Barclays Conference: Citigroup Now Less Vulnerable, More Attractive
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Citigroup (NYSE: C), long the nation's largest commercial bank until late last decade, may be on the mend from its precipitous and long lasting fall from grace. Let's bear in mind that still, its per share price is some 95% less than its 2007 highs. Its CEO, Vikram Pandit represented Citigroup at the recent Barclays Global Financial Services Conference.
There have, other than its poor results, been two factors that have caused my distaste for Citigroup. First, its creation of its Citi Holdings unit, which I believed was an intent to confuse the investing public and its shareholders alike. But I have gotten over that one. The second is management's focus on areas outside the United States. We should be mindful that Citigroup received more in bank bailout money, over $476 billion in loans and guarantees, than any other bank. Despite the largess of the American taxpayer, Citigroup is intent on its plan to focus on the 150 largest cities in the world, the bulk of which are not in the United States. In the second quarter of 2012, Citigroup's North American operations resulted in just 26% of the bank's pretax profits, and Citigroup promises to become even less “American” going forward. You're welcome, Citigroup.
Of course, there is a lot that Citigroup has done right as it recovers from the banking meltdown that it helped to create under old management. Its stated goal since the bottom fell out of it is to become “simpler, smaller, safer and stronger.” Since 2007, it has sold almost 100 different businesses and portfolios it considered at the time to be “non-core.” These sales and writedowns helped shrink Citigroup down by $25 billion in assets to $1.85 trillion, making it the third largest American based commercial bank. In particular, it has shrunk its allegedly “non-core” Citi Holdings unit from over $800 billion in 2008 to just $191 billion in assets as of the close of the second quarter, or just over 10% of the bank's overall asset base.
Earnings wise, Citigroup continued to churn out earnings in the second quarter within a narrow range of recent quarters, posting $2.95 billion, or $0.95 per share. Without those pesky debit and credit reevaluations earnings would have been an even $1 per share. Earnings for the current quarter are in flux, as Citigroup finally sold its minority stake in brokerage Smith Barney to former partner Morgan Stanley (NYSE: MS). This issue had been percolating for over a year, when it first became apparent that Citigroup valued the brokerage at a much higher level than what Morgan Stanley valued it at.
In Citigroup's 2011 annual report, it stated that its 49% in Smith Barney was suffering from a temporary impairment, but the bank would not sell its interest until that impairment reversed, but in any event , any loss on the sale would not be material. Well, now Citigroup will take a $4.7 billion charge, or $2.9 billion net of taxes this quarter, about the same as the previously anticipated earnings this quarter. But more than that, it points to any number of inflated valuations of the assets on banks' balance sheets. PNC Financial (PNC) and SunTrust (STI) have taken large reserves of late to deal with inflated asset values and predatory tactics by Fannie Mae (FNMA) and Freddie Mac (FMCC). I cannot guess how many more billion dollar overvaluations might exist out there.
Citigroup has one other fundamental difference with other large American banks beyond having lost its domestic focus. It has a very limited branch network in this country, with only just over 1,000 branches. That is at least 4,000 fewer than the three other banks of over $1 trillion in assets, JPMorgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC). That at least makes Citigroup less vulnerable to a shallow and flattening interest rate curve than the others.
Citigroup is selling now for about 55% of its book value, and has an attractive 5 year PEG of 0.82. It is not for the faint of heart, but more than any large bank, this has the potential to double or more in price over the next three to five years, if of course it can avoid too many more negative surprises.
Fifth Third Bank (NASDAQ: FITB), the largest bank in the lower Midwest, was represented at the Barclays conference by its President and Chief Executive, Kevin Kabat. There is no question about this large regional's operating history. It was dinged some in the recession late last decade, but has come back to post a trailing twelve month return on assets of 1.32%, along with an 11.44% return on equity.
Fifth Third recently got some good news. Upon a renewed application to the Federal Reserve to return more capital to shareholders, it won permission to raise its dividend 25% to ten cents quarterly, and buy up to $600 million of its stock through the first quarter of next year. Good news to shareholders should start coming in the fourth quarter of this year.
Fifth Third's problem is that it is hard to see any substantial near term earnings growth. Most analysts see earnings in 2013 to be level to slightly below 2012 earnings. The bank is still in shrink mode on its commercial real estate portfolio, but residential mortgage and commercial / industrial loan have ramped up nicely, and management believes that the bank’s net interest margin, recently at 3.56%, should not decline too precipitously. But Fifth Third does rely upon its net interest income for about 60% of its income, and every basis point of margin decline would require millions of additions to the loan portfolio to maintain level interest income.
Fifth Third has gotten a number of recommendations by analysts in recent days, but as well run and profitable as it, it is utterly unexciting, and I want to see real income growth before I would commit to an investment in this bank.
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