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Citigroup 10-Q 2006 Documents found in this filing:QuickLinks -- Click here to rapidly navigate through this document
SECURITIES AND EXCHANGE COMMISSION FORM 10-Q
Commission file number 1-9924 Citigroup Inc.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ý Accelerated filer o Non-accelerated filer o Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: Common stock outstanding as of June 30, 2006: 4,943,944,972 Available on the Web at www.citigroup.com
2 Citigroup Inc. (Citigroup, or the Company) is a diversified global financial services holding company whose businesses provide a broad range of financial services to consumer and corporate clients. Citigroup has some 200 million client accounts and does business in more than 100 countries. Citigroup was incorporated in 1988 under the laws of the State of Delaware. The Company is a bank holding company within the meaning of the U.S. Bank Holding Company Act of 1956 registered with, and subject to examination by, the Board of Governors of the Federal Reserve System (FRB). Some of the Company's subsidiaries are subject to supervision and examination by their respective federal and state authorities. This quarterly report on Form 10-Q should be read in conjunction with Citigroup's 2005 Annual Report on Form 10-K. The principal executive offices of the Company are located at 399 Park Avenue, New York, New York 10043, telephone number 212-559-1000. Additional information about Citigroup is available on the Company's Web site at www.citigroup.com. Citigroup's annual report on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K, and all amendments to these reports are available free of charge through the Company's Web site by clicking on the "Investor Relations" page and selecting "SEC Filings." The Securities and Exchange Commission (SEC) Web site contains reports, proxy and information statements, and other information regarding the Company at www.sec.gov. Citigroup is managed along the following segment and product lines:
The following are the six regions in which Citigroup operates. The regional results are fully reflected in the product results.
3 CITIGROUP INC. AND SUBSIDIARIES SUMMARY OF SELECTED FINANCIAL DATA
4 MANAGEMENT'S DISCUSSION MANAGEMENT SUMMARY Income from continuing operations of $5.262 billion in the 2006 second quarter was up 11% from the 2005 second quarter. During the 2006 second quarter, we continued executing on our strategic initiatives, opening a record 270 new Citibank and CitiFinancial branches (196 in International and 74 in the U.S.). Customer volumes were strong, with average loans up 13%, average deposits up 15% and average interest-earning assets up 15% from year-ago levels. Citibank Direct, our Internet bank launched at the end of the first quarter, has raised more than $4.2 billion in deposits, of which approximately two-thirds is new money to the Company. During the quarter, we completed the full integration of Brazil's Credicard into our international cards business, affirming us as a premier credit card company in Brazil.
5
Revenues increased 10% from the 2005 second quarter, reaching $22.2 billion. Our international operations recorded revenue growth of 17% in the 2006 second quarter, with International Consumer up 12% and International CIB up 23%. Global CIB revenues increased 31%, reflecting strong performance in both Transaction Services and Capital Markets and Banking. Net interest revenue was approximately flat to last year as pressure on net interest margins continued. Net interest margin in the 2006 second quarter was 2.72%, down 40 basis points from the 2005 second quarter and down 14 basis points from the 2006 first quarter. The majority of the decline from the 2006 first quarter was driven by trading activities (see discussion of net interest margin on page 64). Non-interest revenue increased 19%, continuing to benefit from higher customer volume across the businesses. Operating expenses increased 16% from the 2005 second quarter; this was comprised of 12 percentage points due to organic business growth and acquisitions, 2 points due to investment spending, and 2 points due to SFAS 123(R) accruals. Income was well diversified by segment and region, as shown in the charts below.
6 The global credit environment remained favorable; this, as well as significantly lower consumer bankruptcy filings and an asset mix shift, drove a $234 million decrease in credit costs compared to year-ago levels. The Global Consumer loss rate was 1.48%, a 20 basis point decline from the 2005 second quarter, in part reflecting significantly lower bankruptcy filings. Corporate cash-basis loans declined 3% from March 31, 2006 to $799 million. The effective tax rate on continuing operations was 30.3%, comparable to the 2005 second quarter. Our equity capital base and trust preferred securities grew to $122.0 billion at June 30, 2006. Stockholders' equity increased by $1.0 billion during the quarter to $115.4 billion. We distributed $2.5 billion in dividends to shareholders and repurchased $2.0 billion of common stock during the quarter. Return on common equity was 18.6% for the quarter. Citigroup maintained its "well-capitalized" position with a Tier 1 Capital Ratio of 8.51% at June 30, 2006.
