How the mighty are fallen. The chief executive of once the world’s mightiest bank, whose senior executives had the run of a fleet of corporate jets to take them fishing or hastily transport forgotten laser pens, now queues up to fly cattle class on the twice-bankrupt US airline that regularly ranks last in customer satisfaction surveys. Well, good for him, suggests Euromoney.
"I don’t think he has much of a choice," the fund manager says.
It might be as well for Pandit that the investor was hurrying for his own flight that day. If he could have asked the Citi chief executive one question, it would have been this. "Is he just letting the air out of the balloon slowly and is Citi basically in run-off? That’s what it looks like. Parts of it may be doing well, but is it likely to continue to exist for much longer in anything like its present form? The challenge for Citi has been either to create a new model and manage it much differently and better than in the past... or just to break it up completely."
Pandit is given very little credit, it seems, for managing a turnaround at Citi, even though there is plenty of evidence that this is now well on track, after $45 billion of markdowns and losses and $50 billion in capital raised.
Pandit, while waiting for his seat row number to be called, could have told the fund manager that he is doing both things. He split the firm in two at the start of this year. Citi Holdings contains businesses deemed no longer essential to the bank’s future and held for rundown or sale. These include the special asset pool of problem exposures, many now aggressively marked down; the remnants of the Smith Barney brokerage, now held in a joint venture with Morgan Stanley; the CitiFinancial consumer loan business; North American private label credit cards that Citi manages for third-party stores; and Primerica Financial Services, which sells insurance as well as CitiFinancial products and which last month filed for an initial public offering.
From their peak in the third quarter of 2008, assets in Citi Holdings have come down by 20%, from $775 billion to $617 billion.
Set against this, and still overshadowed rather by all the problem businesses and assets, are the keepers, held now in a unit called Citicorp. These comprise regional consumer and commercial banking, where Citi is particularly strong outside the US; credit cards branded under its own name; and what is now called the Institutional Clients Group, which includes the global markets and investment bank and Citi’s industry-leading global transaction services (GTS) group.
Some investors appear to have noticed that the changes are having an effect. In November, it was reported that leading hedge fund manager John Paulson had sold out of his holdings of Goldman Sachs and switched into Citi stock.
From mindshare to market share
Ensuring that these Institutional Clients Group businesses are managed differently and better than in the past is the responsibility of John Havens, chief executive of ICG and a former colleague of Pandit’s from their days at Morgan Stanley.
It’s immediately clear that the people running the global investment bank now see themselves operating an entirely new business model, even if they struggle to express this profound change in anything other than clichés.
"Mindshare will create market share, not the other way around. We’ve gone from a firm focused on being the biggest to one focused on being the best. This organization will no longer base itself on revenue but rather on net income"
John Havens, Citi
But behind all the clichés, something radical has been happening and competitors that have grown used to dismissing Citi – "we just don’t see them at all anymore," one head of equity capital markets tells Euromoney two hours before the meeting with Havens – might be well advised to watch out.
The firm has drastically cut staff – total ICG headcount is down from 31,000 to 22,700, but turnover has been much higher at from 30% to 40% in many businesses. It has also cut the number of corporate and institutional clients with which it seeks to do business. These have been cut from more than 20,000 to closer to 4,000 and the firm has segmented those left on the list carefully into what it calls platinum, core, opportunistic and run-down. It is much more thoughtful and disciplined in its allocation of capital to doing business with them.
Financial sponsors, for example, to which it used to provide leveraged loans and lines of credit to support other activities, are no longer even referred to as clients. They are now relegated to mere counterparties.
The numbers suggest it is becoming a much more efficient and profitable business. In the securities and investment banking business, revenues for the first nine months of 2009 already equal the pre-charge-off revenue number for the whole of 2008 at $22.7 billion.
Well, it’s been a good year for most people in investment banking.
But profits on those revenues are now running at $8.7 billion compared with $5.6 billion for 2008. Productivity has jumped ahead of the old Citi investment bank that danced into a brick wall in 2005 to 2007. Back then, it brought in revenues of roughly 2.9% of the investment bank’s assets, at the low end of a peer group headed by Goldman Sachs with about 5%. For the year to date the new Citi’s securities and investment bank is producing revenues equivalent to 5.2% of assets.
