Two days later, on the other side of the Atlantic, Euromoney sits down with the chief executive of a large, locally focused national champion bank and hears much the same message. “When you see even a bank like HSBC announcing its retreat from markets with such attractive demographics as Turkey and Brazil, you have to ask what on earth is going on. Is HSBC really that bad at managing its local operations, or are large global banks essentially unmanageable?”
A third chief executive sympathizes with Euromoney’s task of choosing a best global bank for 2015. “We are all much less comparable today than we were just a few years ago. We all used to pursue the same global model. But today, we’re all concentrating on our own particular geographic, client and product areas of strength. No one anymore is trying to do all things in all markets.”
Almost no one is.
One bank still operates on the ground in 100 countries, with trading floors in more than 80 of them, clearing and custody networks in over 60 countries and retail banking presences set for the long haul in 24 countries.
And while that bank is indeed cutting back from having consumer banks in over 50 countries just four years ago, its decision to stay in all products and all countries is paying off for its institutional clients group, the division that houses corporate and investment banking, treasury and trade solutions – which encompasses both cash management and trade finance – and private banking. In the first quarter of this year that division brought in revenues of $9 billion. Over the previous 12 months, ICG was the biggest contributor to Citi’s results, generating over $33 billion in revenues, about 60% of the total – nearly $10 billion in net income, for a return on assets of 75 basis points and a 13% return on allocated tangible common equity.
Preliminary results from Dealogic for the first half of 2015 put Citi fifth in the global investment banking revenue rankings across M&A, debt capital markets, equity capital markets and loans. And while it is no surprise to see the bank rank third in debt capital markets, it’s a matter of pride that it should rank fourth globally in M&A revenue, behind runaway leader Goldman Sachs, then JPMorgan and Morgan Stanley; and be fifth in equity capital markets, given that these two businesses were not seen as traditional strengths of Citi.
“We think that emerging markets will grow faster than developed markets in the years ahead and that we will capture a lot of that growth,” Michael Corbat, chief executive of Citi tells Euromoney. “And we have a closed loop payment system covering nearly 100 countries that is extremely valuable to our multinational clients who, by using us, do not have to cross cash flows across many banks and multiple systems to manage their money. That Citi system handles $3 trillion of cash flows a day and brings, as well as regular processing fees, opportunities for example in foreign exchange. To me, the value of that network only goes up. Such are the regulatory obstacles today that I struggle to see how any other bank could ever grow anything comparable.”
James Forese, president of Citi and chief executive of ICG, recalls how the bank’s leadership defined its strategy in the wake of the financial crisis and quickly decided to maintain that far-flung network of countries. “We took a hard look at our business along three axes: geography, products and clients. We asked ourselves if we should stay in 100 countries or cut back, and concluded that that unique range of coverage was a defining strength of Citi that was extraordinarily valuable to large multinational corporate and government clients and one we did not want to lose. Products were trickier, given that some of the products in which we were strongly positioned and that brought in a lot of revenue and profit did not look likely to offer such good returns on equity going forwards. But we decided not to exit businesses, rather to invest and improve, especially on efficiency.”
Forese points out the lesson some banks are still learning today. “Exiting is not an attractive option. It brings a lot of one-off costs and leaves you still with a lot of stranded, continuing expenses and exposures, while revenues disappear at once. You cannot shrink yourself to success.”
Citi chose, in wholesale banking at least, to continue offering all products in all locations, but not to all customers. Like all banks, Citi was forced by higher capital requirements, swollen cost of equity and of funding to concentrate its smaller resources on a narrower group of clients than in the expansionary heyday that followed the 1998 merger of Citicorp and Travelers, owner of Salomon Brothers and Smith Barney. That created the first global financial services conglomerate combining retail, commercial and investment banks with insurance underwriting and brokerage.
Citi is a lot more focused today. It chose to allocate its capital mainly to serving large multinational corporations, governments, banks and large institutional investors. “Clients were the big decision, though it wasn’t actually a particularly hard one,” says Forese. “We identified 16,000 ideal target clients for our products and services inside ICG and discovered that we had been serving about 32,000 of them.”
Allocating more resources to the biggest companies and institutions was obvious. The bank is now fighting every day to increase its wallet share with each of them, grabbing as much as it can from the total amount these clients pay out to financial services providers for cash management and payments transactions, for foreign exchange, capital raising, M&A and the rest.
