Market Cap (USD Mil) 146,391
52-Week High (USD) 55.28
52-Week Low (USD) 45.06
52-Week Total Return % -7.2
YTD Total Return % -7.5
Last Fiscal Year End 30 Dec 2013
5-Yr Forward Revenue CAGR % 2.2
5-Yr Forward EPS CAGR % 3.3
Price/Fair Value 1.00
2012 2013 2014(E) 2015(E)
Price/Earnings 15.9 12.0 10.1 10.5
Price/Book 0.8 0.7 0.7 0.7
Price/Tangible Book 1.0 0.9 0.8 0.9
Dividend Yield % 0.1 0.1 0.1 —
2012 2013 2014(E) 2015(E)
Net Revenue 71,893 76,153 76,729 76,370
Net Revenue YoY % -8.5 5.9 0.8 -0.5
Net Interest Income 47,603 46,793 47,242 47,492
Net Interest Margin % 2.8 2.8 2.8 2.8
Pre-Tax Pre-Provision Earnings 18,784 27,101 28,726 28,974
Pre-Tax Pre-Provision -28.8 44.3 6.0 0.9
Earnings YoY %
Net Income 7,498 13,209 14,421 13,882
Net Income YoY % -31.4 76.2 9.2 -3.7
Diluted EPS 2.49 4.34 4.76 4.58
Diluted EPS YoY % -31.8 74.7 9.5 -3.7
Citigroup is quietly proceeding with its turnaround plan.
Jim Sinegal Senior Analyst
james.sinegal@morningstar.com +1 (312) 696-6105
Research as of 07 May 2014 Estimates as of 07 May 2014 Pricing data through 03 Jun 2014 Rating updated as of 03 Jun 2014
Investment Thesis 27 Dec 2013
There are plenty of reasons to be wary of Citigroup. Over the past few decades, the bank has teetered on the edge more than once, taking massive losses on emerging-markets loans in the 1980s, commercial real estate in the early 1990s, and subprime-related securities in the 2000s. Citigroup has made progress over the past five years by raising capital, shedding assets, and bulking up its board of directors and management team. However, with operations spanning several continents, the bank in many ways still embodies the "too big to fail" concept.
In our view, Citigroup's truly global presence differentiates the bank from nearly all of its peers. With a large portion of revenue coming from Latin America and Asia, the bank is poised to ride the growth of these economies over the coming decade. At the same time, Citigroup is not merely a domestic lender, and it should remain a bank of choice for global corporations thanks to its ability to provide a variety of services across borders. Developing economies offer an attractive combination of high margins and rapid credit growth--especially in comparison with the low rates and declining leverage we expect will persist in the U.S. and other Western economies for the next few years. At the same time, investors should prepare for volatile results out of emerging economies, where governments and economic systems have generally not stood the test of time to the same extent as developed markets.
Since its bailout, Citigroup does not appear to be chasing growth at any cost. Instead, management is attempting to scale back operations and cut expenses--a proven plan for turning around troubled banks. Citigroup is consolidating back-office functions and reducing consumer operations in far-flung geographies like Pakistan and Paraguay and concentrating its branch network in key international markets, including Brazil and Hong Kong. We think investors should view further announcements along these lines with relief rather than disappointment and focus on improvements in the bottom line more so than growth in the top line.
Citigroup is a global financial services company doing business in more than 160 countries and jurisdictions. Citicorp, the company's core business, consists of the global consumer banking segment, which provides basic branch banking around the world, and the institutional clients group, which provides large customers with investment banking, cash management, and various other products and services. Noncore businesses and questionable assets are now part of Citi Holdings.
Profile Vital Statistics
Valuation Summary and Forecasts
Financial Summary and Forecasts
The primary analyst covering this company does not own its stock.
Currency amounts expressed with “$” are in U.S. dollars (USD) unless otherwise denoted.
Source for forecasts in the data tables above: Morningstar Estimates
(USD Mil)
Contents
Investment Thesis Morningstar Analysis
Analyst Note
Valuation, Growth and Profitability Scenario Analysis
Economic Moat Moat Trend Risk Financial Health Capital Structure Bulls Say/Bears Say Management & Ownership Analyst Note Archive Additional Information Morningstar Analyst Forecasts Comparable Company Analysis Methodology for Valuing Companies
Fiscal Year:
Fiscal Year:
1
- 2 2 2 2 3 3 3 4 5 6 - 13 16 18
Valuation, Growth and Profitability 07 May 2014 We are boosting our fair value estimate to $48 from $45 per share, equivalent to 0.7 times book value per share and 10 times our 2015 earnings per share estimate. In our base-case valuation, we think assets will remain flat during the next five years with the continued runoff of Citi Holdings' assets offset by the growth of loans outside the U.S. We think the net interest margin will improve slowly to approximately 3.0% by 2018 as nonperforming assets fall and interest rates normalize somewhat. We forecast noninterest income to increase by approximately 4%
cumulatively during the next five years, as increases in fee-based income are offset by a decline in principal transactions revenue. We expect net charge-offs to slowly decline during our forecast period, averaging 1.8% in the long run. We expect the efficiency ratio to average 61%
over the next five years. Our valuation reflects a middling level of profitability, with return on assets reaching 0.9%
by the end of our forecast period and return on equity reaching 8%. We assign Citigroup a 12% cost of equity based on the volatility of the company's post-provision revenue, the moderate level of operating leverage inherent to the business, and the bank's high level of financial leverage relative to the rest of our coverage universe. We assume that the company will utilize deferred tax assets over the medium term, and we assume a tax rate averaging 27% over our forecast period.
