The Best Thing Going for Citigroup? It’s the Worst

(Bloomberg Opinion) -- Citigroup Inc. has struggled to regain its footing since the financial crisis. The stock is still down more than 60 percent since the fall of Lehman Brothers Holdings Inc., the worst performance by far of the big U.S. banks.

But there’s one thing for which Citi and Michael Corbat, CEO for the past six years, have been praised: cost control. The firm’s efficiency ratio, or expenses as a percentage of revenue, has been less than 60 percent for the past three years. It’s the only big bank to maintain that streak, and was only bested in this closely watched metric by JPMorgan Chase & Co. this year.

The Best Thing Going for Citigroup? It’s the Worst

But Citigroup may be getting credit where it’s not due. That’s the conclusion of a recent report by Mike Mayo of Wells Fargo & Co. The banking analyst argues that Citigroup’s cost-management may, in fact, be “worst-in-class.”

Citigroup may look very efficient, but that, he says, is because of its business mix, not management prowess. The bank gets a greater proportion of revenue than its peers from its credit card operation — which happens to have very low operating expenses, especially in the retailer credit card space, where the firm is particularly active.

The efficiency of Citi’s card operation doesn’t stand out from its rivals. Mayo scrutinized the 20 banks’ credit card businesses and found their average efficiency ratio was 42 percent — the same as at Citigroup.

The problem is in consumer banking, where firms have to operate branches and spend money on technology like mobile banking. Costs like those eat up an average of 65 percent of revenue across the industry. At Citigroup, the figure is higher at 77 percent.

All told, adjust for the firms’ varying business mix, and Citi’s efficiency ratio, according to Mayo, is 7.1 percentage points worse than JPMorgan, and 5.8 percentage points behind Bank of America. (Mayo doesn’t track Wells Fargo, his employer.)

And Mayo says Citi is living in denial. The bank’s most recent proxy statement heaped praise on Corbat and his management team for their cost-containment skills. Citi declined to comment specifically on Mayo’s calculations, saying only that the bank is on track to achieve its targets.

The Best Thing Going for Citigroup? It’s the Worst

Oddly, Mayo thinks all of this makes now a good time to buy Citi, and calls the stock his top pick — even if he has been bullish on the bank well over a year while the stock trodden water. Speaking on Bloomberg Television this week, he predicted that the shares could double over the next four years.

Mayo’s call is — essentially — that being at the bottom of the pack, Citi can only improve from here. More diplomatically, the analyst says there is room for more improvement.

True, there is a valuation argument: The bank doesn’t trade at a premium to the book value of its assets like almost all its peers.

But, even so, not all are optimistic Citi will be able to deliver. Charles Peabody, who runs his own research shop Portales Partners, says costs at the firm’s investment banking unit have been getting worse, not better — a trend that will continue as Citi spends to catch up with its peers. Worse, given where we are in the economic cycle, Peabody is concerned the firm could be expanding its investment bank at exactly the wrong time.

And that seems to be the biggest problem with Mayo’s four-year prediction. A recession in that time period looks not only possible, but likely. Mayo himself says that if Citi can’t deliver decent operating results “in what is probably the most benign credit environment possible combined with favorable tax rates, then not only should management be changed, but the company should be broken up to realize value.”

And in the end, that’s the prediction that might just hold up.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Gandel is a Bloomberg Opinion columnist covering banking and equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

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