Citigroup's Energy Loan Problem

| About: Citigroup Inc. (C)
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Citigroup has the largest loan exposure to energy companies among the big banks, with nearly $58 billion. Competitors have $40-$45 billion in energy loans.

CFO John Gerspach recently declined to disclose how much the company has set aside for loan losses related to energy.

Citigroup's energy loan portfolio is roughly 80% investment grade.

While the Fed's forecast of four rate hikes in 2016 was probably never realistic, the market was expecting interest rates moving up during the year. That made financials a popular pick for the top performing sector of the year. Instead, financials have turned out to be one of the worst performing sectors of the quarter dropping more than 3%. Perhaps more discouraging is the fact that the impetus that was supposed to move financial stocks higher in 2016 may not happen at all.

That's bad news for shareholders of Citigroup (NYSE:C) who've experienced a lot of pain over the past several years. Since the beginning of 2011, Citigroup shareholders have lost nearly 17% of their investment. Earnings estimates have, predictably, been lowered for most of the financial services names including Citigroup, but I feel that those estimates could need to be lowered again soon for reasons I'm about to get into.

I think investors are not expecting much good news coming out of the company's Q1 earnings report but I think the surprise could be how much Citigroup lowers guidance for the remainder of 2016 and beyond given the changing economic environment.

Jefferies (NYSE:LUK-OLD) delivered its fiscal first quarter earnings report in March and if its results are any indication of how the rest of the sector is faring, it could get ugly. Management called January and February "extremely challenging" and reported steep declines in trading as well as big losses on both the top and bottom lines. Citigroup has already warned that trading revenue is expected to drop 15%, marking the fourth straight year of declines in that segment of the business. Investment banking revenue is also expected to be lower by 25%.

Here's what we know: the Q1 earnings results will be weak, forward guidance may need to be lowered, trading revenue will be way down, slowing GDP growth and a flattening yield curve won't help. And any of these might not even be the biggest problem the company is facing.

Citigroup has one of the largest exposures to the energy sector estimated at about $58 billion (Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC) and JPMorgan Chase (NYSE:JPM) all have exposure somewhere in the $40-$45 billion area). CFO John Gerspach went on record disclosing that about 65% of its $20 billion funded portfolio is investment grade while its unfunded loan book is about 87% investment grade. Citigroup's roughly 80% investment grade energy portfolio overall is better than the average bank's 60% investment grade exposure. While the good news is that most of the portfolio isn't junk, the bad news is that we don't know how much the company has set aside in loan loss reserves.

Failure to disclose the actual figure usually means they don't want people to know about it. Wells Fargo claimed they had one of the highest energy loss reserves in the industry at $1.2 billion. That would equate to 7% of its funded book or just under 3% of its total book. How much Citigroup has in reserve for energy loan losses is anyone's guess but the fact that they're trying to keep it under wraps feels like the subprime crisis all over again.


Not even considering Citigroup's exposure to energy loans for a moment, the company's financial results look like they may be in rough shape. The Atlanta Fed has revised its Q1 GDP growth estimate all the way down to 0.1% and there's a distinct possibility that we don't see a rate hike at all until 2017. Both of those will impede Citigroup's earnings and revenues for the remainder of the year.

But its significant energy loan exposure could be its biggest risk factor of all. The fact that we don't know how protected Citigroup is from its portfolio (I'd guess it doesn't have the $1.2 billion set aside that Wells Fargo does) could be increasingly detrimental to shareholder value should oil remain low for a prolonged period of time.

Friday's earnings report could finally give us some answers.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.