Barron's Cover
SATURDAY, JULY 13, 2013
Citi's World of Promise
By SANDRA WARD | MORE ARTICLES BY AUTHOR
The banking giant's new CEO vows to wring more profit from
Citigroup marked its bicentennial in 2012 with a management shake-up, putting bankers in charge of the global banking company for the first time since John Reed's retirement in 2000. After Reed, the nation's third-largest bank by assets was led by an investment banker, Sandy Weill; a lawyer, Chuck Prince; and then a hedge-fund manager, Vikram Pandit. But on April 17, 2012, Michael O'Neill, a former Marine known for whipping Bank of America into shape in the late '90s and turning around Bank of Hawaii, was elevated to chairman of the board, succeeding Richard Parsons, a lawyer and former chief of Time Warner best known for his diplomatic skills.
O'Neill agitated for more cost cuts and better risk controls to get the bank back on solid footing. Within six months Chief Executive Pandit resigned, forced out by O'Neill. His choice to run Citi (ticker: C) was Michael Corbat, a 53-year-old banker and Citi careerist who's worked in many of its businesses, most recently heading up its Europe, Middle East, and Africa operations.
The selection has helped get Citi's third century off to a good start for shareholders. The stock has gained nearly 45% to $50.81 since April of last year, and yet there's "still meaningful upside," says Gerard Cassidy, a longtime bank analyst at RBC Capital Markets. He thinks a price in the mid-$70s to low-$80s -- 50% or more above recent levels -- could be merited over the next two to three years, given the still sharp discount to its $62 a share book value. A 10% to 20% premium to book value would be reasonable as earnings and return on equity rise, he says.
THAT THE STOCK HAS COME as far as it has is a testament to the "Two Mikes," as Corbat and O'Neill are sometimes known. Citigroup required $45 billion in federal bailouts and came close to failing in 2008-09. Shareholders still feel the sting from a 2009 recapitalization in which the number of shares outstanding ballooned to three billion from 600 million when the federal government converted its preferred shares to common. Citi's stock briefly fell below a dollar. The current share price is adjusted to reflect a one-for-10 reverse split that occurred in May 2011. The biggest bank in the world by assets as recently as 2001, Citi's focus now is on being the most profitable bank in the world.
"Our goal is to be viewed as indisputably strong and stable and to be recognized as a company that's got the ability to generate quality, consistent earnings, a company that is known for making good, smart decisions and being a good shepherd of our shareholders' equity, and of our stakeholders' resources," Corbat told Barron's in a phone interview last week.
Corbat does have some big advantages. Citi's banking franchise is, by American standards, uniquely global. The bank now does business in 160 countries and jurisdictions and has a physical presence -- staff and offices -- in 100, many of them fast-growing emerging markets. At the same time, troubled assets, corralled within its Citi Holdings unit, have dropped by more than 80% from approximately $800 billion in 2008, just the start of a process that will free up capital that can now go to more productive uses.
And the bank is sitting on $55 billion in deferred tax assets, or future tax write-offs, which will be increasingly valuable in using its capital more effectively. The diversified, well-capitalized bank should be able to return ever larger amounts of this capital to its shareholders in the form of dividends and buybacks.
The new management has inspired confidence both on Wall Street and in Washington. Earlier this year Citigroup passed the Federal Reserve Bank's Comprehensive Capital Analysis and Review, the so-called stress test now required by regulators to determine if a bank has adequate capital to see it through a crisis at least as severe as the recent one. As a result, it received permission to buy back $1.2 billion of its shares through the first quarter of next year, a relatively modest amount but an important symbolic victory. A year ago the bank was embarrassed when it failed the test -- by a hair's breadth -- and was prohibited from buying back shares as many of its rivals could.
CORBAT, A 1982 ALL-AMERICAN OFFENSIVE GUARD on the Harvard football team, explains that the regulatory test has become an integral part of Citigroup's operating philosophy. "The stress test is really…the way you run and operate your business and it really has to be embedded in the way you budget, in the way you plan, in the way you risk manage," he says.
Investors have noticed. "Between O'Neill and Corbat, you finally have a management team in place that is capable of running a bank and executing as well," says Robert Stoll, an analyst at Institutional Capital, a Chicago-based money-management firm with $27 billion in assets that has held Citigroup stock since January of 2012. "Michael Corbat is more focused and has laid out a clear strategy for executing on things we think are important," says Stoll.
Corbat has established financial targets for Citi to reach by 2015, providing shareholders with a scorecard to track his progress. He plans to lift return on assets to 90 to 110 basis points from the 62 basis points recorded in 2012 (a basis point is one-hundredth of a percent). He's aiming to boost return on equity to more than 10% from 5% in 2012, and to attain an efficiency ratio at Citi (not including the Citi Holdings distressed-asset group) in the mid-50% range, compared with 60% in 2012. A bank's efficiency ratio is a measure of its overhead as a percentage of revenue and a sign of how well run it is. Top-tier banks typically boast an efficiency ratio in the low 50% range.
VOWING THAT HE would be a "maniacal allocator of resources," Corbat in his first nine months has moved to cut 11,000 jobs worldwide, or 4% of the workforce, sold or scaled back consumer-lending operations in Turkey, Romania, Paraguay, Uruguay, and Pakistan, and sold a consumer-finance unit in Brazil to focus on faster-growing business lines. The bank recently agreed to pay the government mortgage agency Fannie Mae nearly $1 billion to settle claims growing out of the financial crisis. And it completed the sale of its stake in the Smith Barney retail brokerage business to Morgan Stanley, giving a boost to its capital base.