7 EVENTS IN 2006 and 2005 MasterCard Initial Public Offering In June 2006, MasterCard conducted a series of transactions consisting of: (i) an IPO of new Class A stock, (ii) an exchange of its old Class A stock held by its member banks for shares of its new Class B and Class M stocks, and (iii) a partial redemption of the new Class B stock held by the member banks. Citigroup, as one of MasterCard's member banks, received 4,946,587 shares of Class B stock, 48 shares of Class M stock, and $123 million in cash as a result of these transactions. An after-tax gain of $78 million ($123 million pretax) was recognized in the 2006 second quarter related to the cash redemption of shares. Sale of Upstate New York Branches On June 30, 2006, Citigroup sold the Upstate New York Financial Center Network consisting of 21 branches in Rochester, N.Y. and Buffalo, N.Y. to M&T Bank (referred to hereinafter as the "Sale of New York Branches"). Citigroup received a premium on deposit balances of approximately $1 billion. An after-tax gain of $92 million ($163 million pretax) was recognized in the 2006 second quarter. Consolidation of Brazil's Credicard In April 2006, Citigroup and Banco Itau dissolved their joint venture in Credicard, a Brazil consumer credit card business. In accordance with the dissolution agreement, Banco Itau received half of Credicard's assets and customer accounts in exchange for its 50% ownership, leaving Citigroup as the sole owner of Credicard. Beginning April 30, 2006, Credicard's financial statements were consolidated with Citigroup. $75 million in purchased credit card relationship intangibles and $270 million in goodwill were recognized in connection with the acquisition. Previously, Citigroup reported its interest in Credicard using the equity method of consolidation. Accordingly, our net investment was included in Other assets. Acquisition of Federated Credit Card Portfolio and Credit Card Agreement With Federated Department Stores In June 2005, Citigroup announced a long-term agreement with Federated Department Stores, Inc. (Federated) under which the companies will partner to manage approximately $6.2 billion of Federated's credit card receivables, including existing and new accounts, executed in three phases. For the first phase, which closed in October 2005, Citigroup acquired Federated's receivables under management, totaling approximately $3.3 billion. For the second phase, which closed in May 2006, additional Federated receivables totaling approximately $1.9 billion were transferred to Citigroup from the previous provider. For the final phase, in the 2006 third quarter, Citigroup expects to acquire the approximately $1.0 billion credit card receivable portfolio of The May Department Stores Company (May), which recently merged with Federated. Citigroup is paying a premium of approximately 11.5% to acquire these portfolios. The multi-year agreement also provides Federated the ability to participate in the portfolio performance, based on credit sales and certain other performance metrics. The Federated and May credit card portfolios comprise a total of approximately 17 million active accounts. Certain of the above statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 81. Adoption of the Accounting for Share-Based Payments On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) 123 (revised 2004), "Share-Based Payment" (SFAS 123(R)), which replaces the existing SFAS 123 and supersedes Accounting Principles Board (APB) 25. SFAS 123(R) requires companies to measure and record compensation expense for stock options and other share-based payments based on the instruments' fair value, reduced by expected forfeitures. In adopting this standard, the Company conformed to recent accounting guidance that restricted stock awards issued to retirement-eligible employees who meet certain age and service requirements must be either expensed on the grant date or accrued over a service period prior to the grant date. The impact to the 2006 first quarter results was a charge of $520 million after-tax ($846 million pretax). This charge consisted of $398 million after-tax ($648 million pretax) for the immediate expensing of awards granted to retirement-eligible employees in January 2006, and $122 million after-tax ($198 million pretax) for the quarterly accrual of the estimated awards that will be granted through January 2007. The following table summarizes the SFAS 123(R) impact, by segment, on the 2006 first quarter pretax compensation expense for stock awards granted to retirement-eligible employees in January 2006:
