Citigroup Earnings Preview: What Should Investors Expect?

With second-quarter earnings season for banks fast approaching -- it kicks off Friday with Citigroup (C 3.06%) and JPMorgan Chase -- investors in bank stocks should anticipate a mixed bag of results.

In Citigroup's case, analysts expect the New York-based bank to earn $1.22 per share in the three months ended June 30. That compares with $1.24 per share in the year-ago period and $1.35 per share in the first quarter of this year.

Image source: Getty Images.

An otherwise good quarter for banks

The slight downtick in earnings aside, it was a good quarter for banks. The Federal Reserve raised short-term interest rates yet again in June, which will translate into higher loan yields and thus more revenue for banks. And a couple weeks after doing so, the Fed also confirmed that all of the banks that took this year's stress tests passed them.

Citigroup's performance through both phases of the stress tests was no exception. It sailed through the first round, the Dodd-Frank Act stress tests, with more than enough capital to survive a severely adverse economic scenario akin to the financial crisis. It also demonstrated in the second phase of the tests, the Comprehensive Capital Analysis and Review (CCAR), that its capital planning process is adequately sophisticated to manage through such an event.

As a result of Citigroup's performance on the tests, it was given a green light from regulators to increase its dividend and share buybacks, which it promptly proceeded to do. Citigroup announced at the end of last month that it would double its quarterly common stock dividend to $0.32 per share and buy back up to $15.6 billion worth of common stock over the next four quarters. All told, Citigroup's latest capital plan adds up to $18.9 billion, the majority of which consists of buybacks.

Data source: Citigroup press releases.

Q2 earnings still expected to fall

Despite these positive developments, Citigroup's earnings are still expected to drop on both a year-over-year and sequential basis. There are two reasons for this.

Most importantly, trading revenues are expected to drop at universal banks -- those with both investment and commercial banking operations. Citigroup is one of these. In the first quarter of this year, its institutional clients group generated $3.6 billion worth of fixed-income trading revenue and $769 million in equities trading revenue, gains of 19% and 10%, respectively, compared with the prior year.

The second quarter isn't expected to be as lucrative on this front, thanks to low volatility and trading volumes. "Volatility has been very low this quarter, which has certainly led to somewhat of a softer trading environment, especially in the fixed-income and equity markets," said chief financial officer John Gerspach at a recent industry conference. "So given that ... slower trading environment, we would expect revenues in our fixed income and equity markets to be down year-over-year in the ... low-double-digits range, maybe 12% to 13%."

Moreover, while short-term interest rates rose during the quarter following the Fed's decision to boost the Fed funds rate by 25 basis points in both March and June, long-term rates trended down for most of the quarter. The yield on 10-year Treasury bonds oscillated between 2.3% and 2.6% in the first quarter, but this range dropped to between 2.15% and 2.4% in the second quarter. Thus, at least a portion of the benefit to Citigroup's net interest income that would flow from higher short-term rates will be absorbed by the detriment of lower long-term rates.

Interest rates and trading results aside, investors in Citigroup can take solace in the ongoing improvement in the bank's performance. Its balance sheet is resilient enough to pass the annual stress tests, and the bottom line on its income statement is steadily moving higher.