Citigroup chief financial officer Ned Kelly was trying to explain an aspect
of the bank’s better-than-expected first-quarter results on Friday morning when
star analyst Meredith Whitney interrupted him. “Could you dumb that down for
me?” she asked.
It was the question of the week. Just a few months after the near meltdown
of the financial system, Citi, JPMorgan Chase and Goldman Sachs all
reported billion-dollar-plus profits for the quarter ending March 31. Wells
Fargo, which won’t be releasing its earnings numbers until next
week, preannounced on April 9 that it made about $3 billion — a record for the
firm.
But what does that actually mean, dumbed down Whitney’s question was specifically about Citi’s $1.7 billion in investment-banking profits in
Europe, and Kelly’s eventual answer was basically just that business had
been good. But bank financial statements are never that simple: Citi’s
overall investment-banking earnings were boosted by a $2.5 billion
derivatives valuation adjustment “mainly due to the widening of Citi’s CDS
spreads.” In somewhat dumbed-down but still utterly flummoxing language:
credit-default swap spreads represent the cost of insuring against
Citi’s default. That cost went up in the quarter as investors fretted about
Citi’s solvency, so Citi was able to book $2.5 billion in gains. Got that
Without that boost, Citi’s $1.6 billion in quarterly profit would have been more
than wiped out. As it was, holders of Citi’s common stock still had to take
a $966 million loss because of accounting adjustments related to the planned
conversion of preferred shares owned by the U.S. government and other
investors into common stock. Again, got that
The upshot is that, while the quarter was Citi’s best since mid-2007, it’s
awfully hard to say what it signifies. The chances that the bank might
eventually be able to earn its way out of its troubles without more taxpayer
help seem to have increased. But it will take many more quarters before
anybody can say that with confidence.
The same goes for the country’s big banks as a group. This week’s positive
results, which had been anticipated by a monthlong rally in bank stocks,
are certainly better than last year’s multibillion-dollar losses. But bank
earnings are extremely sensitive to assumptions about the future, and
whether the banks are actually on the road to recovery will depend to a
great extent on how the economy performs in the coming months.
That said, there are a few dumbed-down lessons that can be taken from the
earnings news thus far:
• The demise of competitors is good for profit margins. For the past 40
years, the rise of a shadow banking system of securitization, investment
banks, hedge funds and private-equity firms has taken business from
conventional banks. Now much of that shadow banking system is gone, and the
surviving banks — battered as they may be — are gaining market share in
everything from mortgage lending to investment banking. As Wells Fargo
shareholder and Goldman Sachs bondholder Warren Buffett put it on CNBC in
early March, “This is a great time to be in banking, you know, if you just
get past the past.”
• While mortgage losses show faint signs of moderating, banks still
have a lot of credit-card ugliness to work through. At JPMorgan Chase, card
services was by far the worst-performing division, with a loss of $547
million. When Whitney asked CEO Jamie Dimon if the business would return to
profitability this year, his answer was a succinct “No.” At Citi, “credit-card losses seem to be breaking their historical correlation with
unemployment,” CFO Kelly said. That is, credit-card losses normally rise with
the unemployment rate. Now they’re rising faster.
• It’s nice to forget December. Investment banks traditionally end their
fiscal year in November, commercial banks in December. Since Goldman
Sachs and Morgan Stanley shifted to commercial-bank status late last year,
they decided to shift their fiscal years starting this year. In doing
so, they orphaned the month of December 2008. For Goldman, it was revealed
this week, that meant saying goodbye to $780 million in losses that will
never show up on the bottom line of an earnings report.See pictures of a grocery auction.See TIME’s Pictures of the Week.
