Citigroup Inc was profitable in the first two months of 2009 and is confident about its capital strength after tough internal stress tests, Chief Executive Vikram Pandit told staff in an open letter.

The news sparked a sharp rise in Citigroup's shares in European trading. It came after the cost of insuring Citi's debt against default hit a record on Monday, and days after shares in Citi, once the world's biggest bank by market capitalization, tumbled below $1 apiece for the first time.

In the letter, Pandit said he was disappointed with Citi's stock price and broad-based misperceptions about our company and its financial position.

We believe our credit spreads are disconnected from our condition and are inconsistent with the government's announcements regarding support for the financial system.

In the note, Citigroup said it was having its best quarter-to-date performance since the third quarter of 2007 -- the last time it made a quarterly net profit.

Revenues excluding externally disclosed marks were $19 billion in January and February alone, almost reaching the $21 billion of the first quarter last year, although Pandit warned market volatility in March could still hit results.

STOPPED LISTENING

The letter said the bank was confident about its capital strength after undertaking stress tests using assumptions that were more pessimistic than those of the U.S. Federal Reserve.

But David Williams, head of European bank research at Fox, Pitt-Kelton, said Citi needed to come cleaner on the tests it had done, and investors had lost faith in both it and peers.

Had you invested in on the back of anything said by these management teams over the last 12 months you would've lost pretty much all of your money. So there is a credibility issue, he told Reuters.

A one-dollar stock price tells you the market has stopped listening.

The market would significantly reward Citi if first-quarter results reflected the letter's upbeat tone, he said.

The New York-based bank has received $45 billion from the taxpayer-funded Troubled Asset Relief Program (TARP), and last month agreed to give the government up to a 36 percent equity stake in the company to bolster its capital base.

Pandit said that deal would leave Citi the strongest capitalized large U.S. bank as measured by tangible common equity (TCE) and Tier 1 ratios.

The emailed letter, a copy of which was earlier obtained by Reuters, was published in a U.S. filing to regulators.

By 1115 GMT (7:15 a.m. EDT) Frankfurt-traded Citigroup shares had jumped 25 percent to 1.03 euros.

Earlier, the Wall Street Journal reported that U.S. officials are examining what fresh steps they may need to take to stabilize Citigroup if its problems mount, citing people familiar with the matter.

Federal officials described the discussions, which are wide-ranging and preliminary, as contingency planning, and no new rescue was imminent, the people told the paper.

(Editing by Hans Peters and Jon Loades-Carter)

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