Citigroup Ignored 2005 Bond Warning After Shedding ‘Handcuffs’

Citigroup CEO Vikram Pandit
Vikram Pandit, chief executive officer of Citigroup Inc. Photographer: Simon Dawson/Bloomberg

Citigroup Inc.’s bond-trading desk was warned in 2005 that it was taking too much risk, three years before mortgage losses in the unit led to a near collapse of the bank and a $45 billion U.S. bailout.

The warning from the Office of the Comptroller of the Currency came in a December 2005 letter to Geoff Coley, then co-head of New York-based Citigroup’s fixed-income trading. A copy was released by the Financial Crisis Inquiry Commission, which explained in its final report yesterday how Citigroup’s former trading chief Thomas Maheras collected $34 million in salary and bonus in 2006 as his division took increasing risks.

“The findings of this examination are disappointing, in that the business grew far in excess of management’s underlying infrastructure and control processes,” bank examiner Ronald Frake wrote in the letter. “Transaction risk is high. Management oversight is considered less than satisfactory.”

The panel was the second watchdog this month to show how the government questioned whether Citigroup can be left alone to manage its risks. Neil Barofsky, inspector general of the Treasury Department’s bank-bailout program, disclosed in a Jan. 13 report that Citigroup’s primary banking unit, Citibank, is under a memorandum of understanding with the OCC requiring risk-management upgrades. A repeat failure of Citigroup could again imperil the global financial system, Barofsky wrote.

The OCC now believes a “key turning point” for Citigroup came in 2006 when regulators lifted sanctions imposed on the bank earlier in the decade, according to the FCIC. The freedom allowed the company, then led by Chief Executive Officer Charles O. “Chuck” Prince, to embark on an “aggressive” expansion, according to the FCIC.

Surge in Assets

In two and a half years, the bank’s balance sheet ballooned by 58 percent to $2.36 trillion as of Sept. 30, 2007, just before Prince was fired.

“With the removal of formal and informal agreements, the previous focus on risk and compliance gave way to business expansion and profits,” OCC Examiner John Lyons wrote in a Feb. 14, 2008, letter to Vikram Pandit, who took over as Citigroup’s CEO in December 2007. The letter, labeled “confidential and non-public,” was posted on the FCIC’s website. “The board and senior management have not ensured an effective and independent risk-management process is in place,” it said.

Mike Mayo, an analyst at Credit Agricole Securities USA Inc., said the OCC letter may indicate bank supervisors will be less willing to release Citigroup from the restrictions now in place. Mayo accused Citigroup’s current management in a report last October of setting aggressive financial targets, and listed what he considers 20 “significant” risk-management breakdowns since 1998.

Handcuffs Off

“When the regulatory handcuffs were taken off, then Citi had a whole new set of problems, so perhaps now the handcuffs will stay on longer,” Mayo, who rates the shares “underperform,” said in an interview.

Citigroup spokeswoman Molly Meiners said Pandit has overhauled risk management and runs a “fundamentally different company today than it was before the crisis.” In an interview yesterday with Bloomberg Television at the World Economic Forum in Davos, Switzerland, Pandit said, “As we move forward, it is now about responsible and sustainable growth.”

The bank, which got a $45 billion taxpayer rescue in November 2008 when it nearly collapsed, last year repaid the last of its bailout obligation with a profit of more than $12 billion to the Treasury Department.

Citigroup’s Growth

In the December 2005 letter to Coley, the OCC’s Frake said risk management in Citigroup’s credit-derivatives business was “disappointing, in that the business grew far in excess of management’s underlying infrastructure and control processes.” The letter was copied to then-Chief Risk Officer David Bushnell, Chief Administrative Officer Lewis Kaden, Chief Financial Officer Sallie Krawcheck, General Counsel Michael Helfer, securities-division head Robert Druskin and Maheras. Coley, Bushnell, Krawcheck and Druskin have since left the company.

Much of Citigroup’s almost $30 billion in net losses in 2008 and 2009 stemmed from collateralized debt obligations, or CDOs, a type of bonds. Many of them were packaged from credit derivatives -- financial contracts linked to mortgage bonds and other debt instruments.

The FCIC cited an internal May 2005 Federal Reserve document faulting the Federal Reserve Bank of New York for staffing its Citigroup team at a level that “has not kept pace with the magnitude of supervisory issues that the institution has realized.”

Risk Management

According to documents labeled confidential and released by the FCIC, Citigroup overhauled its risk management in 2006 after being faulted the prior year for lapses. The Federal Reserve, which in early 2005 had cut its rating on Citigroup’s risk management to “fair” from “satisfactory,” raised it back to “satisfactory” in early 2006, according to an internal central bank memorandum released by the FCIC.

In a hand-delivered letter to then-Citigroup Chairman Sanford “Sandy” Weill in April of that year, New York Fed Assistant Vice President Dianne Dobbeck acknowledged “improvements in the compliance structure and its effectiveness as a result of substantial management effort expended.” The same month, New York Fed Executive Vice President William Rutledge informed Prince in a letter that a March 2005 ban on “significant expansion” at the bank had been lifted.

Rutledge has since retired from the Fed. Dobbeck was promoted to senior vice president in January 2009, according to a Fed statement.

Citigroup’s CDO desk created $22 billion in CDOs in 2006, double the amount in 2005, according to the FCIC report. Coley’s co-head of fixed-income trading, Randolph Barker, got $21 million in compensation that year, according to the FCIC’s report. Coley’s compensation wasn’t disclosed.

Prince’s Compensation

Prince, who told the FCIC that he spent “more than half his time” dealing with “various types of trouble” with regulators, got $79 million of compensation from 2004 through 2007, according to the report. Maheras, who as trading chief oversaw the fixed-income desk, spent “less than 1 percent of his time thinking about CDOs,” he told the FCIC.

“In this case, too-big-to-fail meant too-big-to-manage,” the FCIC’s Democratic majority, led by Phil Angelides, concluded in its report.

Prince fired Barker in October 2007, and Maheras left at the same time. Coley left Citigroup in January 2008, according to securities-industry records, and now works at Chapdelaine & Co. alongside Barker. Coley didn’t respond to calls for comment, and Maheras didn’t return a call to his hedge fund, Tegean Capital Management LLC.

Citigroup had a policy allowing the bank to “claw back” compensation from executives “under narrowly specified circumstances,” according to the FCIC report. “Despite Citigroup’s eventual large losses, no compensation was ever clawed back under this policy.”

Oversight ‘Deficiencies’

On April 15, 2008, New York Fed Assistant Vice President John Ruocco informed Pandit in a hand-delivered letter that Citigroup’s risk-management rating was again being cut to “fair.” The change was due in part to “serious deficiencies” in the prior management’s oversight and controls.

“Senior management at the firm allowed its drive for additional revenue growth to eclipse proper management of risk,” the New York Fed wrote in an accompanying report.

An internal Federal Reserve review in 2009 again found “substantial weaknesses in the New York Fed’s oversight of Citigroup,” according to the FCIC report.

“The New York Fed continuously seeks to refine its supervisory process and is incorporating the lessons of the crisis,” spokesman Jack Gutt said.

Roger T. Cole, former head of bank supervision at the Federal Reserve, told the FCIC that supervisors “did discuss issues such as whether banks were growing too fast and taking too much risk, but ran into pushback.”

“Citigroup was earning $4 to $5 billion a quarter, and that is really hard for a supervisor to successfully challenge,” Cole said.

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