CITIGROUP Investment Category: Income Sector: FINANCIAL Fixed Income Research Evan Marks, CFA October 12, 2018 Company Overview Citigroup (C) is a large financial services company with consumer and institutional businesses across the globe. Consumer operations include retail banking and branded credit cards in Asia, Mexico and the U.S. Its institutional platform expands across 98 countries and includes trading, investment banking and other corporate and institutional services. Appropriate for Income Recommendation We consider bonds of Citigroup Inc. (and its subsidiaries) to be an appropriate holding for Edward Jones clients who seek Income as an objective within a well-diversified portfolio. Edward Jones Credit Strength Assessment Parent Credit Ratings Moody's... Baa1/Positive S&P... BBB+/Stable Fitch... A/Stable Financial Data Debt/Capital... 54% Total Debt/Equity... 139% Earnings to Fixed Charges... 3.9x U.S. Recommended Corporate Bond Sector Weightings Financial (30%- 45%) Utilities (10%- 25%) Industrial (35%- 55%) U.S. Recommended Bond Ladder Short-term (up to 5 years) 30%- 40% Intermediate-term (6-15 years) 15%- 25% 40%- 50% Long-term (16+ years) Investment Summary Citigroup was one of the hardest hit banks in the current financial crisis, but the company has turned the corner and returned to solid profitability. New management has separated the good assets from the bad assets, has bolstered the company's capital position, and has made significant progress in streamlining the firm to better respond to the evolving economic and regulatory environment. We expect Citigroup to continue the process of selling noncore businesses and to increase its focus on its traditional banking business, helping to stabilize earnings and putting the company in a stronger position to meet its current and future debt obligations. Bond Strengths Citigroup has bolstered its capital position and strengthened its balance sheet. We believe Citigroup's renewed focus on core banking should help the bank further improve its fundamentals and reduce volatility. The company significantly tightened its lending standards in the last several years given a decline in risk appetite. As troubled loans drop off and are replaced by higher-quality loans, we believe Citigroup will have a stronger loan portfolio. Citigroup is globally diversified with strong retail and capital markets franchises, which we believe have the ability to generate solid levels of profitability. Bond Weaknesses Citigroup has exposure to a number of higher-risk regions across the globe, which could cause wider swings in operating results compared with more domestically focused peers. Citigroup has significant capital-markets operations. This business has the potential for wide swings in revenue and profitability. Running a large, complex organization across the globe effectively is a significant risk-management and operational challenge, especially given a relatively unproven management team at the helm. Time will tell how effective its actions have been in positioning the company. Please see important disclosures and certification on page 4 of the report. Page 1 of 5
Recent News and Analysis 10/12/18: Citigroup reported second-quarter earnings of $1.73 per share, modestly ahead of analyst expectations. Revenue expanded compared with the same period a year ago, as solid results in the consumer bank, especially outside of the United States, offset weaker-than-expected fee income. Citigroup's expenses were down 1% year-over-year as the firm exhibited solid cost control. Citigroup reported that its Basel III Tier 1 Common ratio, a regulatory measure of financial strength, declined to 11.8% from 12.1% a quarter ago. The highlight of the quarter, in our view, was the excellent expense control. Citigroup's trading results were modestly higher than expected, largely due to solid fixed-income currency and commodity (FICC) trading results. The firm's consumer-banking units posted 3% year-over-year growth, driven by solid results in Latin America (+8% year-over-year). We remain comfortable with the firm's capital position. We continue to consider bonds of Citigroup to be an appropriate holding for investors seeking Income within a well-diversified portfolio. Company Outlook Bolstered Capital Position Since the government stepped in with its bank bailout, Citigroup has gone from being one of the most underfunded banks to being one of the best capitalized. Citigroup improved its position through a variety of asset sales, along with debt and equity capital-raising, and is now sufficiently capitalized, in our view. Its Tier 1 Capital and Tier 1 Common ratios are among the best in the industry, and it has significantly increased its reserves against potential loan losses. The overall effect of these moves has been to limit the impact of unforeseen charge-offs and to restore confidence in Citigroup. Citigroup's capital position has also benefited from improving profitability. Citigroup Basel III Common Equity Tier 1 Ratio (%) Basel III Common Equity Tier 1 Ratio (%) 16% 14% 12% 10% 8% 6% Q113 Q313 Q114 Q314 Q115 Q315 Q116 Q316 Q117 Q317 Q118 Q318 16% 14% 12% 10% 8% 6% CurrentCET1 Ratio CET1 Required Ratio MS C WFC JPM GS BAC Retail deposits are the cheapest form of funding for banks and provide a stable base from which they are able to lend. In our view, a low loan-to-deposit ratio means that banks will be better protected in the event of an unforeseen reduction in capital. Citigroup has increasingly used deposits to fund its loan growth, thereby reducing its loan-to-deposit ratio significantly in recent years. Citigroup's loan-to-deposit ratio now stands below its peergroup average, reducing the company's dependence on alternate forms of financing, such as debt. In addition to these efforts, Citigroup has improved its liquidity position, with liquid assets now representing nearly half of total tangible assets. Focus on Core Businesses Improves Risk Profile Citigroup has focused on simplifying its business and