It has done this not just by cutting and scaling back. While in Havens’ words Citi is about one-third of the way through a "restructuring of the client footprint and the operating paradigm", it has been busily hiring new staff, including global business heads such as Derek Bandeen, who joined from Morgan Stanley in May 2008 to run global equities trading, and Andrew Morton from Lehman Brothers, who joined last October to run rates and risk treasury.
In some areas it is even targeting investment. "It’s all very well to say you are client-centric," says Havens. "But if you don’t have best-of-breed products and services those clients want, you will fail. What do our clients want? They want access to liquidity, whether that comes from us or the markets; they want insights and ideas be they asset managers or corporations; and they want access and connectivity to the world. Clients care about your product capability and the coordination of your delivery."
Filling in the gaps
What Havens found when he arrived just over 18 months ago were notable gaps. "Our old model was far too dependent on the credit cycle and if you looked at equities, commodities, prime brokerage, even rates, we were not best in class. In rates and equities, the most technology intensive of businesses, we had disinvested in technology and so we just got leapfrogged." Part of Morton’s and Bandeen’s task has been to put all that right.
This all sounds well and good. Sandy Weill built Citigroup by acquiring assets on the cheap, treating the various sales forces he picked up along the way as sunk costs that needed product to push – pretty much any product. The idea was born of the financial conglomerate, the provider of every financial product and service to every client. And, very briefly, it even looked as if it might work. Then it all went horribly, horribly wrong.
So the idea of now building a much more focused investment bank inside Citi, doing select things well, for carefully chosen customers, husbanding precious capital, being very analytical in measurement of returns, all sounds rather clever. Whisper it, but the newcomers and the veterans inside the institutional client groups are even using strange new words like "partnership".
"It’s been tough. But even in the most difficult environment our clients appreciated us and kept their business with us. GTS has always been a client-centric business and so Vikram Pandit and John Havens are now talking a language with which we are very familiar"
Francesco Vanni d’Archirafi, Citi
Of course all this has to be paid for at a time when the bank is earning lots of revenue but still suffering large credit losses and so barely turning a profit. Investment has to be funded. Key staff have to be retained by a new senior management team that is telling them that a lot of what they did in the past was wrong. In investment banking, the winners have the best people. Talent has to be recruited at a time when Citi’s biggest single shareholder is the US government and its pay tsar is intent on containing bonuses and even the chief executive flies budget. In February, Pandit told Congress he would take a salary of $1 with no bonus until the bank returned to profitability.
Winning over insiders and outsiders
Clients have seen the bank come close to outright collapse. Competitors are all over them. Equity analysts who cover Citi stock are running sum-of-the-parts valuations in expectation of a complete break-up of the bank that came to define many of the worst excesses of the credit crisis and the greatest dangers of too big to fail. And while Citi’s new senior management has to convince outsiders – customers, investors, creditors, suppliers, regulators – that it is rebuilding a valid business, it also has to win over insiders.
"When Vikram Pandit and then John Havens came in, I have to tell you that not all the old Salomon and Smith Barney people thought everything Citigroup was doing was wrong or that everything Morgan Stanley was doing was right," a departed Citi veteran tells Euromoney. "Remember these guys had lost out in a power battle at Morgan Stanley and as for Old Lane [the hedge fund the two help found in 2006, Citi acquired in 2007 and closed in 2008 after below average performance], well I don’t have to tell you...."
So in overhauling the investment bank, Pandit and Havens had to win over the survivors of a pretty hard-bitten, cynical and unimpressed bunch.
But these were also people who had looked into the abyss and now find themselves with that rare and precious thing in life: a second chance.
The new top management duo seem to be doing OK.
"Vikram Pandit is not a lead-from-the-front kind of guy," says another Citi source, "but he has the right vision, he is smart, analytical and passionate in his own way. He tells people the truth and he and Havens instinctively do the right thing even when it is not the easy thing or the popular thing. Havens is an execution guy who would probably be great on any platform. He shows people the analysis, energizes them and instils the belief and desire to get it done."
