Citi posts higher earnings but warns on growth

Citigroup Inc reported higher quarterly earnings, helped by an accounting gain, but warned that developed markets could face weak growth for years, and the bank's shares fell.

The results were better than expected, but the bank's shares shrugged off early strength and ended the day lower amid broader concerns about the industry's future profitability. Wells Fargo & Co posted a steep drop in lending margins on Monday.

When you look at the (accounting gain) and the loan loss reserve releases, those stick out like sore thumbs, said Matt McCormick, portfolio manager with Bahl & Gaynor Investment Counsel. Investors are saying they like banks to beat expectations, just they don't like how Citi did it.

Like its rivals, Citigroup was hit by the European debt crisis and the sluggish U.S. economy. Investment banking fees dropped and its loan book fell 2 percent. Operating expenses rose, in part because of investments made to boost its business.

Chief Executive Vikram Pandit is trying to turn the bank around after the financial crisis by focusing on emerging markets, where economies are still growing relatively quickly. The weak U.S. economy also weighed on results at JPMorgan Chase & Co last week.

In the developed markets, growth is likely to be slow for years, Pandit said in a conference call with analysts.

He also said the U.S. housing market remains the greatest risk that domestic banks face.

Chief Financial Officer John Gerspach said the bank's net interest margin is expected to decline by a few hundredths of a percentage point every quarter for the next few quarters, if the bank does not make a significant portfolio sale.

Growth in the developed markets is weak, but the emerging markets, which have fueled much of Citigroup's profit gains in recent quarters, showed early signs of sputtering. For example, retail loan volume in Latin America dropped 7 percent in the third quarter from the second quarter.

Citigroup, the third-largest U.S. bank by assets, reported net income of $3.77 billion, or $1.23 per share, up from $2.17 billion or 72 cents per share a year earlier.

The latest results included a pretax gain of $1.9 billion, or 39 cents per share after taxes, due to the bank's widening credit spreads during the quarter. When a bank's debt weakens relative to U.S. Treasuries, it can record an accounting gain because it could theoretically profit from buying back debt.

Excluding that gain, Citi earned $2.6 billion, or 84 cents per share.

Analysts' average forecast was 81 cents per share, according to Thomson Reuters I/B/E/S.

After rising by as much as 3.8 percent in the morning, Citi shares changed course and ended 1.7 percent lower on the day at $27.93.

The bank's share price has fallen about 40 percent this year, in line with declines for other large banks.

IMPROVING CREDIT

Citi, which received three U.S. government rescues at the height of the financial crisis, is seeing its problem loan portfolio shrink.

Nonaccrual loans fell to $7.95 billion in the third quarter from $12.46 billion a year earlier.

As part of the improving credit picture, Citi also announced plans to move its retail partner card business from Citi Holdings, the unit where the bank keeps assets and operations it is shedding, into Citicorp, where it houses its main continuing businesses.

Citigroup had been looking to sell the unit -- which includes $42 billion in credit card loans -- after forming Citi Holdings in 2009.

But CFO Gerspach said the business now makes sense with Citigroup's on-going business, as the portfolio is now markedly different than in 2008 and 2009 at the height of the financial crisis.

We figured out how retail partner cards fit the broader payment strategy for U.S. consumer, Gerspach said. The bank has no plans to take its OneMain Financial business into its Citicorp unit, he added, because it is not as good a strategic fit.

OneMain makes consumer loans, typically to less-wealthy borrowers, while Citigroup is focusing its retail businesses on higher-income consumers globally.

A tough dealmaking market may also be contributing to the card unit's move.

Gerspach said the current market environment is a bit daunting for selling large loan portfolios.

INVESTMENT BANKING HIT

Like JPMorgan, Citigroup's investment banking business was hurt when European market turmoil made companies reluctant to buy competitors or issue securities.

Revenue at Citi's continuing securities and banking business fell 12 percent excluding the debt value adjustment, to $4.84 billion.

Overall operating expenses rose 8 percent from a year earlier. Operating expenses were $12.46 billion and have been hovering around that level since the fourth quarter of 2010. From the beginning of 2009 through the third quarter of 2010, quarterly operating expenses were typically closer to $11.9 billion.

(Reporting by Joe Rauch in Charlotte, N.C.; editing by Gerald E. McCormick, John Wallace and Matthew Lewis)