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Citi upbeat on '17, but investors cautious on light top line

Reduced expenses and robust trading conditions helped Citigroup Inc. post improved profitability for the final quarter of 2016. But its overall revenue slipped from a year earlier, leaving some worried about the company's ability to capitalize on improving conditions to grow lending and interest income.

Shares of Citi fell about 2% in morning trading Jan. 18 after the New York-based banking behemoth reported fourth-quarter results. Net income of $3.57 billion, or $1.14 per share, was up from $3.34 billion, or $1.02, a year earlier. But total revenue fell to $17.01 billion from $18.46 billion a year earlier.

"Revenue was a little light," GBT Capital Management founder and veteran big-bank investor Gary Townsend said in an interview. "That was somewhat of a surprise."

Operating expenses, meanwhile, fell 9% from a year earlier to $10.1 billion, helped by divestitures and lower costs in Citi Holdings, the unit created by the company in the aftermath of the 2008 financial crisis to house more than $800 billion in troubled assets that the bank cordoned off to sell or wind down. That so-called bad bank has since shrunk to about $54 billion in assets, or about 3% of Citigroup's balance sheet. It is now small enough that it no longer drags on Citi's profits, allowing the company this year to cease reporting separate results for the unit. But in large measure, it blamed the winding down of Citi Holdings for the top-line decline.

The company's total cost of credit dropped 29% from a year earlier to $1.8 billion, driven in part by a decline in net credit losses. Citi reported a provision for loan losses of $1.73 billion, down from $2.26 billion a year earlier, bolstering earnings.

Additionally, the company's bottom line benefited from heightened capital markets business during the fourth quarter. Investor optimism in the wake of the Nov. 8 presidential election, buttressed by President-elect Donald Trump's calls for lower taxes and deregulation, drove market activity.

Within Citi's institutional clients group, markets and securities services revenue rose 24% to $4.1 billion. The fixed-income markets operation accounted for much of the surge; revenue soared 36% to $3.0 billion, reflecting improved trading conditions. Equity markets revenue of $694 million advanced 15%.

Jeffery Harte, an analyst at Sandler O'Neill & Partners, said in an interview that both capital markets and expenses were "clearly good news." Given a strengthening U.S. economy that should bode well for credit quality, a stated focus on cost control, and generally positive sentiment in the markets, he thinks Citi can maintain momentum on both fronts.

Loan growth at Citi, however, "was weaker than I expected," Harte said. He "would like to see growth accelerating" by now. Citi's loans of $624 billion at the close of the fourth quarter were up from a year earlier, but only by 1%. Stronger loan growth would have generated more interest income, providing a top-line boost. Citi's net interest margin declined about 7 basis points during the fourth quarter to 2.79%.

That noted, Harte said he anticipates Citi will generate stronger loan growth this year. Townsend agreed, emphasizing that the company has a strong, global deposit base that it can draw upon to fund loan growth inexpensively. "The strong deposit franchise of many of these big banks, including Citi, will being paying off hugely," Townsend said.

Citi executives said their outlook is generally positive, noting a strengthening domestic economy. They cited vigor in select areas of consumer lending as early signs of lending momentum, including growth generated from its 2016 acquisition of the Costco U.S. co-brand credit card portfolio, which gave it more than $10 billion of credit card receivables.

CEO Michael Corbat said during a call with analysts to discuss earnings that, while nobody is certain about the future steps of either Federal Reserve or congressional policymakers, Citi does see "a path" for the Fed to follow a December 2016 interest rate increase with more hikes this year. With higher rates, Citi's lending could become more profitable, and it also would benefit from eased regulation.

Lower corporate taxes, he noted, may require Citi to write down a portion of its deferred tax assets, but that could be more than offset by higher net income and improved returns that the bank could generate in a low-tax environment. Trump also has called for more federal spending on improvements to infrastructure such as roads and bridges.

Corbat said economic sentiment has "clearly become more positive since the U.S. election. In general, we'll benefit from pro-growth policies, as will our clients."

That could help push up Citi's top line. Rising revenue in concert with continued lower costs would help Citi churn out profits more efficiently. The company posted a 2016 efficiency ratio of 59%. Executives said they expect that to decline to 58% this year and then potentially down into the mid-50s the following year.

"At this point, no one actually knows what will become of U.S. policy, but I believe that there are pent-up capital and investment opportunities, which corporates are poised to act on given the right circumstances," Corbat said. If corporate clients invested in expansion, Citi could finance it. More corporate activity, he added, "could boost GDP growth in the U.S. and beyond, given the significance of our economy globally, so we enter the year with a healthy amount of optimism about the prospects of growth strengthening."