Citi announced its quarter this morning and there are various ways to tell that it was good, of which "the stock was up" is probably the main one. A possibly less objective test is that, back in March, Mike Corbat told everyone how he would grade himself, if he was grading himself. As he put it today:
Last month, I presented three targets we aim to reach by the end of 2015. First is achieving an efficiency ratio in Citicorp in the mid 50% range. Second, we want to generate a return on Citigroup's tangible common equity of over 10%. And third is reaching a return on Citigroup's assets of between 90 and 110 basis points in a risk-balanced manner.
Today Citi announced $4.0 billion of net income (excluding CVA/DVA), or $1.29 per share, which I work out to around 82bps of ROA, 9.86% ROTCE, and a 55.6% Citicorp efficiency ratio.1 So ... pretty good, all in all?
One oddity of Corbat's three-part plan is that two of the parts sort of collapse into each other. Return on tangible common equity, after all, is just return on assets times leverage, and leverage is pretty much under Corbat's control. At the midpoint of those ROA expectations - 1% ROA for 10% ROTCE - Citi needs to be have assets of at least 10x its tangible common equity. Which is no problem, right now: Citi has assets of around 11x its TCE, and a current focus is on building equity (to a year-end 10% Basel III tier 1 common target) rather than levering up.
But leverage isn't entirely under Corbat's control, insofar as there's a new Senate proposal that would require Citi to roughly double its capital and thus halve its leverage ratio. We did a little math on that a while back, guessing that it would require Citi to raise another $150 billion or so of equity, and last week Goldman research issued a note coming to around the same place. Goldman calculates that Citi would need to raise $151 billion, which at the rate it's retaining earnings would take it nine years; since Brown-Vitter by its terms would give them only five years, that suggests a few eleven-figure stock sales might be in Corbat's future.2 Here you can read a Bloomberg View piece by Simon Johnson about that Goldman report that I find somewhat objectionable but that's become a reflex with me so whatever.3
Last week Jamie Dimon got asked about Brown-Vitter on his earnings call and refused to take the bait and rage colorfully against it. Nobody even asked Corbat today, presumably because you've got bigger fish to fry on a Citi earnings call than "hey Mike could you talk shit about your regulators for a bit?"
Also, presumably, because no one is that worried about it? One theory - perhaps it's Simon Johnson's - is that vastly raising bank capital requirements would be good for shareholders; sure, Citi's ROTCE would be more like 5% than its planned 10%,4 but on the other hand Citi would be much less risky - practically a utility, really - and so shareholders should demand less in the way of returns. Maybe? On the other hand, with its 10% ROTCE target and focus on operating efficiency, it sort of seems like Citi shareholders are hoping for utility-like performance at best, with the present capital structure. Even utilities tendtohavedoubledigitROEs. Halving Citi's leverage, and its return on equity, would seem like kind of a big deal to shareholders. The fact that the shareholders don't seem worried - the stock went up! - seems like a pretty good way to tell that Brown-Vitter isn't going anywhere anytime soon.
Citigroup Reports First Quarter 2013 Earnings per Share of $1.23; $1.29 Excluding CVA/DVA1 [Citi]
Citigroup’s Earnings Rose 30% in 1st Quarter [DealBook]
Goldman’s Big Guns Fire Dud in Defense of Megabanks [Bloomberg]
- Citicorp efficiency ratio: $10,896 Citicorp expenses ÷ $19,590 Citicorp revenues (page 4of the earnings release);
- Citigroup ROA: $4,006 Citigroup net income (page 3 of the release) ÷ $1,944,423 total assets (page 3 of the supplement), times four;
- Citigroup ROTCE: $1.29 EPS ÷ $52.35 TBV per share (page 3 of the release), times four.
That seems to be how Corbat defines those ratios.
3."What do you do?," someone will eventually ask me, and I'll say "well mostly I make fun of Bloomberg View columns about too-big-to-fail banks." I'll leave this one mostly alone but I can't resist this:
First, notice the lack of sophistication about bank capital itself. The authors write of banks being required to “hold” capital, as if it were on the asset side of the balance sheet. They go on to construct a mechanistic link that implies that “holding” capital prevents lending.
Banks don’t hold capital. The proposals are concerned with the liability side of the balance sheet -- specifically, the extent to which banks fund themselves with debt relative to equity (a synonym for capital in this context). Higher capital requirements push companies to increase their relative reliance on equity funding, thus increasing their ability to absorb losses without becoming distressed or failing. If the transition is properly handled, there is no reason that more equity funding would translate into lower lending.
First of all, criticizing them for using the slightly off but still fairly standard expression "hold capital" is like criticizing them for splitting infinitives. No one reading the Goldman report could think that its bank analysts need a condescending lecture about which side of the balance sheet capital goes on.
Here is the mechanistic link in the Goldman report between capital and lending:
In a scenario where banks would likely struggle to comply with the possible requirements by adding equity alone, we expect they would likely be forced to reduce assets as well. Assuming that banks achieve higher capital ratios through a 50/50 mix of asset declines and more equity, we forecast this would remove an estimated $3.8tn in lending capacity from the US banking system, or 25% of today’s levels.
Is that a good assumption? I dunno. But Johnson waves it off with "If the transition is properly handled," which assumes facts not in evidence. Goldman notes that it would take Citi 9 years, and other banks longer, to just earn their way to Brown-Vitter capital levels. Brown-Vitter says, in words, in the text of the bill, that they'd have only five years. So they'd have to either shed assets or raise equity or, as Goldman assumes, do a 50/50 mix. That seems a safer assumption than "imagine that Brown-Vitter is a different, smarter bill that handles the transition properly."
Also, this is sort of an amusing depiction of what equity research is for:
In this context, it is no surprise to see the financial sector wheel out its own intellectual big guns. A frisson no doubt rippled through the financial-lobbying community last week with the release of a report from Goldman Sachs’s equity research team, “Brown-Vitter bill: The impact of potential new capital rules.” This is the A-team at bat, presumably with clearance from the highest levels of management.
4.Meh, that cheats a bit. Presumably more equity = lower cost of debt as well as equity, though I'm not totally sure. Cost of debt involves a whole lot of insured deposits, etc. One simple bit of math is to take my old math estimating a ~20bps additional funding cost for "too big to fail" banks over smaller (albeit BBB rated) banks. If you just assume that having more equity reduces funding costs by 20bps of assets, then ROA goes from like 90-110bps to 110-130bps, and ROTCE at like ~6x leverage goes to like 6.5-8%.