Citi's Good News: A Cautionary Note

By Mara Der Hovanesian

In the ‘hold on there a minute’ department: Citigroup’s (C) lower-than-expected loss in the first quarter offered a glimmer of hope for the bank and the banking industry, but let’s not ignore that Citi avoided taking some $600 million in revenue hits due to a nifty little change in accounting rules that relate to securities impairments. It will also have to drum up a bunch more capital as a direct result of the government’s stress tests.

The accounting changes related to FAS 157, according to a Citigroup press release, “had no impact on Citi’s financial results.” Some observers beg to differ. David James of James Investment Research says the move was akin to “putting a rug on top of your dirty clothes. It still smells and the mess is still there, it just looks a little better.”

The feds are also conducting stress tests across the industry to see how much of a downturn the banks can withstand given different dire economic outcomes. According to the credit research team at CreditSights in New York, those tests could find that Citi has a capital shortfall of some $47.5 billion. The bank is looking to convert about $52 billion in preferred stock so that will cover the gap.

But the CreditSights analysts are quick to caution that the assumptions about joblessness and other recession metrics that are behind that figure make it a conservative estimate. In a “harsher, severe case” the company’s potential capital shortfall would increase to something like $74 billion.

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