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Citigroup shares were a fabulous winner in 2016!

By Matein Khalid

 

Citigroup has been my favourite US money center bank in the US, recommended in successive columns, most recently at 45 a month before the US election. The bank’s shares surged 15% after the election of Donald Trump for multiple reasons. Trump’s pro-growth policies mean a inflation risk premium in the bond market as Uncle Sam’s deficits and debt issuance surge, the reason the ten year US Treasury note rose from 1.75 to 2.34%. A steeper US yields curve is extremely bullish for US money center banks. The Republican Congress also means a potential rollback of Dodd Frank and the Volcker Rule, which Trump branded a “disaster”. This is hugely positive for Citigroup, J.P. Morgan, Bank of America and Wells Fargo as it means less compliance risk, more trading and market making revenue, less risk of any 1930’s Glass Steagall legislation to separate commercial and investment banking. Trump’s win also means easier Fed stress test rules, more bank mergers, less risk of restrictive capital surcharges. Trump’s platform even includes a moratorium on financial regulation. Both Citi and Bank of America can request higher dividend payout ratios at the next Fed stress test and the 2 year forward US Treasury note yield curve (2018) has shifted up 100 basis points, a 15-20% EPS windfall for both Citi and Bank of America. So the spectacular financial windfall in both banks before and after Election Day was no coincidence.

 

Citigroup’s transformation since Michael Corbat became CEO in November 2012 after a boardroom palace coup ousted Vikram Pandit has been one of the great money making stories of international banking, one I chronicled here in this column at least a dozen times in the past four years as its shares more than doubled from 25 to 55 as I write.

 

Citi has rebuilt its Basel common equity Tier One capital ratio to 12.6% and reduced its legacy Citi Holdings assets from $500 billion in 2009 after the bank’s near failure and government bailout under TARP to a mere $113 billion even as it shrunk its balance sheet from $2.5 trillion to $1.9 trillion now. Citi has revamped the risk controls in its Banamex subsidiary in Mexico where a major fraud caused it to fail a Fed stress test. Citi has slashed its consumer banking footprint in high risk emerging markets where it lacked scale, from Turkey to Brazil, Argentina to Egypt. Citi’s investment banking and trading divisions have begun to perform again, the reason the bank beat its third quarter earnings estimates. Of course, emerging markets still contribute 40% of Citi’s bottom line, more than in any major American bank. So Citi will be hit hardest if Trump launches an assault on NAFTA (Banamex) or China trade (the Asian consumer and corporate bank).

 

I believed Citi was grossly undervalued when it traded at 45 a month ago or at a 34% discount to tangible book value and 9 times forward earnings. However, I do not recommend new money to buy the shares now after their sharp spike at 55 – 56. The easy money in Citi made after the Chinese yuan wobble in March when the bank was a no brainer at 35 and after Brexit when the shares fell to 39. I believe the shares can well give us another opportunity below 50 if risk assets sell off in January or February, as the Age of Trump dawns on world history.

 

Longer term, I have little doubt that Citi will achieve management’s 10% return on equity target. Citi will also return at least $6 billion to shareholders in 2017 as payouts creep higher and share buybacks accelerate. Corbat is obsessive about reducing the bank’s risk weighted assets in capital intensive, low return businesses and slashing the cost/income ratio to the early 50’s. In 2007, the bank’s Chuck Prince boaster “the Citi never sleeps”. In 2008, Citi’s $50 billion in losses wiped out a generation of shareholders and unnerved depositors, who did not sleep! The New Citi finally lets us sleep!

 

Christmas came early in 2016 to owners of Wells Fargo and Bank of America, both profiled ad nauseous in this column. BOA Merril has risen 30% and achieved my $20 target as the most interest rate money center bank in America, thanks to its $1.25 trillion deposit base, with $400 billion in deposits that cost the bank nothing. The bank has also paid $70 billion in crisis era fines (a litigation risk peak). Trump means Merrill Lynch’s “thundering herds” will be in a stampede again in wealth management, mortgage and lending in the US. Brian Moynihan has creates a banking colossus from the ghosts of Charlie Merrill, Countrywide, MBNA, First Boston and LaSalle Bank. The American banking market will be white hot next year.

 

 



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