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We knew bank earnings wouldn’t be good. Analysts have cut their estimates for Citigroup (NYSE:C) several times over the last month, by an average of about 20%. So maybe it’s a good sign that Citi beat expectations handily, reporting $1.23 in earnings on sales of $20.83 billion vs. expectations of $0.81 a share from $19.24 billion.
Those number sound like a blowout. But you’ll also notice the stock didn’t move very much in the pre-market. And there are reasons for that. For one, Citi’s 3Q earnings included $1.9 billion in what’s called "credit valuation adjustment."
Credit valuation adjustments are one of the more absurd accounting rule changes the Treasury enacted to help banks improve their balance sheets and return to profitability. Basically, the credit valuation adjustment means the bank can count lower prices for credit default swaps as a profit. So if Citi sold credit swaps, and the price has fallen, then it’s assumed that Citi can buy the swaps back and show a profit. And whether or not Citi actually buys them back, they can count the paper profit as an actual profit.
I know it sounds crazy to allow this to be counted as earnings. If it were simply a benefit to the balance sheet, that would be fine. But clearly, counting a profit that hasn’t actually been taken is all kinds of dangerous. Interestingly, banks can also treat their bonds this way. Banks can sell bonds and, if the price of those bonds declines, they can count the difference as a profit, on the assumption that they could buy them back cheaper.
Accounting gimmicks like these might help the banks look better. But investors know that it’s not real earnings. The numbers are an illusion. Lose the credit valuation adjustment, and Citi’s revenues were down 8% year over year. Fixed income revenue was down 33% to $2.3 billion and investment banking revenue was down 21% to $736 million.
Those aren’t good numbers. It’s clear the new financial regulations are having an impact (no wonder Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) want to ditch the bank holding company designation). But also, the weak economy, and European uncertainty are having an effect on the banks, too.
And speaking of Europe, let’s all thank German Chancellor Merkel for this gem: "…dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled…[The search for an end to the crisis] surely extends well into next year."
The "dreams" she’s referring to are that Europe might have a solid proposal for Greek debt forgiveness and bank recapitalization by October 23. Apparently that’s not going to happen.
We’ve been through a 2-week cycle of hope on the European situation. We could be entering a period of pessimism. And I’m not sure good earnings can overcome Europe. Fortunately, G-20 leaders are increasing the pressure on Europe, demanding a final response in one week’s time. We’ll see…
I was thinking over the weekend that I haven’t talked about oil enough lately. And then this morning, I’m greeted by the news that Norway’s Statoil is buying out my favorite Bakken oil play, Brigham Exploration (Nasdaq:BEXP) for a 20% premium. Brigham has been in the $100k Portfolio since $18.90. $100K subscribers will profit around 90% on this stock.
If you want to see what else I’m buying, and how I’m growing my personal investment portfolio, just click HERE.
Brigham wasn’t the only energy acquisition. Kinder Morgan (NYSE:KMP) is buying out El-Paso (NYSE:EP) for $21 billion. This deal is about natural gas. And given that both stocks are up, it’s clear the market likes the deal. I know a lot of people have been burned trying to call bottom for natural gas prices. But when companies make acquisitions in a space with weak pricing, you have to wonder if maybe prices are near a bottom.
Write me anytime: [email protected]
Until tomorrow,
Ian Wyatt
Editor
Daily Profit