STANDING ON THE stage at Carnegie Hall, Sandy Weill has heard just about enough. From the floor at Citigroup's shareholder meeting, the tall, elderly man has been complaining in a loud, German accent that it was the shareholders who paid all Citigroup's huge financial penalties in 2004; top executives just went on paying themselves handsome bonuses.
Weill, who took home a mere $10 million last year compared with the $30 million he pocketed in 2003, eases back slightly on his heels, compressing his lips and pushing his jaw forward. "In 17 years, from 1986 to 2003, our stock price grew better than an average 20% a year compounded," he lectures. He keeps his temper in check but his previously jovial tone has given way to something harsher. His face set, Weill sums up in brook-no-argument manner: "So I think management did a pretty good job for shareholders through many markets."
If this is meant to crush the questioner, to put him in his place like a junior employee who has displeased the big boss, it fails utterly. Without missing a beat, the speaker spits back: "The stock's gone nowhere. It's where it was five years ago."
On this fine morning in April 2005 does Weill think back to his last shareholder meeting as head of Travelers in spring 1998, just before the career-defining merger with John Reed's Citibank? Back then, gushing stockholders, fawning employees, a small Sandy-fan army, lined up at the microphones in the aisles of Carnegie Hall to thank their hero for enriching them through his spectacular deal making. On stage to his left, seated side-on and facing Weill, his board of directors among them former US president Gerald Ford offered up its own mute devotion.
Those were the good times; how very different things are today. The firm's senior executives among them the quiet former US Treasury secretary Robert Rubin and its non-executive directors sit together on the front row, close enough to their leaders to offer moral support but safely out of the limelight. Throughout the meeting, as individual stockholders rake over the firm's regulatory problems, representatives of small institutions propose doomed resolutions curbing executive pay and the cranks that dog US shareholder meetings seize the microphone to air absurdities, Weill often glances down to the front row as if for reassurance, or to share with his peers a rueful half smile at this nonsense that has to be endured once a year.
At least he manages not to roll his eyes.
New star with a new plan
There is another big change. Weill is now the warm-up act for the new star, Charles (Chuck) Prince, CEO of Citigroup since 2003. That Prince would become so eminent had not been widely forecast at the outset. He had been Weill's long-serving consigliere chief counsel at Commercial Credit, Weill's building block for Travelers, since the early 1980s, rising to chief administrative officer of Citigroup in 2000. It was only in 2002 that he took his first front-line role, as head of the scandal-hit corporate and investment bank. So when he was first appointed CEO, speculation pinned him as a mere front man for Sandy, who would occupy the CEO's office but follow his mentor's instructions obediently.
This appears to be a mistaken assessment.
Prince walks, talks and acts like a real CEO. A big bear of a man, he has the gift of speaking softly but with sufficient edge to convey true authority. He performs well on the big stage and hits most of the right notes. He comes across as calm and thoughtful but capable of dismissing an unwelcome suggestion or question with little more than a raised eyebrow. As the three-hour shareholder meeting drifts towards its conclusion, one frequent speaker suggests the Citigroup family should get together to air their grievances more often say after each quarter's results. Prince pauses just long enough. "Well, we'll think about that," he deadpans. The audience laps it up. They know he has not the slightest intention of submitting to this, but his tone lets them all in on the joke. He dismisses the idea without even demeaning the questioner.
More important than his stage presence, Prince has a plan. The public version lays out four goals: to make Citigroup the world's most respected financial institution, to grow the consumer business, to grow the international business, and to make the corporate and investment bank the best in its class.
The first of these is the most important and is Prince's response to the unearthing of a string of misdeeds at Citigroup in recent years that have cost shareholders dear in financial penalties and opportunities missed while the firm's leaders were distracted.
Bob Druskin, CEO of Citigroup's corporate and investment bank, lays out some of these missed opportunities during a presentation at the end of May 2005. He says that by the end of 2003 the firm had come to depend on fewer corporate clients than it had at the time of the Travelers/Citibank merger in 1998. The firm had concentrated on increasing its share of wallet among the largest, most international companies, but failed to build its client roster among the next tier of large public companies. He admits Citigroup has been slow to respond to the emergence of hedge funds, to grow in prime brokerage and commodities and to achieve sufficient size in commercial real estate finance. "We have a lot of catching up to do," he says.
