The shadow over Citi’s profit

Citigroup was probably hoping that investors would react jubilantly when it unveiled its first full-year profit since 2007. Instead, its shares were pummeled, falling 6.6 per cent to $4.79, as investors fretted about the bank’s earnings outlook.

The bank’s management had reason to be “very pleased” with the results. The bank’s full-year profit of $US10.6 billion represented a dramatic comeback for the group, which limped in with an $1.6 billion loss in 2009, following the dismal $18 billion loss the year before. It is, in fact, the first time the bank announced a full-year profit since its current boss Vikram Pandit was appointed in 2007.

The main reason for the bank’s profit turnaround has been the steep decline in problem loans, particularly in the consumer area of home loans and credit cards. in 2010, Citigroup’s losses from bad loans totalled $30.8 billion, down from $42.2 billion the previous year.

The bank – which was one of the major casualties of the global financial crisis requiring a taxpayer bailout of $45 billion – is now hoping to lay the nightmare experience to rest. Last month, the US Treasury sold off its remaining stake in the company, recording a gross profit of $12 billion on the investment.but the sceptical reaction of investors to Citigroup’s latest results suggest that the bank won’t be able to cast off its problems quite so easily. Investors were disappointed that the bank’s earnings weren’t more robust in the final three months of the year. as a result, the group’s full year revenue in 2010 fell 5 per cent to $86.6 billion, from $91.1 billion in 2009.

And some investors worry that problems lying ahead for consumers could see Citigroup’s problem loans start rising again.

They point out that a rebound in consumer spending – combined with a spike in inventory investment – was responsible for the pick-up in US economic activity in the second half of 2010.

But with real wages treading water, consumers were only able to finance their increased spending by running down their savings. as a result, the personal savings rate dropped to 5.3 per cent in November last year, from 6.3 per cent four months earlier.

Looking forward, it’s extremely difficult to see US consumers continuing with this pattern, particularly as unemployment remains stubbornly high, and job insecurity is widespread. if consumer spending – which accounts for just over 70 per cent of US GDP – were to drop back, activity in the US economy would again slacken.

At the same time, US households are facing mounting financial problems. House prices are again falling, under the combined pressure of the rising mortgage rates and a continuing build-up in the inventory of unsold homes overhanging the market.

At the same time, consumers are finding that higher food and energy bills are straining their wallets, particularly as real wage levels are stagnant.

And although the deal between US President Barack Obama and Congress has meant that the Bush tax cuts have been extended for a further two years, consumers face a tax slug from higher state and local taxes. Many local authorities have significantly underfunded their pension schemes, and must either cut employee numbers, reduce spending or raise taxes in order to remain solvent. At the same time, worries that some state and local governments will declare bankruptcy has resulted in a sharp increase in municipal bond yields, which has pushed up borrowing costs for most local and state governments.

And if US consumers start to come under financial pressure, Citigroup is likely to find its bad debts – particularly in the home and credit card lending areas – start to rise once more.

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