Stock Pick – Citigroup: A new strategic template?
Citigroup rose almost 50% since I recommended it as a compelling
buy last summer as its valuation metrics were a joke relative to its
franchise value, if not tangible book. Citi offered another opportunity
to accumulate in the trading book last week at 34 as its 12% fall since
Election Day was due to political noise on Asia recession scenarios
required by the Federal Reserve capital stress test and the hoofbeats of
the hedge fund herds eager to chase the high beta US housing rainbow via
Bank of America (NYSE: BAC TYO: 8648 ) is the largest commercial bank in the United States in terms of deposits, and the largest company of its kind in the world.
, the best performing Dow share of 2012.
Yet Citi surged 3 full points last week after
slashed 11,000 jobs and sealed back the Global Consumer Bank in
Pakistan, Uruguay, Romania, Turkey and Paraguay. Citigroup has been my
favourite US money centre bank because I still believe Wall Street
undervalues the sheer earnings power of its global businesses, not least
its US consumer loan/mortgage/wealth franchises as US home price and
capital markets volume/pipeline rise.
The Goldman Sachs Fin conference in New York was, as I expected,
the venue to unveil the strategic template of the post Pandit new Citi.
John Gerspach targets 10% ROE, 125 – 150 basis ROA. This means 2014
could well be as high as 5.60. A post-Fed stress test multiple of 10-
well, you do the math. I did it in June and swiftly grasped that Citi
offered irresistible 60 – 80% money making potential as I scanned the
global banking village. Amazing how luckier you get the deeper you dig
into the homework.
Let me stress that all is not hunky dory in the kingdom of Citi.
See London interbank offered rate (LIBOR).
sanction probe, Dodd Frank, the Volker Rule, Fed CCAP politics
in Congress (stress test/capital returns) could all get nasty as would
consumer debt time bombs in Brazil, India or the GCC. Yet I still
believe Citi is a steal at 36 or 0.65 times tangible book since Wall
Street simply undervalues its exposure to US housing via a consumer
loan/credit portfolios whose scale dwarfs even Well Fargo, JP Morgan, US
Bancorp or PNC.
Citi’s US loan loss reserve releases alone could goose 2012
above current consensus estimates. In any case, capital markets is a
wild card for Citi since Salomon Smith Barney’s balance sheet is
$900 billion, not much smaller than Goldman Sachs. However, Securities
and Banking bottom line will benefit from tighter credit spreads,
emerging markets M&A, Asian/MENA debt underwriting, global FX and
robust FICC market making even as Corbat slashes low margin cash
equities. Trading volumes have been hypervolatile since 2011, another
Corbats no no.
Citigroup has many ingredients I seek in a bank share I intend to
buy. Positive operating leverage in the Global Consumer Bank, a rise in
net interest rate margins, organic deposit growth, improving credit
trends and rise in capital ratios, cost control and efficiency metrics.
The real catalyst for 2013 will success in the 2013 Fed stress and thus
a dividend payout of at least 0.60 and accelerated share buy back
program. Capital return and proactive global restructuring will be the
twin themes that move Citi in 2013, even as the bank achieves Basle
Three compliance, even achieves a 9% Basle Three Tier One ratio by next
year end. These events will have a seismic impact on Citigroup’s
I was asked why I devote so many columns to Citigroup by a senior
UAE banker. Good question. So many of my friends in Citi Dubai from the
1990’s (the ABB era) lost their entire life savings in Chuck
Prince’s CDO/subprime credit Armageddon that I want to keep them
updated on Citi’s epic renaissance. Tangible book value in
Citigroup is now $52 though I believe the bank will continue to trade at
a discount as long as annual Fed stress tests continue. Yet excess
capital returns, the US consumer loan book, emerging markets growth and
loan loss release windfalls for EPS are the reason I believed the bank
was a money maker for investors at 25 – 26, which is exactly what
happened. Citi’s valuation discount will narrow even though the
easy money has now been made at almost 38.
