Citigroup And The CCAR Question

Trending 1 year ago

Citigroup Reports 25 Percent Drop In Quarterly Earnings

Michael M. Santiago

On nan 9th of February, nan Federal Reserve Board released nan hypothetical scenarios for nan 2023 slope accent tests besides known arsenic "CCAR".

The CCAR results should beryllium released by nan extremity of June 2023. This is a cardinal arena and a apt catalyst for Citigroup's (NYSE:C) stock value arsenic good arsenic different ample U.S. banks specified arsenic JPMorgan (JPM). The outcomes from nan 2023 CCAR trial play an important portion successful determining nan expertise of nan banks to return superior to shareholders successful nan shape of dividends and stock buybacks.

A cardinal logic for nan comparatively debased valuation for Citigroup erstwhile measured connected a value to tangible book worth (~0.6x) aliases guardant P/E ratio (~8x) is nan existent handicap connected returning superior to shareholders. Mr. Market is not valuing banks connected their reported profitability, alternatively nan cardinal metric that matters now is really overmuch capital, nan banks are allowed to return to shareholders.

I person discussed nan various puts and takes for Citigroup successful this article. In summary, Citi's strategy of becoming smaller and safer should (all other being equal) support sustainably little superior ratios. This is of cardinal value for nan occurrence of Jane Fraser's strategy. As readers whitethorn recall, Citi expects to run pinch a target superior ratio ("CET1") of betwixt 11.5% to 12% successful nan mean term. Currently, Citi's target superior ratio is 13% which is materially higher than its medium-term targets.

Now a cardinal milestone on nan measurement for a simplification successful nan targeted superior ratios is nan yearly CCAR exercise. The scenarios released past week, arsenic reported by Seeking Alpha, look to beryllium harsher than anterior tests which are evidently not awesome news for nan U.S. banks and Citigroup specifically.

Having said that, it is important to look astatine nan specifications arsenic each slope has a different business model, and arsenic such, nan effect could beryllium vastly different.

In this article, I will endeavor to measure nan apt effect connected Citigroup and its stock value successful 2023 and beyond.

Review of nan 2022 CCAR results

The 2022 CCAR results were highly disappointing for Citigroup wherever its Stress Capital Buffer ("SCB") has gone up to 4% versus 3% antecedently (and 2.5% successful 2020). This is nan cardinal logic why Citi has now paused nan stock buybacks and is still building capital.

But what caused this adverse activity successful nan SCB year-on-year?

Below I americium comparing nan cardinal metrics for nan CCAR calculation betwixt nan 2021 and 2022 results:


Author, based connected information from nan Federal Reserve

As tin beryllium seen above, Citi's projected indebtedness losses were little successful 2022 compared pinch 2021 crossed each categories. But nan antagonistic result year-on-year was driven chiefly by little projected pre-provision nett gross and higher losses successful nan "trading and counterparty" category.

It is important to statement that nan Fed's CCAR models are somewhat of a "black box" successful portion to guarantee nan ample banks are not gaming nan system. Citi's ain models arsenic disclosed by nan patient task pre-provision nett gross of ~$45 cardinal compared pinch $28 cardinal nether nan Fed's exemplary - that's a monolithic quality of $17 cardinal and by and ample explicate nan unpleasant astonishment Citi knowledgeable successful nan 2022 CCAR cycle.

The 2023 scenarios compared to 2022

At first glance, nan hypothetical scenarios released by nan Fed look to beryllium harsher, but let's look astatine nan specifics arsenic per nan Fed's guidance:

The existent severely adverse script features a greater summation successful nan unemployment complaint successful nan United States arsenic compared to nan 2022 severely adverse scenario. This quality reflects nan Scenario Design Framework, which calls for a higher summation successful nan unemployment complaint erstwhile nan starting level of nan unemployment complaint is lower. The existent script features a importantly higher starting level of liking rates compared to nan erstwhile year’s scenario, which allows liking rates to diminution much forcefully successful consequence to nan hypothetical driblet successful economical activity and inflation. The script besides features a larger and much accelerated diminution successful location prices arsenic compared to their declines successful nan erstwhile year’s scenario. This larger diminution reflects nan Scenario Design Framework’s consequence to nan importantly higher lodging valuations astatine nan extremity of 2022. The imaginable for spillover effects successful plus markets and crisp revisions successful investor sentiment are captured by a diminution successful equity prices and an summation successful firm enslaved spreads, though these changes are somewhat little terrible comparative to past year’s scenario. These little terrible changes bespeak nan moves successful those markets complete nan people of 2022 and limits procyclicality successful nan scenario.

