Citigroup Reports Strong All-Round Q3 Performance; Solid Debt Trading Gains Just The Cherry On Top

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Citigroup (NYSE:C) reported better-than-expected results for the third quarter late last week, as a sharp improvement in consumer banking revenues coupled with elevated debt and interest rate  trading revenues boosted the top line. [1] Although revenues for the geographically diversified banking giant were 5% lower than what they were a year ago, the decline was almost completely due to a reduction in revenues for the non-core Citi Holdings division – a good sign given Citigroup’s efforts over recent years to divest these operations. Additionally, Citigroup’s results for Q3 reflect the effectiveness of its cost-cutting measures, as total operating costs have remained at the lowest level in at least a decade over the last two quarters.

Citigroup’s continuing efforts to streamline operations and shrink its non-core divisions are expected to improve profits for the banking giant in the long run. Taken together with the fact that the bank is one of the best capitalized U.S. banking giants, with a common equity tier 1 (CET1) capital ratio of 12.6% and a supplementary leverage ratio of 7.4%, we expect a sizable increase in the amount of cash Citigroup returns to investors through dividends and share repurchases next year. This, and the bank’s steadily growing loan book leads us to believe that the bank is extremely undervalued, as its shares currently trade at just 65% of its book value and below 75% of its tangible book value. We maintain a $61 price estimate for Citigroup’s stock, which is roughly 25% ahead of the current market price.

See our full analysis for Citigroup

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Consumer Banking Division Played A Central Role In Q3

The table above summarizes the factors that aided Citigroup’s pre-tax profit figure for Q3 2016 compared to the figures in Q3 2015 and Q2 2016. Notably, the single biggest factor that positively affected profits is an increase in the bank’s Consumer Banking revenues.

We believe that Citigroup’s biggest strength compared to its U.S. banking peers is its extensive global presence. This allows the bank to benefit from diversified revenue streams that are not subject to the restrictions faced by its peers who are largely focused on U.S. markets. Citigroup’s strong retail banking presence across the globe and in emerging markets gives it access to cheap funds in the form of low-interest rate deposits from the regions in which it operates, allowing it to achieve better net interest margins. As the bank caters to demand for loans globally, its total interest income is not overly dependent on the interest rate environment prevalent in any single country – something that has helped the bank maintain net interest margins largely constant around 2.9% over the last few years. This is in sharp contrast to peers like Wells Fargo that have seen a reduction in this figure of well over 100 basis points (1% point) over the same period.

While the improvement in revenues for the consumer banking division are evident in the chart above, it must be mentioned here that this includes negative forex movements as the U.S. dollar strengthened considerably in Q3. On a constant dollar basis, the division’s revenues actually grew by ~$550 million from Q2 2016 and ~$270 million from Q3 2015. An important factor behind this gain is the integration of Costco’s co-branded card portfolio towards the end of Q2. The deal added $10.6 billion in balances to Citigroup’s card portfolio, and resulted in a corresponding increase in card fees.

FICC Trading Desk Churns Out Best Third-Quarter Performance Since 2012

Citigroup generated revenues of $4.1 billion through its trading operations (fixed income and equity taken together) for the first quarter of the year – a 16% jump from the figure a year ago, but marginally lower than that for the previous quarter. The q-on-q decline was completely due to lower equity trading revenues, with the FICC (fixed income, currencies, and commodities) trading desk generating an exceptionally strong $3.5 billion for the second consecutive quarter. It must be remembered here that Citigroup’s equity trading desk is much smaller in size, with revenues being more volatile. You can see how changes to Citigroup’s FICC trading yield affects our estimate for the bank’s share price by modifying the chart below.

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Notes:
  1. Q3 Earnings Press Release, Citigroup Investor Relations, Oct 14 2016 []