Biggest banks trip over interest rates

Citigroup and Bank of America, the two biggest U.S. banks, reported second-quarter profit that disappointed investors after the firms made wrong bets on the bond market. Shares of both companies dropped.

Citigroup said yesterday that second-quarter profit climbed to $5.07 billion, falling short of analyst estimates for the first time in more than three years.

Bank of America's profit rose 12 percent to $4.3 billion., but results were hurt by a 77 percent slump in revenue from fixed-income trading.

Citigroup Chief Executive Charles Prince said, "The capital-markets environment was one of the worst we have seen in years."

Morgan Stanley and Goldman Sachs Group also reported declines, as they misjudged the direction of interest rates.

JPMorgan Chase President James Dimon said in June that the fixed-income trading results were "terrible" in the first two months of the quarter.

"The trends were clearly difficult, but they appeared to be worse for Citigroup," said Mark Batty, who helps manage $50 billion at Philadelphia-based PNC Advisors, which holds shares of both banks.

Citigroup's stock fell 3.1 percent, the biggest slide in 10 months. The company denied a report on the CNBC television network that Chairman Sanford Weill plans to step down.

Shares of Bank of America declined 1.9 percent.

New York-based Citigroup earned 97 cents a share, up from 22 cents a year earlier, when profit was depressed by $5 billion of legal reserves. The bank was expected to earn $1.02, according to the average analyst estimate compiled by Thomson Financial.

During a conference call, Chief Financial Officer Sallie Krawcheck told analysts and investors, "We weren't positioned for the decline in long-term rates and the flattening of the yield curve."

The yield on the benchmark 10-year U.S. Treasury note slipped to 3.9 percent June 30 from about 4.5 percent at the quarter's start. In the same three-month period, the Federal Reserve twice increased its overnight lending-rate target, raising it to 3.25 percent from 2.75 percent.

Citigroup said revenue from buying and selling debt fell 28 percent to $1.83 billion.

Profit at Citigroup's corporate and investment-banking unit, which includes the former Salomon, the world's biggest bond trader, fell 22 percent to $1.37 billion.

Earnings at the consumer bank, which accounts for more than half of Citigroup's revenue, rose 6 percent to $2.9 billion. The consumer bank includes credit cards, retail branches and loans to individuals and small businesses.

Bank of America reported second-quarter profit of $1.06 a share, up from 93 cents a year earlier. Excluding FleetBoston merger-related costs, profit was $1.08 a share, 7 cents above the average estimate of 25 analysts surveyed by Thomson Financial.

Fixed-income trading revenue fell to $107 million from $456 million a year earlier.

"We took some hits in the second quarter because of the widening credit spreads," CFO Marc Oken said in an interview. "We'd like to think we could have avoided it and differentiated ourselves, but we couldn't and we're disappointed about that."

CEO Kenneth Lewis is looking to parlay momentum in credit cards to increase earnings. Bank of America announced plans last month to buy MBNA for $35 billion.

MBNA yesterday said second-quarter profit dropped 4.3 percent to $632.1 million, or 50 cents a share, because of restructuring-related costs. The company in April said a plan to trim its work force and sell assets would cost $767.6 million.

Citigroup fell $1.42 to $45, and Bank of America fell 90 cents to $45.08 yesterday.