Citigroup Stock: Massive Buybacks In 2023 And Beyond (NYSE:C)

Citigroup (NYSE:C) is currently required to build capital. Consequently, it paused share buybacks. This is extremely unfortunate as Citi is now only trading at ~0.6x tangible book value whereas its underlying performance is going from strength to strength. Year-to-date, Citi has delivered a RoTCE of 10.8%, so it effectively trades at a P/E of ~5.

The good news is that this pause is temporary. In fact, by 2023, Citi is likely to find itself with excess capital that could be deployed towards share buybacks and massively so.

What has caused the capital shortfall?

It was a perfect storm of 3 separate items. It caused Citi’s minimum capital requirements to increase from 10.5% to 12% effective by the end of 2022. Citi also keeps a capital buffer of approximately 100 basis points, so its new target capital ratio is 13%.

Firstly, Citi’s G-SIB score has gone up and consequently increased the minimum capital requirements for Citi by 50 basis points. The increase also impacted several other banks including JPMorgan (JPM). The G-SIB methodology is quite a crude and mechanical calculation that indiscriminately penalizes banks for notional size regardless of actual risks. It has been widely criticized by the banking industry but to no avail.

The second item (and most material) is the results of the latest Fed stress tests also known as CCAR. Citi’s stress capital buffer (“SCB”) has gone up from 3% to 4% and thus effectively increased Citi’s minimum capital requirements by 100 basis points. Back in 2020, Citi’s SCB was a minimum of 2.5%.

The final item has to do with rising interest rates. As rates rise, the bank’s certain bond portfolios are marked down, reducing the capital resources available (known as the “AOCI impact “). This is a temporary accounting impact that reverses over time. Citi estimates that the headwinds to capital are as much as 50 basis points in the first two quarters of 2022. This will start to reverse in Q3.

What will change in 2023 and beyond?

Firstly, Citi will build up to its target 13% CET1 ratio reasonably quickly; I estimate that by the first half of 2023 or earlier. The drivers include (i) organic earnings (ii) reversal of AOIC (iii) Risk-Weighted-Assets (“RWA”) optimization and (iv) completion of asset global consumer disposals.

Importantly, I also believe that in the next cycle of CCAR (June 2023), Citi’s SCB will reduce by at least 50 basis points. Firstly, Citi only barely made it to the 4% bucket, as its actual SCB in 2022 was 3.6%.

Secondly, in the CCAR computation, the starting point for Citi CCAR calculation will be a much higher pre-provision income (as 2022 numbers will be used as opposed to 2021) which should offset projected losses to an extent.

Thirdly, Citi’s projected stress losses will likely be lower given the completion of consumer assets disposals. This will be further materially reduced once Citi completes the sale of Banamex Mexico.

Finally, Citi is also likely to ‘manage’ the CCAR process better (especially on its markets’ trading shock scenario), albeit this will ultimately depend on the Fed’s CCAR scenarios.

Longer-term, Citi’s G-SIB score will also likely reduce due to the disposal of the global consumer franchises. Citi is becoming materially smaller, and that helps the G-SIB score calculation.

In the Q2 earnings call, Citi’s CEO confirmed that its medium target capital remains in the range of 11.5% to 12%, as well as explained the rationale for disposal of the global consumer footprint.

Yes. Let me just underline a couple of points. When we built our strategy, it wasn’t only to generate greater returns, but it was to lower our capital requirements over time.

So while I fully expect Citi to build to a 13% CET1 ratio in the near term, I also expect it to quickly find itself with excess capital, which will lead to massive share buybacks.

The strategy is working

It is becoming increasingly clear that Jane’s strategy is working and quickly. The Q2’2022 earnings report was stellar, and Citi delivered close to ~12% RoTCE even whilst building reserves due to macro uncertainties.

Treasury and Trade Solutions (“TTS”) printed above $3 billion in quarterly revenue and Security Services neared $1 billion supported by higher rates. TTS is likely delivering close to ~30% RoTCE due to increased client volume and higher rates.

Commercial Banking is growing 25% to 30% year-on-year. FICC and Equity trading delivered strong results up 25% year-on-year, outperforming the industry so far. Credit cards outstanding grew 11% year-on-year with charge-offs remaining at historically low levels.

The only slight disappointments included Asian wealth management and investment banking where activity levels were much lower due to economic conditions.

However, and most importantly, it is clear that Jane Fraser has taken the difficult but correct decision to dismantle Citi’s global consumer bank. It is clear that Citi’s minimum capital ratio would have to be higher without making these key strategic decisions.

Finally, Citi is making much-needed investments in its core businesses, people, systems, and technologies. These are absolutely the right decisions and will likely pay off in the medium and long term. Citi is completely rewiring and digitizing the bank. Citi is becoming a simpler, smaller, and much more focused bank with a strategically coherent business model.

Final thoughts

The Citi turnaround story is well on track, and in my view, Citi is just too cheap to ignore. It is trading at 0.6x tangible book value and so far in 2022 has delivered ~11% RoTCE despite increased investments and additional reserving taken.

The increased capital requirements due to CCAR and the pausing of share buybacks are unfortunate. However, this is only a temporary setback – I expect Citi to be in excess capital position by mid-2023 and resume share buybacks.

Investors still have the opportunity to buy a quality banking business at very distressed valuations. There is a lot to like about Citi now compared with its recent chequered past. I remain very bullish and may use long-dated call options.