By Jayson Derrick
The financial sector is full of many powerhouses, but one stock sticks out as having all the qualities of a clear winner, Citigroup (C). I believe that Citi has a lot of positive factors that work on its favor such as an improving operating environment and strong management.
Citi's recent investor presentation
On March 5, CEO Michael Corbat gave a presentation at the company's financial services conference outlying a set of benchmarks for investors to use in evaluating the company. Such benchmarks included efficiency targets and expected returns on assets, two key tools to measuring the strength of a bank. Corbat also detailed how the bank can scale back or completely exit a troubled market if the bank deems that necessary. Shares of Citi rose 2.5% following the presentation, a clear signal that investors were satisfied with what was heard.
Economic and housing recoveries
Citi Holdings should be able to recapture some of its $11 billion loan loss reserve. Citi Holdings contains assets which include a pool of negative mortgages, consumer lending unit, OneMain Financial, Smith Barney. In 2012, Citi Holdings lost $3.7 billion, but management sees an economic and housing recovery that can play in the company's favor. An improvement in mortgage delinquencies and losses could result in the company releasing some of its $8.4 billion in mortgage reserves in the next two quarters. The company's CFO John Gerspach hinted that this would be done "sooner rather than later" but also warned that Citi Holdings is not likely to earn a profit or break even in 2013.
Stress test results
Investors can sleep better at night knowing that Citi was a clear winner in the Fed's 2013 stress test. The company's minimum stressed Tier 1 common equity ratio reached a very strong 8.3% (before capital actions) versus only 5.9% last year. This was an extremely positive improvement and surpassed the stressed minimum levels of Wells Fargo (WFC), JPMorgan (JPM), Bank of America (BAC), Goldman Sachs (GS) and Morgan Stanley (MS).
Perhaps some shareholders were disappointed that the company only asked for a modest $1.2 billion stock buyback for 2013 and no dividend increase. Investors need to focus on the strong stress test results and that the company will be able to increase shareholder value in dividends or buybacks in the future, perhaps a large buyback in 2014-15, and a dividend hike to $0.80 per share by next year. As the company closes out assets in Citi Holdings, the company will have access to about $24 billion in capital that can be used for stock buybacks over the long term. There is little doubt that the company will be in a position to increase shareholder value through buybacks and/or dividends. However, it is unlikely to happen soon. Patience is required for the company to unlock its full potential and completely recover from the recession hangover.
The banking sector as a whole is much healthier today than it was in 2007 with cleaner balance sheets, credit and loan quality improving and higher levels of capitalization. However, investors expecting extreme returns as seen leading up to the financial crisis will be disappointed. The return on equity at Citigroup stood at 6% last year, down from 18% in 2007 and 31% in 2006. At around $46 a share and a favorable year to date performance, relative to peers and sector, the stock still has room for upside movement. Banking stocks should continue rising steadily until earnings show a clear improvement and beating consensus. I don't see that happening until economic growth substantially picks up and interest rates need to rise as well. That being said, the choice is obvious to invest in Citi if an investor requires exposure to the banking sector in a portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.