Citigroup (C) recently sold half its stake in Turkish lender Akbank (AKBTY.PK) as part of its plan to consolidate its capital as part of its efforts to meet more rigid Basel III standards that will be implemented in 2013.
The Akbank sale raised $1.15 billion for Citigroup, which had previously sold stakes in China's Shanghai Pudong Development Bank and India's Housing Development Finance Corporation for combined proceeds of about $2.57 billion.
The asset sales, worth a total of $3.72 billion, combined to add around 74 basis points of Tier 1 Common Capital to Citigroup, bringing its Tier 1 Common Capital ratio to 12.54%. Citigroup revealed that it had a 11.8% Common Capital at the end of 2011.
Citigroup's stock had run up by as much as 45% in the early part of 2012 on positive earnings momentum but surrendered all its gains after reports emerged in the second half of March that it, together with SunTrust (STI), MetLife (MET) and Ally Financial (ALLY-PB), had failed the Federal Reserve's latest round of financial stress tests.
Citigroup, in particular, had been hoping to secure the Fed's approval to return close to $3 billion to shareholders as part of its capital plan, but the Fed's stress test results showed that its Tier 1 Common Capital Ratio would have fallen to 4.9% under the plan it submitted - below the 5% minimum level set by the Fed in its Guidelines.
Notwithstanding the Fed's stress tests, it's worth noting that Citigroup's current Tier 1 ratio is actually above the 7% to 9.5% range prescribed by the Basel III guidelines for large global banks. Moreover, Citigroup has indicated that it intends to re-take the Fed's stress tests later this year, giving investors hope that capital can be returned to them.
Given this, I believe that the negative overhang surrounding Citigroup as a result of its failure to pass the Fed's stress tests is overwrought - and should pass as it becomes apparent that Citigroup fully intends to comply with its revised capital plan.
That said, whether Citigroup merits a "buy" or otherwise also depends on what its performance will be like in the months ahead.
As such, here's a look at Citigroup's individual units:
- Consumer Banking. Consumer Banking contributes the most to Citigroup's revenues, with a 51% contribution in the 1st quarter of 2012. More specifically, Citigroup's Consumer Banking breaks down into its Retail Banking/Deposit-Taking and Credit Card units.
The outlook for its North American unit remains positive after it grew by 5% in the 1st quarter of 2012 over the same period a year earlier. This was largely driven by improving conditions in the U.S. credit card market, with charge-offs declining and the nascent recovery in the labor market translating into an increased willingness to spend.
At the same time, Citigroup's retail banking units, particularly in Asia and Latin America grew by 5% and 6%, respectively, with both regions the beneficiary of strong consumer spending. Interestingly, deposit taking picked-up in formerly hard-to-penetrate Singapore after Citigroup made the unconventional decision to pilot branches modeled after Apple's (AAPL) retail stores. This successful strategy is now being transported to Hong Kong. A successful turn there might actually result in the program being piloted in North America.
More importantly, the growth in these two markets was more than enough to offset the 10% contraction in its smaller European operations. I view Citigroup's relatively small Consumer Banking footprint in Europe favorably; with all the talk of austerity in the region, it is highly unlikely to be a source of strong retail profits for some time.
The key challenge for Citigroup in the retail space is how it makes effective use of mobile. So far, Citigroup has been happy for its branches to become disintermediated as more clients shift their basic banking requirements to their smartphones.
While this might bring costs down, it has a downside: retail branches act as distribution outlets for banks' other services and products. That means that Citigroup will have to evolve their role to compliment mobile.
Moreover, similar to the dilemma of Facebook (FB), Citigroup possesses a hoard of information on its customers - in particular, their spending patterns - but it has yet to find a way to monetize that information, other than as a way to deter fraud. I view this as a key opportunity, particularly as companies such as PayPal and Google (GOOG) challenge traditional consumer banks as transaction facilitators.
- Securities and Banking. The second-largest contributor to Citigroup's profits is its Securities and Banking unit, which is commonly referred to as its Institutional Clients Group (ICG). It is Citigroup's most market-sensitive unit since it includes its Global Markets division, which profits from market making in financial instruments, investment banking, proprietary trading and lending to large corporations (i.e. corporate banking).
This unit contributed 27% of 1st quarter revenues but suffered a 12% contraction from a year earlier arising from steep losses in its credit portfolio as debt markets were roiled by headwinds from Europe as well as widening spreads on European corporate credit.
This could potentially undermine Citigroup's attractiveness to investors, as it has done with JPMorgan (JPM) - but it does bear mentioning that its $15.1 billion net exposure to Europe is not particularly difficult to hedge.
Meanwhile, ICG also includes Citigroup's Private Wealth and Asset Management units; the outlook for these areas is mixed: private banking is expected to grow strongly in Asia but Western markets are likely to see mixed levels of expansion amidst tepid economic growth. Unfortunately, even if this unit does experience strong growth, it is unlikely to overcome losses in more market-sensitive segments.
- Transaction Services. Transaction services are a relatively stable portion of Citigroup's revenue portfolio, largely dealing with cash management, trade transactions and corporate treasury services such as collections and liquidity services. This unit grew by 7% in the 1st quarter and should continue to benefit from high levels of cash on the corporate front.
The only real headwind in this area is from Transaction management; Global Trade is expected to expand by just 3.7% this year.
Indeed, while it does derives a significant portion of its revenues from capital markets, Citigroup is, for the most part, still driven by its consumer banking business, which is showing encouraging signs of picking up, particularly in the credit card space.
In that sense, Citigroup is a bit closer to JPMorgan. In fact, both companies' stocks are trading at similar Price/Earnings (P/E) ratios of 7.4.
Of course, Citigroup's advantage over JPMorgan is its consumer banking presence in Asia and Latin America, where rising incomes have lead to a boom in consumer spending. More importantly, during the first quarter, Citigroup's consumer banking units in Asia and Latin America combined to add 34% more to its overall revenues than its Securities and Banking units in North America and Europe did. That takes the edge off of markets' volatility.
Meanwhile, given its success in liquidating assets in other markets, it's highly probable that Citigroup will succeed in its efforts to raise its capital levels and provide actual returns to shareholders. I see its stress test failure in March as already factored into its current price.
I recommend buying Citigroup stock. As investor sentiment improves after the stress test failure, I believe the bank's strong assets and earnings performance will garner a 50% gain in the next 12 months.