Shadow of Doubt Over Citigroup's earnings?

The following passage from the following article on Bloomberg News, Citigroup's $1.1 Trillion of Mysterious Assets Shadows Earnings caught my attention.

• July 14 (Bloomberg) -- At an investor presentation in May, Citigroup Inc. Chief Executive Officer Vikram Pandit said shrinking the bank's $2.2 trillion balance sheet, the biggest in the U.S., was a cornerstone of his turnaround plan.
  
  Nowhere mentioned in the accompanying 66-page handout were the additional $1.1 trillion of assets that New York-based Citigroup keeps off its books: trusts to sell mortgage-backed securities, financing vehicles to issue short-term debt and collateralized debt obligations, or CDOs, to repackage bonds.
  
  Now, as Citigroup prepares to announce second-quarter results July 18, those off-balance-sheet assets, used by U.S. banks to expand lending without tying up capital, are casting a shadow over earnings. Since last September, at least $100 billion of assets have flooded back onto Citigroup's balance sheet, accompanied by more than $7 billion of losses.
  
  ``If you start adding up all the potential exposures, it's a huge number,'' said Sam Golden, a former ombudsman for the U.S. Office of the Comptroller of the Currency who now heads the financial-industry practice for restructuring adviser Alvarez & Marsal in Houston. ``The banks will say that it was disclosed. Investors are saying, `Yeah, but it was cryptic. We really didn't know what you were telling us.'''
  
  U.S. banks already are reeling from more than $165 billion of writedowns and credit losses, so shareholders are wary of unknown obligations that might force them to take responsibility for additional troubled assets. The risks have become so obvious that accounting officials are proposing new rules -- some of which Citigroup opposes -- that would force many assets back onto balance sheets.
  
  On the Hook
  
  Seven of the biggest U.S. banks, including Citigroup, are on the hook for at least $300 billion of credit and liquidity guarantees for off-balance-sheet loans and bonds, according to a June 30 report from consulting firm RiskMetrics Group Inc. in Rockville, Maryland. Such guarantees were remote when pledged as an inducement to bond buyers. Now, the first year-over-year decline in housing prices since the Great Depression and rising home-loan, commercial-mortgage and credit-card delinquencies have begun to trigger them.
  
  ``You will rapidly realize what a farce these off-balance- sheet things are,'' said Ladenburg Thalmann & Co. analyst Richard X. Bove. ``You could pick up a lot of loan losses with the stuff you're putting back on.''
  
  It's impossible to predict what the losses might be from off-the-books assets or liabilities because disclosures are thin relative to what is required for balance-sheet assets, said Neri Bukspan, chief accountant for Standard & Poor's in New York.
  
  ``A lot of information tends to disappear or becomes second or third class,'' Bukspan said.
  Second-Quarter Loss
  
  Citigroup has had to bail out at least nine investment funds in the past year, including seven structured investment vehicles, or SIVs, whose funding withered. The bank had to assume $45 billion of securities from those SIVs, which are now included in the $400 billion of on-balance-sheet assets Pandit says he's trying to unload in the next three years.
  
  The bank probably will report a second-quarter net loss of $3.7 billion later this week, according to the average estimate of seven analysts surveyed by Bloomberg. A loss would be the company's third straight and add to $15 billion of losses recorded during the previous two quarters.
  
  Citigroup plunged 69 percent in the past year in New York Stock Exchange composite trading. It closed at $16.19 on July 11, down 52 percent from April 6, 1998, when Citicorp agreed to form the modern company by merging with Sanford ``Sandy'' Weill's Travelers Group Inc.
  
  JPMorgan, Merrill
  
  JPMorgan Chase & Co., which has more than $400 billion of off-balance-sheet assets, also reports second-quarter results this week. The New York-based bank, the largest U.S. bank by market value, may say second-quarter profit fell 55 percent to $1.9 billion, analysts estimate.
  
  Merrill Lynch & Co., the third-biggest U.S. securities firm by market value, also reports results this week. New York-based Merrill had to buy about $4.9 billion of mortgage-linked assets last year from an off-balance-sheet financing vehicle, resulting in a $170 million loss. It may post a second-quarter loss of $1.56 billion after reporting about $14 billion of net losses in the previous three quarters, according to a Bloomberg survey of 11 analysts.
  
  ``The riskiest assets we had, our CDOs, weren't even on our balance sheet,'' Merrill Chief Executive Officer John Thain said on a June 11 conference call with investors. Merrill would have to provide $15 billion in financing for CDOs and related obligations under a ``severe stress scenario,'' according to a Merrill regulatory filing published in May.
  
  VIEs, QSPEs
  
  The Financial Accounting Standards Board, the five-member panel in Norwalk, Connecticut, that sets U.S. accounting rules, voted earlier this year to eliminate ``qualifying special- purpose entities,'' or QSPEs, a category of off-balance sheet financing exempted from tighter standards enacted following the collapse of U.S. energy trader Enron Corp. FASB also plans to clamp down on ``variable interest entities,'' or VIEs, that banks used when their vehicles couldn't qualify as QSPEs. And it voted June 11 to force banks to consolidate off-balance-sheet assets whenever an ``obligation to absorb losses can potentially be significant.''
  
  Banks are required to disclose their off-balance-sheet assets in annual reports. According to Citigroup's most recent financial statement, filed in May, the bank's $1.1 trillion of off-the-books assets as of March 31 included $760 billion of QSPEs and $363 billion of unconsolidated VIEs.