Citi’s bail-out by the US government and
federal entities has only fuelled speculation that the banking
behemoth could be broken up and sold off. As a new wave of
consolidation sweeps over the US banking industry, what will this
mean for the world’s largest card issuer? Victoria Conroy

US card issuers: Vital statisticsCiti, the world’s largest card issuer, came
perilously close to collapsing into the abyss that has already
swallowed up the likes of Lehman Brothers, following a dramatic
fall in its share price in late November. It appeared that one of
the world’s most venerable financial institutions was headed for
bankruptcy, until the US Treasury, the Federal Reserve and the
Federal Deposit Insurance Corporation (FDIC) rode to the rescue and
handed Citi a lifeline in the form of a $20 billion US Treasury
investment in Citi preferred stock under the Troubled Asset Relief
Program (TARP) – which comes on top of a previous $25 billion
injection in October.

In return, the Treasury, the Fed and the
FDIC will take on the responsibility of $306 billion of Citi assets
comprised of securities, loans and commitments backed by
residential and commercial real estate and other assets. The rescue
package is structured in a way that means Citi will absorb the
first $37 billion to $40 billion of losses on its $306 billion
asset portfolio, with the US Treasury, the FDIC and the Fed soaking
up any subsequent losses.

Too big to fail, too bloated to

The story of Citi may in future be
regarded as an example of what happens when a company’s relentless
drive for growth in turn becomes the very reason why it came so
close to falling into the precipice.

While it is certainly one of the most
diversified financial institutions in terms of geographic operating
regions (with operations across 109 countries) and business lines
(encompassing cards, current and savings accounts, mortgages and
other retail financial services), Citi also accumulated an
astonishing employee count of 375,000 globally at its peak, and
concentrated too much of its focus on generating profits through
mortgages and by extension the sale of mortgage and other
asset-backed securities via the international wholesale

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As the US housing market collapsed and the
ensuing credit crunch kicked in, Citi buckled under the weight of
rapidly mounting credit losses and debt obligations, and was
perilously close to bankruptcy before US federal entities stepped
in to save it.

Citi’s rescue comes at the end of a
turbulent 18 months for the banking behemoth, which has suffered a
dismal series of quarterly financial results, culminating in
Charles Prince leaving his post as CEO at the end of 2007. It was
only at the start of this year that Citi, under newly-installed CEO
Vikram Pandit, undertook a major cost-cutting drive and
restructuring of its business operations, which included its
various cards operations being redrawn to come under one global
division. That restructuring is highly unlikely to be the last as
Citi is now somewhat obligated to cut costs further and overhaul
its operations yet again in return for the backing it has received
from the US government, and by extension, US taxpayers whose money
is propping up the US financial institutions under TARP.

Pandit’s brief tenure as CEO may also be
in doubt, with many in the industry saying that his future hangs in
the balance unless he can revive the company’s fortunes in
spectacular style. American Express CEO Kenneth Chenault has been
touted as a possible replacement for Pandit should Citi’s fortunes
continue to dwindle. Chenault would be seen as the most likely
candidate, given that Gary Crittenden, current Citi CFO, was
previously CFO at Amex before his departure to Citi. However,
Pandit, for now, has won the backing of one of Citi’s largest
investors, Prince Alwaleed bin Talal bin Abdulaziz, who laid the
blame for Citi’s misfortunes firmly on Pandit’s predecessor Charles

Pandit has already embarked upon a wave of
asset divestiture since taking over the mantle of CEO in a frantic
effort to rein in costs, having sold off $20 billion of assets this
year alone, including the sale of its 15 percent stake in Redecard
of Latin America. He also recently announced that 75,000 jobs would
be shed worldwide.

Questions over Citi’s cards

While the bail-out may have handed Citi a
much-needed lifeline, questions linger over Citi’s future strategic
direction as the world’s largest card issuer – with credit losses
mounting, recession deepening and consumer spending stuttering to a
halt, Citi is in line to be one of the hardest-hit financial
institutions as the global economy continues to weaken.

In an investor presentation delivered in
November 2008 to report its third-quarter financial results, Citi
stated that cards represented $118 billion of assets against its
total asset base of $2.05 trillion – $1.09 trillion is accorded to
securities and banking, while $842 billion is earmarked against
consumer banking, global treasury services, global wholesale
management and other business lines.

Citi’s US credit card portfolio includes
54 million active accounts, but its global cards division posted a
$902 million loss in the third quarter, compared to $1.4 billion
net income the previous year. The bulk of the loss occurred in the
US. For the third quarter of 2008, Citi reported that around 50
percent of adjusted revenues came from outside the US – cards are
growing at a rate of 24 percent outside the US, compared to a US
historical industry growth rate of 3 to 5 percent, while net credit
margins on cards for the year to date are 15.7 percent outside the
US, compared to 6.5 percent in the US.

With industry analysts forecasting even
more credit losses to come (see page 7), it is likely that the
cards business will come under intense scrutiny. Some industry
analysts have speculated that the cards unit could perhaps be
broken up with some elements sold off as part of Citi’s ongoing
cost-cutting exercise. But this may be a step too far, even for
Citi.According to Adil Moussa, a senior analyst at US payment
consultancy Aite Group, it is highly unlikely that Citi will
undertake any further restructuring of the global cards unit, much
less sell any part of it, because despite mounting losses in the US
it is still a profitable growth engine globally.