Scenario Analysis
In an upside scenario, we think the net interest margin could expand to 3.3% as a result of Citigroup's focus on high-yielding emerging-markets consumer loans. When combined with aggressive expense control, this could reduce the bank's efficiency ratio to an above-average level of 53%. In this upside scenario, we envision return on assets reaching 1.2% by 2018. In such a scenario, the stock would be worth $65--1.0 times book value per share and 10 times our upside 2015 earnings per share estimate. In a downside, deflationary scenario, we think the net interest margin could
fall to 2.6%, resulting in efficiency ratios averaging 67%
and returns on assets of only 0.5% in the long run. In this scenario, Citigroup stock would be worth only $32 per share, 0.5 times book value per share, and 12 times our downside 2015 earnings estimate. Finally, we note that a decrease in our assigned cost of equity to 10% would result in a base-case fair value estimate of $59 per share.
Economic Moat
Citigroup's advantages are not the strongest among the financial services companies we cover, but the bank's massive scale in consumer lending and the global reach of its institutional clients group endow the company with a narrow moat. Although consumer lending is essentially a commodity business, few competitors can spread the associated operating costs over such a large asset base, providing a significant cost advantage to the company. On the institutional side of the business, Citigroup's presence in dozens of countries allows it to provide a wider range of products and services than local competitors. This may produce a modest network effect, as each additional market the company services adds value for global corporate customers.
Moat Trend
Bank moat trends are primarily driven by changes in a firm's cost position or changes in the regulatory environment.
Citigroup's moat trend is stable. A sustained reduction in operating costs--we currently expect the efficiency ratio to decline to an acceptable 59% over our forecast period--and a resulting increase in Citigroup's return on assets could persuade us to upgrade our moat trend rating. We think the net interest margin will expand to 3% as bad assets run off the balance sheet and the performance of high-yielding emerging-markets consumer loans shines through.
Conversely, we'd see any further underwriting missteps as evidence of lax risk management. Substantial credit losses and a weakening of the firm's cost position would therefore result in a downgrade of the company's moat trend.
Morningstar Analysis
Risk
Citigroup's presence in emerging markets is the company's biggest advantage, but it's also the source of the most risk.
Rapid credit growth can be highly profitable on the way up, but almost never ends well. Citigroup is banking on the long-run rise of the global consumer, but there are bound to be bumps on the way, leading to volatile financial results.
A secondary source of risk is the company's investment bank, a business that we consider to be a perennial source of disappointment for investors.
Financial Health & Capital Structure
Citigroup maintained an internally estimated Basel III Tier 1 ratio of 10.5% as of March 31, 2014. We expect the company's capital levels will easily meet regulatory standards over our forecast period. Deposits fund about half of Citigroup's $1.9 trillion balance sheet, with long-term debt funding roughly 12%. The company is dependent on several forms of shorter-term debt, including repurchase agreements and trading liabilities. In addition to common equity, Citigroup has about $6 billion in preferred stock outstanding.
Bulls Say Bears Say 3Citigroup is leveraged to the rise of Asia, Latin
America, and other emerging markets, while its competitors will struggle with lackluster loan demand in the U.S. and Western Europe.
3Citigroup is recapitalized and refocused under new management--the perfect conditions for a successful turnaround.
3A shrinking balance sheet, falling expenses, and a harsher regulatory environment provide a perfect combination for capital return over the next five years.
3Many emerging markets depend on the Chinese economy, which looks more vulnerable with each passing day.
3The culture that led to Citigroup's bailout will not be easy to change; a quarter of a million employees under one umbrella for a quarter century cannot change their stripes overnight. The company may be too big for anyone to manage successfully.
3Citi Holdings will be a drag on earnings for the foreseeable future.
Name Position Shares Held Report Date* InsiderActivity MR. MANUEL MEDINA-
MORA CEO, Geographical/Chairman,
Divisional/Co- President 695,737 18 Feb 2014 —
MR. JAMES A. FORESE CEO, Divisional/Co- President 419,576 18 Feb 2014 — MR. WILLIAM J. MILLS CEO, Geographical/Other
Corporate Officer 416,851 20 Feb 2014 —
MR. BRIAN LEACH Other Corporate Officer 367,345 18 Feb 2014 —
MR. MICHAEL L. CORBAT CEO/Director,Director 366,659 18 Feb 2014 —
MR. STEPHEN BIRD CEO, Geographical 309,494 18 Feb 2014 —
C. MICHAEL ARMSTRONG Director 288,922 19 Jan 2010 —
JIM COWLES CEO, Geographical 282,534 20 Feb 2014 —
Top Owners % of Shares
Held % of Fund Assets Change
(k) Portfolio Date
Vanguard Total Stock Mkt Idx 1.49 0.66 647 30 Apr 2014
Vanguard Institutional Index Fund 1.00 0.86 0 30 Apr 2014
Vanguard Five Hundred Index Fund 1.00 0.86 314 30 Apr 2014
SPDR S&P 500 0.94 0.84 187 02 Jun 2014
Vanguard Windsor™ II Fund 0.67 2.01 1,240 31 Mar 2014
Concentrated Holders
VALUEV5 — 21.35 -1 30 Apr 2014
ProFunds VP Banks — 12.14 12 31 Mar 2014
Huerces Inversiones SICAV — 9.02 23 30 Apr 2014
Corvus Alpha Gestión SICAV — 8.93 0 31 Dec 2013
Inversiones Investu SICAV — 8.92 5 31 Dec 2013
Top 5 Buyers % of Shares
Held % of Fund Assets
Shares Bought/
Sold (k) Portfolio Date
Citigroup 401K Plan 0.45 5.97 127,601 31 Dec 2009
New Jersey Division of Pensions and Benefits 0.08 0.15 24,069 30 Jun 2010
Eagle Capital Management LLC 0.50 2.94 15,217 31 Mar 2014
British Columbia Inv Management Corp 0.05 0.17 14,555 31 Mar 2010
BNY Mellon Asset Management Ltd. 0.41 0.65 12,308 31 Mar 2014
Top 5 Sellers
Capital World Investors 1.27 0.52 -28,694 31 Mar 2014
Fidelity Management and Research Company 2.52 0.53 -28,340 31 Mar 2014
Marsico Capital Management, LLC 0.05 0.48 -8,513 31 Mar 2014
Orbis Investment Management Limited 0.07 0.75 -6,333 31 Mar 2014
Arrowstreet Capital Limited Partnership — — -5,404 31 Mar 2014
Management 07 May 2014
Management & Ownership
Management Activity
Fund Ownership
Institutional Transactions
*Represents the date on which the owner’s name, position, and common shares held were reported by the holder or issuer.
