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Citigroup trading drop shows revival obstacles

NEW YORK (Reuters) - A steep drop in bond trading revenue pushed Citigroup Inc's C.N fourth-quarter profit far below expectations, casting doubt over Chief Executive Vikram Pandit's claim that the bank had "turned the corner."

While Citi posted its first full-year profit since 2007, the poor fixed income results left Pandit and other top executives facing myriad questions about what had gone so wrong at the bank, which only survived the financial crisis thanks to a massive taxpayer bailout.

The bottom line result -- 4 cents a share, or 50 percent less than what analysts were expecting -- stoked concern that the bank has yet to resolve the operational weaknesses that have plagued it for years.

Shares of the No. 3 U.S. bank -- which have rallied strongly over the past year as the U.S. government gradually sold off its stake in the bank -- closed down 6.4 percent at $4.80 on Tuesday.

The bank's fixed-income revenue alone dropped 58 percent from the third quarter -- compared to a 7.9 percent drop at larger rival JPMorgan Chase & Co JPM.N, which reported its fourth-quarter earnings on Friday. The two banks' divergent trading results left investors uncertain of what to expect as other financial firms report earnings this week.

“When your earnings are close to zero, everything is under scrutiny,” said Lee Kyriacou, a former banker and a partner at the consulting firm Novantas.

Trading is “a volatile area” across the banking industry, “but at this particular stage of your recovery, your earnings are not negative, but they’re barely positive, so that matters,” he said.

Trading revenues were hit in part by an accounting adjustment stemming from a market perception that Citi debt was less risky, but the results pointed to fundamental weaknesses as well.

“This was one of the weaker quarters for trading,” Chief Financial Officer John Gerspach told reporters in a conference call, acknowledging Citi’s investment bank has also struggled in other areas like the M&A league tables, where Citi fell to eighth place from fourth in Thomson Reuters’ rankings.

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But he argued that trading results tend to ebb and flow, adding that “one quarter doesn’t make a trend.” Gerspach also forecast that “key hires” made in 2010 would boost securities and trading performance in 2011.

He also said the poor performance had come despite relatively strong volumes at the investment bank, run by longtime Pandit adviser John Havens. James Forese oversees that unit’s trading operations as co-head of global markets, including fixed-income, equities and commodities.

Investors suggested that Citigroup, which only shed the last of the government’s stake in December, may have been less willing to take on risks in bond trading than stronger rival JPMorgan.

“These are two different companies here, and when it comes to risk-appetite, JPMorgan’s taking share. Citi’s trying to grow internationally, but they’re (also) still trying to fix the problems” of the financial crisis, said Alan Villalon, an analyst at Nuveen Asset Management, in Minneapolis.

And fixed-income “is not the easiest business to run. Even Goldman has messed up in this space, it’s not just ‘ride the tide’,” he said, adding that Citigroup “has lost a lot of people” over the past few years.

Villalon was still optimistic about Citigroup's long-term outlook on Tuesday, but the weak trading volumes unsettled other investors. They had been reassured by the slight drop at JPMorgan, ahead of other big bank earnings later this week including Goldman Sachs Group Inc GS.N on Wednesday, Morgan Stanley MS.N on Thursday and Bank of America Corp BAC.N on Friday.

Bank of America shares closed down 1.6 percent and the KBW Bank index .BKX fell 1.2 percent.

Citigroup, which took $45 billion in U.S. bailout funds during the financial crisis, reported a net profit of $1.3 billion, or 4 cents per share, for the fourth quarter. The EPS was 50 percent below what analysts had expected, according to Thomson Reuters I/B/E/S.

A Citibank sign on a bank branch in midtown Manhattan, New York, November 17, 2010. Citigroup Inc plans to spend $3 billion to $4 billion on its consumer bank to attract more business from its wealthy, urban customers, the head of its North American consumer bank said on Wednesday. REUTERS/Mike Segar

The bank’s fourth consecutive quarterly profit compared to a year-earlier loss of $7.6 billion, or 33 cents per share. That loss was mostly caused by the costs associated with repaying the government under the Troubled Asset Relief Program.

Citigroup took a $1.1 billion hit to results, before taxes, because of a credit value adjustment. That adjustment -- which Gerspach said accelerated after the government finished selling its Citi stake -- is due to the bond market’s perception that Citi’s credit quality improved during the quarter.

Under accounting rules, that improvement forces the bank to take charges because its liabilities are worth more in theory.

“Most people are still a little shell-shocked on this kind of accounting,” Gerspach said.

TURNING THE CORNER?

Pandit has sold assets, cut staff and tried to focus Citigroup on its main businesses, including investment banking and retail banking for affluent customers globally. But the results show that his overhaul remains a work in progress.

In a memo to employees, Pandit predicted that 2010 would be remembered as “the year Citi turned the corner.”

The Citi CEO, who has earned $1 in salary for each of the last two years but is due for a raise in 2011, also got a vote of confidence from prominent investor Prince Alwaleed bin Talal, who congratulated Pandit by phone on the bank's net profit of $10.6 billion in 2010, Alwaleed's Kingdom Holding Co 4280.SE said in a statement.

Citigroup released about $2.3 billion in reserves for bad loans, mainly due to an improvement in the store credit cards business it has put up for sale.

But a slump in Citigroup’s securities and trading unit hurt revenues, which fell 6 percent on a managed basis from the third quarter to $18.4 billion and were also substantially below analysts’ forecast of $20.4 billion.

It remained unclear why Citigroup’s trading revenues were so poor. Despite repeated questions from investors and reporters during two conference calls on Tuesday, Gerspach and Pandit provided little additional explanation, though Pandit said that bonds constitute a larger portion of its trading business than at some other banks because Citi has smaller equity and commodities businesses.

Gerspach said that excluding the “credit value adjustment” related to narrowing spreads, he was not sure the bank falls “outside the band” of the rest of the industry or that the bank’s trading was more volatile than other banks’.

There was “no indication that there is anything systemic” in the trading results, he added.

The bank has had a relatively small proprietary trading business, even before a new U.S. law this year restricting the degree to which banks can bet with their own capital. Gerspach said during the investor call that the small proprietary trading desk in Citigroup’s equities unit “virtually generated no revenues in the fourth quarter,” down from $150 million in the third quarter.

Through Friday, when they hit a 52-week high of $5.15, Citi’s shares had surged 55 percent since the beginning of 2010, substantially outperforming the overall banking sector.

Reporting by Maria Aspan; additional reporting by Dan Wilchins; Editing by Dave Zimmerman

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