C - Citibank

[ourkid8]

Citi Announces $1.75 Billion Increase to Planned Capital Actions.  Citi is now repurchasing $10.35B in stock this year which is amazing under TBV - huge value creation!

 

http://finance.yahoo.com/news/citi-announces-1-75-billion-124500913.html

[Viking]

Interesting how sentiment can change. A year ago C was trading below $40. Today it is trading over $60. What has changed? Sentiment.

 

At $60 I think C is still cheap. They will earn about $15 billion this year. They will harvest about $2 billion from their deferred tax assets. They are already way over capitalized so they should be able to return $17 billion to shareholders; with the shares trading at $60 a buyback of this size would allow C to retire 280 million shares or more than 10% of shares outstanding. This will be the gift that keeps on giving every year moving forward. 10 year US Treasury yields 2.23% :-)

 

Things to watch:

1.) the US and global economy... as long as we do not see a recesssion C will do well. I follow the calculatedrisk blog and he does not even have the US on recession watch :-)

2.) capital return: what are they approved to return in CCAR in late June? $15 billion looks doable to me and they could surprise with a larger amount.

3.) what kind of top line growth can the business generate moving forward? C investor day in July should answer this.

 

Headwinds:

1.) legacy Citi Holdings continues to mute top line growth (as assets are disposed) and muddy reported results (with sizeable one time gains and losses and restructuring charges). However, at less than 3% of total assets this toxic stew is almost a non issue. My guess is we are about 18 months away from this segment not impacting total C results.

 

Tailwinds:

1.) Regulatory Relief in the US - republican controlled President, Senate and House: up until the election politicians of both parties, especially the Democrats lead by Elizabeth Warren, were very anti big bank. Lots of legislation was passed since 2008 and, more importantly, the appointed department heads interpreted and enforced this legislation in a very punitive way (from the big banks perspective). In the coming years as republicans take over the various appointed roles we can expect the legislation to be interpreted in a less punitive way and this will very good for US banks and their profitability and this will be good for shareholders. My view is we do not need to see any actual changes to laws for the banks to benefit from the Democrat defeat in the fall elections.

 

Good historic overview of C: http://www.economist.com/news/business/21718924-recipient-americas-biggest-bank-bail-out-has-overhauled-its-capital-base-and-its-profits

 

Steve Eisman (the Big Short) goes long US banks: http://www.investopedia.com/news/famous-big-short-investor-goes-long-banks-jpm-bac-c/?partner=YahooSA&yptr=yahoo

 

C shares outstanding have finished each calendar year as follows:

2013 = 3.029 bill

2014 = 3.024

2015 = 2.953  -2.3%

2016 = 2,772  -6.1%

Q1 2017 = 2,753

est 2017 YE = 2,600

est 2018 YE = 2,400

[racemize]

I agree.  I'm still long C/JPM/BAC (although I halved my position since the Trump election).

[Viking]

If Citi does not find a way to improve its results in the next 12-18 months it will face increasing demands to sell off divisions to realize shareholder value (use proceeds to buy back undervalued stock). The Mexico Banimex business appears to be the most popular choice.

 

https://finance.yahoo.com/news/citi-struggles-bring-back-shine-133156379.html

 

[Viking]

Author IP Banking Research recently posted a great article explaining why Citi has been outperforming the other big US banks the past 3 months. https://seekingalpha.com/article/4076879-citigroup-outperforming-big-banks

 

As CCAR results are announced in June I think the conversation with investors will also start to change and focus on return of the excess capital on their balance sheet. Currently C estimates they have $15 billion in excess capital (over and above what the regulators require). They are earning $14-$15 billion per year and also utilizing $2-3 billion of their DTA per year. I see regulators approving $18-$20 billion per year perhaps as early as next year and for many years after. It really is amazing how much cash the big banks are going to be earning and returning to shareholders in the coming years. Their balance sheets are in their best shape in decades. A case can be made that the large US banks are more like utilities now. The yield on C capital return was 7% over the past year and moving forward will be 8-10% each year (with lots of tailwinds). And 10 year US treasuries yield 2.15%

[John Hjorth]

Thanks for sharing your thoughts about this company, Viking.

 

As posted before on here, I'm educated in accounting [Danish CPA], however I consider myself far from some kind of expert in financials for banks.

