Why Citigroup Inc (C) Won’t Break Up After All

citigroupMarshall Hargrave: The talk of big bank breakups is becoming a recurring theme. But until now JPMorgan Chase (NYSE: JPM) has been the primary focus.

It’s now time to shine the spotlight on another big bank: Citigroup Inc (NYSE:C).

The key thesis here is that Citi could break itself up to start delivering higher returns on equity for its shareholders. Citi’s return on equity is less than 4%, while JPMorgan and Wells Fargo (NYSE: WFC) enjoy returns on equity of over 10%. In truth, Citi hasn’t generated double-digit return on equity since before 2007.

That’s not to say that Citi hasn’t come a long way, but there’s still a long way to go. Shares are trading at $50. The stock went from over $500 a share to less than $15 in just over two years’ time when everything unraveled in 2008.

In reality, all the big banks have been tough to own. Wells Fargo has been the only real bright spot in the industry, performing in line with the S&P 500 for the last five years. Meanwhile, the other major players have grossly underperformed the market.

Increased regulation is part of the issue. Regulators are making it tougher and tougher for big banks to return capital to shareholders.

Speaking of which, the annual Federal Reserve “stress tests” have become a big event in the banking industry. It’s meant to ensure that banks have enough reserves to weather a severe economic downturn like we had in 2008. And just this week the Fed completed its latest round of stress tests.

Last year, the Fed labeled Citi as one of the worst performers, with weakness in its data collection systems. It has thus been constrained when it comes to returning capital to shareholders over the last year.

But in a strange twist, Citi is one of the only banks that’s actually on the Fed’s good side this year. It passed its stress test with flying colors.

This comes after Citigroup sold its consumer finance unit, OneMain Financial, earlier this month for $4.25 billion. This is a positive, as OneMain operates in the subprime business, catering to low-income borrowers.

In truth, over the years Citi has become much smaller and simpler. Its investment bank now generates a large part of its revenues, as opposed to the consumer banking unit. The bank has also been upgrading its technology.

The Fed gave Citi approval to up its quarterly dividend payment five-fold to 5 cents a share. That puts its pro forma dividend yield up to 0.4%. Citi also got approval to increase its share buyback program from $1.2 billion to $7.8 billion. That’s good enough to reduce its shares outstanding by 5%.

It’s worth noting that JPMorgan got the nod to up its quarterly dividend by 10% to 44 cents. Wells Fargo is upping its dividend by 7% to 37.5 cents.

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