Citigroup Inc.
Q3 2008 Earnings Call Transcript

Published: 16 Oct 2008

[Operator:]

Welcome to Citi’s third quarter 2008 earnings review featuring Citi Chief Financial Officer Gary Crittenden. (Operator Instructions) Today’s call will be hosted by Scott Freidenrich, Director of Investor Relations.

[Scott Freidenrich:]

Welcome to our third quarter 2008 earnings review. The presentation we will be going through is available on our website at www.citigroup.com. You may want to download the presentation if you have not already done so. The financial supplement is also available on the website. Our Chief Financial Officer, Gary Crittenden, will take you through the presentation. We will then be happy to take any questions you may have. Before we get started I would like to remind you that today’s presentation may contain forward-looking statements. Citi’s financial results may differ materially from these statements so please refer to our SEC filings for a description of the factors that could cause our actual results to differ from expectations. With that said, let me turn it over to Gary.

[Gary L. Crittenden:]

We have slides that are available to you on the website, and as usual I’m going to walk through the slides here, so I will start with Slide 1. Slide 1 shows you our consolidated results for the quarter. There were three factors that drive this quarter’s results

[Operator:]

(Operator Instructions) Your first question comes from John McDonald – Sanford Bernstein.

[John McDonald:]

First question on the government preferreds. Where does that put you in terms of the cap, the maximum amount, that Tier 1 that can be composed of preferred?

[Gary L. Crittenden:]

Well, essentially it is a mute point. If we treated these as normal hybrid securities that we funded in the open market, we would be above our cap. But because this equity is by its very nature deemed as Tier 1, it still factors into our Tier 1 calculation.

[John McDonald:]

So the whole pie goes up so it doesn’t matter.

[Gary L. Crittenden:]

That’s correct.

[John McDonald:]

And is the straight tangible-to-common equity ratio important to any of your constituents, rating indices, regulators? Is anyone tracking that?

[Gary L. Crittenden:]

That conversation really never comes up, in a regulatory session, in a rating agency session. I have yet to have that question posed to me since I have been at Citigroup.

[John McDonald:]

The second question I have is on the international consumer credit. It’s hard for us to evaluate it in the outlook there. Can you separate where you’re having some rising losses because of seasoning, because or where you’ve been growing fast, and where you’re seeing economic stress in some of the international consumer businesses and maybe kind of separate regions and products?

[Gary L. Crittenden:]

I think maybe the best way to think about it, if you turn to Slide 10 that I talked about earlier in the presentation, you obviously can see the split by business. Outside the U.S. we were growing rapidly before we saw these type of increases in our net credit losses. And so I would say that most of what you are seeing here is a fundamental deterioration in credit. And relatively little of this would be related to seasoning, because our growth rate here has been going on for some time period. What I think is important to note, however, is that it appears, at least at this point, to be relatively concentrated. So it’s concentrated, as I said, in Mexico, India, and Brazil. On the right-hand side of that chart you can see the percentage contribution that each of those made to the sequential increases in our NCL ratio. And so while there is some deterioration outside the United States, at this point it appears to fairly concentrated in a few places but generally there is some deterioration in credit broadly. It turns out that both the best opportunities for us and the places where you’re going to have the possibility of credit risk overlap. Clearly we’re trying to grow our business in these regions, we’re carefully managing our credit exposures there, but there is some risk associated with that growth.

[John McDonald:]

And that slide combines both credit cards and the global consumer?

[Gary L. Crittenden:]

That’s exactly right. So this takes both those things into account.

[John McDonald:]

In the U.S. Card, the securitization loss, is that a combination of higher assumed charge-offs going forward and funding costs?

[Gary L. Crittenden:]

That’s exactly right. Most of it was related to credit costs but it also included the higher funding costs.

[John McDonald:]

And why do the higher funding costs not seem to impact your NIM, on a managed basis, in the U.S. card?

[Gary L. Crittenden:]

There were other factors in aggregate that offset it. So if you kind of play through the details, the fact that funding costs overall had come down quarter-over-quarter was sufficient to ensure to our NIMs stayed stable during the quarter.

[John McDonald:]

And do you have any outlook on the card NIM, whether you can hold it stable or is the prime [inaudible] starting to hurt more?