 

In the SA article is written:

 

Finally, the Fed's CCAR process has a huge significance - Citi currently holds a common equity tier 1 (CET1) of 12.6% and accruing capital rapidly due to DTA consumption. Whilst it expects to target around 11.5% CET1 ratio - this essentially means that Citi will need to return more than 100% of its earnings going forward. We shall find out next month what progress Corbat & team have made.

 

This "DTA consumption" - if I understand it correctly - I would phrase different, based on my professional background.

I understand it this way: C's taxable income in its tax returns, after tax loss carry forward, will most likely be about zero for many years going forward. When there is a taxable profit [before tax loss carry forward]  for C in a given year going forward, the tax on the tax loss carried forward from prior years to reduce the taxable income for C to zero is booked in the financials as a decline in the DTA asset in the balance sheet, and it - the decline in DTA - is booked as a tax expense in the income statement.

 

While the CET1 ratio does not include DTAs in the calculation basis under assets, C is growing its CET1 level based on profits before tax, so the ability to pay dividends or do share buybacks is growing based on profits before tax, not profits after tax, [in case there in a given year going forward is generated a profit, that is.]

 

My question here is: Have I understood this correctly?

[racemize]

That is how I understand it, so if that's wrong, I hope someone corrects us.

[John Hjorth]

Thanks for the confirmation here, racemize.

 

In the 2016 financials there are some qualifications about a part of the DTAs and their utilitization, that I right now do not understand, because of lack of US tax knowledge. I will just read up on that, based on self study.

 

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C seems to me to be priced in the market different [cheaper] than the three other major US banks, while at the same time having this DTA utilitization advantage on DTAs positive effect on ability for dividends and share buybacks going forward.

 

It seems weird to me, that it actually is so right now.

[Viking]

John, I am not an expert of US financial reporting; for the past 12 months I have been reading IP Banking articles on Sseking Alpha and he does a pretty good job of explaining the DTA.

 

Bottom line, Citi earnings will be turbo charged for the next 10 years or so as they utilize their deferred tax assets. Citi management is guiding that they should be able to utilize from 2-3 billion in DTA per year.

 

So for 2017 RBC is estimating that C will have net income of $14 billion. If they utilize $2 billion of DTA they will increase regulatory capital by $16 billion. If they return $15 billion to shareholders over the next 12 months they will still be building capital on their balance sheet, $1 billion in my example.

 

Citi management has said that they already have at least $15 billion in excess capital on their balance sheet. They also want to return this and perhaps they will be approved to return this in $2 or $3 billion increments each year moving forward.

 

When you put it all together:

1.) net earnings = $14

2.) DTA = $2

3.) approved return of excess capital = $2

It would not be shocking to see C approved to return $18 billion as part of CCAR (perhaps $15 billion up front and $3 billion later in the year). I am not forecasting $18 billion this year; I just think $18 will be coming at some point in the next year or two and it will continue for many years.

 

C will also be growing its net earnings. RBC is estimating 2018 = $15 billion.

 

The question is how do you value a company that will pay out more than 100% of earnings (div plus share repurchases) that is still able to grow total profits? This is going to happen over many years (this is not a one year phenomenon).

 

C today has a trailing PE of 12.7 ($63.40/$5.00). You get a company with:

- net earnings of $14 billion, growing at $1billion per year.

- DTA utilization of $2.5 billion per year = $0.90/ share ($2.5 billion / 2.750 billion shares)

- $15 billion in excess capital = $5.75/share ($15 billion / 2.750 shares).

 

Next year (2018) C will grow regulatory capital by $15 + $2 = $17 billion. Shares outstanding Jan 1 2018 will be about 2,600 million. They will generate $6.50/share in regulatory capital which puts the PE under 10.

 

In 2019 C will grow regulatory capital by $16 + $2 = $18 billion. Shares outstanding Jan 1 2019 will be about 2,400 million. They will generate $7.50/share in regulatory capital which puts the PE at 8.5

 

C has lots of tailwinds that will make this picture even brighter. As regulatory burdens are eased the big banks will earn even more money and also be allowed to return more even excess capital. 