To succeed, Citi’s surviving investment bankers will have to do more with less. With charge-offs still rising in credit cards, the bank has less capital to throw around even after the hugely dilutive conversion of the US government’s and other holders’ preferred stock into common equity that pushed its tier 1 common to risk-weighted assets ratio up to 9.1% – above the 8% level at which the US government allowed other banks to exit Tarp – on tangible common equity of $100 billion.
The investment bank inside Citi is now aiming to do business with three groups of customers: the largest multinational corporations headquartered in developed markets to which its Global Transactions Services group is already a natural partner; national champions in emerging markets, which it gets to know through its strong presence in many local currency capital markets; and finally a select group of what it bets will be future leaders in higher-growth sectors such as healthcare, power and technology and that it hopes to both serve and grow alongside.
The key group is the large-cap multinationals that are serial users of financial services and which, if all goes well, can be both highly profitable for a bank and very committed. The bank calculates that the top-two banks for such a client can share between them 80% of what it spends on financial services. The lion’s share of the $314 billion of corporate deposits attracted by GTS comes from large-cap multinationals.
Integrating client and capital strategies
Making sure that Citi’s institutional client group can do more for these target clients with less is Michael Roberts, a 24-year Citibanker now in charge of loan portfolio management as head of the global capital and network management group. He likes doing business with those very large companies. "They keep you out of trouble," he says. "They tend not to do stupid things. And they are a positive reinforcement mechanism. If you deal with the world’s largest corporations and financial institutions, you just can’t be lax. They don’t allow it. They need strong suppliers and they keep you on the straight and narrow."
The challenge for Citi, now that it has seen the light on all this, is constantly to allocate capital where it has the greatest cross-sell and can maximize revenues and risk-adjusted returns. Roberts says: "You can’t have a different client strategy and capital strategy. They have to be integrated."
Weren’t they before?
"We didn’t do any of this effectively before," Roberts says. He now chairs an internal group that symbolizes the new approach, the awkwardly named Episodic Deal Acceptance Committee. It debates every business request for any capital commitment greater than $100 million. Roberts, as the senior risk officer on the business side of the investment bank, sees it as a hugely powerful business tool. The initial filters have been set to sift out whacky proposals. These consider the suitability of any deal for a client and for the bank, how quickly the transaction can be turned around – especially if it is bridge finance to a capital markets deal – and the overall benefit to the franchise. The committee becomes a mechanism for ensuring that the firm uses its capital wisely, not just for the immediate returns on any given deal but for the benefit of the whole business.
As capital has become increasingly precious, the bank has had to lower its individual credit limits. That has made it choosier. It now finds that, by devoting capital mainly to higher-quality credits, it benefits from better risk weightings on assets it retains. The obvious danger is building risky concentrations around favoured clients but the firm’s global reach brings it natural geographic diversification and the generally high credit quality helps too. It buys credit default swaps to hedge certain concentrations. It never uses them to add exposures to fill out some idealized optimal portfolio.
What has been the result? "We are increasing returns on a smaller capital base," says Roberts. "This was born in the middle of the crisis and we doubled our return thresholds partly in an attempt to control and limit the balance sheet. It also forced people to get serious. Previously we never had a forum like this for discussing and taking joint ownership of capital commitment decisions. Now we find it has helped the institutional client group double its returns on capital."
Roberts is planning further refinements and adjustments. Some of them – such as charging individual business lines the cost of capital for the credit they put on – seem so basic that it is scary Citi did not do this before. Others carry striking echoes of the very best and brightest firms in the business. Roberts knows that returns go up the shorter the period over which Citi holds assets and will adjust the cost allocated to business for the tenor of commitments as well as the quality of the underlying credit.
New focus on partnership
Roberts says that Citicorp has already moved beyond reducing the balance sheet and reducing capital consumed, which is the point where most outside analysts, investors and competitors still peg it. "We’re increasing the velocity of capital usage, partly shortening the tenor of assets through loan sales and higher return thresholds. We’ve gone from capital reduction to capital recycling and that recycling is in full swing right now. The balance sheet is back to 2006 levels. We’re recycling capital to core clients away from ones we are doing less with and as we generate new capital we’ll allocate some of it to new, growth clients such as alternative energy producers. We want to grow as partners with our core clients."
