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Citigroup's (NYSE:C) Chief Executive Officer has a reason to be optimistic after the company released its third quarter 2012 results. It reported net profit of $468 million, equivalent to earnings per share of $1.26 for the period. This is a decline of 88% compared to the prior year. Excluding one-off items, Citigroup posted profits of $1.06 a share. Despite the decline, this still beats consensus expectations of earnings per share of $0.98. On a quarter on quarter basis, this is higher than the $0.84 per share in the second quarter.

This comes after modest quarterly results in the previous quarters, implying that the bank has shown positive momentum. For the second quarter results, the bank reported a decrease of 12% year on year. This also beats consensus earnings expectations of $0.89 per share. The last couple of quarters showed relatively good results. This gives investors assurance that management has already addressed the issues surrounding the bank during the height of the financial crisis of 2008. In fact, this is also the reason why the bank posted better than expected profitability. The manifestations of a healthy credit position appear clear: decline in net credit of $4 billion and the release of credit reserves valued at $1.5 billion.

The good thing about having a strong balance sheet is that it can focus on growth rather than asset quality. For the period, Citi posted revenues of $17.6 billion, also down by 9% compared to the same period last year. If you strip off the credit valuation and debt valuation adjustments, revenues would amount to $18.4 billion, an increase of 5%. But, its businesses have mixed results. Both transaction services and securities and banking group posted reduced revenues. This offsets the robust revenue growth of its global consumer banking.

Meanwhile, Citi Holdings reported negative revenues of $3.7 billion, a reversal from the previous year's revenues of $1.1 billion. The lower revenues were primarily due to the decline in revenues of its consumer lending businesses from the decline in average assets. This seems normal as the bank has been shedding off non-core assets, notably its $100 billion portfolio of consumer home mortgages that turned sour. Also, other divisions reported decline in revenues. Its operating expenses were down by 2% to $12.2 billion. It has implemented ongoing tight expenses control and reengineering measures. The decline in overall assets at Citi Holdings also contributed to the drop in operating expenses.

Better Profitability Seen as Credit Quality Improves

The bank's credit quality has continually improved. Its non-accrual assets have decreased by 5% year on year to $12.7 billion. On the other hand, its total reserve for loan losses is also down by 5.1% to $25.9 billion. For the last 5 years, Citi's provisions for credit losses have declined from $17.42 billion to $12.13 billion. This translates to a decline of 6% a year. In terms of the rate of decline, this is higher than most of its banking peers. JP Morgan (NYSE:JPM) reported provisions for credit losses from $6.86 billion in 2007 to $5.53 billion in 2011. This yields to a decline of 3% a year for the same period. In contrast, Wells Fargo (NYSE:WFC) reported higher provisions for the 5-year period. Its provisions for credit losses increased from $4.9 billion to $7.6 billion, or an increase of 11% a year. Also US Bancorp (NYSE:USB) reported higher provisions from $792 million to $1.9 billion for the same period. This translates to an increase of 27% a year.

According to the Realtytrac study, the overall foreclosure activity has declined for the third quarter. Foreclosures have declined by 5% from the previous year and 13% compared to the previous quarter. This signals that there is gradual recovery in the housing market and translates to better financial position for these banks. I believe that Wells Fargo will benefit the most as it has always sizable exposure to the real estate market. Overall, this will also benefit consumer portfolio driven banks such as Citigroup and US Bancorp as there will be a trickle-down effect on the economy.

Given this fact, Citigroup could now focus on increasing its loan growth rather than shedding off assets. The lower provisioning of the bank from the recent years implies that it believes that the best strategy is to pursue growth. Its underlying franchises have remained strong although there have been doubts amid the lackluster growth of the US economy. This is something that Citigroup has to work towards in the next 5 years. Its loan book has declined from $777 billion in 2007 to $617 billion in 2011. The decline is attributed to its focus on improving its quality rather than profitability. Other banks have experienced loan growth. For example, Morgan Stanley (NYSE:MS) has posted loan growth from $11.62 billion in 2007 to $15.36 billion in 2011. This equates to annual growth of 6% for the entire period. Wells Fargo reported almost double loan growth from $409 million to $810 million for the period.

Moving forward, Citigroup could bank on its strong global footprint as the catalyst to counter the headwinds its faces. This will translate to better visibility in terms of loan growth and profitability. Its constant investments in emerging markets will also pay off, coupled with its cost efficiency measures. Furthermore, the pickup in economic activity notably in the mortgage sector will contribute to the bank's future growth.

Still Valued as a Low Quality Bank

Citigroup shares remain well below where they were during the financial crisis. It currently trades at 8 times forward earnings and 60% of its book value. This is lower than its 5-year average of 11.3 times earnings and 80% of book value. At these levels, the market is pricing as if Citigroup will close shop tomorrow.

This is also lower than other banking stocks. Morgan Stanley trades at 14 times earnings and 60% of book value. JP Morgan is valued at 9.8 times earnings and 90% of book value. Meanwhile, Wells Fargo trades at 9.1 times earnings and 130% of book value. It seems that most banking stocks are still trading at crisis levels. The reason is quite simple. Asia businesses have slowed down and Europe is still a mess. Despite this scenario, Citigroup's loan growth will continue to grow at a steady pace while provisions will continue to decline.

The market has not yet captured this possibility. The gap between Citi's real value and its market price has widened. An enterprising investor will benefit from this mispricing assuming he has enough patience to wait until the current economic environment improves.

Source: Patience Key To Citigroup Investments