Macro Idea – Making money in Asian sovereign debt
Asian sovereign debt is an asset class with money making potential,
albeit not without risk. I believe the Indian rupee now offers value at
55 – 56 even though the
(guanosine diphosphate): see guanine.
decline, current account deficit, WPI
inflation, political risk, crude oil import dependence, anti-reform
blocs in the Lok Sabha and public debt black holes remain existential
macro risks. Hopefully, RBI Governor Subbarao will initiate a succession
of rate cuts as inflation peaks now that GDP growth has fallen to 5% and
the UPA has won a no confidence parliamentary vote on retail
India’s Stone Age distribution networks, diesel/fertilizer
subsidies removal and chronic power shortages make me pessimistic if WPI
inflation with its supply side component, can fall much below 7.5% on a
sustainable basis even as high interest rates/political cycles hit
business capex. After all, 10 Indian states have elections next year.
This means the RBI has no choice but to opt for easy money, a compelling
argument to go long ten year rupee government debt (G-Sec) even though
the rupee yield curve is much too flat given the FX/inflation risk that
can still devastate returns for the offshore investor.
I have made no secret of my gaga view on the Philippine peso in the
past two years as it has emerged as the strongest currency in Southeast
Asia against the US dollar, the new Sing. A country once derided as the
sick man of Asia
“, plagued by a secessionist war in Mindanao
and even a Marxist rural insurgency, has emerged as a New Age Asian
Tiger 6% GDP growth, $25 billion remittances, a sovereign credit upgrade
cycle, higher tax collections, a shrinkage in the budget deficit,
inflation below the
target and, historic lows in government
borrowing yields. Philippine peso’s epic appreciation will continue
even as central bank reserves rise to $85 billion. After all, the peso
traded at 47 – 48 just three years ago, when I first wrote about the
Philippine peso in this column. I recommend going long the Philippine
peso at 42 for a 38 twelve month target.
Pakistan was once again one of the best performing stock markets in
Asia despite endemic political violence as the elected
President Zardari completes its term. However, the Pakistani rupee will
continue to depreciate against the dollar as inflation risk and a
decline in central bank hard currency reserves (less than $14 billion)
forces Islamabad to seek a new
See International Monetary Fund (IMF).
stabilization program after the
elections. This means the SBP will be forced to end its easier interest
rate policy, particularly as $110 Brent and external debt repayments
pressures hits the current account deficit. While the dollar denominated
Pakistan sovereign Eurobonds (2016 maturity) were a spectacular winner
in 2013, I believe the Pakistani rupee will depreciate as low as 106 –
108 next year for a cumulative 30% depreciation since the end of
President Musharraf’s military government.
The Singapore dollar was my favourite currency in Asia since summer
2006, when it traded at 1.65
on the eve
of one of the epic currency
appreciation in modern times, akin to the Deutschemark’s post Plaza
move in the 1980’s. However, the glory days for the Singapore
dollar’s rise are over, even if the MAS was hawkish in its October
conclave. Southeast Asia’s most open, city state economy is exposed
to a European recession and the rise in
in economics, a word coined in the 1970s to describe a combination of a stagnant economy and severe inflation. Previously, these two conditions had not existed at the same time because lowered demand, brought about by a recession (see depression),
risk as GDP growth
rates stagnate. The new political climate in Singapore is less
pro-immigration (a classic growth risk) and poor productivity data may
force the MAS to dampen its anti-inflation vigilante fervor as wage cost
pressures fall once export markets/domestic demand deteriorate.
Singapore in now in technical recession. The Sing dollar could fall to
1.26 in the next spasm of risk aversion.
Thailand has been my favourite Southeast Asian stock market since
2011, a view profiled ad infinitum in this column. The SET index in
Bangkok is up 30% in dollar terms, with property/bank shares key
winners. Thailand is now on the eve of a central bank easing
cycle that makes Thai baht government bonds a compelling theme, as 50
basis point policy rate cuts mean a sharp rise in long duration baht
Market View – Rethinking the metrics of mispriced risk
Financial markets are replete with shocks, shifts, surprises and,
in the case of Japan, even literal seismic risks. Who would have thought
that the biggest winners of 2012 were Hugo Chavez’s Venezuelan
stock market, Egypt’s EGX index, Greek equities, Portuguese and
Irish debt, all asset classes where the risk of ownership equaled being
gored while running with the bulls in Pamplona? I had recoiled from Club
Med debt simply because I have no intellectual grasp of Greek, Italian
or Spanish/Catalan politics but I recommended French banks (the BNP call
alone is up 40% since July) as proxy surrogates for a
Club Med debt, given their exposure to Greece, Portugal and Spain.
Another contrarian call pooh poohed by even close friends in finance was
my bearishness on the Japanese yen in late September, despite no real
rise in the JGB – US Treasury spreads.
Consensus, complacency, the madness of crowds, can be fatal in
markets, a lesson that spans the centuries from Dutch tulips and the
South Sea bubble
popular name in England for the speculation in the South Sea Company, which failed disastrously in 1720. The company was formed in 1711 by Robert Harley, who needed allies to carry through the peace negotiations to end the War of the Spanish
to the Internet mania, Souk Al-Manakh/Nikkei Dow, Gulf
property and US subprime housing bubbles of our time. So it pays to
, to gaze into the Nietzschean abyss, to question
the macro crystal glass, to diss conventional wisdom. Black swans, chaos
theories, Nessim’s fragile worlds, the oscillations of risk, the
steepness of volatility curves, the Dostoevskian
crime and punishment
emerging markets (think Yukos/Rosneft, Mubarak era Egyptian property
deals, Iran/money laundering sanctions on London banks).
The biggest bubble in the world is in the overvalued, overleveraged
debt casinos in global finance. Imagine if the US economy and the dollar
inexplicably strengthens and forces the Bernanke Fed into a policy
U-turn? A spike in US Treasury debt yields to 3%, a fall in gold to
$1400 an ounce, a 10% hit in the US corporate/high yield debt, a
bloodbath in emerging markets debt (25% falls in leveraged EM bonds
funds!) would be inevitable. After all, the 1994 Greenspan Fed policy
U-turn bankrupted Mexico, led to Latin America’s tequila crisis
and, ultimately, Asia’s currency meltdown and the Russian default
in August 1998.
Wall Street angst is about a fiscal Grand Canyan. My angst is about
a historic, bipartisan Obama-Republican budget deal that would trigger a
capital markets tsunami into the US dollar and devastate the
world’s bond and commodity markets.
I see GDP growth rates plummet in emerging markets and can easily
envisage an epic fall in Brent crude to $80 as every black gold
mania’s endgame is an oil crash. This could prove disastrous for
Mena debt, one of the world’s most overvalued, leveraged asset
classes. This will mean a global liquidity shock that will impact
markets from Wall Street to Riyadh, Jakarta to Mexico, Lagos to Doha,
Denver to Calgary. Lord Keynes said we are in the long run. True. But in
the short run, we get a margin calls!
The world is euphoric on Asian equities markets. Yet what if
Chinese growth disappoints and Europe slips into recessions, even as
Beijing – Tokyo tensions presage a new Asian Cold War in the South
China/Yellow Sea? 1997 traumatized me for life on Asian contagion risk.
What if the bond vigilantes of Europe make a run on French OAT
(deja vu “franc fort” under Mitterrand in the 1990’s)
market? Or Berlusconi’s comeback triggers a renewed Italian debt
crisis? Or Catalan/Walloon
The policy of those maintaining the right of secession.
hits. Spanish and Belgian debt?
In all cases, Euro 1.30 is at grave risk. So the RBA cut its policy rate
but the Aussie is still 1.0450. What if the mining boom in Australia
turn into a bust even as the dollar surges on a US growth spike? The
Aussie dollar could lose 20% of its value. The Japanese yen faces its
nemesis in the LDP’s Shinzo Abe, another source of risk to risk
assets. What if peasant revolts break out across the Middle Kingdom, a
recurrent theme in Chinese history for three millennia, even as 500
Netizens challenge the Politburo, as the Great Firewall crumbles, just
as the Great Wall crumbled before the Manchu barbarian horseman three
centuries ago? As the post Versailles/Sykes
A series of small embroidered loops forming an ornamental edging on some ribbon and lace.
tr.v. pi·coted , pi·cot·ing , pi·cots
To trim with small embroidered loops.
settlement in the
Levant disintegrates with the fall of the Syrian Alawite Bthist regime,
is the Middle East destined for the greatest political violence since
the death rattle of the Ottoman empire in 1918? History and mathematical
models do not help when things fall apart, Lehman fails, the black swans
go ballistic in a world full of unfathomable risk and I am in the
business of buying mispriced risk.
2012 CPI Financial. All rights reserved.
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