reducing its risk profile. Assets in Citi Holdings (the firm's noncore unit) represent less than 5% of total Citigroup assets, versus close to one-third of total assets as of March 31, 2009. The reduction in the influence of Citi Holdings has benefited the firm's risk profile as Citi Holdings has historically generated loan-loss rates well in excess of that experienced in the rest of the firm's operations. While it may still take years to work down the remainder of the Citi Holdings business, loss rates have declined significantly. We believe further efforts to streamline its businesses and actions that would be expected to reduce its overall risk profile would be positive for debt holders. Risk Management Remains Critical Citigroup's overall risk profile has declined, given its remaining business mix is heavily tied to the capital markets and its more traditional banking operations have a global footprint. However, risk management remains paramount to the firm's ability to continue to improve its profitability and capital position. Citigroup currently does business in over 160 countries and has significant operations in Latin America and Asia. Currently, over 55% of core revenue comes from outside the United States. We believe that Citigroup's exposure to geographies with much higher longer-term growth potential could generate above peer growth over the long term. However, it does make risk management overall more complex, which is a slight credit negative. Citigroup also has significant capital-markets operations, with markets revenue accounting for about 25% of total core revenues. This mix is modestly higher than peers, and the heavy capital-markets exposure adds to the need for highly effective risk management capabilities. We are comfortable with Citi's risk-management capabilities overall, but we believe bondholders would benefit from efforts to drive risk exposure lower over time. Source: Company filings, Edward Jones estimates Source: Company filings, Bloomberg, Edward Jones estimates Improved Loan-to-Deposit Mix and Liquidity Industry Outlook The financial services sector can be described as highly competitive and mature. Rising asset values, looser lending standards, the invention of new products, and the increased use of debt led to solid growth in the early 2000s, but the environment Page 2 of 5
changed with the onset of the financial crisis in the second half of 2007. Falling asset values and rising loan losses led to a global reduction in the availability of loans and a sudden increase in the cost of obtaining loans. The U.S. government was forced to intervene and invest in many large financial services companies to bolster their financial positions. All of the large financial services companies repaid their government loans a few years ago, but there are some lasting effects of this difficult period that affect the banking sector today. Government regulation of the banking sector increased dramatically following the financial crisis, and additional regulatory measures continue to be developed. While banks have moved aggressively to meet or exceed the new standards, the need to consistently grow their capital positions has negatively affected returns. We do not expect regulations to ease significantly in the near term, which we believe will lead to the existence of excess capital in the banking system for many years to come. The financial crisis also caused central banks around the world to implement aggressive and at times unprecedented measures. These efforts have contributed in part to the very low interest rate environment in the market today. Banks have experienced a significant decline in the spread between the amount of interest earned when extending credit and the amount of interest paid to fund this activity. Declining spreads negatively affect profitability. While interest rates have increased recently, we continue to believe the intermediate path for interest rates remains uncertain. We also expect the sector will experience a near-term headwind from an increase in credit-related costs from the current nearhistorical low levels. Over the long term, we expect a growing economy and an aging population will increase demand for the services provided by the financial services sector. Financial Strength Loose lending standards and a deviation from its core competencies significantly weakened Citi's financial strength; however, we believe it has taken appropriate steps to bolster its capital position and return to its core banking activities. We believe this renewed focus on fundamental banking and the strong brand image Citigroup continues to possess should help the company to strengthen the credit quality for bondholders. Edward Jones Credit Strength Assessment We believe Citigroup's credit strength assessment is average. This is due to its above-average level of capital when compared with its peer group. This is somewhat offset by the bank's complex business model, a portion of which is made up of unpredictable revenue sources, which we believe will make it difficult for the bank to manage. Page 3 of 5
Required Research Disclosures October 12, 2018 BUY HOLD SELL Corporate Credits 0% 90% 10% Investment Banking 0% 20% 0% Services The table lists the percent of corporate credits we follow globally in each of the equivalent rating categories. We do not assign a "Buy" rating to any corporate credits. Investment banking services indicate the percentage of those subject companies that have been investment banking clients within the last 12 months. Appropriate for Income Appropriate for Aggressive Income Sell FYI Appropriate for Income We consider bonds Appropriate for Aggressive Income We consider Sell We recommend investors sell these bonds. We FYI - For informational purposes only; to be an appropriate holding for investors seeking Income within a well-diversified portfolio. Our time horizon is 3-5 years. bonds appropriate only as a small Aggressive Income portion within a well-diversified portfolio. Bonds within