Citigroup To Take Cautious Approach in 2013

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Citigroup reported net income of $3.8 billion, or $1.23 per share, for the first quarter of 2013. Overall, the results were in line with our expectations, and we do not intend to significantly alter our fair value estimate. We note that Citicorp’s return on assets (which excludes the legacy assets attributed to the Citi Holdings segment) exceeded 1% during the quarter. In our opinion, this level of performance will eventually lead to modest excess return on equity, supporting our narrow moat rating.

Citigroup’s internally estimated Basel III Tier 1 common ratio stood at 9.3% at the end of the first quarter. Considering that the company did not propose any increase to its dividend and plans only minimal share repurchases, we think the company will finish 2013 in excellent shape from a capital perspective, positioning itself for a significant cash-return program next year. For reference, a 30% payout ratio on first-quarter earnings would equate to a 3.3% dividend yield at our $45 fair value estimate. Citicorp expenses fell to $10.9 billion during the first quarter, down 11% from the previous quarter and 2% from the first quarter of 2013, down primarily due to lower legal costs.

Global consumer banking expenses actually rose internationally and in North America, while the bank was able to reduce expenses in the securities and banking segment despite an investment banking-driven increase in revenue. However, the Citi Holdings segment was responsible for an increase in legal expenses, leading to a slight increase in noninterest expenses on a year-over-year basis. Our current valuation does not include significant expense cuts from current levels.

Citigroup did continue to reap some benefits from its presence in developing markets, though net interest revenue fell slightly due to the widespread low-rate environment. Latin American consumer loans were a strong point, with balances up 16% during the past year, though we caution that this book of loans is characterized by relatively high growth, yields, and loss rates. In addition to the growth prospects offered by Citigroup’s consumer exposure, it also benefits from the globalization of business activity–total corporate loans increased 8% over the past 12 months.

Citi Holdings remains a drag on earnings, despite accounting for only 8% of Citigroup assets. The segment generated a net loss of $794 million in the first quarter, despite a reserve release of $351 million. Local consumer lending now accounts for a large majority of Citi Holdings’ assets, and was responsible for $825 million in operating expenses and $920 million in credit losses during the first quarter. We’re pleased with the progress the company has made in this area, but note that the assets are still preventing the company from realizing a fairly large percentage of its potential earnings power, and that the Citigroup is unlikely to be free of legacy assets for quite some time at the current pace of runoff.

Similarly, given the amount of DTAs related to Citigroup’s North American business, we do not expect significant tax benefits to kick in until mortgage problems have subsided to a larger extent. During the first quarter, Citigroup was able to utilize only $700 million of the approximately $55 billion of deferred tax assets on its balance sheet at December 31. As a result, our fair value estimate does not attribute much value to these assets, and we think investors viewing Citigroup’s valuation as a multiple of book value or tangible book value should adjust their viewpoints to account for nonproductive portions of the company’s balance sheet.

 

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