Credit conditions in the US have improved since the spike in bankruptcy filings in late 2005 caused a significant dent in US card issuer profits, but the nature of the saturated market and lower-than-expected earnings in domestic card portfolios is forcing lending giants such as Citi to look overseas for healthier profit margins. According to the Federal Reserve, revolving credit outstanding in the US has increased at a 5.6 percent compound annual growth rate over the last decade (based on non-seasonally adjusted data) and amounted to $883 billion as of February 2007, or $9,300 per household, by some estimates.
However, this has not been enough to satisfy shareholder or institutional pressure to bump up profitability at major US lenders, which are fighting for market share in an increasingly difficult market. With the US banking industry characterised by a spate of mergers and acquisitions over the past few years, there are few targets left for US card issuers to acquire, and high market valuations make the situation even more difficult.
Flat domestic market
In the US, the top ten credit card issuers represent over 87 percent of the US credit card market as measured by receivables outstanding. Citi is the third-largest issuer of general purpose credit cards with a 14 percent market share, behind JPMorgan Chase and Bank of America. A trend of issuer consolidation, combined with debt levels which are on the rise again (mainly due to high levels of bankruptcies related to the subprime mortgage market), and a growing shift towards debit card payments, has left Citi and other issuers struggling with declining fortunes in their US credit card portfolios.
As a result, lending giants are turning their attentions to more profitable overseas markets. Typical of this is Citi, which is looking to new horizons in the search for credit growth. A look at the issuer’s latest financial results bears out the fact that it is the international rather than domestic markets that are underpinning Citi’s profits. Citi’s policy of pursuing organic growth in markets where it is already established, and forging alliances in up-and-coming markets such as Latin America and Asia-Pacific, appears to be paying off after a year of mixed results.
In the second quarter of 2007, Citi reported income from continuing operations of $6.2 billion, a rise of 18 percent compared to the year-ago period – but international revenues and net income rose by a record 34 percent and 35 percent respectively. In the US cards business, revenues fell as growth in non-interest revenues was offset by a decline in net interest revenues, which fell 11 percent. Average managed loans were flat at a 6 percent increase in purchase sales, driven by growth in travel, business and partner portfolios, was offset by lower promotional balances.
However, the picture from the international cards business is somewhat more positive. Revenue and net income growth was driven by higher purchase sales and average loans, up 31 percent and 44 percent, respectively, and improved net interest margins. Loan balances grew at a double-digit pace in Mexico, Europe, Middle East and Africa, Asia, and Latin America. Net income increased 7 percent, reflecting increased credit costs, up 67 percent. Credit costs increased primarily due to organic portfolio growth, acquisitions, and increased overdue accounts and portfolio seasoning in Mexico.
Citi opened or acquired 160 new retail bank or consumer finance branches during the quarter, including 136 internationally and 24 in the US.
Weaker results in the US cards and consumer finance business, and soaring operational costs, led to Citi restructuring its business divisions earlier this year, which resulted in a charge of $1.4 billion in the first quarter of 2007. Among the changes Citi made was to shed about 5 percent of its work force, the bulk of cuts coming in middle management roles. Also, Citi decided to outsource nearly 10,000 jobs to lower-cost overseas locations. According to credit ratings agency Fitch, Citi’s efficiency ratios vary and are high in relation to US peers, while trending upwards recently as a result of numerous, albeit comparatively small, acquisitions. Also, credit quality has begun a downward and increasing delinquencies have been noted in all products, although at very low levels.
However, Citi’s overseas focus could prove to be fortuitous at a time when the US credit market is coming under even more pressure, due to the fallout of the subprime mortgage mess. In its second-quarter results, Citi said that deteriorating credit quality forced it to increase its loan provisioning costs by 50 percent.
As lending standards start to tighten, the effects could yet ripple out into the wider US economy and dent profits further. This happened at Capital One, which only recently acquired two mortgage lending units as part of its bid for diversification: its first-quarter 2007 profits slid as a result. However, Citi may escape the worst effects of the US credit market as the group is already well-diversified, particularly overseas.
In Europe, Citi issues cards in Belgium, the Czech Republic, Germany, Greece, Hungary, Italy, Poland, Portugal, Spain, Sweden and the UK. Its most recent foreign card issuer acquisition in Europe was of Egg, the credit card and internet banking operation of UK insurer Prudential in January 2007. Citi said it intends to retain the Egg brand and the unit will be combined with its UK consumer operations. The purchase includes online products and services including payment and account aggregation services, credit cards, personal loans, savings accounts, mortgages, insurance and investments. Citi said the acquisition will more than quadruple its UK credit card base by adding Egg’s approximately 2.9 million credit card customers to Citi’s 800,000 cardholders.
Also in January 2007, Citi acquired a 20 percent stake in Turkey’s Akbank. The two will undertake a strategic collaboration to pursue new commercial activities, referral arrangements and to share expertise and technology. Akbank currently has 675 branches and 1,617 ATMs and is a full-service retail, commercial, corporate and private bank in Turkey, with assets of $39.6 billion, loans of $19.6 billion and a deposit base of $25 billion.
In Latin America, Citi is already well established. Citi is present in 25 Latin America countries and has over 9 million credit cardholders. It is already well-established in Mexico through its subsidiary Banamex.
