Citigroup 'Faces Pressure' for Q3 Revenue: JPMorgan

NEW YORK ( TheStreet) -- Citigroup ( C) faces "pressures on several revenue sources, international credit costs, and high legal expenses," according to JPMorgan Chase analyst Vivek Juneja.

In his early preview of third-quarter earnings for the large-cap banks covered by his firm, Juneja on Wednesday wrote that the group would be facing significant revenue pains, including a major decline in mortgage loan originations and a decline in gain-on-sale spreads for newly originated loans sold to Fannie Mae and Freddie Mac, "which worsened in September."

In addition to the mortgage decline, which has been widely signaled to investors through an array of economic reports and projections from the Mortgage Bankers Association, Juneja expects a "Larger than normal seasonal decline in capital markets," along with "weak loan growth" and a narrowing of net interest margins "for some."

That last comment may surprise some investors, since the market yield on 10-year Treasury bonds has soared by over 110 basis points since the end of April, in anticipation of a decline in bond purchases by the Federal Reserve. The Federal Open Market Committee will finish its two-day policy meeting Wednesday, after which the committee is expected to announce a modest tapering of the central bank's long-term bond purchases, which have been running at a net $85 billion per month since last September, as part of the "QE3" effort to hold down long-term interest rates.

But for most banks, a parallel rise in interest rates is needed to significantly boost net interest margins and net interest income, and some assets are continuing to reprice at lower rates.

The short-term federal funds rate has been locked in a historically low range of zero to 0.25% since late 2008, and the FOMC has repeatedly said it was unlikely to raise the target rate at least until the national unemployment rate drops below 6.5%. The August unemployment rate was 7.3%, improving slightly from 7.4% in July.

Federal Reserve chairman Ben Bernanke is scheduled to hold a press conference at 2:30 p.m. ET Wednesday.

According to Juneja, a 20% to 30% drop in mortgage revenue for the big banks will be partially offset by higher servicing revenue. He added that "investment banking volumes slowed in 3Q, most notably in debt underwriting, which was hurt by the impact of rising interest rates in August," and also wrote that "3Q trading revenues are likely down double digits on both a quarter-over-quarter and year-over-year basis reflecting a greater than normal seasonal drop in activity levels."

Credit leverage -- with continuing boosts to earnings from the release of loan loss reserves and expense reductions from cuts in staff working on nonperforming assets -- will continue, partially offsetting the expected revenue declines, although the analyst pointed out that "cost cuts are partly offset by high compliance and legal costs."

This is especially true for JPMorgan Chase ( JPM) itself, with CFO Marianne Lake on Sept. 9 saying at a conference that the bank was expecting net losses in its mortgage origination business during the second half of 2013, and that a "crescendo" of regulatory activity would lead to additions to third-quarter additions to litigation reserves "which will more than offset the $1.5 billion or so of consumer reserve releases."

Getting back to Citigroup, Juneja estimates the company will report third-quarter revenue, net of interest expense, of $18.821 billion, declining from $20.479 billion in the second quarter. Revenue is expected to increase from $13.703 billion in the third quarter of 2012, however, the company booked $3.470 billion other-than-temporary impairment losses on its (then) 35% remaining share of the retail brokerage joint venture with Morgan Stanley ( MS).

Citigroup's is the cheapest among the large-cap banks covered by Juneja, to his forward earnings estimates. The shares closed at $51.20 Tuesday and traded for 9.8 times Juneja's 2014 earnings estimate of $5.25 a share. The analyst has a neutral rating on Citigroup, with a $54 price target.

Juneja doesn't cover his own firm, whose stock is arguably even cheaper than Citi. JPMorgan's shares closed at $53.09 Tuesday and traded for 8.7 times the consensus 2014 EPS estimate of $6.09, among analysts polled by Thomson Reuters.

Investors holding shares of Citigroup and JPMorgan may be traveling a rocky road through the end of 2013, with plenty of revenue concerns and a continuing flow of leaks, settlements and other negative headlines for JPMorgan. But long-term value investors who can make a multiyear commitment may be looking at quite an opportunity to load up on cheap bank stocks.

-- 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 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.