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Citigroup: DTAs May Understate ROE, But Are Already Largely Priced In

Summary

Citigroup gained deferred tax assets (DTAs) from large-scale losses suffered during the financial crisis, which affect the firm's standard definition of ROE despite their status as non-core tangible assets.

The accounting quirk associated with Citi's DTAs is mostly priced into the stock.

Citi's catalysts and risks still largely reside in one's opinion concerning the firm's competitive situation within the context of the overlying macroeconomic picture.

Some analysts looking at Citigroup (NYSE:C) mention the company's deferred tax assets ("DTAs") as an accounting specific reason as to why the company is undervalued. Nonetheless, for a stock that is 75% owned by institutions, or relatively sophisticated investors, this accounting quirk is not entirely unknown. Accordingly, it's probably not something that one can reasonably build an entire thesis around. Citigroup is a stock that will largely ebb and flow based on its strongly embedded ties to the macroeconomic picture (an obvious statement), not the market waking up to a failure to properly adjust its price expectations due to the unique accounting treatment of a particular kind of asset.

The DTA Scenario

Citi has $43.1 billion worth of U.S.-based DTAs and $2.3 billion worth of foreign DTAs as of the end of Q2. The firm obtained these assets during the financial crisis in 2008 and 2009, generated from losses related to Citi Holdings. The assets in this segment totaled $66 billion as of the end of Q2, about 4% of Citi's GAAP assets and 10% of the firm's risk-weighted assets under Basel III. Approximately $37B-$38B, or 57% of the total assets, remain of the bank's toxic North American residential first mortgage and home equity loans. While Citi Holdings continues to be unwound through asset sales, the segment continues to be a slight headwind on profitability and therefore ROE. Approximately 6% of the firm's net income for the first half of 2016 have come from Citi Holdings' divestitures and natural run-offs.

DTAs have value in the form of future tax credits, or essentially permit more cash to be retained within the business in the future. Nonetheless, the capital accrued from the DTAs is essentially ignored during the Fed's yearly capital stress tests despite its pertinence to the health of the business, as they do not derive returns on capital in the same way as core tangible assets. Moreover, Citi's peers do not have assets of both this type and magnitude on their balance sheets and should be accounted for when making peer-to-peer comparisons, when applicable.

If this $45.4 billion is swept off entirely from the book value of equity, which totaled $233.0 billion in terms of Citigroup's consolidated holdings (or a projected $240 billion by 2016 year-end), this figure is...


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