Citigroup 10-Q 2007
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SECURITIES AND EXCHANGE COMMISSION
Commission file number 1-9924
399 Park Avenue, New York, New York 10043
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 March 31, 2007: 4,946,439,087
Available on the Web at www.citigroup.com
Citigroup Inc. (Citigroup and, together with its subsidiaries, the Company) is a diversified global financial services holding company. Our businesses provide a broad range of financial services to consumer and corporate customers. Citigroup has more than 200 million customer 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 2006 Annual Report on Form 10-K.
The principal executive offices of the Company are located at 399 Park Avenue, New York, New York 10043. The headquarters' telephone number is 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:
SUMMARY OF SELECTED FINANCIAL DATA
Income from continuing operations of $5.012 billion in the first quarter of 2007 was down 10% from the first quarter of 2006. Diluted EPS from continuing operations was down 9%. Results for 2007 include an $871 million after-tax (or $0.17 per share) restructuring charge related to the Company's Structural Expense Review completed during the quarter.
Customer volume growth was strong, with average loans up 14%, average deposits up 19%, average interest-earning assets up 25%, and client assets under fee-based management up 12% from year-ago levels. U.S. debt, equity and equity-related underwriting increased 21% from year-ago levels. Branch activity included the opening of 99 branches during the quarter (48 internationally and 51 in the U.S.). U.S. Cards accounts were up 14% and purchase sales were up 6%.
During the first quarter of 2007, we continued to invest in expanding our distribution and enhancing our technology as we build a broad, strong foundation for future growth. We successfully completed our tender offer to become the majority (over 60%) shareholder of Nikko Cordial and closed several acquisitions, consistent with our efforts to drive growth through a balance of organic investment and targeted acquisitions and to expand internationally.
* Excludes Japan Automated Loan Machines (ALMs).
Revenues were a record $25.5 billion, up 15% from a year ago, driven by Markets & Banking, up 23%. Our international operations recorded revenue growth of 18% in the quarter, with International Consumer up 14%, International Markets & Banking up 20%, and International Global Wealth Management up 32%. U.S. Consumer revenues grew 6%, while Alternative Investments revenues declined 17%.
Net interest revenue increased 8% from last year as higher deposit and loan balances were offset by pressure on net interest margins. Net interest margin in the first quarter of 2007 was 2.46%, down 39 basis points from the first quarter of 2006 (see discussion of net interest margin on page 63).
Operating expenses increased 17% from the first quarter of 2006. Excluding the restructuring charge in 2007 and the 2006 initial adoption of SFAS 123(R), expenses were up 12% from the prior year. The relationship between revenue growth and expense growth, excluding the aforementioned impact of restructuring and SFAS 123(R), improved during the quarter. As our Structural Expense Review takes shape, we expect the pace of year-over-year expense growth (excluding acquisitions) to continue to moderate through 2007.
Income was diversified by segment and region, as shown in the charts below.
Credit costs increased $1.3 billion from a year ago, primarily driven by an increase in net credit losses of $509 million and a net charge of $597 million to build loan loss reserves. The $597 million net build compares to a net reserve release of $154 million in the prior-year period. The build was primarily due to increased reserves to reflect: a change in estimate of loan losses inherent in the initial tenor portion of the Consumer Loan Portfolio; portfolio growth, and increased delinquencies in second mortgages, in the U.S. Consumer Lending mortgage portfolio; and portfolio growth in Markets & Banking, which includes higher commitments to leveraged transactions and an increase in average loan tenor. The Global Consumer loss rate was 1.69%, a 23 basis-point increase from the first quarter of 2006.
The effective tax rate was 26.9% in the first quarter of 2007, reflecting the impacts of the restructuring charge and $131 million in tax benefits for the initial application under APB 23 relating to certain foreign subsidiaries' ability to indefinitely reinvest their earnings abroad. The 21.5% effective tax rate in the first quarter of 2006 includes the tax benefit related to the resolution of the Federal Tax Audit.