We view Citigroup's recent stewardship of shareholder capital as standard. In our view, an analysis of Citigroup's management must start with the board of directors, which has improved dramatically during the past five years.
Chairman Michael O'Neill turned around Bank of Hawaii during his time as CEO of the island institution, making shareholders multiples of their initial investment. Board member Robert Joss enjoyed similar success during his time at Westpac. Other members of the board boast experience at premier financial services companies, including American Express, RenaissanceRe, and PIMCO, while others served as regulators. We think the board is well positioned to oversee continued improvements at Citigroup.
We also think new CEO Michael Corbat's experience will serve Citigroup shareholders well. In contrast to Vikram Pandit, who brought investment banking and hedge fund experience to the CEO role, Corbat has served in a variety of basic banking roles around the world during his time at Citigroup. We like that he appears to be focused on scaling back the bank's operations, announcing cost cuts and branch closures in his first major move as CEO. However, we think it will take time to change the company's culture, and missteps along the way are inevitable.
In our view, management should be evaluated over the near term by its ability to cut expenses and return capital to shareholders. In addition to the amount of capital returned, we're interested to see how management balances dividends and repurchases. While the restoration of the company's dividend is a plus, we would look favorably upon repurchases as well. A substantial buyback program seems a good fit for the earnings volatility possible thanks to Citigroup's investment bank and international consumer book.
Citigroup Still Improving Despite Mounting Challenges 15 Apr 2014
Citigroup reported net income of $3.9 billion, or $1.23 per share, for the first quarter. The results were slightly better than our expectations, and we expect to modestly increase our $45 fair value estimate to account for the improvements in core performance and the time value of money since our last update.
Most important, in our view, Citigroup's balance sheet continues to improve, with core loan balances growing 7%
during the year and the internally estimated Basel III Tier 1 common ratio and supplementary leverage ratio growing to 10.4% and 5.6%, respectively. At the same time, Citi Holdings assets now total only $114 billion--just over half of the company's $208.5 billion in shareholders' equity.
Despite its rejected Comprehensive Capital Analysis and Review capital plan submission, Citigroup is in an excellent position to return capital if and when management improves its internal oversight procedures.
That said, such improvements will not come without cost.
Though operating expenses fell 2% from the prior year, regulatory, compliance, and legal costs actually increased during the year. This supports our thesis that Citigroup and its large, complex peers will experience elevated levels of legal and compliance costs for years to come, limiting its ability to achieve its efficiency goals.
We still believe Citigroup's presence in developing markets will help the company expand its balance sheet faster than peers over time. However, we are also increasingly cautious of the costs associated with such growth, especially as management incurs expenses related to geographic repositioning and branch reductions. We are not sanguine toward the potential for losses in emerging markets, and we expect volatility in results. Latin America--where credit costs have increased 23% over the past two years--is of
particular concern, given the company's recent troubles with internal controls in its Mexican operations.
Finalized Enhanced Supplementary Leverage Ratio Can Be Constraint for Affected Banks 10 Apr 2014
The Federal Reserve Board, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency announced a finalized enhanced supplementary leverage rule. The enhanced supplementary leverage ratio is for an extra 2% above the 3% minimum SLR at the bank holding company level and 3% above the 3% minimum at the insured depositary institution level. Bank holding companies that are below the minimum plus the buffer will have restrictions placed on their capital returns and discretionary bonuses to executives.
The enhanced SLR applies to bank holding companies and their subsidiaries with more than $700 billion in consolidated assets or more than $10 trillion in assets under custody. The affected financial institutions are Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, State Street, and Wells Fargo. Other advanced-approaches bank holding companies, such as U.S. Bancorp and Capital One, will only have to maintain a 3% SLR starting in 2018. We are maintaining our fair value estimates for the affected banks, as we had already assumed that the proposed enhanced SLR would be enacted.
For certain banks, keeping capital levels above the 5%
enhanced SLR at the bank holding company level could be more restrictive for capital returns than risk-based capital ratio minimums, such as the common equity Tier 1 ratio. For example, at the end of 2013, Morgan Stanley had an advanced-approach CET1 ratio of 10.5% compared with a fully phased-in regulatory minimum including the capital conservation buffer and systemically important bank surcharge
Analyst Notes
of 8.5%. Meanwhile, its estimated SLR was 4.2%. If all of the capital rules were already phased in and with Morgan Stanley's SLR below 5%, the firm wouldn't be able to return more than 100% of its net income despite looking overcapitalized from a CET1 perspective.
