It has been more than two years since Citigroup (C 1.41%) embarked on a sweeping strategic overhaul in an effort to finally boost returns and reward shareholders after more than a decade of huge underperformance since the end of the Great Recession.
Although Chief Executive Officer Jane Fraser and her team have not been afraid to make hard choices, and have also made a lot of progress while dealing with some pretty difficult market conditions, shareholders have little to show for it.
The stock is down about 20% since the beginning of 2021 and trades at roughly 61% of its tangible book value (TBV), or net worth, a significant discount to its peers. Though there is a lot of work left to do, one catalyst that could finally get the shares moving is the sale of Citigroup's Mexican consumer, small business, and middle-market banking operations, known as Citibanamex. Here's why.
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The sale of Citi's Mexican operations will lead to share repurchases
A big part of Citigroup's overhaul is the divestiture of its international consumer banking units, which management does not believe have the scale to compete over the long haul in its various markets. Citigroup then also decided to sell Citibanamex's consumer, small business, and middle-market banking operations.
Citibanamex is a great business but the sale would free up significant capital and potentially lead to lower regulatory capital requirements as the bank becomes less complex. More than a year after announcing its intent to sell Citibanamex, the bank has yet to announce a buyer and therefore has not been able to free up the billions of dollars of capital supporting the business. The deal is complex and management has to work closely with and agree to conditions set forth by the Mexican government because Citibanamex is one of the largest banks in the country.
This has been frustrating for shareholders because, with the bank trading at such a bargain valuation, shareholders want management to buy back stock, which would increase the bank's TBV per share immensely if done while trading at such a discount. Bank stocks tend to trade relative to their TBV, so boosting it would likely be beneficial long term. Share repurchases are also a big part of the reason that investors buy money-center banks.
But Citigroup paused share repurchases in the third quarter of 2022 in an effort to build its regulatory capital levels. When the bank sells Citibanamex, there is going to be a temporary negative capital impact due to the accounting until the sale closes. Furthermore, the bank is unsure how its capital requirements will be affected by annual Federal Reserve stress testing, as well as the final set of big-bank capital rules that are due to come out soon. The economy may also be headed for a recession. All of this has led management to maintain a large amount of excess capital.
It's even more frustrating for shareholders because Citigroup has succeeded in building a significant amount of capital in recent quarters. The bank's 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, was 13.4% at the end of the first quarter. Citigroup's regulatory requirement is only 11.5%, and management plans to target an 11.5% to 12% CET1 ratio in the medium term (three to five years).
Banks can use capital in excess of their regulatory CET1 requirement to pay dividends and buy back stock, so a nearly 2-percentage-point buffer is a lot when you consider that earnings help to rebuild capital each quarter.
Looking for clarity on capital
With all of the moving parts mentioned above, management wants clarity about where capital levels might be after the sale of Citibanamex is complete, as well as what Citigroup's CET1 requirement is heading into next year.
There is also the possibility that Citigroup doesn't find a buyer or get a satisfactory price for Citibanamex, leading the bank to spin out the unit through an initial public offering, which would take longer than a sale. However, Fraser did say on the bank's earnings call that "we are in a very active dialogue right now in Mexico." Last month, Reuters also reported that the Mexican government was pleased with the sale process of Citibanamex and that there were two buyers still in the bidding.
Let's hope the bank announces a sale soon. This would solve a big piece in the capital puzzle and perhaps allow Citigroup to restart meaningful share repurchases in the near future, which would definitely get the stock moving.
