Unexpectedly Intriguing!
August 30, 2010

Last Friday, Fox Business Network's Charlie Gasparino caught our attention with a story reporting that a well-known securities analyst is actively suggesting that Citibank (NYSE: C) may be inflating its earnings through accounting manipulations, with an unusual level of animosity growing between the analyst and Citibank's senior leadership:

An all-out war has broken out between Citigroup CEO Vikram Pandit and a prominent securities analyst who is saying that the big bank may be cooking the books by inflating its earnings through an accounting gimmick, FOX Business Network has learned.

The analyst, Mike Mayo, of the securities firm CLSA, has been telling investors that Citigroup (C: 3.74 ,+0.08 ,+2.32%) should take a writedown, or a loss on some $50 billion of “deferred-tax assets,” or DTAs. That is a tax credit the firm has on its financial statement that Mayo says is inflating profits at the big bank by as much as $10 billion.

For a large institution like Citibank that has trillions of assets on its books, $50 billion may not seem like a lot of money. A writedown of this amount of money would have a significant impact however:

Since then Citigroup has been profitable, albeit marginally. Though it posted a loss for the full year of 2009, after it repaid a government bailout loan during the fourth quarter and began to unwind Uncle Sam's ownership stake. One reason Citigroup may be unwilling to write off its DTAs: to do so may sink the troubled bank back into unprofitability.

To find out if Citi's accounting practices should be suspect, we applied the tool we developed specifically to answer the question "Are They Cooking the Books?", which may be used to find a company's F-Score (or "fraud score"). The F-score provides an indication of the likelihood that a company's financial reports have been manipulated in inappropriate ways.

The F-score was developed by Patricia M. DeChow, Weili Ge, Chad R. Larson and Richard G. Sloan in a 2007 paper, in which they developed a statistical model using data from the late 1970s through the early 2000s to determine if a company's books have been subjected to potentially illegitimate accounting manipulations.

We populated our tool with data we found in Citibank's annual report for 2009 and reposted it below. Just click the "Calculate" button to find Citibank's F-Score.

Income Statement Data
Input Data Year of Interest One Year Prior Two Years Prior
Sales (Revenues)
Net Income Before Extraordinary Items or Cumulative Effect of Accounting Changes
Balance Sheet Statement Data
Input Data Year of Interest One Year Prior Two Years Prior
Cash and Cash Equivalents
Short Term Investments
Receivables (Total)
Inventories (Total)
Total Assets
Preferred Stock (Total)
Total Shareholder's (or Owner's) Equity
Statement of Cash Flows Data
Input Data Year of Interest One Year Prior Two Years Prior
Issuance of Long-Term Debt
Issuance of Common or Preferred Stock

Probability of Accounting Manipulations
Calculated Results Values
F-Score

In the tool above, a positive indication of potential fraud for the F-Score is a value greater than 1.00, but that doesn't necessarily mean that the firm in question is cooking their books. Rather, the inventors of the F-Score suggest that it's an indication that a further, more detailed investigation into the particular company's finances is warranted.

When we ran the tool however, we found that Citibank has an F-Score of 0.90. In a sense, that suggests that Citibank is potentially skirting the edge of accounting manipulations, as a solid financial institution would be much more likely to have a very low F-score.

So we're on the fence in making the call one way or another with respect to Citibank's potential for having committed accounting fraud. Consequently, we believe that only a much more detailed audit of Citi's accounting procedures and records would be capable of resolving the issue.

If the SEC wants to give the impression that it actually has any teeth when it comes to investigating potential accounting fraud among publicly traded companies, a thorough review of Citibank's accounting going back to 2005 would be a good place to begin demonstrating it.

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