Citigroup is an Undervalued Comeback Story

In our previous reports on Citigroup(C), we cannot repeat enough how we believe that investors should view Citigroupas two firms consisting of the following exposures:

  • Citicorp-Consists of the businesses that Citigroup has decided to retain.  These businesses include Consumer Banking, Corporate and Institutional Banking and Transaction Services.  Citicorp generates 93% of its revenue from Citicorp operations.
  • Citi Holdings-Consists of assets that Citigroup is willing to let run-off or try to sell.  The goal with Citi Holdings assets is to minimize losses and expenses with these operations.

We believe this analytical framework allows us to have a prudent and rational opinion of our investment in Citigroup (C).  We could see last year that it is making positive stepsin catching up to its big bank brethren(J.P. Morgan Chase (JPM) and Wells Fargo (WFC)).  Although JPM and WFC continue to post solid overall performance, we can see that Citigroup is keeping pace with those two banks.  We reiterate that a rational, dispassionate investor should be able to see the changes going on with Citigroup and that this is not Charlie Prince’s Citigroup anymore.Even former Citigroup critic Tom Brown of Second Curve Capital could see that the changes at Citigroup have worked out well for the company.

Source: Citi’s Q3 2013 Report

Evaluation of Citigroup’s Corporate and Administrative Performance: 

We were surprised to see that Citigroup’s $1of reported EPS missed the$1.04expectations of the analyst community.  Citigroup’s projected FY 2014 EPS has slipped by $.17 (3.5%) over the last 90 days and its FY 2015 EPS has slipped by $.13 (2.3%).Citigroup passed its 2013 Federal Reserve CCAR stress test in March (whereas it failed the March 2012 test and only passed a September makeup test) and the Federal Reserve allowed Citi to repurchase $1.2B worth of shares and maintain its $.01/share quarterly dividend.  In our August 2012 report on Citigroup, we called on the Federal Reserve to allow Citigroup to repurchase at least $1B worth of stock (before the price increased by over 80% since then) and increase its dividend payout ratio from 1% to 10% ($.01/share quarterly dividend to $.10/share).  Citigroup alsoreduced its bonded debt and borrowings by another$30B in Q4 2012 and $9B in Q1 2013, due largely in part to $50B in asset sales and run-off in order to deleverage its balance sheet. 

Source: Bloomberg LP

We were happy to see Citigroup go through another quarter in which it did not incur any “non-recurring charges”!  In Q3 2012, Citigroup took a $4.68B pre-tax asset impairment charge on its remaining stake in in Morgan Stanley Smith Barney LLC.  In Q1 2012 Citigroup incurred a $1.2B charge on the carrying value of its investment in Akbank T.A.S. (a leading Turkish bank).  Finally, Citigroup took $1B of pre-tax charges due to repositioning activities in Q4 2012.  Citigroup enjoyed a $176M non-recurring tax benefit during the quarter related to the resolution of certain tax audit items, compared to a $582 million tax benefit in the prior year period.  We’re hoping that Citigroup avoids “non-recurring charges” in Q4 2013.

We were also pleased to see that Citigroup’s net CVA/DVA charge was only $198M during the quarter, which shows that its reported EPS was somewhat comparable to its adjusted EPS.  Citigroup’s CVA/DVA gain/loss improved from -$485M in Q3 2012 to -$208M in Q3 2013 while JPM’s regressed from -$211M in Q3 2012 to -$397Min Q3 2013.  We expected to see continued utilization of deferred tax assets.  We were pleased to see that Citigroup was able to utilize $500M of its deferred tax assets in its most recent quarter and $1.8B for the first nine months.  As the company reduces its credit loss provisions from its Citigroup arm and continues to see reduced losses from the reduction of its Citi Holdings asset base, we expect Citi to continue to utilizing its DTAs. 