Our stockholders' equity and trust preferred securities grew to $131.5 billion at March 31, 2007. Stockholders' equity increased by $2.3 billion during the quarter to $122.1 billion. We distributed $2.7 billion in dividends to shareholders and repurchased $645 million of common stock during the quarter. As a result of the Company's recent acquisitions, the successful Nikko tender offer, and other growth opportunities, it is anticipated that we will not resume our share repurchase program during the remainder of the year. Return on common equity was 17.1% for the quarter. Citigroup maintained its "well-capitalized" position with a Tier 1 Capital Ratio of 8.26% at March 31, 2007.
Certain of the statements above are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. See "Forward-Looking Statements" on page 78.
Structural Expense Review
During the first quarter of 2007, the Company completed a review of its structural expense base in a Company-wide effort to create a more streamlined organization, reduce expense growth, and provide investment funds for future growth initiatives.
As a result of the review, a pretax restructuring charge of $1.4 billion ($871 million after-tax) was recorded in Corporate/Other during the first quarter of 2007. Additional pretax restructuring charges of $200 million are anticipated to be recognized by the end of 2007. Separate from the restructuring charge, additional implementation costs of approximately $100 million pretax are expected throughout 2007.
See Note 7 on page 92 for additional information.
Adoption of SFAS 157Fair Value Measurements
The Company elected to early-adopt SFAS No. 157, "Fair Value Measurements" (SFAS 157), as of January 1, 2007. SFAS 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS 157 requires, among other things, Citigroup's valuation techniques used to measure fair value to maximize the use of observable inputs and minimize the use of unobservable inputs. In addition, SFAS 157 precludes the use of block discounts for instruments traded in an active market, which were previously applied to large holdings of publicly-traded equity securities, and requires the recognition of trade-date gains related to certain derivative trades that use unobservable inputs in determining the fair value. This guidance supersedes the guidance in EITF Issue No. 02-3, which prohibited the recognition of day-one gains on certain derivative trades when determining the fair value of instruments not traded in an active market. The cumulative effect of these two changes resulted in an increase to retained earnings of $75 million.
As a result of maximizing observable inputs as required by SFAS 157, Citigroup began to reflect external credit ratings as well as other observable inputs when measuring the fair value of our derivative positions. The cumulative effect of making this derivative valuation adjustment was a gain of $250 million after-tax ($402 million pre-tax, which was recorded in the Markets & Banking business), or $0.05 per diluted share, included in 2007 first quarter earnings. The primary drivers of this change were the requirement that Citigroup include its own credit rating in pricing derivatives and the elimination of a valuation adjustment, which is no longer necessary under SFAS 157.
See Note 16 on page 105 for additional information.
Adoption of SFAS 159Fair Value Option
In conjunction with the adoption of SFAS 157, the Company early-adopted SFAS 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (SFAS 159), as of January 1, 2007. SFAS 159 provides an option for most financial assets and liabilities to be reported at fair value on an instrument-by-instrument basis with changes in fair value reported in earnings. After the initial adoption, the election is made at the acquisition of a financial asset, financial liability, or a firm commitment and it may not be revoked. Under the SFAS 159 transition provisions, the Company has elected to report certain financial instruments and other items at fair value on a contract-by-contract basis, with future changes in value reported in earnings. SFAS 159 provides an opportunity to mitigate volatility in reported earnings that was caused by measuring hedged assets and liabilities that were previously required to use an accounting method other than fair value, while the related economic hedges were reported at fair value.
The adoption of SFAS 159 resulted in an after-tax decrease to January 1, 2007 retained earnings of $99 million ($157 million pretax).
See Note 16 on page 105 for additional information.
Sale of MasterCard Shares
During the first quarter of 2007, the Company recorded a $171 million after-tax gain ($268 million pretax) on the sale of approximately 2.955 million of the 4.947 million MasterCard Class B shares which were received by Citigroup as a part of the MasterCard initial public offering completed in June 2006. The after-tax gain was recorded in the following businesses:
During the first quarter of 2007, the Company recorded a net build of $597 million to its credit reserves, consisting of a net build of $311 million in Global Consumer and a net build of $286 million in Markets & Banking.
