The qualiity of Citigroup’s $1.6 billion first quarter earnings was so lousy that even the mainstream media took notice. And the bank’s stock traded down 9%.
To give the highlights:
$2.5 billion of revenues came from lower market value of its debt thanks to a fall in credit quality. That was a common pattern of last year, when quite a few investment banks, Lehman in particular, marked down their debt, showing a corresponding increase in income.
The bank posted a number of one-off gains:$704 million from the sale of a remaining stake in a Brazilian credit card processor, and $360 million in reversals of reserves (part for a litigation, the rest relating to an audit).
The bank posted negative earnings per share.
Do the math. $1.6 billion – ($2.5 billion + 1.1 billion) is not a positive number.
The EPS will improve on a going forward basis thanks to a pending conversion of preferred stock to common. And as a result of super cheap funding thanks to the Fed, interest spreads are a healthy 3.3%, but per the figures above. unless something improves or Citi can scare up one magic tricks, it needs to see either more revenues or a reduction, not a mere flattening, in credit losses.In theory, the bank has more latitude regarding how it marks its securities portfolio with the relaxation of mark to market rules, but if the PPIP delivers the phony prices that it is intended to yield, the bank may very well post gains of rather questionable quality in coming quarters on its book (note this is less likely to occur with its loan book, since banks can and presumably do mark them on a hold to maturity basis, and anecdotal reports are that valuations there are plenty rich, calling into question how much in the way of gains even the PPIP could deliver).
But as things stand, the bank is still hemorrhaging losses faster than even richer than usual interest income is bringing in. Although the rate of increase in losses is slowing, that’s cold comfort when the absolute level of credit losses is this high.
Note that this follows artificially high earnings at Wells, pumped up by loss reserves that were patently too low, and Jamie Dimon warning that the first quarter may be a high water mark for banks this year.
Both the New York Times and Reuters were up front with skepticism. From the Times:
After more than a year of crippling losses and three bailouts from Washington, Citigroup, a troubled giant of American banking, said Friday that it had done something extraordinary: it made money.
But the headline number — a net profit of $1.6 billion for the first quarter — was not quite what it seemed. Behind that figure was some fuzzy math.
Like several other banks that reported surprisingly strong results this week, Citigroup used some creative accounting, all of it legal, to bolster its bottom line at a pivotal moment….
Meredith A. Whitney, a prominent research analyst, said in a recent report that what banks were doing amounted to a “great whitewash.” The industry’s goal — and one that some policy makers share — is to create the impression that banks are stabilizing so private investors will invest in them, minimizing the need for additional taxpayer money, she said.
Reuters was a tad more polite:
Citigroup pulled a rabbit out of a hat in the first quarter — but can it do it again?
While the Journal also noted the special gains, the tone of the piece was more Citi friendly.
Felix Salmon also read through the transcript of the tortuous earnings conference call, which he deemed “horrible”, and skimming it, I have to agree. There were almost no direct answers to any questions That does not mean new CFO Ned Kelly did not say a lot, but the noise to signal ratio was one of the highest I have ever seen.
Update 5:45 PM: From Egan Jones via Tyler Durden, who has additional commentary on Citigroup:
Accounting and government magic – the recasting of FASB157 enables financial institutions to defer the recognition of losses with the result that C’s March trading profits swung from a $6.8B loss to a $3.8B gain. Another item worth reviewing is the decline in interest expense from $16.5B last year to $7.7B this year.
Nonetheless, much more equity capital is needed. Beyond the conversion of preferred to common, watch the form of any additional capital. The Fed and Treas. have guaranteed $306B of C’s assets, have injected $45B in preferred and converted to common leaving few additional options. The problem is that C has $2T of assets ($3+T including off balance sheet assets) whose values are depressed by 10% to 20%. C needs to be watched.
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The splendidly monikered new CFO of Citi, Ned Kelly! His namesake had a way with bank revenue streams:
http://en.wikipedia.org/wiki/Ned_Kelly
CrocodileChuck
“Potemkin Profits”
A brilliant turn of phrase … soon to be a classic …
Thanks Yves …
It doesn’t surprise me in the least that the CEO of this outsize mortuary would obfuscate and his CFO would prestidigitate. I mean, if they put a real number under their masthead, they’d be out of work, right? What _really_ riles me about numbers like this is that our Federal Government is openly conspiring with private management to lie to potential investors and the public about the state of this firm (and others). That would be criminal if you or I did it, right? Raison d’etat, may be the thinking, but as far as I’m concerned they’re all co-conspirators in an epic crime, which only continues as we watch.
The bit about “2.5 bn $ of revenues from lower market value of own debt” was new to me (though the quote says this sort of effect was already common for many investment banks last year).
So if I understand correctly, the way it works is that Citi has liabilities from derivatives which are somehow linked to the market’s assessment of its creditworthiness, and if the market becomes more skeptical about Citi, the market value of those liabilities goes down, therefore leading to a profit?
OK, to answer my own question:
Read up on it, and apparently, it’s entirely legal to mark down your debt to market value, because you can theoretically buy it back on the market.
(Not sure why the other source I found talked about derivatives. Maybe it’s both about debt and about derivatives.)
Considering that you have a legal obligation to pay back your debt at par on maturity (unless you go bankrupt or agree on a restructuring), that’s a rather bizarre accounting rule, in my very humble opinion.
YS:
Old CPA story. A Fortune 500 CFO wants to hire a new CPA firm. He asks the partner at firm 1, “How much is 2 + 2”? The partner responds, “Four”. He asks a partner at firm 2, who also responds “Four”. The partner at firm 3 responds, “Any number you want it to be”. Obviously KPMG, which audits Citigroup is firm 3. Laugh. It’s that bad out there.
On bank earnings I’ve found it curious that there has been no guidance (of which I am aware) from banks on earnings going forward and no media comment. If I missed it please point me to it, otherwise any insight would be appreciated.
Generally I find using a decline in the value of debt as a reason to claim an increase in earnings is completely offensive: unless you buy back the debt you still have to pay the interest.
In this case it doesn’t bother me so much because there is a high probability that debt holders will be forced to exchange their debt for equity and so Citi will not have to pay all the interest.
You can claim the drop in the value of the debt is a reflection of this and so including it is perfectly valid.
I do think Citi and its auditors should publicly state this.
that joke -‘any number you want it to be’ made the rounds in the 1950s. It referred to the mafia.
Guy comes into the brokers office and says pull down the shades I have a deal for ya or words to that effect …
It got a big laugh; it was such shocking idea.
Now? -not so much.
Zero Hedge has a quote from Egan Jones describing just how this stuff is manipulated:
Accounting and government magic – the recasting of FASB157 enables financial institutions to defer the recognition of losses with the result that C’s March trading profits swung from a $6.8B loss to a $3.8B gain. Another item worth reviewing is the decline in interest expense from $16.5B last year to $7.7B this year. Nonetheless, much more equity capital is needed. Beyond the conversion of preferred to common, watch the form of any additional capital. The Fed and Treas. have guaranteed $306B of C’s assets, have injected $45B in preferred and converted to common leaving few additional options. The problem is that C has $2T of assets ($3+T including off balance sheet assets) whose values are depressed by 10% to 20%. C needs to be watched.
Every business unit at Citi was down in the first quarter. The only area that made money was in trading, which led me to wonder: How’s the risk profile? A spokesman assured me that Value at Risk remained unchanged. Reliance on VaR seems to have helped get the big banks into trouble in the first place. All in all, the first quarter report was less than heartwarming.