For a more detailed look at bank capital ratios, please see our March 4 Select document, "Bank Regulatory Capital Questions and Answers: U.S. Basel III Implementation, CCAR, and Minimum Capital Standards."
Banamex Fraud Still an Issue for Citigroup; Criminal Investigation Rumored 03 Apr 2014
According to reports, FBI and other law enforcement agencies are now investigating the fraud losses that occurred at Citigroup's Mexican unit earlier this year. We speculated that the lack of proper control over the Mexican operations was a major factor in the bank's qualitative failure of the CCAR stress test, and an investigation of this sort supports the assertion that compliance problems were not just a one-time issue. At the same time, it verifies our thesis that legal costs are likely to remain elevated at most large banks for the foreseeable future, limiting earnings expansion. Our current valuation reflects this thesis, and we do not expect to alter it or our narrow moat rating as a result of the latest news. We also note that the company's current earnings power provides a substantial cushion against fines and other similar costs. Furthermore, even a substantial fine is unlikely to significantly affect our fair value estimate for this $144 billion market cap bank.
Swiss Scrutiny of Foreign Exchange Manipulation Deepens 31 Mar 2014
On March 31, global attention about whether banks manipulated exchange rates intensified, when Switzerland’s competition commission (known by the acronym Weko) announced that it has launched its own investigation.
Weko is investigating UBS, Credit Suisse, Zuercher Kantonalbank, Julius Baer, JP Morgan, Citigroup, and Royal Bank of Scotland, and said that it has found “evidence…
that these banks colluded to manipulate exchange rates in foreign currency trades.” Authorities in the U.S. and the U.
K., among others, have launched similar investigations, although this is the first time that Julius Baer and Credit Suisse have been included in formal investigations (Credit Suisse has denied that it was included in the preliminary Weko investigation).
While the parallel Weko investigation is unlikely to change our fair value estimates or moat ratings for the six covered banks being instigated, it does underscore the importance that regulators are placing on this issue and that substantial fines are likely. We think that the bulk of any fines are likely to fall on Deutsche, Citi, Barclays, and UBS, which together control nearly 50% of the foreign exchange market.
Citi's CCAR Failure Is Merely a Modest Setback 28 Mar 2014
Following the Federal Reserve's rejection of Citigroup's 2014 capital plan, speculation over potential responses from the company--ranging from management changes to a breakup of the company--has run rampant in the media and marketplace. We think such speculation is premature for several reasons.
First, we note that Citigroup's capital position is more than acceptable. Under the Federal Reserve's assumptions, the company would maintain a 6.5% minimum Tier 1 common ratio--including its rejected capital return plans--even in a severely adverse scenario. We therefore think the company is capable of handling a major downturn, and that shareholders do not have reason to panic over the results.
In fact, the benefits of additional capital are comparable to those of a modest additional dividend, in our view.
Second, the lack of details relating to specific qualitative objections leads us to believe that a drastic response from Citigroup is unlikely. The Federal Reserve referred to
"heightened supervisory expectations" and problems with the bank's ability to project results across its "full range of business activities," and pointed out that no individual issue would have been large enough to reject the plan.
Additionally, the large case of fraud recently exposed in Citigroup's Mexican operations may have resulted in closer scrutiny. Overall, we don't think it's unreasonable to hold Citigroup--with its global exposures and history of major blunders--to a higher standard than peers, and the absence of a primary issue is a positive, in our view.
Finally, there may be some merit to the belief that regulators are reluctant to approve every plan, as market participants might not take such results seriously. Unfortunately, a lack of objections would lessen the credibility of the annual stress tests, and too much transparency would allow companies to prepare for the tests themselves rather than building robust capital planning schemes.
CCAR Results Are In: Federal Reserve Objects to Five Capital Plans 26 Mar 2014
The Federal Reserve announced on March 26 that it has approved the capital plans of 25 banks participating in the Comprehensive Capital Analysis and Review, but objected to five. Four objections (Citigroup, HSBC North America, RBS Citizens, and Santander USA) were over qualitative concerns, while one (Zions) was because it failed to meet the minimum post-stress test Tier 1 common ratio. Bank of America’s and Goldman Sachs’ plans were approved after they submitted adjusted capital plans. We do not anticipate changing our fair value estimates or moat ratings for any of the banks, but we think there are several key takeaways from the CCAR results.
First, somewhat surprisingly, in our view, Citigroup’s capital plan was rejected. Though Citigroup would maintain an adequate Tier 1 common ratio of at least 6.5% in a severely adverse case--according to the Federal Reserve’s estimates--its plan was rejected on a qualitative basis.
Regulators cited “considerable progress” at Citigroup, but were apparently still concerned with the company’s internal stress testing, particularly related to its international operations. Citigroup will be forced to resubmit its capital plan, and given that there were “a number of deficiencies”
in planning practices, it appears that shareholders won’t see major increases in dividends or repurchases until next year.
Second, Bank of America’s initial failure to meet post-stress Tier 1 risk-based capital and Tier 1 leverage ratio requirements in a severely adverse scenario should be similarly discouraging to shareholders, in our view. Along with the firm’s weak showing in the Dodd-Frank stress tests last week, the fact that Bank of America just skated by in the CCAR bodes poorly for 2014 capital returns.
Third, large U.S. subsidiaries of foreign banks were included for the stress tests for the first time in 2014 and had a difficult go of it. HSBC North America and RBS Citizens both passed the stress tests on a quantitative basis, with Tier 1 ratios of 6.6% and 8.1%, respectively, in the severely adverse scenarios, but their capital plans were rejected on a qualitative basis. The Federal Reserve found that both banks had deficiencies in estimating revenue and losses, and "inadequate governance and weak internal controls."
