Citigroup Inc. (C)
Q2 2008 Earnings Call Transcript
July 18, 2008 8:30 am ET

Executives
Scott Freidenrich -- Citigroup Inc. - Director, IR
Gary Crittenden -- Citigroup Inc. - CFO

Analysts
Glenn Schorr -- UBS - Analyst
Guy Moszkowski -- Merrill Lynch - Analyst
Meredith Whitney -- Oppenheimer - Analyst
Mike Mayo -- Deutsche Bank - Analyst
Richard Bove -- Ladenburg Thalmann - Analyst
James Mitchell -- Buckingham Research - Analyst
William Tanona -- Goldman Sachs - Analyst
Jeff Harte -- Sandler O''Neill - Analyst

Presentation

Operator

Good morning, ladies and gentlemen and welcome to Citi''s second-quarter 2008 earnings review featuring Citi Chief Financial Officer, Gary Crittenden. Today''s call will be hosted by Scott Freidenrich, Director of Investor Relations. We ask that you hold all questions until the completion of the formal remarks, at which time you will be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. Mr. Freidenrich, you may begin.

Scott Freidenrich - Citigroup Inc. - Director, IR

Thank you, operator. Good morning. Thank you all for joining us. Welcome to our second-quarter 2008 earnings review. The presentation we will be going through is available on our website at citigroup.com. You may want to download the presentation if you have not already done so. The financial supplement is also available on the website. Our Chief Financial Officer, Gary Crittenden, will take you through the presentation. We will then be happy to take any questions you may have.

Before we get started, I would like to remind you that today''s presentation may contain forward-looking statements. Citi''s financial results may differ materially from these statements so please refer to our SEC filings for a description of the factors that would cause our actual results to differ from expectations. With that said, let me turn it over to Gary.

Gary Crittenden - Citigroup Inc. – CFO

Good morning to everyone. Thanks very much for joining with us. Please turn to the slides that are now available to you on your website. Slide 1 shows our consolidated results for the quarter. Similar to the first quarter, this quarter''s results were driven by two main factors, write-down and losses related to a continued disruption in fixed income markets and higher North American consumer credit costs.

To summarize our second-quarter results, net revenues declined 29%, driven by the continued disruption in the fixed income markets, partially offset by underlying growth in several of our other businesses. Sequentially, net revenues were better by $5.6 billion. Expenses were up 9% year-over-year. Excluding the impact of acquisitions and divestitures and the press-release disclosed items from both quarters, expense growth was flat versus last year. Sequentially, expenses were actually down a $128 million. We continue to make good progress on the reengineering plan as we are very focused on managing expense levels at the company. Credit cost was up by $4.5 billion over last year, primarily due to higher net credit losses of $2.4 billion and a $2 billion charge to increased loan-loss reserves, both mainly in our North American consumer business. These factors drove a loss of $2.5 billion for the quarter or a loss per share of $0.54. The EPS is based on a basic share count of 5.3 billion. Sequentially, we reduced our losses by $2.6 billion. On a continuing operations basis, we had a net loss of $2.2 billion or a loss per share of $0.49. One important note on the payment schedule of our preferred dividends, the $6 billion of Series E preferred shares that we issued this quarter has a semiannual dividend declaration scheduled for the first 10 years. If dividends are declared on this series as scheduled, the impact from preferred dividends on earnings per share in the first and the third quarters will be lower than the impact in the second and the fourth quarters. All other series have a quarterly dividend declaration scheduled.

Slide 2 highlights the key positive trends of the quarter and I am going to go into each one of these in more detail in the presentation. First, sequential revenues have grown with and without the mark-to-market losses in our securities and banking business. Second, the key drivers of each of our businesses continue to grow at levels consistent with the record second quarter of 2007. Third, net interest margin expanded very nicely this quarter, in part due to lower funding costs, and also driven by substantial progress on reducing lower yielding assets. Fourth, expenses and headcount were down sequentially. Fifth, our capital position was strong and as I mentioned, we made very good progress in reducing our assets, in particular our legacy positions, including divestitures. Finally, we announced a number of new hires to strengthen our leadership team. To name a few, these include Sanjiv Das, the head of our Mortgage business; Terri Dial who joined us this quarter as the CEO of the Consumer Banking North America and Global Head of Consumer Strategy; Richard Evans, our new Chief Risk Officer for ICG; Kate James, head of our global Corporate Communications team; Marty Lippert, our Chief Information Officer and Chief Operating Officer for corporate O&T; and Mark Rufeh, the CAO and head of productivity for the ICG team.

Slide 3 shows our reported revenues in blue bars. For the last four quarters, the area within the dotted lines is indicative of the marks that we have taken in the securities and banking business. Adjusted for these marks, our revenues have continued to grow sequentially since year-end 2007. In fact, this quarter, our revenues are about the same as they were in the record second quarter of 2007. In fact, adjusted for the marks, the first half of 2008 is only 1% lower than the record first half of 2007. Many of our businesses, including cards in Asia, EMEA, Latin America and Transaction Services among others recorded double-digit revenue growth.

