Citigroup: Financial Winner

NEW YORK ( TheStreet) -- Citigroup ( C) was the winner among large financial services companies on Wednesday, with shares rising 2% to close at $29.91.

The broad indexes all showed modest gains, while the KBW Bank Index ( I:BKX) rose 1% to close at 47.36, with all but three of the 24 index components rising for the session.

In its Beige Book report -- an informal review published eight times a year -- the Federal Reserve said that reports from its 12 district banks "suggest economic activity continued to expand gradually in July and early August across most regions and sectors," with six districts indicating a "modest pace" for growth, while three districts cited moderate growth, with the Federal Reserve Bank of Chicago noting "that the pace of growth had slowed from the prior period."

The central bank also said that "the Philadelphia and Richmond Districts reported slow growth in most sectors and declines in manufacturing, while Boston cited mixed reports from business contacts and some slowdown since the previous report."

Following the Federal Deposit Insurance Corp.'s report on Tuesday that the nation's banks and thrifts earned $34.5 billion during the second quarter, for the industry's twelfth straight year-over-year earnings improvement, Rochdale Securities analyst Richard Bove late on Tuesday said that the "basic reason" for the continued improvement is "that banks borrow money at lower rates than the United States government does and they lend it out at a reasonable spread, collecting fees for what they do along the way," and that "when they are unburdened by bad loans their earnings grow consistently as they have for three years now."

Bove added that "bank stocks are finally responding to the earnings increases," and have "outperformed the broader market all year." Looking ahead, "the underlying, unused capital, and liquidity in these companies suggest that their earnings advances have just begun and their stock prices are likely to go much higher."

Citigroup's shares have now returned 14% year-to-date, following a 44% decline last year.

The shares trade for a very low 0.6 times their reported June 30 tangible book value of $51.81, and for less than seven times the consensus 2013 earnings estimate of $4.53 a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $4.09.

The company currently owns 49% of the Morgan Stanley Smith Barney joint venture, with Morgan Stanley ( MS) holding 51%. Morgan Stanley has the option to purchase the remaining stake in the joint venture over a three year period beginning in 2012. Morgan Stanley in May announced plans to purchase an additional 14% stake in the joint venture, subject to a valuation that was to be determined over a 90-day period, which on Wednesday was extended until Sept. 10.

Well Fargo analyst Matthew Burnell, who rates Citigroup "Outperform," with a valuation range of $30 to $33, said on Wednesday that the Morgan Stanley Smith Barney joint venture was being appraised by "Perella Weinberg Partners LP following valuations by the two companies that resulted in a wide difference of opinion on the value of MSSB."

The analyst went on to say that because Citigroup had previously valued its stake in the joint venture at roughly $11 billion, while Morgan Stanley had valued the stake at about $4.4 billion, "the potential pretax writedown of Citi's stake could exceed $6B if MS' valuation is accepted," Burnell believes "a more likely writedown is in the range of about $4B (before tax) based on current retail broker comps and the MSSB contribution to MS (adjusted for elevated noncore expenses in MSSB) compared to our current estimate of Citi's pretax profit of $4.2B."

Burnell also said that the delay in Citigroup's sale of the joint venture stake to Morgan Stanley "could heighten speculation that the two parties could be working on a larger sale of MSSB than the 14% called upon in the joint venture agreement."

C Chart C data by YCharts

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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