NEW YORK (
investors and analysts are narrowing their focus on the bank's massive deferred tax asset (DTA), which is growing despite three consecutive years of profits.
The DTA reflects losses and other deductions that get converted to tax credits. However, Citigroup must generate sufficient profits to make use of the credits before they expire, an issue causing anxiety among some followers of the stock.
Citigroup CFO John Gerspach was asked about the issue by two attendees during a presentation at a conference hosted by Credit Suisse on Tuesday after he noted that $40 billion of the bank's $151 billion in tangible common equity must be used to support the DTA and so cannot be counted for regulatory purposes under the rules known as Basel III.
Neither can the $40 billion be used to generate a return. Citigroup earned a 10.7% return on its remaining $111 billion in tangible common equity in 2012, so if it could have earned that return on the other $40 billion, it could have improved earnings by $4.28 billion.
Gerspach on Tuesday attributed the growth in the DTA to "one-offs" (a euphemism for irregular items that are unlikely to recur), though he gave little indication about when the DTA would begin to come down.
The DTA has grown to $55 billion, up from $38 billion in 2009 and $50 billion in 2010. The fact that it is so large and continues to grow is "very, very troubling," according to Robert Willens, an independent tax consultant who has been critical of Citigroup's tax-related accounting strategies in the wake of the 2008 crisis.
Gerspach attributed the rise to the losses in its Citi Holdings' "bad bank" unit, including an impairment on its stake in wealth-management venture Morgan Stanley Smith Barney, all of which he said added $4.5 billion to the DTA. Tacking on another $1.3 billion was a fourth-quarter "repositioning charge" and an accounting oddity known as a debt valuation adjustment in which a bank's improving creditworthiness actually has a negative impact on earnings.
Gerspach added that "there are elements of the DTA that come about because of actual tax returns that are filed, you can see that mostly in the foreign tax credits, and we'll give you a full rundown of that when we publish the 10K in a couple of weeks, but then there is also a whole series of timing-related issues, and that mostly comes about as a result of reserve movements," according to a transcript of Tuesday's call.
After reviewing the sections of the transcript dealing with the DTA, tax expert Willens said he could make little sense of Gerspach's explanation.
"The only thing I could even remotely comprehend was I think he was trying to explain why the DTA was going up," Willens said.
Willens has argued in the past that Citigroup should reduce the DTA through what is known as a valuation allowance. Companies are supposed to record a valuation allowance instead of a DTA when they believe there is a less than 50% chance they will be able to make use of the tax credits. If the likelihood improves, they can always convert the valuation allowance into a DTA. Willens argues regulators may eventually force Citigroup to reduce the size of its DTA on the expectation that the bank won't be profitable enough to use it before it expires.
Informed of Willens' continued criticism of Citigroup's accounting, a Citigroup spokeswoman responded with an emailed statement.
"As we've noted in regulatory disclosures, Citi's DTA is based on enacted tax laws and rates. Citi believes that the realization of the recognized net DTA is more likely than not based upon expectations of future taxable income in the jurisdictions in which the DTAs arise and available tax planning strategies, including asset sales, that would be implemented to prevent the carry-forward from expiring. Accounting rules would not allow for an adjustment to the DTA unless there is a change in this position and its underlying support," the statement read.
Investors and analysts who follow Citigroup are increasingly sympathetic to this view. CLSA analyst Mike Mayo, for example,
. While he had been an outspoken critic of Citigroup's decision not to take a valuation allowance, he called that "water under the bridge" in a January conference call where he and Willens discussed the DTA with investors.
Instead of continuing to criticize the bank, Mayo has turned his focus to how Citigroup can unlock the value of the DTA. Hypotheses floated during his January call were the sale or partial flotation of Banamex, Citigroup's highly prized Mexican unit.
"They've given no indication of that; this is just us trying to figure out what might be some appreciated assets," Mayo said. Citigroup has considered the sale of Banamex in the past, according to 2009 reports by
The Wall Street Journal
that cited unnamed sources.
Citigroup bulls would be happiest if the bank could make use of its DTA through earnings, and Credit Suisse analyst Moshe Orenbuch argued in a note following Tuesday's presentation by Gerspach that Citi "is better positioned to utilize its DTA in 2013."
The analyst says improved earnings in Citigroup's U.S. credit card business and "a drawdown of loan-loss reserves on the North America mortgage portfolio in Citi Holdings (leading to improved earnings) would likely be the largest drivers of a future reduction."
Another way Citigroup could accelerate profits to capture the DTA more quickly would be through an acquisition. On the January conference call with Mayo, Willens
"Making acquisitions of companies with pretty good streams of taxable income going forward is a tremendous way to utilize DTAs and there are very few impediments in the tax law to prevent that from happening," Willens said.
Despite the tax benefits, a Citigroup acquisition would be a big surprise. The bank has been shrinking ever since the crisis, and most bullish theses focus on cost cuts and capital returns to shareholders. Also, banking regulators might look dimly on Citigroup making an acquisition.
Still, Citigroup watchers do not appear to rule out the idea of an acquisition entirely. Credit Suisse polled attendees at its conference about what they'd like to see the bank do with its excess capital, and it included acquisitions as a possible option. Analyst Orenbuch said during the conference that 60% of respondents voted for a share buyback and 30% wanted to see a dividend increase. He didn't say how many wanted to see the bank make an acquisition.
-- Written by Dan Freed in New York
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