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Citi: Suddenly Thin at the Top

By Mara DerHovanesian They say bad news comes in threes. On July 14, Citigroup (C) investors digested the announcement that after two decades with the company, Robert Willumstad, the banking giant's No. 2 executive, was leaving to run another public financial-services company. Next came disappointing second-quarter earnings. Although Citi reported a little more than $5 billion in profits in the second quarter, or 97 cents a share, the bank missed Wall Street's consensus forecasts by 5 cents.

Analysts had been prepared for poor results from all banks in the quarter ended June 30, but Citi's numbers were worse than its peers in everything from investment banking to credit-card operations. No sooner were the numbers released, than another ominous development set the market abuzz: Founder and Chairman Sanford I. "Sandy" Weill is set to launch a $5 billion private-equity fund with one of Citi's largest investors -- the Saudi Prince Alaweed Bin Talel al-Saud.

Citigroup didn't make CEO Charles O. Prince or Weill available for comment and would not comment on market speculation. Still, the prospect of losing in the span of a week two board members in Willumstad and Weill, who's the preeminent architect of the financial-services supermarket model, had analysts questioning the quality of the bank's operational management. Prince, for example, is a lawyer by trade and only briefly ran Citi's investment bank. Sallie L. Krawcheck is a former bank analyst who until last year was running the brokerage and equity research arm before she took over as chief financial officer.

"THEY'VE LOST THEIR EDGE." "You don't have a lot of people on the very top of the organization with experience running the day-to-day operations and growing revenues," says John E. McDonald of Banc of America Securities. Prudential Equity Group's Michael L. Mayo said in a July 19 report the bank now lacks strong operating experience at the top, calling Weill's potential departure...a "meaningful loss of experience," especially regarding mergers and acquisitions. On the other hand, Mayo blames the corporate culture that Weill cultivated for creating regulatory lapses that got the bank in trouble with authorities in three continents.

Even before the tringo of negative revelations the past few days, some big investors had soured on Citi's shares. Star investor Tom Marsico of Marsico Capital Management in Denver, which runs $53 billion in assets, has been a long-time shareholder. But on Mar. 22 he dumped the bulk of his holdings, or 10 million shares. "We were concerned about the direction of the business going forward," he says. "They've lost their edge. And they've lost their ability to attract very talented people."

Worse, Citigroup's diversity and scale advantages don't appear to be paying off in earnings stability. Analysts across the board cut their 2005 estimates and stock-price targets for Citi after seeing second-quarter results. While fixed income is bouncing back from an April plunge, rising delinquency and bankruptcy rates are hurting credit cards in North America, according to David Hendler of the New York research shop, CreditSights.

"PHENOMENALLY CHALLENGED." Citi's new travails come at a time when many in the industry are questioning the financial-supermarket model that provides all services -- from cards and checking accounts to mortgages and financial planning -- under one roof. Says Adam Dener, a partner at Capco, a financial services consulting outfit in New York: "The economics of the industry are phenomenally challenged."

The question on everyone's mind now is whether Citi can continue to post huge earnings by virtue of its size and global reach. "There are environmental challenges for everybody, but Citi's results were worse than peers," says McDonald of Banc of America Securities, citing the $245 million loss, which was blamed on short-term interest rates and the flattening of the U.S. yield curve. Seemingly, diversity would have worked in the larger banks' favor, but in fact, what's happening is regional banks are holding up really well, and the bigger banks are having more challenges, McDonald says.

Other big regional banks, including Wachovia (WB), which is based in Charlotte, N.C., and U.S. Bancorp (USB), headquartered in Minneapolis, came in with higher second-quarter profits that met or beat analysts' expectations. Bank of America (BAC), the nation's No. 3 bank, reported profits of $4.3 billion, or $1.06 a share, a 12% increase over last year, despite tighter interest rate margins. However, it reported a poor trading quarter as well, down 40% from first quarter.

FREER REIN? The speculation that Weill wants to raise private equity to presumably invest in financial-services companies is telling of the dire straits the industry faces, adds Dener. "These guys go in and aggressively invest and try to improve performance. That's what private equity does," he says. "What does it say about financial services as an industry?"

Analyst Kathleen Bochman of GimmeCredit says that she wasn't surprised to read about Weill's plans. "I understand that Mr. Weill has been more of a figurehead at the company as Mr. Prince has taken over the operations and the regulatory cleanup.... But why couldn't [Weill] just wait until April given the stock-price drop year-to-date?" The $44 stock is down about 7% so far this year.

Though it's not known why Weill might be moving ahead of his scheduled April retirement date, speculation from Wall Street veterans is that he's interested in private equity because it's less regulated than banks. Insurance companies in particular may be a target because no federal regulatory body governs them. Rather, the oversight lies at the state level. Moreover, the insurance sector is ripe consolidation and a business makeover.

"He's a doer. He's not a guy that watches people do," says a banking veteran and former bank executive. "He'll have more freedom as a big investor with a lot of cash to shake things up again."

FIREFIGHTER. And some observers say they think an early retirement for Weill is a good thing for Prince and the bank's future. Say money managers for CalPERS, which owns 39 million shares, through spokeswoman Patricia K. Macht: "The investment staff believe that it's a good thing for Weill to leave and allow Prince to have the reins completely."

For the nearly two years since he was named CEO, Prince has been fighting one regulatory fire after another. Though Citigroup is still the world's most profitable public company, it has had an enormous task of managing its reputation as scandals rocked its good name in three continents. Last summer, the British Financial Services Authority launched a formal investigation into improper bond trading. In the fall, Japan's Finance Ministry banned Citi from participating in its government-bond auctions, and the Financial Services Agency closed its private bank in the country.

Prince has primarily focused on getting such scandals behind him. In the first quarter, he launched a plan to improve the bank's "values, priorities, and internal controls" in an attempt to clean up the cowboy image that has plagued Citi for years (see BW, 2/14/05, "Citi: A Whole New Playbook") . Plus, he has stepped up legal settlements to get the bank's name out of the headlines: On June 1, Citi agreed to pay $208 million to settle regulators' claims that it pocketed fees that should have been passed on to its mutual funds. The settlement with the Securities & Exchange Commission ends part of a probe that Citigroup disclosed in 2003.

BALANCING ACT. Ten days later, Citi agreed to pay $2 billion to a group of investors to settle a class action regarding Enron and the bank's alleged complicity with the failed energy giant's financial shenanigans. Prince is also busily reassessing the bank's different lines of business. In July, Citi will complete the sale of its Travelers Life & Annuity unit to MetLife (MET) for $11.5 billion. Then on June 24, Prince negotiated the sale of Citi's asset-management arm to Baltimore's Legg Mason in a $3.7 billion deal.

When asked at the July 19 conference call with analysts whether he had been focusing too much on regulatory issues and less on growth, Prince said he saw his job as a balancing act between the two. Maybe with all this bad news out of the way, he can begin to focus more on growth and regain the full confidence of the Street and investors.

DerHovanesian is BusinessWeek's Finance & Banking editor in New York

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