 

The one big negative is if the US or world economy enters a recession (nothing looks imminent right now) :-)

 

My guess is it will take 24-36 months for Mr Market to fall in love with the banks. The banks may have already run up anticipating DFAST and CCAR results and may sell off next week. No idea where shares go in the short run. However, greed is a beautiful thing and as investors come to understand the cash machines the US banks have become I believe they will expand the PE multiple. It would not surprise me to see C trade north of $90 in 2019.

 

All the big US banks will do well over the next few years. However, they all have slightly different business models so performance will vary somewhat.

[John Hjorth]

Viking,

 

Thank you very, very much for expropriating your personal and scarce time to share your thoughts about C in your last post here in this topic.

 

For my part, it's very, very much appreciated, that you actually put so much time and energy into sharing your ideas and line of thinking with me and other fellow board members.

 

Your last post this topic is so good, that if we here on CoBF had a monthly, or even yearly, competition about "the post of the month/year", I would without hesitation nominate it.

 

Your post is fairly long, and at the same time short [in the meaning: compressed & comprehensive - one has to do ones own work to fully understand and comprehend each and every line written by you].

 

I read your last post before going to bed yesterday, and it made me get out of bed at 7:00 AM today, to start reading - here, there and everywhere.

 

After working the whole today with C [to now - I'm actually tired now], every sentence you posted in your last post in this topic makes sense to me, after going back and forth between your last post and public available information about C.

 

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This is not a "clear no brainer" - you really need to study the tax situation of C in depth with regard to understanding it, both from the perspective of group accounting, and from the perspective of regulatory capital. If you understand that in detail, to me, it's actually evident, that there is opportunity for getting a real attractive return on your invested capital in this company here, based on the ruling price in the market, and at the same time considering the risks.

 

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Again, thank you for sharing your thoughts and mindset here, Viking. It's very, very much appreciated for my part.

[Viking]

John, thanks for the kind words. Writing definitely helps to crystallize ones thoughts and I appreciate the opportunity to respond to other investors questions and comments. Below are a few more thoughts :-)

 

When I worked for Saputo (large Dairy supplier in Canada) we always wanted to be a supplier to the 'winning horses' those retailers who would dominate food retail for the next 10 years. Back then we targeted Walmart and Costco as they were just entering retail in Canada. Our existing customers were not happy about us supplying a competitor but we made it work. As a result our business did very well for many years and this strategy has stuck with me ever since. One of the keys in investing is to find the 'winning horses', place your bet and then let the horses run the race all the way to the finish line. I think that the large US banks will be one of the 'winning horses' of the next 5 years in the stock market.

 

What price should one pay for a share of the big US banks? C traded at $38 in the last 12 months. Today it trades at $63.40 so after a 67% increase it MUST no longer be cheap! Surely is will trade back into the mid or even low $50's?

 

Is C cheap today based on PE multiple Mr Market has paid the last 10 years for big US banks? No, it looks expensive today (C is currently trading at 12.7 PE). Normally this would lead me to want to sell my position and lock in some big gains and wait for a lower re-entry point.

 

I remember posting on Apple 4 years ago when it was selling for $51 (split adjusted) with a PE of 8. Today it trades for $146 and it has a PE of 17. Apple's business has not changed that much in the last 4 years and profits have grown nicely (on average) each year. What has changed is investors have gone from hating the company to loving the company and they have doubled the PE they are willing to pay for Apple's earnings (from 8 to 17).

 

US banks were easily the most hated sector from 2008 up until Trumps election last year. I think there is a decent chance that over the next couple of years the PE multiple the market will pay for the big US banks earnings will go up. Higher total profits + much lower share count + expanding PE multiple = much higher share price.

 

Currently C trades at 12.7 x prior 12 month earnings. If the PE multiple grows modestly to 14 then C could trade at $81 the end of 2018 ($5.80 est earnings x 14PE) which would be close to a 30% gain in 18 months. This is not a forecast and is intended to show the outsized gains that can happen when PE multiples get re-rated upwards.

 

C does have its warts.

1.) Citi Holdings continues continues to mute top line growth and cloud results (as assets are sold); however, every year Holdings impact is lessened and we are likely 18 months away from being able to forget about This division. Asset sales will continue to mute top line growth (1 or 2%); there will be a few more one time hit to earnings due to restructuring. C has made very good progress over the years in winding Holdings down but we are not done yet.

