By David Henry
(Reuters) - Citigroup Inc (NYS:C) posted weaker-than-expected third-quarter earnings on Tuesday as bond market trading volume dropped, hurting revenue at the No. 3 U.S. bank and across Wall Street.
The bank's bond trading revenue dropped 26 percent, or $956 million, excluding an accounting adjustment, and revenue at most of its major businesses dropped.
The fall in fixed-income revenue could spell trouble for investment banks Goldman Sachs Group Inc (GS) and Morgan Stanley (MS), which post results later this week. Volumes dropped after the Federal Reserve said it plans to continue its bond buying stimulus program, giving assurance to investors that they can hold onto their bonds for a little longer.
Late in the quarter, investors also grew increasingly concerned about the government's fiscal impasse, which made many reluctant to trade.
"I don't think anybody wanted to get in front of that," said Diane Jaffee, who oversees about $6.5 billion of relative value mutual funds for TCW, and counts Citigroup among her top 10 holdings. The budget and debt ceiling crises continue to weigh on trading volumes in the fourth quarter, analysts said.
Investors pointed to Citi's efforts to control costs as the most positive part of the quarterly earnings. Similar moves could be imminent at other banks, especially as Wall Street bonus season - typically a huge part of their budgets - approaches.
In last year's third quarter Citigroup took a $4.7 billion charge before taxes, related to selling its Smith Barney brokerage business. For the bank's board, that hit was the last straw in a series of perceived missteps that ended up costing Vikram Pandit, then the bank's chief executive, his job.
Pandit's successor, Michael Corbat, has struggled to improve Citigroup's fortunes in an environment where client business is tepid and new regulations are raising banks' expenses. Those regulations are designed to make the banking system safer after the financial crisis, which forced Citigroup to seek government rescues three times.
'UNEVEN' BUSINESS CONDITIONS
Corbat told analysts in a conference call that business conditions would remain "uneven" for the rest of the year.
"While many of the factors which influence our revenues are not within our full control, we certainly can control our costs, and I am pleased with our expense discipline and improved efficiency year-to-date," Corbat said in a statement.
The bank's expenses fell nearly $500 million from the second quarter to $11.66 billion as performance-based compensation and transaction costs fell, partly reflecting a weak revenue environment, Chief Financial Officer John Gerspach told analysts.
Citigroup, which has said it was aiming to reduce costs by $1.2 billion annually, said on Tuesday it plans to cut areas like marketing expenses in the fourth quarter. But Gerspach said that no major new expense reduction plans are expected in the quarter.
Investors said that from the outside, it is hard to evaluate how the bank's cost-cutting is affecting its daily operations.
"All these banks are doing a lot on that front (cost cutting), including Citigroup, but it's hard to see from the outside what is happening," said David Ellison, portfolio manager in Boston at Hennessy Funds, which has about $4 billion under management and owns Citigroup shares.
"There's a dumpster in the driveway, but all the activity is in the house, and you can't tell what's happening inside."
CUSTOMER TRADING SLOWDOWN
The third quarter is typically a slow one for bond trading, a state that was only exacerbated by the Fed announcement, according to analysts.
Under generally accepted accounting principles, Citigroup's net income rose to $3.23 billion, or $1.00 per share, from $468 million, or 15 cents per share, a year earlier.
Excluding the Smith Barney charge, as well as the impact of tax benefits and changes in the value of Citigroup debts and those of trading partners, third-quarter earnings slipped to $3.26 billion, or $1.02 per share, from $3.27 billion, or $1.06 per share, a year earlier. On that basis, revenue fell 5 percent to $18.22 billion.
Analysts on average expected earnings of $1.04 a share, according to Thomson Reuters I/B/E/S. A spokeswoman for the bank said that estimate was comparable to the adjusted earnings of $1.02 per share.
Citigroup shares were up 14 cents to $49.74 in midday trading.
On some fronts, Corbat is making progress. Citigroup has winnowed down the assets it is looking to shed, known as Citi Holdings, to $122 billion, down 29 percent from a year earlier and down 7 percent from the second quarter. Citi Holdings now accounts for a little more than 6 percent of the bank's overall assets, compared with about 9 percent in last year's third quarter.
But results were weak at many businesses at Citicorp, the bank's main operations. Revenue for its retail banking business fell 7 percent to $9.24 billion, and revenue for its securities and banking business fell 2 percent to $4.75 billion.
Revenue at its transaction services business was $2.613 billion, about $6 million below the same quarter last year. The bank's transaction services business, long a key driver of profitability, is facing intense competition now.
The bank earned enough taxable income in the United States to use about $500 million of its deferred tax assets, which amount to tax credits and other benefits that Citigroup can only use when it earns enough money domestically. The bank had about $54 billion of deferred tax assets at the end of June, most of which relate to U.S. taxes.
(Reporting by David Henry in New York; Additional reporting by Tanya Agrawal in Bangalore; Editing by John Wallace and Andrew Hay)