## Citigroup’s Earnings Signal Trouble for the Banking Sector: Credit Losses, Regulatory Concerns, and a Lagging ROTCE
The recent earnings season has brought into sharp focus the health of the financial sector, particularly the performance of banking stocks. Investors are keenly watching both commercial banks, which reflect the broader economic landscape, and investment banks, which are more closely tied to consumer spending. Citigroup Inc. (C) has become the latest victim of this scrutiny, with its stock falling over 5% in the wake of its latest earnings report.
While Citigroup’s revenue and fee income weren’t the primary culprits behind the stock’s decline, the bank’s performance highlighted two critical concerns: rising credit losses and increasing regulatory pressure. These issues, far from being unique to Citigroup, are casting a shadow over the entire industry.
### The Looming Threat of Consumer Sector Weakness
Credit losses and delinquency rates are on the rise, a trend that has been gaining momentum in recent quarters. This signals a weakening consumer sector, explaining the recent struggles of consumer discretionary stocks like Nike Inc. (NKE) and Lululemon Athletica Inc. (LULU), both trading significantly below their 52-week highs.
Citigroup’s earnings report showcased this trend in a stark way. The bank reported a $2.7 billion credit loss, primarily attributed to losses in its credit card business. This isn’t an isolated incident; peers like Bank of America Co. (BAC) have also reported similar deteriorations in their credit card businesses. Even corporate banks like Goldman Sachs Group Inc. (GS) have chosen to exit the consumer segment, as evidenced by their decision to abandon their consumer products initiative with Apple Inc. (AAPL) and their credit card collaboration.
The rising 90-day delinquency rate for Citigroup’s credit cards, now at 1.5% compared to 1.3% a decade ago, further fuels concerns about the health of the U.S. consumer. While this alone might not justify the 5% stock drop, the next factor adds significant weight to the bearish sentiment.
### Regulatory Concerns and Faltering Profits Weigh on Citigroup
Citigroup’s CEO, Jane Fraser, faced tough questions from analysts during the earnings call, particularly concerning the possibility of an “asset cap.” This concern stemmed from the recent imposition of an asset cap on another bank found guilty of wrongdoing. While Citigroup isn’t facing similar allegations, analysts are rightly concerned about the potential spillover effects of regulatory action.
Adding fuel to these fears is Citigroup’s declining profitability, specifically its return on tangible common equity (ROTCE). The bank’s ROTCE fell to a meager 7%, a far cry from the near-double returns achieved by its peers. Bank of America, for example, reported a significantly higher ROTCE of 12.8% on the same day.
This decline raises serious questions about Citigroup’s management’s ability to effectively invest the bank’s capital and deliver industry-attractive returns. This translates into concerns about the bank’s future earnings per share (EPS), with a 7% decline in EPS further bolstering the bearish momentum.
### A Look at the Market’s Sentiment
Short sellers are clearly sensing potential downside risk, with Citigroup’s short interest rising from $1.5 billion to over $2.2 billion in the past quarter. The broader market echoes this sentiment, with Citigroup’s valuation multiples reflecting a discount compared to the rest of the finance sector. Citigroup’s price-to-earnings (P/E) ratio currently sits at 18.5x, a substantial discount to the sector’s average valuation of 49.5x. Markets typically discount stocks when they anticipate lower growth or declining prices, a logical reaction given Citigroup’s lagging performance on key profitability metrics and its recent price action.
The recent decline in Citigroup’s stock serves as a stark reminder of the challenges facing the banking sector. Rising credit losses, heightened regulatory scrutiny, and a disappointing ROTCE are all red flags for investors, suggesting that the industry’s future growth may be more precarious than previously thought.