Druskin's admission carries a challenge to Citigroup's shareholders and, by extension, to his own CEO, who must strive to satisfy those shareholders. Investors are annoyed by Citigroup's negative operating leverage. Put simply, expenses have been growing faster than earnings. Shareholders, of course, want it the other way around. Prince has promised positive operating leverage for the full year 2005, having taken the windfall of releases from unneeded loan-loss reserves last year and invested them in hundreds of new branch openings around the world, in marketing and other initiatives. The payoff can't come soon enough.
Citigroup's vast earnings used to grow steadily each year. Last year they flattened out.
Druskin hints strongly that shareholders got too used to good things from Citigroup in the boom years at the end of the 1990s and the start of this decade. "We over-earned and under-invested," he says, adding that the group is "front-loading expenses". Citigroup shareholders might be wise to believe in positive operating leverage only when they see it.
Scratch just beneath the surface of Prince's remaining three goals all obviously predicated on taking advantage of Citigroup's inherent competitive advantages of size, scale, long-established presence in 100 countries and strong brand, particularly in emerging markets and a key underlying theme soon emerges. Prince intends to streamline the sprawling financial services empire Weill built, selling off pieces, simplifying the structure, redeploying capital into the most promising growth areas and moving Citigroup away from the manufacturing of financial products and further into distribution. The thinking inside the group holds that two-thirds of the profits on almost every financial product accrue to the distributor and only one-third to the manufacturer.
The empire breaks up
|Weill: missing the good times?|
At the end of June, Citigroup chose to offload most of its asset management business to Legg Mason, taking that firm's broker network in a business asset swap valued at $3.7 billion.
The vision of the ultimate financial market company owning, manufacturing and selling every financial product is being modified.
Weill built Citigroup to the point where, at the start of this decade, it briefly towered over the rest of the global financial services industry, seeming to establish a new business model that the competition had to strive to match lest they be crushed by it. But the scandals betrayed the fact that the structure had tested the limits of manageability. Read the damning judgement of Japan's FSA on the private-banking business in Tokyo and its relations with Citigroup head office, delivered in September 2004.
"The Bank Headquarters imposes on PB Group at the Japan Branch sales targets that are much higher than the preceding year's actual sales figures, ties the salary system and employee appraisals closely to sales performance, and presses for sales while emphasizing profits and deprecating compliance. However, the top management of the Bank Headquarters is found to be not fulfilling its supervisory responsibility over the business operation of the Japan Branch. A problem is recognized in that the organization and the structure are such that managerial responsibilities of the top management at the Japan Branch, which is charged with the branch operations, and those of the top management at the Bank Headquarters, are extremely ambiguous."
If this was how it worked in Japan, where else did Citigroup deprecate compliance, fail to fulfil its regulatory obligations and permit ambiguous responsibilities to fall between head office and local management?
Other questions have swirled around Citigroup. At the end of May, Jessica Palmer, head of risk management for the corporate and investment bank, reaffirmed that Citigroup was on schedule to meet the advanced IRB standard under Basle II. But 12 to 18 months ago, the many consultants who specialize in advising banks on Basle II compliance were speculating that Citigroup would struggle to consolidate its data from more than 100 countries and across many more businesses to take this approach.
Prince has to refine Citigroup, make it work better and rebuild its damaged reputation. He has to show leadership qualities to replace those of the charismatic Weill. He must impose controls on a firm of 300,000 people so as to prevent more scandals without stifling their entrepreneurial, risk-taking flare. He must create a shared culture where none has previously existed. He has to do all this while disappointed investors are hungry for growth and regulators have closed off the old familiar way of securing it, by banning large-scale acquisitions. That's some challenge.
A culture of responsibility
|"The bank headquarters emphasizes|
profits while deprecating compliance...
is found to be not fulfilling supervisory
responsibility... responsibilities of
management at the branch and
headquarters are ambiguous"
That all sounds well and good. But is it for the birds?
Prince hits one sour note at Carnegie Hall when responding to an enquiry about how long Citigroup will remain in the penalty box with the Federal Reserve over new acquisitions and what it has to do to get out.
When approving the firm's acquisition of First American Bank this March, the Fed had added a stinging rider. "Given the size, scope, and complexity of Citigroup's global operations, successfully addressing the deficiencies in compliance risk management that have given rise to a series of adverse compliance events in recent years will require significant attention over a period of time by Citigroup's senior management and board of directors. The [Federal Reserve] Board expects that management at all levels will devote the necessary attention to implementing its plan fully and effectively and will not undertake significant expansion during the implementation period. The Board believes it important that management's attention not be diverted from these efforts by the demands that mergers and acquisitions place on management resources."
