Pandit ‘Globality’ Goal Imperiled as Economic Growth Stagnates

Vikram Pandit, who oversaw Citigroup Inc. (C)’s recovery with the help of a $45 billion government bailout, faces a profit squeeze as he adds staff and branches outside the U.S. amid a global economic slump.

The bank, which gets more than half of its profit from emerging markets, could see earnings stagnate next year if U.S. growth stays at about 1 percent and Chief Executive Officer Pandit doesn’t cut expenses, according to Charles Peabody, an analyst at Portales Partners LLC. Net income may be $10.8 billion, 31 percent less than the $15.7 billion average estimate of analysts surveyed by Bloomberg, Peabody said.

“Their operating margins, their efficiency ratios, are probably going to deteriorate in the short run because they need to maintain some level of investment,” said Peabody, who is based in New York. “There’s no question in my mind that people have to make some adjustments to their earnings estimates.”

Investor concern that the U.S. economic recovery has stalled and markets such as Brazil, India and China are cooling has helped push Citigroup shares down 41 percent this year. That’s more than global rivals such as HSBC Holdings Plc (HSBA) and Standard Chartered Plc (STAN), both based in London, which saw their shares fall 22 percent and 25 percent respectively.

The economic slowdown could impede what Pandit, 54, described in a letter to shareholders this year as Citigroup’s goal of regaining “our company’s place as the world’s premier international bank.” Pandit, who has said that “globality” was the lender’s defining strength, wants to more than double staff in China to 12,000. The bank, which he joined in 2007, has added 900 branches in Latin America in the past six years.

‘Key Differentiator’

Citigroup’s global reach is a “key differentiator” for investors choosing between the New York-based company and domestic rivals such as JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC), according to Richard Staite, an analyst with Atlantic Equities LLP in London.

While Pandit’s spending has helped boost revenue, expenses have increased faster. Citigroup’s Asian and Latin American consumer-banking units posted combined revenue of $8.7 billion for the first half of 2011, an 11 percent increase over the same period last year. Operating expenses rose 18 percent as profit fell 7.1 percent to $1.84 billion.

‘Global Footprint’

“We remain committed to leveraging our unique global footprint to serve our clients and will continue to make prudent investments in overseas and domestic markets while tightly managing expenses,” said Shannon Bell, a Citigroup spokeswoman.

Citigroup also counts countries in the Middle East, Africa and Eastern Europe as emerging markets, while excluding some Asian nations such as Japan. The bank earned $2.3 billion before taxes from consumer banking in emerging markets in the first half of 2011 compared with $2.2 billion during the same period in 2010, according to a company presentation.

Economists surveyed by Bloomberg News in August predicted that the world’s economy would grow by 4.2 percent in 2012, 0.3 percent less than what they estimated in January. They also cut their outlook for U.S. economic growth next year to 2.4 percent from 3.2 percent. There’s a 30 percent chance of another U.S. recession in the next 12 months, according to the survey.

Citigroup economists led by Willem Buiter cut their predictions for 2012 global growth to 3.2 percent from 3.7 percent in an Aug. 24 report. The estimate is their seventh- biggest monthly cut in the past decade, according to the report.

Drag on Profit

Emerging markets drove the global economy during the U.S. recession from December 2007 to June 2009. That’s unlikely to happen again as regulators in China, Brazil and other nations seek to curb inflation amid rising consumer defaults. The MSCI Emerging Markets Index, which tracks the performance of 826 companies, has tumbled 14 percent this year, after more than doubling during the previous two years.

Any slowdown in global growth could mean that the cost of building out Citigroup’s presence overseas is more of a drag on profit. Pandit’s consumer-banking chief, Manuel Medina-Mora, 61, told reporters in March that he intends to invest between $3 billion and $4 billion over the next two to three years. About half of that will probably go to Asian countries including China, a person familiar with the matter said in April.

