Citigroup's rehab means fewer managers

Cutting layers of management can make a company faster and cheaper to run. For Citigroup Inc, this is just one part of its interminable quest to close its yawning stock valuation gap with rivals.

The lender flagged this month that it won’t directly replace respected veteran executive Paco Ybarra when he retires from the bank. The heads of three divisions he ran under the institutional clients umbrella could end up reporting directly to Chief Executive Officer Jane Fraser instead, the Financial Times reported this week.

This change alone may not be hugely significant, but it’s emblematic of the simplification and sharpening up of Citigroup that Fraser has pursued since taking the top job two and a half years ago. She’s won plenty of praise for her strategy, but investors bruised by years of disappointments aren’t buying her vision until they see the results.

Mike Mayo, Wells Fargo banks analyst, is a long-time critic who characterises Citigroup’s creation 25 years ago as one of the worst deals in banking history, but has begun to be won over. It’s still hard for investors to believe in a fresh start, he says, but Fraser has changed the tone at the top and pointed the company in the right direction. “Under the current CEO, we have not noticed the types of egregious mishaps like in the past,” he wrote after meeting with her in June.

Fraser’s strategy involves getting out of consumer banking in much of the world outside the US while investing heavily in technology to automate labor-intensive functions, such as risk and compliance. The company has already exited retail banking in seven Asian countries and is set to quit Indonesia and Taiwan. It is shrinking consumer businesses in China, Russia and Korea, and it hopes to sell its Mexican arm, Banamex, in an initial public offering in 2025.

The problem with retail banking is that it offers few economies of scale or revenue benefits beyond national markets. Fraser is directing Citigroup’s focus instead at its global corporate banking and transactions business. It is also expanding wealth management for rich clients, especially in Asia — a very competitive market where the collapse of Credit Suisse this year offers rivals the chance to snag more customers.

These changes were long overdue: Citigroup has lagged rivals such as JPMorgan Chase & Co and Bank of America Corp on many metrics for years. Its annual returns on equity have exceeded 10 percent only twice in more than a decade. Its net revenue per employee has consistently been far behind the two US-based rivals, although it has at least beaten HSBC Plc, the UK-based bank with a similar business model to Citigroup.

Beneath all this, costs have become the main issue for analysts and investors. Citigroup’s have been rising as Fraser tries to reshape and modernise the bank: It added almost $10 billion in expenses in just the past four years. This year, its expects to take $450 million of severance costs to slash 5,000 staff in response to the downturn in investment banking and trading.

The company has the highest cost per dollar of revenue of the four banks I’ve mentioned, and analysts forecast this to worsen before it improves. The contrast with HSBC is stark: Citigroup’s cost-to-income ratio is set to hit more than 68 percent in 2024, while HSBC’s is expected to drop to 51 percent. HSBC’s returns are forecast to accelerate away from Citigroup’s as a result.

Fraser has pledged that costs will start to decline in absolute dollar terms from the final quarter of next year and then keep falling in the medium term as the benefits of technology investment emerge. Erika Najarian, analyst at UBS, says that investors need more clarity on exactly how much costs will fall — and when — in order to start believing in Citigroup’s return targets.

Citigroup as a global banking supermarket was unfocused and unwieldy. Fraser’s vision is considerably more coherent, but the company still has a long way to travel to realise it.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Views are personal and do not represent the stand of this publication.