“Wallet share is our metric,” says Forese. “Sometimes you can only estimate it, but many clients will tell you both what they spend in total on financial services and what our share of that spend is. In just about everything we do from transaction and trade services, to M&A, ECM, DCM and in FICC we have seen our wallet share grow. It might vary across geographies, products and customer groups. Some years it might only grow by 10bp to 20bp but when you do that consistently for five years, you find yourself getting somewhere.”
Citi was one of the biggest casualties of the financial crisis, brought to the point of insolvency by sub-prime mortgage and CDO exposures in 2008, rescued by the US government’s injections of equity capital and provisions of guarantees in what now looks like an extraordinarily quick turnaround. The US government was out of Citi stock five years ago and the bank, first under Vikram Pandit and since 2012 under Corbat, has set out to make itself simpler, smaller, safer and stronger and to show that it can generate returns.
While Citi remains the last man standing as a global universal bank, it has pulled back sharply on the consumer banking side. The bank, which retains a non-core unit of assets held for disposal or in run down, now splits into just two large core operating divisions: ICG run by Forese, which remains unapologetically global; and then global consumer, now to be run by Stephen Bird, former regional chief executive of Citi for Asia. It is in global consumer, the laggard next to ICG, where the real story lies.
If HSBC was in some ways the bank of the British Empire, funding trade across Asia, India and the Middle East, Citicorp was the bank of the US empire, built up by legendary industry figures such as Walter Wriston and John Reed. Corbat has that legacy firmly in his sights.
“An underappreciated aspect of the Citi story has been the transformation of the global consumer business,” Corbat tells Euromoney. “If you look back at Citi’s history, what had been built was a confederation of country-run consumer banks, each with their own products, pricing, IT and support systems and processes in 56 countries. That worked well for a while. But in nearly every country you look the local banks dominate the top three to five spots in market share. Citi’s locally run consumer banks were also very product-focused as well as geographically separate. They each did their own auto loans, student loans, mortgages and credit cards.”
The determination with which Corbat has striven to implement that change is a big contribution to Euromoney naming Citi as bank of the year for 2015. Corbat, very much a numbers man, has a calm and clear vision of what is obviously required. That doesn’t make it easy to do. Even those senior Citi bankers who only know the names of Reed and Wriston from their history books may shudder at the institutional memory of Chuck Prince pulling Citi out of Saudi Arabia following the terrorist attacks of 2001 and the humiliation of him regretting that decision as the Saudi economy boomed, and periodically hovering around the central bank in Riyadh like Banquo’s ghost hoping for an invitation to come back in.
“When you’re out as a consumer bank, you’re out,” agrees Corbat, “and you’re not coming back. It can be a tough decision in some countries that may have attractive demographics but where you lack scale or where there are near-term political risks, but we have gone from 50 countries to a target of 24. And often it is a straightforward decision. We had a good consumer business in Japan, which was reflected in the price we got for that business.”
|“When you’re out as a consumer bank, you’re out and you’re not coming back"|
Michael Corbat, Citi
Citi announced on Christmas Day 2014 that it was selling its Japanese retail banking operations to Sumitomo Mitsui after 100 years. If it was one of the tougher decisions, Corbat disguises it well.
Other countries besides Japan designated at the time of the third quarter results in 2014 – when Corbat’s transformation of the consumer bank stepped up a gear – for sale or withdrawal also included Egypt, Hungary, Czech Republic, Peru, Panama, Nicaragua, Guatemala, El Salvador and Costa Rica, with those disposals set to be completed by the end of this year. They follow on from withdrawals from retail banking in 2013 and 2012 in Uruguay, Paraguay, Turkey, Romania and Pakistan. The bank has also pulled back from consumer lending in Korea.
Given its demographics, Turkey was presumably a tougher call than Japan. Citi sold its consumer business to DenizBank in April 2013. This March, it sold its near 10% stake in Akbank for $1.2 billion. If Citi had ever harboured ambitions to own Akbank, then the financial crisis put paid to them. And with no obvious way to build on that stake, with the Sabanci family unlikely to sell and Basel regulators now requiring one-for-one equity capital be held against minority shareholdings in other banks, Citi decided to take that capital and put it where the bank had better medium-term prospects for return on investment in upgrading the technology infrastructure of the global consumer bank.
Just days before he sat down with Euromoney in June, Corbat had inked a deal to sell Citi’s retail bank in Egypt, where it had operated for 40 years, to Commercial International Bank. Some of the tough decisions have also been about staying in countries as a retail bank. One can only image that it would have been easy to leave Russia. Citi is staying. It is sub-scale in Brazil. But it’s staying there too.
