Citigroup’s Earnings: More Fuzzy Math
Posted by Larry Doyle on April 18, 2009 9:21 AM |
In reviewing bank earnings this week, I truly get the sense with a number of institutions that they determine just how much they want or need to outperform analyst expectations and then they figure out how to “manage” the books in order to get there.
This “managed earnings” process can be played for an extended period, but ultimately the earnings – or more importantly “hidden losses” – come out in the wash.
Citigroup played this game yesterday. The NY Times reports, After Year of Losses, Citigroup Finds a Profit. I give the Times credit; they did not report that Citigroup generated a profit, but that they found it. Where did they find it? The Times offers:
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.
Citi utilized creative accounting supported by the pressure applied by Congress on the FASB. Where is the pressure applied by the SEC and FINRA on behalf of investors? Isn’t it only fair that somebody speaks up for investors? Is the SEC and FINRA in bed with Congress to “play the game?” Let’s move on.
The top rated banking analyst on the street chimes in:
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.
One accounting tactic banks have used to generate “phantom income” is to mark the value of their debt trading in the market at “current prices.” For example, if Citigroup issued $1 billion in debt at 100 and it is now trading at 80, Citigroup could and does book an increase in “income” of $200 million dollars. No true income is generated because Citi still pays the rate on the debt when it was issued. If the banks want to value debt at current prices, then assets need equal treatment.
The Times reports,
Edward J. Kelly, Citigroup’s financial chief, defended the practice of valuing its bonds at market prices, since it values other investments the same way. The number fluctuates from quarter to quarter. For instance, Citigroup recorded a big loss in the fourth quarter of last year, when the prices of its bonds bounced back.
Kelly’s assertion is inaccurate. The relaxation of the mark-to-market allows Citi and other institutions to mark “so called” impaired assets to market at valuations the bank deems appropriate. If that is a fair process, wouldn’t it also be fair to allow those institutions which own bank debt to also deem the debt as an “impaired asset” and mark it where it deems appropriate? For example, if Citi’s bank debt is trading at 80, but I – as an owner – view that as “impaired,” perhaps I should mark it at 90 for purposes of reporting my income.
As anybody involved in the markets knows, that approach to valuing bank debt for an investor would be palpably absurd. In the same vein, allowing banks to mark their assets at valuations they deem appropriate is equally absurd.
I would propose that bank analysts must now not only review earnings but, given these “games” being played by the banks, the analysts should also grade the integrity of the earnings based upon transparency and quality.
Fool me once, shame on you. Fool me twice, shame on me.