In the 2006 second quarter, the accrual for estimated January 2007 awards was $104 million after-tax ($168 million pretax). The Company has changed the plan's retirement eligibility for the January 2007 management awards, which impacted the amount of the accrual in the 2006 second quarter. Additional information can be found in Notes 1 and 8 to the Consolidated Financial Statements on pages 87 and 95, respectively. The Company will continue to accrue for the estimated awards that will be granted through January 2007 in each quarter of 2006. 8 Settlement of IRS Tax Audit In March 2006, the Company received a notice from the Internal Revenue Service (IRS) that they had concluded the tax audit for the years 1999 through 2002. For the 2006 first quarter, the Company released a total of $657 million from its tax contingency reserves related to the 1999 through 2002 Federal tax audit (referred to hereinafter as the "resolution of the Federal Tax Audit"). The following table summarizes the 2006 first quarter tax benefit by segment of the resolution of the Federal Tax Audit:
Sale of Asset Management Business On December 1, 2005, the Company completed the sale of substantially all of its Asset Management Business to Legg Mason, Inc. (Legg Mason) in exchange for Legg Mason's broker-dealer business, $2.298 billion of Legg Mason's common and preferred shares (valued as of the closing date), and $500 million in cash. This cash was obtained via a lending facility provided by Citigroup CIB. The transaction did not include Citigroup's asset management business in Mexico, its retirement services business in Latin America (both of which are now included in International Retail Banking) or its interest in the CitiStreet joint venture (which is now included in Smith Barney). The total value of the transaction at the time of closing was approximately $4.369 billion, resulting in an after-tax gain to Citigroup of approximately $2.082 billion ($3.404 billion pretax). This gain remains subject to final closing adjustments. Concurrently, Citigroup sold Legg Mason's Capital Markets business to Stifel Financial Corp. (The transactions described in these two paragraphs are referred to as the "Sale of the Asset Management Business.") Upon completion of the Sale of the Asset Management Business, Citigroup added 1,226 financial advisors in 124 branch offices from Legg Mason to its Global Wealth Management business. During March 2006, Citigroup sold 10.3 million shares of Legg Mason stock through an underwritten public offering. The net sale proceeds of $1.258 billion resulted in a pretax gain of $24 million. Additional information can be found in Note 3 to the Consolidated Financial Statements on page 89. Sale of Travelers Life & Annuity On July 1, 2005, the Company completed the sale of Citigroup's Travelers Life & Annuity and substantially all of Citigroup's international insurance businesses to MetLife, Inc. (MetLife). The businesses sold were the primary vehicles through which Citigroup engaged in the Life Insurance and Annuities business. Citigroup received $1.0 billion in MetLife equity securities and $10.830 billion in cash, which resulted in an after-tax gain of approximately $2.120 billion ($3.386 billion pretax). On July 3, 2006, Citigroup completed the sale of its MetLife shares, resulting in a $133 million pretax gain, which will be recorded in the 2006 third quarter. On July 31, 2006, the final settlement with MetLife was completed, resulting in an additional after-tax gain of $75 million ($115 million pretax), which will be recognized in the 2006 third quarter as part of discontinued operations. The transaction encompassed Travelers Life & Annuity's U.S. businesses and its international operations, other than Citigroup's life insurance business in Mexico (which is now included within International Retail Banking). (The transaction described in the preceding three paragraphs is referred to as the "Sale of the Life Insurance and Annuities Business"). Additional information can be found in Note 3 to the Consolidated Financial Statements on page 89. 9 Credit Reserves During the three months ended June 30, 2006, the Company recorded a net release/utilization of its credit reserves of $210 million, consisting of a net release/utilization of $328 million in Global Consumer, and a net build of $118 million in CIB. The net release/utilization in Global Consumer was primarily due to lower bankruptcy filings and a continued overall improvement in the consumer portfolio. Partially offsetting the releases were builds in Taiwan, related to recent credit trends in credit cards, and Mexico. The net build of $118 million in CIB was primarily composed of $120 million in Capital Markets and Banking,which included a $138 million reserve increase for unfunded lending commitments. The net build reflected growth in loans and unfunded commitments and an update to historical data used for certain loan loss estimates. For the six months ended June 30, 2006, the Company recorded a net release/utilization of $364 million, consisting of a net release/utilization of $515 million in Global Consumer and a net build of $151 million in the CIB. Credit Reserve Builds (Releases/Utilization)(1)
