The Citi Rally

You may have noticed the market rallied some 6.4% today. Why such a big move? An internal memo from Citigroup CEO Vikram Pandit was made public. In the memo, found here, Vikram extols the solid profitability of Citigroup so far this year. In fact, he says "we are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007". Well, that's good news indeed. If Citi is on the mend, then the governments fixes may be working and/or perhaps the economy is not deteriorating as fast as feared.

Puzzled by such news, I immediately dug deeper. Take a look at this spreadsheet, conveniently put into Adobe PDF for easy viewing. The spreadsheet and data are directly from Citigroup. (You can find all the info here, if you want to get it direct or in other formats.) From the memo, Pandit says:

"In January and February alone, our revenues excluding externally disclosed marks, were $19 billion. During 2008, our full quarterly average for these revenues as adjusted was $21 billion"

Look at the pdf spreadsheet, do you see "average quarterly revenues" working out to $21 billion? Looks to me like the average is more like $13.2 billion. I tried adding back principal transactions and got $18.7 billion. In other words, this number doesn't mean anything in an absolute sense. But Pandit goes on:

"Based on 2008 average quarterly revenues (ex marks) and fourth quarter expense run rate, quarterly pre-tax (PT) pre-provision earnings are $8.3 billion (PT), or $33.3 billion annualized. These PT pre-provision earnings (ex marks) help absorb elevated credit losses, additions to loan loss reserves, and potential marks."

Ok, so let's forget about the fact he didn't give us any useful numbers (at least without digging through volumes of other supplementary data). He predicts $8.3 billion in pre-tax (PT), pre-provision earnings. That's right folks: pre-provision. If you didn't guess, "pre-provision" is before accounting for delinquent loans. This provision was $5.9B in Q1 last year and has been steadily rising as the economy has worsened, as expected. In the 4th quarter, the provision was $12.7 billion. Assuming Pandit's $8.3B is for two months (which isn't entirely clear) and we generously extrapolate this into $12.5B for the quarter, then provisions must be less than last quarter in order to turn a profit unless regular operating expenses (like rent, computers, salaries, etc.) come in much lower than previous quarters. Judging by the spreadsheet, there isn't too much to be cut though.

So, what are the odds that the economy, which is currently deteriorating even faster than 4Q08, will result in fewer loan losses this quarter? In reality, I think the odds are dismal. But provisions are determined not by actual events, but by management's assessment of recent trends. Might the temporary foreclosure moratorium make a plausible case that the provision be lower? It might, but I wouldn't bank on it being a multi-quarter trend.

In short, a desperate Pandit is betting his reputation that the quarter turns out ok. Should he disappoint in coming quarters, you can bet it is the end of his reign at Citi. This news sure doesn't change my outlook.