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Citi’s discount to Bank of America looks unfair

Citigroup deserves a bit more love from its shareholders. The bank run by Michael Corbat posted $3.8-billion (U.S.) in profit for the first quarter thanks in part to strong trading. It was its best showing in 18 months – longer, on core business performance. Citi still has work to do in a slow recovery. Despite looking better placed than Bank of America, though, on a couple of important metrics Citi trades at a discount to its Charlotte-based rival. That looks unfair.

Neither bank is in tip-top shape. Both are saddled with returns on equity in the single digits – Citi at 8.2 per cent annualized in the latest quarter. The rule of thumb is that big banks only start covering their cost of capital when ROE hits 10 per cent. Citi, though, is further along in its transformation than BofA, from cutting costs to dealing with the remaining toxic assets from the financial crisis.

As with JPMorgan's last week, Citi's report on Monday was free of much of the noise of recent years caused by asset sales, quirky accounting rules and other one-offs. And the bank's annualized ROE was better than any three-month period, adjusting for the oddities, since the crisis except 2010's first-quarter showing of 12 per cent – and that would have been below 10 per cent had it been based on Citi's current, better stuffed cushion of common equity.

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Citi also managed to tap its huge deferred tax asset, essentially a tax shield built up from years of losses. Admittedly, that was only to the tune of $700-million out of a total $49-billion. But the more it utilizes over the coming years, the more the bank can release the capital set against it, further boosting returns.

As for valuation, Citi stock trades at 88 per cent of tangible book value, behind BofA's 92 per cent. Based on their relative strengths at present – BofA, led by Brian Moynihan, is only expected to post a first-quarter ROE of 4.7 per cent on Wednesday – that seems unjustified.

On top of that, BofA shares trade at 12.5 times expected 2013 earnings. That bests not only Citi's multiple, but those of Wells Fargo and U.S. Bancorp, too. A premium might be justified when BofA's turnaround fully kicks in. For now, though, Citi's valuation discount looks unwarranted.

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