Evaluation of Citigroup’s Banking Performance: Credit and Deposits

 Deposits:We preferred to see stronger growth in consolidated deposits from Citigroup.  Citigroup grew its deposits by +1.82% on a linked-quarter basis and by +1.15% versus last year’s comparable quarter. This was not as good as the -92bplinked quarter deposit growth and +12.4% year-over-year deposit growth that J.P. Morgan Chaseenjoyed andthe +1.99% linked quarter deposit growth and +9.4% year-over-year deposit growth that Wells Fargo.  Citigroup was gaining ground on Wells Fargo concerning deposits during the first three quarters of 2012 however; Wells Fargo has begun to pull away from Citi since the beginning of Q4 2012.  At least Citigroup’s Q3 2013 deposit growth rate of 1.82% was higher than JPM’s -92bp.

Source: Bloomberg LP

Credit Losses:We expected further declines in Citi’s credit losses, especiallyfrom the Citicorp “good bank core operations” business units.  Citigroup’s total net credit losses declined by $1.47B versus last year’s quarter (38%).  Citi decreased its provision for loan losses, benefits and claims by $661M, which shows that Citi is reducing reliance on releasing loss reserves in order to prop up the income statement.   Citicorp saw credit losses decline by $295M year-over-year (14%)but increased its credit loss provision by $384M (26%).Citigroup’s consolidated loan loss reduction of $661M wasthe result ofreductions in credit losses at its Citi Holdings operations.  Citigroup was able to reduce its loan loss provision by 25% year-over-year.  However, this was less than the 130% reduction that JPM (which accrued no additional loan loss reserves and released $543M in existing reserves) was able to achieve as well as the 85% that Wells Fargo achieved.  We previously forecasted favorable credit trends for Citigroup and its peers however, this is dependent on the global macroeconomic environment and we see a number of potential headwinds here. 

Evaluation of Citigroup’s Business Segments 

Citi Retail Banking:Citi Retail Banking continues to seeincremental growth year-over-year in investment sales, deposits and loans, however its revenues declined by 7% due to significantly lower U.S. mortgage refinancing activity and continued spread compression globally more than offset the ongoing volume growth in most international businesses.Citi Global Consumer Banking’s expenses decreased by 4% year-over-year as its retail branch footprint has steadily declined for seven straight quarters.We were surprised that its credit loss provision increased by 14% year-over-year even though its Net Credit Losses declined by 11% during the same period.  

One bright spot during the period for Citi Retail Banking was the performance of its Citi Personal Wealth Management Business.  Although Citigroup sold off its Smith Barney brokerage operations to Morgan Stanley, a person could still invest in a brokerage account with Citigroup Global Markets in conjunction with Citi Personal Wealth Management.  Citi Personal Wealth Management is similar to other bank-based brokerage operations in that it also offers a special relationship account (Citigold) for mass affluent clients ($250,000 in combined balances).  Citi PWM enjoyed incremental year-over-year growth in investment sales and AUM growth of 7.2% thanks to the run-up in the stock market over the last year, though this was below the 30% investment sales growth and 16% AUM growth at JPM’s retail branch banks. 

Citi-Branded Cards:We were disappointed in its performance.  Citi Cards’s business segment revenue was flat and its income increased by 1% on a year-over-year basis but increased by 7% on a linked quarter basis.  This was due to 4% lower average loan balances year-over-year, reduced credit provisions and higher operating expenses versus the Q3 2012 period. 


Citi Securities and Banking:Recurring business segment revenue decreasedby 10% year-over-year excluding changes in the credit valueadjustments on derivatives and debt value adjustment on the fair value of Citigroup’s debt.  Investment Banking revenues declined by 10% ($-94M) but lending grew by 38%($63M) versus soft performance endured during Q3 2012.  This was offset by softness in capital market activities.  Equity capital markets revenues grew by 36%($188M)but fixed income capital markets activities declined by 26%%($-956M).  Net operating expenses declined bynearly 4% versus the linked quarterly period and by 3% versusQ32012though credit loss provisions increased by $193M.  Our favorite business line in this division is Citi Private Bankbut itsaw its revenue increase by 82bp year-over-year and decreased by4.8% versus the linked quarter.  

