Citigroup is Getting Back to the Basics

By Chad Henage - October 18, 2012 | Tickers: BAC, C, JPM, WFC | 0 Comments

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You could make the argument that in the Great Recession the two big banks that suffered the most were Citigroup (NYSE: C) and Bank of America (NYSE: BAC). Both of these companies made complicated investments that it seems they didn't even understand, and I remember a time when both stocks looked like they were headed for the scrap heap of bankrupt companies. However, each one managed to survive, and in Citigroup's recent earnings report you can see the company is getting back to the basics.

The New Citi and the Old Citi:

I'm not suggesting that Citigroup is out of the woods by a long shot. The company's Citi Holdings is a huge drain on the bank and will likely stay that way for several years. This is the critical difference between Citi and Bank of America. Citi owned up to the fact that some of its business was beyond repair, and essentially created a so called “bad bank” inside of the overall company. Bank of America to date has taken a different route by including everything in its results. I personally prefer the approach at Citi. This reminds me of something that Peter Lynch said about the old Fannie Mae. He said that company at the time had two portfolios, one tied to bad bets that he referred to as the block of granite, and the new portfolio. He saw “chunks” of this block of granite being resolved and it was easier to envision the consistent growth the new Fannie Mae could achieve. Citi is using this same approach with Citi Holdings. Since investors know that Citi Holdings will eventually disappear, it's easier to see what the “new Citi” is capable of.

Citi Outperformed its Peers in Deposit Growth:

Even including Citi Holdings, Citigroup turned in a respectable quarter. The company showed revenue up 3%, and excluding one-time items net income increased 27%. While loan growth wasn't impressive relative to their peers, deposit growth was a different story. Take a look at the difference between Citi and its competition when it comes to deposit and loan growth in their most recent quarter:

(calculations from each company's most recent quarterly earnings) 

You can see that among their large bank peers, Citi reported loan growth that was close to its peers, and deposit growth that actually came in ahead of their competition. Since Citi reports in several different segments, let's look at each individually.

Global Consumer Banking:

Of the three main divisions in Citicorp, the company's most significant segment is their Global Consumer Banking unit. To be clear, Citicorp is what Citi considers its ongoing business and is reported separately from Citi Holdings, which is the “bad bank.” Global Consumer Banking generated about 58% of Citicorp's revenue. While this unit only showed a 2% increase in revenue, lower loss reserves, and better expense management helped Citicorp generate a 20% increase in net income. Global Consumer Banking contributed 7% of this 20% increase, and showed the strongest loan growth in the bank, with a 9% increase. Deposit growth at this unit was a bit weaker than overall results with a 3% increase.

Securities and Banking:

The company's Securities and Banking division showed extremely strong growth in essentially all areas except lending. Total revenue increased 15%, driven primarily by huge growth in the company's securities business. This unit showed investment banking revenue up 26%, equity markets revenue up 76%, and fixed income markets revenue up 63%. However, all of this impressive growth couldn't make up for the 81% decline in lending, which led to net income declining by 48%. Most of this difference was due to the difference of losses on hedges this year of $252 million versus a gain on hedging activities last year of $702 million. Without this hedging impact, the company's core lending revenues increased 35% on a year-over-year basis.

Transaction Services:

The company's Transaction Services unit is the smallest contributor of the three main divisions, which was a good thing with revenue down 2% and net income down 4%. In the two sub-businesses, Treasury and Trade Solutions showed growth of 2%, but a 13% decline in Securities and Fund Services dragged down results.

Conclusion:

While it may take years for Citigroup to eliminate its “bad bank,” at least investors can judge the results without these undesirable businesses. Overall the bank's results were pretty good. Anytime a company can report a $3.5 billion loss from a division and still show overall net income growth, that's an amazing achievement. Of the big bank's that Citi competes with, analysts expect the highest growth over the next five years from the company calling for almost 12% EPS growth. With the stock selling for just nine times forward earnings, the main thing holding the stock back is the lack of flexibility on the dividend. Once Citigroup is able to return more to shareholders in the way of a dividend payment, the stock should move up nicely. Investors will probably continue to choose JPMorgan Chase and Wells Fargo for their much better yields of 2.83% and 2.6% respectively. However, patient investors who are willing to wait for Citigroup's “block of granite” to fall should be rewarded nicely.

Interested in Additional Analysis?

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