EUR 850.00 For Business Accounts Only

Morningstar | Without Tradeweb Gain, Revenue Growth Remains Challenging for Citigroup, Now Factoring in Rate Cuts

Narrow-moat rated Citigroup reported OK second-quarter results, which were boosted by a pretax gain of $350 million from the bank’s ownership in Tradeweb (which recently became public). Net income came in at $4.8 billion, or $1.95 per share, on $18.76 billion of revenue. Revenue growth of 2%, along with a decline in operating expenses of 2% led to growth in earnings before taxes of 4%. A lower tax rate helped drive net income growth of 7%, while share repurchases brought EPS growth to 20%.

In our view, results were mixed. Citi is meeting many of the goals it set out in its 2017 investor day; however, the bank is also dragging on others. We think a combination of several rate cuts and pressure within more market-sensitive revenue areas could cause Citi to miss some of its medium-term goals, but overall we recognize that many of these factors are market related and are not completely under Citigroup’s control. We still believe that the business is heading in the right direction. After updating our models, we are now projecting three rate cuts between now and the end of 2020, and we have updated our fair value estimate to $80 per share from $83. We still view shares of Citi as relatively attractive compared with our overall banking coverage but recognize the banking sector is in a tough spot given the current macro backdrop.

On the bright side, Citigroup reduced its average diluted shares by 10% year over year and received approval to return another $21.5 billion in capital to shareholders over the next four quarters. We calculate that the bank can likely repurchase another 9%-10% of its share base during this time. Citi is also managing its expenses well, with expenses down for the bank in the quarter, and operating leverage occurring in all segments. We would also highlight that Citi appears to be one of the less interest rate sensitive names among our coverage, with management guiding that a single rate cut would equate to roughly $50 million in lost net interest income per quarter. On the negative side, revenue growth of the Institutional Clients Group (ICG) has been tough to come by, and management did admit that if too many of these cyclical items begin to go against the firm, it would make hitting the bank’s targets that much tougher, adding some unpredictability to the final results. With potentially multiple rate cuts coming, continued pressure on the bank’s ICG group, and slower growth in Mexico and Asia, we think we may be approaching the point of “too much to overcome.” We are already modeling in Citigroup missing many of its 2020 goals but note that the current market price of the stock implies even more pessimism. Growth may remain an issue, but the improvements in profitability are a welcome development for a franchise that has historically struggled here, and the bank still has its expense and capital levers to pull to offset some of its growth headwinds.

Citigroup’s return on tangible common equity was 11.9% for the quarter, again largely meeting management’s goal of a 12% return on tangible common equity in 2019. However, we will point out that, ex the gain from Tradeweb, the ROTCE was closer to 11.1% by our calculations. Most of the pressure is coming from ICG, where revenue was down roughly 4% without the gain from Tradeweb. Investment banking, equity, and fixed income revenue were all under pressure. Treasury & Trade Solutions revenue were up 7% on a constant dollar basis, which we view as a bright spot for the bank considering this is a core offering for the bank’s main client base and often leads to broader relationships. Given trade and supply chain uncertainties, Citi may be in a better position to benefit as international clients are forced to make adjustments and enlist the bank in the process.

The Global Consumer Banking unit had a decent quarter, with revenue up 4%, in line with the bank’s growth goals. Net income was up 11%, as some growth returned to Asia, while solid expense control helped margins expand. North America GCB had a very encouraging trend of improving interest bearing balances within the branded cards portfolio, supporting Citi’s initial strategy of having a period of promotional balances with zero interest charged. Average branded cards balances were up 2%, while purchase sales were up 8%. Overall, we like where GCB is headed but note that growth in Asia and Latin America continues to be a bit below management’s original expectations from 2017.

Credit costs did begin to normalize a bit, up 15% year over year; however, most credit metrics remain relatively stable, with the increase in costs being largely driven by expected seasoning and growth within the bank’s cards portfolios. Costs here are coming in on the higher end of management’s previous guidance, but it expects card-related net credit losses to be proportionally down in the second half of the year, keeping credit costs within the expected range.