Citigroup Inc. (C, Financial) is set to release its third-quarter earnings report on Oct. 13. The consensus on the street is the American banking giant will deliver an earnings per share figure of $1.23 and revenue of $19.23 billion.
Although estimates of the bank's earnings are available, the volatility embedded in today's bond market dictates the fundamentals of banking companies such as Citigroup be frequently revisited to ensure accurate portfolio monitoring.
Let's traverse into a deeper analysis of Citigroup's recent events to determine whether its third-quarter earnings report will align with estimates.
Affirming past results
Combining recent events within the bond market with Citigroup's second-quarter results provides critical insights.
First, to set a foundation, let's run through the bank's second-quarter numbers.
Source: Citigroup
During the three months ended June 30, Citigroup achieved $19.4 billion in revenue and delivered earnings per share worth $1.33. Although profitable, Citigroup's net income shrunk by 36% year over year, reminding investors of the headwinds embedded within the bond market.
Most of Citigroup's second-quarter headwinds stemmed from input costs as rising funding costs, enhanced focus on risk analysis and continued restructurings proved cataclysmic.
The company's $500 million quarter-over-quarter increase in cost of credit illustrates its enhanced funding costs. Fundamentally, most of the cost pressure stems from resilient interest rates and credit risk, which resulted in elevated implied borrowing costs.
Further, Citigroup's quarterly operating expenses surged by 9% year over year. Most of its rising costs derived from enhanced risk control budgets, restructuring charges and severances. Trivially speaking, risk budgeting costs can only be expected to subside once the bond market stabilizes. Moreover, Citigroup's ongoing restructuring into wealth management and out of retail banking is cumbersome, meaning sustained cost pressures are likely.
Outlook
Interpolating Citigroup's past results with the bond market provides a few interesting talking points.
As a starting point, it has to be pointed out the U.S. yield curve, swaps market and credit curve experienced significant changes in the past months. For example, the U.S. yield curve notched up again, raising short-term funding costs for banks. However, the curve also steepened toward the longer end, providing Citigroup with opportunities to enhance income on its long-term-orientated debt portfolio by collecting higher coupons from variable interest instruments and by rolling down the yield curve with new positions in longer-dated bonds.
Source: Citigroup
Further, the swaps market and credit curve both experienced changes in the past few months. As illustrated in the following diagrams, the swaps market's overnight funding rates have increased in the past month, adding more pressure to Citigroup's funding costs. However, credit risk on high-grade debt has dissipated since the bank's latest earnings report, meaning its asset base likely experienced significant support from a valuation point of view.
Source: Chatham Financial (SOFR)
Source: MacroMicro (U.S. AAA Credit Risk)
Despite lower credit spreads, it seems like the yield curve and the swaps market pose significant threats to Citigroup's third-quarter results. However, the bank possesses robust Basel III metrics, implying best-in-class liquidity. Banking investors often emphasize liquidity, meaning temporary earnings headwinds might be phased out as long as Citi's Basel III metrics remain solid.
Source: Citigroup
Quantitative earnings metrics
Accrual versus cash-based earnings recognition means parsimonious quantitative earnings metrics speak volumes in modern capital markets analysis.
One such metric is the Beneish M-Score, a measure of the aggressiveness of a company's earnings recognition policy. The basic idea is an M-Score below -1.78 shows a company's recent earnings release followed conservative procedures, phasing out the risk of an accruals-based event and deterring the organic financial results of the reporting entity.
Fortunately, Citigroup's Beneish M-score reads well at -1.79, suggesting an unwanted accruals-based event is unlikely to occur.
Another factor to consider is earnings momentum, a simplified yet effective way of inferring whether a company will likely beat its prospective earnings estimates.
According to past data, Citigroup has a 50% year-over-year win rate, suggesting no clear trajectory regarding earnings momentum. In my view, the inconsistency of the company's past earnings releases might result in a volatile environment for its stock, which investors should be aware of.
China consumer wealth portfolio sale
A drift away from parsimony and looking into recent idiosyncratic events shows Citigroup's third-quarter statements might reveal a material occurrence.
The bank revealed earlier this week it is in the process of selling $3.6 billion worth of its Chinese consumer wealth portfolio to HSBC.
The move forms part of Citigroup's pivot out of consumer banking and into a wealth management-centric model, and an official statement from the company read: "We are taking important steps forward in exiting our consumer banking business in China and continue to make progress in our divestitures as part of our strategy to simplify Citi. This is an excellent outcome for our local consumer wealth colleagues and clients in China."
The bank believes the transaction will conclude in early 2024. Although the sale adds liquidity to Citigroup's balance sheet, it remains to be seen whether the reallocation thereof will yield superior returns.
Valuation and dividends
Stock market participants often emphasize price-book ratios when judging banking stocks. Methodologically, a bank's net asset base fairly reflects its fair value as most of its assets are quoted and liquid.
Cyclical data implies Citigroup's price-book ratio is on the lower end of the scale, suggesting an argument for relative value exists. A deeper analysis is required to consolidate the argument; however, an overview implies the stock is likely undervalued.
Furthermore, Citigroup's salient dividend metrics suggest the stock is a solid income-generating investment. For instance, Citigroup's 5-year dividend yield on cost of 9.91% and continuous share buybacks illustrate the ability of the stock to reduce an investor's cost basis in the long term.
Final word
Various observations suggest Citigroup's third-quarter earnings report could provide a few surprises.
The credit spread environment and funding costs are tangled. Further, the bank's recent disposition of its Chinese consumer banking portfolio adds liquidity to its balance sheet; however, it remains to be seen how productive the reallocation of capital will be.
Lastly, key metrics suggest Citigroup's stock has total return potential. Nevertheless, unfavorable catalysts might result in the stock being a value trap.
