Citigroup's Comeback Continues On After Bill Ackman's Sale

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 |  About: Citigroup Inc. (C)
by: Saibus Research

In our previous reports on Citigroup (C), we repeatedly said that we believed investors should view Citigroup as two firms consisting of the following exposures:

  1. 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 95% of its revenue from Citicorp operations.
  2. 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 from operations.

This analytical framework allows us to have a prudent and rational opinion of our investment in Citigroup. In Q2 2012, we could clearly see that it is taking positive steps to catch up to its big bank brethren, JPMorgan Chase (JPM) and Wells Fargo (WFC). Although JPM and WFC continue to post solid overall performance, Citigroup is keeping up pace. We reiterate that a rational, dispassionate investor should be able to see the changes going on with Citigroup and that this isn't 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.

Evaluation of Citigroup's Corporate and Administrative Performance

We were pleased to see that Citigroup's $1.25 of adjusted EPS was able to smash through the $1.18 expectations from the analyst community. Citigroup passed the Federal Reserve's 2013 CCAR stress test in March 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). In our professional opinion, Citigroup should be allowed to repurchase $10B worth of stock and increase its dividend from $.01/share quarterly to $.20/share. We like that Citigroup has reduced its bonded debt and borrowings by nearly half since the end of Q1 2010. This is due largely in part to asset sales which increased equity capital levels as a percentage of assets and steady growth in its deposit book.

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Source: Bloomberg LPClick to enlarge

We were happy to see Citigroup go through a second quarter in which it did not incur any material amounts for "non-recurring charges". Citigroup's net CVA/DVA gain was only $293M during the quarter and $95M for H1 2013. This shows that its reported EPS is somewhat comparable to its adjusted EPS. Citigroup's CVA/DVA gain/loss improved from +$140M in Q2 2012 to +$293M in Q2 2013 while JPMorgan Chase's declined from +$755M in Q2 2012 to +$355M in Q2 2013. We expected to see continued utilization of deferred tax assets. We were pleased to see that Citigroup was able to utilize $1B of its deferred tax assets in its most recent quarter after using $700M in Q1 2013. 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 50bp on a linked-quarter basis and by 2.64% versus last year's comparable quarter. JPMorgan Chase enjoyed a higher year-over-year deposit growth rate (8%) but a lower linked quarter deposit growth rate (4bp). Wells Fargo checked in with 1% linked quarter deposit growth and 10% year-over-year deposit growth. Citigroup was gaining ground on Wells Fargo with regards to 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 FY 2012 deposit growth rate of 7.5% was higher than JPMorgan Chase's 5.8% and its YTD deposit growth of 85bp is slightly higher than JPMorgan Chase's (78bp).

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Source: Bloomberg LPClick to enlarge

Credit Losses: We expected further declines in Citi's credit losses, especially from the Citicorp "good bank core operations" business units. Citigroup's total net credit losses declined by $883M versus last year's quarter (25%). Citigroup decreased its provision for loan losses, benefits and claims by $672M, which shows that Citi is reducing reliance on releasing loss reserves in order to prop up the income statement. Citicorp saw its credit losses incurred decline by over $324M year-over-year (15%) but increased its credit loss provision by $141M. Citigroup's consolidated loan loss reduction of $883M was primarily driven by reductions in credit losses at its Citi Holdings operations. Citigroup was able to reduce its loan loss allowance by 25% year-over-year. Although this was less than the 78% that JPM was able to achieve and the 64% that Wells Fargo achieved, at least Citigroup is still making progress in reducing its loan loss provisions and this is helping it utilize a portion of its deferred tax assets. 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 see year-over-year growth in investment sales, deposits and loans; however its revenues only grew by 2%versus the prior year period. We were relieved that at least Citi Global Consumer Banking's expenses inched down by 1% year-over-year as its retail branch footprint has steadily declined for six straight quarters. We were surprised that its credit loss provision increased by 20% year-over-year even though its Net Credit Losses declined by 12% 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 year-over-year growth in investment sales of 42% and AUM growth of 12% thanks to the run-up in the stock market over the last year, though this was below the 53% investment sales growth and 16% AUM growth at JPM's retail branch banks.

