Just shows you should never believe the headlines when it comes to quarterly earnings—especially for banks right now.

According to the headline numbers, third quarter earnings at Citigroup (C) climbed by 74% to $3.8 billion. The headline number put Citigroup’s earnings per share at a huge $1.23. So according to the headlines, Citigroup killed this quarter since Wall Street had been projecting that the bank would earn just 82 cents a share for the period.

Just one tiny problem—the headlines are misleading big time. $1.9 billion of the bank’s $3.8 billion in earnings this quarter are due to a very quirky accounting gain. I say quirky because the $1.9 billion is the result of a decline in the bank’s credit quality. When a bank’s credit quality declines, accounting rules say the bank should revalue the debt that it owes its creditors. The theory is that debt is now worth less because the bank’s creditors think there’s a greater chance that the bank will default. The effect is that as a bank’s credit rating–as expressed in the market for credit default swaps—drops, the bank gets to record a big accounting gain on its debt. That’s where $1.9 billion in Citigroup’s earnings came from this quarter.

Of course that $1.9 billion gain is all on paper. Read more

Big U.S. banks are leading the U.S. stock market down today.

The driver here isn’t simply the prospect of slower economic growth represented by the lack of any job growth in August data released today—although that certainly doesn’t help.

Bank stocks are reeling because the big U.S. mortgage lenders and mortgage packagers are reportedly facing a suit be filed next week from the Federal Home Finance Administration, the agency that represents Fannie Mae and Freddie Mac, seeking to force these financial companies to repurchase bad mortgages. The amounts at stake, and it’s extremely hard to put a dollar figure on this suit, could dwarf the $20 billion sought in a suit brought by the nation’s states attorneys general. Fannie Mae and Freddie Mac own about $227 billion of the so-called private label mortgages that are the subject of this suit. (Bank of America probably faces the biggest exposure since it sold the most of these private label mortgages to Fannie Mae and Freddie Mac.)

No surprise then that Bank of America (BAC) was down 8.7% as of 3:30 p.m. New York time, JPMorgan Chase (JPM) 4.7%, Goldman Sachs Group (GS) 5%, Citigroup (C) 5.1%, and Wells Fargo 4.5%.

The suit would be the result of 64 subpoenas issued last year to originators and servicers of mortgage-backed securities. The statute of limitations is due to expire next week so the Federal Home Finance Administration has to file or forever hold its piece.

The subpoenas and the likely suit focus on so-called private label mortgage-backed securities originated by mortgage lenders, packaged by Wall Street investment companies, and then sold to investors. Fannie Mae and Freddie Mac were permitted to buy slices of these securities that carried AAA ratings. As of the end of July, the two companies, now owned by taxpayers, held nearly $78 billion and $149 billion in such securities.

Private label mortgage-backed securities have been among the worst performing mortgage-backed assets, showing the kind of losses nobody expects from AAA-rated securities. The likely suit would allege that the banks in question misrepresented the content of the mortgage pools when they packaged them and sold them to Fannie Mae and Freddie Mac. Testimony in front of the Financial Crisis Inquiry Commission showed that a large percentages of mortgages included in mortgage-backed securities deals had received inadequate due diligence and that the big Wall Street investment companies ignored those problems and packaged them in the mortgage pools anyway.

A suit from the Federal Housing Finance Agency would be a nightmare for the big mortgage banks not just because of the sums involved, but because it would also pretty much blow up all other efforts to put together settlements that would cap bank liabilities. Forget about the proposed settlement with state attorneys—a settlement already in danger. And it would almost certainly bring other investors into court demanding that banks buy back their mortgage paper too.

But the effects don’t stop there. Read more

Like other U.S. banks Citigroup is having trouble generating revenue growth from banking

“Citi achieved another solid quarter of operating performance as we continue to execute our strategy,” Citigroup (C) CEO Vikram Pandit said on Friday, July 15, as the bank released its second quarter earnings report.

Huh? Vikram and I must have read different quarterly reports. The one I saw showed a bank that still hasn’t been able to generate any significant revenue growth in its home market and that is seeing earnings grow only because its reserves for bad debt are falling.

I do see one bright spot in Citigroup’s international business, but I sure don’t see a “solid quarter of operating performance.” But rather than engaging in a battle of the spin, let’s look at the numbers that the bank reported. Read more

Looks like a tough earnings season ahead for the biggest U.S. banks

Investors won’t get their next dose of bank earnings reports until JPMorgan Chase releases second quarter earnings on July 14, but earnings season is already looking awfully iffy for the big U.S. trading banks.

Trading revenues are forecast to fall again for the quarter. That would mark the fifth straight quarterly year-over-year drop.

Revenue from fixed income trading at U.S. banks will fall 30% from the first quarter, according to a report from Citigroup this week. Revenue from equity trading will drop by 15%. Total trading revenue at the five biggest Wall Street banks–Goldman Sachs (GS), JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Morgan Stanley (MS)–may drop 4.4% in the second quarter of 2011 from the second quarter of 2011, and 17% from the first quarter of 2011, according to a report by Oppenheimer & Co. Trading accounted for almost a quarter of these bank’s revenues last year.

Analysts have been busy cutting their earnings estimates for the group–according to Bloomberg, seven analysts have cut their earnings estimates for Goldman Sachs and Morgan Stanley, for instance, in the last four weeks. So the question for earnings season will be have the stocks fallen so much—10% or more since March 31—and have estimates come down so much, that bank shares will actually rally on just the expected degree of bad news.

In an earlier quarter—say the last quarter of 2010—I would have voted for “Rally on the bad news.” But I think that’s unlikely this quarter.

Why? Read more

I’m suggesting that you think about lightening up on your exposure to financials. I don’t think you need to sell all your bank stocks, but the sector is showing signs of breaking down with another 10% drop in the cards. The sector showed a decent little bounce yesterday on JPMorgan Chase (JPM) CEO Jamie Dimon’s presentation at the company’s shareholder meeting, but it’s back on the downside again today.

The question is not just whether to sell, but also what to sell. Today I’m selling Citigroup (C) out of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/

Another 10% correction in this sector isn’t so big a correction that investors can’t sit still through it. But what troubles me is the good possibility that some of the biggest names in this sector aren’t going much of anywhere very quickly when the correction is over. Read more