Story updated with comments from the Citigroup conference call.

  • Citigroup reports fourth-quarter profit of $1.2 billion or 38 cents a share.
  • Excluding CVA/DVA and repositioning charges, Citi posted an EPS of 69 cents. Analysts expected 96 cents per share, according to consensus estimates available at Thomson Reuters
  • Net revenue came in at $ 18.2 billion or $18.7 billion excluding CVA/DVA, against estimates of $18.81 billion.
  • Bank reported profit of $ 7.5 billion in 2012, on revenues of $70.2 billion.
  • Newly appointed-CEO Mike Corbat sayes operating environment remains challenging.

NEW YORK ( TheStreet) -- Citigroup ( C - Get Report) missed expectations significantly in the fourth quarter, as higher-than-expected legal expenses and lower reserve releases hurt profit.

The third largest U.S. bank reported fourth-quarter profit of $1.2 billion on sales of $18.2 billion.

The results include a previously announced $1 billion restructuring charge and accounting losses from the changing value of Citigroup bonds(CVA/DVA loss) of $485 million.

Excluding items, Citi posted an operating profit of $2.2 billion or 69 cents per share, up 68% over the previous year, with adjusted revenues coming in at $18.7 billion. Analysts, however, expected an adjusted earnings per share of 96 cents and revenues of $18.81 billion.

This is the first earnings report under the new CEO Michael Corbat, who has, so far, impressed analysts with a major restructuring program and management overhaul.

"Our bottom line earnings reflect an environment that remains challenging- with businesses working through issues like spread compression and regulatory changes- as well as the costs of putting legacy issues behind us," Corbat said in a statement. "It will take some time to work through the challenges of the current environment but realizing our core earnings potential, as well as improving our returns on assets and tangible equity, are critical goals going forward."

Citi's shares were falling 2% at the open.

The miss seems to have been largely driven by an unexpected rise in legal expenses to $1.3 billion. The bank took a $305 million charge related to the foreclosure settlement with the Federal Reserve announced recently.

Citi has been recording a quarterly rate of about half a billion worth of legal expenses.

In a media conference call, CFO John Gerspach said that the bank was provisioning for expected legal expenses related to its U.S. consumer business. He did not share more details, except to say that the expected liabilities were not unique to Citigroup. He also said it was unrelated to the mortgage business.

Another factor behind the miss was the fact that the bank released only $86 million in reserves, significantly lower than the $1.5 billion in the year-ago quarter.

The bank's North American card business saw lower reserve releases, while Citi Holdings, the bank's non-core arm, saw credit costs increase 14%to $1.2 billion, as the bank booked a loss on loan sales of $100 million, offsetting a reserve release of $49 million.

Net income at Citicorp, the bank's core operating unit, dipped 1% year-on-year to $2.25 billion, while adjusted revenues climbed 9% to $17.62 billion. Securities and Banking revenues excluding CVA/DVA jumped 47%, on strength in investment banking. The bank's restructuring in fixed income trading appears to be paying off. Fixed income trading revenues declined 27% quarter-on-quarter, but was up 58% year-on-year.

Global consumer banking revenues rose 4%, while transaction services revenue increased 1%. End of period loans at Citicorp grew 7%.

Operating expenses at Citicorp, however, rose 8% over the year-ago period to $12.2 billion, largely reflecting repositioning charges and higher legal and operating expenses.

Operating expenses will be a closely watched metric in the upcoming quarters as analysts bet that Corbat's restructuring efforts at Citigroup pay off.

In December, shortly after Corbat took over from former CEO Vikram Pandit, Citigroup announced that it would eliminate 11,000 jobs, shut unprofitable branches and exit low return markets such as Pakistan and Romania to improve efficiency across the company.

The repositioning effort is expected to generate expense savings of $900 million in 2013 and $1.1 billion annually in 2014, while dragging revenues by $300 million a year.

Citi Holdings saw net revenue, excluding CVA/DVA, decline 2% to $1 billion. Citi Holdings now accounts for 8% of Citi's total assets. That is down from nearly 40% at the peak in 2008.

The bank's pace of asset sales in Citi Holdings has slowed, as it struggles to dispose assets in bulk without taking a substantial loss.

One potential lever for the bank is releasing reserves against mortgages in its Holdings business, something other banks have already begun doing on signs of a housing recovery. JPMorgan Chase ( JPM), for instance, has said mortgage reserves will have to come down in the coming quarters.

However, Citigroup remains cautious on the housing recovery. CFO Gerspach said during the media conference call that the bank would like to see how Washington resolves the debt ceiling issue and the expenses sequester before concluding that the recent uptick in housing is sustainable. Only then, will they release reserves.

Citi Holdings has $8.5 billion in mortgage reserves against a portfolio of $95 billion. Releasing those reserves would have a dramatic impact on credit costs and profits, according to analysts.

--Written by Shanthi Bharatwaj in New York

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