The build of $311 million in Global Consumer was primarily due to increased reserves to reflect: a change in estimate of loan losses inherent in the initial tenor portion of the Consumer Loan portfolio; increased delinquencies in second mortgages, and portfolio growth in the U.S. Consumer Lending mortgage portfolio. Additionally, market expansion in Mexico Cards and the integration of the Credicard portfolio in Brazil added to the increase.
The build of $286 million in Markets & Banking was primarily in Securities and Banking, which had a $300 million reserve increase during the quarter due to portfolio growth which includes higher commitments to leveraged transactions and an increase in average loan tenor.
During the first quarter of 2006, the Company recorded a net release/utilization of its credit reserves of $154 million, consisting of a net release/utilization of $187 million in Global Consumer and Global Wealth Management, and a net build of $33 million in Markets & Banking.
Acquisition of Bisys
On May 2, 2007, the Company announced an agreement to acquire Bisys Group, Inc. (Bisys) for $1.45 billion. At closing, Citigroup will sell the Retirement and Insurance Services Divisions of Bisys to affiliates of J.C. Flowers & Co. LLC, making the net cost of the transaction to Citigroup approximately $800 million. Citigroup will retain the Investment Services Division of Bisys, which provides administrative services for hedge funds, mutual funds and private equity funds. The transaction is expected to close in the second half of 2007 and is subject to Bisys shareholder approval and to regulatory approvals in the U.S., Ireland and Bermuda. Bisys will be included within Citigroup's Transaction Services business.
Tender Offer for Nikko Cordial
On April 26, 2007, Citigroup completed its successful tender offer to become the majority shareholder of Nikko Cordial Corporation in Japan. Approximately 541 million shares were tendered for approximately $7.7 billion. Following the May 9, 2007 scheduled closing date Citigroup will own a total ownership stake in excess of 60%. Once the tender offer is closed, Citigroup will consolidate Nikko and its operations with the minority stake disclosed as Minority Interest.
This acquisition accelerates Citigroup's growth strategy in the world's second largest economy and is intended to provide a broad base of global products and services to Nikko Cordial's client network.
Agreement to Acquire Old Lane Partners, L.P.
On April 13, 2007, the Company announced a definitive agreement to acquire 100% of the outstanding partnership interests in Old Lane Partners, L.P. and Old Lane Partners, GP, LLC (Old Lane). Old Lane is the manager of a global, multi-strategy hedge fund and a private equity fund with total capital under management and private equity commitments of approximately $4.5 billion. Old Lane will operate as part of Citigroup's Alternative Investments (CAI) business. Following the completion of the transaction, Old Lane's Vikram Pandit will become Chief Executive Officer of CAI. The transaction is subject to customary regulatory reviews and is expected to close in the third quarter of 2007.
Acquisition of ABN AMRO Mortgage Group
On March 1, 2007, Citigroup acquired ABN AMRO Mortgage Group (AAMG), a subsidiary of LaSalle Bank Corporation and ABN AMRO Bank N.V. AAMG is a national originator and servicer of prime residential mortgage loans. As part of this acquisition, Citigroup purchased approximately $12 billion in assets, including $3 billion of mortgage servicing rights. The acquisition of AAMG added approximately 1.5 million servicing customers to the U.S. Consumer Lending portfolio.
Acquisition of Bank of Overseas Chinese
On April 9, 2007, Citigroup announced the agreement to acquire 100% of Bank of Overseas Chinese (BOOC) in Taiwan for approximately $427 million, subject to certain closing adjustments. BOOC offers a broad suite of corporate banking, consumer and wealth management products and services to more than one million clients through 55 branches in Taiwan.
This transaction will strengthen Citigroup's presence in Asia making it the largest international bank and 13th largest by total assets among all domestic Taiwan banks. Citigroup's acquisition of BOOC is subject to shareholder and U.S. and Taiwanese regulatory approvals and is expected to close during the second half of 2007.
Strategic Investment and Cooperation Agreement with Guangdong Development Bank
On December 17, 2006, a Citigroup-led consortium acquired an 85.6% stake in Guangdong Development Bank ("GDB"). Citigroup's share is 20% of GDB and its investment of approximately $725 million is accounted for under the equity method.
