Late last week, Citigroup (NYSE:C) reported revenues and earnings for the fourth quarter that were ahead of investor expectations. While expectations for the overall banking industry were quite low given the weak market conditions over the period, the geographically diversified banking giant did well to cut quarterly operating costs to the lowest level in at least a decade – helping it report an improvement in profits quarter on quarter.
Like other banking giants, Citigroup’s top line faced considerable headwinds from poor equity market activity, which hurt trading revenues and also weighed on advisory and underwriting fees. Additionally, Citigroup’s fee-based revenues from global consumer banking operations remained depressed for the second consecutive quarter due to a marked reduction in the sale of retail investment products. The deteriorating quality of loans to energy companies also resulted in an increase in loan provisions from $1.92 billion in Q1 2015 to $2.05 in Q1 2016.
All things considered, Citigroup remains one of the best capitalized U.S. banking giants, with a common equity tier 1 (CET1) capital ratio of 12.3%, and its continuing efforts to streamline operations and shrink its non-core divisions will improve long-term profitability. Taken together with the fact that the bank is currently trading at less than 65% of its book value and roughly 75% of its tangible book value, the shares appear undervalued. We maintain a $60 price estimate for Citigroup's stock, which is roughly 30% ahead of the current market price.
Trading Revenues Improve Quarter On Quarter; Investment Banking Operations Suffer
Citigroup generated revenues of $3.8 billion through its trading operations (fixed income and equity taken together, adjusted for CVA/DVA) for the first quarter of the year – roughly 13% lower than the figure for the year-ago period, but 36% ahead of the figure for the previous quarter. While the large sequential improvement in trading revenues can be largely explained by the fact that the first quarter of a year usually sees the highest revenues due to the seasonal nature of the industry, the year-on-year decline is similar to what was reported by peers JPMorgan (NYSE:JPM) and Bank of America (NYSE:BAC) for the period.
Revenues for the FICC (fixed income, currencies and commodities) trading desk increased 40% from the exceptionally low $2.2 billion in Q4 2015 to $3.1 billion in Q1 2016, although the figure fell 11% year on year. Citigroup’s smaller equity trading desk did well to rope in $706 million in revenues for Q1 2016 – up 17% q-on-q, but 19% lower y-on-y.
In comparison, Citigroup’s advisory and underwriting fees tanked by roughly 25% compared to Q1 2015 and Q4 2015, as the bank saw a sharp decline in revenues for its M&A advisory, debt origination as well as equity underwriting units. Total advisory and underwriting revenues added just $875 million to the top line – the lowest since Q3 2013.
Consumer Banking Division Suffers On Multiple Fronts
Citigroup’s biggest strength is its extensive global presence. That allows the bank to benefit from diversified revenue streams that are not subject to the restrictions faced by its peers who are largely focused on U.S. markets. Citigroup’s strong retail banking presence across the globe and in emerging markets gives it access to cheap funds in the form of low interest rate deposits from the regions in which it operates, allowing it to achieve better net interest margins.
As the bank caters to demand for loans globally, its interest income is not overly dependent on the interest rate environment prevalent in any single country – something that has helped it maintain net interest margins around the 2.9% mark over the last few years. This is in sharp contrast to peers like Wells Fargo (NYSE:WFC) that have seen a reduction in this figure of well over 100 basis points (1% point) over the same period.
Thanks to the stable net interest margin figure and steady growth in its global real estate loans portfolio, interest-based revenues for Citigroup’s consumer banking division remained strong in Q1 2016 despite negative foreign exchange movements. However, the non-interest revenue figure remained depressed at $1.36 billion – 26% below the figure a year ago.
The decline was primarily due to a fall in the sale of investment products from $25.5 billion in Q1 2015 to $16.4 billion in Q1 2016. While this reduction is evident across operating regions, things have been particularly bad for the combined Asia-Pacific and EMEA region, where investment sales have shrunk 50% from an average of $12 billion in the first half of 2015 to $6 billion now.
Disclosure: No positions