Citigroup Inc. (NYSE:C) is the third largest bank in the US and also has an extensive global presence. It was also the only large cap bank that failed the stress test in 2012. Owing to this and other reasons, the board at Citigroup appointed a new CEO with hopes that the bank will be able to address all of its outstanding issues. Unfortunately, the situation has not improved much since then and I see headwinds for the bank in the coming future.
Is it back on track?
Multiple factors lead to the resignation of former Citigroup CEO Vikram Pandit and the appointment of Michael Corbat. The board and the bank’s investors hoped that the new management would get the bank back on track and that Citigroup would be able to pass the 2013 stress test.
While the bank did pass the most recent stress test, it is still far from coming back on the track. The near future is filled with headwinds for Citigroup. Let’s see how some of the headwinds might affect the bank’s performance.
Competitive edge turning into a disadvantage
Over a third of Citigroup Inc. (NYSE:C)’s earnings come from outside the US. It has the most extensive global footprint among the US large cap banks. In the past, when the US macroeconomic and loans growth was sluggish, Citigroup’s extensive global footprint lead it to report growth in its lending activities. However, now this competitive edge has turned against the bank.
The extensive international presence has led the bank to be exposed to tremendous foreign exchange currency translation risk. Due to this risk, the bank is estimated to lose nearly as much as $1.5 billion, which is 1% of its tangible book value. Since financial stocks trade in proximity to their book values, this could mean a direct depreciation in the company’s stock price.
Other estimates place this figure as high as $7 billion if the dollar gains against euro or other currencies in the emerging markets. If this happens, this could be the worst currency loss for Citigroup is nearly five years. Talks of a quantitative easing unwinding have led the dollar to gain against euro recently, so Citigroup is bound to report currency translation losses this quarter.
The prior year’s estimates put this loss within the range of $3 billion to $5 billion, against which the bank reported a loss of $1.6 billion.
The woes don’t stop here
It seems that Citigroup Inc. (NYSE:C)’s woes don’t end at the translation risk of foreign currency. The bank is also forecasted to report a loss in its book value due to the prevailing higher interest rates environment.
According to estimates by analysts at Credit Suisse, the bank might report a book value decline of around 0.8% this quarter. This is against expectations of 1.1% growth in JPMorgan Chase & Co. (NYSE:JPM)’s book value and 0.2% growth in U.S. Bancorp (NYSE:USB)’s book value.
How the competition is dealing with rising rates
JPMorgan Chase and US Bancorp have the second and third largest market shares in the US home lending markets respectively. The management at both of these banks have confirmed that higher mortgage rates during the current quarter will to increase their revenues.
US Bancorp’s CFO was reported saying that investors should expect higher originations during the current quarter despite higher mortgage rates. He explained that the lag between the time a mortgage application is received and the time the mortgage is closed will lead the bank to report higher originations and the resultant higher mortgage banking revenues. Analysts at Citigroup expect the bank to report a moderate 1.5% growth in its mortgage banking revenues, while US Bancorp is expected to benefit from its relatively large payments business which might surge up to 7% over the prior quarter.
JPMorgan’s CEO told investors should expect additional $5 billion in revenues if the 10-year Treasury yields climb 300 basis points, while this figure would still be a positive $2 billion if the yield increased 100 basis points. With regard to the company’s capital position, however, JPMorgan’s shareholder distributions could be threatened by a hike in the simple leverage ratio required by banks. The stock currently yields 2.8% on its quarterly dividend of $0.38 per common share. If regulators decide to double the simple leverage ratio requirement to 6%, you should expect the bank to suspend its dividends for up to 5 years in an attempt to hold on to more capital.
A way out for Citi
I believe the best way out for Citigroup Inc. (NYSE:C) is to concentrate on business that are making it money and divest from businesses that are losing money. In an attempt to cut costs, the bank’s management has decided to exit from as many as 21 emerging markets where the costs overshadowed benefits. These countries produce less than 10% of the bank’s revenues while offering a return on asset of only 0.4%.
Conclusion
While the third largest bank by assets received new management, the woes for Citigroup Inc. (NYSE:C) did not end yet. The bank’s competitive edge has turned against it, causing it to report as much as $1.5 billion in losses from foreign currency translation risk. Additionally, the design, structure and duration of the bank’s available for sales securities will lead the bank to report a book value decline of 0.8%. In my opinion, the best way out for the bank is to reduce its costs and focus on businesses that are efficient.
The article All Is Not Well for Citigroup originally appeared on Fool.com and is written by Adnan Khan.
Adnan Khan has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup Inc (NYSE:C) and JPMorgan Chase & Co (NYSE:JPM). Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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