- Citicorp-Consists of the businesses that Citigroup has decided to retain. These businesses include Consumer Banking, Corporate and Institutional Banking and Transaction Services. Citicorp generates 96% of its revenue from Citicorp operations.
- Citi Holdings-Consists of assets that Citigroup is willing to let run-off or try to sell. The goal with Citi Holdings assets is to minimize losses and expenses with these operations.
This analytical framework we believe allows us to have a prudent and rational opinion of our investment in Citigroup. We could see in Q2 2012 that it is taking positive steps to catch up to its big bank brethren (J.P. Morgan Chase (JPM) and Wells Fargo (WFC)). Although JPM and WFC posted solid performance in Q3 2012, we can see that Citigroup is keeping pace with those two banks. We reiterate that a rational, dispassionate investor should be able to see the changes going on with Citigroup and that this isn't Charlie Prince's Citigroup anymore. Even former Citigroup critic Tom Brown of Second Curve Capital could see that the changes at Citigroup have worked out well for the company.
Evaluation of Citigroup's Corporate and Administrative Performance:
We were pleased to see that Citigroup's $1.06 of adjusted EPS was able to smash through the expectations of the analyst community even though the analysts have raised their Q3 2012 estimates from $.95 to $.98 over the last 90 days. Citigroup received notice from the Federal Reserve that it passed its makeup stress test in Q3 2012 and it reduced its bonded debt and borrowings by another $26B in the linked quarter, due largely to $30.3B in new deposits during the quarter.
We expected to see continued utilization of deferred tax assets. Citigroup disclosed the DTA status in the Conference Call. The DTAs increased by $2.3B this quarter, primarily due to $1.8B in DTA additions due to losses on its Morgan Stanley Smith Barney LLC assets and $582M in non-recurring tax benefits due to the resolution of certain tax audit items.
Although it is never fun to see Citigroup take a $1.34B realized loss due to the sale of 14% of its interest in Morgan Stanley Smith Barney LLC to Morgan Stanley (MS) and a $3.34B asset impairment charge on its remaining 35% interest in MSSB, we were pleased to see that this was the only non-recurring charge that Citigroup incurred during the period. Citigroup's reported earnings were also negatively impacted by a $485M post-tax DVA/CVA adjustment. JPM also reported a negative $211M pre-tax DVA adjustment in the most recent quarter as well so we can see that CVA/DVA gains in Q2 2012 are being partially offset in Q3 2012.
Evaluation of Citigroup's Banking Performance: Credit and Deposits
Deposits: We preferred to see stronger growth in consolidated deposits from Citigroup. Citigroup grew its deposits by 3.3% on a linked-quarter basis and by 11% versus last year's comparable quarter. This compares to the 2.1% linked quarter deposit growth and 4.3% year-over-year deposit growth that J.P. Morgan Chase enjoyed and the 2.5% linked quarter deposit growth and 6.3% year-over-year deposit growth that Wells Fargo saw. Not only did Citigroup improve its year-over-year deposit growth rate on an absolute basis, but also on a relative basis in relation to its peers. Citigroup's total deposit balance is within $8B of Wells Fargo's total deposits and although Wells had solid deposit growth in the most recent quarter, Citigroup new deposits in the most recent quarter were $7B more than Wells Fargo's.
Credit Losses: We expected further declines in Citi's credit losses, especially from the Citicorp "good bank core operations" business units. Citigroup's total net credit losses declined by over $535M versus last year's quarter (12%). Citi only reduced its provision for loan losses, benefits and claims by $.65M, which shows that Citi is reducing reliance on releasing loss reserves in order to prop up the income statement. Citicorp saw credit losses decline by over $459M year-over-year (17%) and reduced its credit loss provisions by $261M (12%). Citigroup's consolidated loan loss reduction was $656M and primarily driven by loan loss releases at its Citi Holdings operations. Citicorp's loan loss reductions were comparable to the $220M reductions at Wells Fargo and Citigroup's consolidated loan loss reductions of $656M were comparable to the $622M reduction at JPM. Overall, we can see favorable credit trends for Citi.