In accordance with the parties' agreement, Citigroup will have significant management influence at GDB to enhance GDB's management team and corporate governance standards, instill operational and lending best practices, improve risk management and internal controls, upgrade GDB's information technology infrastructure, and further develop GDB's customer service and product offerings.
U.K. Market Expansion
On May 1, 2007, Citigroup completed its acquisition of Egg Banking plc (Egg), the world's largest pure online bank and one of the U.K.'s leading online financial services providers, from Prudential PLC for approximately $1.127 billion. Egg has more than three million customers and offers various financial products and services including online payment and account aggregation services, credit cards, personal loans, savings accounts, mortgages, insurance and investments.
On March 1, 2007, the Company completed the acquisition of Quilter, a U.K. wealth advisory firm with over $10.9 billion of assets under management, from Morgan Stanley. Quilter has more than 18,000 clients and 300 staff located in 10 offices throughout the U.K., Ireland and the Channel Islands. Quilter's results are included within Global Wealth Management.
Central American Acquisitions
On December 13, 2006, Citigroup announced the agreement to acquire the subsidiaries of Grupo Cuscatlan for $1.51 billion in cash and stock from Corporacion UBC Internacional S.A. Grupo Cuscatlan is one of the leading financial groups in Central America, with assets of $5.4 billion, loans of $3.5 billion, and deposits of $3.4 billion. Grupo Cuscatlan has operations in El Salvador, Guatemala, Costa Rica, Honduras and Panama. This acquisition is subject to local country regulatory approvals and is expected to close during the second quarter of 2007.
Grupo Financiero Uno
On March 5, 2007, Citigroup completed its acquisition of Grupo Financiero Uno (GFU), the largest credit card issuer in Central America, and its affiliates.
The acquisition of GFU, with $2.2 billion in assets, expands the presence of Citigroup's Latin America consumer franchise, enhances its credit card business in the region and establishes a platform for regional growth in Consumer Finance and Retail Banking.
GFU has more than one million retail clients, representing 1.1 million credit card accounts, $1.3 billion in credit card receivables and $1.5 billion in deposits in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Panama. GFU operates a distribution network of 75 branches and more than 100 mini-branches and points of sale.
Purchase of 20% Equity Interest in Akbank
On January 9, 2007, Citigroup completed its purchase of a 20% equity interest in Akbank for approximately $3.1 billion. Akbank, the second-largest privately owned bank by assets in Turkey, is a premier, full-service retail, commercial, corporate and private bank.
Sabanci Holding, a 34% owner of Akbank shares, and its subsidiaries have granted Citigroup a right of first refusal or first offer over the sale of any of their Akbank shares in the future. Subject to certain exceptions, including purchases from Sabanci Holding and its subsidiaries, Citigroup has otherwise agreed not to increase its percentage ownership in Akbank.
Resolution of Federal 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 (referred to hereinafter as the "resolution of the Federal Tax Audit"). For the first quarter of 2006, the Company released a total of $657 million from its tax contingency reserves related to the resolution of the Federal Tax Audit.
The following table summarizes the 2006 first quarter tax benefits, by business, from the resolution of the Federal Tax Audit:
Adoption of the Accounting for Share-Based Payments
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), "Share-Based Payment" (SFAS 123(R)), which replaced the existing SFAS 123 and superseded Accounting Principles Board (APB) Opinion No. 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 or deferred 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. 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.
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 ("the 2006 initial adoption of SFAS 123(R)"):
The Company recorded the quarterly accrual for the stock awards that were granted in January 2007 during each of the quarters in 2006. During the first quarter of 2007, the Company recorded the quarterly accrual for the estimated stock awards that will be granted in January 2008.
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 IncomeSegment and Product View
Citigroup Net IncomeRegional View
Citigroup's Global Consumer Group provides a wide array of banking, lending, insurance and investment services through a network of 8,140 branches, approximately 19,100 ATMs, 708 Automated Loan 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.
U.S. Consumer is composed of four businesses: Cards, Retail Distribution, Consumer Lending and Commercial Business.