Prince gives this a new spin that might interest the Fed. "The Federal Reserve did not prohibit us from making acquisitions. They have written down what we told them that our highest priority this year is to implement the five-point plan." He goes on: "I would be very surprised if the team brought us anything significant in this period. When we have made significant progress with the five-point plan then we can turn to inorganic growth. I would expect that late in 2005 we would be comfortable approaching large acquisitions."
Maybe it was just unfortunate phrasing, but it sounds arrogant to say that the Fed examiners, like diligent B students, have simply written down and parroted what Citigroup told them. Is the hidden message that Citigroup must simply appear to undertake a short period of penance before resuming its acquisition-led growth? Or has the Federal Reserve seized the chance to look tough without having to act tough by banning Citigroup from doing something that it doesn't want to do anyway?
Sallie Krawcheck, chief financial officer, tells investors in June: "We're often asked what's the next big thing for Citigroup. There is no next big thing. We're attempting to allocate capital so we have many small and medium-sized opportunities."
Citigroup presents a tough challenge to US regulators. Its persistent offences demand action. But its size leaves regulators fearful that excessive penalties against the group would increase systemic risk.
For Prince and Citigroup, declaring that your new overriding aim is to be the world's most respected financial institution is an awfully fuzzy objective. It's not like setting out to earn a 25% return on invested capital in every business or to grow earnings at a double-digit rate over a set period. How do you even measure respect?
Prince acknowledges the difficulty. He says that the firm will regularly test opinion among clients, existing staff and potential recruits as well as regulators. He asks: "How do our employees feel about the place and do they accept that management, from the top down, is really focused on these principles?" He admits: "We're going to have problems. We're a fast-moving, dynamic organization. But the level of awareness for these issues and training for our people is unlike anything we have had before. The proof is in the pudding and we cannot work in a zero defect environment but when issues do come up, how do we respond, how do we deal with them?"
Prince avows that all this is more than mere show. At the start of June he addressed an analyst and investor conference hosted by Sanford Bernstein. His message was about the shared responsibilities and the five-point plan. "If anyone sees this as preachy do-goodism or as a temporary response to the regulatory environment, they are missing the point," he said. "This is a necessary facilitator for our growth. We can't grow as fast as we would like to if we don't have the culture and the controls for guiding our business practices. This is our highest priority today."
It all sounds impressive. But then Prince is also given to asserting that Citigroup is "the best brand in the world".
Hold on a minute, Chuck. The brand might be well recognized, but how much more reputational damage can it withstand?
Long and difficult chapter
|Krawcheck: no next big|
thing for Citigroup
The list runs on and on. In March 2005, a Senate subcommittee investigating money laundering and foreign corruption disclosed that for over 25 years Citigroup had maintained 63 US accounts and CDs benefiting former Chilean dictator Augusto Pinochet and his family, many of them opened in disguised variants of his name. Although the bank cooperated with the inquiry into US accounts, it cited bank secrecy laws and provided very little information about accounts in Argentina, Chile, the Bahamas, Switzerland and the UK.
The Senate report's authors noted: "Over the past 10 years, despite having excellent anti-money-laundering policies on paper, Citibank private bank has undergone repeated criticism for poor due diligence practices, lax implementation of its ALM controls, and failure to close accounts of foreign public figures who appear to be depositing the proceeds of foreign corruption into their private banking accounts." The last Pinochet account had been closed just six months before this report was published.
On June 10, Citigroup announced that it would pay $2 billion to settle a class-action suit brought by investors in Enron. Prince trotted out his now familiar line about "putting a difficult chapter in our history behind us". Analysts emphasized that Citigroup had already set aside a reserve for litigation liabilities at the time of the WorldCom settlement that more than covers this latest payout. Another day, another hit to shareholders: business as usual at Citigroup.
The University of California, the lead plaintiff, had alleged that Citigroup participated in an elaborate scheme to defraud investors. Citigroup denies violating any laws. It was left to retired federal judge the Hon J Lawrence Irving, an adviser to the board of regents of the university, to point out: "The size of this settlement is unprecedented for a stock fraud case." The Citigroup settlement includes plaintiffs' attorney fees.
According to Weill at the recent shareholders' meeting, Citigroup paid out $650 million in outside legal fees last year, and that's on top of the 1,000 lawyers on its own books.
