naked capitalism

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.