After years of lagging returns, Citigroup (C 0.26%) embarked on a multiyear transformation plan at the beginning of 2021 that involves disposing of 14 international consumer banking units, ramping up investment in its stronger-performing businesses, and modernizing the bank.
As one might imagine, to do a transformation of this magnitude at such a large and sprawling institution like Citigroup requires a lot of investment, which leads to elevated expenses. Not only did Citigroup expenses rise a lot in 2022, which hurt the bank's earnings, but it is expecting more of the same this year.
However, management said on Citigroup's recent earnings call that it expects to "bend the curve on expenses toward the end of 2024." This could mark a major turning point in the bank's transformation. Here's why.
Expense growth is partly required and partly opportunistic
While Citigroup is conducting a broad transformation, it is also dealing with regulatory issues. In 2020, regulators slapped Citigroup with a $400 million civil fine and told the bank to correct long-standing issues related to its compliance, data, and risk management controls.
But the bank had already been investing to improve its control infrastructure before the enforcement action, and it has also decided to do its broader transformation as it makes the necessary regulatory improvements.
Image source: Citigroup.
A large chunk of the bank's expense growth is related to improving the control infrastructure, but there were also expenses set aside for other technology initiatives and for hiring investment bankers and wealth advisors, businesses the bank wants to focus on long term. Citigroup now has 11,000 people working on the transformation. The bank is also dealing with expenses from the sale and exits of its international consumer banking units, which is part of the bank's efforts to simplify its incredibly complex organization. Excluding the impacts of these legacy franchises, Citigroup increased expenses 8% in 2022.
In 2023, management is projecting expenses excluding legacy franchise impacts to rise by close to 7%. This will be driven by continued investments to modernize the bank and address consent orders from regulators, revenue-related expenses, and inflation-driven expenses.
But toward the end of 2024, said Citigroup's Chief Financial Officer Mark Mason, the expense curve will bend, implying that expenses would peak and then start to trend lower. This will be needed for the bank to achieve its medium-term return on tangible common equity target (ROTCE) of 11% to 12%.
Expense cuts will come as a result of exiting the overseas units, the payback from investments it is making in technology and its control infrastructure, and the further simplification of the bank's organizational structure. Mason the legacy franchises have operating costs of $7 billion, $4 billion of which will be transferred to the buyers and $3 billion of which will be eliminated over time.
A turning point
I do see this expense break as a turning point in the transformation because at this point all of the sales or wind-downs of the international consumer franchises should be complete. This will make Citigroup a much simpler organization and hopefully lower its regulatory capital requirements as well.
Furthermore, it also seems like the bank would be more or less done investing in its technology and modernization efforts and would be in a better place with regulators. This would mark roughly four years from when regulators issued the consent orders, so it's not out of the question that they could be lifted by the time expense growth peaks.
Citigroup could then focus on hitting its medium-term ROTCE targets, which the bank badly needs to do to help regain credibility with shareholders.
