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Citigroup: Q2 Outlook And Capital Adequacy

Jun. 05, 2020 8:42 AM ETCitigroup Inc. (C)JPM25 Comments
IP Banking Research profile picture
IP Banking Research


  • Citi is quite often seen as a trading position and not a long-term holding.
  • The current crisis may change this perception.
  • The key metric to pay attention to is Citi's capital ratios.
  • Citi is poised to deliver a strong Q2 in the investment bank.
  • In this article, I consider the near-term outlook and risks.

Some punters on Seeking Alpha (such as my colleague Jeff Anderson) at times view Citigroup (NYSE:C) as a trading stock and not as a core long-term holding. The trading strategy is to buy at a deep discount to tangible book value and sell at or slightly above tangible book. To be fair, in the last 8 years or so, that has been quite a profitable strategy. No argument there. It seems like every time the global economy sneezes, the banking industry catches a cold and Citi stock ends up with the flu!

Fortunately, it generally recovers quickly as well - we saw it in January 2016, December 2018 and most recently in the recent COVID-19 crisis.

My personal view, though, is that Citi is on the cusp of a new paradigm. It will earn its stripes navigating through this crisis and investors will reprice its cost of capital - earning it higher multiples and lower beta. It is clear that in the current regulatory framework, the risks of a large bank imploding is materially lower than pre-2008 and its business model and earnings are sustainable. It makes no sense to apply the same cost of capital like its pre-2008.

However, to reach that conclusion, Mr. Market needs to see this bank navigating successfully through a deep crisis - COVID-19 might just be that opportunity.

I intend to cover the quality and sustainability of the business model and earnings in my next article - but in this article, I want to focus on the near term outlook and risks.

Capital ratio is the key

The key number to watch is Citi's common equity tier 1 (CET1) ratio. As of Q1'2020, CET1 declined to 11.2 percent compared with a management target of 11.5 percent and minimum regulatory requirements of 10 percent.


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IP Banking Research profile picture
Independent banking research focuses on financials, deep value, special situations, and financial arbitrage. Agnostic and apolitical approach for scouring the earth for durable and uncorrelated cashflows that work well in both inflationary and deflationary settings.See my tipranks profile below:https://www.tipranks.com/bloggers/ip-banking-researchTo benefit from independent insights and quality analysis from a banking insider - subscribe as a "real-time" follower above.

Analyst’s Disclosure: I am/we are long C, JPM. 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.

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Comments (25)

Targets being raised. Positive stress tests await. Citi heading higher.
Hi I have read that the regulators has postponed the start of CELC but major US banks went ahead with it. Is this accurate and if so which US banks went ahead with CELC? Could you explain the implications of the new regulations more thoroughly? I understand that they have to recognise the loan losses for the next 2-3 years now, however, how does this impact their ability to grow their loan book and earnings in the future? Thank you.
IP Banking Research profile picture
important to distinguish between the followings:
1) CECL day 1 adjustment versus on-going adjustments (quarterly based on refreshed macroeconomic input to models)
2) Accounting and regulatory capital regime.

From a capital (CET1) perspective, the day 1 adjustment (i.e. recalculation of loan loss provisions as at 1/1/2020) - there is no impact until 2022 (transitional relief under reg capital rules).

From an accounting perspective, it is fully reflected by in the retained earnings line (so no impact on net profit or EPS).

On-going adjustments are to do with changing economic forecasts - like what happened in the Covid19 situation in Q1. These fluctuate from quarter to quarter depending on economic forecasts. Hence expected build in Q2 as macroeconomic forecasts have changed (higher unemployment, deeper GDP decline etc).
From reg capital perspective, the transitional relief is much lower (only 25% of provisions taken).

Remember CECL measures expected lifetime losses of assets.
Thank you for your reply.

I have a few things I do not fully understand.

Why does CECL loan provisions not affect the bottom line? Is it due to the OCI account which goes straight to retained earnings?

If so, how does the CECL affect your thesis on US banks? Does it mean that US banks balance sheet are healthier than market expects? If proprietary models are overly aggressive or if the V shaped recovery is really here, how will write backs affect the stock price of US banks?
IP Banking Research profile picture
Only the day 1 impact (i.e. one off on implementation) is a balance sheet item only (i.e. no impact on P+L, earnings or EPS). On a going forward both up and down movements in CECL provisions do impact EPS, earnings, P+L. As we have seen in Q1 where CECL driven a reduction in EPS.