Citi Transaction Services: Transaction Services has been Citigroup’s island of tranquility in an otherwise truculent market during the last five years, which is why we were surprised to see unremarkable performance for it in FY 2012 and ebbing performance in 2013.  This quarter it generated a 23bp year over year revenue decline due to soft revenue performance at its Treasury and Trade Solutions business and its Securities and Fund Services business.  Operating expenses actually increased by 2.7%and Transaction Services reduced credit loss provisionsof$22M.  At least the division saw a $1.1T year-over-year increase in EOP Assets under Custody and a 10% year-over-year growth in average deposits.  

Citi’s Securities and Fund Assets under Custody increased by 8.6%on a year over year basis, which was comparable to what J.P. Morgan Treasury and Securities Services achieved.  J.P. Morgan TSS showed stronger revenue and profit growth in its Treasury and Trade Services and its Worldwide Securities Services businesses than Citigroup.We maintain our stance that ifCiti Securities and Fund Services business continues to struggle, Citigroup should consider selling this business to its former CitiStreet Investor Services joint venture partner State Street (STT). 

Citi Holdings (“bad bank”):Poor Bill Ackman!  First, he buys into the Ron Johnson experiment at J.C. Penney in 2011.  Then he sells his Citigroup position in order to acquire a stake in P&G during the summer of 2012.  While P&G may be up by 34% since then, Citigroup went up by 90% during that period.  Then GGP fails to accede to his demands that it sell itself to SPG.  Now that Citi Holdings accounts for less than 7% of Citigroup’s total revenue and 6.4% of its assets, we cannot help but reiterateabout how Bill Ackman of Pershing Square had sold out of his Citigroup position before he was able to realizethe value generated from the core Citicorp continuing operations.Citi Holdings was able to narrow its adjusted losses from $670M in Q3 2012 to $102M in Q3 2013 due to 28% revenue growth and a $1.045B reduction in its loan loss provisions.

Source: Citigroup’s 2012-13 Earnings Releases 


In conclusion, we continue to hold on to our stake in Citigroup, and selectively accumulate a larger position.  We reiterate our positive outlook for the companybecause we see that Citigroup continues to achieve the followingperformance accomplishmentsin Citigroup’s business lines:

  • New CEO Michael Corbat replacing Vikram Pandit
  • Assets for Citi Holdings are now $122B and only represent 8% of total company assets.
  • Lower credit costs across Citigroup’s diverse business lines
  • Increased credit/debit card purchase transaction volumes from Citi Cards
  • Lower Operating Expenses from the Securities and Banking division
  • Steady revenue growth from Citi Private Banking
  • Citigroup’s new-found ability to replace high-cost debt and trust securities with low cost customer deposits, which enables it to improve its net interest margin versus JPM/WFC.
  • Citigroup passed the 2013 stress test on its first attempt.  This enabled it to buy back $1.2B in shares over the next 12 months and we expect more capital returns in 2014 (contingent on the economy of course).


Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. This report is confidential and may not be distributed without the express written consent of the original author and does not constitute a recommendation, an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential private offering memorandum.

Investments may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this letter for any reason. The author hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any of the investments.

All of the views expressed in this research report accurately reflect the research analysts’ personal views regarding any and all of the subject securities or issuers. The research analyst is not registered with FINRA, and may not be subject to FINRA rule 2711 restrictions on: communicating with the subject company, public appearances, and trading securities held in the research analysts’ account. No part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. The analyst responsible for the production of this report certifies that the views expressed herein reflect his or her accurate personal and technical judgment at the moment of publication.

Under no circumstances must this document be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

Disclosure: Analyst covering this company hold shares in C .

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