[Gary L. Crittenden:]

What is fundamentally happening here is payment rates have in fact slowed a bit as we have come into this more difficult credit cycle. As payment rates have slowed obviously that’s had a yield benefit associated with it. So if you anticipate that that’s going to persist as we go through the next few quarters, particularly compared to the prior year, and you add to that the fact that it’s unlikely, at least in the short term I think, for funding costs to go up, it’s a reasonable assumption I think that the NIM here is durable for a while.

[Operator:]

Your next question comes from Glenn Schorr – UBS.

[Glenn Schorr:]

Could you help us with what some of the larger components of the unrealized loss position on the balance sheet. And such a big change this quarter, maybe just point us in the larger buckets.

[Gary L. Crittenden:]

I would be happy to. There was a change, obviously, in the quarter that took place in OCI. If you go to the supplement, under the balance sheet section of the supplement, you can get a good sense for what that looks like. So quarter-over-quarter it went up about $6.0 billion. So if you look at the split of that, it was in two separate categories. The two separate categories are the AFS book and then the marks that we take as a result of deteriorating currencies in countries outside the U.S. where we have significant investments. For example, if we have an investment in Brazil, that investment is held in local currency terms, we hedge that position, obviously. When those currencies deteriorate, that has a negative impact on our OCI calculation. And that accounts for roughly half of the value. The other half, as I said, was related primarily to spread widening in AFS securities. And the single largest component of that was in the Alt-A category and I took you through some detail on the Alt-A category in the earlier presentation.

[Glenn Schorr:]

And I would assume that both go toward standard tests over time for a permanent impairment and that will just probably not play out over time.

[Gary L. Crittenden:]

We have a very comprehensive process that we go through that reviews this each quarter. What we do is we look at all our positions in the book, we compare those positions against where they are currently trading. If there was a trading analog to these securities. We make estimates about the realizability of the position that we are carrying. Unless we are absolutely convinced that for some reason we can hold these securities to value and recognize the amount that we are carrying them for, we then take an impairment as we need to. And in this quarter you saw, I think, something over $500.0 million in impairments that we took against AFS securities for exactly that purpose. So for those, obviously, have an other than temporary impairment are recognized as appropriate. And in the case of the FX impact, or the $3.0 million or so that was related, those kind of impairments would only be realized if we actually sold our position in a particular market.

[Glenn Schorr:]

Maybe you could provide some commentary on undrawn commitments, what you’ve experienced so far from the clients side and what have you been doing proactively that you could actually start reassessing those cuttings where you need to cut, repricing where you need to reprice.

[Gary L. Crittenden:]

As you might guess we have anticipated this time for quite a while. So the first time I participated in a meeting where we discussed this was probably a little over a year ago, where we sat down and we looked at other historical periods of economical weakness, how much had been drawn on lines during that time period, and we did a pretty comprehensive view of what we thought the maximum draws might be and where those draws might come from, and we started a program back then to proactively manage our relationship with those accounts where we thought we might have the most negative effect. And particularly if the breadth of our relationship was such that it was not particularly profitable. And so we’ve been working on that for a while. Now we’re actually obviously into a period now of economic weakness and we’ve seen accounts begin to draw on their credit lines. At this point there is nothing out of pattern with those draw-downs that we haven’t seen in prior recessions. And we clearly have thought very carefully about the liquidity implications of this. So as part of our normal ongoing stress events, one of the things we look at is the impact of that draw-down, the impact of that on our liquidity and we manage our liquidity to ensure that we’re in a position to absorb that. So I think as we view things now, obviously draw-downs have increased, it seems to be roughly in pattern with what we’ve seen in other economic slow downs and I think we’re managing it well from a liquidity stand point.

[Glenn Schorr:]

And just in general, do you have the ability to reduce and eliminate, and that goes across both consumer and corporate, because similar to your comments on how you never know but credit card loss rates could be higher, I would think draw-down rates could be higher, too, especially when the CP world freezes up the way it did.

