I have been outspoken about my belief that the banking sector in general is ridiculously cheap right now. After the positive economic catalysts of the past week or so -- notably the Federal Reserve announcing the taper and the relatively easy passage of a budget for the first time in years -- it's starting to look like an even better bet that bank stocks could perform well in 2014 and beyond.
Of the banking sector, the company with the most upside potential at its current price could be Citigroup (NYSE:C) Let's take a look at just a few of the reasons to love this company.
Reason No. 1: Citigroup is a much stronger company than it used to be
Ever since the financial crisis ended, Citigroup has done a great job of taking action to once again become the strong, stable institution that it once was. Most significantly, in terms of improving the company's strength, is the winding down of Citi Holdings, the arm of the bank where Citigroup parks the assets that it wants to get rid of.
Citi Holdings has reduced its exposure to residential mortgages and home equity loans significantly over the past year, recently reporting a 29% decline in assets from the same quarter in 2012. The amount of loans that were 90 days delinquent or more decreased by an even more impressive 41% year over year. .
There was plenty of other good news about Citigroup's strength in its latest earnings release. For instance, the company's Tier 1 capital ratio has improved to 10.4%, and the Citicorp segment grew its (healthy) loan portfolio by 5%.
Reason No. 2: Improving housing market
Although Citi Holdings now represents just 6% of the company's assets, the company still anticipates notable mortgage losses from the segment. In fact, Citigroup is currently allowing for $7.3 billion in loan losses from the segment, representing 7.6% of the loan portfolio.
However, if the housing market continues to improve, the actual amount of loan losses could be much less. To illustrate this, consider that Citigroup was anticipating more than $11 billion in loan losses just about a year ago. Rising home prices lifted the value of Citigroup's mortgage assets significantly, and experts are expecting home prices to rise another 3% to 5% in 2014, which should further help the company mitigate its loan losses.
Reason No. 3: Extremely low valuation
Citigroup trades at an extremely low valuation right now: slightly less than its tangible book value. This is extremely cheap, not only considering its pre-crisis valuation, but its valuation since then. In other words, Citigroup is trading for just 97% of the value of its tangible assets. As the chart below shows, Citigroup is trading almost as cheaply as it ever has.
While most of the big banks are cheap right now, compare Citigroup to its peers Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM), which are trading for 1.2 and 1.6 times tangible book value, respectively. Both are cheap on a historical basis as well, but they are not the bargain Citigroup is. Plus, both companies seem to be much bigger targets of post-crisis legal action than Citigroup.
JPMorgan already settled for $13 billion with the Justice Department and is also on the hook for its role in the Madoff scandal to the tune of more than $1 billion. Bank of America acquired Countrywide Financial and Merrill Lynch during the crisis, both of which have produced constant legal headaches for the company related to bad lending behavior.
I have no delusions that any of the big banks will be trading for three to four times tangible book value anytime soon, but the right combination of renewed confidence in the U.S. economy and banking system, permission to begin issuing dividends again, and strength in housing and lending could easily prop the multiple up to about 1.5 times or so, which would translate to a share price of around $82, which I feel is completely reasonable by the end of 2014.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.