this category are riskier, with a higher possibility of loss due to default, than bonds classified as Income. Our time horizon is 3-5 years. believe these bonds are no longer an appropriate fixedincome holding because, in our opinion, they offer an factual, no opinion. unattractive risk/reward scenario at current prices. Our time horizon is 3-5 years. Initiated Coverage (Appropriate for Income) 8/6/10 Analyst Certification I certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers; and no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report. Evan Marks, CFA Edward Jones has received compensation from this company for investment banking services within the last twelve months. Edward Jones has provided investment banking services for this company within the past twelve months. Edward Jones has received compensation from this company for providing non-investment banking securities-related services within the past twelve months. This company, or an affiliate, is a Program Bank in the Edward Jones Insured Bank Deposit Program. Edward Jones transfers available cash balances in client accounts into FDIC insured deposit accounts at Program Banks. Edward Jones receives a fee from each Program Bank based upon total balances on deposit. Analysts receive compensation that is derived from revenues of the firm as a whole which include, but are not limited to, investment banking, sales, and trading revenues. Edward Jones trades as principal in the debt securities that are the subject of this research report. Other Disclosures Edward Jones publishes research reports on both this issuer's bonds and common stock. These reports are authored by different research analysts. Further, Edward Jones utilizes different analysis techniques in analyzing bonds and common stock investments. While bond and common stock research reports about the same issuer may appear inconsistent or contradictory, the separate reports should be reviewed independent from one another. This report does not take into account your particular investment profile and is not intended as an express recommendation to purchase, hold or sell particular securities, financial instruments or strategies. You should contact your Edward Jones Financial Advisor before acting upon this report. This report is a product of the Edward Jones Fixed Income Research Department. All investment decisions need to take into consideration individuals unique circumstances such as risk tolerance, taxes, asset allocation and diversification. Before investing in bonds, you should understand the risks involved, including interest rate risk, credit risk and market risk. Bond investments are subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity. Edward Jones limits inventory positions for fixed income securities. This security may currently be subject to these internal limits; however, this should not be considered contrary to our current recommendation. This opinion is based on information believed reliable but not guaranteed. The foregoing is for INFORMATION ONLY. Additional information is available on request. Past performance is no guarantee of future results. This issuer may have issued bonds in both large and small offering sizes. Bonds which are part of small offerings are generally less liquid, which may cause the price you receive in the secondary market to be lower than prices received by investors in large issues of the same issuer's bonds. If you sell this security prior to maturity, you may receive more, less, or the same dollar amount you originally invested because the security's market value may fluctuate over time due to various market factors (e.g., interest rates). Information about research distribution is available through the Investments and Services link on www.edwardjones.com. For U.S. clients only: Member SIPC --- For Canadian clients only: Member - Canadian Investor Protection Fund Diversification does not guarantee a profit or protect against loss in declining markets. In general, Edward Jones analysts do not view the material operations of the issuer. Credit ratings generally represent the rating company's opinion of the bond's ability to meet its ongoing contractual obligations. These ratings are estimates and should be one of many factors considered in evaluating fixed income investments. These ratings do not address suitability or future performance. N/A indicates no rating available. When investing in issuers incorporated outside your own country of residence, you should consider all other material risks such as currency risk, political risk, liquidity risk and accounting rules differences, which can adversely affect the value of your investment. Please consult your Financial Advisor for more information. Edward Jones Credit Strength Assessment: Low Our opinion is these credits are of low financial quality. We believe these credits are the most likely to default and experience the most financial hardship. Below Average Our opinion is these credits are of below-average financial quality. We believe these credits are more likely to default or experience financial hardship than the average. Average Our opinion is these credits are of average financial quality. We believe these credits have a low probability of default or low chance of experiencing financial hardship. Above Average Our opinion is these credits are of above-average financial quality. We believe these credits are less likely to default or experience financial hardship than the average. High Our opinion is these credits are of the highest financial quality. We believe these credits have the lowest probability of default and will experience the least financial hardship. Ratings from Standard & Poor's ("S&P"), Moody's and Fitch may be shown for certain securities. S&P requires we inform you: (1) Ratings are NOT recommendations to buy, hold, sell or make any investment decisions and DO NOT address suitability or future performance; (2) S&P DOES NOT Page 4 of 5
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