Citigroup Keeps Banks on a Roll


In another positive result for the banking sector, Citi's first-quarter loss beats expectations. But some investors remain wary

Could it be springtime on Wall Street? Citigroup (C) is the latest big bank to post encouraging results that beat forecasts when it announced first-quarter results on Apr. 17. Although the New York bank reported a loss of 18¢ per share, the number was below the consensus forecast of a 34¢ loss. Analysts and investors were upbeat about the stream of good earnings news coming out of the banking sector in the past week, but they remain circumspect about economic headwinds, the pending outcome of ongoing federal stress tests, and the ugly loans still souring on balance sheets.

"At least there is less bad news, which is good news in itself," says James Early, senior analyst with The Motley Fool. "But banks are in the same conga line as everybody else; if the economy is going to worsen, so will banks." Adds Scott Colyer of Advisors Asset Management: "Citi continues to be a mess. We may have a bit of good news this morning, but they still have a lot of wood to chop to get themselves out of a nasty situation and decaying debt."

Citi's first-quarter results reflected better operating margins and a 23% decline in expenses in the past year, mainly the result of 13,000 job cuts. U.S. deposits rose by $28 billion and revenues nearly doubled from a year ago, to $24.8 billion. Also, capital markets trading at the investment bank was robust, mirroring the results coming out of Goldman Sachs (GS) and JPMorgan Chase (JPM) this week. In fact, Citigroup would have posted a profit had it not been for a $12.5 billion convertible preferred stock offering in January 2008. The offering did not have an impact on profits, but resulted in a reduction to income available to shareholders of $1.3 billion, or 24¢ per share.

$2.7 Billion Added to Loan Loss Reserves

"The big guys are not blowing up and, hey, that's a positive," says Anton Schutz, fund manager for the Burnham Financial Services fund. "These things were priced in early March for absolute disaster and it is definitely not absolute disaster, so that's good." Citi's shares, which had plummeted to a low of 97¢ in early March, fell about 4%, to 3.84 in morning trading.

"While we and the industry face challenges in the coming quarters as we work through the weak economy, we will remain focused on strengthening the Citi franchise," CEO Vikram Pandit said in a release accompanying the earnings. "We will continue to reduce our legacy risk, aggressively manage expenses, and improve efficiency." In March, Pandit bolstered the market and his stock when he told investors that the bank had been profitable for the first two months of the year.

To be sure, Pandit still anticipates a rocky road ahead: Citi's results included $7.3 billion in net credit losses and a net addition of $2.7 billion to their loan loss reserves. That's an indication that Citi—along with others such as JPMorgan, which put $4.2 billion in reserves in the first quarter—is bracing for more losses in consumer credit, from mortgages to credit cards, and corporate loans and commercial real estate. JPMorgan now has $28 billion reserved for losses, while Citi has set aside $32 billion.

Corporate Default Concerns

That has investors such as David James of David James Investment Research in Dayton, Ohio, which has $2 billion under management, still on the sidelines. He's concerned in particular about the level of credit derivatives held by Citi and also the dilution of shares spurred by the bank's need to issue preferred stock in exchange for government funding. "They've increased revenues and decreased expenses, and that's a good recipe for growth, but we're not seeing good relative strength and profitability," James says. "They've diluted shares by about 5% and that's not a good thing. I'm looking for confidence among insiders to buy back shares. Until then, we're bearish on large financial companies."

The deterioration of corporate loans may be among Citigroup's biggest ongoing challenges. "From the standpoint of nonperforming loans, Citi's results will continue to worsen; I feel very strongly about that," says Joshua Siegel of New York's StoneCastle Partners, which specializes in bank investments and has $3.1 billion under management. "You're going to see massive corporate debt defaults and that will continue to be a major source of problems."

The formula for success for Citi and all banks is to maintain earnings by keeping margins up and growing faster than the pace of oncoming losses. That effort will continue to be bolstered by massive liquidity and stimulus that the Federal Reserve and the Treasury are pumping into the banking system. "This is a much better quarter for banks and bank stocks," says Colyer of Advisors Asset Management. "But what is interesting is that we've never applied this kind of stimulus in the history of the U.S. One quarter is not a trend, but these are the early indications that the direct investment by the government is working very well."

Der Hovanesian is Banking editor for BusinessWeek in New York.

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