is so cheap right now that I feel like much of the bad news has been priced in. Citigroup also has a high dividend yield of 4.6% based on recent share prices. You'll have to be patient, but you are being compensated through the dividend and the upside could be quite significant from here, which is why I do think the stock is a buy right now.
