On Friday, a Calyon Securities analyst dropped a bomb on Citigroup (NYSE: C) in a note warning investors the bank may have to take a $10 billion writedown on its deferred tax assets in the fourth quarter -- equivalent to nearly 10% of its tangible common equity. The reaction was immediate -- shares fell more than 5% on Friday. If we needed any more proof, this demonstrates the challenge of investing in complex and opaque financial companies.

What is a deferred tax asset?
When a bank incurs losses -- such as the $28 billion Citi lost in 2008 -- these can be offset against future earnings in order to reduce income tax expense. This is recorded as a deferred tax asseton the balance sheet, which contributes partially to the bank's Tier One capital.

In order to create this asset, firms must estimate their future profits; however, if they go on to lower their estimates, they may be forced to write down the value of the deferred tax asset. Another circumstance that could trigger a writedown is a "change of control"; in fact, Citi is concerned this could apply when the government moves to offload its 34% stake in the bank. To this end, Citi recently held discussions with U.S. Treasury officials.

Citi's at the top of the table -- the wrong table
As the following table indicates, Citi looks particularly vulnerable among its peers to a revaluation of its deferred tax assets:

Bank

Net Deferred Tax Assets (Calendar Q2 2009)

As a % of Tangible Common Equity

As a % of Common Equity

Citigroup (NYSE: C)*

$44.0 billion

175%*

39%

Bank of America (NYSE: BAC)

$28.9 billion

49%

19%

Morgan Stanley (NYSE: MS)

$6.2 billion

25%

18%

JPMorgan Chase (NYSE: JPM) Continued...