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Bright lights, rich Citi

27 December 2011 By Antony Currie

Investors may soon find that the joke’s on them about Citigroup. The bank has managed to step into every financial mess of the last few decades. In the boom, its business model lagged behind rivals in profitability before it lost tens of billions of dollars on mortgages in the bust, leading to a double government bailout. Any hint of financial distress anywhere seems to send the stock lower; it trades at just over 40 percent of book value. But 2012 may be the year when investors believe this time it’s different at Citi.

That’s because the institution, led by Vikram Pandit, may be in a position to start handing back more cash to shareholders over the next few years than almost any of its rivals. Granted, JPMorgan is already serving up a tasty $4 billion a year in dividends, and its chief executive, Jamie Dimon, is hoping the Federal Reserve will give him permission to bulk up the offering after the latest round of stress tests.

If he can return to paying out around a third of its net profit in dividends by 2013, that could reach $7 billion, based on the consensus earnings estimate of sell-side analysts.

So by comparison, Citi’s symbolic 1 cent-a-share payout barely qualifies as an amuse-bouche. And with the remnants of the group’s foray into questionable assets still on course to cut some $2 billion off 2011 earnings, it’s hard to see how Pandit can come close to matching his rival’s lavishness, let alone outperforming it.

But Citi has a couple of tricks up its sleeve. First, it still has around $250 billion of unwanted assets in Citi Holdings, almost half of which is composed of the bank’s remaining bad mortgages and the rest a collection of nonbank lending businesses mostly accumulated by one of Pandit’s predecessors, Sanford Weill. Selling or running these off may free up around $25 billion of capital. Citicorp, which houses its regulated banking businesses, is already well capitalized. So unless that money is returned to shareholders it will sit on the balance sheet, dragging down returns.

More for shareholders, though, should come from Citigroup’s $50 billion in deferred tax assets, a consequence of losing so much money over the years. Regulators allow only around $11 billion of this asset to count toward common equity. If the remainder did too, Citi’s Tier 1 common ratio would near an exceptionally robust 15 percent. Calamities aside, Citigroup would probably not need that surplus capital, which means there could be an additional $39 billion for shareholders to feast on over time.

There is, of course, one rather large sticking point with both pots of gold. First, Citi Holdings will take several more years to fully wind down. And Citigroup needs to actually earn money to monetize the deferred tax asset because it tapped into some $2 billion in the first nine months of this year, and various triggers ought to allow it to speed up the pace from 2012. Myriad different tax requirements in the more than 100 countries in which it operates makes this exceptionally difficult to model.

But using an admittedly back-of-the-envelope approach, assume it takes 10 years to pass on all the benefits. That makes for an average of $6.5 billion of excess capital to hand back to shareholders every 12 months. If Citigroup can also start paying a dividend from its core business’s earnings, investors’ total windfall could top $12 billion a year, which would be almost double JPMorgan’s potential payout.

There’s just the not-so-small matter of convincing investors that it can survive any fallout from Europe’s debt woes, another recession in the United States or a possible slowdown in emerging markets, where Citi leads its American counterparts. And savvy investors would want some assurance that Citi won’t use its newly found riches to splash out on excessive bonuses for employees or value-destructive acquisitions.

Investors are unlikely to see much of this El Dorado from Citi over the next 12 months. But they will begin to see evidence of whether Pandit has put the bank on a trajectory to cashing in these chips. As that confidence increases, Citi shares should pull ahead of the pack.

Predictions: Breakingviews is publishing a series of articles over the holiday that look ahead to 2012. The pieces will be collected together in the annual ’Predictions Book,’ produced in print and electronic form early in the New Year.


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