Citigroup Sustains $2.4 Billion First-Half Currency Hit

Citigroup Inc., the U.S. lender that operates in more than 160 countries, posted a $2.41 billion first-half equity deduction from currency swings, approaching analyst Charles Peabody’s forecast for a year of foreign-exchange pain.

Profit growth, including a 42 percent increase in second-quarter net income, still enabled the New York-based company to boost common equity during the period. Accounting rules require banks to subtract unrealized losses on some assets from shareholder equity instead of from profit.

Peabody, who leads research at Portales Partners LLC, predicted last month that a drop in the value of emerging-market currencies would cost Citigroup $5 billion to $7 billion in regulatory capital this year. The bank said at the time that it hedges against foreign-exchange losses. The capital deduction increased to $1.7 billion in the second quarter from $711 million in the first, according to figures from the company today.

“The currencies that hit us the most this quarter would have been the peso, maybe a little on the Indian rupee, the reais had some impact on us,” Chief Financial Officer John Gerspach said on a conference call with reporters, referring to Mexico’s peso and the plural word for Brazil’s real. “It was fairly widespread.”

Peabody said in an e-mail that he expects losses to accelerate in the second half of this year as the dollar becomes stronger and volatility in Asian currencies increases.

Stock Gains

The Mexican peso slid 4.9 percent against the dollar in the quarter while the the Brazilian real plunged 9.4 percent. The Indian rupee tumbled about 8.6 percent, and the South Korean won fell 2.6 percent. At the current pace, the bank would report the worst translation loss in five years, exceeding the $3.5 billion deficit in 2011.

Peabody’s forecast has been driven by Citigroup’s bigger presence in developing countries than competitors. Non-U.S. markets provide more than half of the firm’s profit.

He’s had a sell rating on Citigroup stock since March 2012, in contrast with peers who predict the company will outperform competitors. The bank has climbed 31 percent this year as of 4:44 p.m., outpacing the 24 percent gain in the 81-company Standard & Poor’s 500 Financials Index.

Because of U.S. accounting rules, currency losses don’t necessarily reduce Citigroup’s reported net income. Instead, they show up in accumulated other comprehensive income, or AOCI, and erode book value, which measures total assets minus liabilities. Under rules proposed by the Basel Committee on Banking Supervision, known as Basel III, Tier 1 common equity will be affected by AOCI gains or losses.

Rising Rates

The bank also sustained a $2.1 billion deduction from equity caused by unrealized losses on securities classified as available for sale. Gains and losses on so-called AFS securities are excluded from net income and instead counted in equity. U.S. banks have been reporting losses on their AFS securities because rising interest rates have eroded the value of their bond portfolios.

A drop in bond values helped cut $6.5 billion from equity at San Francisco-based Wells Fargo & Co. and New York-based JPMorgan Chase & Co., according to reports from those banks last week. Like Citigroup, both banks had enough profit in the quarter to make up for those losses and boost regulatory capital.

$4.18 Billion

Citigroup posted $4.18 billion in second-quarter net income that helped boost common equity, along with a $1.2 billion contribution from changes to the value of pension holdings and cash-flow hedges, the company reported. Common equity rose to $191.6 billion at the end of June from $190.2 billion in March, according to a presentation. The bank’s Basel III Tier 1 common ratio climbed to 10 percent from 9.3 percent.

The increase in regulatory capital and book value was seen as vindication by some analysts who disagreed with Peabody’s concerns about the potential foreign exchange hit.

“The impact of FX and rates on tangible book value turned out to be much ado about nothing,” Chris Kotowski, an analyst with Oppenheimer & Co. in New York who rates Citigroup “outperform,” wrote in a research note today. “We have long maintained that Citigroup has been in many emerging markets for decades, that their revenues and expenses are in local currency and that we don’t think that management gets vastly concerned with the FX translation of the balance sheet on a quarterly basis.”