Corbat is trying to reposition Wriston’s and Reed’s legacy for the modern age, against the 21st century trends of urbanization and digital technology, which former chief executive Vikram Pandit clearly identified. Citi, Corbat claims, no longer thinks in terms of countries, but rather of cities. It is not so much a retail bank across America, rather it is a mass affluent bank for the inhabitants of seven US cities: New York, Boston, Washington DC, Miami, Chicago, Los Angeles and San Francisco. While the ICG division is a wholesale bank for large companies covering 100 countries, the consumer bank aims to cover about 100 cities around the world.
A big part of the transformation of the consumer bank has been pulling out of countries where it made marginal returns – add Guam to the list above. But it has also been about investments – organically funded by the global consumer bank itself – to put the whole business onto unified IT systems.
Corbat has spent his entire career at Citi. Most profiles cast him as the classic team player, partly based on his starring performances as an offensive guard in college football. A clear talker and thinker, he is not immune to the kind of toe-curling management speak for which his famous predecessors were also renowned. His colleagues are required to show enthusiasm for his pet phrases such as “the maniacal drive to common” and “the power of one”, as they labour to bring Citi’s 24 national retail banks onto a unified IT platform.
“The typical complaint email or letter Citi used to get would be from a long-time card holder or current account holder, saying some variant of: ‘Thank you so much for charging me $39 for temporary arrears on my account, I’ll be pulling the $5 million I have in your bank and taking it so someone else,’” says Corbat. An even-tempered man, Corbat sounds like he’s read a few too many of these. “Today we are building a unified bank, unlike any of the other large global banks, that genuinely allows us a holistic view of our customers’ entire financial lives.”
If the bank is already 70% of the way along its IT transformation for the global consumer bank, surely results should be evident. Where are they, Euromoney asks? Corbat takes us back to those 832 credit card offerings, now down to 400. “When it comes to card offerings,” Corbat says, “you can group them into five categories – value for mass-market, travel, rewards, cash back and affluent cards – and we continue to simplify our products onto one of those five engines.”
The results he says are evident in two big deals that Citi struck in March of this year. The first was with Costco, which previously had American Express processing its credit card network, whereby Citi, the world’s largest issuer of consumer credit cards, will become the exclusive issuer of Costco’s co-brand credit cards. Two days later Citi announced a 10-year agreement with MasterCard whereby Citi will begin aligning the company’s consumer proprietary credit and debit portfolios to the MasterCard network. Corbat takes evident pride in both.
“Costco has a quite intense focus on customer service. Its cardholders are more than just customers, they are members. Costco had their choice of partners and determined that we were the best fit,” Corbat tells Euromoney. “Our disparate structure had not previously allowed us to negotiate with the buying power appropriate to the largest global issuer of cards, but we were able to work with MasterCard on a great deal for both sides that will speed up our delivery of enhanced digital payments capabilities and increase satisfaction for consumers as well as merchant customers. It’s the kind of deal that is a game changer.”
If Corbat was gratified by the external validation from Costco of the transformation of its cards business, one can only guess at his delight just a week later, when Citi received a pass mark from an even more important arbiter and a tougher judge. On March 11, 2015 the Federal Reserve Board announced that it had no objection to the planned capital actions requested by Citi as part of the 2015 Comprehensive Capital Analysis and Review (CCAR).
That’s a small announcement: but it’s a very big deal.
After Pandit and John Havens turned round Citi following its near insolvency in 2008, it was lingering concerns of regulators and their refusal to permit capital return to shareholders that led to their ouster in 2012. Corbat and Forese have been at pains to say that it was Pandit and Havens that set Citi on the right course, even as they rolled up their sleeves for the intense work still to be done. But failed stress tests have been a harbinger of doom for Citi chief executives, and even Corbat, widely praised when he took over from Pandit as the safe pair of hands that had wound down much of the mess inside Citi Holdings, must have been shifting uncomfortably in his seat in March 2014 when the Fed rejected Citi’s plans for stock repurchases and dividends, apparently fearing that the bank faced risks it was not on top of and for which it still needed all its capital as a buffer.
|"Historically, banks have only been periodically obsessed with productivity. We have to become permanently fixated on it. The mistakes this bank has made in the past were never when we were too strict with resources, but rather when we were too liberal with resources, including capital and risk” |
James Forese, Citi
Back then, Corbat said that he was “deeply disappointed” by the Fed’s rejection of plans for only a modest level of capital return and that Citi would work with the Fed to “better understand their concerns” and “meet their standards on a qualitative basis as well”.