Allowance for Credit Losses
10 Repositioning Charges The Company recorded a $272 million after-tax $(435 million pretax) charge during the 2005 first quarter for repositioning costs. The repositioning charges were predominantly severance-related costs recorded in CIB $(151 million after-tax) and in Global Consumer $(95 million after-tax). These repositioning actions were consistent with the Company's objectives of controlling expenses while continuing to invest in growth opportunities. Resolution of Glendale Litigation During the 2005 first quarter, the Company recorded a $72 million after-tax gain $(114 million pretax) following the resolution of Glendale Federal Bank v. United States, an action brought by Glendale Federal Bank, a predecessor to Citibank (West), FSB, against the United States government. Acquisition of First American Bank On March 31, 2005, Citigroup completed its acquisition of First American Bank in Texas (FAB). The transaction established Citigroup's retail branch presence in Texas, giving Citigroup 106 branches, $4.2 billion in assets and approximately 120,000 new customers in the state at the time of the transaction's closing. The results of FAB are included in the Consolidated Financial Statements from March 2005 forward. Divestiture of the Manufactured Housing Loan Portfolio On May 1, 2005, Citigroup completed the sale of its manufactured housing loan portfolio, consisting of $1.4 billion in loans, to 21st Mortgage Corp. The Company recognized a $109 million after-tax loss $(157 million pretax) in the 2005 first quarter related to the divestiture. Divestiture of CitiCapital's Transportation Finance Business On January 31, 2005, the Company completed the sale of CitiCapital's Transportation Finance Business based in Dallas and Toronto to GE Commercial Finance for total cash consideration of approximately $4.6 billion. The sale resulted in an after-tax gain of $111 million $(157 million pretax). 11 SEGMENT, PRODUCT AND REGIONAL NET INCOME The following tables show the net income (loss) for Citigroup's businesses on a segment and product view and on a regional view: Citigroup Net Income—Segment and Product View
12 Citigroup Net Income—Regional View
13 SELECTED REVENUE AND EXPENSE ITEMS Selected Revenue Items Net interest revenue of $9.8 billion for the 2006 second quarter increased $11 million from the 2005 second quarter, as higher customer deposit and loan balances were offset by spread compression. Total commissions, asset management and administrative fees, and other fee revenues for the second quarter of 2006 of $7.0 billion increased by $1.6 billion, or 29%, compared to the 2005 second quarter. This was attributable to the mark-to-market of the Consumer Lending's servicing assets, as well as increased investment banking fees, volumes, and assets under custody in CIB. Principal transactions revenue of $1.7 billion increased $859 million from the second quarter of 2005. Realized gains from sales of investments were down $153 million, or 34%, to $302 million in the 2006 second quarter primarily due to the absence of the gain on the sale of the shares of St. Paul Travelers during the prior-year quarter. Other revenue of $2.5 billion declined $283 million, or 10%, from the 2005 second quarter, and included $123 million from the MasterCard IPO. Operating Expenses Total operating expenses were $12.8 billion for the 2006 second quarter, up $1.8 billion, or 16%, from the comparable 2005 period. The increase was primarily in compensation and benefits due to higher headcount and an increase in incentive compensation in CIB, primarily Capital Markets and Banking, as well as increased costs of branch expansion and higher business volumes in Global Consumer. Global Consumer reported an 11% increase in total expenses from the 2005 second quarter. U.S. Consumer increased $193 million, or 6%, on increased business volumes and investments in new branches. International Consumer expenses increased $381 million, or 16%, versus the second quarter of 2005, primarily due to investment in branch expansion, and the integration of Credicard. CIB expenses increased 23% from