Citi's Big Quarter in Perspective

Another day, another big first quarter announced by a struggling bank. Citigroup today reported that for the first time in a year, it's turned a profitable quarter with revenue rocketing up 99%, following in the steps of strong earnings from Goldman Sachs and Wells Fargo. The banking industry is indeed showing signs of recovering, but with two enormous caveats. First this is a recovery that is still very much on federal life support. Second, we could be on the verge of another wave of crashing credit.

But first, the happy news. As the New York Times explains, if the runup to Fall 2008 was a perfect storm of crushing credit, we're beginning to see glimmers through the thunderclouds.

Ultralow interest rates have led flocks of consumers to seek deals on mortgage loans. Investment banking and trading activities are enjoying a bounce from the billions of dollars spent to thaw frozen credit markets.

We can argue about the sustainability of Citi's recent rise (and we should), but we can't argue the rise itself. The stock has quadrupled since March (not difficult, perhaps when you're trading a level fit for the Dollar Menu), the $24.8 billion in revenue is basically double what Citi raked in a year ago, and this quarter's profit is about the same amount Bloomberg analysts expected Citi to fall in the first six months of '09. Now about those caveats.

1. Citi is Still an Inpatient. Nobody is forgetting that Citigroup has been the beneficiary of absurd levels of government reconstructive surgery and medicine - three bailouts, including a $45 billion purchase of preferred stock and hundreds of billions of guaranteed assets from the Federal Reserve and FDIC. In addition, the mark-to-market accounting change allowed Citi to rejigger its debt calcuation, resulting in a one-time gain of $2.5 billion. In other words, even with the government's triple bailout, Citi might not have posted a profit this quarter without the eased accounting rules.

2. Another Credit Crunch? Traders still see plenty to worry about. First they note the gaping hole between yields on FDIC-backed versus unbacked bonds, signalling that Citi won't be clamoring Goldman-style for the feds the leave them alone any time soon. Second investors are still left guessing at the health of Citi's mortgage-backed securities. Theoretically, the stress tests could reveal them to be significantly underpriced, as Geithner is hoping. Practically, many of the banks mortgage-backed CDOs - of which Citi was a imprudent glutton - are wilting into thin air. Finally, even if the housing sector does clean up in the next few months, we're only beginning to see the impact of the credit crunch on America's malls, shops and other commercial real estate. Yesterday we brought word that General Growth, the nation's second biggest mall operator, has filed for bankruptcy. Here's the NYT again:

Many banks are preparing for the next rainy stretch, setting aside more money now to cover future loan losses. Regional and community lenders, which are particularly exposed to corporate and real estate loan defaults, are socking away tens of millions of dollars to add to their reserves; big banks like JPMorgan are adding billions.

The big banks announcing historic profits this week are rebuilding their leaky ships with somebody else's wood in a still-falling tide. We're still a ways from profits we can believe in.