Capital markets trading helped to push Citigroup into unfamiliar territory in the first quarter — the land of profitability. Well, profitability for a firm that has taken $45 billion from the government and now owes so much money on preferred shares dividends that per share earnings swung to a loss.
So on the conference call with CFO Ned Kelly, one analyst asked: What about those bonuses for those traders and investment bankers? Actually, he didn’t use the word bonuses, because no one uses the word bonus in mixed company anymore. He asked about “incentive compensation.”
Kelly snapped back pretty quickly: “We don’t pay based on one quarter.”
The ailing banking giant attributed the big trading gains to “widening spreads” in various instruments, including interest rate products, currencies, and fixed income. In January the markets were turbulent, making for a profitable month for many. Does this mean that the company was raising its risk profile with taxpayer money? “There was no rise in value at risk,” a Citi spokesman said, referring to a controversial measure of risk known simply as VaR. VaR has been blamed in this crisis for making managements across Wall Street too complacent about their risk exposure to the mortgage market and their levels of leverage. VAR provides a snapshot in the moment of risk; but doesn’t reveal weak points in the system in the event of major market disruptions — to wit, Bear Stearns, sub-prime mortgages and Lehman Brothers. I was surprised that the spokesman so casually dropped the VaR as the sine qua non as risk-taking.
For the record, Citi posted $1.59 billion in net income in the first quarter, compared to a $5 billion loss a year earlier and a $17.5 billion loss in the fourth quarter. But per share earnings showed an 18-cent loss because the company needs to pay $1.3 billion (24 cents/share) in dividends to preferred shareholders. In addition, the company took $1.3 billion in cash flow for the anticipated conversion of preferred to common stock. A spokesman said it was too complicated to tease out what the per share “impact” of the conversion price reset would be. Shareholders know, however, to expect dilution to leave them with one-fourth the size of their original stakes.
Citigroup and the other bankers should also offer incentive compensation to the accountants who changed a rule in 2007 that enabled Citicorp to post a $2.5 billion gain because the value of its debt has dropped so dramatically. Bloomberg reports: “Under the rule, companies are allowed to record any declines in the market value of their own debt as an unrealized gain. The rule reflects the possibility that a company could buy back its own debt at a discount, which under traditional accounting methods would result in a profit.”
Sentiment on Wall Street has shifted: Most investors are increasingly willing to find the silver lining in earnings and economic data. But today, after a trio of “good” earnings reports this week from TARP recipients Goldman Sachs, JPMorgan and Citicorp, investors are pausing. They wonder if the profits are fleeting. The bailout firms did a good job trading and Citicorp and JPMorgan each benefited from a quirk in accounting. But Marketplace reports that some have concluded that the “consumer remains strapped.” And with unemployment still high it could be some time before anyone will see profits based on fundamentals.