So the first wave of earnings results have come, with a mixed but fairly unsurprising picture. Financial sector earnings were the first to come in, with JPMorgan (JPM), Wells Fargo (WFC), and Citigroup (C) reporting over the last week. The Citi earnings report was perhaps the most interesting, as analysts were off by the widest margin on the company's projected earnings, which came in 12 cents below the average analyst's estimate of 50 cents. Given that analysts' estimates were off by such a wide margin, it is interesting to see where they were wrong and why.
What is interesting about these analyst estimates is that they were not only off by over 20% in their fourth quarter projections, but they also had to take their numbers down from around 70 cents a share to 50 in the weeks prior to Citi's earnings report. Given the comments from JPM that highlighted weakness in the traditionally seasonally weak trading businesses, as well as the expected weakness in the investment banking division, the stock's sell-off to nearly 7% seems over done.
Citi's earnings report highlighted several issues. First, their core retail franchise did very well in the emerging markets where Citi derives the majority of its international revenue from. Consumer loans grew in the mid-single digits in both Latin America and Asia. Citi has built an impressive franchise throughout these regions, and the strength in these economies seems to be encouraging given how poorly most emerging market equities have traded. Citi did not report any material weakness amongst Asian consumer despite China's fairly high exposure to Europe.
The second area Citi reported was their retail franchise in the mature markets, the U.S. and Europe. Here the story was mixed. In Europe, as expected, weakness in the investment banking and consumer division was slightly worse than expected. In the U.S. loan growth was fairly static, but spreads tightened as loan quality improved in the consumer and corporate segments of their domestic lending business.
The two areas of Citi's earnings that were particularly weak were the investment banking division and their trading revenues. Here I think analysts got ahead of themselves. In addition to the seasonal weakness that trading normally sees in the 4th quarter, JPMorgan and other financials had been warning about weakness in this segment for several quarters.
The investment banking business was also known to take a hit when corporate confidence was hurt by the issues in Europe and more tight lending by many of the financials. However, while the trading revenues have remained weak as expected in this volatility environment, the markets have been remarkably calm, and it is unlikely the trading environment will get much worse in the near term given the vix is now at around 20 and uncertainty in Europe and other areas remains.
However, while the investment banking division had poor results this quarter, corporate balance sheets remain strong while interest rates remain low. Citi's significant exposure to Asia also hurt their investment banking business more than expected this quarter, as that region was negatively affected more than most by the weakness in Europe. Given the bullishness companies have towards the long-term growth story in Asian, the sell-off in many companies with significant exposure to Asia should create some nice acquisition opportunities over the next couple quarter if credit concerns in Europe continue to ease. The weakness in Asia, particularly in China, given their heavy exposure to Europe, should have been predictable with how weak China's PMI had come in the previous quarters and the clear lack of any merger and acquisition activity in the region.
To conclude, the trading environment may certainly remain weak for some time if volatility remains low and markets continue to be fairly calm. However, as lending markets stabilize and corporate confidence returns, the sell-off in equities exposed to China should create some nice long-term buying opportunities.
Also, while the trading environment is currently very poor, the 4th quarter is often a period of season weakness in this division, and it is hard to imagine trading revenues deteriorating much further from here. Whenever a company misses an earnings estimate their is an element of disappointment that traders and investors will feel. However, with credit issues easing in Europe and Asian equities already off nearly 40% in the past year, it's likely that the much of weakness many in the financials earnings reports will stabilize and improve throughout the year. With expectations low, and getting lower, an improving macroenvironment should lead long-term investors to be able to find value in selective financials like Citi here.