After Year of Heavy Losses, Citigroup Finds a Profit

After more than a year of crippling losses and three bailouts from Washington, Citigroup, a troubled giant of American banking, said Friday that it had done something extraordinary: it made money.

But the headline number — a net profit of $1.6 billion for the first quarter — was not quite what it seemed. Behind that figure was some fuzzy math.

Like several other banks that reported surprisingly strong results this week, Citigroup used some creative accounting, all of it legal, to bolster its bottom line at a pivotal moment.

While wisps of recovery are appearing in the nation’s banking industry — mortgage lending and trading income are up industrywide — many banks are doing all they can to make themselves look good.

The timing is crucial. Federal regulators are preparing to disclose the results of stress tests that could determine which banks are strong enough to return the taxpayer dollars that they have accepted, and which might need more. Many banks are eager to extricate themselves from the strings attached to the government bailout money, including restrictions on pay.

Meredith A. Whitney, a prominent research analyst, said in a recent report that what banks were doing amounted to a “great whitewash.” The industry’s goal — and one that some policy makers share — is to create the impression that banks are stabilizing so private investors will invest in them, minimizing the need for additional taxpayer money, she said.

Citigroup posted its first profitable quarter in 18 months, in part because of unusually strong trading results. It also made progress in reducing expenses and improving its capital position.

But the long-struggling company also employed several common accounting tactics — gimmicks, critics call them — to increase its reported earnings.

One of the maneuvers, widely used since the financial crisis erupted last spring, involves the way Citigroup accounted for a decline in the value of its own debt, a move known as a credit value adjustment. The strategy added $2.7 billion to the company’s bottom line during the quarter, a figure that dwarfed Citigroup’s reported net income. Here is how it worked:

Citigroup’s debt has lost value in the bond market because of concerns about the company’s financial health. But under accounting rules, Citigroup was allowed to book a one-time gain approximately equivalent to that decline because, in theory, it could buy back its debt cheaply in the open market. Citigroup did not actually do that, however.

“It’s junk income,” said Jack T. Ciesielski, the publisher of an accounting advisory service. “They are making more money from being a lousy credit than from extending loans to good credits.”

Edward J. Kelly, Citigroup’s financial chief, defended the practice of valuing its bonds at market prices, since it values other investments the same way. The number fluctuates from quarter to quarter. For instance, Citigroup recorded a big loss in the fourth quarter of last year, when the prices of its bonds bounced back.

“I think it is unfair to focus on it in isolation rather than considering it with all the factors,” Mr. Kelly said.

Other banks have taken a similar approach. Bear Stearns, now absorbed into JPMorgan Chase, and Lehman Brothers, which plunged into bankruptcy last autumn, took advantage of credit value adjustments as their bonds lost value last year, as did Goldman Sachs.

JPMorgan, which reported strong results on Thursday, added $638 million to its first-quarter profit by availing itself of this adjustment. Bank of America and other large financial companies are expected to take similar steps when they report their results.

Citigroup also took advantage of beneficial changes in accounting rules related to toxic securities that have not traded in months. The rules took effect last month, after lobbying from the financial services industry.

Previously, banks were required to mark down fully the value of certain “impaired assets” that they planned to hold for a long period, which hurt their quarterly results. Now, they must book only a portion of the loss immediately. (Any additional charges related to the impairment may be booked over time, or when the assets are sold.)

For Citigroup, this difference helped inflate quarterly after-tax profits by $413 million and strengthened its capital levels.

Citigroup and other banks also benefit simply by taking a sunnier view of their prospects. Banks routinely set aside money to cover losses on loans that might run into trouble. By squirreling away less money, banks increase their profits.

That is what Citigroup did. During the fourth quarter, Citigroup added $3.7 billion to its consumer loan loss reserves, more than analysts had expected. In the first quarter, even though more loans are going bad, it set aside just $2.4 billion.

“Citi pulled out all the stops,” David Hendler, an analyst at CreditSights, wrote on Friday. “While Citigroup is making progress, its recovery is likely to be more volatile than other big banks’,” he said.

Mr. Kelly said that Citigroup would increase its provisions if the recession deepened and that its reserves would be adequate.

“When they did the reserving, they were anticipating losses that were higher than losses turned out to be,” Mr. Kelly said. “You could argue we were just as cautious in the fourth quarter as we were aggressive in the first quarter.”