Summary
- Citi is often derided as a near-basket case with a bad history and a messy business structure that doesn't work.
- It compares well to the popular Bank of America in terms of ROE and ROA. This has not always been the case, but these days it is.
- The stock is 60% cheaper than BAC and offers a higher yield.
Citigroup (C) gave the market some bad news this week in the shape of an impending Fed reprimand about its antiquated risk systems not being updated quickly enough. Some articles suggested that the resignation of Michael Corbatt may have been hastened by this development.
I released an article on Citi just prior to the news coming out. My timing for a bullish article could hardly have been worse. Still, I don't think the buy case for Citi is affected too negatively by the systems issue it faces. This is not a new theme for the bank, and while it is disappointing that Citi has not moved quickly enough to avoid the Fed's formal disapproval, the sell-off has given investors an opportunity.
In my previous article, I suggested Citi has the potential to double, which incurred a fair amount of pushback in readers' comments.
The case was simple. All bank sector stocks can appreciate substantially if the economy recovers, and Citi offers additional upside if it can catch up to the kind of multiples peers like Bank of America (BAC) and JPMorgan (JPM) trade on.
The widespread negativity on Citi is poorly founded
Most of the points made tied in with the direction of an article in the Financial Times, covering the leadership transition Citi will undergo in February 2021, when Jane Fraser takes over from Michael Corbat.
As the FT put it this week:
Citi’s returns continue to badly lag those of its two closest rivals, JPMorgan Chase and Bank of America. These banks have balance sheets of roughly Citi’s size (about $2tn) and also combine capital markets, retail banking and corporate banking. But while Citi has fought to reach a 12 per cent return on tangible equity, Bank of America is approaching 16 per cent and JPMorgan has hit 19 per cent.Another problem... is structural. Much of the outsize success of Citi’s rivals in the past decade was due to their big retail operations in the US, which have solid, steady returns - and which create strong cross-selling opportunities with their wealth management businesses.
Make sure you are looking at the right measures of performance
As a former pro-bank equity analyst, I have never understood why commentators, let alone some major institutional investors, seem to use Return on Tangible Equity (ROTE) as their first reference point when discussing the profitability of a bank.
Intangible assets are certainly an important item to consider in relation to bank capital. Prior to 2008, we saw much goodwill built in expensive bank sector acquisitions that led to write-downs after disaster struck with the financial crisis of that year. The focus on tangible equity also reflects the focus on bank capital adequacy after the crisis, because intangibles are deducted from shareholder funds as part of the calculation of Tier 1 ratios for regulatory purposes. But tangible equity has little, if anything, to do with measuring shareholder returns in a bank.
Very simply, you can't buy only "tangible equity" in a bank (or any company) when buying the shares. You get all of the equity, including any equity invested in goodwill or other intangibles. As an investor, what concerns you is simple return on common shareholders' equity (ROE).
Banks can operate with different levels of equity, of course, so you next want to look at Return on Assets (ROA) as a kind of "deleveraged" measure of return that is closer to a margin metric.
