Tuesday, 16 October 2007

Citi Q3 signals this is not a one quarter event

From marketwatch.com:

Citigroup quarterly profit falls 57%

Citi's (C) third-quarter net income slipped to $2.38 billion or 47 cents a share, down from $5.51 billion or $1.10 a share earned in the same period a year ago.

Analysts polled by Thomson First Call had, on average, expected the financial-services giant to report earnings of 44 cents a share. Citi's quarterly revenue was $22.66 billion, up from $21.42 billion last year.

We all knew the numbers were going to be terrible so no surprise there. The interesting part as I've been saying for a while is the forecast for the 4Q07 and beyond. In that respect management's commentary was very revealing:

"Obviously, we are at a point in the credit cycle that has been difficult for us. It has been -- there is no doubt about it. That may very well impact us as we go into the fourth quarter,"

"We continue to watch credit very closely. Our expectation, based on the acceleration in our mortgage delinquencies in September ... is that consumer credit in the United States will continue to deteriorate in the fourth quarter,"

This is a more negative tone than that given by Citi on October 1st when they made their pre-earnings announcement of a 60% drop in net income but said that they expected the company's business to return to more normal levels in 4Q07. Today was a different story, Gary Crittenden, Citi's chief financial officer, also had this to say:

"We are in a deteriorating credit environment. ... There really is a deterioration happening in mortgages right now,"

This is an interesting statement. What does he mean by 'really?' Did Citi just think it was a bad rumour until they had a look at their 3Q07 accounts?

I believe firmly and have been saying for a number of months that US financials have been operating in an environment that facilitated a period of abnormally high profits that cannot be sustained and that we will see some reversion towards the mean over the next 12 months. That idea is starting to come through in the commentary: Consider this from Citi's Crittenden:

"Many parts of the fixed-income market and many types of investment vehicles such as CDOs have shrunk dramatically, and we're not optimistic that they will regain a foothold in the market.,"

When earnings expectations come down PE's start to expand and the argument that the market is not expensive doesn't wash. As Warren Buffet once said:

"Only when the tide goes out do you discover who's been swimming naked"