The deep value metrics of the new Citigroup

Citigroup shares have tanked from their 52 week high at 61 to only 41 now as Wall Street repriced credit risk in Asia, Latin America and high yield energy loans.



By Matein Khalid

Published: Sun 13 Mar 2016, 11:00 PM

Last updated: Mon 14 Mar 2016, 9:04 AM

Citigroup is arguably the most controversial money center bank on Wall Street. America's third largest bank almost failed in 2008 due to horrific $50 billion losses in toxic credit derivatives and only survived because of Uncle Sam's TARP bailout. Citigroup also almost failed in the early 1990s after its balance sheet was gutted by losses on property/leveraged buyout loans in 1991 and was rescued by its white knight shareholder Prince Waleed bin Talal, Chairman of Kingdom Holdings. In the late 1970s, Citigroup led the ill fated US sovereign lending binge in Latin America since its then CEO Walter Wriston naively believed that "countries do not go bankrupt". It is a pity that Wriston was ignorant about the sovereign default of Plantagenet England during the Wars of Roses, a default that contributed to the collapse of Florence's Banco Medici empire in the Renaissance.
Yet the Citigroup of 2016 is a far smaller, more diversified, less leveraged bank, better capitalised bank than the bloated institution that former CEO Charles Prince ruined because he wanted to "keep dancing" as the music played on in the netherworld of US subprime mortgage excreta. While J.P. Morgan and Bank of America have bigger balance sheet than Citigroup, Citi is the most global US megabank with a footprint in 160 countries.
Citigroup shares have tanked from their 52 week high at 61 to only 41 now as Wall Street repriced credit risk in Asia, Latin America and high yield energy loans. The softness in US manufacturing data awakened fears about "recession risk" and the fall in US Treasury bond yields since last summer compressed net interest rate margins for US banks. However, 2008 is not remotely 2016. Citigroup has $150 billion equity Tier One capital and the Citi Holdings loan book has been reduced to only $100 billion, down from $500 billion when Vikram Pandit first succeeded Chuck Prince as CEO in 2009.
Citigroup is trading at an unjustified discount to its net tangible book value of $60 a share. The 242,000 February payrolls data and a 4.9 per cent unemployment rate also convinces me that a June FOMC rate is now a high probability event, as implied by the Eurodollar futures market in Chicago. This is bullish for Citigroup, as is the fall in emerging market and oil and gas loan credit risk spreads in the past month. In fact, since I expect at least seven rate hikes in 2016-17, I expect Citigroup's net interest rate margins to rise, possibly to as high as 280 basis points by 2018. Citigroup could well earn a return of shareholder equity near 12 per cent, so its current Cinderella valuation of 0.68 times tangible book value a compelling entry point to me.
The old Wall Street adage argues the big money is made when things go from Godawful to just plain awful. This is exactly what will happen to Citi's Third World debt/energy portfolio in 2016-17. CEO Michael Corbat has exited underperforming businesses around the world, boosted capital, diversified the bank's global funding base and reduced the banks systemic risk, though it is vulnerable to the regulatory strait jacket of Dodd Frank, the Volcker Rule and Basel Three. Yet if there was ever a "too big to fail" megabank in world finance, Citigroup's vast consumer, corporate and investment banking empire across 160 countries is it.
Citigroup's key competitive advantage is its $900 billion low cost retail deposits and economies of scale in cash management, securities underwriting/placement, global custody, corporate banking and issuer services. Though fate is fickle, the litigation cost cycle has now peaked.
Citi passed the 2015 Fed "stress test" and its Basel Tier One ratio is 10.7 per cent. Emerging markets risk will remain the Achilles heel on Citi's $1.9 trillion balance sheet. Yet I believe these risks are not systemic, unlike the case in 1991 or 2008. Citigroup has transformed its culture, governance, balance sheet, risk management protocols and funding base since Vikram Pandit was ousted in a boardroom palace coup in late autumn 2012. Selling 100 contracts of Citi 45 strike, January 2017 expiration put options generates $75,000 in premium. This means the worst case scenario on this strategy is to own Citigroup at 37 or eight times earnings if I am delivered the shares. If this happens, as we say in the Gulf, ahlan wa sahalan.


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