Citi-Branded Cards: We were relieved in Citi Cards' performance. Citi Cards' business segment income increased by 6% year-over-year in Q2 2013 versus Q2 2012 and its revenue increased by 2% during the same period. This was due to 5% lower average loan balances year-over-year and reduced credit provisions which more than offset higher operating expenses versus the Q2 2012 period.

Citi Securities and Banking: Recurring business segment revenue increased by 21% year-over-year, excluding $264M of reduced credit value adjustments on derivatives and debt value adjustment on the fair value of Citigroup's debt. Investment Banking grew its revenues by 21% ($179M) year-over-year. Equity capital markets activities (+10%, or $381M) and fixed income capital markets activities (18% or $511M) checked in with strong revenues as well. This was offset by softness in lending, which declined by $147M (26%) versus Q2 2012. Net operating expenses declined by nearly 2% versus the linked quarterly period and by 2% versus Q2 2012 and credit loss provisions decreased by $138M. Our favorite business line in this division is Citi Private Bank and it saw its revenue increase by 9% year-over-year and 3% 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 stale performance in 2013. This quarter it generated a 1% year over year revenue decline as a 5% revenue increase in its Treasury and Trade Solutions business was not enough to offset a 3% revenue decline at its Securities and Fund Services business. Operating expenses actually increased by 2% and Transaction Services' credit loss provisions declined by $27M. At least the division saw a $1.2T year-over-year increase in EOP Assets under Custody and 7% year-over-year growth in average deposits.

Citi's Securities and Fund Assets under Custody increased by 10% a year over year basis, which was higher than what JPMorgan Treasury and Securities Services achieved (7%). JPMorgan's Securities Services had stronger revenue growth (+1%) than Citi Fund Services (-3%) but JPMorgan Treasury Services had weaker revenue growth (-2%) than Citi Treasury and Trade Solutions (3%). We reiterate our stance that if Citi 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 (NYSE:JCP) 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 38% since then, Citigroup went up by 107% during that time frame. Then GGP fails to accede to his demands that it sell itself to SPG. Now that Citi Holdings accounts for 5% of Citigroup's total revenue and 7% of its assets, we can't help but reiterate about how Bill Ackman of Pershing Square had sold out of his Citigroup position before he was able to realize the value generated from the core Citicorp continuing operations. Although we were displeased that Citi Holdings increased its operating expenses by 23% year-over-year, we were more than mollified because Citi Holdings' net credit losses incurred and loan loss provision accruals declined by 46% and 44% respectively.

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Source:Click to enlarge Citigroup's 2012-13 Earnings Releases

Conclusion

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 company because we see that Citigroup continues to achieve the following performance accomplishments in Citigroup's business lines:

  1. Stability from the Retail Consumer Banking business segment
  2. Michael Corbat replacing Vikram Pandit as Citigroup's CEO
  3. Assets for Citi Holdings are now $131B and only represent 7% of total company assets.
  4. Lower credit costs across Citigroup's diverse business lines
  5. Increased credit/debit card purchase transaction volumes from Citi Cards
  6. Lower Operating Expenses from the Securities and Banking division
  7. Steady revenue growth from Citi Private Banking
  8. Citigroup enjoyed 11% year-over-year revenue growth in Q1 2013 (8% adjusted for CVA/DVA) versus Q2 2012. JPMorgan Chase's revenue growth was due to a one-time dip in Q2 2012 relating to the London Whale episode. Wells Fargo's revenue inched up by 42bp during the period.
  9. 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 its peers.
  10. Citigroup passed the 2013 stress test on its first attempt. This enables it to buy back $1.2B in shares over the next 12 months and we previously discussed how we expect more capital returns in 2014 (contingent on the economy of course).

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Source: Bloomberg LPClick to enlarge

Disclosure: I am long C. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no commercial or pecuniary relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.