BREAKINGVIEWS-Citi is a prime candidate to revive big-bank M&A

By Stephen Gandel

NEW YORK, March 31 (Reuters Breakingviews) - The bank that once proclaimed it never sleeps is rousing from a coma. After years of operational fumbles, Citigroup’s C.N shares have outpaced Wall Street peers to rise 58% over the past 12 months. Yet it still pays dearly for customer deposits while generating subpar returns. With U.S. authorities as amenable as they’ve been in years, boss Jane Fraser would be well-served by acquiring some extra size.

Citi dismissed the idea that it is “planning to buy” a rival lender, after Bloomberg reported that executives had discussed the idea with regulators. There is cause for conservatism: the bank only now seems to have wrangled its error-prone back office, which led to fat-finger trades and payments like the $900 million wire to a customer’s creditors.

Fraser has made headway, though. Citi's market value, boosted by improvements in investment banking and wealth management, recently eclipsed its tangible book value, a key investor benchmark, for the first time since the 2008 financial crisis.

Even so, the bank’s deposit costs sit 60% higher than major U.S. rivals such as JPMorgan JPM.N and Wells Fargo WFC.N, according to Visible Alpha. Low funding costs, driven by sticky consumer balances, are the secret sauce of American banking. The issue is that Citi gets more than 70% of its deposits from corporate customers, who are more apt to seek better deals. Buying a consumer‑heavy regional bank could shift the balance in Fraser’s favor.

Truist fits the bill, and trades at a cheaper valuation than other candidates to boot. The Southeast regional lender’s cost of deposits sits at 1.8%, versus 2.5% for Citi. Simply smushing the two together would raise the buyer’s return on tangible common equity, or ROTCE, to 11%, from about 9% for Citi alone.

Furthermore, a 1999 Federal Reserve study found that the average bank merger results in a 4% cost reduction. Tax that windfall at the standard corporate rate, and ROTCE rises to 12%. Big banks also consistently pay less for deposits. Bank of America's interest costs are just 0.6% on consumer balances. If a bulked-up Citi can drive down Truist’s deposit costs to that level, ROTCE would jump to nearly 14%.

A rule of thumb is that a bank’s share price roughly tracks returns: a 10% ROTCE should translate into a valuation, broadly speaking, of one times tangible book value. Put the two banks' market values together, add a 20% premium for Truist, and credit them for the aforementioned profitability uplift, and they should trade at about 1.4 times, creating about $40 billion in extra shareholder value.

Grinding down deposit costs takes time, but peers show such goals are attainable. Whatever Citi may be saying about deals, now is a great time to strike one.

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CONTEXT NEWS

Citigroup executives are considering whether they should buy a regional bank, Bloomberg reported on March 27. The bank's executives have reached out to regulators, who were receptive to the idea of an acquisition, according to the report.

Citi dismissed the report, saying in a statement to Reuters that “the suggestion that Citi is planning to buy a regional bank, wealth brokerage - or any other financial services firm - is baseless speculation.”