There’s that "partnership" word again.
He continues: "This is very different from the past when we were very additive. The path of least resistance was often simply to step up and make the commitment." The figure of Chuck Prince almost seems to dance into the room as he speaks. "We just added, added, added exposures all the time. We weren’t as thoughtful about reducing exposure to industries or clients here and increasing it there. And we weren’t like a classic investment bank that turns its balance sheet over constantly and trades everything on a mark-to-market basis. As a bank, we took stickier commitments... and unfortunately a lot of bad stuff stuck to us."
What other firm on the Street does this sound like? Havens was determined when he arrived not to attempt to recreate Morgan Stanley, even though he made initial hires from that firm. It would have been the wrong thing to do, he says, and the organism into which he had been injected would have rejected him. This sounds more like Goldman Sachs.
"Progress has been much faster than most people expected on growing our strongest core Citicorp franchises and reducing Citi Holdings’ assets"
Tyler Dickson, Citi
Are clients also impressed? Are they standing by the bank?
They certainly are in the cornerstone business that separates Citi’s institutional clients group from such firms as Morgan Stanley, Goldman Sachs and Bank of America Merrill Lynch: Global Transaction Services.
The jewel in the crown
For all Citi’s troubles, even as the group teetered on the brink of bankruptcy and was bailed out by the US taxpayer, Euromoney’s own customer polls showed just how highly multinational companies continued to value its capability in the basic but essential business of moving their cash efficiently around the world (see EuromoneyOctober 2009). On any given day, it will move $3 trillion of its customers’ money.
Vikram Pandit has taken to speaking first about GTS in any review of the firm’s results. He describes it as the foundation of the firm’s global presence, as the financial operating system of large multinationals, the backbone of their back offices. He calls it simply "the best business in financial services". Over the past five years, it has grown profitability at a compound annual rate of 30%. It continues to grow deposit balances, attracting $26 billion more in the third quarter of 2009, bringing them up to $314 billion.
After the bank reported third-quarter results, analysts valued GTS on a theoretical standalone basis at about $44 billion, when the market capitalization of the whole of Citi was just $100 billion.
But it is almost impossible now to imagine it ever being broken away from Citi. It is one of the pillars on which the reformed bank is built, together with that much-trumpeted international network of presences in over 100 countries.
Yes, GTS is hugely technology intensive. It requires that Vikram Pandit and the board authorize in the region of $1 billion a year in investment spending – roughly a third on maintenance capex; one third to keep at the front of the pack in providing relevant services to customers; and a third more on pure innovation. It is asset light, low risk, high return and can pull in $300 million of net income a month. Pulled together from 2002 to 2006 under previous head Paul Galant, a business that started out back then roughly the same size as the equivalent at JPMorgan is now three times as big.
Of course, even this business has not been immune to customer concerns over the bank’s poisoned balance sheet. Francesco Vanni d’Archirafi, chief executive of global transaction services, says: "It’s been tough. But even in the most difficult environment our clients appreciated us and kept their business with us. GTS has always been a client-centric business and so Vikram Pandit and John Havens are now talking a language with which we are very familiar. We simplify our clients’ lives. We take their problems away. Yes clients may have concerns about the stability of banks, but if they chose to move away from our global platform they would probably have to migrate to at least four other banks and that’s very complex and problematic for them. Clients really do want us to thrive and do well."
The strength of the GTS business can hardly hurt Citi’s investment bankers when they go calling on clients to do financing and other capital-raising deals, especially since they finally took the painfully obvious step of combining and coordinating commercial bank lending and capital markets coverage teams, years after most of its competitors had done the same.
Of course, it should be pointed out that what can be classed as generations of Citi leaders – albeit in the space of the past five years – have long claimed that GTS was the bank’s gateway to other client revenues. It did not apparently work too well before. So what is different now?
Most important, does GTS’s success really make it any more likely that a company will hire Citi for top-level strategic advice on the really critical deals? Because, by definition, that’s what it must increasingly aim for now that it concentrates on a smaller, more select group of clients. It must aspire to be their chosen trusted adviser.