Evaluation of Citigroup's Business Segments
Citi Retail Banking: Citi Retail Banking continues to see year-over-year growth in accounts, deposits and loans. This resulted in 10% year-over-year growth in net revenue. We saw prudent branch network and expense management during the quarter, as revenue grew faster than expenses versus prior year levels. Citi Retail Banking's 10% revenue growth and 4% decline in credit losses helped power the division's 26% year-over-year profit growth. Geographically, Citigroup's North American Retail Banking 6% year-over-year revenue growth more than offset a 4% revenue decline from Citigroup Asia and flat revenue performance from Citigroup's Latin American and EMEA operations. This is comparable to the performance of J.P. Morgan's Consumer and Business Banking business, which saw a 7% revenue increase and a 21% increase in net income.
Citi-Branded Cards: We were disappointed in its performance. Citi Cards's business segment income declined by 1% on a year-over-year basis but increased by 14% on a linked quarter basis. This was due to lower loan balances and the Durbin Amendment providing headwinds to its debit card revenue. We take comfort in that JPM's Card Services business momentum was the opposite of Citi Cards's. JPM Card Services saw its net income increase by 4% year-over-year but declined by 11% in the linked quarter.
Citi Securities and Banking: Recurring business segment revenue increased by 15% year-over-year, excluding a $2.667B decline in the credit value adjustment on derivatives and debt value adjustment on the fair value of Citigroup's debt. The only weak spot during the quarter for Citi Securities and Banking was lending, which saw its revenues decline by 81%. This was offset by growth in investment banking (up 26%) and capital markets activities (64%). Excluding the mark-to-market impact of loan hedges related to accrual loans, lending revenues rose 35% to $445 M versus the prior year period reflecting higher lending volumes and improved spreads. Net operating expenses declined by nearly 3% versus 2011's levels and credit loss provisions were reduced by nearly $250M. Our favorite business line in this division is Citi Private Bank and it saw its revenue increase by 8% year-over-year and 3.5% versus the linked quarter. This exceeded the 5% year-over-year growth and 2% linked quarter growth that J.P. Morgan Private Bank generated.
Citi Transaction Services: Transaction Services has been Citigroup's island of tranquility in an otherwise truculent market during the last five years. This quarter it generated a 2% year over year revenue decline due to slower revenue growth with its Treasury and Trade Solutions business and a shocking 13% revenue decline at its Securities and Fund Services business. Operating expenses declined by 5% and Transaction Services built up credit reserve losses by $51M. At least the division saw a $700B year-over-year increase in EOP Assets under Custody and a 14% year-over-year growth in average deposits.
We were disappointed that although Citi's Securities and Fund Assets under Custody increased by 6% on a year over year basis, it was dwarfed by the 12% growth seen at J.P. Morgan TSS. J.P. Morgan TSS showed stronger revenue and profit growth in its Treasury and Trade Services and its Worldwide Securities Services businesses than Citigroup. We reiterate that if the Citi Securities and Fund Services business continues to struggle, Citigroup should consider selling this business to its former CitiStreet Investor Services joint venture partner State Street (STT).
Citi Holdings ("bad bank"): Now that Citi Holdings accounts for less than 5% of Citigroup's total revenue and 9% of its assets, we believe that investors will see that Bill Ackman of Pershing Square had sold out of his position before realizing the value generated from the core Citicorp continuing operations. We were content in that Citi Holdings reduced its year-over-year operating expenses and credit loss provisions by 21% and 26% respectively.
In conclusion, we are intending to hold on to our stake in Citigroup, as well as looking to selectively accumulate a larger position. Due to the market weakness and deep discount from market price relative to its tangible book value, we may even increase our rating to a "Strong Buy" from "Accumulate. We have recently added to our position in Citigroup and reiterate our positive outlook for the company because we see that Citigroup continues to achieve the following performance accomplishments in Citigroup's business lines:
- Stability from the Retail Consumer Banking business segment
- New CEO Michael Corbat replacing Vikram Pandit
- Assets for Citi Holdings are now $171B and only represent 9% of total company assets.
- Lower credit costs across Citigroup's diverse business lines
- Increased credit/debit card purchase transaction volumes from Citi Cards
- Lower Operating Expenses from the Securities and Banking division
- Steady revenue growth from Citi Private Banking
- Citigroup's new-found ability to replace high-cost debt and trust securities with low cost customer deposits, which enables it to improve its net interest margin versus JPM/WFC.
- Citigroup passed the stress test and we expect that the company should be allowed to return cash to its shareholders through dividend and share repurchases.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.