Turning to slide 4, this shows a five-quarter trend in some of the key drivers of our business. One key note on this slide, many of the drivers are showing a sharp drop-off in the growth rate as acquisitions that we made last year have [lapped] in this quarter. In EMEA for example, the Egg acquisition contributed between 21% and 29% to loan growth, between 22% and 34% to deposit growth and between 6% and 10% of international cards purchased sales growth in the last four quarters. Similarly, in Latin America, Grupo Uno and Cuscatlan contributed between 11% to 15% to loan growth, between 9% to 12% to deposit growth, and between 1% to 3% to international cards purchased sales growth in the last four quarters. So in order to get an apples-to-apples comparison, you would have to adjust the historical numbers to reflect the impact of the growth rates of those acquisitions. In Transaction Services, third-party liabilities have declined sequentially, have declined slightly sequentially to levels consistent with the fourth quarter of 2007, following a substantial buildup of cash given market disruptions and a flight to quality. Year-on-year operating account balances grew 24% while timed deposits were down 6%. This underscores continuing strength in our underlying business activities.

We have seen a slowdown in our North American card purchase sales as we have tightened underwriting standards and where discretionary spending is declining and spending on essentials, such as gas and food, is increasing due to higher prices. Finally, growth in investment sales and assets under management were affected by a slowdown in capital markets activity in many regions, particularly in Asia. Before I move on, let me give you a few examples of key successes in the quarter that are not included in the numbers that I mentioned above. For example, we advised Time Warner on its separation from Time Warner Cable in a $45 billion transaction, the second-largest separation in the media space. We had a lead role in a 20 billion rupee bond for Tata Steel, the first private Indian company to issue unsecured domestic debt in meaningful size and recorded India''s largest ever pure corporate bond issue and a number of very other compelling wins. In Transaction Services, we have had significant wins in the first six months of this year, totaling over $1 billion, and in the cards business, we renewed our coveted partnership with American Airlines.

Slide 5 shows the nine-quarter sequential trend in net interest margin for the company. Net interest margin for the quarter is at 3.18%, up 34 basis points sequentially and 77 basis points over the prior period. The primary driver of this improvement is from significantly lower funding costs driven by deposits in Fed funds, which is reflecting the benefit of the Fed''s rate cuts. The full impact of the January and March cuts and the two-month benefits from the April rate cuts are manifesting themselves in the current quarter''s net interest margin. In a sequential quarter comparison, total assets were down by $99 billion this quarter with approximately two-thirds driven by a reduction of legacy assets. Consumer and corporate loans and trading assets were all down significantly. Obviously the extent to which we benefited this quarter was highly dependent on the rate cuts in the first and early part of the second quarters. Our ability to continue reducing low-yielding assets will depend on the liquidity that we have in the markets.

Slide 6 shows the trend in our expense growth. Expenses for the quarter grew 9% versus last year. The key components are four percentage points from acquisitions and divestitures, three percentage points from $446 million in repositioning charges related to a number of activities such as headcount reductions and branch closings, including an expected reduction in force of 2900 people in addition to the expected reductions of 13,200 that we have announced over the last two quarters. We will continue this process as we make progress in our productivity and reengineering program. Third, two percentage points were accounted for by $300 million of a litigation reserve release that took place in last year''s second quarter. That results in business-as-usual expenses being flat in a year-over-year comparison. Foreign-exchange contributed three percentage points to our expense growth as reflected across the categories that I just mentioned. Sequentially in spite of the higher activity levels in most of our businesses that I described earlier, expenses declined for the second quarter in a row and we were down 1%, evidence that our reengineering efforts are taking hold. A word on our efficiency ratio, on Citi Day, we showed you that our first-quarter efficiency ratio adjusted for the disclosed security and banking marks and press-release disclosed items was 62% and that our target, two or three years out, is 58%. After making the same adjustments in the quarter, the efficiency ratio has stayed at 62%. However, further adjusting the impact of the net loss from the mark-to-market on the mortgage servicing right and related hedge, which I will discuss later in the conversation this morning, our efficiency ratio would have been at 60%.

Slide number 7 shows the trend in our headcount growth. The graph indicates that we have significantly slowed the year-over-year headcount growth from the 12% to 16% range last year to 1%. This 1% growth was primarily driven by acquisitions net of divestitures. This quarter''s repositioning charges relate to nearly 3000 headcount reductions. In the last three quarters, we have recorded cumulative disposition charges of approximately $1.6 billion relating to approximately 16,000 heads. Of that 16,000, almost 7000 have already been reduced from our headcount with the remainder expected to be realized over the next 12 months. Since the end of the quarter, headcount has come down by another 2500 due to the closing of the Citi Street divestiture. Year-to-date, that brings our net headcount reduction to 14,000. Once the Citi Capital and German retail banking transactions close, headcount will be reduced by approximately an additional 7000.

Slide number 8 shows a historical trend of our asset balances on the left and a number of our key capital ratios on the right. As the left-hand graph shows, we added over $470 billion in assets from year-end 2006 to the third quarter of 2007. Since then, we have reduced assets by over $250 billion in the last three quarters. As the graph on the right shows, all of our capital ratios declined during 2007, driven primarily by acquisitions, organic asset growth and the negative earnings impact of the fourth quarter. This quarter, due to additional capital raising and the diligent management of our balance sheet, our Tier 1 capital ratio was 8.7%, well in excess of our internal target. The TCE ratio was 6.9%, also in excess of our internally stated target of 6.5%.