Why we're lowering our price estimate for Citigroup
Write-offs in sovereign debt holdings are expected to continue over subsequent quarters, driving down trading margins
Citigroup's (C) shares are currently trading well below $30 -- lows unseen by the global financial group since the peak of the global economic crisis in early 2009. We believe that this significantly depressed price mirrors the extremely pessimistic market sentiment towards banks in particular.
Although weak global economic conditions -- primarily the escalating debt situation in Europe -- a string of lawsuits continue to present downside risks to the bank's value, we believe that the low price for Citigroup's shares is unwarranted.
We have updated our price estimate for Citi's stock from $40 to $35 and detail below the reasons for this 12.5% reduction in our estimate, which are similar to our recent updates for JPMorgan Chase (JPM) and Bank of America (BAC).
Sales & Trading Revenues to Stay Low in Near Term
The extreme volatility in capital markets across the globe has seen almost all major banks reporting negative operational revenues from their sales & trading unit last quarter. As the market it expected to remain unstable well into next year, yields for Citi's trading operations over our forecast period are expected to be lower than what we estimated earlier.
Moreover, banks have also had to suffer write-offs to their trading asset base over recent quarters. Citigroup has already incurred credit losses of $424 million over the first three quarters of the year for its institutional securities business. Write-offs in sovereign debt holdings are expected to continue over subsequent quarters, driving down trading margins.
Consumer Banking Business to Bear Brunt of Mortgage Misgivings
We have introduced additional information in our analysis for Citigroup to accurately capture the impact of loan provisions made by its consumer banking unit on its overall value. As the consumer banking business includes the various types of loans given out by the bank, including mortgages, the new driver allows better understanding of how changes in provisions affect our price estimate.
As seen in the chart above, provisions as a percentage of consumer banking assets were at their peak in 2009, and have seen a reduction since then. But concerns about the quality of Citi's loan portfolio – primarily linked to real estate – still exist, and they will keep provision numbers elevated for some time to come.
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