U.S. Cards is one of the largest providers of credit cards in North America, with more than 150 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 The Home Depot, Federated, Sears, Dell Computer, Radio Shack, Staples and Zales Corporation.
Revenues are primarily generated from net interest revenue on receivables, interchange fees on purchase sales, securitization activities and other delinquency and servicing fees.
1Q07 vs. 1Q06
Net Interest Revenue decreased 14% reflecting the securitization of higher margin receivables and net interest margin compression, which was partially offset by higher risk-based fees. Non-Interest Revenue increased 11% primarily reflecting a $161 million pre-tax gain on the sale of MasterCard shares, 6% growth in purchase sales, and a higher level of securitized receivables.
Operating expenses decreased slightly, primarily reflecting the timing of advertising and marketing campaigns and the absence of the charge related to the 2006 initial adoption of SFAS 123(R).
Provision for loan losses and for benefits and claims increased, primarily reflecting a lower loan loss reserve release, partially offset by lower net credit losses. The net credit loss ratio increased 31 basis points to 4.58% primarily reflecting an increase in bankruptcy filings over unusually low filing levels experienced in the first quarter of 2006.
Net Income also reflected the absence of an $89 million tax benefit resulting from the resolution of the Federal Tax Audit from the first quarter of 2006.
U.S. Retail Distribution provides banking, lending, investment and insurance products and services to customers through 993 Citibank branches, 2,495 CitiFinancial branches, the Primerica Financial Services (PFS) sales force, the Internet, direct mail and telesales. Revenues are primarily derived from net interest revenue on loans and deposits, and fees on banking, insurance and investment products.
1Q07 vs. 1Q06
Net Interest Revenue increased primarily due to deposit and loan growth of 22% and 12%, respectively, which was partially offset by a decrease in net interest margin in higher cost deposits. Non-Interest Revenue increased as a result of higher investment product sales and higher insurance and banking fees.
Operating expense growth was primarily driven by higher volume-related expenses, increased investment spending related to the 51 new branch openings during the quarter (21 in Citibank and 30 in CitiFinancial), and costs associated with Citibank Direct. The increase in 2007 was affected favorably by the absence of the charge related to the 2006 initial adoption of SFAS 123(R).
Provisions for loan losses and for benefits and claims increased primarily due to higher customer volumes and the absence of a loan loss reserve release in the first quarter of 2006. The net credit loss ratio increased 19 basis points to 2.85%, primarily reflecting an increase in bankruptcy filings over unusually low filing levels experienced in the first quarter of 2006.
Deposit growth reflected balance increases in e-Savings accounts (which generated $12.9 billion in end-of-period deposits), certificates of deposit, partly rate-sensitive money market products and premium checking. Loan growth reflected improvements in all channels and products. Investment product sales increased 21%, driven by increased volumes.
Net income also reflected the absence of a $51 million tax reserve release resulting from the resolution of the Federal Tax Audit in the first quarter of 2006.
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.
U.S. Consumer Lending (Continued)
1Q07 vs. 1Q06
Net Interest Revenue increased primarily due to average loan growth of 16%, partially offset by lower net interest margins. Non-Interest Revenue increased on higher net servicing fees and higher gains on sales of mortgage-backed securities. Average loan growth reflected a strong increase in originations, with increases in real estate and auto lending of 22% and 55%, respectively.
Operating expenses increased primarily due to higher loan origination volumes. The increase in 2007 was affected favorably by the absence of the charge related to the 2006 initial adoption of SFAS 123(R).
Provisions for loan losses and for benefits and claims increased primarily as a result of increased net credit losses due to higher volumes and portfolio seasoning, increased loan loss reserves to reflect a change in estimate of loan losses inherent in the initial tenor portion of the portfolio, and increased delinquencies in second mortgages. The net credit loss ratio in real estate lending increased 14 basis points to 0.33%
Net income also reflected the absence of a $31 million tax reserve release resulting from the resolution of the Federal Tax Audit in the first quarter of 2006.
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.
1Q07 vs. 1Q06
Net Interest Revenue declined 4% on continued net interest margin compression across several products, partially offset by higher volumes. Average deposits and average loans increased 12% and 8% respectively, while both experienced spread compression. Revenues also reflect an increase in tax-advantaged transactions.