the 2005 second quarter, primarily due to an increase in incentive compensation on a revenue increase of 31%. Global Wealth Management expenses increased 24% as compared to the prior year's three-month period, primarily related to costs associated with the Legg Mason integration and higher compensation costs. Alternative Investments expenses increased 25% from the 2005 second quarter. Provisions for Credit Losses and for Benefits and Claims The provision for credit losses decreased $234 million, or 13%, from the 2005 second quarter to $1.6 billion. Policyholder benefits and claims in the 2006 second quarter increased $19 million, or 9%, from the 2005 second quarter. Global Consumer provisions for loan losses and for benefits and claims of $1.6 billion in the 2006 second quarter were down $398 million, or 19%, from the 2005 second quarter. The declines were mainly due to lower bankruptcy filings and a continued favorable credit environment that drove lower net credit loss ratios. Total net credit losses were $1.754 billion, and the related loss ratio was 1.48%, in the 2006 second quarter, as compared to $1.797 billion and 1.68% in the 2005 second quarter. The consumer loan delinquency ratio (90 days or more past due) declined to 1.22% at June 30, 2006 from 1.70% at June 30, 2005. See page 54 for a reconciliation of total consumer credit information. The CIB provision for credit losses in the 2006 second quarter was up $187 million from the 2005 second quarter. CIB's reserve for credit losses was increased by $150 million for unfunded lending commitments in the 2006 second quarter due to higher exposures and an update to historical data used for certain loss estimates. Corporate cash-basis loans at June 30, 2006 and 2005 were $799 million and $1.6 billion, respectively, while the corporate Other Real Estate Owned (OREO) portfolio totaled $171 million and $133 million, respectively. The decline in corporate cash-basis loans from June 30, 2005, was related to improvements in the overall credit environment and write-offs, as well as sales of loans and paydowns in the portfolio. Income Taxes The Company's effective tax rate on continuing operations was 30.3% in the 2006 second quarter, compared to 30.4% in the 2005 second quarter. The 2005 second quarter included a $65 million tax benefit related to the resolution of an interest calculation for a prior appeals settlement. Regulatory Capital Total capital (Tier 1 and Tier 2) was $112.6 billion and $106.4 billion, or 11.68% and 12.02% of net risk-adjusted assets at June 30, 2006 and December 31, 2005, respectively. Tier 1 capital was $82.0 billion, or 8.51% of net risk-adjusted assets, at June 30, 2006, compared to $77.8 billion, or 8.79%, at December 31, 2005. 14 ACCOUNTING CHANGES AND FUTURE APPLICATION OF ACCOUNTING STANDARDS See Note 1 to the Consolidated Financial Statements on page 87 for a discussion of Accounting Changes and the Future Application of Accounting Standards. SIGNIFICANT ACCOUNTING POLICIES The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company has identified five policies as being significant because they require management to make subjective and/or complex judgments about matters that are inherently uncertain. These policies relate to Valuations of Financial Instruments, Allowance for Credit Losses, Securitizations, Income Taxes and Legal Reserves. The Company, in consultation with the Audit and Risk Management Committee of the Board of Directors, has reviewed and approved these significant accounting policies, which are further described in the Company's 2005 Annual Report on Form 10-K. The net income line in the following business segment and operating unit discussions excludes discontinued operations. Income from discontinued operations is included within the Corporate/Other business segment. See Notes 3 and 4 to the Consolidated Financial Statements on pages 89 and 92, respectively. Certain prior period amounts have been reclassified to conform to the current period's presentation. 15 GLOBAL CONSUMER
Citigroup's Global Consumer Group provides a wide array of banking, lending, insurance and investment services through a network of 7,670 branches, approximately 18,000 ATMs, approximately 800 Automated Lending Machines (ALMs), the Internet, telephone and mail, and the Primerica Financial Services salesforce. Global Consumer serves more than 200 million customer accounts, providing products and services to meet the financial needs of both individuals and small businesses.
16 U.S. CONSUMER
U.S. Consumer is composed of four businesses: Cards, Retail Distribution, Consumer Lending and Commercial Business.
