Lower price-to-book ratio
Citigroup’s (C) stock currently trades at a price-to-book ratio of ~0.72. For more on this topic, read Understanding the price-to-book value ratio. This is much lower than its peers JP Morgan (JPM) and Wells Fargo (WFC), which trade at price-to-book ratios of 0.98 and 1.64, respectively. Citigroup’s ratio is equal to that of Bank of America’s (BAC), which is also currently trading at a price-to-book ratio of ~0.72.
The average price-to-book ratio for equity holdings in the Financial Select Sector SPDR ETF (XLF) is 1.37, as shown in the graph above. Why is Citigroup trading at such a low price-to-book ratio?
Low returns on equity
Citigroup’s return on equity, or ROE, was the hardest hit at the time of the financial crisis, and the bank nearly collapsed. The bank’s ROE finally became positive in 2010, as shown above. Since then, its ROE continues to be lower than its peers JP Morgan and Wells Fargo. The only bank among the big four banks to have a lower ROE than Citigroup is Bank of America. This explains the relatively lower price-to-book ratios for Citigroup and Bank of America.
Where the Fed comes in
Aside from lower revenues and higher costs, including litigation, one of the factors contributing to Citigroup’s lower ROE in recent years has been its higher equity base. The bank hasn’t been able to implement its share buyback or dividend distribution capital plans because the Fed won’t allow it. A buyback generally leads to greater ROE as a result of a smaller equity base used in the calculation. It also typically leads to increased stock price.
The Fed conducts an annual test to review the capital plans of large banks under stressful economic conditions. It’s called the Comprehensive Capital Analysis and Review, or CCAR test. Citigroup failed the test in 2012 and then again in 2014. Although Citigroup is better capitalized than its peers, the Fed has concerns about the reliability of the bank’s capital planning process, as well as the risks related to its global operations.
What does all this mean for the stock going forward? Read the next part of this series.