Citibank (NYSE: C) shares took a major hit on Friday after accounting expert Robert Willens said that Citibank would likely have a $10 billion fourth-quarter charge on its tax-deferred assets.
A $10 billion charge would be approximately 10% of Citibank’s tangible equity and about 25% of its $38 billion in deferred tax assets, according to CLSA analyst Mike Mayo during a recent conference call.
During CLSA’s conference call, Willens said: “I would be surprised if in year end, we didn’t find that a valuation allowance would be taken here,” noting that he had expected such a step to happen at the end of last year.
Morgan Stanley accounting expert, Tony Catanach, commented on a separate conference call that, “the bank appears to have real strategies to prevent it from taking a hit on its deferred tax assets.”
Deferred tax assets can arise because companies typically keep two sets of books, one for taxes and one for reporting to investors. Income in both sets of books may be reported differently at different times. If a company has a loss, it will report it to its investors, but it can’t always record the tax purposes right away, so it’s listed as a deferred tax asset, which will increase the company’s overall cash flow because they will be paying lower taxes.
If a company expects that it won’t be able to generate enough taxable revenue in the future, it will be forced to write down some of its deferred tax assets, which is performed by creating a “valuation allowance” on its balance sheets. The valuation will cut into the income reported to investors and can lower the bank’s overall regulatory capital.
