Why Citigroup would be better in bits

September 2, 2014

By Rob Cox

The author is a Breakingviews columnist. The opinions expressed are his own. 

Nine years ago, Breakingviews proposed an “extreme idea” to Citigroup’s then-leader Charles Prince. The $240 billion New York bank’s market capitalization was lower than the worth of its parts valued separately. By splitting into three separate units, the idea was, Prince could hand shareholders an extra $50 billion or so, the equivalent of one entire U.S. Bancorp at the time.

As it turned out, Citi had bigger concerns ahead. The housing crash exposed spectacular losses, wiping out capital and necessitating a government bailout. Prince was sent dancing onto the golf course. With the crisis now fairly distant in the rear-view mirror, however, it’s time for current Chief Executive Michael Corbat to revisit the case for a breakup.

Now cleaned up and well capitalized, Citi’s market cap today is about $160 billion – though any loyal shareholders are still nearly 90 percent worse off than in 2005. Despite the revamp, the bank is still prone to the stumbles that have proved characteristic since Sandy Weill, Prince’s predecessor, stitched the behemoth together.

This year, for example, Citi revealed an embarrassing fraud at its big Mexican subsidiary, Banamex. While not material to Citi’s capital, the $400 million swindle rekindled concerns that sprawl makes it too complex to manage. That’s one reason the Federal Reserve subsequently thwarted Citi’s plans to increase its dividend.

Slicing Citi into more manageable pieces would be one way to soothe regulators at home and abroad, not to mention U.S. taxpayers fearful of being on the hook for another bailout in the future. For any voluntary breakup to gain support, though, it would need to reward shareholders well beyond breaking the dividend logjam. Some arithmetic on Citi’s component parts suggests that’s possible.

Start with Mexico. Spanish bank Santander’s Mexican offshoot fetches twice its book value on the stock market. At about a 20 percent discount for the less profitable Banamex Citi’s unit may be worth about $15 billion – perhaps more to the likes of local billionaire Carlos Slim. Santander’s blueprint is a good one: separate ownership, or at least a separately listed entity, provides clarity and incentives for managers. In Santander’s case, a degree of local involvement also comforted regulators in both Madrid and Mexico City, according to an executive familiar with Santander’s initial public offering.

Citi’s North American consumer business, which includes its branded and white-label credit cards and 900 bank branches, could also be cut free. Spinning off a business highly dependent on capital market fundraising would have been unthinkable during the crisis. But General Electric’s successful IPO in July of its consumer financial arm, Synchrony Financial, proved that times have changed.

Citi’s U.S. retail division reported net income of $2.1 billion in the first half of this year. Annualize that and put it on a price-to-earnings multiple of 13 times, and the division is worth perhaps $55 billion.

That leaves what may be best dubbed “Core Citi” – the wholesale and corporate bank, which includes the world’s top cash management and foreign-exchange backbone and a big investment bank. If Core Citi matches its first-half results through the year, it will report $11 billion of profit in 2014. At 12 times earnings, a discount to State Street and slight premium to Goldman Sachs, the business would be valued at around $132 billion.

Add up the pieces, and that’s around $200 billion – a quarter more than Citi is worth today. That doesn’t even include some other bits like the international consumer arm, which could remain with the core Citi business. Excluding Latin America, this segment is on track to earn about $1.3 billion in 2014. Managed without the shackles of a board focused heavily on the United States, the more attractive pieces of this, like franchises in Southeast Asia, Hong Kong and India, might over time even add up to another Standard Chartered in their own right.

Predictably, there are flies in the ointment. The biggest is Citi Holdings, the division into which previous bosses dumped orphaned and unwanted assets. Holdings lost $48 million in the first half of this year and would be hard to separate from the North American consumer arm, where it would eat into returns on capital for some years to come.

Another wrinkle is Citi’s so-called deferred tax asset, which the bank values at around $50 billion. This is essentially an accumulation of past losses that will offset future earnings and thereby reduce future taxes. In a breakup, only a portion of this would remain with Core Citi and the North American retail arm, necessitating a multibillion-dollar accounting charge. But in the important area of capital, this would be unlikely to hurt Citi, because international bank capital rules disqualify all but a small portion of the deferred tax asset for regulatory purposes.

And even some of these clouds may have silver linings. For example, the revival of investor interest in subprime lending bodes well for the OneMain Financial unit, currently inside Citi Holdings. The former Associates lending business, now on the block, could be worth $4 billion or more based on the multiple of book value commanded by rival Springleaf. Profitable sales of such non-core assets could accelerate the cleansing process and free up capital.

Corbat, the CEO, shows no sign of considering such a radical restructuring. Without pressure from Citi’s board or Chairman Michael O’Neill, who ousted Vikram Pandit, the last CEO, a breakup isn’t likely to gain traction. But Corbat is a thoughtful executive, and the exercise in outlining how the bank could be wound down speedily in the event of distress – conducted at the behest of regulators – will also have revealed mechanisms that could be used to break the company up.

For now, he is focused on a strategy that Citi’s leaders believe will help the stock price narrow the bank’s 30-odd percent discount to book value. If successful, that will close the gap between the company’s market cap and the value of its parts. Any further mishaps, though, and shareholders, board members and regulators alike might start to think Citi would be better broken into bits.

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