A Closer Look at Citigroup's Declines After Earnings

| About: Citigroup Inc. (C)

Before the stock market opened on July 15, Citigroup (NYSE:C) reported a 21% earnings per share increase in second quarter above the comparable 2010 quarter. Its stock surged $1.37 or 3.5% at the opening to $40.39. This rise in price was accompanied by heavy volume and seemed to offer a glimmer of hope to long suffering shareholders. By noon, however, Citigroup had lost all its gains. During the afternoon C fell as low as $38.12, before ultimately finishing the day off $0.64 or 1.64% at $38.38.

The dispiriting price action for Citigroup was accompanied by price declines in JP Morgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC). The percentage decline at C was greater than at these other large banks.

It seems clear that in the current environment market, participants will always be able to find something disturbing with bank financials that will outweigh any improvements cited by management. In the case of Citi, the decline in net interest margin (NIM) to 2.82% in the second quarter of 2011 from 2.88% the previous quarter was particularly unwelcome news. During the second quarter of 2010, Citi had reported a NIM of 3.15%; therefore, NIM declined by 33 basis points or 10.5% in one year. Wall Street hates declines in margins and has a long history of punishing companies and/or industries that experience such declines.

An examination of the decline in net interest margin at Citi reveals it was largely attributable to a very pronounced decline in the yield on its investment portfolio. The yield on that portfolio was 2.79% during the quarter just ended, while it was 3.17% during the first quarter of 2011 and 3.89% during the second quarter of 2010. This is a remarkable and worrisome decline in yield on an investment portfolio that averaged $318 billion during the second quarter of 2011, $320 billion in the prior quarter and $311 billion during the second quarter of 2010.

Adding further selling pressure to C was the fact that Citigroup increased its staff by 2%, or 3,000 people during the second quarter. The fact that it increased staff while margins were under pressure is a source of concern even though its total staff is the same as it was the year before. Investors generally expect payroll reductions, not additions, when margins are under pressure.

On a positive note, it should be mentioned that loans outstanding rose slightly in the second quarter versus the prior quarter, and the average loan yield rose 13 basis points to 7.93%. Loans outstanding still remain well below the level of the prior year.

The positive impact that would result from redeploying funds from investments yielding 2.79%, and deposits with other banks yielding 1.06% into quality loans yielding 7.93%, is obvious. Citi needs to accelerate its lending if it expects to meaningfully increase its income by reversing the decline in its net interest margin, and it must do so without compromising credit quality. If its lending staff cannot generate quality loans, then Citi will have to start acquiring fixed and floating rate corporate obligations with the ample funds it currently has available.

Disclosure: Author is long C