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Citigroup's Emerging Market Bet Remains Best Profit Hope

Tickers in this article: JPM C WFC

NEW YORK ( TheStreet) -- On the surface, Citigroup's(C) vanishing emerging market growth this quarter may mystify some investors who expect the bank to have the brightest international growth prospects on Wall Street.

But while growth has temporarily vanished, overall profits overseas are not a lost cause.

Citigroup's second quarter earnings beat came from better-than-expected earnings at its investment bank, which combatted expectations of a revenue drop. In addition, Citigroup benefitted from expense cuts and improving credit quality at its North American banking unit.

However, revenue and profit at its international consumer banking unit fell compared with the same period last year. In fact, weak emerging markets revenue may have clouded Citigroup's entire 'Global Consumer Bank' lending operations. The unit's revenue of $9.8 billion came in slightly short of expectations, wrote KBW bank analyst David Konrad in a Monday note to clients.

Those results may dissapoint investors who have long expected a recovery in Citigroup's shares -- and even a long-anticipated dividend boost -- as the bank executes on a multi-year runoff of unwanted U.S. businesses, bolsters capital and focuses on overseas growth.

But don't be fooled by second quarter numbers because those results mask strong growth and credit trends in Citigroup's emerging market operations.

While profits at Citigroup's international consumer bank fell 12% to $795 million and revenue fell by a similar measure to $4 billion, the drop was given a push by currency adjustments as the U.S. dollar strengthened against key emerging market currencies like the Mexican Peso.

Excluding currency adjustments, Citigroup's revenue grew 8% in Latin America and was flat in Asia and other emerging markets. Meanwhile, the bank said that all international regions grew deposits and loans as credit quality generally improved.

Stable credit quality may actually confirm Citigroup's strategy to target growth outside of the U.S. as it runs off a portfolio of 'non-core' holdings and reinvests in banking opportunities with higher-than-trend gross domestic product (GDP) growth outlooks.

Prior to Monday earnings, Citigroup faced a crucial test to its emerging markets strategy as a Eurozone recession and a developed market growth slowdown chip at emerging markets. Some analysts feared that rising loan losses and deteriorating credit quality in second quarter earnings could be a signal that Citigroup's growth strategy was poised to backfire.

"The big story for Citigroup is the emerging market piece of its earnings," said Jim Sinegal, a director of bank equity research at Morningstar, in a July interview prior to earnings. "If Citigroup can manage to grow without having major credit problems, I think people will look pretty favorably on that," he added, noting that this quarter would mark the biggest recent test of the bank's credit quality outside of the U.S.