Citigroup Inc. — Second-Quarter 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Citigroup is a global bank, reporting Global Consumer Banking (GCB), Institutional Clients Group (ICG), and Corporate/Other. Comparisons below are with the second quarter or first half of 2016, as applicable.
Financial performance and position
- Second-quarter earnings: Revenue was $17.9 billion, up 2%; net income was $3.9 billion, down 3%; diluted EPS was $1.28, up 3%, helped by a 6% reduction in average shares. Income from continuing operations was $3.883 billion. The effective tax rate was 31.6%, versus 29.9% a year earlier.
- First-half earnings: Revenue was $36.0 billion, up 3%; net income was $8.0 billion, up 6%; diluted EPS was $2.63, up 12%.
- Costs and margins: Second-quarter operating expenses were $10.5 billion, up 1%, and the efficiency ratio was 59%, unchanged. Provisions for credit losses and benefits and claims were $1.7 billion, up 22%. Net interest revenue was $11.2 billion, down 1%; net interest margin was 2.72% on a taxable-equivalent basis, down 14 basis points.
- Business results: GCB revenue rose 5% to $8.0 billion, while net income fell 12% to $1.1 billion as credit costs and expenses increased. ICG revenue rose 6% to $9.2 billion and net income rose 6% to $2.8 billion; stronger Banking revenue was partly offset by lower Markets and securities services revenue. Corporate/Other revenue declined 45% to $653 million, with a $15 million net loss, amid legacy-asset run-off.
- Balance sheet: At June 30, total assets were $1.864 trillion, deposits $958.7 billion, loans net of allowance $632.7 billion, and long-term debt $225.2 billion. Year over year, assets, deposits and end-of-period loans each increased about 2%; long-term debt increased 9%. Book value per common share was $77.36 and tangible book value per share was $67.32.
- Capital and liquidity: Fully implemented Basel III CET1 and Tier 1 ratios were 13.1% and 14.7%; the supplementary leverage ratio was 7.2%. Average high-quality liquid assets were $424.4 billion and average LCR was 125%, versus 121% a year earlier. Citi reported it exceeded applicable capital minimums and was well capitalized.
- Cash flows, first half: Operating activities used $21.5 billion, investing activities used $39.8 billion, and financing activities provided $58.9 billion. Cash and due from banks ended at $20.9 billion. These cash-flow movements reflect banking and trading balance-sheet activity and should not be read as a conventional industrial-company free-cash-flow measure.
Material changes versus comparable periods
- Higher credit costs, expenses and taxes contributed to the quarterly net-income decline despite revenue growth. EPS rose because average shares outstanding fell.
- Consumer net credit losses increased 11% year over year to $1.6 billion, primarily reflecting the Costco card portfolio, portfolio growth and seasoning, and changes in North American card collections processes. Corporate net credit losses declined 45% to $77 million, with improvement in energy exposures.
- ICG Banking revenue increased 19%, including a more favorable loan-hedge mark-to-market comparison; excluding loan-hedge gains and losses, Banking revenue rose 13%. Markets and securities services revenue fell 5%, amid low volatility and comparison with prior-year Brexit-related activity.
- Corporate/Other assets declined 21% year over year to $92 billion as Citi continued to wind down legacy assets. First-half Corporate/Other revenue included about $750 million of asset-sale gains, partly offset by a roughly $300 million charge related to exiting U.S. mortgage servicing; related episodic expenses were also reported.
- First-half net income benefited from ICG growth and lower credit costs, while the prior-year comparison included a $404 million gain from the 2016 Primerica coinsurance novation. Segment presentation was realigned in 2017; prior periods were reclassified, with consolidated results unchanged.
Outlook, commentary, risks and unusual items
- Management described the quarter as solid, citing momentum in consumer and institutional businesses and continued investment. Citi expects consumer cost of credit to rise near term with volume growth; it also expects Corporate/Other credit costs to be moderately higher as they normalize.
- Management expects North American mortgage revenue to remain pressured during the rest of 2017 by higher rates and the mortgage servicing rights sale. Branded-card revenue may face continued headwinds from non-core portfolio run-off. ICG Markets revenue is expected to remain sensitive to market conditions, including low volatility, interest-rate uncertainty and tax-reform uncertainty.
- Following no objection to Citi’s 2017 CCAR capital plan, Citi announced plans to return $18.9 billion to common shareholders over the next four quarters beginning in Q3 2017, including a $15.6 billion repurchase program and a planned quarterly common dividend of $0.32 per share, subject to Board approval.
- At June 30, net deferred tax assets were approximately $45.8 billion; Citi used about $900 million of DTAs in the first half. Management identified potential tax-law changes and DTA utilization as risks to earnings and regulatory capital. Citi estimated CECL adoption could increase credit reserves by approximately 10%–20%, subject to economic conditions and implementation uncertainties; adoption was scheduled for January 1, 2020.
- Key risks include economic and geopolitical uncertainty, Brexit-related effects, regulatory and capital-rule changes, market volatility, credit deterioration, funding or rating pressure, cybersecurity and operational risks, and litigation and regulatory proceedings. Management estimated reasonably possible unaccrued losses for disclosed matters of up to approximately $1.5 billion in aggregate; outcomes could differ materially. A May 2017 DOJ settlement of remaining Bank Secrecy Act/anti-money-laundering inquiries included a non-prosecution agreement and approximately $97 million forfeiture.
- Unusual and other notable items include early adoption of an accounting update that reduced opening 2017 equity by $156 million after tax; the U.S. mortgage-servicing exit and related sale loss and costs; completed sale of CitiFinancial Canada, which generated a $350 million pretax gain; and a pending sale of the Yield Book and index businesses, expected to close in the second half of 2017 subject to conditions.
Important facts for investors to verify
- Whether card-credit performance and reserve builds—particularly in North American cards—remain consistent with management’s expectations as portfolios season.
- Whether announced capital returns are completed as planned and whether the $0.32 quarterly dividend receives Board approval.
- How recurring earnings perform after separating asset-sale gains, mortgage-servicing exit charges, loan-hedge marks and other unusual or legacy items.
- Whether liquidity, capital ratios and funding costs remain resilient as assets, deposits and debt change, and under potential rating downgrades or market stress.
- How tax reform and CECL implementation affect the value of DTAs, regulatory capital and credit reserves.
- Developments in the disclosed litigation and regulatory matters, including the estimated unaccrued-loss range and the pending Yield Book/index sale.