Citigroup Inc. — Third Quarter 2009 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 nine months ended September 30, 2009; comparisons below are generally with the prior-year period unless noted.
Key financial results
| Metric | Third quarter 2009 | Comparison / context |
|---|---|---|
| Revenue, net of interest expense | $20.4 billion | Up 25% year over year |
| Net interest revenue | $12.0 billion | Down 10% year over year |
| Non-interest revenue | $8.4 billion | Up from $2.9 billion |
| Operating expenses | $11.8 billion | Down 16% |
| Credit-loss and benefits provisions | $9.1 billion | Approximately unchanged year over year |
| Continuing-operations income | $593 million | Compared with a $3.5 billion loss |
| Citigroup net income | $101 million | Compared with a $2.8 billion loss |
| Diluted EPS | $(0.27) | Includes preferred-exchange-related charges affecting common earnings |
| Net interest margin | 2.95% | Down 20 basis points year over year and 29 basis points sequentially |
For the first nine months, revenue was $74.9 billion, continuing-operations income was $6.7 billion and net income was $6.0 billion, compared with a $11.0 billion continuing-operations loss and a $10.4 billion net loss in the first nine months of 2008. Nine-month results included significant gains and valuation changes; they should not be read as a measure of recurring earnings.
Cash flow, balance sheet and capital
- Nine-month cash flow from continuing operations was negative $13.8 billion; investing activities provided $4.7 billion and financing activities provided $5.5 billion. Cash and due from banks was $26.5 billion at September 30, down from $29.3 billion at year-end 2008.
- Total assets were $1.889 trillion, down 8% from September 30, 2008 and from $1.938 trillion at December 31, 2008. Total deposits were $832.6 billion, up from $774.2 billion at year-end. Long-term debt was $379.6 billion, compared with $359.6 billion at year-end.
- