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Sell Citigroup (C)
05/18/2011 12:59 pm EST
The question is not just whether to sell, but also what to sell. Today I’m selling Citigroup (C) out of my Jubak’s Picks portfolio http://jubakpicks.com/
Another 10% correction in this sector isn’t so big a correction that investors can’t sit still through it. But what troubles me is the good possibility that some of the biggest names in this sector aren’t going much of anywhere very quickly when the correction is over. There’s now a good chance that global bank regulators will require the world’s biggest banks—those that regulators deem systemically important to global financial markets—to keep a higher percentage of reserves than banks that primarily operate in just one country. Exactly the way that designation as a systemically important institution will change the rules for any individual bank will depend on bank regulators in individual countries. The U.S. Federal Reserve, so far, looks like it will be really tough on the big banks that posed so much danger to the financial markets in the recent crisis.
HSBC (HBC) recently estimated that the new Basel III rules would reduce its Tier One capital ratio by 2.5 to 3 percentage points. But the truth is that no one really knows.
The financial markets, of course, hate uncertainty and these rules are introducing uncertainty exactly where it hurts. Raising capital requirements and tightening the rules on what kinds of capital count will lower a bank’s return on equity.
I don’t think this is on most investors’ radar screens for the financial sector. Right now things like loan growth (or the lack of it), the recovery in credit quality, and how quickly loan loss reserves can be moved back into earnings are the top of mind issues.
Not all banks have the same exposure to the new Basel III rules and not all banks will have a need to raise more capital or shrink their loan books.
Going forward I think I’d like to own banks with growing market share in core businesses, banks that won’t fall into the systemically important category, banks that will be able easily to raise any capital they might need, and banks that aren’t looking at a big need to dispose of lots of assets to help meet the new capital requirements among other things.
Citigroup really doesn’t score too well on this priority list. The company has done a reasonable job of disposing of bad assets but at the end of the first quarter Citi Holdings, the bank’s home for impaired assets, still held $337 billion in assets that the bank wants to get rid of. That’s two-thirds of the total at the beginning of 2008 but that’s still a lot of paper to sell.
Given the weight of this load of assets and the bank’s need to raise more capital if the Basel III rules play out as I think they will, it’s hard for me to see how Citigroup can return to the days when it earned a 17% to 20% return on equity. Somewhere around 12% seems more likely going forward. That’s barely above the 11% that Morningstar.com calculates as the bank’s cost of capital.
I thought Citigroup shares would get a bigger boost from the very clear improvement in credit quality at the bank and from the return of loan loss reserves to the earnings stream.
That hasn’t played out for Citigroup shares over the last quarter (In other words I was wrong) and looking at the banking sector in the second half of the year I think you can find better bank shares to buy.
I’m selling Citigroup today with a loss of 1.6% since I added it to the portfolio on October 26, 2010.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Citigroup as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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