We're not surprised by the finding for RBS--we've long thought that the U.S. subsidiary has been neglected while the parent focused on its massive turnaround, but we're more surprised by the finding for HSBC. HSBC was among the first large banks to identify problems in the U.S.
mortgage market and has been cleaning itself up since
Analyst Notes
2007--the Federal Reserve's objection increases our questions about whether HSBC is simply too large and sprawling to manage effectively.
Fourth, Goldman Sachs received a nonobjection to its adjusted capital plan. Apparently, with its original capital plan, it would have had a minimum Tier 1 leverage ratio in 2015 of 3.9% compared with a regulatory minimum of 4%.
Under the adjusted plan, its 2015 Tier 1 leverage ratio would be 4.2%. Overall, we remain satisfied with the company’s capital ratios under the Federal Reserve’s severely adverse scenario.
Fifth, the only bank that the Fed issued an objection to on a quantitative basis was Zions Bancorporation, as the severely adverse scenario of the test placed its ending Tier 1 common ratio at 3.5%, below the Fed’s minimum 5%
threshold. The magnitude with which Zion’s failed the test was a bit of a surprise, but the fact that Zions failed was less of a surprise given its recent disclosure that it held a significant amount of trust-preferred securities that it took an impairment on. Additionally, results indicated that the miss was due to pre-provision net revenue evaporating and loan loss provision expense and securities losses pushing net income deeply negative over the test horizon. The bank believes that part of the reason for the poor result was because the test was conducted on its security portfolio before it sold $630 million, or 28%, of its CDO portfolio in early 2014. Zions will be resubmitting its capital plan to account for this and other new information, but given the gap that it must close to reach the 5% Tier 1 ratio under a severely adverse scenario, it is unclear whether it will improve to a passing status.
Sixth, Santander Holdings USA, a wholly owned subsidiary of Spanish parent Santander, received an objection on qualitative grounds. The Fed cited deficiencies in its capital planning processes that call into question the overall
reliability of its capital planning processes. This was a bit of a surprise to us, since we hold the management of the parent in high regard. The bank will be required to resubmit its capital plan as a result. As a note, Santander Consumer USA, the banking operation in the U.S., was spun off by the parent in January and is 60% owned by the Spanish parent Santander.
Federal Reserve's Stress Test Results Largely as Expected 20 Mar 2014
Late on March 20, the Fed released the results from the supervisory stress tests conducted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As expected, nearly all of the nation’s largest banks subject to the supervisory stress test passed. Out of the 30 banks subject to the stress test, 29 of the banks passed as the minimum of their Tier 1 common ratio stayed above the 5%
level under the stress-case conditions. The only bank to not meet this hurdle was Zions Bancorporation.
The results are no surprise to us, as they are generally in line with Morningstar's own Stress Test analysis. Under the Federal Reserve’s stress test, Zions (rating: BBB-) would have a Tier 1 common ratio of less than 5%. For example, besides Zions, the two worst banks in the Fed's stress test were Bank of America (rating: BBB) and M&T Bank Corporation (rating: BBB+), which ended up with stressed Tier 1 common ratios of 6.0% and 5.9%, respectively. Our credit ratings on both of these banks are comparatively low, due in part to M&T’s relatively low level of current tangible capital compared to peers, and Bank of America’s still middling profitability and lingering litigation expenses. That said, while these banks did perform below average, they are far from being "in trouble." The Fed noted in its press release that all the large banks are "collectively better positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago," which has been Morningstar's opinion of the large
banks for some time.
We also are interested to see that estimated losses relating to trading activities and large counterparty failures were manageable across the universe of large banks--totaling only $57.4 billion--in the Fed’s adverse scenario, as public information on individual counterparty exposures is scarce.
For Bank of America, Citigroup, and JPMorgan Chase, these estimated losses pale in comparison to projected pre- provision net revenue. We’re therefore marginally more comfortable with the banks’ nominally massive exposures as a result of the disclosed loss estimates.
Next on the calendar for the Fed is the March 26 release of the results from the Comprehensive Capital Analysis and Review. The CCAR takes into account each company's capital plans, such as dividend payments, stock repurchases, or planned acquisitions. The Fed basically evaluates whether each bank would still pass the stress test even after planned capital releases. Last year, JPMorgan and Goldman Sachs Group were required to submit revised capital return plans by the end of third- quarter 2013. We do not expect any of the banks to make the mistake of requesting capital returns that would be deemed excessive by the Federal Reserve given their past experience with this process.
Citigroup Uncovers Mexico Fraud; Adjusts 2013 Earnings 28 Feb 2014
Citigroup announced that it is reducing its previously reported 2013 earnings by $235 million, or $0.07 per share, after discovering a large fraudulent transaction in its Mexican subsidiary. After a detailed review of its books, Citigroup's Banamex subsidiary found that about $400 million of accounts receivable obtained in connection with the financing of an oil services company were nonexistent.
The charge does not affect our fair value estimate, and we
currently have no reason to believe that other illegitimate transactions exist. However, the charge does support our thesis on Citigroup and other complex financial institutions in two ways. First, this charge--along with the "London Whale" and a plethora of similar incidents at peers in recent years--illustrates the difficulty of keeping tabs on widespread operations. More importantly, a previously undetected fraud of this size supports our belief that compliance costs are more likely to rise than to decline from current levels. In our view, each additional incident of this type illustrates the need for better oversight and monitoring at large banks--both internally and externally. We think the costs of such improvements will limit the potential for earnings improvement in the near term.
