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Citigroup Inc.’s (C - Analyst Report) fourth-quarter 2011 earnings per share of 38 cents missed the Zacks Consensus Estimate of 50 cents. The company’s earnings per share also deteriorated from the prior quarter’s $1.23 and year-ago quarter's 40 cents.

For full year 2011, Citigroup’s earnings came in at $3.66 per share. This also fell short of the Zacks Consensus Estimate of $3.83 per share. Yet, the results improved from $3.55 earned in the prior year.

With the weakness in the economy as a whole and fundamental stress on the banking sector in particular, top-line headwind continued at Citigroup. Expenses also increased in the quarter. However, as expected, the negatives were partly offset by an improvement in credit quality and the company reported a drop in provisions for credit losses.

For the fourth quarter, Citigroup reported net income of $1.2 billion compared with $3.8 billion in the prior quarter and $1.3 billion in the prior-year quarter. However, full year net income of $11.3 billion compared favorably with $10.6 billion reported in the prior year.

Fourth quarter revenues came in at $17.2 billion, down 7% year over year. The revenue figure also fell short of the Zacks Consensus Estimate of $18.7 billion. Full year 2011 revenues were $78.4 billion, down 10% year-over-year and missed the Zacks Consensus Estimate of $79.8 billion.

With credit spreads tightening during the fourth quarter, Citigroup results included a loss of $40 million for credit valuation adjustment (CVA) and debt valuation adjustment (DVA),. Full year CVA/DVA in 2011 was $1.8 billion compared to a loss of $469 million in 2010. Excluding CVA/DVA, fourth quarter 2011 revenues were $17.2 billion, down 12% year-over-year while full year revenues were $76.5 billion, reflecting a drop of 12% from 2010.

However, it is encouraging to note that the fourth quarter total provisions for credit losses and benefits and claims at Citigroup plunged 41% year over year to $2.9 billion. The improvement was attributable to a 40% decline in net credit losses to $4.1 billion, coupled with a $1.5 billion release of credit reserves. For full year 2011, total provisions for credit losses and benefits and claims were down 51% year-over-year to $12.8 billion.

Quarter in Detail

At Citicorp, excluding CVA, revenues inched down 8% year over year to $14.1 billion. Lower revenues in Securities and Banking primarily pulled the figure down. However, the company reported a slight increase in Regional Consumer Banking (RCB) and Transaction Services revenues.

Revenues at Citi Holdings also plummeted 30% year-over-year at $2.8 billion and reflected the company’s continuing efforts to reduce this segment’s assets. On the other hand, higher revenues from hedging activities which was partly offset by reduced investment yields and lower gains on sales of AFS securities augmented Corporate/Other revenues $238 million year-over-year to $384 million.

Operating expenses at Citigroup ascended 4% year over year to $12.9 billion. The uptick was due to higher legal and related costs and repositioning charge. Moreover, the company experienced a $470 million increase in the provision for taxes primarily owing to the write-down in the value of Japanese deferred tax assets reflecting legislation in Japan that decreased the corporate income tax rate.

Credit Quality

Citigroup’s credit quality metrics improved in the quarter. Non-accrual assets of $11.8 billion decreased 44% from the prior-year quarter, reflecting a 62% decline in corporate non-accrual loans and a 26% drop in consumer non-accrual loans. Citigroup's total allowance for loan losses was $30.1 billion at quarter end, or 4.7% of total loans, down from $40.7 billion, or 6.31%, in the prior-year period.

Capital Ratios

Citigroup continued to improve its capital strength, with Tier 1 Common ratio improving to 11.8% from 11.7% in the prior quarter. Tier 1 Capital Ratio also ascended to 13.6% from 13.45% in the prior quarter.

Book Value per share moved up to $60.78 from $60.56 in the prior quarter and $56.15 in the year-ago quarter. Tangible Book Value per share increased to $49.81 from $49.50 in the prior quarter and $44.55 in the year-ago quarter.

At quarter end, Citigroup’s end of period assets was $1.87 trillion, down 2% year over year while deposits of $866.9 billion, were up 3% year over year. Citi Holdings’ assets declined 25% from the year-ago period to $269 billion at the end of the fourth quarter of 2011.

Our Take

Although Citigroup’s underlying franchises of the consumer businesses have remained strong, revenues have continuously been under pressure for the past several quarters. Considering the protracted economic recovery, top line is expected to remain suppressed in the upcoming quarters.

Though Citigrou’s strategy to shrink non-core assets would improve the valuation over time, the trimmed Citi Holdings portfolio would result in revenue challenges, partially restricting the upside potential of the stock.

While we believe that investments and efficiency savings will help in garnering a solid market share, volatile equity markets, weak loan demand, low liquidity and a tough regulatory environment remains our major concern.

With the thrust of new banking regulations, there will be pressure on fees and loan growth could remain feeble. Additionally, expenses are projected to increase, thus depressing its bottom-line figures.

There are increasing concerns related to the European economy. In addition, Citigroup has failed to significantly enhance shareholder value following the financial crisis and this somewhat weakened its competitive position.

Yet reduction in reserves for future losses and improved credit trends are expected to counter the negatives. At least in the short run, one can consider a company like Citigroup as a value investment given its global footprint and attractive core business. It is also among the best reserved banks.

Following the announcement of fourth quarter results, the stock is trading at a discount. Citigroup shares are maintaining a Zacks #3 Rank, which translates into a short-term Hold rating. However, considering the fundamentals, we have a Underperform recommendation on the stock.

Among Citigroup’s peers, JPMorgan Chase & Company (JPM - Analyst Report) came up with its fourth quarter earnings release last Friday. Similar to Citigroup, JPMorgan’s earnings per share of 90 cents marginally missed the Zacks Consensus Estimate of 92 cents. Results were worse than $1.12 earned in the prior-year quarter.

With a global footprint, Citigroup’s results give us a clue about the economic indicators and their trends and hence needs to be analyzed thoroughly. Following Citigroup, Goldman Sachs Group Inc. (GS - Analyst Report) will report on January 18 and Bank of America Corporation (BAC - Analyst Report) on January 19.

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