17 U.S. Cards
U.S. Cards is one of the largest providers of credit cards in North America, with more than 140 million customer accounts in the United States, Canada and Puerto Rico. In addition to MasterCard (including Diners), Visa, and American Express, U.S. Cards is the largest provider of credit card services to the oil and gas industry and the leading provider of consumer private-label credit cards and commercial accounts on behalf of merchants such as Sears, The Home Depot, Federated, Dell Computer, Radio Shack, Staples and Zales Corporation. Revenues are primarily generated from net interest revenue on receivables, interchange fees on purchase sales and other delinquency or services fees.
18 2Q06 vs. 2Q05 Revenues, net of interest expense, were flat as the positive impact of 12% growth in purchase sales, higher securitization revenues, and the addition of the Federated portfolio in the 2005 fourth quarter were offset by continued net interest margin compression and higher rewards program costs. The net interest margin compression was driven by a combination of increased payment rates, higher cost of funds, and the mix of receivable balances. Included in revenues in the 2006 second quarter was a gain from the MasterCard initial public offering of $59 million. In the 2005 second quarter, revenues included gains from other asset sales of $70 million. Operating expenses increased, primarily reflecting the addition of the Federated portfolio; this was partially offset by a decline in advertising and marketing expenses, largely reflecting the timing of advertising campaigns. Provision for loan losses and for benefits and claims declined, primarily reflecting a decline in net credit losses due to lower bankruptcies, the favorable credit environment, and a loan loss reserve release of $160 million. 2Q06 YTD vs. 2Q05 YTD Revenues, net of interest expense, declined as the positive impact of 11% growth in purchase sales and the addition of the Federated portfolio in the 2005 fourth quarter were more than offset by continued net interest margin compression and higher rewards program costs. The net interest margin compression was driven by a combination of increased payment rates, higher cost of funds, and the mix of receivable balances. Operating expenses increased, primarily reflecting the addition of the Federated portfolio in the 2005 fourth quarter and the adoption of SFAS 123(R) in the 2006 first quarter; this was partially offset by a decline in advertising and marketing expenses, largely reflecting the timing of advertising campaigns. Provision for loan losses and for benefits and claims declined, primarily reflecting a decline in net credit losses due to lower bankruptcies, the favorable credit environment and a loan loss reserve release of $232 million. Net Income also reflected an $89 million tax benefit resulting from the resolution of the Federal Tax Audit in the 2006 first quarter. 19 U.S. Retail Distribution
U.S. Retail Distribution provides banking, lending, investment and insurance products and services to customers through 892 Citibank branches, 2,361 CitiFinancial branches, the Primerica Financial Services (PFS) salesforce, the Internet, direct mail and telesales. Revenues are primarily derived from net interest revenue on loans and deposits and from fees on banking, insurance and investment products.
20 2Q06 vs. 2Q05 Revenues, net of interest expense, increased 6% primarily due to the $132 million pretax gain on the Sale of New York Branches. Growth in deposits and loans, up 8% and 10%, respectively, and increased investment product sales were more than offset by net interest margin compression. This resulted in part from a shift in customer liabilities from savings and other demand deposits to certificates of deposit and e-Savings accounts. Operating expense growth was primarily due to higher volume-related expenses, increased investment spending driven by 74 new branch openings and advertising costs associated with the launch of e-Savings. Provisions for loan losses and for benefits and claims declined primarily due to lower bankruptcy filings and a $31 million loan loss reserve release in CitiFinancial. The net credit loss ratio declined 85 basis points to 2.65%, reflecting the continuing favorable credit environment. Deposit growth reflected balance increases in certificates of deposit; e-Savings accounts, which generated $4.2 billion as of the end of the quarter; premium checking; and partly rate-sensitive money market products. Loan growth reflected improvements in all channels and products. Investment product sales increased 37%, driven by increased volumes. 