Not to be left behind by JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC), Citigroup (NYSE:C) announced a respectable set of results for its second quarter, featuring much of the same “better fee income, lower credit costs, but tighter spreads and weak lending” themes we have seen and expected for this quarter. Citi continues to make progress pulling itself out of its own credit/loan loss mess, and relative normalcy seems to be in sight.
Citi is a curious stock when it comes to valuation, though. While the market seems willing to assume that the bank will return to a low double-digit ROE for the long-term, investors appear to be awarding the company a lower tangible book value multiple than would otherwise seem fair relative to the returns it generates on assets. In any case, these shares appear to be somewhat undervalued, but don't seem like a major opportunity at this point.
SEE: JPMorgan Seeing Strong Credit, But Iffy Growth Momentum

A Familiar Story So Far
While we are still very early in the earnings reporting cycle, Citigroup's earnings for the second quarter were pretty consistent with what JPMorgan and Wells Fargo reported. In particular, “core banking” trends are pretty soft, but fee income and lower credit costs are boosting earnings and Citi is slowly accreting value (as measured by tangible assets).
Adjusted revenue rose 8% from the year-ago period and fell 3% from the first quarter, good for a 1% beat relative to consensus. Net interest income was up 3% and flat, respectively, as net interest margin declined slightly from last quarter and average earning assets were slightly higher. Fee income was a major contributor (up 19% and 4%), as trading revenue jumped from last year. 

All told, conditions for consumer banking (the largest overall business at Citi) were tough but manageable. Revenue in the North American operations (over 50% of revenue) declined 1% from last quarter, while improving 1% in Latin America, coming in flat in Asia, and declining 1% in the EMEA regions.
On a company-wide basis, Citi is doing a good job of controlling operating expenses. Adjusted expenses declined slightly, leading to a worthwhile improvement in the efficiency ratio and operating income growth.

SEE: Earnings Expectations For The Week Of July 15
The Lending Environment Is Still Weak
While Citi, JPMorgan, Wells Fargo, U.S. Bancorp (NYSE:USB), and Bank of America (NYSE:BAC) all look to fee-generating business to contribute meaningful revenue and income, the overall lending environment is still a very relevant driver of the business. To that end, Citi continues to see a challenging environment. Period-end loans were flat with the first quarter (and down 2% from last year), as consumer lending declined on lower mortgage lending.
Credit does continue to improve, though. Non-accrual loans were down 9% sequentially, and the non-performing asset ratio (NPA) declined another 14bp. The ratio of reserves to non-performing loans stands at over 220% (versus just under 200% for JPMorgan), and reserves are 3.35% of outstanding loans – down from 3.67% in the first quarter and 4.22% last year.
Citi also looks to be in good shape relative to capital standards. The Basel 1 Tier 1 common ratio came in at 12.2%, while the Basel 3 ratio was 10%. Citi is also just under the target Basel 3 leverage ratio (4.9% versus 5%) and in better current shape than JPMorgan. Bank accounting is deliberately opaque when it comes to assessing risk and capital from the outside, but I would say that Citi looks to be in good shape barring a major unexpected event (like a large trading loss).
The Bottom Line
I favor a two-part approach when valuing banks, but that provides very different results in the case of Citigroup. With these results, I'm willing to bump up my long-term ROE target to 10%, which suggests a fair value of $55 today (more or less in line with the current price).
Looking at Citi's return on tangible assets and book value, though, suggests an odd anomaly. Citi's return on tangible assets would suggest a fair P/TBV multiple of around 1.5x or 1.6x, but the stock is trading at around 0.95x, and no analyst appears to be willing to go close to 1.5x in their models. Now there could well be some good reasons for this discount/discrepancy (principally overstated asset values due to future mortgage repurchases and/or credit losses), but I find it interesting all the same.
In any case, while I acknowledge that Citi may be undervalued today, particularly if you believe the bank can do better than 10% for its long-term ROE, it's not undervalued enough to make me want to swap out my stake in JPMorgan for shares of Citi.
Disclosure – As of this writing, the author owns shares of JPMorgan.

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