Citi's $1.6 billion profit from $2.5 billion accounting trick in 1st quarter '09

Citi's $1.6 billion profit based on $2.5 billion accounting trick

Posted Apr 17th 2009 8:22AM by Peter Cohan
Filed under: Earnings reports, Citigroup Inc. (C)

Today we have another example of why it is such a huge mistake to let companies write their own report cards. That's right folks, Citigroup, Inc. (NYSE: C) reported a $1.6 billion profit for the first quarter of 2009. Doesn't this sound great? It sure does until you take two seconds to realize that the profit would have been a $900 million loss were it not for a $2.5 billion accounting trick.

What accounting trick? I could not believe my eyes when I read it but it turns out that Citi was able to take to a $2.5 billion gain on a rule that lets it record any declines in the market value of its debt as an unrealized gain. The rule, which Citi adopted in 2007, 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. But Citi didn't do that -- this has to be some kind of an error.

How could an accounting rule allow a company to record a decline in the market value of its debt as a gain? Does this mean that Citi got $2.5 billion in cash because it owes less to its lenders based on a temporary decline in the value of its debt? Are accounting rules letting Citi record a profit for getting less and less attractive to lenders? This rule makes no sense to me.

And there should be a rule that forces Citi to take a loss for a decline in the market value of its assets too. But thanks to FAS 157-e, it can record any gain it wants on the value of its toxic waste -- and I would not be surprised if Citi did just that in the first quarter.

On a real-world level, there was a mix of bad and good news in the report. Bad loans boomed. Net credit losses in Citi's North American credit card division rose 81% from 2008. Citi's total credit costs were $10.3 billion during the quarter, up 76% from a year ago.

But expenses fell -- Citi's operating expenses dropped 23% from the first quarter of 2008 with 13,000 fewer employees, to 309,000 since the fourth quarter 2008. And like its peers, Citi benefited from strong fixed-income trading results -- its investment banking and trading businesses reported net income of $2.8 billion.

Overall, Citi's "profit" did not translate to shareholders -- it reported a loss of 18 cents a share, reflecting the conversion price of a $12.5 billion preferred share offering from January 2008.

But the market expected worse and Citi stock is up 12% in pre-market. I should be happy but I don't trust the numbers when I realize that Citi's executive pay is tied to its use of accounting gimmicks.