[Gary L. Crittenden:]

So we have very actively managed that. So as client accounts come up for renewal, as these lines come up for renewal, we do an active evaluation of that and in some cases we size them down, in some cases we eliminate them all together and in some cases we stay where we are. It just depends on what the situation is. But we’ve had a very active process to do that. One of the best ways to actually see evidence of that is to look at the corporate loan portfolio. On the second slide in the deck I showed that the corporate loan portfolio in this quarter was down something like 15%. And that’s reflective of the fact that we really are very focused on client profitability. So one of the reasons why our assets are down by the $308.0 billion over the course of the last few quarters, is that we have taken a very hard look at customer profitability and have ensured that we have a good breadth of relationships with the customers that we serve so that we can fully meet all of their needs, but do it within the confines of the profitability that we set out for ourselves.

[Glenn Schorr:]

It seems like between expenses, the undrawn commitments, customer profitability, you are controlling what you can control in this horrible environment. On the heels of the Wachovia mess, what do you think now on the strategic front? Do we wait for the next situation to arise, because we all know that more situations will arise?

[Gary L. Crittenden:]

Here’s what I think we would say internally, what we’re saying to ourselves. Basically we had a strategy that we outlined at Citi Day that had us focusing on growing five businesses. Two of those are asset businesses, our card business and our markets and banking businesses and three of those are liability-gathering businesses, deposit gathering businesses. That’s our wealth management business, our consumer retail business, and our GTS business. Our focus is behind those businesses and that remains exactly as it was before. And in order to fund those businesses we have the program underway that you just talked about. We’re cutting our expenses, we’re showing good traction on that, we’re moving assets out of categories that don’t fit with that profile. We’ve been selling businesses that didn’t match there. We’ve carefully managed down our headcount. So we have worked very hard to execute against that strategy. And that’s our strategy. Now, opportunistically, we had the chance, obviously, to acquire Wachovia. For all of the reasons you’re aware of, that’s not going to happen. But the net result of that is not a change in our strategy. Our strategy still fundamentally remains as it was, to execute against the plan that we had set out at Citi Day. And I think as you correctly said, we’re doing our level best to execute on all of the factors that are in our control.

[Operator:]

Your next question comes from Guy Moszkowski – Merrill Lynch.

[Guy Moszkowski:]

Could you comment on the degree to which you have thought through the potential use of the tarp for disposition of mortgage-related assets? Is that something that you think might be appropriate for Citi?

[Gary L. Crittenden:]

We are in the process of doing that. So as you know, all of the parameters here are still ill-defined. What we have tried to do is go through a whole set of scenarios about how this might work. We’ve obviously had many conversations with Treasury about this, going back more than a month ago, about how this might work. And obviously depending on how it’s structured is of more or less use to us. So at this point I would say there is active engagement but little concrete that I can report in terms of how we think we might potentially use it.

[Guy Moszkowski:]

On the newer portion of the program, which is the capital injection, you talked about the $25.0 billion, how are you thinking about the use of those funds? Are you looking at is as more of an opportunity just to shore up the balance sheet or actually an opportunity to, in conjunction with the availability of debt funding, at a very low cost with the FDIC guarantee, being able to sort of more aggressively use this as a way of say going out into the market and acquiring distressed assets?

[Gary L. Crittenden:]

I think you asked the question in just the right way. So I think in the first instance we can say that we felt good about our capital position before this whole thing happened. We didn’t know this was going to happen until we actually found out about it on Monday, and we felt good about the fact that we had a strong capital position, about to become stronger as a result of the sale of our business in Germany. And so this represents, in many ways, something that we had not counted on, something that we hadn’t planned for. And it does present, then, the possibility of our taking advantages of opportunities that otherwise might have [inaudible] to us. Now, as we think about that, the way we approach it is in the same disciplined manner that we’ve approached these other opportunities over the last few weeks. So I think in total now we have looked in detail at the possibility of acquiring three institutions, two of which you’re aware of and one that we haven’t talked about publicly in any way. And as we approached that, we did it with a very well-defined set of parameters. There is only a certain set of circumstances which made sense for us to do that. We will think about the use of this capital in the same way. It is an attractively priced amount of equity capital, and as you correctly said, an attractively priced amount of fixed income, that can match with that. But we’re going to approach it with exactly the same discipline. If it makes sense for us, if it grows our business in the five areas that I talked about, if it furthers our strategic agenda in some way that is fundamental, then we’ll use it in that way. But we’re not going to treat this like a windfall and in some way back off of the measures that we have underway to get the company fit because we have this as an additional capital capacity.

