America loves comeback stories and I believe that Citigroup (C) is one of the finest that we have seen in recent history, and we are still in the very early innings of this turnaround. Price is what you pay and value is what you get, and with Citigroup the investor is truly buying stock in the bargain bin. It is interesting that industries related to the housing such as homebuilders, trade at multiples of book value, while many of the large banks still trade at discounts. There is a disconnect here and if anyone truly believes homebuilding is a better business than banking over the long term, I'm sure you can find some swampland in Florida at a great price. The fact is that the regulatory landscape hasn't been this bad since at least after the Great Depression, and market participants are still reeling from the trauma that occurred to the financial system during the Great Depression. Market participants are increasingly focused on the short term, which ultimately sets the stage for one of the best long-term investment opportunities of my lifetime in the financial sector, and Citigroup in particular. With each quarter it will become more clear that Citigroup has materially changed for the better, and profitability and increased returns should follow, but if you wait too long to build a position you will miss the party.
Citigroup ended the 1st quarter with 3.043 billion shares outstanding, so at a recent price of $44.83 of the company has a market capitalization of roughly $136.42 billion. This is exceptionally cheap when you consider common shareholders' equity of $190.222 billion, and tangible equity of $159.289 billion. As the table above shows, Citicorp's earnings before taxes have been steadily improving and are now well over $20 billion before taxes, on a trailing twelve-month basis. If Citigroup can just get to a 13% return on equity, then $6.80 of normalized earnings power is well within reason, and that is not even factoring in the expected growth in book value. The company was approved to buy back $1.2 billion of stock through the CCAR process, so this should be highly accretive when you factor in the large discount to book value the stock trades at. I believe it won't be until 2015-2016 that Citigroup is really clicking on all cylinders, but that doesn't mean that the stock can't continue to increase materially before that. I believe that Citigroup should trade at tangible book value at a minimum and I believe there is upside to $70-80 per share, as book value and earnings continue to grow.
On April 15th, Citigroup reported 1st quarter net income of $3.8 billion, or $4.0 billion excluding CVA/DVA. This was up dramatically from net income of $2.9 billion, or $.95 per diluted share a year ago. Revenues were $20.5 billion or $20.8 billion excluding CVA/DVA, which was up from $19.4 billion in the year ago quarter. Citigroup grew deposits by 3% YoY to $934 billion, and the core Citicorp franchise grew loans by 5%, to $539 billion. Citi Holdings, which has been the albatross hiding the inherent profitability of the Citicorp franchise, reduced assets by 29% YoY to $149 billion, and now only represents 8% of total Citigroup assets. Citicorp revenues were up 2% YoY and Citi Holding revenues were actually up 15%. Citigroup's return on tangible equity was 14.1% in the 1st quarter of 2013, which lags some of its key rivals, but when you look deeper, Citicorp has a return on Basel III Capital at 9.5% of 22.2%, while the overall company's return was 14.2%. I believe Citicorp is a top-tier global bank, which will ultimately have many levers that it can pull to bolster the long-term earnings power of the company.
As the table above shows, Citicorp's earnings before taxes have been steadily improving and are now well over $20 billion before taxes, on a trailing twelve month basis. If Citigroup can just get to a 13% return on equity, then $6.80 of normalized earnings power is well within reason, and that is not even factoring in the expected growth in book value. The company was approved to buy back $1.2 billion of stock through the CCAR process, so this should be highly accretive when you factor in the large discount to book value the stock trades at. I believe it won't be until 2015-2016 that Citigroup is really clicking on all cylinders, but that doesn't mean that the stock can't continue to increase materially before that.
Citicorp continues to post improving profitability and I'm pleased to see the efficiency ratio heading in the right direction. In the 1st quarter Citicorp had net income of $4.794 billion, which was up from $4.496 billion one year ago. Citi Holdings continues to impair Citigroup's financial results and mask the true underlying earnings power of the company. In the 1st quarter Citi Holdings loss was down to $788MM, and I'd expect that improvements in the housing market should continue to reduce the loss moving forward. Citi Holdings not only impairs financial results because of the losses but it also is a major draw on capital, so the sooner that asset can be divested the better, but of course management is being prudent on making sure that asset sales aren't done at fire-sale prices. Morgan Stanley (MS) is likely to call away the remaining stake in MSSB that it doesn't already own, which should free up another $8 billion, and this would also improve Citigroup's capital ratios by a material amount.
