2. Currency exchange risks
In connection with Citi’s strong international exposure, the recent sell-off in international currencies doesn’t bode well for Citigroup Inc (NYSE:C)’s next earnings release. A 10% decline in a basket of emerging market currencies would mean a decrease of more than 5% in Citigroup’s total revenue, other factors being equal. Citi recorded currency losses of more than $0.7 billion in the first quarter of 2013. Total accumulated currency losses amount to $10.6 billion. The primary contributors to the negative $0.7 billion adjustment for the first quarter were (in order of impact) the Mexican peso, Japanese yen, British pound and Korean won.
The international currency adjustments are recorded in the balance sheet and reported as part of the “Accumulated Other Comprehensive Income” (or loss) instead of the annual and quarterly income statement. So, the currency fluctuations don’t directly impact Citi’s income. However, thanks to being recorded in the balance sheet and being part of the Tier 1 ratio, they can negatively weigh on Citi’s efforts to improve its Tier 1 ratio and overall reputation.
Impact on Tier 1 capital ratio
On March 31, 2013, Citi’s estimated Basel III Tier 1 Common Ratio was 9.3%, compared to an estimated 8.7% on December 31, 2012. However, the negative currency adjustments slowed down the effort.
I am bullish in Citigroup Inc (NYSE:C) over the long-term, as I believe the bank will continue to gradually improve its balance sheet and margins, as well as continue to generate higher revenue and income from well-diversified international sources.
On the other hand, the risks Citigroup is currently facing in terms of its international markets exposure, as well as the associated U.S. dollar currency exchange rate, could very well turn out to be advantages, or drags on Citigroup’s financial results in the upcoming quarters. Therefore, Citigroup poses a greater risk than its peers such as Wells Fargo & Co (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM) or Bank of America Corp (NYSE:BAC), once BAC’s Countrywide financial settlement is swept off the table.
Citigroup’s stock is likely to reflect this increased volatility and risk by trading more erratically and sideways, in contrast to its strong performance over the past 12 months.
Martin Vlcek holds a long position in Wells Fargo. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Citigroup Inc (NYSE:C) and Wells Fargo. Martin is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Citigroup: Strong Currency Headwinds Will Impact Tier 1 Ratio originally appeared on Fool.com is written by Martin Vlcek.
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