Declining Fixed Income Revenues Could Spell Downside for Citigroup Stock
Citigroup (NYSE:C) is a globally diversified financial services holding company which provides a broad range of financial products and services. It competes with global financial services firms like Deutsche Bank (NYSE: DB), Credit Suisse (NYSE:CS), JP Morgan (NYSE:JPM) and Bank of America (NYSE: BAC).
We estimate that Citigroup’s Sales & Trading division constitutes around 42% of our $4.17 price estimate for the company’s stock, and is the single largest driver of its stock value. Our price estimate is roughly 13% below Citigroup’s current market price.
Fixed income trading represent the largest source of revenues for Citigroup’s Sales & Trading division, making yield on fixed income securities a critical metric in defining the company’s overall profitability.
Yield on Fixed Income Trading Securities Has Recovered Since 2007
Yield realized on Citigroup’s fixed income trading securities fell from 5% in 2005 to 3% in 2007 (estimated), with the company suffering losses on structured credit products during the subprime crisis, as volumes and liquidity slipped.
However, yield on these securities increased to 6% by 2009, primarily due to near-zero interest rates that enabled Citigroup to access cheap capital for trading activities. Markets also began to recover in the early part of 2009, generating growth in both volumes and liquidity.
Yield on fixed income trading securities is typically volatile and strongly dependent on the global debt markets. As the global economic environment continues to recover, we should see trading activity pick up and risk appetite return, further sustaining increased volumes and liquidity. Our base forecasts currently suggest a yield on fixed income trading securities of around 6% beyond 2010.
Recent Declines in Fixed Income Revenues Could Add Downside to Our Price Estimate
However, over the last few quarters, fixed income revenues for Citigroup have slipped, dropping from $5.4 billion in Q1 2010 to $3.5 billion in Q3 2010. [1] [2] The majority of the decline was due to weakness in credit products and securitized products, which reflected a difficult market environment and limited client activity. Rates and currencies revenues also declined, as growth in local markets, which primarily includes rates and foreign exchange trading in emerging markets, was more than offset by lower G10 trading revenues.
Continued weakness over the next few quarters could present downside to our current forecasts. If yield on fixed income trading securities falls to around 4% by the end of our forecast period, it would generate nearly 10% downside to our $4.17 price estimate for Citigroup’s stock, which already stands about 13% below market price.
Drag the trend-line in the chart above to see how various yield scenarios for fixed income trading securities might affect Citigroup’s stock value.
See our full analysis of Citigroup here
We estimate that the Yield on Fixed-Income Trading Securities fell from 5% in 2005 to 2.8% in 2007, with the company suffering losses on structured credit products during the subprime crisis. in addition to fall in volumes and liquidity during the global economic downturn. However, it increased to 6% by 2009 mainly due to near-zero interest rates enabling Citigroup to access cheap capital for trading activities. In addition to this, markets began to recover in the early part of 2009, bringing back higher volumes and liquidity. This yield is usually volatile and strongly dependent on the debt capital markets globally. However, as the global economic environment improves we should see trading activity pick up as risk appetite returns. This should improve volumes and liquidity. We forecast the Yield on Fixed-Income Trading Securities to stay around the 6% mark during our forecast period.
However, over the last few quarters, the Fixed Income Markets revenues for Citigroup has been falling. It decreased from $5.4 billion in 1Q FY10 to $3.5 billion in 3Q FY10. The majority of the decline was from weaker results in Credit Products and Securitized Products, which reflected a difficult market environment and limited client activity. Rates and Currencies revenues also declined, as growth in Local Markets, which includes rates and foreign exchange trading primarily in emerging markets, was more than offset by lower G10 Rates trading revenues.
Continued weakness over the next few quarters can result in a downside to our current forecasts. If the Yield on Fixed-Income Trading Securities falls to around 4% by the end of our forecast period, it would mean around 9% downside to our current price estimate for Citigroup’s stock.