Lack of history, lack of culture
A senior Citigroup manager has been talking to Euromoney for some time about the promising earnings prospects for his business. Now asked how much damage all the scandals have done to the brand, he pauses before admitting, "a fair amount". He recounts: "In 1999 and 2000, there was a lot of scepticism that we could get the merger right, but we achieved way beyond what many people expected, and by 2001 we were developing an incredible brand. But then came Enron and the rest and all that dragged us back to earth. By the time the Japan thing hit us, it got to the point where clients were taking me aside and asking, almost out of personal concern, 'are you OK?'"
On March 1 2005, Charles Prince launched his new shared responsibilities initiative by broadcasting a 25-minute documentary, The story of Citigroup, to some 30,000 employees. The aim was to emphasize the rich history of Citigroup and the vision and leadership of previous generations who had poured their working lives into building the firm. The message to employees: cherish and build on this legacy so as to hand it on to those who come after you; be proud of it and do nothing to risk this great franchise.
It's the kind of corporate propaganda that makes most people cringe with embarrassment or gag with cynicism. True to form, Citigroup employees covering the predictable rainbow of ethnicities are portrayed declaring their pride in working for the firm. Then, just as the cynics' eyes might be glazing over, the film becomes genuinely interesting, with fascinating snippets about the beginnings of National City Bank, Schroders, Salomon Brothers, Smith Barney, Travelers, Handlowy and Banamex; personal appearances from Sir Win Bischoff from Schroders; old footage of Walt Wriston and his protégé John Reed, who had developed the technology behind the ATM; and, of course, Sandy himself. For anyone interested in the history of banking and financial services, it's well worth seeing.
However, the single lesson it imparts about the history of Citigroup is that it doesn't have much of a history. Citibank did, Schroders did, so did several other of the predecessor firms. But Citigroup itself only came into existence seven years ago and, as the senior executive recalls, its brief history comprises a brilliant success after the ground-breaking merger, a moment in the sun, a proud track record of earnings and profits unfortunately overshadowed by a litany of scandals.
Citigroup's leaders might have brought the pieces together, even organized them reasonably efficiently with the full panoply of management matrices, but what common culture ever bound together these 300,000 employees? Profit before all else, suggests Japan's FSA.
The Citigroup senior executive sounds exasperated. "We always thought doing business the right way was what the organization does. We thought saying 'don't do anything stupid, don't do anything illegal' was a given. Maybe it wasn't."
Does he not take responsibility for driving some employees so hard to deliver results that, for fear of being sacked for failure, they crossed a line into unacceptable practices? The appearance of exasperation increases. "People say that, but I don't follow. I could look around our senior management committee and every person there had, at some time or another, missed budget. None of us was ever sacked."
Well, quite. It's a comment that raises the question of how far removed the firm's generals have become from the troops in the trenches. Do the top managers know what goes on at their own firm?
Back at the shareholder meeting at Carnegie Hall, Matthew Lee, executive director of Inner City Press, a lawyer campaigning against predatory lending in poor communities in America, has a question. How come the firm, which undertook in January 2003 on its corporate citizenship website to stop making so-called Hoepa loans, has, according to its own home mortgage data for 2004, made a further 837 such loans? The reference is to high-cost loans charging 800 basis points or more above treasuries that are usually extended to borrowers with poor credit histories in poor neighbourhoods and now covered by the Home Ownership and Equity Protection Act.
Into the breach steps Robert Willumstad, president and chief operating officer of Citigroup. He tells Lee that the bank doesn't make such loans and that Lee must have misinterpreted the data. That's odd, Lee replies, as he is looking at a spreadsheet of loan figures provided by Citigroup that has a Hoepa status column with 837 loans marked yes. Home Mortgage Disclosure Act data is as familiar ground to Lee as negative operating leverage ratios are to the average bank analyst.
Citigroup later pleads that although it instituted the policy of not originating Hoepa loans in January 2003, various divisions that it had acquired through the purchases of Associates and parts of Washington Mutual only phased in this new approach to lending over time. It's a messy fudge of an explanation.
Perhaps, then, Prince's five-point plan and shared responsibilities are exactly what Citigroup needs. At the very least, they constitute an effort to impose a common set of values, standards and expectations for behaviour the key elements of a strong culture. "Employees have been starved, I think, of this kind of vision," says the Citigroup business head. "Working for a company that's the most profitable in its sector is OK, but working for the most respected company may be far more rewarding."
For this to succeed, all employees must believe that they really are expected to follow these guidelines, that senior management is doing more than paying lip service to them so as to get the regulators off their backs. Line managers must not spend one day of the working year talking about ethics so as to keep senior management off their backs and every other day demanding that employees pack unwanted, unneeded high-cost insurance into already high-cost loans and other such grubby business practices if they want to keep their jobs and earn their bonuses.
