Citigroup beats estimates, delays preferred conversion date

Citigroup (C) surprised Wall Street today, reporting a lower than expected loss of 18 cents per share and higher than expected net income of $1.6 billion, further fueling sentiment that a recovery in the banking sector may be underway. Citi reported revenues of $24.8 billion, almost double last year's first quarter performance, citing strong trading and investment banking activity and lower net write-downs in its securities and banking division as the main catalysts. The numbers represent the best quarter for Citi since the second quarter of 2007.

Analysts had expected Citi to lose about 32 cents per share, and a year ago, Citi suffered a loss of more than $5 billion. So what led to the turnaround?

"We have lowered risk and dramatically reduced the problem legacy assets that have caused many of our losses," said Citi CEO Vikram Pandit in a company statement. "We have meaningfully lowered expenses and headcount and improved efficiency. We have also increased our capital base."

During a morning conference call, Citigroup Chief Financial Officer Edward "Ned" Kelly said management would continue to make adjustments to restore the bank to profitability that are contingent upon the current challenging environment. "Our bias has shifted from growth to risk management," he said.

Citi's trading operations and Institutional Clients Group bought in the bulk of its revenues during the quarter as clients traded out of stocks and into fixed income investments, then moved back to stocks as the market rebounded in the first three months. The bank also benefited from investors who were happy to sit on the sidelines as its bank deposits increased $8 billion for the quarter and were up $28 billion year-over-year. And the bank's cost cutting measures that saved $3.7 billion in operating expenses were also a big contributor to the company's success.

Mr. Kelly acknowledged that Citi still faces numerous challenges, indicating that the bank's key concerns were reducing losses within its credit card business, making certain the bank had enough reserves to cover any future losses from its consumer loan and corporate loan units and reducing the more than $101 billion in risky assets that still remain on Citi's balance sheet. He said the bank had made progress in all those areas, but more work had to be done.

Addressing those issues, Mr. Kelly said Citi's consumer nonperforming credit losses came in at about $1 billion, half of what the bank had projected. The bank has more than $24 billion in reserves to cover consumer credit losses and holds 4.4% of the value of its corporate loan porfolio in reserve in case of default, which he said should provide adequate protection. And Mr. Kelly said the bank was moving more of its risky real estate assets into accrual accounts so that they can be held to maturity effectively sheltering the bank from write-downs.

Investors will need to monitor Citi's progress to determine how much exposure to the banking giant they want to have going forward. According to the website Seeking Alpha, Oppenheimer funds recommends that investors should consider moving from Citi's common shares into preferred shares. Citi was expected to announcement a date for its planned exchange of as much as $52.5 billion worth of preferred stock into common stock this morning, but Mr. Kelly said the announcement would be delayed until after the results of the government's financial stress tests on the nation's top 19 banks are concluded.

Investors can profit from the arbitrage between Citi's preferred and common shares, which currently have a conversion price of $3.25. When asked if the bank expected to raise the strike price of the preferred shares before the conversion date, Mr. Kelly said, "We have an agreement with the government and with the private investors....we cannot envision changing the stock price or the conversion ratio." Stay tuned.

Citigroup stock didn't move much on the positive news, in fact by noon, the stock had lost 2 percent, trading at $3.90. The Associated Press reported that Kent Engelke, chief economic strategist at Capital Securities Management, said Citi's stock had already enjoyed a surge as speculators bid its price up over the last two weeks as Goldman Sachs, Wells Fargo and J.P. Morgan Chase reported positive earnings. Investors will have to determine whether Citi's stock price will stay above the $3.25 level or whether changing economic conditions will cause the price to drop prior to whenever Citi announces the date it will convert its preferred shares.

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