No party for Citi's owners: You and me

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Citigroup's health is slowly improving, but the bank's owners are stuck paying for its costly rehabilitation.

The New York-based financial giant returned to the black Friday after five quarterly losses, saying it swung to a $1.6 billion profit. Citi (C, Fortune 500) cited stronger trading results and a 23% drop in operating costs, driven by 13,000 job cuts during the latest quarter.

But common shareholders, who are the ultimate owners of the struggling bank, are still waiting to enjoy the fruits of CEO Vikram Pandit's turnaround push.

That's because as accounting rules dictate, Citi calculated its profit before deducting the costs related to preferred shares. The bank has issued these in droves in recent years, to the government and private investors alike, in a bid to bolster its capital cushion against souring loans and trading bets gone bad.

Paying for the preferred shares has gotten expensive, as a look at Friday's earnings statement shows. In the first quarter alone, Citi paid out $1.2 billion in preferred stock dividends. It also took a $1.3 billion hit when the price on some convertible preferred shares it sold in January 2008 reset.

Those costs come out of common shareholders' pockets - which is why the bank ended up posting a loss of 18 cents a share in a quarter that was otherwise profitable.

The unusual split - a profit for the bank but a loss for the shareholders - highlights the cost of the blizzard of preferred stock Citi has issued since Pandit took over at the end of 2007.

In his first two months at the bank's helm, Citi issued $30 billion in preferred shares to private investors around the globe. Since last fall, the bank has issued an additional $45 billion of preferred stock to the government.

Despite the huge sums raised by Citi via the preferred share sales, investors have continued to fret about the health of the bank's balance sheet as real estate prices tumble and more consumers fall behind on their auto and credit card payments.

In hopes of quelling worries about the bank's capital and ending talk of nationalization, the government announced a plan in February to convert the bulk of Citi's preferred shares to common shares.

Citi said Friday that the conversion, which had been scheduled to take place this month, will be delayed until regulators complete their stress tests on the 19 biggest U.S. banks. Results are expected by early May.

As a result of the swap, private sector holders of existing preferred shares will end up owning 38% of Citi and taxpayers will own 36%.

The conversion will reduce Citi's preferred dividends. That should mean that when Citi posts a profit in future quarters, common shareholders will share in them.

But the downside for current shareholders is that the preferred-to-common conversion will result in the issuance of billions of new common shares - which will reduce their stake in the company by three-quarters.

Still, given how poorly Citi has done since the collapse of the credit boom nearly two years ago - it had rung up $28 billion in losses since its last profit back in the third quarter of 2007, and saw its shares dip below a dollar each earlier this year - investors and taxpayers will gladly take even modest progress.

And there were signs Friday that Citi is, like the other giant financial institutions that have posted their first-quarter numbers this month, enjoying the benefits of cheap government-backed funding and less competitive financial markets.

Thanks to federal programs that allow big financial companies to borrow at low, subsidized rates, Citi's net interest margin - the difference between the bank's lending rates and its borrowing costs - rose half a percentage point from a year ago, to 3.3%.

Like its rivals JPMorgan Chase (JPM, Fortune 500) and Goldman Sachs (GS, Fortune 500), Citi posted a strong quarter in its trading business. The bank's securities and banking unit posted a first-quarter profit of $2 billion, reversing the year-ago loss of $7 billion, which was driven by writedowns of Citi's exposure to subprime mortgage securities.

Citi said revenue at its fixed income markets business hit $4.7 billion, "as high volatility and wider spreads in many products created favorable trading opportunities."

But as with its peers, there are questions as to whether Citi will be able to replicate that trading performance in coming quarters.

More than half of the first quarter's fixed income revenue - $2.5 billion worth - came from a valuation adjustment on Citi's derivatives books, mostly due to a widening of the bank's credit default swap spreads.

Credit default swaps are insurance-like contracts. Widening spreads reflect a greater belief that a company may not be able to pay back its debt. So in a sense, Citi was profiting from increased bets that it and other banks were in danger of failing. Those fears may subside a bit following the release of the stress test results.

Perhaps more alarming for Citi -- as well as JPMorgan, Wells Fargo (WFC, Fortune 500) and Bank of America (BAC, Fortune 500), which will report its first-quarter results Monday -- is just how high losses on consumer loans such as credit cards could go later this year.

Citi's North American cards business swung to a $209 million loss in the first quarter, reversing the year-earlier $537 million profit. Credit costs - reflecting loans gone bad and expenses tied to reserving against future losses - nearly doubled.

The surging losses reflect "rising unemployment, higher bankruptcy filings and the housing market downturn," Citi said - national trends that show few signs of slowing any time soon.

Altogether, credit losses on the global cards business rose to 9.49% in the first quarter from 5.39% a year ago.

But consumers also appear to be doing a better job of keeping their cards in their wallets. The company reported an 18% decline in North American credit card purchase sales during the quarter. This drop will add to the pressure on the company's card portfolio.

Those declines were mitigated somewhat, however, by a rise in interest and fee revenue, as already debt-laden consumers ran bigger balances on their cards and made smaller payments.

So no matter how you look at the results, it seems that the taxpayer -- especially those who also happen to be Citi customers -- still have little reason to celebrate with the bank's return to profitability.