[Guy Moszkowski:]

What is the Tier 1 impact of the sale of the German operation and CitiStreet?

[Gary L. Crittenden:]

We had estimated that the German business would impact by about 60 basis points or so, at the time that it takes place. And CitiStreet has a gain I think of about $300.0 million, so the impact on Tier 1 is relatively modest.

[Guy Moszkowski:]

And you gave a number of the marks at which you are now carrying various described assets. But I don’t think you can us that for leveraged finance assets.

[Gary L. Crittenden:]

The reason for that is obviously there are a discrete number of names that are held in our highly-leveraged finance commitment bucket and we just don’t think that competitively it makes sense for us talk about where those are marked.

[Guy Moszkowski:]

Well, let me try a different way. JP Morgan talked about $0.71 yesterday. Would you be materially different from that?

[Gary L. Crittenden:]

The way to think about this is there is lots of benchmark information out here and we look at those benchmarks all the time. Obviously from the things that are funded, to the extent that there are marks, we carry them at whatever those marks are. For the things that are unfunded, we compare all the time, the nature of those agreements, what those agreements look like, with other securities in the market and we ensure that we conform with the other securities in the market. So you don’t have to worry about there being some odd mark associated with this segment of our balance sheet. I think we do a pretty good job of ensuring that it’s properly marked.

[Guy Moszkowski:]

You spoke to rolling securitized card balances into balance sheet funding. Is there any update more broadly on the potential for asset securitizations to have to be consolidated under either FAS, I think it’s FSP 140-3 or 46R?

[Gary L. Crittenden:]

I’m impressed by your ability to pull those out of the air. There isn’t really any update. I mean, the current anticipation is that on January 1, 2010, the QSPEs will come onto the balance sheet. For us that primarily has an impact on our credit card receivables that have been securitized. As we go through this year next year, as we go through 2009, the amount of securitization that we do and the amount that will actually just come back on our balance sheet as loans will in large measure be a function of the funding opportunities that exist in the different markets. So if the markets for securitization open up, funding costs come down, we are likely to continue to do more securitization. If they don’t and if they’re tight and if funding costs are high, as they were at the back end of the last quarter, then we’re likely to have those come onto our balance sheet. In some ways this would then represent a gradual movement from where we are to the position that we would be at at the beginning of 2010. And obviously this whole thing continues to evolve and we’re not sure that 2010 is going to be the final number. But that’s what we know today at least.

[Operator:]

Your next question comes from Michael Mayo – Deutsche Bank Securities.

[Michael Mayo:]

I have an easy, medium, and hard question. The easy question is what’s the size of the tax benefits in Corporate and Other?

[Gary L. Crittenden:]

Because it’s an easy question, I don’t know it off the top of my head. I just don’t know it as a fact, so if it is immaterial we’ll handle it just from a regular call. You can call the IR team.

[Michael Mayo:]

The medium question, you’ve downsized assets by $300.0 billion from the peak. How much more do you have to go and what’s the timing?

[Gary L. Crittenden:]

Here’s what we set out to do. And in fact it’s actually a good question because it allows me to clarify something a little bit. As you know, at Citi Day we talked about legacy assets of between $400.0 billion and $500.0 billion. Let’s assume for a minute that that number was $450.0 billion and we talked about over a three-year time period getting down to a $100.0 billion. That would kind of be the target. So the objective was $350.0 billion over a three-year time frame. We have now taken $67.0 billion of that out in the last quarter and in the quarter that we’re in we’ve taken out about $48.0 billion or so. So you take the $67.0 billion and you add it to the $48.0 billion, we’re somewhat up over $100.0 billion of the $350.0 billion target that we’ve had. So we’re a little bit better than a third of our way there after two quarters’ worth of effort. And I think the good news about that is obviously this has been in a time period where it hasn’t been easy to reduce those assets, where it’s been difficult to do it. So we feel good about the progress. I think that gives you rough benchmarks on kind of the bookends of where we’re trying to head. And we are seeing some benefit of that, obviously in our NIM. So we did have, as I mentioned, some improvement in yield and part of that is due to the fact that we’re peeling off low-yielding assets.

