It is still best to be cautious despite bullish talk from banks

THE US financial sector advanced by over 30 per cent this week, with Citigroup’s announcement that it is enjoying its best quarter since the end of 2007 fuelling talk the worst of the banking crisis may be over.

In a leaked memorandum, Citigroup chief executive Vikram Pandit denied the bank was losing depositors and clients, as well as claiming it was now the “strongest capitalised large US bank”.

What really captivated investors, however, was the boast that Citi was profitable in the first two months of this year, securing operating profits of more than $8 billion and $19 billion in revenues.

That led to financials going on a “complete bender” on Tuesday, as Goodbody analyst Eamonn Hughes put it, with Citigroup, Bank of America and JP Morgan enjoying one-day gains of 38 per cent, 28 per cent and 23 per cent respectively. The overall banking sector enjoyed its second biggest one-day gain in the last 10 years.

Thursday saw further bullish talk from the banks. Bank of America chief executive Ken Lewis predicted profitability for the bank in 2009, while Citigroup chairman Richard Parsons said no further government aid would be needed. Competition in the sector has been reduced and margins have increased, meaning that first-quarter banking results might not be so bad after all.

Despite this, there are many reasons why commentators remain circumspect. Citi is not the first bank to stress its liquidity position and its high capital levels – the same boast was uttered by Bear Stearns and Lehman Brothers.

Crucially, Citi admitted that the $19 billion figure excluded “externally disclosed marks” – a euphemism for the toxic assets that have crippled the company.

Despite the aforementioned revenues, Citi has endured $37.5 billion in losses over the last five quarters as a result of writing down the value of troubled assets. The continued deterioration in the commercial property market, allied to rising mortgage and credit card delinquency, mean that further write-downs are a given.

“The key remains as to whether illiquid assets on these banks’ balance sheets will still eventually offset the profitability of the core businesses,” cautioned Deutsche Bank analyst Jim Reid in a research note.

Deutsche research found that total US bank loan losses “should exceed those seen at the peak of the Great Depression”, he added.

Merrill Lynch analysts also preached caution.

“The key thing to watch for is a deceleration in the rate of increase in non-performing loans.”

Unfortunately, non-performing banking loans grew at 25 per cent in the fourth quarter, up from 17 per cent in the third-quarter.

Citi’s upbeat tone jars with the fact that government officials are currently engaged in so-called “contingency planning” with the bank. Monday’s Wall Street Journal revealed that regulators are examining additional stabilisation measures in the event that conditions take a turn for the worse.

Republican senator Richard Shelby, a ranking member on the Senate Banking Committee, called Citi a “problem child” on the same day, adding that regulators needed to “bury” some big banks. It is hardly a co-incidence, sceptics suggest, that the Citi memorandum was leaked the very next day.

Other chief executives are joining the fight. Mr Lewis warned on Thursday that nationalisation would be an unnecessary “nightmare”, while JP Morgan’s Jamie Dimon said the banking system could be saved if the “vilification” of corporate America ended.

Citi shares are still trading below levels recorded at the end of February despite this week’s bounce. As for the broader financial sector, it enjoyed an even bigger one-day gain of 18 per cent last September. Within 13 days, the sector had hit a new low.

That’s not to say a similar fate is inevitable this time. There are many reasons as to why technically oversold markets might build on this week’s gains. The opportunely-timed Citigroup statement, however, might not be one of those reasons. “An upbeat message by under-pressure CEOs doesn’t alter our fundamentally cautious view on the sector,” warned Merrill Lynch.