Citigroup Inc. reported its third straight quarterly profit, beating forecasts and boosting optimism that the banking sector is on track to recover even amid a tepid economic expansion.

Relief about the improving results, bolstered by slowing credit losses and reduced reserves for bad loans, outweighed lingering concern about the foreclosure crisis, boosting the bank’s shares nearly 4 percent.
Citigroup, whose problems in the crisis were so severe that it needed three taxpayer rescues, is the second of the top banks to beat forecasts. JPMorgan Chase & Co. posted better-than-expected earnings last week. The No. 1 U.S. bank, Bank of America Corp., is due to report  Tuesday.

The gain in Citigroup shares helped fuel a broader rally in bank shares and lift U.S. stock indexes.

“It kind of fits what JPMorgan said on their conference call, that they expect the losses to persist but the worst is behind them,” said Anthony Polini, an analyst with Raymond James. “But the level of uncertainty is what the market plays on, and until we can be more certain about foreclosure issues etc., these stocks could have a ceiling on them. “repeated their assurances of recent weeks, saying the bank is “fairly confident” its methods for documenting mortgages and foreclosures are sound.

“We’ve intensified the ongoing reviews of our process, and based upon these reviews we have not identified any system issues,” Chief Financial Officer John Gerspach told reporters on a conference call.

The bank’s assurances on foreclosure practices are “certainly favorable” but “it’s a little early to start calling who did good and who did bad,” said Michael Nix, co-chief investment officer of Greenwood Capital Associates.

He attributed the rise in bank stocks to “a little relief rally” after a wide sell-off on foreclosure crisis worries last week.

Citigroup, the third-largest U.S. bank by assets, also said it is looking at the home loans it bundled into bonds and sold to investors to make sure the paperwork is in order. So far, it has not found any problems.

Investors in such mortgage bonds may be entitled to sell bad loans back to banks at face value because of documentation issues. U.S. banks could be left holding billions of dollars of bad loans, which could affect profits for years to come.

Citigroup’s third-quarter revenue rose slightly from a year earlier but fell from the second quarter, and the bank dipped into reserves to cover bad loans. The bank said revenue was hit by a slump in fixed income trading and losses on credit derivative hedges.

CEO Vikram Pandit said on a conference call with analysts that he believed the bank was in compliance with new tougher global bank capital standards.

He also forecast the bank would be in a position to return capital to shareholders as soon as 2012, subject to regulatory approval.

Pandit has sold assets, laid off staff and tried to focus Citigroup on its main businesses, including investment banking and retail banking for affluent customers globally.

Like stronger rival JPMorgan, Citigroup beat earnings expectations in part by releasing money it had set aside to cover bad loans.

Analysts, who tend to discount earnings powered by reserve releases as “low-quality,” have questioned how bank profits can keep growing if a sluggish economy results in low loan demand and relatively high credit losses.

“It’s a problem for all the banks now — they have trouble raising revenues,” said Matt McCormick, a portfolio manager, Bahl & Gaynor Investment Counsel Inc.

“Reducing loan loss reserves is not something you can do indefinitely — eventually, they’ll get to the point where they’ll say ‘We can’t keep going down this path.’ ”

Citigroup’s outstanding loans, after subtracting money set aside to cover losses, fell 5.5 percent in the quarter as consumer loans dropped. Corporate loans edged higher.

In North America and Western Europe, “we’re not necessarily seeing the same shrinkage that we saw in the loan book before, but it’s not robust growth,” Gerspach said on the call.

Citigroup, which is still 12 percent owned by the U.S. government, has struggled to make new loans this year.

Since April, the government has whittled down its remaining stake in the bank. It originally intended to unwind that stake by mid-December. Gerspach said on Monday that the bank expects the government “to attempt” to meet that target.

The bank said it had $421 billion of assets in Citi Holdings, its repository for businesses it is trying to sell or wind down, at the end of the third quarter. It expects that figure to fall below $400 billion, or 20 percent of Citigroup’s overall assets, by the end of the year.

The bank posted a third-quarter profit of $2.2 billion, or 7 cents per share, compared with a year-earlier loss to shareholders of $3.2 billion, or 27 cents per share.

Analysts on average had expected a profit of 6 cents a share, according to Thomson Reuters I/B/E/S.

Excluding an $800 million pre-tax loss on the sale of its student lending operations, Citigroup earned $2.6 billion, or 8 cents per share.

Revenue was $20.7 billion, the lowest figure for any quarter this year.