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CITI BANK, A CHEAP WAY TO PLAY U.S BANKS

|Includes:Citigroup Inc. (C), DB, GS, JPM, MS

 Sources: Credit Suisse, JP Morgan, Barclays, Bloomberg                                           

                   Citi Bank, a cheap way to play U.S banks 

Industry Dynamics – Optimistic Outlook about 2012 

So far, concerns related to sovereign risk, regulatory uncertainty, mortgage put-back, litigation issues, and fears of credit down-grades have been the some the major themes driving stocks in the finance sector for this year. Despite these concerns, we have a favorable outlook for the sector, primarily on the basis of its long-term improving fundamentals. 

Sovereign concerns with respect to Europe have not vanished yet; near-term volatility for 2012 will likely stem from development on this front. Nonetheless, the crisis has helped US banks in several aspects. Re-intermediation of the high yield credit market has driven increased C&I loan growth for the banking industry. The deleveraging of European banks has created opportunities for US banks to acquire Euro-zone dollar based assets and businesses at attractive yields. In such a scenario banks with global businesses such as Citi are well positioned to capitalize on gaining international market share. Citi and JP Morgan have expressed 4Q capital market revenues to be in line with 3Q revenues. 

Regulatory developments and balance sheet strength of US banks will be the key theme for US banking stocks in 2012. A major development yet to be seen is that US banks have the Fed’s 2012 CCAR exam to pass. We believe that most of the banks will pass the CCAR threshold of 5% given that teir 1 capital ratio is already higher than 10% for most of the banks and lower losses and reduced leverage have been achieved by each of the banks. 

All three credit agencies have largely completed their reviews on US banks, leaving most institutions in the single-A category; reducing the likelihood of any further downward revision. Regulatory clarity would also initiate effective liability management and optimization of corporate structures which will result in smaller institutions having less risky balance sheets. 

We think most of the banks will be in a position to increase capital returns in 2012 and may reach 50% payout ratios, which is equal to a 5% effective yield. However, due to guidance provided by the Fed to keep dividend payouts at/below 30%, most of the banks are expected to remain conservative. 

Company Profile: Citigroup to outperform its peers 

Citigroup Inc. (NYSE:C) is a global diversified financial services holding company, with the world's largest financial services network, spanning over 160 countries and jurisdictions, with approximately 16,000 offices worldwide. The company employs approximately 260,000 staff and operates 200 million customer accounts around the world. The company is also a primary dealer in US Treasury securities. Before the global financial crisis in 2008 hit the financial industry, the group used to be the largest company and bank in the world by measure of total assets. Currently, it is ranked 10th in size by composite index and enlisted as one the Big Four banks in the US, along with Bank of America, JP Morgan Chase and Wells Fargo. JPMorgan Chase now ranks as the largest bank. 

Citigroup operates in two primary business segments: Citicorp and Citi Holdings contributing 77% ($66 billion) and 23% ($19 billion) respectively towards revenues. Citicorp consists of Regional Consumer Banking businesses and Institutional Clients Group, while Citi Holdings consists of Brokerage, Asset Management, Local Consumer Lending, and Special Asset Pool. 

Despite recording huge losses during the global financial crisis, the group has been able to post sharp improvements in its fundamentals. The company has been able to build-up an enormous amount of cash approximating $460 billion, mostly a result of asset sales. Citigroup’s current Tier 1 common equity ratio stands at 11.7% and Tier 1 capital ratio at 13.5%, making it one of the most capitalized financial institutions in the world. 

Capital Ratios: C – one of the best-capitalized banks 

On the basis of capital ratios, the company stands out as one of the best-capitalized banks. As per latest fillings, the company’s Tier 1 capital and common equity ratios stand at 13.5% and 11.7% compared to peer median of 12.4% and 9.8%, respectively. Citigroup has high total risk-based capital ratio at 16.9%, compared to the peer median of 16.0%.

 

Name

Ticker

Tier 1 Capital Ratio

Tier 1 Common Equity Ratio

Total Risk-Based Capital Ratio

EV / Market Cap

Citigroup Inc

C

13.45

11.71

16.89

10.88

JP Morgan Chase & Co.

JPM

12.10

9.90

15.30

3.70

Bank of America Corp

BAC

11.48

8.65

15.86

7.73

HSBC Holdings PLC

HSBA

12.20

NA

14.90

1.03

US Bancorp

USB

10.80

8.50

13.50

2.17

Goldman Sachs Group Inc.

GS

13.80

12.10

16.90

12.43

Suntrust Banks Inc.

