Citigroup (C)

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Luis Miguel Ochoa

Kryssia Uraguchi

Sean Hinton

Citigroup (NYSE:C) is one of the world's largest diversified financial services firms, which means that it makes money by loaning out money and receiving interest on the loans. Citi had significant exposure to the subprime mortgage industry and suffered considerable losses in 2007 and 2008 from large write-downs and write-offs on many of its mortgage-backed securities and collateralized debt obligations. Citi has posted 5 straight quarterly losses, most recently $10.4B 3Q and $8.29B 4Q losses.^[1][2]

On 16 January 2009, Citi announced that it would be splitting into two businesses to focus on its core business. Citicorp acts as a traditional bank with $1.1 trillion in assets, while Citi Holdings manages its riskier assets, which it will try to sell to raise cash. In an effort to avoid considerable future losses due to mortgage-backed securities and collateralized debt obligations, Citicorp will be 65% deposit funded.^[3] To reduce operating costs, Citi has sold branches such as CitiStreet, CitiBank, and its banking operations in Germany.^[4][5] Citi's efforts to cut costs has stretched up to its CEO, Vikram Pandit, who announced that he would accept only a salary of $1 and no bonus until the firm was returned to solvency^[6] These efforts represent a shift away from an investment bank into a standard holding bank.

In June 2009, Citi was removed from the Dow Jones Industrial Average (.DJIA). The move was prompted by a number of issues, including its share price dropping more than 90% over the year and receiving $45B in Troubled Assets Relief Program (TARP) funds, which it used to extend $36.5B in loans - mostly to mortgage backed securities. The $45B bailout has given the government a 34% stake in Citi through ownership of common stock. This size stake has called into question whether Citi is a nationalized bank.

In addition, in mid December 2009 Citi reached an agreement with U.S. government and its regulators to repay the $20 billion the government holds in TARP trust preferred securities. In order to finance the repayment, Citi will issue $17 billion of common stock and $3.5 billion of tangible equity units. Citi has also decided to terminate its loss sharing agreement with the government and cancel $1.8 billion of the $7.1 billion in trust preferred securities it originally issued to the government as consideration for the benefits provided by the agreement. Termination of the agreement will increase Citi's risk-weighted assets by approximately $144 billion.^[7]

Business Overview

Citigroup operates four business segments in four regions. The four regions include North America (including US, Canada, and Puerto Rico), EMEA (Europe, Middle East & Africa), Latin America (including Mexico, and Asia (including Japan)

Consumer Banking

This division provides traditional commercial banking services. Lending opportunities are also available under this arm of Citi, including loans for housing, auto-financing, and for students. Citi also issues credit cards under the Visa, MasterCard, Diners Club, and American Express networks, with around 120 million cardholders globally. On July 17, 2008, Citi announced that it had received approval from the Chinese government to issue debit cards to its customers in China, giving it access to the booming market there (in 2007, the number of card transactions in China totaled roughly 13.5 billion).^[8]

Institutional Clients Group

This unit, also referred to as corporate and investment banking, offers financial advice to companies interested in raising capital or involved in mergers and acquisitions and provides clients with cash management and treasury services, such as streamlining multiple asset classes under one processing system. In addition, its Global Capital Markets division provides sales, trading, and research services, and is the second largest brokerage system in the U.S.

Global Wealth Management

This unit provides high-net worth individuals and institutions with trust maintenance and advisory services in over 30 countries. The latter includes governments, private firms, companies, and foundations. It includes Smith Barney, its private wealth management unit that manages more than $1.2 trillion in assets, and Citigroup Investment Research, which covers 90% of the companies featured in major international benchmarks. In addition, this unit encompasses an alternative investment arm, which includes a private equity division and a hedge fund.

Global Cards

The Global Cards segment includes the handling and management of credit cards, such as Visa, MasterCard, Diners Club, and American Express. It is the world's largest provider of credit cards with over 200 million accounts, both consumer and business.^[9] In addition, it is the largest earning segment for Citi's consumer business.^[9]

Trends & Forces

Government influences and regulations will greatly affect Citi's future

Stress Test Asks Citi To Raise $5.5B

In February, Secretary of Treasury Timothy Geithner announced that banks with more than $100 billion in assets will be required to participate in a "stress test" -- a series of financial assessments to determine the health of the bank and if the bank needs additional capital.^[12] On May 7 2009, the government determined that Citi must raise an additional $5.5 billion^[13]. Citi ranked 4th in the amount of capital it has to raise to help buffer themselves for a continued difficult economic situation through 2010.^[14] Additionally, Citi, along with nine other banks required to raise approximately $75 billion in capital to help buffer the potential substantial losses in 2009-2010.

