In fact, year-to-date the bank’s revenue and EPS are down 8%, and 17%, respectively. That’s despite a 4% reduction in expenses and a solid 4% reduction in share count, courtesy of the bank’s aggressive buyback program.
The declining earnings are mainly a result of Citigroup’s net interest margin, the spread between its borrowing and lending costs, being under pressure by continued low interest rates.
Now there is good news for Citigroup on this front. Should interest rates rise by even 1% in the US, Citigroup’s net income would rise by $1.4 billion, or roughly 10% compared to the last 12 months (according to the company’s 10-Q).
Since the Federal Reserve expects interest rates to rise by 2.75% over the next four years, Citigroup could potentially be looking at a 27% boost to its bottom line. And that’s not even counting further cost reductions or share buybacks.
This potential to profit from rising interest rates, as well as its strong presence in developing markets such as Asia and Latin America, means that Citigroup has a potentially bright future ahead of it. That assumes, of course, that management’s new conservative, “whatever you do, don’t blow up the bank” mentality seeps into its entire corporate culture.
Given that management has been so good over the years at focusing on long-term growth, as seen by its impressive ability to grow tangible book value per share (up 7.7% year-over-year in the last quarter) despite falling sales and earnings, Citigroup’s corporate culture has indeed shown progress.
Key Risks
While Citigroup has managed impressive improvement since the bank was nearly destroyed during the financial crisis (unlike Wells Fargo or JPMorgan Chase which still made billions in profits thanks to their more conservative banking cultures), investors need to keep in mind that Citigroup remains the lowest quality and most speculative of America’s megabanks. Specifically, there are four major risks to keep in mind.
First, thanks to Citigroup’s large investment banking arm, Citigroup has the second highest exposure to derivatives of any bank, according to the Office of the Comptroller of the Currency.
Now, understand that, while the CDOs (credit default swaps) that ultimately turned a downturn in the US housing market into a global financial meltdown are one kind of derivative, not all derivatives are equally dangerous.
Derivatives are merely a “financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity, credit, and equity prices.”
Most derivatives, such as options and interest rate swaps (what makes up the majority of bank derivative holdings), are designed to hedge against abrupt changes in important economic metrics (such as interest rates) and smooth out a bank’s cash flows. The global market for derivatives is enormous, over $2.5 quadrillion dollars (34.25 times the size of the world economy in 2015).
