Pandit Picks Emerging Markets as Citigroup Future in New Risk

Vikram Pandit, who steered Citigroup Inc. (C) through a $45 billion government bailout, has staked his bank’s future on emerging markets -- just as investors are pulling back.

Citigroup, the third-largest U.S. lender by assets, now earns more than half its profit from developing countries, Chief Executive Officer Pandit said at a March 9 conference in New York. The bank increased assets in Latin America and Asia by 16 percent to more than $470 billion last year, adding customers in countries such as Brazil, Mexico and India.

Pandit, 54, predicted in June 2009 that Citigroup would become the “largest emerging-markets financial-services company,” a long-term bet that could pay off if growth rates keep soaring. The expansion, which coincides with two regulatory reports questioning the firm’s ability to manage risk, could also make it more vulnerable than other U.S. lenders.

“If it grows like a weed, maybe it is a weed,” said Mike Mayo, an analyst at Credit Agricole SA in New York who recommends investors sell Citigroup shares. “They’ve had risk- management mishaps. We’re not convinced the culture has changed enough to prevent similar mishaps from occurring.”

As rising inflation threatens growth in developing countries, investors have withdrawn more than $21 billion from emerging-market equity funds this year, about 22 percent of what flowed in last year, according to EPFR Global, a Cambridge, Massachusetts-based financial-research firm. The MSCI EM Index, which tracks shares of 812 companies in countries including Brazil and India, has fallen 2.9 percent in 2011 after more than doubling during the two previous years.

Photographer: Simon Dawson/Bloomberg

Vikram Pandit, chief executive officer of Citigroup Inc. Close

Vikram Pandit, chief executive officer of Citigroup Inc.

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Photographer: Simon Dawson/Bloomberg

Vikram Pandit, chief executive officer of Citigroup Inc.

‘Risks of Overheating’

Citigroup, which previously has stumbled in Japan and Latin America, costing the bank at least $4 billion in writedowns, operates in more than 100 countries. It has more than 50,000 employees in Asia and 28 million customers in Latin America, according to the New York-based company’s website.

Pandit, who declined to be interviewed for this story, acknowledged in a speech in New York last month that many emerging economies are “operating at or near capacity, and there are risks of overheating.”

Still, he has framed his strategy in emerging markets as one that aims to capitalize over the long run on the rise of a new middle class. Consumers in developing Asia may spend $32 trillion in 2030, compared with $4.3 trillion at the end of 2008, according to an August 2010 report by the Asian Development Bank.

“The underlying secular story is really strong in a lot of these markets,” Pandit said at the March 9 conference.

‘Potential Slowdown’

The bank’s shares have fallen 12 percent since touching a 16-month high on Jan. 14, in part because of the “potential slowdown in emerging economies,” Richard Bove, a Lutz, Florida- based analyst with Rochdale Securities LLC, wrote in a March 2 note. Bove recommends investors buy Citigroup shares.

Standard Chartered Plc (STAN), one of Pandit’s rivals for banking dominance in emerging markets, fell 6.8 percent during the same period, and HSBC Holdings Plc (HSBA) declined 8.4 percent.

Both London-based banks rely on Asia for more than half of their income and avoided bailouts during the financial crisis. HSBC posted annual profits throughout the period, while Standard Chartered reported its seventh successive record annual profit this month. Standard Chartered shares trade for 1.58 times net assets, a measure of investors’ expectations, almost double the ratio of Citigroup, whose shares trade for 0.8 times net assets, according to data compiled by Bloomberg.

Citigroup Profit

Citigroup reported net income of $10.6 billion in 2010, the bank’s first profitable year since Pandit became CEO in December 2007. The results were boosted by consumer-banking units in Asia and Latin America, where net income more than doubled to $4.1 billion on increased lending, compared with a 17 percent drop at the U.S. business.

In Asia, regional co-CEOs Stephen Bird and Shirish Apte added almost $10 billion of loans, about half linked to real estate, as loan volume grew 19 percent to $61.2 billion at the end of 2010. Bird said in August that he wants to triple staff in China to 12,000 in three years.

Citigroup has a bigger loan book in India than Standard Chartered with a branch network half the size, according to Mayo. The bank had what it calls a “cross-border exposure” of $28.3 billion in India at the end of 2010, compared with $24.9 billion the previous year, according to a company filing. The figure is the difference between Citigroup’s liabilities and claims in the country and includes loans to banks as well as investments in local franchises.

India’s economy will probably expand 8.6 percent in the year ending March 31 from a year earlier, the most in three years, the government said last month.

‘Red Flag’

In Latin America, under Americas consumer-banking chief Manuel Medina-Mora, Citigroup increased real estate and commercial lending in 2010 by 31 percent, to $16 billion, over the previous year. That was more than double the rate at which Medina-Mora increased deposits from customers.