The Fed's criteria for the Stress Test included measures such as, GDP, unemployment rates, and housing prices. These measures were used to simulate two economic scenarios: one similar to what has been predicted and one that is worse-than-expected. To measure how the bank could withstand such scenarios, the banks were asked to report estimated numbers, such as the amount of write downs and the bank's loan loss provision. Write downs occur when the bank's assets are overvalued compared to market value, so a high write-down number brings uncertainty in the true value of a bank's balance sheets. As "bad loans" were a key driver of the crisis, a bank's loan loss provision (LLP) provides information as to how many "bad loans" the bank has. In short, including write-downs and LLP helps to measure how much public shareholders would receive if the bank were nearing bankruptcy and had to sell most of its portfolio for cash (liquidation).

$45 Billion Bailout and Repercussions and Subsequent TARP Repayment

By February 2009, the government had given Citi $45 billion in Troubled Assets Relief Program (TARP) funds, giving government a 35% stake in Citi. As part of its agreement with Citi, the government had opted to take on more risk and convert $25 billion of its preferred stock to common shares. The government beared more risk by converting its shares because it became subject to the volatility of Citi's stock prices. By converting its shares, Citi gained more tangible equity available to improve its balance sheet. Its equity-to-asset ratio improved from 1.5% to approximately 4%.^[15] The Federal Deposit Insurance Corporation (FDIC) defines a bank as being critically under-capitalized with a ratio under 2%.^[15]

This move negatively effected stockholders because the huge conversion to common stock will lead to a dilution of shares, and Citi has agreed to stop paying dividends for at least the next 3 years. In addition, the government has the right to convert its remaining $20 billion in shares to common stock in the future. This would further dilute the stock and give the public even less of a stake in Citi.^[15]

On December 14, 2009, Citi announced that it reached an agreement with the U.S. government and its regulators to repay U.S. taxpayers for the $20 billion in TARP trust preferred securities held by the government. Citi also decided to cancel its loss-sharing agreement with the government, which will increase its risk-weighted assets by approximately $144 billion. As a result of the repayment of TARP trust preferred securities and the termination of the loss-sharing agreement, Citi expects a net reduction in annual interest expense of approximately $1.7 billion as well as $0.5 billion in lower amortization expense associated with the loss-sharing agreement. Once the repayment and agreement cancellation are official, Citi will no longer be deemed a beneficiary of "exceptional financial assistance" under Tarp beginning in 2010, restoring some credibility and stability to the company. ^[7]

Corporate Restructuring and Focus on Core Business

Citicorp and Citi Holdings

In January 2009, Citi announced its plans to split Citigroup into Citicorp, its $1.1 billion traditional banking arm, and Citi Holdings, for its riskiest investment assets. Citi stated that the split would allow the company to focus on its core business, and allow Citicorp to return to profitability and stabilize sooner than Citigroup could have as a single firm.^[16] The split was triggered by a tumultuous 2007 and 2008. In 2008, Citi reported an almost $19B loss in 2008, and $8.3B in the fourth quarter alone.^[17] In addition, it cut approximately 52,000 jobs.^[18]

However, Citicorps's pledge to focus on its core business will make profitability difficult in the current economic situation. The recession has effected its entire business and it remains at the will of major macroeconomic factors such as consumer spending, the U.S. housing market, and consumer confidence in the finance industry. For example, Global Cards revenue, Citi's highest earning consumer business unit, decreased 10% from 1Q2008 because of a decreased amount of purchase sales (17% in North America, 16% in EMEA, 19% in Asia, and increased 10% in Latin America).^[13] The decreased amount of purchases and overall spending can be attributed to the current recession and high credit rates. In addition, Consumer Banking's revenue declined 12% from 1Q2008 because of lower volumes of deposits, investment sales, and loans.^[13] Interest revenue from loans also declined due to the decreased volume and amounts of loans. The Institutional Clients Group (ICG) and Global Wealth Management also suffered 24% and 22% year-over-year declines, respectively.^[13] ICG and Global Wealth Management revenues were mainly attributed to lower client activities (i.e. mergers, acquisitions, IPOs, personal investments, etc).^[13]