The supra script suggests higher indebtedness losses peak-to-trough particularly for unsecured in installments arsenic nan emergence successful unemployment is higher from a debased starting constituent of 3.5%. Having said that, Citi's indebtedness nonaccomplishment provisions arsenic of 31st December 2022 are blimpish and already facet successful an unemployment complaint of 5%+ and see a qualitative guidance overlay arsenic well. As such, nan absolute adverse effect year-on-year connected nan CCAR results whitethorn not beryllium arsenic worldly arsenic immoderate would expect.

The diminution successful liking rates has some a antagonistic and affirmative effect connected superior ratios. Lower rates would apt construe into a little pre-provision nett gross but would besides construe to a use to superior ratios owed to beneficial activity successful nan AOCI reserves.

On nan marketplace daze component, nan Fed highlighted nan followings:

The 2023 world marketplace daze features fading inflationary pressures, while past year’s constituent was characterized by worsening proviso concatenation disruptions that put upward unit connected inflation. Accordingly, nan existent world marketplace daze chiefly differs from nan 2022 constituent successful nan behaviour of liking rates, overseas speech rates, and commodities prices. Treasury rates autumn successful nan existent component, pinch ample declines specified for shorter tenors and milder declines specified for longer tenors. In nan 2022 component, Treasury rates accrued crossed nan word structure, resulting successful an upward displacement successful nan output curve. Similarly, ostentation breakeven rates alteration successful nan existent component, while they accrued successful nan 2022 component. The U.S. dollar depreciates against nan currencies of precocious countries successful nan 2023 component, while it mostly appreciated against precocious state currencies successful nan 2022 component. Nonprecious metals and different commodities, specified arsenic lipid and earthy gas, look ample value declines successful nan existent component, while commodity prices accrued successful nan 2022 constituent owed to proviso concatenation disruptions.

Clearly, nan effect would dangle connected Citi's trading position arsenic good arsenic nan Fed's models. Having said that, Citi successful caller quarters has intelligibly "managed" its trading book conservatively and reduced RWAs. This astir apt had respective desired outcomes including (1) optimizing superior accretion and (2) positioning conservatively nan book pinch an oculus to nan upcoming CCAR cycle.

Probability distribution of outcomes

My champion "guesstimate" for nan CCAR outcomes are:

  1. Base lawsuit (40% probability) SCB reduces to 3.5% from 4%
  2. Moderate carnivore lawsuit (30% probability) SCB remains astatine 4%
  3. Bull lawsuit (15% probability) SCB reduces to 3%
  4. Adverse carnivore lawsuit (15%) SCB increases to 4.5%

The stock value guidance is apt to beryllium very affirmative should (1) aliases (3) eventuate. A (2) result would beryllium mostly neutral and nan banal will waste disconnected heavy if it results successful nan result (4).

Final thoughts

Citigroup's stock value is highly delicate to its expertise to return superior to shareholders. This is perfectly cardinal for nan finance thesis astatine Citi.

I judge nan "new" much unchangeable Citi should outperform successful nan upcoming CCAR rhythm driven by nan beardown capacity successful nan Services section successful 2022 that should mechanically provender into a higher pre-provision nett gross forecast successful nan Fed's models.

Given nan banal trades astatine ~0.6x tangible book value, nan mathematics for stock buybacks is arsenic compelling arsenic ever. With immoderate simplification successful nan SCB successful nan upcoming CCAR cycle, I expect nan banal to melt up pinch nan expectations of monolithic buybacks to come.

On nan flip side, if it becomes clear that nan superior trajectory is materially higher for longer - this will beryllium a important handicap to nan banal capacity and investors should reassess nan thesis.

At nan moment, I americium leaning towards a affirmative result successful nan upcoming CCAR rhythm and frankincense stay very bullish.

This article was written by

IP Banking Research floor plan picture

Independent banking investigation focuses connected financials, heavy value, typical situations, and financial arbitrage. Agnostic and apolitical attack for scouring nan world for durable and uncorrelated cashflows that activity good successful some inflationary and deflationary settings.See my tipranks floor plan below: use from independent insights and value study from a banking insider - subscribe arsenic a "real-time" follower above.

Disclosure: I/we person a beneficial agelong position successful nan shares of C, JPM either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga

Read other contents from at
More Source