Medina-Mora, 60, was previously CEO of Citigroup’s Banamex subsidiary in Mexico, one of the bank’s largest overseas operations with 1,700 branches, according to a regulatory filing. The unit made a profit of 22.2 billion pesos ($1.9 billion) in 2010, an 18 percent increase over the previous year. As credit quality among Mexican customers improved last year, Medina-Mora increased Citigroup’s cross-border exposure to the country by 38 percent to $17.6 billion.

“Whenever I see growth rates that substantially exceed the average, it’s a red flag,” said David Knutson, a Chicago-based senior analyst at Legal & General Investment Management America, which oversees $18.5 billion, including $85.3 million of Citigroup bonds, according to data compiled by Bloomberg. “It’s a sign that you need to examine how you’re achieving that growth. It doesn’t matter if it’s a car-loan portfolio or if it’s commercial or real estate lending in the Third World.”

Prince, Weill

Pandit’s lending in emerging markets helped him increase assets in Citicorp, the division containing the bank’s core businesses, by 15 percent in 2010. Pandit predecessor Charles “Chuck” Prince, 61, increased assets annually by an average of 13.8 percent between 2005 and 2007. Prince resigned in November 2007 as the bank faced billions of dollars in losses linked to subprime mortgages and related securities.

Prince’s predecessor, Sanford Weill, 77, sought to expand the bank’s presence in Japan through the $31 billion purchase in 2000 of Associates First Capital Corp., the biggest U.S. consumer-finance company, which had a Japanese subsidiary. Citigroup executives misjudged borrowing habits in Japan, and a 2006 change in laws capping interest rates further damaged the business, Mayo wrote in a November report on the bank’s risk control. Citigroup has disclosed losses of about $1 billion linked to the Japanese unit, which was closed in 2008.

Debt Crisis

“Aggressive growth in other regions in Asia or elsewhere, especially if they are driven by asset growth expectations, could lead to similar adverse problems,” Mayo wrote. “Citi’s loan portfolio is larger and more aggressive than its peers in general, and consequently it tends to be more severely impacted during credit cycles, such as the most recent one.”

Under former CEO John Reed, 72, the bank was also one of the biggest U.S. lenders to Latin America in the years before the region’s 1982 debt crisis. Reed added $3.3 billion to loan- loss provisions in 1987 after government defaults, according to a report by the Federal Deposit Insurance Corp. The bank also took more than $2 billion in pretax credit losses and related charges after Argentina devalued the peso in 2001, according to company filings.

MOU ‘Stomachache’

Pandit’s expansion of Citigroup’s emerging-market loan book is taking place while the bank is subject to a memorandum of understanding with one of its regulators, the Office of the Comptroller of the Currency. An MOU is an enforcement action in which a bank commits to remedy what has displeased a regulator.

The MOU has been in place since June 2008 and relates to “risk management weaknesses,” according to a Financial Crisis Inquiry Commission report released in January.

“Any MOU gives me a stomachache,” Legal & General’s Knutson said. “It’s compounded in the case of Citibank when you have an institution that stretches not from Maine to Alaska, but when you have something that goes globally.”

In January 2009, the Federal Reserve Bank of New York assigned Citigroup a supervisory grade of 4 on a scale of 1 to 5 -- 5 is the worst -- citing “material weaknesses in the firm’s ability and its systems to monitor key vulnerabilities,” according to a document released by the FCIC.

Pandit’s Progress

Pandit told CNBC on Feb. 9 that the bank is growing with “no impediments” from regulators. Robert Garsson, a spokesman for the OCC, declined to comment, as did New York Fed spokesman Jack Gutt.

“Since Vikram Pandit became CEO, Citi has added significant resources and talent to the risk-management team and has revamped its risk structure and processes,” Shannon Bell, a spokeswoman for the bank, said in an e-mailed statement. “As a result, we believe we have the right risk-management processes, procedures and culture in place to manage growth plans around the world.”

Bell declined to comment about the MOU.

Born in Nagpur, India, Pandit moved to New York at the age of 16 to attend Columbia University. In 1986, in pursuit of a doctorate in finance at Columbia, he submitted a thesis that examined “the properties of asset prices in a multi-consumer, dynamic economy under uncertainty.”

He joined New York-based Morgan Stanley in 1983 and became the firm’s head of sales, trading and investment banking 20 years later. He quit in 2005 after a dispute with then-CEO Philip Purcell and founded a hedge fund called Old Lane Partners LP with John Havens, another former Morgan Stanley executive.

Losing Wachovia

Citigroup, then headed by Prince, bought the multi-strategy fund in March 2007, paying Pandit $165.2 million and putting him in charge of the bank’s alternative-investments division, overseeing its hedge funds. When Prince was ousted in November 2007, Pandit took the top job. Citigroup lost $27.7 billion as a result of subprime mortgages and related securities and took $45 billion in bailouts during Pandit’s first year in charge.

In September 2008, Pandit failed to land the faltering Wachovia Corp. Wells Fargo & Co. (WFC), based in San Francisco, bought it instead, adding $450 billion of deposits and an East Coast branch network.

