Dick Bové’s Forecast for Citigroup: “C” Is for Caution

When it comes to the earnings outlook of the world’s largest financial entity, the veteran bank analyst is keeping an eyebrow raised.

Institutional Investor

May 5, 2014


By Robert Stowe England


Dick Bové, veteran bank and equity research analyst at Garden City, New York–headquartered Rafferty Capital Markets, sees extraordinary strength in the overall U.S. financial sector. Capital as a share of assets is at its highest level since 1938. Liquidity is the most flush it has been in 40 years. In the generally fair skies of the banking industry, however, Bové sees one looming cloud: Citigroup.

After the global bank on April 14 announced earnings for the first quarter that exceeded analysts’ expectations, Bové upgraded his rating of Citi’s stock from a sell to a hold. The bank reported earnings of $1.30 a share on $4.1 billion in earnings on an adjusted basis. Analysts had expected a lower $1.14 per share, according to a poll released in mid-April by Thomson Financial Research and FactSet Research Systems. According to Thomson First Call, 21 of 30 analysts rated Citigroup a buy or strong buy in April, with eight of them rating it a hold and one a sell.

Although Bové sees positive developments at Citi, he remains skeptical about its outlook. For one thing, Citigroup’s return on equity fell in the first quarter, to 7.8 percent from 8.2 percent a year earlier, although that was higher than the 4.8 percent in the fourth quarter of 2013. Michael Corbat, who took over the reins as chief executive officer in October 2012, promised investors in March 2013 that the bank would be able to offer a 10 percent or higher return on tangible common equity by 2015. Since the Federal Reserve rejected Citi’s 2014 capital plan in March, it has looked to be nearly impossible for Citi to reach its goal by the end of next year.

In its submission to the Fed, Citi proposed to raise its quarterly dividend to 5 cents per share and repurchase $6.4 billion of its stock.

The Fed found that the company had failed to adequately design a process to conduct internal stress testing to reflect its full range of business activities and exposures. This result was a stinging setback for Citigroup. But Citi did pass the Fed’s stress test — a success in its own right, based on what Corbat has called an “industrial strength” effort to build a comfortable capital cushion. After the Fed’s rejection of the plan, Citi continues to be limited to a paltry dividend of 1 cent per share and the $1.2 billion in stock repurchases the Fed approved a year ago.

Beyond the company’s failure to pass muster with the Fed, Citigroup also suffered an embarrassment before the Securities and Exchange Commission in the first quarter. In February, the bank disclosed to the SEC that it had discovered a $400 million gap owed to it by Oceanografía, a company that provides oil services to Pemex, Mexico’s state-owned oil company. In April Citi chief financial officer John Gerspach revealed a second breach involving the same parties in Mexico, this time of less than $30 million.

According to Bové, public opinion has been more forgiving of Citi’s present top brass than of its predecessors. But investors remain unconvinced about Citi’s prospects. Even though tangible book value per share rose to $56.40 in the first quarter, the bank’s shares closed at $47.73 as of the market close on May 2. In an interview with Institutional Investor, Bové delves into Citigroup’s recent earnings and outlook, and he outlines the financial company’s strengths and weaknesses.

Institutional Investor: What did Citigroup’s first-quarter earnings report reveal about the state of the company?

Bové: From a balance-sheet standpoint, it was a very positive report. It basically indicated that the company has a massive amount of liquidity and is meeting both the capital requirements of Basel III and the supplementary ratio. It’s the reason I decided to take the stock up to a hold from a sell. From an income statement point of view, basically they took their trading profits up — I’m just going to say for hyperbole — three times, right? I think we’ve got a lot of mark to market, and I think we’ve got the sale of assets in those numbers. I’m not sure the company will show that level of improvement in the next quarter. Their trading will be down.

But the bottom line is: The market is not going to want to sell this stock. So if the market doesn’t want to sell it and if Citi’s balance sheet is in decent condition, I see no reason to keep my sell rating on it. I don’t want to own the stock, however. There is a lot I don’t like about the company.

What don’t you like about Citigroup?

The core problem I have is that over the past 18 years, there were six different administrations in that company. And each one of these administrations — Walter Wriston, John Reed, Sandy Weill, Chuck Prince, Vikram Pandit and now Michael Corbat — has approached the business differently. There is a lack of stability in management and direction. I think it’s showing up in the fact the company’s revenues are flat from where they were a year ago, and they were down in three of the quarters in the interim period.

The core businesses did not grow during the first quarter. The average earning assets were down slightly. Net interest income was down, and they took a big chunk out of reserves to ease that blow. And if you took the capital gain and trading out from “other income,” it doesn’t look like the non-interest-income businesses did very well. Those businesses only cut their cost by about 1 percent. There’s no compelling reason to sell or to buy the company, thus I’ve got a non-entity-hold rating on it.

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Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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