CITIGROUP INC quarterly report, Q2 FY2010

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Citigroup Inc. — Second-Quarter 2010 Form 10-Q

Business context and period. Citigroup is a global financial-services holding company operating through Citicorp, Citi Holdings and Corporate/Other. This unaudited report covers the quarter and six months ended June 30, 2010. Comparisons require care: effective January 1, 2010, adoption of SFAS 166/167 brought certain securitization entities, including credit-card trusts, onto the balance sheet. For comparability, some prior-period credit-card measures are presented on a managed basis.

Financial performance and position

  • Quarter earnings: Net income was $2.7 billion, or $0.09 per diluted share, versus $4.3 billion and $0.49 per diluted share a year earlier. Continuing-operations income was $2.7 billion, down 38%.
  • Revenue and expenses: Net revenue was $22.1 billion, down 26% from reported second-quarter 2009 revenue; managed revenue was down 33% to $22.1 billion. The prior-year comparison included the $11.1 billion pretax ($6.7 billion after-tax) Smith Barney sale gain. Operating expenses were $11.9 billion, down 1%.
  • Credit costs: Net credit losses were $8.0 billion, down 31% year over year on a comparable managed basis and 5% sequentially. The provision for credit losses and benefits/claims was $6.7 billion, down 47%. Citi recorded a $1.5 billion net release to credit reserves and unfunded commitments.
  • Interest and margin: Net interest revenue was $14.0 billion, up 9% year over year. Net interest margin was 3.15%, down 9 basis points from a year earlier and 17 basis points from the first quarter; management cited portfolio de-risking, loss mitigation and the Primerica divestiture.
  • Segments: Citicorp earned $3.8 billion, up 17% year over year; Citi Holdings lost $1.2 billion, compared with $1.2 billion of income in the prior-year quarter. Regional Consumer Banking revenue was $8.0 billion and Transaction Services revenue was $2.5 billion. Securities and Banking revenue was $6.0 billion, down 11%; Citi Holdings revenue was $4.9 billion, down 68%.
  • Six-month results: Net income was $7.1 billion, up 21%; revenue was $47.5 billion, down 13%. Provision expense was $15.3 billion, down 34%, and operating expenses were $23.4 billion, down 1%.
  • Cash flow: For the six months, operating activities provided $41.6 billion (versus $20.4 billion used in 2009), investing activities provided $40.3 billion (versus $16.5 billion), and financing activities used $82.6 billion (versus $1.0 billion provided). Cash and due from banks ended at $24.7 billion. These bank cash-flow totals include substantial balance-sheet and funding movements.
  • Balance sheet and funding: Assets were $1.938 trillion, deposits $814.0 billion and long-term debt $413.3 billion at June 30. Short-term borrowings were $92.8 billion. Deposits were down 2% sequentially and up 1% year over year; long-term debt was up 19% year over year.
  • Capital and liquidity: Tier 1 capital ratio was 11.99%, up from 11.28% at March 31; Tier 1 Common was 9.71%, total capital 15.59% and leverage 6.31%. The company reported $310.9 billion in aggregate liquidity resources and structural liquidity of 71% of assets. Stockholders’ equity was $154.8 billion.
  • Credit quality: The allowance for loan losses was $46.2 billion, or 6.72% of loans, versus 6.80% at March 31. Consumer 90-plus-day delinquency was 3.67%, versus 4.01% at March 31; consumer non-accrual loans were $13.8 billion. Corporate non-accrual loans were $11.0 billion, down from $12.9 billion at March 31.

Material changes and unusual items

  • The Smith Barney divestiture gain in 2009 was the principal reason for lower year-over-year reported revenue and earnings; Brokerage and Asset Management reported a $95 million net loss in the quarter.
  • SFAS 166/167 adoption consolidated securitized receivables and related funding. At adoption, it added approximately $137 billion of assets and $146 billion of liabilities and reduced retained earnings by $8.4 billion; the reported balance-sheet and credit-card comparisons are therefore not directly like-for-like.
  • Citigroup added $347 million to its mortgage repurchase reserve in the quarter; the reserve ended at $727 million. Unresolved repurchase claims rose to 4,478 from 3,088 at year-end 2009. Management said no meaningful reasonably possible loss range could be determined.
  • Citi Holdings assets fell to $465 billion, about 24% of total assets, following sales, run-off and paydowns. Citi reported that its ABCP CDO super-senior exposure had been reduced to zero and all 17 Citi-structured ABCP CDO deals had been liquidated.
  • The Special Asset Pool reported $572 million of revenue, including approximately $1.0 billion of positive marks on subprime-related direct exposures, partly offset by commercial real estate and Alt-A mortgage write-downs. Management cautioned that future marks would be episodic.
  • Primerica was deconsolidated following its IPO and related transactions. The quarter also included approximately $400 million of U.K. bonus tax expense.

Outlook, risks and contingencies

  • Management expected quarterly expenses of $11.5–$12.0 billion for the remainder of 2010. It expected Citicorp investment spending to continue and Citi Holdings expenses to decline as assets run off.
  • Management expected consumer credit costs to continue declining if economic recovery continued, but noted that card losses would likely remain elevated until U.S. employment improved significantly. Mortgage credit quality remained particularly exposed to unemployment, home prices, modification programs and foreclosure regulations; corporate credit costs were expected to be episodic.
  • Management estimated the 2010 CARD Act net revenue impact at $400–$600 million for Citi-branded cards and revised the Retail Partner Cards estimate to $150–$200 million. Most of the impact was expected in the second half of 2010. Capital-markets conditions were expected to continue driving Securities and Banking revenue.
  • Citigroup expected to issue $18–$21 billion of long-term debt in 2010, excluding local-country debt, while refinancing only part of 2010 maturities and not currently expecting to refinance maturing TLGP debt. Ratings downgrades could increase collateral and funding needs; the filing estimates a one-notch Citigroup downgrade scenario could trigger loss of specified funding and about $1.0 billion of derivative-related requirements.
  • The Dodd-Frank Act was signed July 21, 2010. Management cited uncertainty about implementing rules, future capital and liquidity requirements, business restrictions and added costs. Basel capital and liquidity standards also remained subject to development.
  • Legal matters include credit-crisis-related litigation and regulatory inquiries. On July 29, 2010, the SEC announced a proposed settlement of a subprime-disclosure investigation for a $75 million civil penalty, subject to court approval. The filing states that management could not estimate possible losses for certain significant proceedings; adverse outcomes could affect results or cash flows in particular periods.
  • Management concluded disclosure controls were effective as of June 30, 2010 and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Reconcile reported and managed revenue, credit losses and loan balances for the effects of SFAS 166/167, and separate the 2009 Smith Barney sale gain from recurring performance.
  • Track whether credit-loss declines persist, especially in U.S. cards and mortgages, and assess the adequacy of the $46.2 billion loan-loss allowance against delinquency, non-accrual and modification trends.
  • Monitor mortgage repurchase claims, reserve assumptions and potential additional reserve requirements; the filing does not provide a clear reasonably possible loss range.
  • Assess the sustainability of Citi Holdings asset reductions and Special Asset Pool marks, including whether dispositions occur without material losses.
  • Verify capital and liquidity resilience against debt maturities, ratings changes, government-support assumptions and evolving Dodd-Frank/Basel requirements.
  • Review the full legal-proceedings disclosures and the status and financial effect of the SEC settlement, other litigation and regulatory inquiries.