Not much has changed over the years, but the market remains wrong Citigroup (NYSE: C.). As banks face a tough economic scenario here in mid-2022, Citigroup has already survived a rather weak second quarter and the stock it is insanely mispriced by the market trading so much below tangible book value. My investment thesis remains bullish on the big bank.
Spending for the future
Citigroup fell earlier this year due to the big bank’s plans to spend on technology to improve risk mitigation and modernize systems. The market has extrapolated this higher spending as a sign of weakness, while other companies in the industry are able to cut costs.
For the second quarter of 22nd, the big bank added 7,200 people in technology while increasing spending by 14%. In total, Citigroup spent 8% more on non-interest related expenses to reach $ 12.4 billion.
The best part of the second quarter report is that the US economy may already be in a recession and the big bank actually thrived in the quarter. Revenues increased 11% to $ 19.6 billion, helping Citigroup offset higher costs while still generating a 63% efficiency ratio.
If nothing else, the extra expenses turned out to match the strong activity resulting from the increase in net interest income which increased 10% quarterly alone to reach $ 12.0 billion. The bank had 223,000 employees at the end of 2021 and struggles to match the efficiency of JPMorgan Chase (JPM) which gets over $ 130,000 in additional revenue per employee.
The bank just forecast another $ 1.8 billion increase in interest margin in the second half after the $ 2.0 billion increase in the first half. The Fed has just raised interest rates by 75 basis points and these higher interest fees will help offset the rise in technology costs and credit costs.
The market expects greater earnings weakness due in part to higher credit costs, but Citigroup is expected to still exceed an EPS of $ 7. Even taking all the known and now expected economic weakness, the unloved bank is expected to produce profits annual for 13.5 billion dollars.
Buybacks will come back
The biggest problem that Citigroup and big banking stocks actually face is regulators imposing more and more restrictions on business at the worst times. Due to the persistent effects of the financial crisis, capital ratios are always being raised just when big banks are expected to buy extremely cheap stocks.
Citigroup has a tangible book value, or TBV, of $ 80.50 per share while the stock is only trading at $ 51.90 right now. The big bank is expected to buy shares far below TBV here, but regulators have gotten to the point where Citigroup has raised the CET1 ratio to 11.9%, but the bank still doesn’t have enough capital.
Regulators increased the Stress Capital Buffer to 4.0% from 3.0%, raising the October 2022 regulatory CET1 requirement to 11.5%. Citigroup is already up 11.9%, but the bank doesn’t have much headroom at this level.
Additionally, the GSIB surcharge will increase to 3.5% from 3.0% in January. Citigroup will suddenly be forced to maintain a CET1 ratio of 12.0% when the actual minimum requirement is only 4.5%.
In addition, management wants the internal buffer to include an additional 100 bps, pushing CET1 targets to 13.0%. Citigroup must now raise its capital ratio by 110 bps before returning to the purchase of its own shares.
These numbers are ridiculous to Citigroup or any bank that now has 7.5% capital in excess of the actual minimum capital. In the recent CCAR, Citigroup found itself with the lowest CET1 ratio of 9.0% in the worst possible financial scenario that is unlikely to occur in the next 100 years.
The company released this statement on buybacks and capital returns on the 22nd quarter second quarter earnings call:
We will generate significant capital given our earning power and the completion of pending divestments. We know how important buybacks are to creating shareholder value, particularly when we operate at these levels, and we are committed to restarting them as soon as it is prudent to do so.
Citigroup will continue to pay what equates to a 4% dividend yield. Ultimately, the big bank will have a significant amount of capital and share buybacks will come back pretty soon. In the future, the bank is likely to see lower capital requirements providing a further boost. Not being able to use the extra capital does not eliminate the capital.
The key point for investors is that Citigroup shouldn’t be trading far below tangible book value. The bank generates a substantial amount of profits and any reduction in share buybacks in the next year only adds to the capital position of the large financial company to easily survive and thrive during any economic downturn in the next year. Investors should use any soft spot to buy the security well below its tangible book value.