Citigroup Inc. warned that nonprime U.S. mortgage investments will negatively impact second-quarter earnings, though writedowns will likely decline from the first quarter. But earnings will continue to be hampered through the rest of this year.
Gary Crittenden, chief financial officer of the New York-based company, discussed earnings in a Deutsche Bank Securities investor conference call Thursday.
Citigroup previously reported a $5.1 billion first-quarter loss -- though that was an improvement from the $9.8 billion fourth-quarter loss. The first quarter included $6.0 billion in subprime-related write-downs and $1.0 billion in Alt-A write-downs. Crittenden said second quarter write downs are expected to be less.
Direct super senior subprime collateralized-debt obligations continue to be marked down based on Citigroup's proprietary cash-flow models primarily because few of these securities are trading. The collateral is primarily from vintages issued before 2006.
Crittenden noted that in the first quarter, a 10 basis point increase in the discount rate resulted in a $90 million decline in the value of super senior exposure. The company's CDO positions have generally been hurt because of this during the second quarter, though as of today, subprime CDO markdowns will likely be less than first-quarter markdowns. But recent trends leave open the possibility that these costs could rise by the end of the quarter and may continue through the year.
Ailing monoline insurers will also have a negative impact on second-quarter earnings.
"Credit costs in the consumer business may continue to rise throughout the year," Crittenden stated. "You've seen us build reserves, and as this trend persists, we continue to believe that consumer credit costs could have a meaningful impact on our results for the remainder of this year.
"In the second quarter, we expect to build reserves primarily in our U.S. mortgage portfolio."
Credit costs company-wide will exceed first-quarter levels as several U.S. asset classes continue to deteriorate.
While Citigroup took $3.1 billion in markdowns on highly leveraged loans during the first quarter, the company doesn't expect the current quarter to be as severe.
The CFO explained that credit costs in the current cycle, which are typically driven by unemployment, are currently being driven more by the real estate market.
Crittenden said commercial mortgage investments are around $25 billion and include loans with low loan-to-values.
The company expects to reduce its assets from a high of between $400 billion and $500 billion to less than $100 billion in assets in two to three years. The mortgage portfolio will be reduced by about $45 billion over a 12-month period. Much of the decline will result simply from maturity of the portfolio.
Expenses will be cut by $15 billion.