Operating expenses declined 9% primarily driven by improved expense controls and the prior-year impact of the initial adoption of SFAS 123(R) of $10 million.
Provision for loan losses increased primarily reflecting a current period loan loss reserve net build of $10 million and the absence of a prior-year loan loss reserve release of $38 million.
International Consumer is comprised of three businesses: Cards, Consumer Finance and Retail Banking. International Consumer operates in five geographies: Mexico, Latin America, EMEA, Japan, and Asia.
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 and servicing fees.
1Q07 vs. 1Q06
Net Interest Revenue increased 45% driven by growth in average receivables, as well as the CrediCard portfolio in Latin America, and the impact of the acquisition of Grupo Financiero Uno. Non-Interest Revenue increased 22%, primarily due to a $66 million pre-tax gain on the sale of MasterCard shares and higher purchase sales of 25%, led by growth in Latin America, Asia, and EMEA. The positive impact of foreign currency translation also contributed to increases in revenues.
Operating expenses increased, reflecting the integration of the CrediCard portfolio and the acquisition of Grupo Financiero Uno, along with volume growth across the regions, continued investment spending, higher customer activity, and the impact of foreign currency translation. The increase in 2007 was favorably affected by the absence of the charge related to the 2006 initial adoption of SFAS 123(R).
Provision for loan losses increased 30% driven by portfolio growth, target market expansion in Mexico and the integration of the CrediCard portfolio in Latin America, partially offset by the absence of a 2006 first quarter loan loss reserve build in Taiwan due to the industry-wide credit deterioration.
Net Income also reflected the absence of a 2006 first quarter $20 million tax benefit resulting from the resolution of the Federal Tax Audit.
Regional Net Income
Mexico income increased due to the gain on the sale of MasterCard shares, higher sales volumes, and average loans driven by portfolio growth and target market expansion, partially offset by higher expenses and volume related provision increases. EMEA income increased due to higher sales volumes and average loans. Latin America income increased primarily due to the CrediCard portfolio and the acquisition of Grupo Financiero Uno. Asia income increased due to higher average loan volumes and a decrease in credit costs related to credit conditions in Taiwan. Japan income declined due to lower revenues.
International Consumer Finance provides community-based lending services through a branch network, centralized sales platforms and cross-selling initiatives with International Cards and International Retail Banking. As of March 31, 2007, International Consumer Finance maintained 2,377 sales points comprised of 1,669 branches in more than 25 countries, and 708 Automated Loan Machines (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.
International Consumer Finance (Continued)
1Q07 vs. 1Q06
Net Interest Revenue declined, driven by lower results in Japan reflecting recent changes in the operating environment and the passage of changes to consumer lending laws in the 2006 fourth quarter. Excluding Japan, Net Interest Revenue increased, driven by 25% growth in average loans and a stable net interest margin. Non-Interest Revenue increased primarily on higher insurance and other fees and the impact of foreign currency translation.
Operating expense decreased, primarily driven by lower expenses in Japan due to the repositioning of the business that included closing 84 branches and 101 automated loan machines during the quarter. Excluding Japan, expenses increased reflecting higher volume related expenses, and higher investment spending driven by 29 branch openings.
Provision for loan losses increased primarily due to higher net credit losses in Japan due to legislative and other actions affecting the consumer finance industry. Excluding Japan, increased credit costs were primarily in EMEA and Asia, driven by higher volumes, increased loan loss reserves due to portfolio growth and the absence of a prior-year release related to a portfolio sale.
The increase in average loans across all regions outside of Japan was mainly driven by higher personal-loan and real-estate-secured portfolios. In Japan, average loans declined 6% due to the impact of foreign currency translation and narrowing of the target market related to the passing of changes to consumer lending laws.
International Retail Banking delivers a wide array of banking, lending, insurance and investment services through a network of local branches and electronic delivery systems, including ATMs, call centers and the Internet. International Retail Banking serves 53 million customer accounts for individuals and small businesses. Revenues are primarily derived from net interest revenue on deposits and loans, and fees on mortgage, banking, and investment products.
