The four largest U.S. banks experienced the financial crisis in wildly different ways. JPMorgan Chase (JPM, Financial) and Wells Fargo (WFC, Financial) exited the crisis stronger having acquired smaller, failing institutions, while Bank of America (BAC, Financial) and Citigroup (C, Financial) were pushed to the brink of insolvency.
After many years of bank management teams focusing on building sustainable capital buffers, in addition to a more rigorous regulatory environment, the largest U.S. banks are back on stable footing and are generating strong returns for shareholders.
Among the four big bank stocks, Citigroup has the best total return prospects today.
Company overview
Founded more than 200 years ago as the City Bank of New York, the company has since become a huge player in global finance. The bank competes in credit cards, commercial banking, trading and other related financial activities. It has less exposure to traditional deposit-taking and lending than its immediate peers and is more reliant upon its international operations, while the others are more U.S.-focused.
Citigroup produces about $75 billion in annual revenue and has a market capitalization of $159 billion.
The bank reported first-quarter earnings on April 15. Revenue came in at $18.6 billion, a decline of 2% year over year. The lower top line was attribued to lower equity markets revenue as well as mark-to-market losses on loan hedges. In addition, Citigroup continues to wind down legacy assets from the financial crisis, resulting in lower revenue.
Operating expenses came in at $10.6 billion, a decline of 3% from the prior-year quarter. Lower costs were driven by efficiency savings, which Citigroup has been working on in earnest for years, but those gains were partially offset by targeted investments. The efficiency ratio was 57%, down slightly from 57.9% a year ago. The bank's efficiency ratios used to be in the 70% range following the financial crisis, so it has certainly come a very long way toward operating efficiency. This has immensely helped profitability in recent years, and Citigroup has truly put the crisis behind it at this point.
Total loans at the end of the quarter were $682 billion, up fractionally from last year. Excluding the impact of foreign exchange translations, Citigroup’s loans grew 3% thanks to gains from the institutional clients group as well as global consumer banking, partially offset by the wind down of legacy assets.
Allowances for loan losses was $12.3 billion at the end of the quarter, or 1.82% of total loans. This was largely comparable to the $12.4 billion and 1.85% recorded a year ago. Citigroup’s focus on non-traditional banking activities means its loan losses tend to be higher than the other large banks, but its returns on those loans – due to their relative riskiness – tend to be higher as well.
End-of-period deposits were $1 trillion, an increase of 3%. Institutional deposits drove the increase, moving 8% higher year over year, while global consumer banking saw a 2% increase in deposits. These deposits are critical sources of cheap funding for Citigroup as it builds its reserves of lendable funds.
Net profits came in at $4.7 billion in the first quarter, a gain of 2% year over year, driven by lower expenses and a lower tax rate. The decrease in revenue and higher cost of credit offset some of those gains, but Citigroup still managed to grow earnings per share by more than 11%, from $1.67 to $1.89, thanks to a lower share count.
Book value is now at $77.09 per share and tangible book value is $65.55, increasing 8% and 7% over the past year. The bank’s capital position remains very strong as its common equity tier 1 ratio is 11.9%, unchanged from the prior year despite billions of dollars' worth of share repurchases and dividend payments in the interim.
Indeed, Citigroup repurchased 66 million shares in the first quarter. It returned a total of $5.1 billion to shareholders via dividends and buybacks.
Following the first-quarter report, we’ve reiterated our expectation of $7.50 in earnings per share for this year.
Growth prospects
Citigroup’s growth prospects have been very cloudy for much of the past decade, given the struggles the company faced coming out of the crisis. Many years of intense focus on controlling costs and limiting exposure to the riskiest lines of business, however, has resulted in a very strong bank that can rival the other three largest banks.
We see 8% annual growth moving forward, representing a slowdown from recent years’ growth. Indeed, should Citigroup hit the estimate of $7.50 in earnings per share for this year, it will have compounded earnings in the past three years by nearly 17% per year. We don’t think this sort of growth is reasonable to expect going forward, but we also don’t see the company’s growth story as finished by any means.
We believe Citigroup will achieve strong annual growth via higher revenue from its core business lines, though some of that will be offset by the continued wind down of legacy assets. We see revenue as a low-single-digit tailwind at best as the bank is no longer aggressively chasing loan growth. Instead, it is focusing on operating as efficiently as possible and limiting credit exposure to risky investments.
Despite what we see as a relatively unfavorable environment for revenue growth, Citigroup has other levers it can pull to boost earnings per share. Its efficiency ratio continues to decline, which boosts profit margins as expenses fall. Most of the heavy lifting has been done on that front as Citigroup is now more in line with its peers than it has been in the past decade. However, continued focus is paying off and we see margin growth as another small tailwind moving forward.
The buybacks will account for most of the bank’s earnings per share growth in the coming years as Citigroup continues to spend billions of dollars buying back shares at or just above tangible book value. We see this as a very prudent use of cash as the bank is buying back very cheap stock and, thus, boosting earnings per share at strong rates irrespective of earnings growth on a dollar basis. We think Citigroup can continue to relatively easily reduce the float by mid-single digits or better in the coming years, fueling the bulk of earnings per share expansion. In total, we see 8% annual earnings per share growth as quite achievable, even if economic conditions deteriorate somewhat, since its growth is largely dependent upon buybacks.
Valuation, dividends and expected returns
Citigroup shares trade for 9.2 times our earnings per share estimate of $7.50 for this year. That is cheap on an absolute basis, as well as against our estimate of fair value at 10.5 times earnings. Should the stock’s valuation drift higher over time, we see it adding approximately 3% to total returns annually in the coming years.
The dividend yield is 2.6% currently, so Citigroup offers income investors an above-average payout as well. We believe the dividend will nearly double in the next few years as the bank continues on its journey to rebuild its once-devastated payout. This, we believe, will see Citigroup remain a relatively strong income stock choice for investors as it grows the dividend along with earnings.
Overall, we see Citigroup producing low double-digit total returns in the coming years as the stock enjoys a small tailwind from the valuation, an above-average yield and high single-digit earnings per share growth.
Final thoughts
Citigroup certainly had a tough time during and after the financial crisis. Years of rebuilding efforts, however, have led the company to becoming a premier global banking franchise once more. With the stock just above tangible book value and 9 times earnings, we see it as quite attractive. Citigroup offers investors approximately 14% prospective total annual returns today, and we rate the stock a buy as a result.
Disclosure: No positions in any stocks mentioned.
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