As those of you who follow the financial markets are well aware, bank stocks fell sharply from mid-2007 to early 2009, as a result of the 2007-2009 worldwide economic recession and the devastating downturn that occurred in the U.S. housing market during that period. Bank stocks then moved in a volatile sideways pattern over the past two-and-a-half years, as most investors avoided stocks of financial companies.
Although most individual investors have continued to shun bank stocks, numerous factors and developments suggest that now is a good time to invest in such stocks, especially in the stocks of banks that have made substantial improvements to their capital base and operating structure and that have implemented measures to increase their earnings. One such bank is Citigroup (C).
In addition to raising large sums of money during 2008 and 2009, Citigroup made substantial reductions to the size of its worldwide workforce over the past few years and it sold superfluous assets, divested unprofitable divisions, and restructured its operations.
For example, during 2008 Citicorp raised $45 billion from the U.S. government, in exchange for preferred stock and warrants to purchase common stock that it issued to the government. It also entered into a loss-sharing agreement with various U.S. government entities that covered $301 billion of the bank’s assets. In addition, Citigroup raised $32 billion in private and public offerings during 2008.
During that same year, Citigroup completed 19 strategic divestitures in an effort to reduce its operating costs and to improve its financial condition. In addition, the company during 2008 reduced the size of its workforce by 52,000.
Of substantial importance, during 2008 Citigroup reclassified certain of its assets to a held-to-maturity classification, from a mark-to-market classification, which enabled the company to reduce the volatility in its reported earnings.
During 2009, Citigroup continued to improve its capital base by exchanging approximately $27.5 billion of its preferred stock for the issuance of common stock. In addition, the company repaid $20 billion of trust preferred securities that were held by the U.S. Treasury under the U.S. government’s Troubled Asset Relief Program (TARP) and it exited from its loss-sharing agreement, which covered a specified pool of assets, with U.S. government agencies.
Meanwhile, the company completed 18 divestitures during 2009, including its sale of Smith Barney, Nikko Cordial Securities, and Nikko Asset Management, with the goal of exiting non-core businesses and improving the company’s financial operating results.
Citigroup also continued to reduce the size of its worldwide workforce during 2009, eliminating 57,000 jobs during that year.
In an effort to focus on its core businesses, Citigroup restructured its operations during 2009 into two primary business segments: Citicorp and Citi Holdings. The Citicorp division now conducts the company’s retail and commercial banking activities, as well its institutional investment banking and institutional money management businesses, while the Citi Holdings division operates the company’s retail brokerage and asset management business and conducts the company’s retail lending activities.
As a result of the operational changes that Citigroup implemented during 2008 and 2009, the company’s operating expenses declined by $10.9 billion over the two-year period ended Dec. 31, 2009.
Separately, the company improved its financial condition substantially over that two-year period, with its Tier 1 Capital Ratio rising to 11.7 percent during the year ended Dec. 31, 2009, from 7.1 percent at the end of 2007. That’s a substantial improvement, considering the fact that U.S. bank regulators require commercial banks to have a Tier 1 Capital Ratio of just 4 percent.
Those same regulators consider banks that have a Tier 1 capital ratio equal to or greater than 6 percent to be well-capitalized. Tier 1 Capital Ratios are computed by dividing a bank’s shareholders' equity by the bank’s primary assets, such as its total loans outstanding.
Citigroup also made substantial improvements to its short-term liquidity during that period by lengthening the maturity structure of its liabilities, increasing its balances of cash and highly liquid securities, and growing its deposit base, as well as by raising substantial amounts of equity capital. As a result of those improvements, the company’s structural liquidity, which is defined as deposits, long-term debt and equity as a percentage of a bank’s total assets, grew to 73 percent at the end of 2009 from 63 percent at the end of 2007.
During 2010, Citigroup continued to implement its turnaround plan, with an emphasis on growing and investing in its core Citicorp businesses and reducing its operations in the company’s Citi Holdings division.
As a result of the positive restructuring activities that Citigroup implemented during 2008 and 2009, the company returned to profitability during 2010, reporting a $10.6 billion net profit (35 cents per diluted share) for the year ended Dec. 31, 2010. That compares to losses of $6.39 and 76 cents per diluted share for the years ended Dec. 31, 2007 and Dec. 31, 2009, respectively.
Citigroup also continued to improve its Tier 1 Capital Ratio during 2010, with that ratio rising to 12.9 percent as of Dec. 31, 2010, from 11.7 percent during the prior year.
With limited exposure to the problematic European debt situation, and the company expecting to lose substantially less money this year on its non-performing loans — loans that Citigroup made to its customers that are not repaid — Citigroup expects to grow its earnings per diluted share to approximately $3.89 for the year ending Dec. 31, 2011, from $3.50 for the year ended Dec. 31, 2010.
Looking forward, I expect Citigroup to continue to increase its earnings during the year ahead, as my research indicates that economic conditions in most regions of the world will improve and that the pace of worldwide economic growth will accelerate during 2012.
With Citigroup’s stock currently trading at a low level in relation to the company’s expected three- to five-year growth rate, my research indicates that now is a good time to establish a position in this stock.
Note: The author of this article owns shares of Citigroup.
About the Author: David Frazier
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