It's probably too much to hope that money center banks like Bank Of America (NYSE:BAC) or Citigroup (NYSE:C) will ever report completely clean quarters (as there are just too many moving parts), but it seems like it's always something with Citi. While third quarter results looked OK on the surface, there still isn't much sustainable momentum behind the numbers and it's hard to feel great about the company with now-former CEO Vikram Pandit stepping down.
One quarter ago, I did think that Citi was a good pick for aggressive investors, and the stock has climbed nearly 40% since then. Given where valuation is now relative to others such as JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB), the potential disruptions from the leadership transition and the underlying momentum, I'd be less inclined to buy this stock over some of those other high-quality banks.
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Third Quarter Results - Not As Strong As It Seemed
Investors reacted quite positively to Citi's third quarter earnings report, as the adjusted number surpassed the average analyst estimate by about 10 cents. Unfortunately, I think a closer look reveals less momentum than investors might hope. Adjusted revenue (stripping out DVA and MSSB adjustments) rose 3% this quarter, with global consumer banking up 4%, securities/banking up 7%, and transaction services down 5%.
Net interest income rose 3%, as a modest (five basis points) increase in net interest margin complemented modest growth in earning assets (1% growth in loans and 4% growth in securities). All in all, credit quality continues to get better. Although reported non-accruals were up 11%, the reporting methodology changed and non-accruals would have been down about 3% under the old method. Loan loss provisions were down 3% for the quarter, but the company elected not to take reserve releases from the North American mortgage operations.
So, What's the Problem?
On the surface, those numbers above all look pretty good. So why do I say Citi's earnings were lacking? For starters, loan growth was very modest at 1% (and flat in the consumer business). Given where securities yields are (and are likely to continue to be under the latest quantitative easing), that's not going to help margins. What's more, Citi is seeing the same weakness in consumer card balances as JPMorgan, as consumers continue to deleverage. Last and not least, while Citi is seeing improving mortgage originations, they really don't stand out from Wells Fargo or JPMorgan.
It's also important to note that more than 80% of Citi's revenue growth came from much better performance in its trading operations. In my mind, if the bank is going to be excused when trading revenue is down (this is a very volatile business), it can't be celebrated when it turns up. I'm also disappointed to see that CEO Vikram Pandit has elected to step aside and that the COO (John Havens) elected to go with him. The board has named Michael Corbat as the new CEO, and while I do think he is up for the job, it adds an element of uncertainty to the story.
The Bottom Line
There continues to be good reasons to be optimistic on Citigroup over the long term. Citi is highly leveraged to a U.S. housing recovery, probably more so than many investors realize. The bank is also making good progress with its capital position (the Basel 3 Tier 1 ratio improved 70 basis points to 8.6%) and the drag from the Holdings segment should continue to decline.
All of that said, I am worried about the underlying sluggishness in core North American consumer banking and cards, as well as the possibility of slower growth in the Latin American operations. The good news is that Citi is still not expensive relative to the likes of Wells Fargo and U.S. Bancorp, even with pretty modest long-term return on equity assumptions. On the other hand, the strong run-up this year does knock it off the top of my list for new bank investments. Citi remains a respectable long-term recovery play, but as I said earlier with Wells Fargo, there are better values to be found in banking right now.
At the time of writing, Stephen D. Simpson owned shares of JPMorgan for more than five years.