Citigroup: A Turnaround Story for the Patient Investor
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As we head into what promises to be a fun-filled earnings season, I wanted to take a good look at some of the big banks' resolution reports that were filed July 2 with the Federal Deposit Insurance Corporation as part of the Frank Dodd financial reform package. The point of these reports was for banks to explain how, in the event of their failure, they could be wound down without devastating the positions of other banks, or requiring financial bailouts such as the TARP program. I am going to look today at Citigroup (NYSE: C).
Up until 2008, Citigroup was the largest bank in America, and is the only large bank to have shrunk in a meaningful manner since the beginning of last decade's recession. At one point it had assets of over $2.1 trillion, and a loan portfolio of about $770 billion. It has shrunk to the nation's third largest bank, with about $1.95 billion in assets, and loans have fallen to under $620 billion.
Much of that shrinkage of the loan portfolio had to do with the creation and the unwinding of the Citi Holdings unit. The unit was formed at the height of the banking crisis, created to house and deal with the more troubled assets of Citigroup's loan portfolio. All of the company's mortgages, commercial real estate loans, auto loans, student loans, and any other loans that Citigroup did not want to include as a part of the “core Citigroup” were placed into Citi Holdings, which held over $800 billion in assets in early 2009; it was down to $209 billion in assets on March 31, 2012.
Citigroup's resolution report begins by summarizing the positive steps it has made since 2008, including the aforementioned shrinking of its balance sheet. Perhaps more importantly and somewhat related to the shrinkage is the bank's Tier One Capital ratio of 14.3%, or double what it was five years ago. Citigroup's unencumbered liquidity resources at March 31 stood at $420 billion, meaning Citigroup is not reliant upon capital markets for its day to day operations. By almost any measure, Citigroup really is better equipped to withstand economic stress than it was five years ago, and that is the good news.
In the event of a substantial deterioration of Citigroup's business, the preferred resolution strategy is to use holding company assets to recapitalize Citibank, and then place the holding company into bankruptcy court. As for Citigroup's investment bank that currently holds some $400 billion in assets worldwide, this could be either sold or spun off to raise further cash. If things get so bad that Citigroup or another major bank is on the cusp of failure, there will be no buyers for large chunks of the bank. Alternatively, Citigroup believes that in an economic cataclysm the holding company can recapitalize the bank and the broker dealer network, and once those businesses are stabilized, the holding company can take back over. Welcome to Fantasyland.
Without question, the only reasonable chance for the long-term success of a bank of Citigroup's size and scope is to have sufficient capital on hand to offset any economic storm. The company has decided that its future growth is not going to be in North America, but rather, in developing markets in Asia, Africa, and Central and South America. Citigroup defines “North America” as the U.S, Canada, and Puerto Rico. As of March 31, 2012, the North American segment held 42% of bank assets and accounted for 36% of net income in the first quarter. Citigroup is committed to serve the 150 largest cities in the world, and only about 10% of those are in North America. Already 58% of banking assets and 64% of profits are gained outside of North America, and the North American slice of Citigroup's pie, while still the largest of the company's segments, will continue to decline compared to growth outside its home region. The 150 city strategy will place most of the energy of Citigroup's banking activities in emerging market countries, where 116 of the target cities are placed.
If Citigroup were to simply quietly clean up its legacy issues, and carefully re-expand its loan portfolio, the story could have a happy ending. Yet, it seems banks like Citigroup cannot go more than a quarter or two without there being some sort of expensive scandal, typically stemming from the investment bank. And so it goes again as I write this. Citigroup is being dragged into the London Interbank (LIBOR) scandal, which promises to be a doozy. The first of the fines to a dozen or more large banks has been leveled, starting with Barclays (NYSE: BCS), for about $450 million. Barclays also lost its CEO and Chairman due to the scandal.
Citigroup's stock has fallen by more than 25% since mid-April, and a case can be made that at least Citigroup has a strategy, and the resources to make it work. I highly doubt it will approach the 1.3% to 1.5% return on assets that it did year after year early last decade, but I also believe there is substantial upside in the three to five year period - more than with any other of this country's trillion dollar banks. So, if you can stomach the occasional unpleasant surprise, I think this is as good a turnaround candidate as there is in the banking sector for a patient investor.
If your time horizon is not that long, another Northeastern Bank that might fit the bill is Buffalo-based M&T (NYSE: MTB). M&T, with about $80 billion in assets, is nowhere near the size of Citigroup, but still ranks among the twenty largest commercial banks in the country. Its earnings in the first quarter of 2012 were flat with the year earlier, but due to some dilution related to M&T's acquisition of Wilmington Financial, per share net fell by 5% down to $1.50 per share. Still, except in quarters when M&T gives tens of millions of dollars to its charitable foundation, this is a reliable achiever of earnings of at least 1.0% of assets. Its debt ratings were recently increased by Fitch's. You are not going to see headlines about M&T splashed across the New York Times, but it is one of the premier large regional banks, pays a generous 3.3% yield, and has a 5-year PEG of 1.4. It is a bit ironic, but this regional is as well suited for conservative, income oriented investors as far larger and more well-known Citigroup is for risk taking growth investors; but that is the way it is.
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