Citigroup released Q2 earnings this morning. The shares reacted positively at the open, but sold off during the morning. Tangible book value increased to $48.75, so the stock trades at 80% of TBVPS. Credit continues to get better. Here are some of my thoughts on the release and the conference call:
1. Credit losses declined 18% Q/Q and 35% Y/Y. Loan Loss Reserve release declined to $2B from $3.3B in Q1, so earnings are higher quality compared to Q1.
2. One negative that I see throughout the release is the negative operating leverage across the businesses. In the Citicorp segment, revenues declined 1%, but expenses increased 5%. It seems like Citigroup continues to have an elevated level of investment spending in its core business. We’ll have to wait until 2012 to see how this translates into revenue growth. on the conference call, there were many questions about expenses. management called out three drivers of high expenses: 1) adverse FX moves, 2) higher legal costs, and 3) investment spending. I think the FX issue is a little smoke and mirrors because there should be offset revenue gains. The legal costs will eventually go away and are certainly not as problematic as BAC’s issues. The last is investment spending. They said they expected Latin america and Asia to show positive operating leverage in Q4 this year. The other businesses will not show operating leverage until at least 2012, but probably late 2012.
3. In Citicorp, managed loans grew 27% Y/Y which is both exciting and troubling. It could reflect Citi taking advantage of the faster growth of these markets and their strong global brand. On the other hand, the most dangerous banks are the ones that are growing fast in risky lending segments. I would define lending in emerging markets as risky.
4. The story in CitiHoldings is improving rapidly. Net loss in this segment declined to $200M. They are steadily reducing assets in this segment through paydowns and sales.
5. Several times in the press release and the investor presentation, management makes comments about returning capital to shareholders in 2012.
6. One of the side benefits of Citigroup reporting profits is it utilizes its deferred tax asset (DTA) so it improves the quality of the company’s capital.
7. As Citigroup winds down the assets in CitiHoldings, it is reducing its risk-weighted assets. This will make compliance with Basel III capital requirements easily attainable.
8. On page 26 of the attached earnings presentation, there is a review of Citigroup’s exposure to the PIIGS. It does not appear outsized.
9. I believe Citi should retain the retail partner cards business. Although the CFO stated the business does not fit with Citi strategically, it is simply not the right time to be marketing this business. The business is profitable and generating $3 billion in pre-tax net income. They should retain it for a few years, use the pre-tax profits to absorb so of their DTA, and sell it down the road when the market again places a premium on credit card receivables.
Overall thoughts: At 80% of of tangible book value and with as much as $30B in excess capital, it is difficult to see how there is much downside to C’s stock price relative to the overall market. The credit improvement has been rapid. At the current stock price, the if the company can repurchase stock in 2012, it will be materially accretive.
Disclosure: Long C
Disclaimer: This is not investment advice. This intended to be a window in my analysis of C’s earnings report. Please do you own work before making an investment. My positions listed in the disclosure may change without further update.
Texas Capital Bancshares (TCBI) is an interesting organic growth banking story, but the bank’s declining credit metrics make it a better short from here. The bank is 12 years old and has grown by lifting out relationship bankers from the big banks. These relationship bankers bring their best customers over to TCBI. This is an efficient and capital friendly growth strategy. This strategy also allows the bank to grow even in periods of weak loan demand.
However, the credit metrics of the bank have deteriorated significantly over the past 4 quarters. The only potential catalyst that matters is a sign stability in the bank’s credit metrics. The next data point won’t be for another 7 weeks when the bank releases Q3 numbers.
Here’s a look at the credit numbers for TCBI
| |
2009 Q2 |
2009 Q3 |
2009 Q4 |
2010 Q1 |
2010 Q2 |
| Loans Outstanding |
$4,211 |
$4,290 |
$4,457 |
$4,443 |
$4,463 |
| |
|
|
|
|
|
| Loan Loss Provision |
11.0 |
13.6 |
10.1 |
13.1 |
15.7 |
| Net Charge-Offs |
6.8 |
2.8 |
8.0 |
9.3 |
12.6 |
| Loan Loss Reserve |
54.3 |
65.8 |
67.9 |
71.7 |
74.9 |
| |
|
|
|
|
|
| Non-Accrual Loans |
49.6 |
85.3 |
95.6 |
115.9 |
138.2 |
| Other Real Estate Owned |
31.4 |
34.7 |
27.3 |
28.9 |
42.1 |
| Non-Performing Assets |
81.0 |
119.9 |
122.9 |
144.8 |
180.3 |
| |
|
|
|
|
|
| Non-Accruals/Loans |
1.18% |
1.99% |
2.15% |
2.61% |
3.10% |
| Reserves/Loans |
1.32% |
1.54% |
1.55% |
1.63% |
1.68% |
| Reserves/Non-Accruals |
109% |
77% |
71% |
62% |
54% |
| |
|
|
|
|
|
| Tangible Common Equity |
456 |
466 |
473 |
491 |
504 |
| Texas Ratio |
16% |
23% |
23% |
26% |
31% |
TCBI’s numbers are showing a disturbing trend. Non-accrual loans have accelerated the past two quarters. Plus, it looks like management has not been adding to the loan loss reserve aggressively as non-accruals have climbed.
One could argue that TCBI has been under reserving for loan losses during the past 4 quarters. The loan loss reserve to non-accrual loan ratio has declined from 109% to 54% over the past 12 months. If management had kept this ratio constant, TCBI would have report a losses instead of profits over the past 4 quarters.
TCBI shares trade 1.15x tangible book. I think the profitability of the bank is questionable given the declining reserve ratios. If you add in the worsening credit metrics, I think TCBI will have a lid on its stock price until it reports a quarter with stable credit metrics. Since TCBI is well-capitalized, the viability of the bank is not in question. But, the decline in the credit quality suggests that the credit issues are open-ended. I think investors should demand a discount to book value to own a bank stock with credit quality continuing to worsen at rate like this. At 70% of tangible book, the stock would trade at $9.50 or a decline of 35% from the current price.
