Citigroup: Is Banamex Mexico Sale Imminent? (NYSE:C)

In several press reports in Mexico, there is an indication that the sale price of Citigroup’s (NYSE:C) Mexican consumer operations have been agreed (in principle) at $11 billion (examples for the reports are here and here). Strangely though, none of the main U.S. or European business news outlets (Bloomberg, Reuters, Financial Times) have picked up this story or confirmed these reports which may mean this is going below the radar for many U.S.-based investors. So I wouldn’t open the champagne bottles just as yet. Having said that, and in line with previous guidance by Citigroup of advanced discussions, I do expect an announcement latest within H1’2023. This also explains why Citi elected not to restart the share buyback program in the current quarter given the signing of a transaction results in a temporary capital hit. In the recent earnings call, Citi’s CEO Jane Fraser noted the following on the sale process:

So, we’re in active dialogue at the moment, so I’m obviously not going to comment in great detail here. We do continue to pursue a dual path as you’d expect, because both are very viable options here. And when we are in a position to give you clarity we will do so. I think we’ve been fairly clear about the timing….. But we are pursuing the dual tracks and when we have something to announce, we will be delighted to do so

I expect the share price to jump once the sale is confirmed. I also think that the $11 billion sale price is a very good price. Whilst it is short of the $15 billion asking price, it is well above the current book equity allocated to it (~$4 billion). The accounting (and perhaps tax implications) are likely to be quite complex, so we will need to wait for official confirmation by Citigroup’s press release.

Why Is The Sale Of Banamex Mexico So Important?

The selling of Citi Banamex is a watershed moment in Citigroup’s restructuring. The Mexico consumer operations are by far Citi’s largest international consumer disposal. There are a number of other reasons why this is so meaningful for the overall share price:

1. Firstly, it should release ~$11 billion of capital. Citi Banamex is being sold at a multiple of book value whereas Citi has the opportunity to buy back shares at 0.6x tangible book. This is exceptionally accretive from shareholders’ perspective. And the proceeds reflect over 10% of Citi’s current market cap (~$100 billion).
2. The overall targeted capital ratio (“CET1”) of Citi should be materially reduced, all else being equal. There are two factors in play currently that are driving Citi’s target capital ratios. The first one is the Fed’s annual stress test known as CCAR. Citi Banamex operations perform rather poorly under the CCAR stress test due to large forecasted loan losses in severely adverse scenarios. This in turn drives up the Stress Capital Buffer (“SCB”) Citi is required to maintain and feeds through to a higher targeted capital ratio. Note that Citi’s SCB has increased from the minimum 2.5% to the current 4% in the last 3 years and thus the key reason Citi’s targeted capital ratio rose from 11% previously to 13% now. Secondly, Citi’s GSIB score should also reduce quite mechanically, all else being equal, under the Basel GSIB assessment methodology as can be seen below:

3. The disposal of Banamex is making Citi’s digital transformation program and addressing the Fed’s Consent Order a much simpler endeavor. Uplifting Banamex technology systems, processes, and procedures to the level required by U.S. gold standards of regulation requires a lot of investment dollars and would have taken years to accomplish. A clean sale makes much more sense.

4. The disposal of Banamex signals the “beginning of the end” of Citi’s transformation. Citi’s management attention should now pivot from executing the divestitures to dealing with cost-base impacts (including stranded costs). Citi’s CFO sharpened this point in the Q4 earnings call:

First, let me remind you that at this point, the ongoing expenses in Legacy Franchises are approximately $7 billion. Of the $7 billion, roughly $4 billion is transferred to the buyer upon closing or through a transition services agreement that typically lasts about a year. The remaining $3 billion relates to potentially stranded costs and the wind downs, which takes time to eliminate. Second, as our investments in Transformation and control initiatives mature, we expect to realize efficiencies as those programs transition from manually intensive processes to technology-enabled ones. And finally, we remain focused on simplifying the organization and we expect to generate further opportunities for expense reductions in the future.

The Temporary Capital Impact

The signing of an agreement to sell Banamex is likely giving rise to a material accounting charge which in turn reduces Citi’s reported CET1 in the quarter. The good news is that it is only a temporary accounting (and capital) adjustment that fully reverses on the closure of the transaction as I explained in my previous article:

Citi Banamex is recorded as Held-For-Sale (“HFS”) and thus on the contract date (disposal), Citi is forced to recognize an FX accounting loss, even though that loss has already been reflected in its equity line as AOCI. On completion, this FX loss is reversed out of AOCI and thus flows as a benefit to CET1. In short, this is a temporary capital hit that reverses on completion. Now, given the book value of Citi Banamex, this temporary hit to CET1 is likely to be in the billions (Citi does not disclose the exact amount).

Final Thoughts

The disposal of Citi Banamex is a key catalyst and signals the inflection point in Citi’s strategic transformation. In my view, a successful exit is a very solid step in derisking the execution and making Citi a simpler and safer bank.

The benefits are unquestionably massive; Citi is becoming a much smaller and safer institution, the sale releases $11 billion of capital for buybacks and/or investments, capital ratio targets are reduced and transformation efforts are further simplified. This is to be a huge step forward for Citi and I believe the market will begin to recognize this in 2023.

The key risk is that there are further setbacks in the sale process and Citi is forced to go down the path of an IPO (which will clearly delay proceedings and introduce uncertainties). I think this is unlikely in light of reports in Mexico also Citi’s actions (no restarting buybacks in the current quarter). This suggests to me that the sale of Banamex is indeed imminent. I expect an announcement and a pop in the share price during Q1.

I expect Citi to resume share buybacks in H2-2023 and buy back shares massively in 2023 and 2024, driven by proceeds from disposals, earnings, and positive results from the Fed’s CCAR stress tests that are due to be released in June 2023.

Citi remains a top conviction buy and my #1 pick in the large U.S. banking space.