International Retail Banking (Continued)
1Q07 vs. 1Q06
Net Interest Revenue increased 6% driven by 7% growth in deposits, and 13% growth in average loans. The deposit growth was led by Asia, which increased 10%, while average loan growth was led by double-digit increases in Asia, EMEA, and Latin America. The Latin America increase includes the impact of the acquisition of Grupo Financiero Uno. Non-Interest Revenue increased 20% reflecting improvements in all regions, driven by an increase in investment product sales of 33%, led by an increase in Asia of 46%. Additionally, the increase was due to a $41 million pre-tax gain on the sale of MasterCard shares, and the acquisition of Akbank in EMEA. Assets under management grew by 12%.
Operating expenses increased due to higher investment spending, which included 19 new branch openings during the quarter and 85 branches acquired as part of the acquisition of Grupo Financiero Uno, leading towards a net increase of 336 branches from the first quarter of 2006. Higher advertising and marketing costs and higher business volumes additionally drove an increase in expenses. The increase in 2007 was favorably affected by the absence of the charge related to the 2006 initial adoption of SFAS 123(R).
Provisions for loan losses and for benefits and claims increased primarily due to portfolio growth, the absence of the 2006 first quarter loan loss reserve release in Korea, and increased loan loss reserves to reflect a change in estimate of loan losses inherent in the initial tenor portion of the portfolio. Additionally, the increase was due to lower net recoveries. The 90 days past-due ratio fell from 1.21% to 0.88%.
Net Income also reflected the absence of a 2006 first quarter tax benefit in Mexico of $72 million related to APB 23 benefits and a 2006 first quarter $55 million benefit from tax reserve releases related to the resolution of the Federal Tax Audit.
Regional Net Income
Mexico income declined, driven by the absence of tax benefits related to APB 23 in the 2006 first quarter, partially offset by lower expenses that included a decrease in profit sharing, higher fee revenues, and gain on the sale of MasterCard shares. Latin America income declined primarily due to higher expenses associated with growth in Brazil and the absence of 2006 first quarter tax benefits, partially offset by strong growth in loans and deposits, up 55% and 21%, respectively. EMEA income declined primarily due to higher expenses driven by increased business volume and investment spending tied to retail bank branch expansion, a reserve build to reflect a change in estimate of loan losses inherent in the initial tenor portion of the portfolio, and lower recoveries. Partially offsetting the decline was strong growth in loans and deposits, up 16% and 9%, respectively, stronger investment product sales, and the impact of foreign currency translation. Japan income declined due to lower average loans, higher loan loss reserve, and the absence of 2006 first quarter benefit related to the resolution of the Federal Tax Audit. Asia income declined primarily due to the absence of a 2006 first quarter loan loss reserve release in Korea, and increased loan loss reserves to reflect a change in estimate of loan losses inherent in the initial tenor portion of the portfolio, and increased investment spending related to retail bank branch expansion. Partially offsetting the decline was strong growth in loans and deposits, up 14% and 10%, respectively, and an increase in investment product sales of 46%.
Other Consumer includes certain treasury and other unallocated staff functions and global marketing.
Revenues and expenses reflect certain unallocated items that are not reported in the Global Consumer operating segments.
The net loss increase was primarily due to the absence of the 2006 first quarter tax benefit of $40 million reflecting the resolution of the Federal Tax Audit, partially offset by higher treasury results and lower unallocated expenses.
Markets & Banking provides a broad range of trading, investment banking, and commercial lending products and services to companies, governments, institutions and investors in approximately 100 countries. Markets & Banking includes Securities and Banking, Transaction Services and Other Markets & Banking.
Securities and Banking
Securities and Banking offers a wide array of investment and commercial banking services and products, including investment banking and advisory services, debt and equity trading, institutional brokerage, foreign exchange, structured products, derivatives, and lending. Securities and Banking revenue is generated primarily from fees for investment banking and advisory services, fees and spread on structured products, foreign exchange and derivatives, fees and interest on loans, and income earned on principal transactions.
