3 Signs This Bank Is Still on the Right Earnings Track

Citigroup (C -0.32%) is set to announce fourth-quarter earnings next week. With analysts upgrading the bank left and right, investors should keep their eyes peeled for three areas in the Citigroup earnings release for evidence that new CEO, Michael Corbat, is keeping the bank on track.

Capitalization
In preparation for the new Basel III banking rules to set in, banks have been building up their capital reserves by stockpiling high-quality assets. As of the banks' last round of earnings releases, Citi was in the No. 2 spot based on its capital:

Source: Company Q3 2012 earning presentations.

But with recent news that the Basel III rules were loosened , banks now have more time to reach the required levels of capitalization. Since the change wasn't announced until after year-end, it would be surprising if Citi's capital reserves were reduced in the fourth quarter. Investors should be sure to pay attention to Citi's capital ratio -- any reduction before the rule change would be reason for further investigation.

Credit trends
Most of the banks are happy to highlight a declining trend in non-performing loans and other signs of improved customer credit. But a change in guidance from the Office of the Comptroller of the Currency forced banks to adjust their treatment of mortgages for customers that have gone through Chapter 7 bankruptcy -- resulting in substantial write-offs of chunks of their loans. Citi charged off $186 million in residential first mortgages and $449 million in home equity loans, but offset those charges with a release of $600 million from its reserves. 

The impact of the OCC guidance changes should have been resolved in the third quarter, so investors should see a return to the downward trend in loan losses. If the bank continues to have large charge-offs, it's a sign that the underlying credit of Citi's loan portfolio is still less than stellar.

Citi Holdings
Back in 2009, Citi lumped together its non-core business segments into Citi Holdings. Ever since then, the company has been strategically reducing Holdings through asset sales. As of the third quarter 2012, Holdings was down to $171 billion in assets, a far cry from its $600+ billion balance at the start. But Holdings still accounts for almost $3 billion in losses per quarter, and Citi should be looking for ways to sell the remaining assets.

Investors should look for further reductions in the size and effect of Citi Holdings. Any new sales of Holdings assets would be a huge win for Citi, with plenty of positive impact on its bottom line.

And with those three things...
Investors should be ready to both gauge how Citi performed in the final quarter of 2012, and sense where it's headed in 2013.