Mike Mayo takes on Citigroup (A) and (B)
Do you agree with Mike Mayo’s concerns about the extent of Citigroup’s DTA’s? Why or why not?
I agree with Mike Mayo’s concern about Citigroup’s Deferred Tax Assets (DTA’s). Citigroup’s DTA’s increased from $4.7 billion at the end of 2006 to $38 billion by the third quarter of 2009. Citigroup would use the huge DTA’s to shield future profits from taxation to a tune of $38 billion. However, the accounting rules require that a firm can only carry the DTA’s if it is reasonably probable that the firm would earn profits within a particular timeframe. Citigroup cumulative losses of three years provide significant negative evidence of Citigroup ability to make a profit. In the light of the cumulative losses it seems imprudent for Citigroup to claim that there was no need for a valuation allowance. According to Mike, Citigroup ought to have written down the DTA’s by $10 billion because; one, the cumulative losses for three years presented significant negative evidence about Citigroup profitability, two, Citigroup was facing an uncertain economic environment, and three, other firms in a similar position had written down their DTA’s.
Why might Citigroup be reluctant to follow Mayo’s advice?
Citigroup may have been reluctant to take Mayo’s advice because it would have adversely affected the firm’s share price and the value of the firm. Mayo was suggesting Citigroup to take a write-down of $10 billion equivalent to 26.32% of the DTA’s of $38 billion and 10% of the bank’s tangible equity. In addition, such a write-down might be viewed by investors as management having a bearish outlook on the future performance of the bank.
Do you agree with Citigroup’s reaction (i.e., freezing him) to Mayo’s dissenting views?
I do not agree with Citigroup’s reaction to Mayo’s dissenting views because freezing Mayo served to escalate Mayo’s criticism of the company and draw the attention of other stakeholders including the SEC. It is likely that had Citigroup invited Mayo for a discussion much earlier, there would have been less uncertainty about Citigroup DTA and its share price would have experienced less pressure. On the day Citigroup met with Mayo, its share price rose by 4.6% with much of the rise occurring after 1.00pm when Mayo’s meeting started. This indicates that it would have been better for Citigroup group to counter Mayo’s criticism by engaging him rather than shutting him out.
Deferred taxes arises whenever the amount of tax calculated in accordance with financial reporting rules, differs from the amount of tax calculated using the tax rules. A company sets its own depreciation policy. Depreciation expense reduces the reported taxable profit. Companies may have an incentive to accelerate the depreciation of an asset in a bid to book higher tax shields in the early years of an asset. With such a practice, tax authorities would receive lower tax income in the early years of an asset. Tax authorities make no reference to a company depreciation rules when calculating taxable income. Instead, the tax authorities use their own rules to calculate the capital allowances available to the company for each period. Depreciation causes temporary or timing differences with differences arising in one period reversing in another period. For instance, if a company depreciates its assets faster than the tax authority would, in the early years of the assets, the company ends up paying higher taxes than the tax expense reported in the income statement resulting in a deferred tax asset. On the other hand, if a company depreciates its assets slower than the tax authority would, in the early years of the asset, the company ends up paying lower taxes than the tax expense reported in the income statement resulting in a deferred tax liability.