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Citigroup ended the first quarter strongly capitalized, with an estimated 9.3% Basel III Tier One capital position; that is expected to increase to more than 10% by year end. At that level, Citi should meet the expected capital requirements, which haven't yet been finalized, well ahead of the target date of 2019. Many believe the bank is overcapitalized, in light of its distressed loan portfolio and its deferred tax assets.
BUT WHAT REALLY distinguishes Citi from its U.S. banking peers is that hard-to-replicate international business. It's a gem. All told, about 58% of Citigroup's $70 billion in revenue comes from outside North America.
In contrast JPMorgan Chase (JPM) gets just 19% of its revenue from abroad, and Bank of America (BAC), a mere 13%. HSBC Holdings (HSBA.UK) and Standard Chartered (STAN.UK), both based in London, are Citi's biggest rivals abroad.
That gives Citigroup a big competitive edge, especially as banking growth in the U.S. is crimped by increased regulation in the wake of the financial crisis and a still-vulnerable economy. In Asia and Latin America -- the latter contributes 13% to overall revenue -- Citigroup's corporate and retail banking revenues are increasing at double-digit clips compared with domestic growth that's been flat, excluding Citi Holdings.
Of the roughly 58% of revenue Citigroup collects from its international businesses, about 43% comes from consumer banking and the rest from corporate, securities and banking and transaction services.
A GLOBAL FRANCHISE is even more important today as U.S. regulators and policy makers debate the wisdom of having banks that are "too big to fail" and could require federal bailouts to survive. The government is unlikely to sanction bids by any of the biggest banks to get bigger still through major mergers and acquisitions. And building an overseas network on a scale such as Citigroup's would now be cost-prohibitive at this juncture.
"Our business model has become more unique…and has become more valuable, and we're focused on that," says Corbat.
Citi's corporate transaction-services business, providing global cash management services for multinational corporations and their clients, facilitates more than $3 trillion a day in money flows and benefits greatly from its international footprint. It is seen as central to Citigroup's goal of tapping into upwardly mobile and affluent individuals who have migrated to urban areas in Mexico, India, China, and Malaysia, among others that the bank has targeted for investment. Transaction services is a hugely profitable business, generating 45% pretax profit margins.
The bank's long-term strategy, says Corbat, hinges on the secular themes of globalization, urbanization, and digitization. It wants to be the banker to more mobile societies with newly rich populations, connecting with them via technology and providing them with services and products wherever they may be.
There are huge savings and opportunities to be had, too, as the bank upgrades the back-office technology of its global consumer operations, introducing a common operating platform for its far-flung network to replace what has been a loose confederation of locally run systems. That will allow Citigroup to make more products and services available to a broader set of customers, and it will be able to deliver those products in a digital format to accommodate evolving customer demands.
AS IMPRESSIVE AS THIS expansive global strategy sounds, shareholders are likely to get a more immediate kick from the enormous amount of capital expected to come back to them via stock buybacks and dividend increases. These will result from Citi's efforts to wind down its portfolio of problem loans at Citi Holdings and its ability to utilize the $55 billion in deferred tax assets -- future tax write-offs that it racked up as a result of losses related to the financial crisis -- as its earnings improve.
"It's a big priority," says Corbat, of unlocking the value represented by the capital that is tied up currently within the bank.
The level of problem assets in Citi Holdings stands at $149 billion, well off its peak of about $800 billion in 2008. Even so, it represents 8% of the bank's balance sheet and ties up 20% of its capital on money-losing assets, creating an enormous drag on earnings. Most of the problem assets are U.S.-related mortgages, mortgage-backed securities, and home-equity loans. But with the housing market on the mend, with higher prices and improved loss-rates, Citigroup is able to recover more for the assets and lower the reserves it has to hold for losses.
Just unlocking the capital connected to Citi Holdings could add as much as $10 a share to his price target of $60, says Moshe Orenbuch, bank analyst at Credit Suisse. Hedge-fund manager Leon Cooperman of Omega Advisors expressed in these pages a few weeks ago ("Dynamic Duo," Barron's, May 20), that Citigroup by year-end 2014 could be a $70 stock.
Macquarie Capital analyst David Konrad sees Citi lifting its quarterly dividend payout to 15 cents a share in 2014 and 40 cents a share in 2015, up sharply from the current one-cent a share. He also expects buybacks of $4.7 billion in 2014 and $7.7 billion in 2015.
As the bank can put more of these assets to productive use, it creates a kind of virtuous circle. Freed-up assets help improve earnings, which enable the bank to utilize more of the $55 billion in deferred tax assets. Citigroup used $700 million of the write-offs in the first quarter because its taxable U.S. earnings rose. It will be able to draw on more of these tax offsets once it generates more consistent earnings, and that will make more capital available for shareholders. The drawdown of the tax benefit was good news to investors who had grown concerned because the pile of deferred tax assets increased last year, leading to some skepticism that Citi would ever be able to use them.
The bank is scheduled to report second-quarter earnings Monday. Analysts estimate it will earn $1.18 a share on revenue of $19.8 billion. That compares with $1 a share and $18.6 billion in revenue a year ago. For the full year, the consensus view is that Citi will earn $4.73 a share compared with $3.86 in 2012. Wall Street expects $5.44 a share in earnings in 2014.
CITIGROUP IS "a really interesting internal story," says Arnie Schneider, founder and chief investment officer of Schneider Capital Management, which has about $2 billion under management in Wayne, Pa. But in addition, "there is momentum externally," which gives even more allure to the shares.
It's up to banker Corbat, now in his 30th year at Citigroup, to make both the internal and external parts work to the benefit of shareholders.
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