Progress Slows at Citigroup, but Potential Remains 16 Jan 2014
Citigroup reported net income of $2.7 billion, or $0.85 per diluted share, for the final quarter of 2013, bringing full-year income to $13.9 billion, or $4.42 per share. The results were slightly less than we expected, but the difference was based primarily on the rate of provisioning. We therefore do not expect to alter our fair value estimate for the narrow moat bank, and believe potential upside is limited at the current stock price.
Among large U.S. banks, Citigroup's claim to fame is its international consumer exposure. Over the long run, we agree that exposure to credit growth overseas will be a key advantage, but investors should not anticipate a smooth ride. In fact, Asian revenue actually fell slightly during both the quarter and the year--driven mostly by regulatory and other changes in Korea--and average international deposits did not grow at all during the year. We don't expect such blips to alter the long-term outlook for the bank's international business, and might view further weakness as buying opportunities in future quarters.
Analyst Notes
Though we don't view legal and repositioning costs as true one-time items, as the large banks have been experiencing such costs for years, it's encouraging to see core operating expenses totaling less than $11 billion during the fourth quarter, and management expects similar levels in the coming year. However, without help from a more favorable interest rate and investment banking environment, the company's efficiency goals may be tough to meet, as adjusted revenue actually fell slightly during the year.
Outside of the core business, Citi Holdings continued to take a toll, though the segment now accounts for only 6% of assets at only $117 billion worth, most of which are North American mortgages. Citi Holdings was still responsible for a $422 million loss, however. Obviously, this earnings headwind should subside over the next several years, allowing the bank's core earnings power to shine through.
Other areas of Citigroup's balance sheet also continued to improve in 2013. The bank grew corporate loans by 11%
during the year. We don't expect this rate of growth to continue, as this has become an area of intense competition among banks in recent quarters. Citigroup has also built a sturdier balance sheet in recent quarters. Its Basel III Tier 1 common ratio now stands at 10.5%, up more than 50% since the beginning of 2012. Unfortunately, earnings don't necessarily support a share price approaching the company's reported tangible book value per share of about
$55, in our view. In fact, management is targeting a 10%
return on tangible common equity by 2015. Because such results are both hypothetical and almost two years in the future, we think a modest discount to tangible book value-- as our fair value estimate implies--is justified.
In the company's Securities and Banking segment, investment banking revenue rose 3% during the year as increases in equity and advisory revenue offset a decline in
debt underwriting fees, thanks in part to a rising stock market. Similarly, equity markets revenue rose while fixed income revenue fell. We don't have any unique insights into near-term activity, but note that the combination of Fed tapering and current stock prices--the Morningstar market price/fair value ratio now stands at 105%--might bode poorly for future market-related revenue.
Volcker Rule's Prohibition on Proprietary Trading Looks Benign 11 Dec 2013
Five U.S. agencies have signed off on the Dodd-Frank Volcker Rule. Broadly speaking, the Volcker Rule was made to limit risk-taking at U.S. insured depository institutions by prohibiting proprietary trading and restricting investments in hedge funds and private equity funds. While the final rules were fleshed out from the initial proposal several years ago, we didn’t see anything new that materially changes our thoughts on its potential effect on financial institutions.
Therefore, we are maintaining our current moat ratings and fair value estimates.
Leading up to the final rules release, our greatest concern was if the prohibition on proprietary trading would be ill defined and have the unintended consequence of curtailing market-making activity. Practically speaking, all “bright line” proprietary trading businesses of the large banks were divested or closed several years ago, but market-making is still a significant part of some companies, such as Goldman Sachs whose FICC and equities client execution operations comprised approximately 40% of net revenue over the last three years. The final Volcker Rule explicitly carved out an exemption for market-making that looks like it will be benign to the banks.
The limit on ownership interests in hedge funds and private equity funds under the de minimis exclusion remains at 3%
of tier 1 capital. While several banks are over this limit, they have until July 21, 2015 to be in conformance. Additionally, we believe that the winding down of the stakes will be value
neutral to the companies, as they should be able to liquidate their positions at a fair market value, which takes into account the future lost revenue.
Growth (% YoY)
3-Year
Hist. CAGR Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015
5-Year Proj. CAGR
Net Interest Income -5.0 -11.4 -1.7 -1.7 1.0 0.5 2.2
Pre-Tax, Pre-Provision Earnings -11.0 -31.2 -28.8 44.3 6.0 0.9 4.4
Net Income 7.4 2.4 -31.4 76.2 9.2 -3.7 3.2
Diluted EPS 129.5 913.7 -31.8 74.7 9.5 -3.7 3.3
Profitability
3-Year
Hist. Avg Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015
5-Year Proj. Avg
Net Interest Margin % 2.8 2.8 2.8 2.8 2.8 2.8 2.8
Non-Interest Income (% of Revenue) 36.9 38.4 33.8 38.6 38.4 37.8 37.7
Efficiency Ratio % 70.9 69.0 78.4 65.4 62.7 62.1 61.1
Return on Average Assets % 0.6 0.6 0.4 0.7 0.8 0.8 0.8
Return on Average Equity % 5.8 6.4 4.2 6.8 7.4 7.3 7.8
Return on Tangible Equity % 6.7 7.6 4.7 7.7 8.7 8.6 9.2
Leverage
3-Year
Hist. Avg Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015
5-Year Proj. Avg
Assets/Equity 9.87 10.54 9.86 9.20 9.52 9.76 9.71
Tangible Common Equity/Tangible Assets % 8.35 7.77 8.36 8.92 8.57 8.32 8.35
Tier I Ratio % 13.52 12.91 13.55 14.10 — — —
2012 2013 2014(E) 2015(E)
Price/Fair Value 0.88 1.16 — —
Price/Earnings 15.9 12.0 10.1 10.5
Price/Book 0.8 0.7 0.7 0.7
Price/Tangible Book 1.0 0.9 0.8 0.9
Dividend Yield % 0.1 0.1 0.1 —
Cost of Equity % 12.0
Long-Run Tax Rate % 27.0
Stage II Net Income Growth Rate % 4.0
Stage II Return on New Invested Capital % 14.0
Perpetuity Year 15.0
USD Mil Firm Value (%) Per Share
Value
Present Value Stage I 62,277 44.2 20.54
Present Value Stage II 39,649 28.1 13.08
Present Value of the Perpetuity 39,022 27.7 12.87 Total Common Equity Value before
Adjustment 140,947 100.0 46.49
Other Adjustments — — —
Equity Value 140,947 — 46.49
Projected Diluted Shares 3,032
Fair Value per Share —
Morningstar Analyst Forecasts
Forecast Financial Summary and Forecasts
Valuation Summary and Forecasts
Key Valuation Drivers
Discounted Cash Flow Valuation
Additional estimates and scenarios available for download at http://select.morningstar.com.