2Q06 YTD vs. 2Q05 YTD Revenues, net of interest expense, were flat to the prior-year period as the $132 million pretax gain on the Sale of New York Branches was offset by the absence of a $110 million gain in the 2005 first quarter related to the resolution of the Glendale litigation and other revenue declines. Growth in deposits and loans, up 7% and 9%, respectively, and increased investment product sales were more than offset by net interest margin compression. This resulted in part from a shift in customer liabilities from savings and other demand deposits to certificates of deposit and e-Savings accounts. Operating expense growth was primarily due to higher volume-related expenses, increased investment spending driven by 110 new branch openings, the impact of SFAS 123(R), and advertising costs associated with the launch of e-Savings. The impact of the FAB acquisition also contributed to higher expenses. Provisions for loan losses and for benefits and claims decreased primarily due to lower bankruptcy filings. CitiFinancial Branches also had higher loan loss reserve releases of $69 million. The credit environment was favorable during the first half of 2006. Deposit growth reflected balance increases in certificates of deposit; e-Savings accounts, which generated $4.2 billion in end-of-period deposits; premium checking; and partly rate-sensitive money market products. Loan growth reflected improvements in all channels and products. Investment product sales increased 31%, driven by increased volumes. Net income in 2006 also reflected a $51 million tax reserve release resulting from the resolution of the Federal Tax Audit. 21
U.S. Consumer Lending provides home mortgages and home equity loans to prime and non-prime customers, auto financing to non-prime consumers and educational loans to students. Loans are originated throughout the United States and Canada through the Citibank, CitiFinancial and Smith Barney branch networks, Primerica Financial Services agents, third-party brokers, direct mail, the Internet and telesales. Loans are also purchased in the wholesale markets. U.S. Consumer Lending also provides mortgage servicing to a portfolio of mortgage loans owned by third parties. Revenues are composed of loan fees, net interest revenue and mortgage servicing fees.
22 2Q06 vs. 2Q05 Revenues, net of interest expense, declined as a 21% increase in average loan balances and higher gains on securitizations of real estate loans and student loans were more than offset by lower net mortgage servicing revenues and net interest margin compression. Average loan growth reflected a strong increase in originations across all businesses, driven by a 16% increase in prime mortgage originations and home equity loans. Operating expenses increased primarily due to higher loan origination volumes. Provisions for loan losses and for benefits and claims decreased due to a continued favorable credit environment, and higher loan loss reserve releases of $75 million in the Real Estate Lending and Auto businesses. The 90 days-past-due ratio declined across most product categories. 2Q06 YTD vs. 2Q05 YTD Revenues, net of interest expense, declined as a 19% increase in average loan volumes and higher gains on securitizations of real estate loans were more than offset by lower net mortgage servicing revenues and net interest margin compression. Average loan growth reflected a strong increase in originations across all businesses, driven by a 17% increase in prime mortgage originations and home equity loans. Operating expenses increased primarily due to higher loan origination volumes and the impact of SFAS 123(R). Provisions for loan losses and for benefits and claims declined due to a continued favorable credit environment and loan loss reserve releases of $111 million in the Real Estate Lending and Auto businesses. 23 U.S. Commercial Business
U.S. Commercial Business provides equipment leasing, financing, and banking services to small- and middle-market businesses ($5 million to $500 million in annual revenues) and financing for investor-owned multifamily and commercial properties. Revenues are composed of net interest revenue and fees on loans and leases.