2.) underinvested in Mexico for many years after the crisis (had to preserve capital). Catch up spending will be elevated the next few years (I think C said they are investing about $350 million per year moving forward with $1 billion in total over a couple of years).

3.) past culture was not shareholder friendly; it will take C many years to prove their new business model and current management team are good. C has been morphing for the past 10 years and the new company is only now coming into focus. The C investor day in July will be important to communicate to analysts further details and build credibility.

[Viking]

John, i made the call late last week to go heavy with C.  I decided the bigger risk was not having an overweight position and missing the next move higher. I believe the story is so good for the big US banks that I am happy to buy now and let time work its magic and live with the short term volatility. As I stated in my last post, C trading at $63.40/share is not cheap looking in the rear view mirror (how Mr Market has valued the company the past 10 years). When I look at C and look out a year or two it looks cheap to me at $63.40. It is difficult to predict when the various catalysts will happen - I am just confident that a year from now the big US banks will have higher earnings, a much lower share count and will be given a higher PE multiple by Mr Market (as investors fall in love with the sector) - when these three things happen at the same time a stock increases in price a lot.

 

Possible Catalysts:

1.) CCAR: I think the CCAR announcement on June 28 will be good for C and I think they will be approved to return $14 billion to start and another $2 billion later in the year for a total capital return of about $16 billion July 1 to June 30. We will have details in a few days and we will also learn what Mr Market has already priced into C shares.

2.) Citi Investor day in July: if C provides further details on how to improve returns in its consumer business (focus will be credit cards but there will hopefully be more). Another opportunity is more concrete details of what they will do with $15-$16 billion of excess capital they are currently carrying (grow top line or return it to investors or some mix of the two).

3.) 3rd rate hike in the fall by the Fed. Should US economy continue with 2% or 2.5% growth in 2H my guess is the Fed will hike fed funds rate again in the fall which would be great news for C.

4.) regulatory relief: as Trump fills vacant positions in the regulatory agencies I expect the current rules to be interpreted in a more bank positive way. At some point in the next year I also expect some of the actual laws to be modified in a pro bank way.

5.) Obamacare repeal/tax cuts: I think there is a better than 50% chance the Senate will approve Trumpcare and it will also get through the house. Republicans need to approve Trumpcare as it provides the massive savings needed for aggressive tax cuts. This will benefit C much less than the other big banks but it will still be a benefit to C (C will need to write off a chunk of their DTA).

 

[John Hjorth]

Thanks again for sharing your thoughts about C here, Viking,

 

I agree with you on all points and on the overall considerations of yours.

 

Today, I have been thinking about the C case the whole day on/off, rereading the stuff in the 2016 financials, going to and from it the whole day. There is no more time for thumb sucking here any longer - there is only two days to hopefully grab some more at a decent price - most likely.

 

I'm still thinking about the downside risk, if we at some point in the future begin approaching an adverse scenario, if something somewhere breaks and bursts. We will have to jump off the train at whatever speed, if we see it start derailing and hope for a not too hard landing.

 

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The C CEO Michael Corbat has approx. USD 30 M skin in the game here. That's not pocket money.

 

Furthermore - and at least to me, more important - he is the person who has been responsible for winding down the "bad bank" parts of C [Citi Holdings - in the period, before he became C CEO] after the GFC. This fact gives me at least some confidence, that prudent banking has been reinstated and will be maintained going forward. That kind of work - and why it was needed - most likely is in his long term memory like some script hammered with a chisel into a stone, so that a similar situation will not occur again.

 

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Yesterday evening the eyes of the Lady of the House turned big like teacups when I told her about the size of the losses in Citi Holdings from 2008 going forward - it's USD 63.7  B [and over now] - to comprehend this size of a loss I think I need to swich yardstick from tons of spilled milk to multiples of book value of the Great Belt bridge connecting Funen and Sealand here in Denmark.

[racemize]

It is nice to see some bank discussion on here after so many years. We bought Citi at various levels under book value for the last few years.

 

I don't disagree with anything said here, but I thought it might be useful to put some more bearish thoughts down for consideration.

 

Since the GFC, Citi and BofA were both in the penalty box and have been trying to dig their way out of it. Both took quite a bit longer than many of us hoped, but it is especially true in Citi--they have missed targets quite a few times, and I have to say I was disappointed with the recent updated guidance that they could get to 10% returns, if you exclude quite a bit of DTA. They have also been slow on ROA targets.