Fast forward a year and the Fed’s decision this March to bless a token five cent quarterly stock dividend and a $7.8 billion common stock repurchase programme over the five quarters beginning in the second quarter of 2015 might just have saved Corbat’s job.
“Getting validation on CCAR was a very gratifying feeling. We had put a lot of work into it and the stakes were high,” Corbat allows. “Between receiving the Fed’s objection to our capital plan in March 2014 and receiving the next CCAR scenario in November 2014, there was a lot of work that needed to be done around risk modelling and scenario testing. We had to put a lot of changes in place, do a lot of back testing and refine our models to come to the point where the Fed had confidence in what we were submitting.”
If the bank’s senior management felt like Christmas had come in March this year, they quickly went back to work. “We now have to show to the Fed and to the market that what we have delivered is sustainable. We know that the bar will keep being raised on CCAR,” Corbat says.
Senior bankers the world over claim to be mystified at times by what their regulators are actually most worried about and what they’re really testing for. In Europe bankers complain that when regulators can’t clamp down any more on market risk or credit risk risk-weighted assets, they’ll just ramp up operational risk RWAs if they catch the faintest whiff of anything that concerns them. In the US, the Fed’s CCAR is the big annual bogeyman for the banks.
In the journey to make itself simpler, smaller, safer Citi has arrived at the point where its fully loaded Basel III common equity tier-1 ratio is 11%. That’s nearly 200bp better than when Corbat became CEO. And at the end of the first quarter Citi’s supplementary leverage ratio stood at 6.4%. That all looks pretty good. Having to retain even more capital will necessarily reduce the return on equity that Citi can deliver to shareholders, hence it’s urgent desire for the Fed’s blessing to start returning more of what it earns. Like all banks, Citi has to find a way to satisfy the sometimes conflicting demands of both regulators and shareholders, as well as customers.
What lies behind all the Fed’s micro-management of its risk models? No one really knows. Is it concern that Citi’s global wholesale bank inevitably exposes it to the next country and regional crisis? Is its spaghetti bowl of IT systems now actually producing reliable, timely and useful information on market and credit exposures? Can any of the big bank’s IT systems really do that? Or does the Fed have more prosaic concerns: what are the chances of another fraud inside Citi’s far-flung network like that at Banamex?
The irony is not lost on Euromoney that we are naming as our bank of the year an institution that now employs 30,000 staff in compliance and control. One in eight people who go to work at Citi every day are there to check on what the next seven people are up to. That’s the global banking industry today. Inside the banks, outside the banks, distrust is everywhere.
One of the wisest bankers Euromoney knows counselled us this year not to give the best bank award to any institution whose shares still trade at a discount to tangible book value. For a long time, the stock market has priced Citi at a discount, but by the end of June the stock price was at $56.75, within a whisker of tangible book value for share at the end of the first quarter at $57.66. The market, like the Fed, is offering a form of quiet validation.
But one glaring question remains. Citi, like all the banks, enjoyed a strong first quarter, buoyed in particular by an ICG division firing pretty much on all cylinders, even though its traders got on the wrong side of the big move in the Swiss franc. The operating divisions of the bank work on a very decent efficiency ratio of 54%, with a net interest margin of 2.92% as funding margins stay low and a decent return on assets of over 1%. For several years after the financial crisis, Citi’s chief financial officer John Gerspach refused even to offer a target return on equity, suggesting instead that while regulators worked to define the denominator Citi should instead simply try and deliver a return on assets of between 90bp and 110bp.
Bowing to reality, shortly after he took over as chief executive, in March 2013, Corbat set an aim for return on tangible common equity of 10%. For the whole of 2014, it recorded a 6% return. In the first quarter, it reported an 11% return on tangible common equity (ROTCE). It’s getting there, but not quickly. Corbat explained in May to an investor meeting that the Fed’s prohibition on handing capital back to shareholders left the bank struggling to meet its return targets. “Last year, when we didn’t receive permission in terms of capital distribution, that target became very challenged because of the denominator issue. Importantly, that capital was not destroyed; it was delayed. We completely understand the need and desire for ROTCE, if you go look at the first quarter, and again, the first quarter is just a quarter. But we are actually about 11%.”
It’s worth asking, though, how impressive a target is a 10% return anyway for a bank whose cost of equity still attracts a high risk premium, reflected by the – admittedly now narrowing – discount to book value at which its shares have traded ever since the crisis? A reasonable estimate for Citi’s cost of equity would surely be around 10% or 11%. Citi will need to show more quarters of steady earnings, clean of legal costs and credit charges, for that implied cost of equity to fall.
