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.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Investing

    The 8 Best Business and Finance T.V. Shows

    With so many talking heads to choose from, which is the right show for your business and money matter needs? We review the best shows on now.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!