Exactly how well capitalized is Citigroup (C)?
That’s a question that the Financial Times raised on September 7. The answer, the paper reported, depends on not so much on who’s counting the beans, but on who’s deciding what beans count.
At issue is something called deferred tax assets. A deferred tax asset basically is a loss in the past that can be used in the future to offset taxes. And Citigroup, after pretax losses of more than $60 billion in 2008 and 2009, has a lot of deferred tax assets on its books. About $50 billion of them.
Current accounting rules say a bank can count its deferred tax assets as capital (Hey, don’t ask me how losses can be capital, but that’s what the rules say)—if the bank is confident that will earn $99 billion in taxable income in the next two decades.
And that’s the issue.
Citigroup says, No sweat. The bank points out that it had annual pre-tax profits of $20 annually from 2002-2006.
Some accountants, Wall Street analysts, and even the Securities & Exchange Commission (SEC) aren’t so sure. They say projections are fine and dandy but that Citigroup ought to be creating reserves against the possibility that, in the current global financial uncertainty, the bank won’t record the necessary level of profits. The SEC asked the bank to explain its treatment of deferred tax assets last year. And, as is SEC policy, the agency isn’t talking about whether it still has questions or is satisfied.
The question comes at a very awkward time for Citigroup.The biggest U.S. banks are finally seeing their need to add new reserves to capital against bad loans decline. If bad loans decline enough, banks will go from having to take money out of earnings to put into reserves to taking money out of reserves and adding it to earnings. The switch will have a dramatic effect on bank profits and losses and that effect is being felt right now and should accelerate in the rest of 2010.
Any autumn rally in bank stocks will be based at least partly on this shift in reserves.
I think you can count on that shift adding to assets at big banks such as JPMorgan Chase (JPM) and Bank of America (BAC).
At Citigroup you can probably count on that shift—but it’s not quite as certain as with other big banks. And that makes Citigroup just a little bit more of a gamble.