"Our results this quarter reflect the strength of Citi's franchise and we are pleased with our performance." (link)
Citigroup CEO Vikram Pandit


Is there a holiday equivalent to the fortuitous effects of fair value accounting? If so it would have, perhaps, "smoothed out" the derived (dis)pleasure of my Easter break and eliminated the aggravation caused by constant rain, blocked plumbing (and here I pass over the detail), burst pipes and excitable house-bound children in the middle of an isolated French forest.

Citi is suffering the financial parallel of such an experience - yet it is hard to see the distress in their latest quarterly earnings as reported by Bloomberg: $1.6bn of net income! Great Recession? What Great Recession? And the quality of those earnings must be good for Citi say in their statement that:

"The adoption of the changes to FAS 157 had no impact on Citi's financial results."

Fair value accounting and FAS 157 caused, of course, a few ripples earlier this month and even featured here. Citi said at the time it would have no impact and so it has proved - the Good Guys would not stoop to abuse the latitude the new guidance provided for in accounting for toxic assets. Very reassuring - even if the $4.7bn of trading income Citi scored could not exactly be called the solid, low risk, recurring revenue a banking giant requires to sustain itself.

And yet the Bloomberg piece also refers to $2.5bn of mysterious "unrealized" earnings booked by Citi from:

"accounting rules that allows companies to profit when their own creditworthiness declines"

These paper gains reflect increases in the worth of derivative insurance against declines in the value of Citi's own debt and are termed CVA's in the Citi statement. Or more helpfully (maybe) "credit value adjustments". The accounting directive referred to by Bloomberg is, presumably, FAS 159. Which is another one of the Financial Accounting Standard Board's "fair value" statements (surprised?). While its objective:

"to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions."

is reasonable - and the effects can cut both ways - when the bottom line impact equals 156% of net earnings, as it does in Citigroup's case, it is surely questionable whether the statement is truly serving its purpose.

But at least it does, as Mr Pandit states, reflect the true "strength" of the Citigroup franchise.

NB: FAS 159 is the election to use fair value methods on assets AND liabilities; FAS 157 is the guidance on how this should be done. Citi adopted FAS 157 on January 1 2008 (having alread made the FAS 159 election). The statement that the relaxation of FAS 157 would have no offect on the latest results may suggest that there was already enough margin in the deterioration of Citi's liability side (the $2.5bn) to defer use of the softer FAS 157 until a later date.

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