Citigroup's Great Strength -- and Weakness

The banking giant thrives on a worldwide presence, but that also means global risk -- everything from Enron to Argentina

By Heather Timmons

Citigroup marked a milestone in 2001: It surpassed Deutsche Bank to become the world's largest financial-services company as measured by assets. But Citigroup's virtual omnipresence -- more than 190 million corporate and consumer accounts in 100 countries, covering vastly different business lines -- is a two-edged sword. Citigroup's (C ) scope ensures that it will be touched by nearly any financial crisis in any industry around the world. But its diversity means that any one crisis should have a limited impact on earnings.

Admits Citigroup Chief Financial Officer Todd Thomson: "There are few things that don't affect Citigroup in some way." But he adds: "They don't affect the company enough to stop ongoing earnings growth." The bank's stock made a spectacular 35% recovery in late 2001, after closing at a 52-week low of $36.36 a share on Sept. 21 due to losses from the World Trade Center terrorist attacks.

Still, difficult times may be ahead for the financial-services giant. Citigroup is one of the biggest lenders to Enron, which in recent weeks became the largest bankruptcy in U.S. financial history. And Citi is also one of the most active American banks in nearly bankrupt Argentina.


  The risk with Citigroup is that all these little hits to earnings will pile up. Already, the company warned on Sept. 21 that it would take a $700 million charge to third-quarter earnings, mainly because of insurance losses from the World Trade Center attacks. Citi reported $3.18 billion in net income for the quarter, a 9% drop from the year before. This quarter, the company could be facing losses from loans, insurance, and trading businesses with Enron, exposure in Argentina, and industrywide increases in late payments from its corporate and consumer borrowers.

Some analysts are forecasting trouble, at least in the short term. Prudential Securities analyst Mike Mayo downgraded Citigroup from buy to hold on Nov. 16, saying the share price -- around $50 at the time -- did not provide a "sufficient margin of safety for potential unforeseen risks." Later that week, Piper Jaffray analyst Andrew Collins cut estimates for Citigroup's fourth-quarter earnings by 5 cents a share, citing exposure to Enron.

Other analysts -- as well as the company -- disagree. On Nov. 28, UBS Warburg analyst Diane Glossman reiterated her strong buy, saying fears were overblown. On Nov. 30, Moody's Investors Services reaffirmed Citigroup's investment-grade rating, saying exposure to Enron will be "manageable." And Citi has not issued a warning about its 2001 earnings, which are estimated at $2.83 per share.


  As one of Enron's largest lenders, Citigroup has an estimated $800 million to $1 billion in exposure to the energy giant's flame-out. But Citi's actual losses will be far lower, because all but $300 million of these loans are said to be backed by assets and because the company hedged the loans with financial instruments known as credit derivatives. Citigroup, along with J.P. Morgan Chase, extended an additional $1.5 billion to Enron on Nov. 30, as a "debtor in possession" loan, which generally carries high fees and puts both lenders first when the company starts to repay its debts.

At the same time, Citi and UBS have let it be known that they may try to buy Enron's online-trading operation -- an investment that probably won't top $100 million for a company with earnings of $4 billion in just one quarter. Some analysts believe Citigroup will simply absorb the bankruptcy without even a blip. "Will Enron really disrupt their earnings outlook? No," says Henry "Chip" Dixon, a Lehman Brothers bank analyst, who has Citigroup rated a strong buy.

This quarter, though, Citigroup may also have to face losses in Argentina, where Citibank has been active since 1918. The country is nearly bankrupt and has frozen assets at most of its big banks to halt a run on deposits. Though Argentina is an integral part of Citigroup's Latin American strategy, it contributed just 2% of the company's overall earnings at the end of the second quarter.


  In an absolute worst-case scenario -- one where the peso is devalued and the country's government debt defaults -- some analysts estimate Citigroup would lose just $200 million. "The fact that emerging markets are volatile is not a new idea for us," says CFO Thomson. In fact, Citigroup could ultimately gain business, he says: "In volatile times, customers often leave their local banks and come to Citigroup."

Less high profile, but perhaps more destructive to earnings, could be Citigroup's massive consumer-loan portfolio. On its balance sheet, consumer loans grew 9%, to $245.1 billion in the 12 months ended Sept. 30. Still, allowances for credit losses from these loans slipped from 2.30% of the portfolio to 2.16% during the same time.

Some of these loans are more risky than others. Citigroup's consumer-finance unit, which accounted for nearly one-tenth of third-quarter income, or $308 million, lends money to consumers who don't qualify for bank loans and are known as subprime borrowers. These customers often are the hardest hit in a recession. In the third quarter, 3.2% of these loans were 90 days or more late, up from 2% a year ago.


  Other subprime players have already hit the wall. Last month, Providian, a subprime credit-card issuer, restated fourth-quarter and 2002 earnings because bad loans have piled up. Federal regulators have since barred Providian from the subprime business.

Income at the Citigroup finance unit got a boost this year from its purchase of Associates Financial. During the third quarter, income for the subsidiary was up 45%, in part because of expense reduction from the merger. But the easy part is done -- nearly two-thirds of the cost savings already have been realized. Citigroup will need to reach further to reduce expenses -- at the same time that the bank tries to keep problem loans down.

Even Citigroup's biggest admirers admit some problems could be ahead. But they say the bank is well equipped to handle them. "They have greater capacity to deal with this environment than just about anyone," says Lehman's Dixon. "Yes, it's a challenge, but they can get through this."


  The easiest thing for investors to do may be to write off 2001 as a wash and sit tight until the economy improves. The bank's stock closed on Dec. 10 at $47.92 a share, somewhat below the opening price of $51.75 on Jan. 2, and a poor contrast with the 8% year-over-year increase for the Standard & Poor's banking-sector index.

True, things were much worse for some other financial-services firms. Both insurer AIG and investment bank Merrill Lynch watched their stock drop 20% in 2001. But Citigroup faces a series of risks in the near term, and its outlook is unlikely to get much better until the global economy improves. So investors may be better off on the sidelines until well into 2002.

Timmons covers the banking industry for BusinessWeek in New York

Edited by Beth Belton

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