[Michael Mayo:]

So the new $25.0 billion of preferred, maybe you don’t lend so aggressively with that new money but just it gives you more flexibility to de-lever faster and take some marks if you need to?

[Gary L. Crittenden:]

I wouldn’t necessarily say that. I mean, the way we are approaching it is just the way I just described it, which is we hadn’t planned on this capital. It’s incremental to what our plans have been and we want to make sure we use it in the smartest way possible. So we’re going to be opportunistic with that. And as we see opportunities that when approached in a highly disciplined fashion are things that we think make sense to do, we will continue to do that. Even if that would imply growth to the balance sheet as we’re bringing down other balance sheet categories that we’re trying to exit.

[Michael Mayo:]

Then the hard question. What can the government do to bring down LIBOR and how much does that hurt you? Because LIBOR is still not coming down, despite the new government plan and that’s a little frustrating. On the other hand, I guess it’s an opportunity for you that they’re guaranteeing a three year debt so you can term out your debt a little bit more. So can you talk about how LIBOR is bad but the new government guarantee is good and how do you benefit from that and what else can the government do?

[Gary L. Crittenden:]

Obviously there are a lot of people who are focused on what can happen to bring LIBOR down. And I wouldn’t pretend to be able to say that I have the answer that will finally make that change happen. I think the important thing is, if it continues at these rather dislocated levels, we will obviously have to take some steps in our business that will allow us to have different basis on which we recognize our cost of funds. If we have this dislocation between the pricing mechanism we use, for example, in our card business, and the cost of funds, over time that disparity is something that we would not able to tolerate and so we would make adjustments in the way that we approach things, to reflect the discontinuity that exists. So it is a little bit puzzling, given all the efforts that have taken place, that the movements have been so modest. But again, a lot of these things have not happened yet. I mean, they’ve been announced, we’re in the process of implementing them. It’s going to take time to actually get them implemented. And when they actually get implemented is the time at which it kind of changes your perspective on things. The funding, for example, which I think is very helpful, I think for any institution to be able to borrow at these rates, plus the insurance premium that you pay as a result to having access to this fixed income funding, is a real benefit. And obviously it goes a long way to ensuring that there will be adequate funding to be able to pursue business opportunities. But that’ not available yet. It’s not part of the process yet. I think the way I have thought about it is that these are good incremental steps that obviously have added on to where we thought the world was headed, that with time are more likely than not, to help the financial system overall. And we will see how they actually play out but I generally think of them as very positive.

[Michael Mayo:]

So when can we expect some new three-year debt from Citigroup with that government guarantee so then we can monitor how it’s working?

[Gary L. Crittenden:]

We don’t know exactly what the time is going to be. I don’t think anybody knows exactly the timing of when this is going to be available. We have I think something like $7.0 billion worth of maturities that are happening through the remainder of this year. And so assuming things happen kind of in the normal course here, we will probably have the opportunity to do at least that $7.0 billion.

[Operator:]

Your next question comes from Meredith Whitney – Oppenheimer & Co.

[Meredith Whitney:]

On the card business and the funding, and this quarter’s charge, prospectively if things don’t change, how does the IO write-downs and then whatever funding problems you had during this quarter, how does that model out for future quarters, at least the fourth quarter. And then maybe the first or second quarter of 2009?

[Gary L. Crittenden:]

I went into that in some detail in the material that I covered. So the IO strip itself has about $1.0 billion and so that’s kind of the maximum amount at risk would be the way to think about that. So if you had a major dislocation in credit markets it could be at a much higher level, over time, that would be recognized and there would be a P&L impact associated with that. The second piece, as regards the residuals that flow out of the trust, that had an impact on the financial results this quarter, that is mainly a credit impact. It’s only partially funding. Funding is a relatively small portion of the total. To the extent that there continue to be higher credit losses, we’re going to see that impact. And when I went through the revenue slide in the early part of the deck, I specifically talked about that as being one of the effects that could continue, it could be durable and we might have to face over time and wouldn’t be a head wind for our results as we go into next year.

[Meredith Whitney:]

I follow that. I guess what I am specifically asking is if any of your card receivables were funded with ABCP and that market was unavailable, what costs would be associated with that going forward?