In February 2005, Citi and Brazil’s Banco Itaú said they would equally split the assets of Credicard, the Brazilian credit card issuer which had 7.6 million cardholders. In the deal, Citi added 3.8 million cardholders to its roster. In 2008, either Citi or Itaú will take on the Credicard brand exclusively.
Strong hold in Latin America
In November 2006, Citi announced the acquisition of Grupo Financiero Uno (GFU), the largest credit card issuer in Central America with $2.1 billion in assets, and its affiliates. Citi said the acquisition of GFU will significantly expand the presence of its Latin America consumer franchise. GFU had more than 1 million retail clients representing 1.1 million credit card accounts, $1.2 billion in credit card receivables and $1.3 billion in deposits in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Panama as of 30 September 2006. It operates a distribution network of 75 branches and more than 100 mini-branches and points of sale.
This was followed in May 2007 with the acquisition of Grupo Cuscatlán in Central America, a financial group that has operations in El Salvador, Guatemala, Costa Rica, Honduras and Panama. It serves more than 45,000 corporate banking customers and 1.2 million consumer banking customers through a distribution network of 202 branches and 263 ATMs throughout the region.
In July 2007, Citi and Chile’s leading business conglomerate, Quiñenco, reached a definitive agreement to establish a strategic partnership that gives Citi the option to acquire up to 50 percent of LQIF, a holding company through which Quiñenco controls Banco de Chile. Through this partnership, Citi operations in Chile will be combined with Banco de Chile’s local banking franchise to create a banking and financial services institution with an approximately 20 percent market share of the Chilean banking industry. Banco de Chile is the second-largest bank in Chile with total assets of more than $23.9 billion. It serves more than 1 million clients, including credit card customers, corporate clients and individual consumers through its network of 293 branches, 1,456 ATMs and other electronic distribution channels.
However, Citi has had decidedly mixed fortunes in the Asia-Pacific region. In 2004, Japanese regulators forced Citi to shut its private banking business due to rules violations. In July 2007 it relaunched its local unit, Citibank Japan, as a Japanese bank, becoming the first foreign lender to receive a licence to operate as a local entity. It has also begun opening branches beyond Tokyo in suburban areas and cities, and is aiming to double the number of branches to around 60.
In April 2007, Citi announced the successful completion of its tender offer to become the majority shareholder of Nikko Cordial, a Japanese brokerage. Citi and Nikko Cordial, under the direction of a joint steering committee, will be identifying a range of opportunities to leverage their respective businesses.
Caution over Asia-Pacific
Joe Dickerson, an analyst at Atlantic Equities, commented: “The Nikko deal is consistent with Citi’s international strategy of building out market presence through the acquisition of a strong local player. Evidence of Citi’s success in this regard is the 2001 acquisition of Banamex (Mexico) and the 2004 acquisition of Koram Bank (Korea). Indeed, the Nikko deal would be the largest for Citi since Banamex, which was valued at $12.8 billion.”
In a note of caution, Dickerson continued: “Citi and Nikko are claiming that the transaction will leverage Citi’s strong credit card and Asian retail banking franchise with Nikko’s brokerage customers; strengthen the existing Nikko Citigroup investment banking venture and expand private equity opportunities in the Japanese market. We seriously question the ability of the combined venture to leverage Citi’s card and retail banking platforms with Nikko’s brokerage customers, given that, in our view, this has not been successful in the US with Smith Barney and Citi’s retail bank (outside of mortgages).”
Also in April 2007, Citi announced its intention to buy the Bank of Overseas Chinese, a mid-size Taiwanese bank. If the transaction is successful, Citi will add 55 branches to its existing retail network of 11 branches to become the largest foreign bank in Taiwan, with total local assets of $22.8 billion. Bank of Overseas Chinese has an asset base of $8.5 billion, serving more than 1 million clients.
China is perhaps the biggest prize for any foreign lender, and in November 2006, Citi signed an agreement to take a 19.9 percent stake in Guangdong Development Bank (GDB), a mid-sized national bank with more than 500 branches in China. GDB has assets of $47.9 billion, 12 million consumer customers and over 9 million bank cardholders.
Citi’s acquisitions have certainly helped drive up profits in the international cards business, but some industry analysts say the pace is not as quick as expected. After Citi announced its first-quarter 2007 results, Dickerson said: “International consumer businesses did not see earnings growth, with a 16 percent year-on-year decline in net income driven by poor results in international consumer finance, where earnings were down 85 percent on weakness in Japan, Europe, Middle East and Africa, and Latin America.”
In mid-April, following the announcement of Citi’s restructuring plan, he commented: “Investments in non-US consumer operations appear not to be delivering revenue growth in a timely fashion; the US consumer business is faced with eroding margins, in addition to the fact that the company appears to have under-invested in its US retail network.”
With many of its acquisitions over the past few months yet to become accretive to earnings, it is hard to say whether Citi’s foreign card businesses will deliver the growth and profitability that Citi will need to fully offset poor results at home. Indeed, some industry analysts have speculated that Citi could be broken into various spin-offs along business lines such as investment, international and domestic to improve shareholder return and operational efficiency.
However, this would be fraught with difficulty as consumer finance and card business models in, for example, the US, are very different from those in Asia-Pacific and Latin America.
But with its current restructuring ruthlessly eliminating overheads, Citi’s policy of foreign expansion looks set to be far more successful over the long term, particularly in markets such as China and Latin America, where huge growth is anticipated in card payments.