Breaking Citigroup in two could unlock US $72bn in market value, according to Keefe, Bruyette & Woods analyst Brian Kleinhanzl. Last week the bank brushed off a shareholder proposal to split itself up, but as calls for a two Citi solution grow, the bank may be forced to offer a more detailed defence of its current configuration and size.
In a research note, Kleinhanzl argued that the value of Citi's consumer banking would be about US $91bn on a stand-alone basis and Citi's corporate banking business would have a market value of US $100bn. The sale of its international consumer banking business, Banamex and some small and medium enterprises could fetch another US $7.5bn for a total market value of US $198bn, compared with the bank's market cap of US $126bn on March 17.
The bank has so far been successful in its plans to simplify and shrink and simplify but the strategy has not generated improved returns, the analyst said. KBW projects Citi will earn 8.5% tangible returns on tangible common equity in 2017, down from 9.3% in 2015. At the same time, Citi's cost of equity is almost 11%, suggesting that the bank will earn 23% below its cost of capital, KBW estimated.
"We believe Citi will not break up in the next year or so, but we do see a break-up of Citi as a potential outcome given returns may not increase above the company's cost of capital for the foreseeable future and shares have traded consistently below the company's tangible book value for an extended period of time," Kleinhanzl wrote. At the crux of Kleinhanzl's argument for breaking the bank in two is that as one of the eight largest US banks Citi will be subject to ever increasing capital requirements that will keep the bank from handing capital to its investors, in sufficient quantity or with sufficient speed.
"We fully believe that regulators are more than comfortable having capital build at the largest banks," Kleinhanzl said. The next big leap in requiring the biggest banks to hold more capital will come if the Federal Reserve forces banks to account for G-SIB surcharges during the stress test process. "One of the primary benefits of becoming smaller is escaping the vice that is the current regulatory environment," Kleinhanzl wrote. "We have made conservative assumptions and yet there is a path for Citi to improve its valuation by almost 60% versus where the combined company trades currently."
Last week responding to a proposal to split the bank from shareholder activist Bartlett Naylor, the bank said it has relied on expert counsel for its chosen strategy which is "most likely one to create the best long-term outcomes for stockholders." Citi has reduced assets in its Citi Holding "bad bank" to US $74bn or 4% of assets today down from US $619bn or 32% of assets in the fourth quarter of 2008.