The flight to Citi trade

April 18, 2011, 6:45 PM UTC

In the truth is stranger than fiction department, Citigroup is now the U.S. banking sector’s shining beacon.

Shares in Citi (C), the giant bank that took the most bailout money during the financial meltdown, rose modestly Monday, even as other financial stocks were hammered by Standard & Poor’s decision to cut its outlookon the United States’ credit rating to negative.

Crossing fingers on credit improvement?

Why the sudden flight to Citi? The New York-based firm reported its fifth straight quarterly profit, beating Wall Street estimates. And because Citi has a much bigger overseas banking business – particularly in Asia andLatin America – than its peers, fans say Citi is the U.S. bank most likely to cash in on the emerging market growth cycle investors are currently so taken with.

“When you get 62% of your revenue and three-quarters of profits from international operations, that gives you some pretty good growth potential,” said Tom Lewandowski, a financial services analyst at Edward Jones in St. Louis. He rates the stock buy.

To be sure, there are some pretty substantial negatives that Citi bulls are contorting themselves to overlook. Revenue, for instance, plunged 22% from a year ago, which indicates the Citi-as-growth-stock case is perhaps a little overwrought. And more than half the latest-quarter profit came from the release of previously booked loan loss reserves.

But Citi has a fair amount of company in those camps. First-quarter revenue fell 9% at JPMorgan Chase (JPM) and 16% at Bank of America (BAC), as the trading boom that boosted top lines a year ago has collapsed and the feds have cracked down on the absurd fees that used to pad bank wallets.

As for loan loss reserves, there’s nothing exactly untoward about releasing them as credit trends improve. All the big banks have been doing it (see chart, right), and as long as the economic recovery remains intact there is not a huge amount of risk associated with the decision.

But reserve releases constitute an inherently low quality source of earnings, because even if the economy starts roaring the bank will soon get to a point where it can no longer run down its reserve balances.

At that point all those loans inBrazil and India had better be paying off, or Citi’s profits are going to be so weak that shareholders will lose patience with CEO Vikram Pandit’s turnaround plan.

But for now, Citi looks to be on the verge of a healthy couple of years, assuming the roller coaster global economy remains on track.

“Loans were up 16% in Latin America and 22% in Asia,” said Lewandowski. “Those are numbers you’re not going to see in North America.” Ain’t that the truth.

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