NM Not meaningful 2Q06 vs. 2Q05 Revenues, net of interest expense, increased 5% primarily due to the $31 million pretax gain on the Sale of New York Branches. Strong growth in core loan and deposit balances, up 13% and 11%, respectively, was more than offset by the continuing impact of net interest margin compression. Operating expense growth was mainly due to higher volume-related expenses and restructuring costs from site consolidation. Provision for loan losses decreased primarily due to the stable credit environment and the continued liquidation of non-core portfolios. Deposit and core loan growth reflected an increase in savings deposits and strong transaction volumes and growth in loan balances across all business units, partially offset by declines in the liquidating portfolio. 24 2Q06 YTD vs. 2Q05 YTD Revenues, net of interest expense, declined 16%, primarily due to the absence of the $161 million pretax gain on the CitiCapital Transportation Finance business in the prior-year period, partly offset by the $31 million pretax gain on the Sale of New York Branches. Strong growth in core loan and deposit balances, up 17% and 18%, respectively, were more than offset by the continuing impact of net interest margin compression. Operating expense growth was primarily due to higher volume-related expenses, the impact of the FAB acquisition and SFAS 123(R), partially offset by lower expenses from the absence of the transportation finance business and severance costs in the prior year. Provision for loan losses declined primarily due to loan loss reserve releases of $28 million, a stable credit environment, and the continued liquidation of non-core portfolios. Deposit and core loan growth reflected strong transaction volumes and balances across all business units and the impact of the FAB acquisition, partially offset by declines in the liquidating portfolio. Net income also reflected a $4 million tax reserve release resulting from the resolution of the Federal Tax Audit. 25 INTERNATIONAL CONSUMER
International Consumer is composed of three businesses: Cards, Consumer Finance and Retail Banking.
NM Not meaningful 26
27 International Cards
International Cards provides MasterCard, Visa and Diners branded credit and charge cards, as well as private label cards and co-branded cards, to more than 30 million customer accounts in 43 countries outside of the U.S. and Canada. Revenues are primarily generated from net interest revenue on receivables, interchange fees on purchase sales and other delinquency or service fees.
NM Not meaningful 28 2Q06 vs. 2Q05 Revenues, net of interest expense, increased, driven by a 15% increase in purchase sales and 18% growth in average receivables across the regions, the integration of the Credicard portfolio, and a gain on the MasterCard IPO of $35 million. Operating expenses increased, reflecting the integration of the Credicard portfolio, continued investments in organic growth, and volume growth across the regions. Provision for loan losses increased, driven by the industry-wide credit deterioration in Taiwan, portfolio growth and target market expansion in Mexico, credit losses relating to the Credicard portfolio in Latin America, and volume growth in all regions. Regional Net Income Latin America income increased primarily due to volume and purchase sales growth. Mexico income increased due to higher sales volumes and average loans, as well as a gain from the MasterCard IPO of $9 million after-tax. EMEAincome increased primarily due to higher purchase sales and volume growth, partially offset by higher credit costs and higher expenses. Asia income declined due to an increase in credit costs related to Taiwan, partially offset by higher purchase sales and loan growth. Japan income decreased primarily due to lower purchase sales. 2Q06 YTD vs. 2Q05 YTD Revenues, net of interest expense, increased, driven by a 12% increase in purchase sales and 16% growth in average receivables across all regions, the integration of the Credicard portfolio, and a gain on the MasterCard IPO of $35 million. Operating expenses increased, reflecting the integration of the Credicard portfolio, continued investment in organic growth, costs associated with a labor settlement in Korea, volume growth across the regions, and the adoption of SFAS 123(R). This was partially offset by the absence of 2005 first quarter repositioning expenses of $13 million. Provision for loan losses increased, driven by the industry-wide credit deterioration in Taiwan, portfolio growth and target market expansion in Mexico, and volume growth in all regions. Regional Net Income Mexico income increased due to higher sales volumes and average loans, as well as a gain from the MasterCard IPO of $9 million after-tax and tax benefits in the 2006 first quarter of $6 million. Latin America income increased primarily due to volume and purchase sales growth, and the benefit of foreign currency translation. EMEA income increased primarily due to higher purchase sales and volume growth, partially offset by higher net credit losses. Asia income declined due to an increase in credit costs related to Taiwan and costs associated with a Korea labor settlement, partially offset by higher purchase sales and loan growth and a gain from the MasterCard IPO of $7 million. 29 International Consumer Finance
International Consumer Finance provides community-based lending services through its branch network, regional sales offices and cross-selling initiatives with International Cards and International Retail Banking. As of June 30, 2006, International Consumer Finance maintained 2,506 sales points comprising 1,697 branches in more than 25 countries and 809 ALMs in Japan. International Consumer Finance offers real-estate-secured loans, unsecured or partially secured personal loans, auto loans, and loans to finance consumer-goods purchases. Revenues are primarily derived from net interest revenue and fees on loan products.
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