In March, Citi announced the sale for $4.25 billion to Springleaf Holdings of OneMain Financial, a consumer lender to sub-prime borrowers that was the last large standalone business held for sale within Citi Holdings. At the end of the first quarter, Citi Holdings accounted for about 7% of Citi’s total assets, having accounted for 30% at one point after the crisis. With the agreement signed to sell another roughly $32 billion of those in deals expected to close this year, Holdings now effectively accounts for just over 5% of assets, with roughly $54 billion of the remaining $90 billion of assets comprising US mortgages in run off or available for opportunistic sales. That battle isn’t quite over. But it’s been fought reasonably well. “If anyone wants to pay what those assets are worth, they can come and talk to us,” says Corbat. “But we won’t sell them unless the economics make sense for us.”
The DTA accounts for another $32 billion of shareholder equity that simply does not translate into regulatory capital that Citi can plough into its operating businesses, leverage into earning assets and so earn a return on.
That’s $49 billion of shareholder equity on which Citi for now earns nothing. A 90bp return on assets, delivering $16 billion of quarterly earnings on $124 billion of the remaining shareholder equity actually available for use would imply a return of closer to 13%. That’s starting to look more respectable. Unfortunately shareholders get paid on actual reported returns, not theoretical ones.
“We aim to optimize our businesses, to run down Holdings as quickly and as rationally as we can, to utilize our DTA and to produce good-quality sustainable earnings,” Corbat says. “There was a time not so long ago when our DTA stood at $55.3 billion and heading in the wrong direction, and there were many who said we would never be able to utilize it. We’ve utilized about $7 billion since the start of 2013, and we have to demonstrate our ability to continue utilizing DTA, which also has the benefit of adding to our regulatory capital position.”
This is not a man declaring victory, but Corbat adds: “I like the balance of our business. I would say over 70% of revenue and earnings comes from stable and growing businesses where we’ve already taken out a lot of the redundant costs of legacy systems, like cards and consumer banking, and also treasury and trade solutions within ICG and traditional corporate banking with a lot of local currency loans match-funded against low-cost local currency deposits. I like that ICG is a real bank. And there are synergies with consumer.”
Of course the withdrawal from consumer banking in 32 countries removes some of that ability to match-fund commercial loans with cheap, local retail deposits. Not a problem in Guam so much, but maybe more of an issue in Japan.
|Best global bank 2015: Citi|
Corbat’s analysis leaves less than 30% of revenue and earnings derived from the more market-dependent businesses within ICG. “The trading businesses are our delta,” he agrees. Could the incessant shareholder pressure to produce returns push the bank to take imprudent risk to achieve them amid an abundance of capital? A sceptic might pick up the odd whisper, for example, of Citi rising up the US equity capital markets league tables in part thanks to aggressive capital commitments on risky bought deals.
“Some banks aren’t distributing these, they’re warehousing them,” a banker at another firm tells Euromoney. “And that’s OK only while the market is bailing you out. We’ve seen shorts take on what looked like mispriced new equity issues in the tech sector in the last 12 months and get horribly squeezed. But if you keep bidding aggressively on capital commitment equity trades, you are going to get stuck.”
Forese tells Euromoney. “We have an industry-leading operating efficiency inside ICG. Historically, banks have only been periodically obsessed with productivity. We have to become permanently fixated on it. The mistakes this bank has made in the past were never when we were too strict with resources, but rather when we were too liberal with resources, including capital and risk.”
Earnings for Citi’s and other banks’ trading businesses in the first quarter were strong because there was clear conviction especially around dollar strength. But that has vanished. Some clients are hanging on to the remnants of a carry trade but they don’t have strong convictions anymore.
Corbat is offering no hostages to fortune. While US bankers hope to benefit from rising rates and a steepening yield curve when the Fed raises short-term rates and Citi may yet benefit from strong operating leverage if revenues pick up across newly efficient and scalable systems, Corbat sounds appropriately cautious.
“I do worry about reduced market liquidity and the potential for increased volatility. The shadow financial system has filled in some of the voids left by the banks retreating. But we could see some classes of assets transition very quickly from trading on yield to trading on price.”
But these are shorter-term concerns. Corbat’s task is to deliver in the long term on a strategy that looks a bit old-fashioned in this new era of banking. If he gets it right, the last man standing will have the last laugh over those who say the era of global universal banking is dead.