3 More Reasons to Buy Citi
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
At the end of the first week of January this year, the Basel committee announced relaxation in the conditions governing the Liquidity Coverage Ratio of the banks. The Liquidity Coverage Ratio is designed to ensure that financial institutions have the necessary assets on hand to meet short-term obligations. Usually, banks are required to hold assets that are highly liquid in nature like Treasury bonds, at least equal to the net cash over a 30 day period. This will act as a buffer against 30-day market crisis.
Under the relaxed conditions, a wider definition of high quality assets will be used, the phase-in period has been extended and the cash outflow parameters have been reduced. Original versions of the rules required banks to comply with regulation by the start of 2015. In contrast, the amendments have laid out a phase starting at 60% of the proposed ratio in 2015 and building by 10% each year until 2019.
I summarize the amendments made by the Basel committee on banking supervision as follows:
- Four year extension of the LCR phase in to 2019 rather than 2015; only 60% compliance required on the starting date of 2015
- Level 1 fixed income high quality liquid assets should see less medium-term demand at the margin due to the extension of the phase in; this would include Treasuries, Supranationals, GNMA along with some Level 2 assets.
- The addition of several assets that may be used with significant haricuts, referred to as Level 2B assets, to the list of approved HQLA that banks may hold; these include lower-rated investment grade corporate bonds, unencumbered equities, and some highly rated residential mortgage backed securities. Level 2B assets are limited to 15% of total high quality liquid assets (HQLA).
The news is a blessing for all the major banks in the US, like Morgan Stanley, JPMorgan (NYSE: JPM), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC). However, I believe Citigroup will be a major beneficiary. While the rest will benefit from the reduced need of liquidity, for Citigroup the relaxation means much more. While most of the company's peers don’t disclose their Liquidity Coverage Ratio, Citigroup did so this quarter.
The LCR of 116% reveals Citigroup was under distress meeting the regulatory requirements. The relaxation will allow Citigroup to use any excess liquidity to invest in higher return opportunities. For Citigroup, the relaxations mean up to $50 billion of cash freed. Imagine a return of 5% on this amount and Citigroup would add up to $250 million in additional revenues.
Citigroup is seemingly in a much better position to benefit from the amendments or relaxations than its competitors. It has the added advantage of being highly exposed to developing world market (they provide 40% of its revenue), while firms like Bank of America are locked in a United States economy still moving slow to recovery.
Citigroup has attractive valuations compared to most of its peers in the US. Citigroup is trading at a 16% discount to its tangible book value, compared to an 18% discount for Bank of America. In contrast, JPMorgan and Wells Fargo are trading at 25% and 55% premiums to their respective book values.
In conclusion, attractive relative valuations, a vast global footprint and an opportunity to generate additional revenues from the freed up cash due to the relaxations governing banking liquidity make me bullish on Citigroup.
equityfinancials has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!