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Why Citi is a candidate for a valuation rerating.

Summary: Macro trends in bank's global credit card business seem iffy

Matein Khalid Global Investing

Citi has disappointed on the improvement in its efficiency ratio. (AFP)

Citigroup, the most global of America's money centre banks, fell 17 per cent from its January 2018 high of 80 due to a myriad of entirely predictable factors. One, Citi has operated consumer/corporate banking franchises in Brazil, Mexico and Argentina for more than a hundred years. So the vicious bear market in emerging markets currencies made Citi shares fall eight per cent more than JPMorgan or Bank of America as Wall Street sagged.

Two, Citi owns full-service consumer banks in 12 Asian countries. The prospect of a US-China trade war is a disaster for the bank's growth engine in global consumer banking. Three, the flattening of the US Treasury bond yield curve in 2018 despite two Fed rate hikes in 2018 is not exactly positive for banking net interest rate margins. Four, the New York and London commercial real estate markets are flashing a major SOS to me. Manhattan condos are down 20 per cent from recent peaks. This is bad news for Citi. Five, Citi has disappointed on the improvement in its efficiency ratio. Six, macro trends in Citi's global credit card business seem iffy.

So it does not surprise me that Wall Street has derated Citigroup to a modes, even Cinderella valuation of 0.94 times tangible book value as I write. Justified? Absolutely not. Citigroup is the best shareholder capital return story in international banking, as attested by the 2018 Fed stress test results last week. CEO Michael Corbat has indicated that Citi will return $20 billion a year (12 per cent of current market cap) in share buybacks alone as it generates excess capital from some of the most profitable banking franchises ever accumulated since the Medici Bank financed the Florentine Renaissance and the Roman Curia five centuries ago.

The hedge fund Value Act accumulated a $1.2 billion strategic stake in Citi for precisely this reason and estimates the bank will return $50 billion to shareholders in the next two years, $10 billion more than Corbat's own projections. Apart from its Mexican banking subsidiary Banamex's debacle, Citi has had no problem passing the Federal Reserve's stress tests, an essential metric for dividend growth. Unlike 2007, when Chuck Prince's bond traders lost $50 billion in toxic, credit/mortgage derivatives and forced the Bush White House to engineer a TARP bailout of the bank that wiped out equity shareholders, Citi is a bank obsessed with risk management and regulatory compliance. Even Trump's rollback of Dodd Frank and the Volcker Rule will not mean the return of the old Citi aggressive risk taking corporate culture. This is Wall Street's ultimate "too big to fail" systemic risk bank and will only benefit from the woes of risky, overleveraged, mismanaged, TLAC (total loss absorbing capital) non-compliant German, Italian and European banks.

The US banking system is the most attractive destination for global savings as financial markets exhibit bubble valuations reminiscent of 1929, 1987, 2000 and 2007. Systemic risk in US banking is at lowest since the 1960s while it is rising alarmingly in Europe, Southeast Asia and the emerging markets. Citi is embedded in the plumbing of Wall Street and the global banking system, thanks to its cash management, Treasury services and global custody businesses, which lower earnings volatility and boost margins. Citi's Basel Tier One capital ratio, its global funding base and its rising returns on equity all tell me that the bank is a potential candidate for a valuation rerating.

Obviously, Citigroup's second quarter earnings and conference call will be the real-time vindication (or not!) of my bullish take on the bank's shares at current levels. I have invested and traded in Citi shares since Sandy Weill "tore down the walls" with his bids for Salomon Brothers and Travelers (both shares I owned) to forge Citigroup. Citigroup is one of my favourite financial shares with Morgan Stanley, KKR, the Chicago Merc and Blackstone, as readers of my column know all too well. I expect Citi to trade in a 64-80 trading range this year, though I acknowledge it will be a rollercoaster rise as factors such as the Mexican/Brazil elections, the Fed stress test results, the Sears/Cosco partnership in credit cards, the FICC and corporate finance pipeline, the China trade war could all move the shares big time. Stay tuned. It is a labour of love for me to chronicle the pendulum of greed and fear in Citigroup shares.

The writer is a global equities strategist and fund manager. He can be contacted

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Publication:Khaleej Times (Dubai, United Arab Emirates)
Date:Jul 1, 2018
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