1Q07 vs. 1Q06
Revenues, net of interest expense, increased, driven by broad-based volume improvements across products and regions and by the $402 million benefit of the SFAS 157 accounting adoption. Equity Markets revenues increased, driven by strong growth globally, including cash trading, derivatives products, equity finance and prime brokerage. Fixed Income Markets revenue increases were driven by improved results across all products, including interest rates and currencies, and credit and securitized products. Investment Banking revenue growth was driven by higher equity underwriting and advisory and other fees.
Operating expenses growth was primarily driven by increased staffing and higher business volumes. The growth in 2007 was favorably affected by the absence of a $346 million charge related to the 2006 initial adoption of SFAS 123(R).
The provision for credit losses increased due to a net charge of $286 million to increase loan loss reserves. The increase in loan loss reserves was driven by portfolio growth, which includes higher commitments to leveraged transactions and an increase in average loan tenor.
Regional Net Income
Net income in the U.S. increased, driven by double-digit revenue growth in Fixed Income Markets and Underwriting and Equity Markets and Underwriting as well as Advisory. Compensation expenses were almost flat to last year due to the absence of the 2006 initial adoption of SFAS 123(R).
Mexico net income increased, driven by double-digit revenue growth in Fixed Income Markets and equity underwriting.
Latin America net income increased, driven by double-digit revenue growth in Fixed Income and Equity Markets. Revenue growth was partially offset by higher taxes due to the absence of prior-year tax benefits from the resolution of the Federal Tax Audit.
EMEA net income increased, driven by strong double-digit revenue growth across all major product lines and geographies on higher volumes and growth in customer activity. Results also include a $171 million pre-tax increase to loan loss reserves due to portfolio growth, which includes higher commitments to leveraged transactions and an increase in average loan tenor.
Net income in Japan declined primarily due to lower results in Fixed Income Markets and Equity Underwriting. Net income in Asia increased, driven by double-digit revenue growth in Investment Banking and Lending.
Transaction Services is comprised of Cash Management, Trade Services and Securities & Fund Services (SFS). Cash Management and Trade Services provide comprehensive cash management and trade finance for corporations and financial institutions worldwide. SFS provides custody and fund services to investors such as insurance companies and pension funds, clearing services to intermediaries such as broker-dealers, and depository and agency/trust services to multi-national corporations and governments globally. Revenue is generated from fees for transaction processing, net interest revenue on Trade Services loans and deposits in Cash Management and SFS, and fees on assets under custody in SFS.
1Q07 vs. 1Q06
Revenues, net of interest expense, increased, reflecting growth in liability balances, assets under custody, and rising interest rates in Cash Management and SFS. Average liability balances grew 25% to $213 billion in the first quarter due to growth across all regions, reflecting positive flow from new and existing customers.
Cash Management revenue increased, reflecting growth across all regions, higher liability balances, rising interest rates, and increased revenues from new sales.
Securities & Funds Services revenue increased, reflecting growth across most regions with record new sales, increased liability balances, higher assets under custody, and transaction volumes. Assets under Custody reached $10.7 trillion, an increase of $1.9 trillion, or 22%, on continued momentum from new sales as well as global markets.
Trade Services & Finance revenue increased primarily due to growth in Asia Pacific, partially offset by EMEA and Latin America.
Operating expenses increased due to organic business growth, acquisitions, and investment spending.
Regional Net Income
Net income in the U.S. increased, primarily due to growth in liability balances and rising interest rates.
Mexico net income increased primarily due to growth in liability balances and rising interest rates.
Latin America net income increased primarily due to increased revenues from new sales, growth in liability balances and rising interest rates.
EMEA net income increased primarily due to increased revenue from new sales, growth in liability balances and assets under custody, rising interest rates and strong volumes, which drove growth in Cash Management, SFS, and Trade Services.
Asia net income increased primarily due to increased revenue from new sales, higher customer volumes, and growth in liability balances and assets under custody and rising interest rates.
Japan net income increased primarily due to increased revenue from new sales, growth in liability balances and assets under custody, and rising interest rates.
Other Markets & Banking
Other Markets & Banking includes offsets to certain line items reported in other Markets & Banking segments, certain non-recurring items and tax amounts not allocated to Markets & Banking products.