Hiring a top payments bank to advise you on M&A sounds a bit like asking your chiropodist to perform brain surgery because he did such a good job on those ingrown toenails.
Key advisory mandates
It’s easy to write Citi off. But take a look at some of the big high-profile deals playing out around the world right now and it keeps cropping up. It is one of the advisers to Kraft Foods on its unsolicited bid for Cadbury, which the merger arbs are now betting will rise well above the present $17 billion, if it succeeds.
It played a key role advising Volkswagen in the protracted and highly complex transaction with Porsche that began with Porsche attempting to build a controlling stake in the larger company through the equity options market. This is now on course to resolve itself instead in a whole series of transactions by which Volkswagen will take a 49.9% stake in the main Porsche operating company by subscribing to a capital increase. To protect its credit rating Citi’s client will finance this through an issue of preferred shares in the capital markets. The end result is intended to be a full merger of Porsche as a standalone brand inside the VW group by the end of 2011.
In June, when BlackRock unveiled the $13.5 billion cash-and-stock acquisition of BGI from Barclays that will make it the largest fund manager in the world, Citi was a lead adviser along with Credit Suisse. It was also one of the providers of $2 billion 364-day line of credit to help fund the cash portion of the deal.
Its equity capital markets franchise has taken a hit during the crisis, when banks have been the biggest users of the market and investors might well have been unimpressed by the imprimatur of a lead arranger that had suffered credit problems on Citi’s scale. At the end of the third quarter, it sat eighth in the global ECM rankings, with 4.8% market share just below Deutsche and Credit Suisse and far behind leader JPMorgan which boasts a 14.6% share.
Still Citi has not surrendered here. It will get a big league table boost as one of the joint global co-ordinators, alongside UBS and Bank of America Merrill Lynch, and a joint dealer manager on the £22.5 billion capital raising for Lloyds Banking Group. Comprising a £13.5 billion rights issue and a £9 billion offer to exchange existing tier 1 and upper tier 2 capital securities into common shares or new enhanced yield notes that will convert into equity in the event that Lloyd’s core tier 1 capital ratio falls below 5%, this is one of the biggest deals ever done in the global equity capital markets.
And in the M&A business, it is hardly an also ran. In the global rankings for advisers on deals announced in the first three quarters, Citi ranks at the bottom of a breakaway top four, led by Goldman Sachs, Morgan Stanley and JPMorgan. By deal value, the gap between Citi in fourth and fifth-placed Lazard is as wide as the gap between first and fourth. It’s in the champions league places.
Clients that have stuck with Citi clearly value it. The firm was reported to have earned a $32.5 million fee from Affiliated Computer Services (ACS) for its advice on the firm’s acquisition by Xerox. The transaction, valued at $8.3 billion including assumed debts, is the biggest Xerox has ever done and should make it a global leader in document and business process management. ACS shareholders received a 34% premium to the stock price in the week the deal was closed at the end of September.
It was a protracted affair. "We were working on ACS for 18 months," says Ray McGuire, head of global banking. In fact, it took even longer. Citi had been retained two years ago to advise on a possible buyout of ACS by Cerberus but that deal fell victim to the credit market seizure at the end of 2007.
So is the new strategy of focusing harder on a smaller group of clients working for the M&A business? McGuire tells Euromoney: "Our client revenues in M&A are ahead of where they were in 2008. The boards of companies such as Kraft, Volkswagen, ACS, have a choice of who to do business with and they chose to partner with us."
He rejects any suggestion that Citi has fallen behind in M&A, a charge competitors like to make. "It takes time to repair the mistakes we’ve made as an institution in the past. This is a new management team that is transforming the business. In the meantime, the competition has sometimes done neither us nor themselves any favours.
"Clients understand the necessity for this firm to succeed. They need a choice of responsible global financial advisers."
As all Citi executives always must, McGuire rehearses the obvious strength of its global network and its ability to raise funding and capital in local currency as well as developed markets. But he insists that the M&A business has a clear objective of its own. "Yes, where the firm has a GTS-based relationship there is an opportunity to include strategic advisers. Where we are already a trusted adviser in the boardroom there is the opportunity to cascade that through the organization. Further, we can provide more global strategic solutions than boutiques or other firms, given the power and importance of our GTS business.