The bottom line and important point for investors to understand - CECL has the effect of front-loading expected provisions as you enter a crisis (so in the current crisis, think of it as Q1 and Q2 financial impact). It is pro-cyclical meaning that it amplifies the financial impact at the begining of the crisis (and also begin to incur real losses) - but on the flip side, as you come out of the crisis - this gets reversed especially if you get a V shaped recovery or that assumptions are too conservative (perhaps due to fiscal bridge).
So my base expectation for these provisions to be reversed towards the end of 2020 and 1H of 2021, assuming recovery takes hold.
Less need for forbearance announced this morning. Good for the big banks.
Lone Wolf Capital profile picture
i went in on banks with both hands on the market crash in March and April. C is still the best bargain. Bought more on this mornings dip.
Bhughes7918 profile picture
FBSS is a solid bank to hold look at asset quality back in 2008!
Today most banks way up as is OPY again we are selling another 15% today down to about 60% of all funds. Looks like $27 is in the cards now.
We sold all of these in full AROW, CHMG, Friday .
Bought a bunch more FBSS up to $14.75 the past few days. Very cheap still.
Bought a ton PCSB under $13, wait for a 10% pullback to get in.
FFIC under $12 got in heavy, moved to fast now, wait for a 10% pullback and get in heavy. We might sell all today.
Corbat has a great vision for Citi. It was trampled during the market fall and should therefore rebound with velocity. Remains undervalued.
I.P.....I only use the yahoo statistics numbers....I'm sure they are inaccurate, but that's all I have....also just saw interview on bloomberg with corbet....he stressed strong cash position and need to stay in hong kong and expand in asia....
I know Citi paused the buybacks but are they allowed to buy call options to lock in a price? Also, unless I read it incorrectly, they had 2.08 billion shares when they stopped the buy backs....now 2.180....either I read it wrong or they have added shares....for bonuses? I'm not sure.....
IP Banking Research profile picture
Hi gdc41. definitely not allowed to buy options.
when looking at share count need to distinguish between end of period (EOP) and average share count. which ones are you referring to?
06 Jun. 2020
I am glad I brought some Jan 2022 calls a few weeks back. Already in the money
IP Banking Research profile picture
well done. made sense at the time. I was pretty agressive too.
While long-term Citi shareholders (like myself) will never (as I think Warren Buffett pointed out years ago) recover the value lost in the 2008-09 financial crisis, and the consequent 1 for 10 share consolidation in 2011, Citi has a place in a diversified portfolio, and good prospects going forward,-- bearing in mind that it is a cyclical stock in a cyclical sector and its performance over the short, medium, and longer term will be ... well ...cyclical. (I have held my shares throughout. After their collapse they were not worth selling.)
06 Jun. 2020
I wouldn’t say never, if C can grow earnings at 10%+ combined with dividend you should recover in 15-20 years. Not great obviously ....
IP Banking Research profile picture
isnt the right question the current opportunity cost of holding Citi versus other investment alternatives?
the 2008-2009 is already a sunk cost.
Jeff Anderson profile picture
Well stated! I picked up 1/22 call options when C was sub $40 and plan on riding them to the finish line. Hopefully my horse doesn't break a leg on the way there. May add more if I can get another bite at the apple closer to $50. Might be wishful thinking at this point though given the horse looks to have already left the stable.

Really looking forward to your next article IP!
06 Jun. 2020
I did the same, not quite the entry you had, I think C was in low 40s when I brought my 1/22 calls
IP Banking Research profile picture
cheers, Jeff. sounds like you made huge profits....well done!

I would be nervous not to capitalise some.....but upside is there, so really depends on an individuals risk appetite.
Jeff Anderson profile picture
$50 ... here we go! Maybe a little lower still?? Time to start thinking of taking another bite.
Billbrows profile picture
I bought into C in early April. Planning to keep for the long term.
IP Banking Research profile picture
I do think coming out of the crisis, the market will begin to realise the underlying value, quality of earnings and sustainability of a much lower risk business model. Will discuss this in my upcoming articles, so stay tuned if of interest.
I consider Citi the best value in banking. JPM remains prime player. Stick with the best!
IP Banking Research profile picture
JPM is certainly one of the best banks in the world. Well diversified, number 1 in so many areas. Core holding for me in the 30s
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