- Strong quarterly report demonstrates good business practices and profitability.
- 7% growth in loans, with increases in both commercial and consumer loans.
- Second fraud case in Mexico identified.
- Citigroup's capital plan good for investors.
Through our analytical comparison of 2014's first quarter-report with the 4 reports from 2013, we see a continual pattern of streamlining the company, more efficient operations, more effective leadership in all the right places and, maybe the most important, is the concern the company's leadership is taking toward the stock holders. The company's book price continues to appreciate, although the company had a slight setback from the fraud case incident in Mexico. The company is better off than one year ago, and we assess the investors are better positioned today, with a positive forecast for the future.
The opening statement in the quarterly report stated:
"The net income for the first quarter 2014 of $3.9 billion, or $1.23 per diluted share, on revenues of $20.1 billion. This compared to net income of $3.8 billion, or $1.23 per diluted share, on revenues of $20.2 billion for the first quarter 2013."
Initial reaction is why the net income is up, while the revenues slightly dropped. Part of this is due to the decline in Citi Holdings, which the company has continued to sell off in an orderly and profitable manner. The company still lost money from Citi Holdings, but assets produced more income, and the loss was much less than a year ago. The company also grew in the right places to expand its business in more profitable areas.
Citicorp loans grew 7% to $575 billion, and the Net Interest Margin increased to 2.90%. That is a healthy growth over a one-year period. Corporate loans grew by 12% to $279 billion, and 2% growth in consumer loans to $296 billion. The growth in consumer loans reflected the acquisition of Best Buy's (NYSE:BBY) U.S. credit card portfolio in the third quarter 2013. Outside of the acquisition, the consumer loans would have been flat. We see this as a smart move by management to buy the right types of investments for the company.
Citi also recouped $1.1 billion of Deferred Tax Assets for the quarter. DTA reflects losses and other deductions that get converted to tax credits. Citigroup still has over $55 billion of DTAs built up over the last 7 years. Citi must generate sufficient profits to make use of the credits before they expire. This is a simple process only after the hard work of reducing the negatives from the balance sheet and displaying higher profits that qualify to use the DTAs. One way Citigroup could accelerate the use of the DTAs would be to purchase additional assets, similar to the Best Buy credit card portfolio, which quickly gained consumer loans that drives stronger profits. Citigroup has the capital to make these types of investments, but it must be a solid, profitable move before Citi closes the deal. It is projected Citi will continue to use some DTAs each quarter, but it is likely that a good percentage of them will expire before the company can use all of them.
Flying under the radar in the report was the Estimated Basel III Tier 1, Common Ratio was 10.4% and the Supplementary Leverage Ratio was 5.6%. These are strong numbers and exceeded the Fed's requirements. Most of this capital is sitting on the sidelines, held as assurances for the Fed's safety net, and not engaged in increasing revenues. Citi and all banks are required to hold these funds, but after building these huge cash piles, Citi should be able to invest more capital in quality investments, rather than sitting on the cash.
Second Fraud Case Uncovered in Mexico
Reported in the Wall Street Journal on April 14, 2014, Citigroup stated
"it has discovered alleged fraud in its dealings with a second company in Mexico, which a person familiar with the matter identified as Representaciones y Distribuciones EVYA. EVYA, an engineering and construction firm, is a supplier to Mexican state-owned oil company Petróleos Mexicanos, or Pemex. On a media call, Chief Financial Officer John Gerspach said the alleged fraud was under $30 million and that the bank expects to receive full restitution."
In February, Citigroup found an apparent gap of $400 million in an account that owed money to Citigroup's Mexico unit, Banco Nacional de Mexico, or Banamex. The problems started after Banamex extended credit to a Mexican oil-services company, Oceanografía SA de CV, to finance amounts that were allegedly owed to the oil-services company by Pemex. A Citigroup review of its relationship with Oceanografía - a supplier to Pemex - led the bank to discover that a significant portion of the amounts allegedly owed to Banamex were based on fraudulent invoices from Oceanografía.
Mexican Attorney General Jesús Murillo Karam said last week that the government is seeking bankruptcy proceedings for Oceanografía in an attempt to save the company's 11,000 jobs, maintain its operations for Pemex, and to pay back creditors where possible. Representatives of Oceanografía have been unavailable to comment since the government intervened in the company's operations at the end of February.
These 2 reported cases of fraud demonstrate that the processes in place must always be challenged and reviewed, but both are in public view and described as fraud, not bad loans or mismanagement, but illegal activity. The first case of the $400 million dollar fraud is assessed to be the reason the Federal Reserve denied Citigroup's capital plan, even though the company met all the standards in the Basel III requirements and the Supplementary Leverage Ratio requirements.
Citigroup's capital plan consisted of a $6.4 billion common stock repurchase program through the first quarter of 2015 and an increase of Citi's quarterly common stock dividend to $0.05. Citi will be permitted to continue with its current capital actions through the first quarter of 2015. These include a $1.2 billion common stock repurchase program and a common stock dividend of $0.01 per share per quarter.
It is our assessment that the buyback plan of approximately 24 million shares out of the current 3 billion outstanding shares is less than 1%, but a step in the right direction. Citi will hold these shares in its treasury and be able to resell at anytime in the future, possibly at a higher price for additional capital. One result of repurchasing will help increase the stock price (ever so slightly) over time.
Michael Corbat, chief executive officer of Citi, stated during the quarterly brief,
"Despite a quarter that was difficult for our company, we delivered strong results. Both our consumer and institutional businesses performed well and we grew both loans and deposits while holding the line on our expenses. We reduced our deferred tax assets more than any other quarter since the crisis and drove Citi Holdings closer to break even."
As most readers know from my previous articles, I am impressed with Mr. Corbat's ability to lead Citigroup. This quarter's report again demonstrates the focus to grow the company in the right sectors, without taking on additional, unproductive assets. Citigroup continues to sell off assets in Citi Holdings at fair market prices and limiting the write-offs of huge losses. Citigroup continues to grow its business and hold the line on expenses, which we assess shows the determination to evaluate the benefit-to-cost value of adding assets for the right reasons.
We believe Citigroup will continue to post solid returns through 2014, and although will not pay above the $0.01 per share dividend, we should see a strong appreciation in the stock price and book value through 2014 and into 2015. A 10-15% stock value increase is likely in 2014. Citigroup's current stock price at the open on April 21, 2014 is $48.22, and a consensus end-of-year price is targeted near $55.