"But in order to continue to distinguish ourselves this has to be an ideas-led franchise, first and foremost."
Competing for talent
Being a top-ranked corporate and investment bank requires one more thing beyond the capital strength Citi has been rebuilding, the product capability it has been investing in, the competent senior management it appears to have assembled and the international reach that it has always had and that now promises strong profits from growth markets. That ingredient is really good people.
Citi is a Tarp bank, still with the US government as a big shareholder and with the US government’s pay tsar burrowing through the contracts of its 100 most senior people. It has recently been forced into one economically irrational decision: selling its highly successful Phibro LLC commodity trading unit to Occidental Petroleum at flat-to-asset value so as to avoid a showdown over the $100 million pay package due to its top trader.
Given that unfortunate precedent, how can it expect to compete for talent?
"You can’t have a different client strategy and capital strategy. They have to be integrated. We didn’t do any of this effectively before"
Dickson is particularly enthused about his own origination business, describing the times we are now living through as a "golden age for capital markets". The firm hasn’t retreated far in the debt capital markets. It was a bookrunner on many of the multi-billion dollar bond financings by corporates early in the year, with a notable string in the healthcare sector, which Havens picks out as a speciality for Citi.
It was a joint bookrunner on each tranche of Roche’s $16.5 billion, €11.25 billion and £1.25 billion deals in February, the largest-ever corporate fund-raising in the bond markets, to pre-fund the acquisition of the remaining stake in Genentech. Before that it had been an active joint bookrunner on each part of Pfizer’s $13.5 billion-equivalent and $10.5 billion-equivalent three-currency bond financings of the Wyeth takeover.
These kinds of transactions are exactly what Havens is looking for. He knows that he has to keep his veterans enthused as well as attracting new recruits. "It’s their plan," he says, "their business model", nodding to his office door and the other executive offices beyond. "All I did was provide a lot of analysis that shows it will work. It’s not exactly rocket science. But sadly the world is full of brilliant business plans that weren’t executed. We have to make it work and build a partnership culture of taking ownership of results."
Havens joined the firm in March 2008 and on his first day the news broke that Bear Stearns had collapsed. It has been tough. Famous for his piercingly hard stare, Havens can at times be quite self-effacing. The excuse often given for Citi’s failings is that it became too big and complex to manage. Is this business too big for Havens to manage? "There is absolutely nothing on my CV to suggest I can manage something this size," he says. "The last business I ran was 4,000 people, so we’ll have to see."
In his office are two paintings depicting ships at sea, one that used to hang in Walter Wriston’s office, one that used to hang on the wall of John Reed’s. Havens recalls paying a visit, as a younger man, accompanied by the then head of Morgan Stanley’s ECM business, one Vikram Pandit, to discuss a capital-raising with Reed as he led Citicorp away from the commercial real estate, highly leveraged transactions and emerging market loan problems that almost killed it at the start of the 1990s. "John Reed had many opportunities to offload the international network but always resisted," says Havens, "and that was very wise."
In this crisis, while the bank has shed many thousands of jobs, Havens has had to try to recruit good people. He has brought in about 50 at managing director level or above. The lure for many of them will be the same as it presumably was for Havens himself, for Bandeen, Morton, McGuire and countless bankers before them: the extraordinary potential of this bank with its huge international reach. That potential was almost squandered by the most recently departed leaders.
Harnessing it is still the dream that it is now the turn of Havens to peddle. "I had a young man in here just the other day who has spent 15 years at one of the top firms and now deals with China," he says. "If you look where Chinese companies are very active right now it’s natural resources and Africa. He pointed out that one of the things that attracted him to Citi is that we are in 16 countries in Africa."
If Havens can forge a partnership between the new recruits and the veterans, Citi could be a force to be reckoned with again and maybe very quickly. "The opportunity going forward is huge," Havens says. "Our people have done terrifically well with these terrible headwinds against us. Think what these people can do when those headwinds abate.
"Talk about battle-hardened."
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