Even at $3.90 a share, Citigroup is still overvalued

Citigroup may seem like an attractive buy but check its balance sheet again (photo Alexandra Harris/MEDILL)

Following  Citigroup Inc.’s stellar first-quarter earnings report, the New York Times’ Andrew Ross Sorkin blogged about how Citi had trounced its competitors, Bank of America Corp. and JPMorgan Chase & Co. and, citing Thomson Reuters, was ready to turn the corner.

Around the same time, I started looking at Citigroup’s stock to determine why people had this unfounded optimism, because I thought the banking behemoth was overvalued even though its stock was hovering around $5 toward the end of April.

In April, Citi had the fourth-lowest price-to-book ratio at 0.94 among its banking peers. This means that an investor would only pay 94 cents on the dollar for its balance sheet. While the stock looked to be on the rise because of first-quarter earnings that beat expectations, investors still wouldn’t even pay parity for Citi’s balance sheet. (For comparison purposes, JP Morgan Chase’s price-to-book ratio is 1.16).

According to Bloomberg data, Citigroup’s debt ratio—long-term debt over equity—for first-quarter 2010 was 290.70, considerably lower than for fourth-quarter 2009, 382.04, and third-quarter 2010, 398.52, and much lower than the debt ratios of its chief competitors, which didn’t make much sense. Also, Citi’s net debt was still relatively high, at $882 billion, which made me think something was wrong.

Three words: short-term repurchase agreements.

Also known as “repos,” banks use this type of short-term borrowing to get cash in the near-term by putting up securities as collateral. Repos also enable banks to make bigger bets with borrowed money.

On May 25, the Wall Street Journal’s Michael Rapoport and Tom McGinty reported that Citi, along with Bank of America and Deutsche Bank AG, used the repo program as “window dressing,” or as a way for the banks to shed debt before reporting quarterly earnings.

Additionally, in a follow-up story, Rapoport reported that Citi and Bank of America hid repos as “sales” when they should have been reported as “borrowings.”

This explains why Citi’s price-to-book ratio was still below parity, in spite of strong first-quarter earnings. Now, Citi’s price-to-book ratio is 0.74—the only banks lower than Citi are Region’s Financial Corp., 0.59, Sun Trust Banks Inc., 0.71, and Bank of America, 0.72. Citi’s total debt to common equity ratio is 473.42 percent compared with Bank of America’s 426.63 percent and JPMorgan’s 448.71 percent, which means Citi still has more debt than cash holdings than its competitors.

Following this news, Citi’s stock price has declined 21 percent since its April 21 close of 4.93, but is up 2 percent since the repo news broke.

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