Citigroup shares plummeted and customers began withdrawing deposits in the weeks after the deal. The government, which had already provided Citigroup with $25 billion, arranged another $20 billion bailout in November.

Split in Two

With the bank reporting its worst annual results, Pandit announced in January 2009 that he was splitting Citigroup into two divisions. One would be used to offload more than $600 billion of troubled assets and the other, Citicorp, would focus on core operations such as consumer banking, trading and investment banking -- areas where the company has a strong presence outside the U.S.

“They left the idea of being the next JPMorgan or Wells Fargo with the Wachovia situation,” said Knutson. “They were relying on their preeminence in Latin America, Asia and the Middle East.”

Investors flocking to emerging economies aided Pandit’s strategy by pouring $178.9 billion into emerging-market equity funds in 2009 and 2010 while taking $139 billion out of developed markets, according to data collected by EPFR Global.

‘Beat the Expectations’

Citigroup’s earnings rebounded in 2010, and shares rose 43 percent. The U.S. Treasury Department, which had owned 27 percent of the bank as a result of the bailout, largely exited in December, making a profit for taxpayers of about $12 billion. The firm is expected to earn $29.9 billion over the next two years, according to a Bloomberg survey of 15 analysts.

“He handily beat the expectations that people set at the start of the year,” said Pri de Silva, an analyst at CreditSights Inc. in New York. “Talking to him you get the feeling that he is focused on correcting the ship and getting it on the right path.”

Pandit shows no signs of changing course. In a March 10 letter to shareholders, he wrote that capturing a greater share of emerging-market business is a “key execution priority” for this year.

“Nearly half of our 2010 consumer-banking revenues were generated in emerging markets, where margins are higher and growth prospects brighter,” Pandit wrote. “According to one estimate, by 2020, three-quarters of incremental consumer spending will come from emerging markets. If that estimate is correct, then by that same year, consumer spending in Asia will overtake North America to become the world’s largest consumer bloc.”

Emerging-Market Bonds

Citigroup also earned 47 percent of its trading and investment-banking income, or $3.07 billion, from continuing operations in developing economies in 2010, Pandit said March 9.

While the bank slipped to third place from second among underwriters of emerging-market bonds last year, behind HSBC and Frankfurt-based Deutsche Bank AG, overall debt issuance has more than doubled to $709.6 billion since 2008, according to data compiled by Bloomberg.

The bank jumped to second place last year from ninth among underwriters of Latin American equities, trailing Spain’s Banco Santander SA, and fell to seventh place from first in 2008 among underwriters of shares in Asia, excluding Japan, according to Bloomberg data.

Brazilian Credit Cards

A test of Pandit’s strategy may come in Brazil, Latin America’s largest economy, which expanded 7.5 percent last year and where policy makers recently moved to avert a credit bubble. The bank increased its cross-border exposure there by 64 percent to $16.9 billion last year, according to a regulatory filing.

Citigroup’s Brazilian unit is run by Gustavo Marin, who reports to Medina-Mora. It employs more than 6,000 people, according to the bank’s website. Through its CrediCard SA subsidiary, Citigroup now controls between “7 percent or 8 percent” of the credit-card market, Medina-Mora said in a December interview in New York.

“We see the Brazilian financial system as very solid, very healthy, very well-supervised,” Medina-Mora said in December. “Our operation there is doing very well -- expanding, growing as the country is growing.”

That same month, facing its highest levels of inflation in five years, the Brazilian central bank took measures to slow consumer lending. Consumer-loan delinquencies of less than 90 days rose to 5.9 percent in January from 5.3 percent in December, the central bank said. Average home prices in Sao Paulo and Rio de Janeiro have jumped 81 percent and 99 percent, respectively, over the past three years, according to Brazil’s Institute of Economic Research.

‘Riskier Than Peers’

Citigroup’s loan book in Brazil is “riskier than peers” because 70 percent of its retail loans are linked to the credit- card business, according to a report yesterday by ratings company Standard & Poor’s, affirming the bank’s stable outlook.

“Although the bank follows strong guidelines and committee policies, its overall nonperforming asset levels have been historically above the industry average, as have credit losses,” credit analyst Vitor Garcia wrote.

Money earned from Brazilian bank customers should make up for rising defaults, said Simon Nocera, a former economist with the International Monetary Fund and a founder of San Francisco- based hedge fund Lumen Advisors LLC, which does not own any Citigroup shares. With local interest rates of more than 11 percent, a Brazilian bank can make a return on its assets of about 2.5 percent, he said. That is five times what Citigroup’s retail bank in North America made in 2010.

A country rich in commodities like Brazil will continue to thrive if prices for iron, steel and oil continue to rally on demand from China, Nocera said.

“What I’m confident of is that commodities prices are going to continue to rise for the next couple of years,” said Bove, the Rochdale Securities analyst. “If you tell me that there’s going to be a crack in commodities prices, I’d get really worried about Brazil, about Latin America and about Citigroup’s position in those regions.”

To contact the reporter on this story: Donal Griffin in New York at dgriffin10@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net.

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