When the Citi (C) stock price fell to $10 in 2008 many analysts could not believe that the once mighty bank had been reduced to such a low valuation. There was a suspicion that the markets had gone crazy and were mispricing assets. Well, they were right in one way, because Citi was not worth $10, it was only worth about $4 and (adjusting for the 10 for 1 swap last May) that is pretty much where the stock price has remained.
Banks in general are not the most popular sector at the moment. Part of this is self inflicted and due to previous misadventures, part of it is due to global economic concerns that affect all companies but have a greater affect on highly leveraged banks, and part of it is due to uncertainty regarding future regulation.
Vikram Pandit has done much to address the mistakes of the past by improving risk management, reducing leverage and exiting non-core businesses. The impact of the measures can be seen in recent performance and balance sheet numbers.
Q1 results published on April 16th show Citicorp revenues up 6% on Q1 2011, adjusted group earnings up 8% at $3.4bn and EPS of $1.11 compared to $0.99 the previous year. The progress can be seen in each of Citi's core divisions with Consumer Banking income 14% higher and Transaction Services 10% higher. The investment bank was down 25% on 2011 but this reflects the extremely difficult M&A environment and compares favorably to peers such as JPMorgan (JPM) that experienced a 29% reduction. Loan growth was a healthy, but not excessive, 12%, and Tier One capital was a very satisfactory 14.2% compared to 13.3% in 2011 and only 8.6% in 2006.
These numbers show the continuing progress that Citi is making in restoring core profitability with conservative underwriting of new business and a robust balance sheet.
It is true that if the Euro area breaks up and causes a second economic crisis that the direct and secondary effects would have a large and negative impact on Citi (and the rest). However, I would only attach a probability of around 5% to such an outcome (readers may have other opinions). However, with a 95% probability of a more stable economic outlook, Citi looks well placed to benefit from reducing credit charges, a strong recovery in investment bank income and growing revenues in fast growing emerging markets where Citi has a very strong franchise.
Net credit losses reduced by a remarkable 37% in the first quarter, although the impact was offset by a large release of provision in Q1 2011 that was not repeated in 2012. However, if the economy remains relatively stable for the rest of the year, the reduced risk in the loan book should have a greater impact on the bottom line as the writebacks in Q2, Q3 and Q4 2011 were much reduced. In short, a 30% reduction in credit provisions of $11.8bn should lead to a $3bn to $4bn improvement in the pre-tax income. This would be a significant increase on the $14.6bn pre-tax profits reported in 2011.
Trading under 10 times earnings on April 24th provides little acknowledgement of the improvements already accomplished or of the positive outlook I have outlined above. Markets are deeply unsettled by events in Europe and it is unlikely that this will improve anytime soon. However, for those who take a balanced view of risk and reward, Citi may look attractive for a medium term hold.
Disclosure: The author holds no positions in Citi but is long JPM.
Risk Disclaimer: This article does not constitute a recommendation to buy or sell. Investing in stocks or other securities and derivatives is a high risk activity and not suitable for everyone. It is strongly recommended that individuals should consult with a SEC registered investment advisor prior to making any investment decisions.