Citigroup posted net income of $6.34 billion for the first half, following a $10.6 billion profit for all of 2010. The bank could earn $12.3 billion this year before increasing profit again in 2012 to more than $15 billion, according to the average estimate of 13 analysts surveyed by Bloomberg.

Estimate Cut

Such an upward trajectory is unlikely, said Michael Yoshikami, CEO and founder of YCMNet Advisors, a Walnut Creek, California-based fund that manages $1 billion, including Citigroup shares.

“We could easily lose a third of consensus growth,” said Yoshikami, who estimated the bank could earn $12 billion next year. “If the economy slows down in emerging markets, I don’t think we should be surprised about that.”

Glenn Schorr, a bank analyst at Nomura Holdings Inc. in New York, trimmed his 2012 profit estimate for Citigroup by 11 percent to $14.7 billion, citing “regulatory uncertainty and the slower economic recovery,” according to a note to clients yesterday. Schorr has a “buy” rating on Citigroup.

Other analysts remain more optimistic. Jeffery Harte of Sandler O’Neill & Partners LP in Chicago predicts that Citigroup will post a $12.4 billion profit this year and then boost net income by 36 percent to $16.8 billion next year, according to data compiled by Bloomberg. Harte, who recommends that investors buy Citigroup, reduced his 2012 estimate from $18.6 billion since January, the data show.

Pandit’s Strategy

Emerging markets have been central to Pandit’s strategy for the bank’s recovery. Citigroup posted $29.3 billion in losses tied to subprime mortgages for 2008 and 2009, his first two full years in charge, and received a $45 billion bailout and a $301 billion asset guarantee from U.S. taxpayers.

The lender now gets more than half of its profit from emerging markets, Pandit said in March.

“They’re going to do OK in the U.S. banking business, but that’s not why we got in the stock,” said James Cullen, president of Cullen Capital Management LLC in New York, which owns about 2.9 million Citigroup shares. “From a long-term perspective, it gives you exposure to a potentially interesting market, international and emerging.”

Pandit should continue to invest shareholders’ money overseas even if it hurts profit margins, Atlantic Equities’ Staite said in a phone interview. He should instead target the company’s Citi Holdings unit, the so-called bad bank created in 2009 to house and sell about $600 billion of troubled businesses and assets. Its operating expenses were $4.2 billion for the first half, 17 percent of the lender’s total.

Disposing Assets

Pandit has disposed of about $300 billion of unwanted assets from Citi Holdings, leaving about $308 billion to sell. That goal could also be undermined by an economic slump, Portales Partners’ Peabody wrote in a June 21 note to clients.

Declining prices will make it more difficult to sell CitiFinancial, a consumer-finance lender with more than 2,000 branches and $32 billion in assets, and the bank’s store-branded credit-card business, which has $46 billion of assets, Peabody wrote. The bank is also struggling to reduce its portfolio of residential mortgages, he said.

Warren Buffett’s Berkshire Hathaway Inc., Leucadia National Corp. and Centerbridge Partners LLC are in talks to buy CitiFinancial, two people with knowledge of the talks said in July. The store-branded card business posted a $769 million profit before taxes in the second quarter, according to a company presentation. Bell, the spokeswoman, declined to say whether the bank was in talks to sell the unit.

‘Short-Term Hit’

“I absolutely would like to see him continue to invest in growth markets and cut costs and retrench in more established markets,” YCMNet’s Yoshikami said. “As an investor, I’m OK with a short-term hit on profitability if it’s being invested wisely. I’m willing to take the short-term pain for the long- term payoff.”

Pandit told analysts on a Jan. 18 conference call that “macro trends will dominate micro trends, especially for the next few quarters,” citing weak job creation, a slumping U.S. housing market and “excessive government leverage” among some European nations. The bank was seeking “responsible growth” in this environment, he said.

“He really foresaw a lot of this,” Peabody said. “This period of slow-to-no-growth is not a total surprise to Pandit. If anyone was reading between the lines, he was telling you that the estimates were too high.”

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

To contact the editor responsible for this story: Rick Green in New York at rgreen18@bloomberg.net

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