Citigroup’s quarterly report, out on Tuesday, followed the playbook set by giant rival JPMorgan last week: a searing tax-related smack which investors shrug off, so long as long-term advantages from the new Tax Cuts and Jobs Act are confirmed.
Nothing to see here
Citi profits also outpaced Wall St forecasts—if the one-time $19bn impairment from revised tax benefits is overlooked. These had to change because a tax break designed to avoid double taxation is no longer available to Citi. It is also bringing money onshore in the wake of new rules that allow cash stashed overseas to be repatriated at a less punishing rate. But the pay-off in Citi’s case cost it another $3bn in Q4. All in, Citi’s $22bn taxation hit dragged earnings per share $7.15 into the red. On an adjusted basis, the result was a $1.28 EPS rise, well above $1.19 widely expected.
Knock-on effects from hastily retooled tax arrangements included a dent to the group’s closely watched regulatory capital. But tax impacts only equated to 40 basis points of the reduction. The rest of the slide in its key Common Equity Tier 1 ratio—to 12.3% vs. 13%—was linked to non-tax effects. That helps explain why Citigroup’s optimistic share price surge of almost 3% in pre-opening business translated to a gain of just a few cents at the time of writing. Citigroup had after all a quarter much in keeping with the rest of rather stolid year in big banking. The bank’s Institutional Clients Group, comprising investment banking and trading fell 1%, as persistent low volatility across market again took its toll. With rivals seeing similar softness however, investors look to differentiate less on the basis of trading revenues.
Equity trading perks up
Citi didn’t miss out on firmer equity markets over the quarter which also buffered JPMorgan’s stock trading business. Like JPM, Citi saw a reported decline in bond and stock markets. The latter decline, however, was due to a single client’s losses. The client is likely to be the same one that JPMorgan was exposed to, beleaguered South African retailer Steinhoff. The group’s collapse resulted in JPM’s equity revenue sliding in Q4 as well.
Some of the support for Citi’s earnings came from a $400m reduction in operating expenses, helping edge underlying profits up 4% on the year. Investors seemed to reassess that win later though, regardless of its Global Consumer Banking business revenue rising 5.6%. The division accounted for half of Citi’s total revenue, helping offset weak market and leaving a slightly better than expected total of $17.26bn.
The overall better tone of the quarter and year helped Citi dump its ‘also ran’ tag among the U.S. bulge-bracket. That is reflected in Citi shares’ almost 30% rise over a year, in line with larger rival JPMorgan. Because Citi earns half its profits overseas where tax is already lower than in the States, hoped for advantages from revamped tax laws are commonly forecast to be lower. But a fair quarter will do its stock no harm. Nor will the 5 percentage point reduction it expects to its tax rate. This should enable the bank to keep matching the unspectacular pace of rivals’ improving returns.
Cost savings boosted
another two thirds of a percentage point.
The snag with Citigroup's C.N decade-long climb back from the financial brink is that it's largely driven by forces boss Mike Corbat doesn't control. Changes to the U.S. tax regime show that's sometimes a good thing.
Tax cuts just left Citi with a big loss, and a bigger opportunity. The $203 billion U.S. lender took an $22 billion charge in the last quarter of 2017 as it wrote down deferred tax assets – credits against future tax bills – and took a hit for deemed repatriation of overseas earnings. That left it deep in the red. But its new corporate tax rate of an effective 25 percent will hike earnings in future. If it had been in effect in the period, the 9.6 percent return on tangible common equity Corbat just reported for the year would have risen to above 10 percent – already beating his target for 2018, and suggesting he can get more ambitious.
Beyond that, the impact of tax cuts gets less clear, but probably still helpful. If consumers and small businesses feel richer, as rival JPMorgan JPM.N said last week it expects they will, it should benefit a company like Citi that makes roughly one-quarter of its revenue from credit cards. Corbat warned last year that the cost of writing down unrecoverable loans was going to rise a little more than expected – and credit losses on its North American own-brand card business rose 10 percent in the quarter. More cash flow for households may keep that in check, and it might actually encourage more borrowing.
Where Corbat can steer Citi directly, he is doing so. Expenses fell to 58 percent of revenue, compared with 59 percent a year ago. Investment banking was more mixed: revenue from fixed-income trading, where Citi is heavily exposed to flaccid rate and currency movements, plunged by almost one-fifth. Yet the bank is taking more advisory fees. Its share of the overall pot rose a little to 4.8 percent in 2017, according to Thomson Reuters data.
Citi is still a passenger in some important ways – rate setters will decide what happens to the yield on its $1.8 trillion of assets, while regulators must still sign off on future cash returns to shareholders. And of course, some of what's saved in tax will go to staff and customers, but then that's the case for other banks too. Citi was for a long time the only big U.S. lender with a market value below the book value of its equity. Whether through its own doing or not, it can now leave that sorry label behind.
StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.