Macroeconomic Factors

Interest Rates

Rising interest rates raise the cost of borrowing for all lenders, dampening the overall demand for mortgages and other home loan products. The U.S. Federal Funds Rate could help to stimulate demand for loans and lower default rates by allowing people to refinance their homes at lower rates. The Fed has been consistently lowering rates since 2007. For example, in July 2009 it was 0.5%, compared to 2% in July 2008 and 5.25% in September of 2007.^[19][20]

Housing loans have traditionally been a strong source of revenue for banking firms. With the current interest rate environment, owners of real estate are selling to take advantage of the high short-term rates. With low interest rates in the future, prospective home owners are staying out of the market and waiting for short-term rates to drop before looking for a loan. This over-arching attitude has weakened the housing loans business for banks, such as Citi.

The Yield Curve

Typically banks charge higher interest rates on loans which qualify as long term debt than they they pay on deposits (short term debt). A flat or inverted yield curve, implies that long-term rates are the same or lower than short-term rates. This drastically reduces the profitability of loans. Citi is particularly vulnerable to interest rates fluctuations as it depends more heavily on wholesale funds than its competitors. This means that its cost of borrowing is higher than that of many rival bank.

Competitive Landscape

The major players in Citi's league are Bank of America (BAC), Deutsche Bank AG (DB) and J P Morgan Chase (JPM). These firms typically operate on a business model that gradually introduces clients to complex financial services and solutions as the client matures. In this way, these banking firms try to cater to the client's entire life span by offering as many products as possible. For this reason some have identified this strategy as building "banking supermarkets." This mode of thinking has changed recently, as Citigroup increasingly focuses on its most profitable products, continues to cut costs and personnel, and relocates offices to regions that are experiencing robust growth.

Sub-prime loans composed 70% of the CitiFinancial lending portfolio which put the company under extreme stress. The high default rates forced Citi to keep the Troubled Assets Relief Program (TARP) funding longer than some of its rivals. While JP Morgan and other investment based firms were able to repay their loans in under a year, Citi was not given permission from the US Treasury to repurchase the loans.

References

1. ↑ Fox59 "Citi to split in two, reports $8.29B 4Q loss" 16 Jan 2009
2. ↑ Q2 2008 Financial Supplement
3. ↑ Samay Live, "Citi to split itself into Citicorp, Citi Holdings," 01/16/2009
4. ↑ Credit Mutuel to Buy Citi's German Operations for EUR4.9 Billion
5. ↑ Yahoo Finance "Form 10-Q for Citi Group Inc" 1 Aug 2009
6. ↑ Bloomberg "Citigroup’s Vikram Pandit to Take $1 Salary, No Bonus" 11 Feb 2009
7. ↑ ^{7.0 7.1} Citigroup, U.S. Government and Regulators Agree to TARP Repayment
8. ↑ Citigroup Debit Cards for China - WSJ.com
9. ↑ ^{9.0 9.1} Citi About Us
10. ↑ C 10-K 2008 "Selected Financial Data" p.116
11. ↑ 10-K 3Q2009 "Consolidated Statement of Income" p.2
12. ↑ Board of Governors of the Federal Reserve System, "The Supervisory Capital Assessment Program:Design and Implementation," 04/24/09
13. ↑ ^{13.0 13.1 13.2 13.3 13.4} Citi 10-Q, March 31, 2009
14. ↑ MSNBC "Ten of the largest U.S. banks need $75 billion," 05/08/2009
15. ↑ ^{15.0 15.1 15.2} CNN Money,"http://money.cnn.com/2009/02/27/news/companies/citigroup/index.htm," 02/27/09
16. ↑ BBC News, "Citigroup to split as losses grow," 01/16/2009
17. ↑ cnn.com, "Citigroup to split after $8.3B loss," 01/16/2009
18. ↑ cnn.com, "Citigroup to split after $8.3B loss," 01/16/2009
19. ↑ Bloomberg.com, US Rates and Funds
20. ↑ Federal Reserve Board "Open Market Operations" 16 Dec 2008
21. ↑ Herald Tribune "Bank of America claims top spot in assets" 15 June 2009