 

As a result, I do think they deserve a discount to peers, even BofA. On the other hand, I think they should be at least 1.3x tangible book.

 

For what it is with, we had 30%+ exposure to banks in BofA, JPM, and C going in to this year--we still hold all of them, but sold each in even proportions, including C based on my thoughts above.  We still have 5% each though, so I do believe the upside is still present.

[vinod1]

Lots of good comments.

 

I had a large allocation (50% to 120% of portfolio) to banks for most of the last 6 years and still have a decent sized position in a few banks though not Citigroup at this time. My preference had been to invest in BAC when it is at a similar price/IV to Citigroup and they have tended to trade together for most of the time. So I always ended up with BAC but I have sold off even that early this year. Now it is different of course with Citigroup cheaper than BAC.

 

I cannot think of any reason why banks should be mispriced now from investor fear. Not after 70% to 100% jump in share prices over the last year and half.

 

That said, many people worry about mean reversion of profit margins, earnings multiple, interest rates, etc. of the market overall. For bank investors, these would be tailwinds and benefit from them, if there is mean reversion in any one of those things :)

 

Coming to Citigroup, I think it would be better to value the excess capital and DTA's separately to make comparisons with other banks easier.

 

The company has $15 billion in excess capital beyond the regulatory requirements that can be distributed to shareholders with approval of regulators. Assuming about 70% of this would be distributed over the next 3 to 4 years the present value is about $3 per share.

 

In addition it has about $30 billion in DTA that are excluded from the capital requirements and which reduce cash taxes over the next 15 to 20 years. At a discount rate of 9%, and assuming DTA's would be utilized uniformly over the next 15 years at $2 billion each year, the present value is about $20 billion or about $7 per share.

 

Thus, the present value of total excess capital that can be distributed without any impact to earnings power is about $10 per share. Given a current earnings power of about $5 per share, it is at about 11 times earnings after the $10 in PV of excess capital.

 

Qualitatively, the current management is doing all the right things that have been neglected for so long even after the financial crisis when they wasted several years under Pandit while BAC is working on streamlining the company.

 

For me one concern is that Citigroup and its predecessors never had a good consumer credit underwriting history. All the other big banks, had solid underwriting history on the consumer side. BAC's Countrywide being an exception. I wonder how much of Citigroup's credit underwriting culture has changed, since that is a very tough thing to do. At present the current multi-decade low level of credit losses can mask those things. They had provisions of $6.75 billion in 2016 and even very modest normalization could mean another $2 billion in provisions.

 

So over the next couple of years there is a possibility that if growth does not materialize  in sufficient quantity, credit losses could hinder earnings growth and even chew up some of the excess capital.

 

As the Economist put it, if JP Morgan Chase balance sheet is fortress like, Citigroup is like a nuclear bomb shelter. Given the capital strength and other factors mentioned above, it is difficult to see how one can lose money from these levels and not make better returns than the market.

 

Vinod

 

 

[Viking]

IP Banking has another article out on C and CCAR: https://seekingalpha.com/article/4083939-something-really-odd-citigroup-ccar-results

 

 

He also has one out BAC and CCAR: https://seekingalpha.com/article/4084173-bank-america-ccar-payout

[Jurgis]

Given the capital strength and other factors mentioned above, it is difficult to see how one can lose money from these levels and make better returns than the market.

 

I can't quite parse this. Are you saying that from current prices people will likely not lose money, but they will likely underperform the market? Or something else?

[racemize]

One other thing to note, the Costco card acquisition is also costing them money now, which should ameliorate in the next six months, I believe.

[John Hjorth]

Given the capital strength and other factors mentioned above, it is difficult to see how one can lose money from these levels and make better returns than the market.

 

I can't quite parse this. Are you saying that from current prices people will likely not lose money, but they will likely underperform the market? Or something else?

 

With all due respect for you and the content of your very good post, Vinod, I'm in on the question to you from Jurgis too.