[Gary L. Crittenden:]

We have a wide range of choices for how we fund the receivables, I think is the way I would think about that. You know, we have the entire right-hand of the balance sheet for the most part. And so if one category doesn’t become available to us, we would shift and fund in a different category. And so as I talked about just a minute ago, the decisions that we make about securitization will largely evolve over time. We will look and see how those markets look and what the funding costs look appropriate, then we will probably do that. If not, then there’s a wide range of additional sources that are available to us to fund.

[Meredith Whitney:]

With respect to the investment banking, or institutional clients group, will you look at what’s gone on over the past year and you look at the size of that business, what’s the appropriate quarterly expense base for that business and has that changed over the last few months?

[Gary L. Crittenden:]

I think obviously the volume levels are down. There’s no doubt about that. And some aspects of the business are down for the foreseeable future. And so as I said in some of the comments I’ve made, we have taken 5,000 people out over the course of the last year. I think we took 1,100 people out over the course of the last quarter. We are very focused on making sure that that business is right-sized for the future opportunities that the business has. Now, the third quarter was unusually dislocated period. And so I wouldn’t extrapolate off of that base necessarily to say that’s the ongoing business volumes that we have. In fact, the best way to think about it is, we had a terrific quarter in the second quarter. We had a less than average quarter in the third quarter. You really have to look at these things over the course of a number of quarters to kind of get the real run rate levels. But that doesn’t take away from the point that the business is going to be smaller down the road, we have taken aggressive action so far to make sure that the staffing is right-size and we are going to continue to do that, if necessary.

[Meredith Whitney:]

Has that impacted any of your technology efforts, in terms of your technology spends?

[Gary L. Crittenden:]

No, in fact, the opposite. So we’ve had a pretty significant effort that is focused on upgrading our technology there and the fact that we have reduced our heads has not impacted the effort around technology. In fact, if anything, it gives us more incentive to make sure that we complete this program.

[Operator:]

Your final question comes from Betsy Graseck – Morgan Stanley.

[Betsy Graseck:]

On the card side, I just want ask a little bit about the revenue line as it relates to some of those proposals that are outstanding by the Fed and the regulations that they’re reviewing currently. Could you speak to any that you may need to change in the event that that went through?

[Gary L. Crittenden:]

I think it obviously just depends on exactly how these proposals shake out. In its current form, they would have what I would say is probably a material impact on the way we currently approach the card business and it would require us to make changes to our business model. There have been things like this that have happened in other places around the world and generally the competitors who participate in the business change the nature of the business model to reflect what the new regulation is. At the end of the day, you have to earn a return on capital in the business that justifies the risk that you’re taking, and that can come from a number of different ways. We currently have a process that has that coming from merchant discount fees, it comes from fees that customers sometimes pay for cards, depending on the card product, depending on the interest rate that we earn. There are back-end fees, there’s a whole variety of sources from which we take income. And if the legislation or the regulations come through, as they are kind of currently contemplated, my guess is it will change the mix of those items that are currently used as revenue generation around the business. What I’m quite sure of is that people are going to want to continue to use charge cards as a payment product. It’s going to an important part of the payment system, not only in the United States, but globally. And that we’re going to be a major factor in that. And although all of those things may not happen perfectly, that is we might get impacted by one thing before we’re able to make the changes, in an additional quarter, and it might take some time to sort its way out, my guess is over the course of time this will be a business that’s going to have the turns that are sufficient to attract the capital that’s necessary to support it. But we’ll see. I think it will play out probably over the next few months.

[Betsy Graseck:]

And then on the LIBOR stress that’s going on, at what point do you decide to take action on that? And clearly it’s hard for any of us to know exactly when it’s going to start.

[Gary L. Crittenden:]

Probably sooner rather than later. So it is something we are very focused on and it has obviously put the squeeze on the cost of funding. And so this has now gone on for a while. We are well into the second quarter where this has become an issue. So we are very focused on it. And we are looking at a number of different scenarios and I think we will see how this whole thing plays out here over the next few weeks. But we will take action obviously if it continues to be kind of disconnected. Thank you all very much. We appreciate you joining us on the call

[Operator:]

This concludes today’s conference call.