Moussa told CI: “I don’t think the card
aspect is something that Citi would want to sacrifice. It’s a
department that has been very strong for a number of years now and
it still represents a very good income stream for Citi.”

Economic shocks to the

Citi has already taken some steps to
buffer its card portfolio from forthcoming losses, such as raising
interest rates on some card products, tightening lending criteria
and slashing credit limits – but these are steps that Citi began to
take in the latter part of last year.

Even with allowing for the lag effect of
these changes taking place and the subsequent impact on
cardholders, it has not been enough to stave off massive losses on
its US card portfolio. Further measures now include cutting
marketing expenditures, particularly on new accounts, and using
mortgage data to pinpoint geographical US locations where the
collapse of the housing market has been felt the hardest.

Unemployment data is also being
scrutinised as according to Citi, credit losses are very closely
correlated to unemployment rates. The news that the US economy lost
a record 533,000 jobs in November 2008 alone, pushing the US
employment rate to a 15-year-high of 6.7 percent, will not have
helped the mood at Citi.

CFO Gary Crittenden told investors during
a recent presentation: “While it’s impossible to know if historical
relationships would hold in this environment, it remains possible
that we may see loss rates exceed their historical peaks. For the
cards portfolio, at the end of the third quarter, we were into the
fourth consecutive quarter of increasing losses. Our scenario
planning includes unemployment rates ranging between 7 percent and
9 percent into 2009. Obviously such unemployment levels would
result in higher credit costs well into 2009.”

Regulation remains a thorn in the

What Citi should be worried about is
regulation, according to Moussa. The increase in charge-offs that
is happening across the US credit industry is likely to escalate
further in 2009, especially in light of rising unemployment
figures, and according to Moussa, a swathe of new legislation
making its way though the US Congress could cause more hurt for
Citi and its rival card issuers in the US. The passage of such
legislation, while not guaranteed, is being helped along by a
political climate that is placing more importance on the rights of
cardholders, particularly at a time when consumers are bearing the
brunt of economic pressures.

“One piece of proposed legislation is the
Credit Cardholders’ Bill of Rights Act, which is taking aim at all
the different practices that different card issuers have, such as
hiking interest rates without cardholder consent, and also other
fees like late fees, over-limit fees, and certain other practices
like double-billing. Those practices are really being scrutinised
by Congress – and those practices represent a huge income stream
for credit card issuers,” Moussa told CI.

“Another act, the Credit Card Fair Fee
Act, is looking at capping interchange or at least reducing
interchange which is the other income stream that credit card
issuers rely on. The credit card industry is really under attack
from two sides – and those two sides are almost bringing the credit
card industry to its knees. That’s mostly what Citi should be
worried about, not about what they’re going to do with their cards

Citi’s card options

CITI: Global cards unit net incomeCustomer acquisition and retention remains a key
factor, however. Direct mail, previously a fundamental customer
acquisition component for many US card issuers, no longer holds any
attraction given that volumes are falling across the industry and
response rates are dwindling. In 2005, direct mail accounted for 19
percent of Citi’s new card accounts, but by 2007 this figure had
fallen to 8 percent.

Moussa noted that in addition to the
risk-based re-pricing efforts that Citi is applying to its card
portfolio, it is likely that Citi will concentrate more of its
efforts on branch-based cardholder acquisition.

Branch-based acquisition comprises a core
element of any issuer’s cardholder acquisition and retention
strategy, but in this area Citi, with 1,019 branches across the US,
sorely lags behind its rivals Bank of America (6,143 branches) and
the newly-combined Wells Fargo and Wachovia (6,782 branches).

Citi’s thwarted attempts to acquire
Wachovia, and its rumoured but fruitless interest in acquiring
regional bank Chevy Chase (see page 1), could prove to be a case of
once-bitten, twice-shy for Citi, as currently there does not seem
to be any other acquisition targets with the branch network scale
needed for it to compete.

As such, Citi might choose to concentrate
more on lower-cost customer acquisition channels such as the
internet. But even this route might not prove hugely successful.
According to Moussa, internet acquisition is surprisingly not that
effective as a cardholder acquisition method either.

“In the credit card industry, people have
not been able to crack the internet as an acquisition method yet.
Of all the credit card issuers that I talk to, around 85 percent
are looking at branches to be the next channel for acquiring new
customers,” he explained.

The affluent cardholder segment is one
that is increasingly appealing to major card issuers in the US, and
according to Moussa, it makes sense for Citi to devote greater
resources towards this segment.

“Even if they’re only transactors, that’s
still great because there’s a sizeable income stream coming from
interchange. If some of them choose to revolve then obviously
there’s still an income stream from interest on revolving balances.
But you have to offer something to the affluent so that they sign
up with you. That means rewards and experiential rewards,” Moussa

It looks like Citi has already taken that
message on board. In early December Citi announced that it had
linked up with online retailer Amazon to establish what it claims
is the largest-ever rewards programme in the industry. The
partnership gives 13 million Citi cardholders who use a variety of
Citi cards the ability to shop online for goods fulfilled by
Amazon. The programme also allows cardholders to accrue points by
booking travel on internet travel website Expedia or using Smith
Barney debit cards, and is part of a long-term strategy to inspire
loyalty by providing more rewards selection and better customer
service, according to Nancy Gordon, executive vice-president of
Citi’s rewards programme, called ThankYou Network.

“Compared to a lot of other programmes,
it’s like rewards on steroids,” said Gordon. Citi must be hoping
that such an initiative will give its card business a much-needed
shot in the arm.