Citigroup (C), the third-largest bank in the United States by assets, has reported results that were ahead of EPS and revenue estimates for the second quarter. Revenues at $20.0 billion were $330 million ahead of estimates and the EPS was $1.25 per share compared to the estimate of $1.18 per share. Profits were up by 42% year-over-year because of better pricing at home, better capital market activity and stronger loan demand in emerging markets.
Among other highlights of the results were a decline in loan losses, a small spread reduction of 0.03% as well as an increase in both book value and tangible book value. Analysts had earlier feared that book value would actually decline. The loan portfolio grew 3% from the previous year period despite higher interest rates and the use of deferred tax assets enabling the bank to reduce its tax payment. The overall performance can be considered to be impressive. Despite the impressive performance, Citigroup must contend with possible future problems such as reduced debt underwriting volumes because of rising yields and reduced profitability because of weak GDP growth in the emerging markets. There is also a fear that unfavorable foreign exchange rates may have an adverse effect on exchange translation.
Reshuffle at the top
Citigroup celebrated its 200th anniversary by reshuffling top management placing bankers in senior positions for the first time in more than a decade. Michael O'Neill (who is best known for reviving Bank of America in the late '90s and turning around Bank of Hawaii) became chairman of the board. O'Neill pushed for placing the bank on a sound footing by cutting costs and controlling risk better and, within a few months, had succeeded in forcing CEO Vikram Pandit to resign. His choice as a replacement was veteran Michael Corbat who has extensive experience in many of Citigroup's businesses. The stock has since gained substantially. The new team of O'Neill and Corbat has some big advantages on their side. Citi has a banking franchise that is almost unmatched in global terms and does business in 160 countries with a physical presence in 100 countries, many of which are located in the emerging markets. Simultaneously, the troubled assets in the "bad" bank, Citi Holdings, have been reduced by more than 80% from a peak level of almost $800 billion, which will free up capital that can be used for more productive and profitable purposes. Finally, Citi has $55 billion in deferred tax assets and future tax write-offs to help cushion its tax liabilities.
The new management seems to have earned the trust of Wall Street as well as Washington, especially since the bank has passed the Fed's Comprehensive Capital Analysis and Review, commonly known as the stress test, which it had agreed to pass last year. As a result, it has received approval to commence share buybacks worth $1.2 billion from the first quarter of next year. The amount may not be particularly large but does represent an important step forward.
The new team's targets
Corbat has set financial targets for Citigroup to achieve by 2015 as well as providing investors with a scorecard so that they can track the progress. Among other things, the plan calls for an increase in return on assets from 62 basis points in 2012 to a range of 90 basis points to 110 basis points and return on equity from 5% in 2012 to 10%. Another target is to improve the efficiency ratio (exclusive of the distressed assets) from 60% in 2012 to the mid 50% range. The efficiency ratio, which measures the quality and effectiveness of management, is calculated by looking at overheads as a percentage of total revenue. The best performing banks have a ratio in the region of around 50%.
The bottom line
Citigroup appears to be well placed to deliver more value to its shareholders. It has revealed a book value of $63.02, which means that at the current price of $52.35, it is trading substantially below book value. Analysts estimate have an average mean target price of $57.91 and an average median target price of $58.50 and I personally believe that the stock has the potential to trade even higher based on its emerging markets exposure and increasing efficiency.