The proof of the pudding will indeed be in the eating. At the start of June, Prince says the shared responsibilities initiative is going well, but also lets slip his own doubts. "I'd say we're doing better than I expected," he concedes.
The price of integrity
Even if the initiative succeeds, it might come at a cost. If Citigroup really is going to forswear exploiting its subprime customers, refuse business from private-banking customers when it doubts the provenance of their wealth, pass up on corporate and investment banking transactions designed to disguise the true state of a client's balance sheet or P&L and in all cases recommend only business that best suits the client, not Citigroup itself, common sense suggests this will entail at least a short-term hit to earnings.
It's a question that vexes Citigroup executives. Their first instinct is to deny that it is even an issue. "Revenues have to grow," says Druskin at the Q&A session. "We don't believe a greater focus on reputational risk issues should have any impact on revenues." Their second instinct is to turn the issue around and argue that it's better to forgo dubious business than to face the management distraction of dealing with another scandal. So, later in the same session, Druskin qualifies himself. "I think the problems we have had have hurt us because they occupy an enormous amount of management time. If we lost a couple of transactions in future, or didn't do certain business, then so be it. The distraction when there is a real event is considerable. We have a zero tolerance, pretty much, for big problems."
Prince too likes to turn the question around. "Some people ask if we're going to have to give back growth. I think it's just the opposite. If we had not had our regulatory problems in Japan, we would be growing much faster there. If we had not had our unique MTS trade in Europe, we would be doing more business on the continent." This may be true, but it focuses on the costs of being caught, not on the costs of ensuring that businesses and employees don't do anything for which they are liable to be caught. Just how much business is Citigroup willing to forgo?
There is a danger too of Prince's response to the scandals creating excessive bureaucracy, limiting the discretion of Citigroup employees to take decisions in a straitjacket of controls designed to prevent scandals.
Its leaders suggest that much of the company's growth will come from emerging markets and consumer business. They trot out an old Citibank mantra in striving to present their company as a growth play. Citigroup might be big, they say, it might have more than $100 billion in shareholders' equity and it might be in 100 countries, but its share of each market in which it operates is small. Prince has mastered the mouth-watering statistics. The middle class is developing at such a pace in emerging countries that Citigroup estimates 740 million potential new customers will emerge between now and 2009.
Securing that potential growth, then, requires it to grow in emerging markets where standards of business integrity may vary. Citigroup is on the brink of major expansion in Russia for example. Prince brushes aside investors' fears about what risks this might entail. "If you're worried about international," he tells investors, "you should go buy Wells Fargo."
But he also now declares that Citigroup will not compromise its business mores or adapt its tolerances to any lower local standard to win business in emerging markets. "We have one standard worldwide for operating our business," he says. "And we are a US bank." In the long run, gaining a reputation for trustworthiness and ethics might well pay off, as long as Citigroup is truly committed to it. But it will likely entail short-term costs, as the group weeds out questionable business. Will shareholders put up with this?
Best way to get the stock price moving
The markets are, understandably, a little cynical about Citigroup. There is a three-hour presentation to analysts and investors in May, for example. After Prince, Druskin and other top managers front the presentation on the strengths of the corporate and investment bank which in the fourth quarter of last year topped the underwriting rankings in investment-grade debt underwriting, high-yield debt underwriting, equity capital raising and M&A they may be disappointed with the follow-up questions. "It's slower growing than the rest of the business, more complex and has had a few more regulatory problems," points out one questioner. "Under what circumstances might it be sold off?"
Prince can't think of any. He also delivers an update on the nervous market conditions of the second quarter following the junking of GM and Ford, rising interest rates and the flattening yield curve. "Last quarter the industry enjoyed very healthy capital markets; this quarter it is experiencing an environment in some ways the most difficult of recent times and we're seeing that in CIB's financial results to date." But, he points out, his approach is not to manage for quarterly results.
Managing the company not the stock price and aiming for double-digit earnings growth over time, but not promising it for each quarter or even each year, might be wise. But will investors put up with a further short-term slowdown in earnings while Citigroup restructures its business portfolio, invests in its new growth initiatives and cleans up its act?
They have little choice. "The price/earnings ratio is probably as much as two points below where it should be because of reputation and litigation risk," says the Citigroup senior executive. "Shareholders are in the same boat as us: even if it does divert us from double-digit earnings growth, getting these business practice questions right is the best way to get the stock price moving again."