(USD)
Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015
Net Interest Income 48,447 47,603 46,793 47,242 47,492
Provision for Losses on Loans 11,773 10,848 7,604 8,015 9,000
Net Interest Income after Provision 36,674 36,755 39,189 39,228 38,491
Non-Interest Income 30,163 24,290 29,360 29,487 28,879
Net Revenue 78,610 71,893 76,153 76,729 76,370
Net Revenue After Provision (excluding Gains on Sale) 66,837 61,045 68,549 68,714 67,370
Gains on Sale 1,997 3,251 748 128 —
Net Revenue After Provision (including Gains on Sale) 68,834 64,296 69,297 68,842 67,370
Non-Interest Expense 54,210 56,360 49,800 48,131 47,396
Operating Income 12,627 4,685 18,749 20,584 19,974
(excluding Gains on Sale)
Taxes 3,521 27 5,867 5,592 5,393
Minority Interest, net of income taxes 148 219 227 227 227
Income after Taxes 10,955 7,690 13,403 14,893 14,354
Cumulative Effect of Accounting Change — — — — —
After-tax Non-recurring Items 186 — 262 — —
Discounted Operations -112 149 -270 — —
Preferred Dividends 26 192 194 472 472
Net Income attributable to common shareholders, 10,929 7,498 13,209 14,421 13,882
Excluding All After-tax items
Net Income attributable to common 10,855 7,349 13,217 14,421 13,882
shareholders, including all after-tax items
Average Diluted Shares Outstanding 2,999 3,016 3,042 3,032 3,032
Diluted EPS Excluding Charges 3.64 2.49 4.34 4.76 4.58
Diluted EPS Including Charges 3.62 2.44 4.35 4.76 4.58
Income Statement (USD Mil)
Forecast
Earning Assets Dec 2012 Dec 2013 Dec 2014 Dec 2015
Cash and Due from Banks 36,453 29,885 34,398 35,430
Interest Bearing Deposits at Banks 102,134 169,005 147,420 151,842 Federal Funds Sold and Securities Borrowed 261,311 257,037 262,178 267,421 or Purchased Under Agreement to Resell
Brokerage Receivables 22,490 25,674 26,187 26,711
Other Receivables (excluding interest — — — —
receivables)
Trading Assets 320,929 285,928 325,000 330,000
Investment Securities Held to Maturity 312,326 308,980 300,000 305,000
Investment Securities Available-for-Sale — — — —
Financial Instruments Owned, at Fair Value — — — —
(trading securities)
Other Earning Assets — — -450 -450
Loans Held for Sale — — — —
Loans and Leases 655,464 665,472 663,365 649,720
Unearned Discount — — — —
Allowance for Loan Losses -25,455 -19,648 -18,243 -16,243
Net Loans and Leases 630,009 645,824 645,122 633,477
Premises & Equipment, Net — — — —
Premises & Equipment, Gross — — — —
(Accumulated Depreciation) — — — —
Interest Receivables — — — —
Goodwill 25,673 25,009 25,009 25,009
Identifiable Intangibles 7,639 7,774 7,774 7,774
Deferred Tax Assets 55,000 52,800 52,800 47,520
Other Non-Earning Assets (Other Real Estate 90,696 72,466 72,466 72,466 Owned etc.)
Total Assets 1,864,660 1,880,382 1,897,904 1,902,200
Liabilities Dec 2012 Dec 2013 Dec 2014 Dec 2015
Total Deposits 930,560 968,273 997,321 1,027,241
Customer Deposits 930,560 968,273 997,321 1,027,241
Federal Funds Purchased and Securities Loaned 211,236 203,512 203,512 203,512 or Sold under Agreements to Repurchase
Brokerage Payables 57,013 53,707 53,707 53,707
Trading Liabilities 115,549 108,762 108,333 110,000
Financial Instruments Sold, but not yet pur- — — — —
chased at Fair Value
Other Payables — — — —
Short-Term Debt 52,027 58,944 57,897 53,912
Long-Term Debt 239,463 221,116 217,189 202,240
Additional Debt 67,815 59,935 58,870 54,819
Total Short-Term, Long-Term 359,305 339,995 333,956 310,971 and Other Debt
Deferred Tax Liabilities — — — —
Other Liabilities (bank acceptance outstanding, — — — —
accrued expenses, etc.)
