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December 16, 2008

The painful Citi saga rumbles on

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 worlds largest card issuer?

By Verdict Staff

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 reports.

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 survive?

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 markets.

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 Prince.

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 operations

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 system

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 side

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 unit.”

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 added.

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.

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