[John Hjorth]

IP Banking has another article out on C and CCAR: https://seekingalpha.com/article/4083939-something-really-odd-citigroup-ccar-results

 

 

He also has one out BAC and CCAR: https://seekingalpha.com/article/4084173-bank-america-ccar-payout

 

You actually beat beat me to it, Viking,

 

This one on C is to me very good too: IP Banking Research on SA: Citigroup: The Importance Of CCAR.

 

This person behind this particular username on SA I consider in his [or her] very own leage with regard to banks, ref. what Viking has posted before in this topic. Most importantly, the person is aware of own circle of competence - there is a request for discussion with other SA users about the C taxes, so if you're interested, please read all the comments to the article too. Please be aware, there is actually a CPA [<-!] posting rubbish to IP in the comments.

 

Thank you to Viking for guiding me to this SA author. It's the first one I have ever started following on SA.

 

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I'm in some kind of state of excitement today - like the day every year before I get to read Mr. Buffetts next shareholder letter - can't wait to read the C CCAR report and annoucement to be disclosed tomorrow.

[vinod1]

Given the capital strength and other factors mentioned above, it is difficult to see how one can lose money from these levels and make better returns than the market.

 

I can't quite parse this. Are you saying that from current prices people will likely not lose money, but they will likely underperform the market? Or something else?

 

Sorry, it came up opposite to the way it is intended. Corrected it above. I think one can make better returns than the market with Citigroup.

 

Who knows what the market will do, but 5 to 6% annual share reduction and 1% dividend yield with even just 1% to 2% top line growth should provide returns that would be hard for the overall stock market to match. There are catalysts to increase IV much faster for Citi.

 

Nothing to be too excited about but if one is drowning in cash, not a bad investment.

 

Vinod

[Valuehalla]

Why your Gusy think C has better potential than BAC or WFC? During last days BAC and WFC were at the top of the big banks, concerning price-increase.

 

My main reason to be in BAC and WFC is that BRK is behind it. And they were extremly cheap in past.

[Viking]

Valuehalla, I think all the big US banks are very well positioned moving forward and will do well looking out 3 to 5 years. However, their businesses have important differences.

 

In the near term I like Wells Fargo the least; the retail account scandal has resulted in elevated expenses that will only come down in late 2018 or 2019. This will slow earnings per share growth compared to the other big US banks in the near term. There is also the risk that the accounting scandal will limit the amount of capital they are approved to return in this CCAR cycle; we will see in a few hours if this is true.

 

I think JPM has the best management team. The stock is the most expensive.

 

I expect BAC to do very well in the coming years. One of the keys for BAC will be 10 year rates as this impacts their business more than the other banks; if 10 year US treasuries move higher in the 2H of 2017 (as Gundlach expects) and in future years then BAC shares will go much higher.

 

I have followed C very closely for close to two years now. I tend to stick with what I know. :-)

[Viking]

Wow! The capital return at C is much larger than forecasted (I think consensus was a total of $14 billion). Dividend doubled from $0.16 to $0.32/quarter which will give shareholders about a 2% yield. Buyback is $15.5. With shares trading after hours at $66.70 this would allow C to retire 235 million = 8.5% of total outstanding (shares issue as part of compensation will offset a small part of this). Between dividends and buybacks shareholders will receive yield of about 10.5% in capital return over next 12 months. I wonder if C will front load the buyback like they did this year. I also wonder if they have the ability to ask for a small top up (as they were allowed this past year). This also bodes well for a similar (or perhaps even larger) award next year. Getting excess capital off balance sheet will also help C achieve its ROTCE target etc. C management was telegraphing a large CCAR award so this is definitely a feather in their cap and builds their credibility. The investor day in July will have lots of good news to talk about and if C is able to show a credible path to better returns in its consumer business we will be set for a good 2H. All of this should lead to upgrades and higher price targets and ultimately a rising share price. Lots more tail winds to this story! :-)

 

"The planned capital actions include an increase of Citi’s quarterly common stock dividend to $0.32 per share (subject to quarterly approval by Citi’s Board of Directors), as well as a common stock repurchase program of up to $15.6 billion during the four quarters starting in the third quarter of 2017. These planned capital actions total $18.9 billion over the next four quarters."

 

https://finance.yahoo.com/news/citi-announces-2017-planned-capital-203800096.html

[LC]

Thanks Viking. Bought shared in C two days ago. Wish I bought more!

 

$19B capital return plan or 10.5%