Citigroup: Mr. Market Has Lost The Plot
Feb 25 2016, 08:46
About: C • Includes: JPM
(Note by Sananda: the author claims regulatory measures that makes banking self sufficient. Face value. This is not a Sistemic Failure, he argues Unregulated shadow banking, stock swap under the table. no eyes no Tobin Tax… if you read me. And then there’s,those little bugs buying and selling every millisecond. Evil things happen at nightful darkness of any kind. And it is not sex unless sex is evilized. Of course, sure he knows better, he is the professional expert. But, Alice Hood Rider, I am the expert in experts and my mom taught me to distrust everything, to think for the worse in any situation. I learned it far too late a lifetime after. Now I seldom see myself amyss, even if for a time, worldly feedback will not comply and I see myself like out of touch with reality. I am just years ahead, thousands of years in some fields, reaching fast past the best, in others.)
Mr. Market is absolutely hammering the financials.
Q1 for the large U.S. banks looks pretty ugly.
CCAR scenarios seem to be more adverse than 2015 and incorporate a negative rates scenario.
The Fed looks scared and is backtracking on the dot plot.
Investors are simply fearful.
Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.
Citigroup (NYSE:C) is trading at ~$38, whereas its TBV is expected to be around $62 by the end of this quarter – this equates to around 0.6x tangible book value.
The bad news are plentiful for sure – but Mr. Market has lost the plot and taking a very short-sighted view.
Let me tell you why.
It is not a systemic banking crisis
The large global banks are well-capitalized and highly liquid – the regulatory framework made sure of that.
The data as of 4Q’2015 speaks for itself:
$147 billion of Common Equity Tier 1 (CET1)
$380 billion of high quality liquid assets
~$270 billion of TLAC (bail-able debt)
All of the other G-SIB global banks are in a similar scenario. The financial system is extremely strong.
Yes….but what about oil exposures?
Citi’s going-forward oil exposure under a $25 oil price for 18 months is estimated at somewhere around $2 billion. Keep in mind though, that a one dollar movement in the share price equates to ~ $3 billion of market value.
The correlation with oil just does not make any sense (especially given this is largely a supply shock). I have discussed Citigroup and oil in this article.
In fact, I am very satisfied with Citigroup’s risk management – a clear display of practicing industry concentration limits and proactive management of credit risk. Given the steep decline of more than 70% in the price of oil – this is a good outcome.
The potential loan losses are really just a drop in a bucket.
Global recession, China and other exposures
I have discussed Citi’s exposure to EM in the following article.
The bottom line is that the asset quality of the portfolio comprises of mostly affluent and secure lending (excluding credit cards and Mexico). In a global recession scenario, the credit portfolio is likely to hold reasonably well. The corporate portfolio is of very good quality as well with ~80% being investment grade and a large proportion is short-term funding.
Citi will perform reasonably well in a garden-variety type of recession. Of course, if you believe we are seeing a repeat of 2008/2009 (remote possibility to my mind), then you know what to do (e.g. short the stock market?).
Negative rates and flattening of the yield curve
I believe the Fed is very far from going down that path – but clearly some fear the prospects of negative rates as well as the flattening of the yield curve. The concern of course is the impact of low interest rates on Citi’s net interest margin (NIM).
Consider the following rates sensitivity analysis from Citi’s recent 10-Q:
(click to enlarge)
As can be seen from above – Citi is most impacted (in terms of net income) from movements in the Fed’s over-night rate as opposed to the 10-year. So a move of 100 basis points in the short end results in a $2 billion pre-tax benefit whereas a decline of 100 basis in the 10-year results in a decline of $253 million only.
The main reason for this is the liquidity rules that operate and Citi has close to $380 billion of liquid assets (which ~$90 billion would be in cash).
Negative rates are somewhat of an unknown. I am reasonably confident though, that the Fed (even if it went down that path) would not apply negative rates for banks’ regulatory-driven deposits.
Clearly though, as asset yield decreases one would expect some further level of compression in banks’ NIMs.
I am researching an article on the topic of negative rates and banks – so if interested in topic, do add me as a “real-time” follower.
Dismal investment banking environment
It is a dismal investment banking environment as confirmed by JPMorgan’s (NYSE:JPM) investor day presentation. The guidance provided by JMP included the following elements:
So far 20 percent decline in Markets income year on year (although last year’s comparison included gains on Swiss franc un-pegging).
Estimated 25 percent decline for equity and debt underwriting – not unexpected given that the markets were not open for business for much of the 1st quarter.
Only one or two days of trading losses only (and modest losses).
M&A holding up well.
One would expect Citi performance to be somewhat comparable to JPM’s. But the key points are that these are difficult trading conditions – and debt/equity issuances will be delayed (and revenue will be accrued in future quarters).
Bottom line, it is just one quarter’s trading and the banks seem to have performed reasonably well considering the macro background.
Stepping back though, it is clear that Citi is clearly set to benefit from secular and cyclical trends in investment banking – hence, it is quite short-sighted to focus on one or two quarters trading performance.
What about the positives?
There are plenty of positives I can think of:
Accretive buybacks at a significant discount to intrinsic value.
Regulatory rules largely finalized and business model pressures abating.
Unwind of Citi Holdings and DTA consumption.
Expected CCAR ask of $10-$15 billion (more than 10% of shares based on current market value).
De-risked balance sheet supported by plenty of capital and liquidity.
A unique Institutional Client Group (NYSE:ICG) that cannot be replaced.
Underlying franchise delivered 12% RoTCE in 2015.
And you could buy all of the above at 0.6x tangible book value and about half of intrinsic value.
The close correlation with oil does not make any sense at all. This is indiscriminate selling – Mr. Market is shooting first then asking questions.
I think its mostly a trust and perception issues – the investor community does not trust the banks given what transpired in the GFC. Investors are busy fighting the last war (08/09 financial crisis) rather than considering the true fundamentals and prospects for the banks.
Perhaps the large banks need this type of a crisis to begin earning the trust of investors again.
In the meantime, this is an opportunity for the brave – perhaps it is time to get greedy. What do you think?
My next articles will be focused on CCAR impact on the U.S. banks – if interested in topic, please don’t forget to add me as a “real-time follower.”
I provide independent and quality coverage of U.S., European, Asian, Canadian and Australian large-cap banks – identifying long and short opportunities. If interested in the topic, feel free to add me as a “real-time follower” or message me if interested in a specific banking name.
Disclosure: I am/we are long C.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Every day, earlier, for the next 5 days, that coronal hole in the solar equator is going to be hitting the terrestrial equator from north to south and back.. See how it passed through central America, in the image below, that I screenshooted this afternoon —my UTC, GMT, Orchilla Meridian Time, were it was before Greenwich— think of its impact on volcanoes, quakes and weather movements ongoing, as I have been reporting, for my Atlantic home and the storms, tornadoes and quakes currently happening in the US. Fracking makes it worse because hammering drills expand electricity throughout the fractured crust and faullines. Also the methane emissions multiply global watming gases and Canadian Tar Sand exploits, as well as Chesapeake bay operations, it looks to me, are responsibles for noreasters attacking Boston and north Atlantic USA, as well as British, French, Portuguese, Spanish and Baltic floods, as well as west mediterranean seas and inland coasts landslides. I mea. Investors in Wall Street shoul think of this things.