Citi delivers profit surprise -- kind of

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Citigroup stock has nearly tripled in value since March when word leaked that the company was profitable during the first two months of the year.

NEW YORK (CNNMoney.com) -- Citigroup surprised Wall Street Friday as the company delivered its first profit in more than a year, helped by strength within its investment banking division.

The company reported net income of $1.6 billion during the first quarter, reversing a loss of $5.1 billion a year ago.

Yet, after taking into account the conversion price of a $12.5 billion preferred share offering from January 2008, and $1.22 billion in preferred stock dividend payments to the U.S. government among others, Citigroup reported a loss of $966 million, or 18 cents a share.

Even after including those special items, Citigroup still fared better than many on Wall Street were anticipating. Analysts were forecasting a loss of $1.39 billion, or 34 cents a share.

Since the credit markets began to unravel in late 2007, the company has posted net losses of more than $28 billion. That led the government to take a $45 billion stake in Citigroup in the form of preferred shares and warrants to help stabilize the bank.

Citigroup CEO Vikram Pandit said he was "pleased" with the firm's performance this quarter, but those remarks were tempered by a cautious outlook.

"While we and the industry face challenges in the coming quarters as we work through the weak economy, we will remain focused on strengthening the Citi franchise," he said in a statement.

Investors were not convinced however, as shares of Citigroup (C, Fortune 500), which have soared in recent weeks along with the rest of the banking sector, fell more than 7% in midday trading Friday.

The company said it benefited this quarter from expense cuts and a $704 million after-tax gain related to its sale of its stake in Brazilian credit card company Redecard.

But much of the bank's profit was driven by big numbers in its institutional clients group, which houses its investment banking and trading businesses.

After reporting a steep loss just a quarter ago, the division reported net income of $2.8 billion, helped by strong fixed-income trading results, which were mostly due to a widening of the bank's credit default swap spreads.

Nevertheless, Citigroup continued to have problems across a number of its consumer-related loan portfolios as unemployment climbed higher.

Net credit losses in the company's North American credit card division rose 81% from a year ago. The company noted that the recession was having an effect not just domestically but in lending operations overseas, such as Mexico, the U.K., Greece and India.

"The total scope of the problem is still growing, not only domestically but in some key markets," said Joe Scott, a senior director at Fitch Ratings who tracks the company.

Newly installed Chief Financial Officer Ned Kelly warned that credit costs would remain a "headwind" through the remainder of the year, particularly in its consumer-related loan portfolios.

"The thing we are bracing ourselves for is what is going to happen to the economy and the consumer," Kelly told investors during a conference call Friday morning.

Notably absent from the presentation though was Citigroup CEO Vikram Pandit. Last month, Pandit made headlines after he wrote in an internal memo to the company's staff that the bank was profitable during the first two months of 2009, suggesting that Citigroup's fortunes may be changing.

Kelly maintained that the company was continuing to make progress on its dramatic reorganization announced earlier this year, which effectively split the company into two divisions.

He also gave little indication as to Citigroup's level of participation in the government's soon-to-be-launched toxic asset plan.

"We are watching it closely," said Kelly.

Separately, Citi also delivered an update Friday about the government's planned conversion of up to $25 billion in preferred shares to common stock, which was announced in late February in an effort to improve Citi's capital base.

The bank said the proposed exchange would not take place until after the government completes its stress test program of the nation's 19 largest banks, which includes Citigroup. Results of those tests are expected to be released in early May.

Investors, however, seized on the issue during the company's conference call, peppering Kelly with questions about the move. He offered few details on the exchange or its pricing, adding that it simply "made sense" to delay the offering.

Citi's earnings surprise is the latest bit of positive news from large banks. Over the past week, JPMorgan Chase (JPM, Fortune 500), Wells Fargo (WFC, Fortune 500) and investment bank Goldman Sachs (GS, Fortune 500) all reported better-than-expected profits during the first three months of the year.

Bank of America (BAC, Fortune 500) is the next big bank due to report its first quarter results. It is scheduled to release them on Monday.