Commentary

Citi's Fogged-Up Crystal Ball


By Jonathan Weil

(Bloomberg) — When the Treasury Department shelved its plans to sell $5 billion of Citigroup Inc. (C) common stock in a public offering last week, the news came only two days after the bank had said the sale was a go. The delay was a reminder that predicting the future can be a tough exercise.

So imagine how difficult it must be for Citigroup to predict the amount of taxable income it will generate during the next 20 years.

If you think its executives can do that, then you just might believe the $38 billion net value for an item on Citigroup's balance sheet called deferred-tax assets, which represent 27 percent of the company's shareholder equity. Keep in mind, this is the same Citigroup that didn't see the credit crunch coming until it was too late, and wouldn't have survived without a government rescue.

Deferred-tax assets generally consist of tax-deductible losses and expenses carried forward from prior periods, which companies can use to reduce future tax bills. The catch is they are valuable only to companies that are making money and paying income taxes.

Citigroup probably will record its second straight annual net loss, according to the average estimate of analysts surveyed by Bloomberg. It reported a $27.7 billion loss for 2008, which eclipsed its previous two years of earnings. The way it's been able to keep those assets on its books is by assuming it will earn enough taxable income in the future so it can use them all.

Otherwise, it would have to write them down by recording an offsetting reserve called a valuation allowance. This is where Citigroup's recent assumptions look awfully bold.

Always a ZeroCitigroup's allowance was zero as of Sept. 30, the same level it's been at since 2006, when Citigroup was posting near-record profits and its net deferred-tax assets were just $4.7 billion. None of the other three U.S. commercial lenders with more than $1 trillion of assets has adopted such an extreme stance. Their tax assets also are much smaller than Citigroup's.

Even the strongest of those too-big-to-fail banks, JPMorgan Chase & Co. (JPM), had included a $1.3 billion valuation allowance in its $13 billion net deferred-tax asset as of last Dec. 31, which was the last time it disclosed a complete tax footnote in its financial filings. Wells Fargo & Co. (WFC) and Bank of America Corp. (BAC) also had set up at least some allowance against theirs.

How could it be that Citigroup didn't need an allowance, while those other banks did? A Citigroup spokesman, Jon Diat, declined to answer that question. This result might make sense to me if Citigroup were the healthiest, most profitable bank of them all. It's anything but that.

Looking FishyAnother reason Citigroup's lack of allowance looks fishy is that the bank has reported a cumulative loss for the past three years. Under the Financial Accounting Standards Board's rules on the subject, "forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years."

In its financial filings, Citigroup has said it overcame that presumption by concluding it "more likely than not" will generate at least $85 billion of taxable income over the next two decades. It also has said it has "sufficient tax-planning strategies" to fully realize the asset. That Citigroup was able to raise $20.5 billion last week, including $17 billion from sales of common stock, could help the company's case, too.

Still, the notion that Citigroup can credibly make far-ranging forecasts cries out for skepticism.

Making News"It's a mystery to me," says Robert Willens, a tax and accounting specialist who teaches at Columbia Business School in New York. "They have the strongest possible negative evidence and the weakest source of taxable income, and somehow when you put those together they don't need a valuation allowance."

Citigroup's deferred-tax assets were in the news again this month, after the Internal Revenue Service granted the company an exemption so that it wouldn't lose any of them as a result of the Treasury's planned stock sales. Normally, such sales would be deemed an ownership change under the tax code, in which case Citigroup would have lost its right to use much of the assets.

Even with the IRS exemption, though, Citigroup still must demonstrate it can use them all, to avoid writing them down for financial-reporting purposes.

It wasn't until 1992 that the FASB began letting companies record deferred-tax assets that depend on future taxable income. Banking regulators limit the amounts lenders can count toward their capital measures, because such assets can't be used to absorb future losses. At Citigroup, $21.9 billion of its deferred-tax assets were disallowed for purposes of calculating its regulatory capital as of Sept. 30.

Rich HistoryThere's also a rich history of companies with large deferred-tax assets waiting until they're on the verge of collapse to write them off. Among them: Fannie Mae, Freddie Mac, General Motors Corp., Bethlehem Steel Corp. and Nortel Networks Corp. Citigroup's tax assets would have been rendered worthless last year had the government not bailed the company out.

Other assets at Citigroup may need major writedowns, too. The company now has a $93 billion stock-market value, including the government's 27 percent stake. That's $47.5 billion less than the common shareholder equity it reported as of Sept. 30, which tells you investors still don't trust its balance sheet.

Maybe they know something Citigroup doesn't.

Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.


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