STI

11.10

9.31

13.91

2.68

Morgan Stanley

MS

15.20

13.20

16.40

16.46

BB&T Corp

BBT

12.50

9.80

16.10

2.46

Barclays PLC

BARC

13.50

NA

16.90

12.74

Credit Suisse Group

CSGN

17.70

NA

23.50

3.74

Wells Fargo & Co.

WFC

11.26

9.34

14.86

1.70

Median

 

12.35

9.80

15.98

3.72

 

Source: Bloomberg

 

Valuations: Attractive from all spheres 

Citigroup’s shares currently a have market cap of $80.3 billion with a 52 week high and low at $51.5/share and $21.4/share respectively. At its  current market price of $27.5 the stock is trading at attractive valuations. Price to tangible book-value multiple for the company stands at 0.52x compared to the peer median of 0.86x. It has a forward P/E, P/CF and P/FCF multiple of 6.30x, 1.75x and 1.93x compared to the peer median of 7.64x, 2.00x and 2.14x respectively. The company’s NIMs continue to be higher at 2.87% vs. the peer average of 2.37%, while efficiency ratios remain in line with industry average. 

Dividend yield so far for the company has been on the most conservative side. By 3Q11, the company has $6.7 billion of stock repurchases under its authorized repurchase programs, though no material share repurchases were made during first 3 quarters of 2011. Resumption of shares repurchase activity and higher dividends will be a key catalyst for the stock in 2012.

 

 

Ticker

Name

Mkt Cap (USD millions)

2012

P/E est

P/CF

P/TBV

P/FCF

NIM

ROA

ROE

Div

Yield

Non Int Exp

/ Revenue

Efficiency

Ratio

Overhead Efficiency Ratio

C

Citigroup Inc

80,285

6.30

1.75

0.52

1.93

2.87

0.58

6.71

0.08

61.26

61.26

55.86

JPM

JP Morgan Chase & Co.

127,558

6.92

1.74

0.93

1.74

2.70

0.87

10.69

2.66

61.16

60.82

38.20

BAC

Bank of America Corp

56,761

5.75

1.37

0.47

1.41

2.57

(0.13)

(1.45)

0.65

61.10

60.57

29.57

HSBA

HSBC Holdings PLC

87,561

7.94

5.87

1.38

6.41

2.49

0.59

10.26

2.92

89.80

56.63

50.78

USB

US Bancorp

52,462

10.38

4.03

2.20

NA

3.55

1.36

14.35

1.81

52.17

51.54

11.28

GS

Goldman Sachs Group Inc.

47,898

7.44

NA

0.79

NA

0.65

0.39

5.51

1.48

120.35

125.01

99.34

STI

Suntrust Banks Inc.

9,532

9.49

2.24

0.77

2.34

3.51

0.36

3.20

0.45

72.07

71.08

56.15

MS

Morgan Stanley

30,376

7.83

0.86

0.53

0.91

0.05

0.57

5.35

1.48

62.82

61.06

803.57

BBT

BB&T Corp

17,759

10.75

3.03

1.35

3.18

3.92

0.67

6.47

3.00

67.28

66.09

47.32

BARC

Barclays PLC

21,832

5.51

1.19

0.73

NA

1.44

0.17

5.20

2.14

NA

64.72

75.64

CSGN

Credit Suisse Group

26,815

7.09

NA

1.16

NA

0.79

0.32

10.15

NA

86.13

85.04

160.27

WFC

Wells Fargo & Co.

146,525

8.67

3.77

1.39

3.77

3.89

1.14

12.07

1.70

59.49

58.97

26.07

Average

 

 

7.64

2.00

0.86

2.14

2.37

0.58

6.59

1.70

62.82

61.16

53.32

 

 
   Source: Bloomberg

 

Investment Rationale: Buy stance 

We have a BUY stance on the Citigroup (C) primarily on the back of significant improvement witnessed by the company in its capital and liquidity position in advance of the implementation of the Basel III capital rules. Significant reduction in risk, stronger balance sheet and improving profitability makes the stock look attractive on valuations. Stock currently trades at 0.52x tangible book value. According to our estimates the stock should trade at 0.9x forward tangible book value and 10.7x 2012 earnings. Company is expected to post 9% return on tangible equity (OTC:ROTE) and double digit ROTE for the core Citicorp in 2012 followed by a 27% contraction witnessed in 2011. 

Credit quality is expected to continue to improve driven by declining losses in Citi Holdings, while strong growth is expected in pre-tax pre-provision earnings for the next three years. Key catalyst for Citigroup shares would be the potential of high capital return in the form of higher dividends and the resumption of share buyback in 2012.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Stocks: C, JPM, GS, MS, DB