The Revenue Growth Fixation

Financial analysts have been focusing their attention on revenue growth because of a general belief that companies need such growth to fuel earnings at this stage of the business cycle. While this focus certainly has merit for most businesses, it is far less applicable to financial firms.

Revenue at the major commercial banks is a mixture of interest income and noninterest income and is not identical to sales figures reported by nonfinancial firms. The former is determined by the level of interest rates and the volume of earning assets. Increases in rates and volume of earning assets will be accompanied by revenue growth.

Analysts were quick to point out that gross revenue at Citigroup was down 22% in the first quarter of 2011 versus the first quarter of 2010. Few, however, mentioned that the decline in assets at Citi Holdings was a prime contributing factor.

Citi Holdings is effectively the “bad bank” Citigroup created to house its worst assets during its near death experience. The assets in Citi Holdings fell by $166 billion or 33% from the end of the first quarter of 2010 to the end on the first quarter in 2011. Concurrently, revenue declined 50% to $3.3 billion and that accounted for 57.9% of the decline in Citigroup’s total revenues.

As of March 31, 2011 Citi Holdings had total assets of $337 billion, which is down from a peak of $827 billion reached during the first quarter of 2008. Citigroup management has clearly stated it considers the businesses and assets contained in Citi Holdings to be nonessential to its core business going forward. The remaining assets are to be liquidated through business divestitures, portfolio run-offs and asset sales.

A continued reduction in Citi Holdings assets will weigh on Citigroup’s gross revenues; however, it should continue to lower Citigroup’s risk profile. Citi Holdings reported losses of $36.5 billion in fiscal 2008, $8.8 billion in 2009, $4.0 billion in 2010 and $0.6 billion during the first quarter of 2011.

Disclosure: I am long Citigroup (C)

Tough Comparison For Citigroup (C)

Citigroup (C) is scheduled to release its first quarter earnings on April 18. It is important to note that the first quarter of 2010 was, by far, the most profitable quarter last year for Citi. In that quarter it earned $4.428 billion.

The first quarter of 2010 was followed by progressively worse quarters as it earned $2.697 billion in the second quarter, $2.168 billion in the third quarter and $1.309 billion in the fourth quarter. This trend of declining quarterly earnings is unacceptable, weighs of the stock price and must end in 2011. Bank earnings should be relatively consistent throughout a year.

Recent appearances and comments by Chairman Richard Parsons and CEO Vikram Pandit suggest that Citi has turned the corner. The forthcoming April 18 report will either reinforce that view and be well accepted by shareholders, or Parsons and Pandit will be confronted by a hostile crowd at Citi’s annual stockholders’ meeting on April 21.

The fact is that it will be difficult for Citi to report earnings above last year’s first quarter and that is why Citi call options are so quiet. Things could change quickly if Citi reports an increase in reported earnings and they then forecast even better results for the rest of 2011. Today, few market participants seem willing to bet on such a favorable scenario unfolding in the next few weeks.

Disclosure: I am long Citigroup (C)