Citigroup has done a wonderful job managing its interest margin where it also benefits from its diverse geographic footprint. In the 1st quarter net interest margins actually increased to 2.94%. Net credit losses of $3.0 billion were down 25% YoY, highlighting the improving credit quality that has been a consistent theme across the banking sector. Citigroup had a loan loss reserve release of $652MM in the 1st quarter, which was down from $1.2 billion YoY. Importantly, the company utilized $700MM in deferred tax assets. Citigroup must generate stronger profits in its North American business to get the full benefit of its massive net operating losses, or the bank might not be able to realize the full benefit. I believe the company has some levers it can pull to help utilize the full asset, so I wouldn't worry too much about that. Operating expenses were up 1% YoY to $12.4 billion, mainly due to an increase in legal and related costs, in addition to repositioning charges. Citigroup's global footprint has made expense rationalization more difficult historically, but the new CEO Michael Corbat seems committed to getting the job done. The stated goal is to get the whole company at a 55% efficiency ratio, which would truly be an excellent accomplishment if Corbat is able to deliver it. The company's cost of credit in the 1st quarter was $2.5 billion, which was down 16% YoY. Total non-accrual assets fell 9% YoY to $11.1 billion, and consumer loans that were 90+ days delinquent, excluding the Special Asset Pool, declined 26% versus the prior year period to $6.6 billion, or 1.7% of consumer loans.
Citigroup has been transformed into one of the strongest capitalized banks in the world with a Basel I Tier 1 Common Ratio of 11.8%, and an estimated Basel III Tier 1 Common Ratio of 9.3%. Amazingly, despite Citigroup's clearly improving financial picture and growth prospects, the stock still trades at a material discount to both its tangible book and book value of $52.35 and $62.51, respectively. Citigroup didn't see the same increase in book value as some of the other large banks, but this was largely due to the write-down of the Morgan Stanley Smith Barney (MSSB) stake. Moving forward, I'd expect to see tangible book and book value to grow by around 10% per annum, leaving ample room for dividends and stock buybacks.
Citigroup is a different bank than it was prior the "Great Recession." It will never be a Wells Fargo (WFC) with the same high quality deposit and mortgage franchises, but Citigroup's international scale is unmatched. It is in just about all of the key and growing markets with a strong consumer franchise, which it can leverage to foster higher overall growth. In the 1st quarter, the Global Consumer Bank generated $831MM in net income, down 5% from $881MM one year ago. The North American Consumer Bank posted $1.113 billion in net income, down 14% from last year. The Securities & Banking business performed extremely well with net income up 17% to $2.503 billion. Citigroup is benefitting from the reduced competition in the industry, and the company has one of the few viable FICC businesses, which have been impaired by the increased capital requirements and regulatory hurdles. Citicorp Transaction Services saw net income decline 5% to $833MM. Citigroup was a mess of an operation just a few years ago, so many of the core businesses such as credit cards are more in need of repair in terms of operating efficiency, than some of its primary competitors like Wells Fargo or J.P. Morgan. Corbat is a longtime Citigroup veteran and a real banker, and I sense that he is tired of Citigroup being seen as the neighborhood pariah, so he is making the tough decisions necessary to become a stronger franchise.
Monday's large market sell-off actually gives investors the opportunity to buy Citigroup at a wonderful price, despite the very strong earnings results. If the housing market can continue to gain momentum, Citi Holdings will become much less of a burden, accelerating the dramatic improvement in the company's financial results that I expect to occur. The bank has one of the strongest capital and liquidity positions in the world, and if management hits its 10% goal in terms of the Basel III Tier 1 Capital ratio by the end of the year, the company will have a huge amount of capital that it can return to shareholders. In the meantime, there will be numerous concerns and issues, but long-term investors need to see the forest through the trees by ignoring anything but the facts.