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View the Euromoney 25 |
In the middle of 2017, Citigroup hosted an investor day, its first in many years.
Its message was that the restructuring of Citigroup is now over: that it is a simpler, smaller, safer and stronger institution; one that has been increasing revenues faster than costs for some time while also investing in businesses that should materially boost earnings in the years ahead.
The unspoken message was that it should no longer trade at a valuation discount to its peers.
When third-quarter 2017 results rolled round, Citigroup showed continued positive operating leverage, with year-to-date revenues up 3% to $54 billion, operating expenses flat and net income up 7% to $12 billion for the nine months. The bank has been buying back equity, so further boosting returns, with earnings per share up by 13% compared with the first nine months of 2016 and return on tangible common equity of 8.3%, up from 7.8% a year earlier.
The Federal Reserve took a while to accept that Citigroup was excessively capitalized, rejecting its plans to buy back stock in 2014.
“It’s only three years ago [in 2015] that we got CCAR [Comprehensive Capital Analysis and Review] approval to buy back $7.8 billion of stock. So, when we received approval this year [2017] to buy back $18.9 billion, that felt like a very significant step,” John Gerspach, chief financial officer of Citigroup, tells Euromoney. “It’s the result of work that has been done over many years to transform this company.”
The three-year plan laid out on investor day has revenues increasing at a 3% compound annual growth rate to 2020, with the efficiency ratio falling from 58% for 2017 to the low 50s.
Revenue rises alone won’t achieve that.
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| Michael Corbat |
CEO Michael Corbat put his own people on notice that: “Throughout the franchise, we will be bending the cost curve.” If Citi gets all this right, it should boost reported annual profits to $20 billion by 2020 and, with plans to buy back $60 billion of equity over the next three years, so push return on tangible common equity to 11%.
To win CCAR approval to return $20 billion of capital a year, its risk managers will have to make sure it does not sacrifice underwriting standards in the pursuit of earnings growth.
Together, co-branded and proprietary US cards are a big part of Citigroup, accounting for 20% of group revenues. The bank has been a big acquirer of both kinds of portfolios, arguing that it has the know-how and technology to manage greater scale.
But the bank has been warning about rising credit-card charge-off rates in recent months, for example recently increasing guidance for net credit losses in Citi Retail Services, which manages private-label credit cards, up from 490 basis points to a range from 510bp to 525bp. It still sees credit cards as a strong return on asset business. But something new seems to be happening and it’s not clear what.
Gerspach says: “The underwriting in Retail Services is much stronger today than before the crisis, and you can see this in the Fico scores of our customers. When it comes to NCLs [net credit losses], what we have been seeing [in Retail Services] is a collections issue, not a credit issue. The rate of our customers who go delinquent has remained steady for several years, but once they tip into delinquency, they are moving more quickly into full charge-off.”
How has the bank responded.
Gerspach says: “Some of the rules have changed recently about how and how often you can contact customers in arrears, which may be a contributing factor. But this is something we are watching carefully and we have already built up a lot of reserves.”
He adds: ‘We know very well that investors will be watching to see if we have to continue building reserves. It’s my job to worry about everything, but we are comfortable with our underwriting diligence. In US branded cards, we have longer-term guidance for 325bp of losses, but we are currently only seeing only about 285bp.”
Investors will be hoping this is not a canary in the coalmine.
Another red flag to look out for when the bank reports fourth-quarter 2017 earnings in January 2018 will be declining fixed income markets revenues.
The good news is that the bank is building up in secondary equities and has already improved its standing in equity capital markets, up to fifth spot in the US from ninth a few years back. The Institutional Clients Group business is becoming more balanced. And investment banking revenue for the first nine months of 2017 was up 24% on 2016.
In consumer banking, Citi has shown signs of what it might achieve through investments in digital technology with the relaunch of its Citigold offering for affluent customers last year.
The number of households availing themselves of Citigold increased 20% last year, with balances also growing fast.
Gerspach says: “We believe that while global consumer banking is a 13% return on tangible common equity business today, we can get it to 19% in 2020.”
