NEW YORK – After a rough few years plagued by scandals and settlements at Citigroup, recent data show robust investment banking operations poised to give the company's third-quarter earnings a boost.
Indeed, Citigroup (C) led all bookrunning managers in the third quarter with $127 billion in underwriting volume, compared with $89.3 billion for second-place J.P. Morgan Chase & Co. (JPM) , according to Thomson Financial.
Citigroup took top honors in several securities underwriting league tables this quarter including global debt, global equity and equity-related and U.S. investment grade.
Last week, Merrill Lynch raised its estimate for Citigroup's third-quarter earnings to $1.01 a share from 97 cents, citing better-than-expected equity underwriting and trading results.
Analysts polled by Thomson First Call expect Citigroup, on average, a 3% decline in earnings in third quarter to 98 cents a share. Lehman Brothers sees 3% growth year-over-year and 9% sequentially, excluding a gain and discontinued operations.
"We expect the positive impact of improvement in trading results, the resumption of positive operating leverage and an acceleration of share-repurchase activity to overshadow slow growth in North American cards and the continued adverse impact of a flattening yield curve," analyst Jason Goldberg said in a note to clients.
He predicted Citigroup would become more aggressive in its share-repurchase plan - citing the stock price -- especially given the money that became available from the sale of its Travelers Life & Annuity group and the swap of its brokerage and money manager Legg Mason.
The stock is off nearly 6% year-to-date. But that compares favorably with J.P. Morgan, off more than 14% year-to-date, and Bank of America (BAC) , down more than 10%.
However, Lehman Brothers (LEH) shares have increased in value by almost 28%, and Goldman Sachs' (GS) stock is up 14%. Morgan Stanley's (MWD) stock is down 3.6% in the same period. The S&P 500 (SPX) has declined 2%.
Ryan Caldwell, an assistant portfolio manager for Waddell & Reed's Asset Strategy fund (UNASX) , doesn't currently hold Citigroup shares, but his firm owns 1.5 million. He's been waiting for an opportunity to get back in for some time, and though he called the recent investment banking figures positive, it's not enough.
Citigroup has to "show us the ability to demonstrate positive operating leverage and revenue growth above and beyond the investment banking," Caldwell said. "The retail bank has to do something, which has been a drag, the credit card business is flattish, though internationally the retail side of the bank has been pretty good."
Citigroup also has to prove itself without the Travelers business and Legg Mason.
"If I just wanted capital exposure, I'd buy Goldman or Lehman," Caldwell said.
Looking ahead, Goldberg sees overseas growth as the biggest catalyst for earnings.
"The emerging middle class in developing countries is causing its potential customer base to expand," he said. "Citigroup has unique advantages that are difficult to replicate, which enable it to pursue opportunities other can't."
This includes the ability to capitalize on what Morgan Stanley called the "option value" of the Asian international franchise.
"Despite strong expected growth, Asian international operations have limited near-term earnings value," said Morgan Stanley analyst Betsy Graseck in a note to clients. Regulatory restrictions will make it difficult for acquisitions for at least a few years, she said.
However, Morgan Stanley believes it's possible the market "will be mispricing the long-term earnings power and growth potential of this attractive international franchise if it does not account for Citigroup's ability to reinvest significantly more capital into this region in the future."
According to Graseck's calculations, Citigroup's stock is undervaluing the international business by 61% compared with its peers.
In the medium-term, Citigroup will realize most of the incremental value from expansion in India, Korea, Brazil, and Mexico.
"These markets have the right combination of increasing penetration of the banking system, high economic growth and improving regulatory and financial conditions," Graseck said.
Dick Bove, an analyst at Punk Ziegel & Co., pointed out that Citigroup can do things others cannot because it has more capital than the Big Five on Wall Street combined. It has broader corporate reach than other companies, with a presence in more than 100 countries. It has long-standing relationships - it's been in Argentina, for example, since 1912; and its products "can't be matched."
Over the past few years, the market's and the company's focus were on what went wrong at Citigroup - particularly in the wake of the Enron and Worldcom scandals, subsequent litigation and billion-dollar settlements.
Chief Executive Chuck Prince took over for Chairman Sandy Weill (search) in late 2003. At the same time, Robert Willumstad, then the president, added the role of chief operating officer to his responsibilities. Willumstad announced his departure from Citigroup in July, saying he wanted to pursue his goal of becoming a CEO.
Shortly afterward, Marge Magner, the head of Citigroup's consumer division, announced she would step down at the end of September. The company named Ajay Banga and Steven Freiberg co-heads of the group, reporting to Prince.
Prince "just moved people around until he found the right combination. He has been making shifts within the organization at all levels, many of which have been high profile and public," Bove said.
Prince also grappled with the issue with corporate governance, which took time and focus away from sales, Bove said. Prince also had to establish parameters for the investment banking division and train employees to work within the new guidelines.
"For a period, Citigroup wasn't able to compete as aggressively as it had been," Bove said. The third quarter marked the first time in about the past three years that Citigroup began to show increases in market share, he said.
"It would appear, in essence, that they have corrected the factors they felt needed correcting, and now people are going out there again and selling," he said. Whether Prince is the best person for the job, Bove couldn't say, but he said Prince has made his mark by being an activist CEO.
"There's been more positive activity at the company since he's come in than with all of the people that preceded him," Bove said. "They were global thinkers, who got involved in major changes at Citigroup. Prince is the first guy to come in and focus on fixing the engine and go forward to do that."
Bove predicted the strides Citigroup has made in investment banking will be played out in other divisions.
"Prince has really done a lot in a short period of time, most of which I would consider to be positive," he said.