Total Liabilities 1,673,663 1,674,249 1,696,830 1,705,431
Common Stock 30 31 31 31
Paid-in Capital 106,391 107,193 106,743 106,743
Retained Earnings 97,809 111,168 105,175 100,871
Preferred Equity 2,562 6,738 6,738 6,738
Treasury Stock -847 -1,658 -1,658 -1,658
Accumulated Other Comprehensive Income -16,896 -19,133 -17,749 -17,749
Other Equity — — — —
Shareholders?Equity 189,049 204,339 199,280 194,976
Total Liabilities & Shareholders?Equity 1,864,660 1,880,382 1,897,904 1,902,200 (including Minority Interest)
Morningstar Analyst Forecasts
Balance Sheet (USD Mil)
Non-Earning Assets Equity
Forecast Forecast
Company/Ticker Value 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 1.0 8.5 13.2 10.2 10.6 1.1 1.1 1.0 1.1 1.5 1.4 1.4 1.3
Bank of America Corporation BAC USA 1.0 46.4 17.7 20.0 12.6 0.8 0.8 0.8 0.8 1.2 1.3 1.1 1.1
Average 27.5 15.5 15.1 11.6 1.0 1.0 0.9 1.0 1.4 1.4 1.3 1.2
Citigroup Inc C US 1.0 15.9 12.0 10.1 10.5 0.8 0.7 0.7 0.7 1.0 0.9 0.8 0.9
Company/Ticker Total Assets (Mil) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 2,415,689 USD 10.6 8.6 10.3 10.1 0.9 0.7 0.9 0.9 13.6 10.9 13.7 13.0
Bank of America Corporation BAC USA 2,102,273 USD 1.8 4.9 4.2 6.5 0.2 0.5 0.5 0.7 2.6 7.3 6.4 9.8
Average 6.2 6.8 7.3 8.3 0.6 0.6 0.7 0.8 8.1 9.1 10.1 11.4
Citigroup Inc C US 1,880,382 USD 4.2 6.8 7.4 7.3 0.4 0.7 0.8 0.8 4.7 7.7 8.7 8.6
Company/Ticker Revenue (Mil) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 96,606 USD -0.2 -0.4 -2.3 3.3 -5.9 -19.1 39.7 2.6 16.1 -14.6 22.4 -3.1 Bank of America Corporation BAC USA 87,691 USD -9.6 7.3 -2.1 3.3 -14.7 75.5 -11.3 48.5 NM 244.6 -13.2 58.9
Average -4.9 3.5 -2.2 3.3 -10.3 28.2 14.2 25.6 16.1 115.0 4.6 27.9
Citigroup Inc C US 76,153 USD -8.5 5.9 0.8 -0.5 -28.8 44.3 6.0 0.9 -31.8 74.7 9.5 -3.7
Valuation Analysis
Returns Analysis
Growth Analysis
Price/Earnings Price/Book Price/Tangible Book
Return on Average Equity % Return on Average Assets % Return on Tangible Equity %
Net Revenue Growth % Pre-Tax, Pre-Provision Earnings Growth %
EPS Growth % Last Historical Year
Last Historical Year Price/Fair
Company/Ticker Revenue (Mil) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 96,606 USD 2.2 2.0 2.1 2.1 65.7 72.3 60.9 61.4 53.7 55.2 55.2 57.2
Bank of America Corporation BAC USA 87,691 USD 2.3 2.4 2.4 2.5 86.7 77.7 78.5 69.8 50.3 51.8 52.1 52.9
Average 2.3 2.2 2.3 2.3 76.2 75.0 69.7 65.6 52.0 53.5 53.7 55.1
Citigroup Inc C US 76,153 USD 2.8 2.8 2.8 2.8 78.4 65.4 62.7 62.1 33.8 38.6 38.4 37.8
Company/Ticker Total Debt (Mil) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 353,731 USD 11.6 11.4 11.1 11.1 6.3 6.4 6.6 6.6 12.3 12.6 — —
Bank of America Corporation BAC USA 295,673 USD 9.3 9.0 9.1 9.1 6.4 6.9 7.1 7.1 12.9 12.4 — —
Average 10.5 10.2 10.1 10.1 6.4 6.7 6.9 6.9 12.6 12.5 — —
Citigroup Inc C US 339,995 USD 9.9 9.2 9.5 9.8 8.4 8.9 8.6 8.3 13.6 14.1 — —
Company/Ticker Market Cap (Mil) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E) 2012 2013 2014(E) 2015(E)
JPMorgan Chase & Co JPM USA 210,430 USD 59.6 56.1 55.4 53.8 2.6 2.6 1.5 1.2 54.8 55.2 51.1 51.2
Bank of America Corporation BAC USA 159,943 USD 80.0 81.4 77.0 72.6 1.6 2.5 2.2 1.7 39.5 38.2 38.7 39.4
Average 69.8 68.8 66.2 63.2 2.1 2.6 1.9 1.5 47.2 46.7 44.9 45.3
Citigroup Inc C US 146,391 USD 67.7 66.7 64.7 61.7 3.1 3.5 3.4 3.2 38.7 39.5 40.5 41.3
Comparable Company Analysis
These companies are chosen by the analyst and the data are shown by nearest calendar year in descending market capitalization order.
Profitability Analysis
Leverage Analysis
Liquidity Analysis
Net Interest Margin % Efficiency Ratio % Non Interest Income % of Revenue
Assets/Equity Tangible Common Equity/
Tangible Assets %
Tier I Ratio %
Loans/Deposits % Short-Term Debt % of Liabilities Liquid Assets (% of Total Assets) Last Historical Year
Last Historical Year
Last Historical Year
