Even with the strong improvement in Citigroup's capital levels and asset quality since the financial crisis, the bank still trades at a remarkably low valuation. In fact, as of this writing, shares trade for just 89% of their tangible book value.
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In other words, investors can essentially buy Citigroup's tangible assets for less than they're worth, and any future growth in the company is just a nice bonus.
Why so cheap?
There are several possible reasons for this. For starters, Citigroup's asset quality has improved significantly. In fact, the Citi Holdings division, which consists of the company's "legacy" (read: unwanted) assets, has been trimmed from $290 billion to just $98 billion since 2011. While this is a huge improvement, $98 billion in risky assets for a company with a market capitalization of about $145 billion remains a significant amount.
Another big factor is Citigroup's international exposure, which is much greater than that of the other big U.S. banks. International exposure isn't necessarily a bad thing per se, but it adds an element of risk in terms of vulnerability to fluctuations in foreign currencies and economies.
One final reason Citigroup trades cheaply is that investors aren't particularly confident in the bank and its management. Who can blame them? As my colleague John Maxfield has pointed out, Citigroup has a history of irresponsible risk management that has led the bank to the brink of failure several times over the past 100 years. However, I don't necessarily agree that things will never change, especially in the new era of government regulation.
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The "stress tests" and Citigroup's capital levels
When the latest Comprehensive Capital Analysis and Review is released in March, the Federal Reserve will look at several things.
Basically, it will examine whether Citigroup has adequate capital levels and procedures to assess its own capital adequacy, which is an indicator of the bank's ability to absorb losses. Then, the company's plans to return capital to shareholders through buybacks or dividends will be reviewed.
The market was relatively surprised when the Fed rejected Citigroup's capital plan last year, so this year's improved levels of capitalization should be more than enough to justify a dividend increase. Since the end of 2013, the company's Basel III Tier 1 capital level has improved from 10.7% to 11.4%, and its Basel III supplementary leverage ratio has improved from 5.4% to 6%.
Aside from the capital levels, there is one more issue to worry about. During the 2014 stress tests, the Fed noted that Citigroup's capital plan reflected deficiencies in its capital planning process. That will most likely be the deciding factor this time around, but I'd be surprised if the bank has not fixed last year's mistakes.
How much will the dividend go up, and what could it mean?
Citigroup is one of the last major banks to still have its dividend frozen at just a penny per share each quarter. Judging by its peers' post-crisis dividend increases, the next logical step would be a quarterly payout of $0.05 per share, which is actually what the bank asked for last year. A more aggressive increase is possible, but I'd call it highly unlikely.
While this would produce a paltry yield of about 0.4% per year, the significance of a dividend increase could go far beyond its dollar amount. It would tell the market that Citigroup has finally put the financial crisis behind it and is ready to look to the future and start returning serious amounts of capital to shareholders.
The article Citigroup's Shareholders Could Get the Most Important 0.4% Dividend Ever originally appeared on Fool.com.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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