Hide and seek

Citi/BofA: Bank of America and Citigroup are each putting on a brave face. The two struggling megabanks unveiled seemingly decent second-quarter earnings on July 17 - $3.2 billion and $4.3 billion respectively. Sure, there was a good showing from some of their businesses and a few rays of hope for the future. But the results relied on a combined $20 billion from asset sales as well as a bit of help from the tax man. Strip those out and both firms lost more than $2 billion apiece.

Citi, for example, got an $11.1 billion boost - $6.7 billion after tax - from hiving off its Smith Barney brokerage unit into a joint venture controlled by Morgan Stanley. Without that, Citi actually lost $2.4 billion. But the firm’s overall tax rate was just 17 per cent. Adjust that to a more normal 33 per cent and tack on $164 million in rebates on 2003-2005 earnings and Citi loses another $1 billion. Bank of America, meanwhile, raised $9.1 billion from selling its merchant processing business and part of its stake in China Construction Bank. After taxing that and also subtracting an $845 million deferred tax asset gain, BofA’s profit for the quarter disappears, replaced by a $4.6 billion loss.

It’s not quite as bad as that, though. Both took a hit as the spreads on their own liabilities improved. From a funding perspective, that’s good news. But under the daft US accounting quirk which forces bank to mark their own liabilities to market, they lost money. Strip those out and Citi’s loss falls to $3 billion and BofA’s to $2.1 billion.

There is some good news, though. For starters, the quarter’s asset sales and other capital-raising measures leave both with much stronger balance sheets.

Their investment banking arms also pumped out some good numbers, as did BofA’s mortgage unit. Citi even managed to post write-ups on some of its toxic subprime mortgage assets. What’s more, there are some signs that the pace of consumer delinquencies is slowing.

But even BofA boss Ken Lewis doesn’t expect that to have much impact until next year. And with unemployment still rising, default rates could just as easily worsen again. Unless they find more bumper asset sales to hide behind, that means both Citi and BofA could find it harder to avoid headline losses.