Citi's Warning Was Expected; BAC To Follow?

Includes: BAC, C
by: Todd Sullivan

Citigroup (NYSE:C) just announced it expects to report that Q3 earnings will drop about 60% from a year earlier due to "dislocations in the mortgage-backed-securities and credit markets, and deterioration in the consumer-credit environment."

The decline "was driven primarily by weak performance in fixed-income credit-market activities, write-downs in leveraged loan commitments, and increases in consumer-credit costs," CEO Charles Prince said in a statement. They expect a write-down of $1.4 billion pretax, net of underwriting fees, on funded and unfunded highly leveraged finance commitments and expect losses of $1.3 billion pretax, net of hedges, on the value of subprime mortgage-backed securities warehoused for certain securitizations; and $600 million pretax in fixed-income credit trading due to significant market volatility and the disruption of historical pricing relationships.

Citi's announcement follows Swiss banking giant UBS (NYSE:UBS), which on Monday said it will take a 4 billion Swiss franc ($3.4 billion) hit in the third quarter from its subprime mortgage exposure.

This means we can expect a $.42 cent hit to earnings that ought to be in the neighborhood of $.63 cents a share or about $4.10 for the year. That means that even with this hit (that was somewhat expected) Citi still sports a PE of 11 for 2007. In other words, do not expect this news to have too much of an effect on the stock price. We ought to get a selloff early today as the panicky folks bail out, but it will simply be a nice chance to pick up some more shares at discounted prices.

What will be interesting to watch will be if other institutions like Bank of America (NYSE:BAC) sell off in sympathy today as investors may anticipate a similar warning there.

All in all, to have the announcement out of the way to be digested ought to get the weight off shares as investors have been waiting for news like this and now that it is out there, assuming they believe this is the end of the write-downs (it will cost Prince his job if is isn't) people can move on.

After Goldman (NYSE:GS), Merrill (MER), Bear Sterns (NYSE:BSC) and Lehman (LEH) all wrote down fixed income assets the last few weeks, only a foolishly optimistic person would have expected this situation to not reach Citi and the other big banks.

The questions that needs to be answered: "Is this it"?. Clearly investors in Goldman Sachs believe it is, as shares have rallied 20% off their lows in only a couple of weeks. What will happen to Citi shares will not be a result of the announcement, but whether or not investors believe the worst is over and Citi has come clean.

Actual earnings will be released the 15th.

Disclosure: Author is long C