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Tuesday, 30 September 2014

Long time coming

Citi's mediocrity shines through dark quarter

It’s time for Vikram Pandit to start making Citigroup shine a little more. The chief executive of the U.S. mega-bank can be happy with some of the progress being made, including a continuation of overall positive operating leverage and a rock-solid balance sheet. But for shareholders, mediocrity is still radiating through the third-quarter storm.

The headline figure is pretty awful. Net income of $468 million equates to a return on equity of just 1 percent. It would have been a loss of $118 million if not for a sizable tax benefit.

A couple of big items obscured the bank’s underlying performance. Booking changes in the value of its own liabilities as a loss whacked $776 million from revenue. A hit to the value of its remaining stake in Morgan Stanley Smith Barney sizzled another $4.9 billion.

Strip those and the tax gain out and Citi earned a more respectable-looking $3.3 billion. Even then, the return on equity amounts to only 7 percent. The return on tangible equity would be 11.8 percent, but relies on a large dose of optimism.

First, the figure ignores $40 billion of tangible common equity that’s tied up with the bank’s deferred tax assets. The implied tax rate on earnings of $3.3 billion is a low 26 percent. And a third of that net income comes from releasing loan loss reserves.

Pandit’s hands are partly tied. It’ll take years for the bank to earn enough money to utilize the tax deferrals and release the equity set against them. The unwanted dross in Citi Holdings, though diminished, remains a drag. And only the Federal Reserve can authorize a U.S. bank to return capital to shareholders.

Absent a rapid increase in business, Citi has one other lever: cutting expenses. They have dropped slightly as revenue has increased. A Breakingviews analysis shows that slashing Citi’s investment banking pay to 30 percent of the unit’s revenue would increase the group’s ROE to about 8 percent.

That’s hardly sparkling, but Citi’s stock trades at a bleak 57 percent of book value. Even parting just a few more clouds would make things brighter for suffering shareholders.

Context News

Citigroup on Oct. 15 reported third-quarter net income of $468 million, or 15 cents a share, equal to a 1 percent return on equity. Revenue was $14 billion. The consensus estimate of sell-side analysts was for earnings of 96 cents a share. Citi executives point out that the consensus estimate does not include some or all of the exceptional items booked during the quarter.

These included a $776 million hit to earnings from having to book as a loss improvements in the bank’s own credit spreads. Citi also took a $586 million tax benefit in the quarter. And the bank recorded a $4.9 billion pre-tax loss ($2.9 billion after tax) after writing down the value it ascribes to its wealth management joint venture with Morgan Stanley <MS.N>.

Excluding these three items, Citi would have earned $3.3 billion, or $1.06 a share, equating to a 7 percent return on equity. The bank also released $1.5 billion from its loan loss reserves.

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