January 16, 2024 | Last week Citigroup (C) CEO Jane Fraser announced more losses and thousands of layoffs in coming years. Readers of The IRA might think we did a victory lap. After years of investors and analysts calling for improvements in the bank’s operating efficiency, Citi is finally making significant changes.
The prospect of thousands more people losing their livelihoods in finance does not make us happy. More, Citi cannot cut its way to profitability. Truth is that there are too many big banks in New York. Several ought to adopt a similar approach as Citi to enhancing shareholder valaue.
But maybe more radical action is needed. There are numerous examples of large public companies that defy logic and their shareholders when it comes to managing expenses, especially personnel expenses. Yet when we look at Citi, personnel expenses are not the only problem.
Citi’s operating results vs average assets, for example, shows that the bank is in line with Peer Group 1. But when we look at expenses vs net operating income, suddenly Citi’s operating profile shows a definite downward skew. Total operating expenses for Citi in the Q3 2023 Form Y-9 are actually below peer when measured against average assets, but jump up to the 76th percentile of Peer Group 1 vs adjusted operating income.
In plain terms, Citi’s income is too low for its growing overhead expenses, thus Fraser is cutting people. Citi’s personnel expenses are four points higher than its peers measured against operating income, according to the Form Y-9. But cost cutting alone is not going to fix the problems at Citi. A big part of the challenge facing Citi is in the business model. The decision to sell Smith Barney to Morgan Stanley (MS) in 2009 may have made sense in the depths of the financial crisis, but the sale of the asset management business left Citi crippled in terms of future business prospects. The chart below shows Citi (blue) vs JPMorgan (JPM) in gold.
Source: Google Finance
The lack of an asset manager deprives Citi of significant non-interest revenue that would make the business more stable. The table below from the FFIEC illustrates some of the key operating and financial differences between Citi and industry leader JPMorgan.
Source: FFIEC Q3 2023
Note in the table above that JPM had $1.5 trillion in mutual funds and annuities in Q3 2023 vs zero for Citi. JPM’s cost per employee is significantly higher than Citi but so is the assets per employee at $12 million vs $9.8 million. Citi’s efficiency ratio is 16 points higher than JPM, which still benefits from the acquisition of First Republic Bank.
Non-interest income is only one third of operating income at Citi vs almost half for JPM. And overhead expenses less non-interest income is just 5% of operating income at JPM vs a third for Citi and Peer Group 1. In a serious economic downturn, Jamie Dimon could literally run his bank on fee income alone and devote all of net interest income to loss mitigation. Kinda makes you wonder why the Fed and other regulators want to make JPM raise capital.
Keep in mind that Fraser and her team actually grew topline revenue 4% in 2023, but expenses rose twice as fast. Even though Citi’s occupancy expenses are half of its peers, the bank loses ground on other operating expenses, which again are four points higher than its peers. Thus Citi's net income remains well-below the top-five banks by assets.
Source: FFIEC
We congratulate Jane Fraser for tackling Citi's poor financial performance, but think that mere cost cutting is not enough. Citi has some very valuable businesses, including a global payments platform, a high-yielding consumer lending business and a global banking franchise. What is missing is a large asset management business to add non-interest income to the bank. The $2.3 trillion asset bank needs to merge with an qually large asset manager, but many of the properties are already taken.
If Jane Fraser and her team are not able to combine with a large asset manager, then the only alternative that makes sense to us is to break up the bank and sell the pieces to other institutions. At 0.53x book at the close on Friday, the various pieces of Citi are clearly more valuable individually than the whole business is valued by the market today.
The global payments platform alone should be worth more than the market value of the whole bank today as a going concern. Yet the fact is that Cit has been destroying shareholder value for several decades. In that regard, a little context is important in any discussion of Citi and long-term shareholder value. Pam & Russ Martens wrote last November in Wall Street on Parade:
"Citigroup did a 1-for-10 reverse stock split on May 9, 2011. That means that investors holding 100 shares of Citigroup back in January 2007 saw their position shrink to 10 shares after May 9, 2011. So yesterday’s closing price of $42.04 for Citigroup is effectively $4.20 for long-term shareholders, adjusting it for the reverse stock split. To put that in even starker terms, investors who have held onto this dog for almost 17 years have watched 92 percent of its share price vanish."
The real question, of course, is why is Citi even around in 2024. The bank that first introduced no-doc subrime mortgage lending to banks in the early 1980s lost its reason to exist after the rescue by the Treasury in 2008. But the Fed is particularly incapable of allowing large banks to fail as businesses and be broken up. The prefered pathway of the Fed and other regulators is to merge good banks with bad and thereby create overall mediocrity.
We've been following Citi since we worked in Bank Supervision at the FRBNY in the 1980s. In those days, anything with the "foreign" label was considered fair game by US intelligence operatives. US banks, multinationals and even the Fed itself often housed American officials engaged in covert work for Uncle Sam. Indeed, several of our colleagues from that era worked for the OSS in WWII and later for the CIA.
During the Cold War, Citi was a very convenient bank indeed. Citibank had offices in all of the right cities that might support US strategic interests, whether that was Lagos or Vienna or Beijing or Tel Aviv or especially Mexico City. But the business model that kinda made sense during the Cold War is irrelevant 50 years later.
The fact that Citi is unable to sell or IPO its Banamex unit in Mexico speaks volumes about the real book value of this corporation. One day, we'll have to tell the story of Citibank Private Banking during the term of Mexican President Carlos Salinas de Gortari. The scandal involving Raul Salinas de Gortari led to the exit of CEO John Reed in 2000.
Cost cutting is fine and long overdue, but we think that Jane Fraser and the board still needs to articulate a vision for Citigroup going forward. Why does this bank still exist in 2024?? What communities does this bank serve and why? Is a voluntary combination with another organization the best alternative for C shareholders? Or should Fraser seek a mandate from the board to sell the company? Fact is, were it not for the protection afforded by the Bank Holding Company Act, Citi would already have been broken up years ago.
Source: FFIEC
Our rough, back of the envelope guess is that Citi is worth at least 1.5 book in a breakup. The payments platform alone should be worth multiples of the current market value of equity at $100 billion. The gross yield on the bank's $2.1 trillion in earning assets is north of 9%. Black Rock and Santander attempted to buy Citi's consumer book back in 2011.
With interest rates likely to fall, maybe it's time for Citi's board to take another look at asset sales. Even if we assume that the investment bank and Banamex are a zero, we think a breakup strategy ought to be actively considered by Fraser and the Citi board. If the objective is to recover value for the long-suffering Citi shareholders, how else would Fraser and the board of Citi proceed other than selling the company? If Fraser cannot articulate a coherent reason to keep the business together, a breakup may be the most sensible strategy.
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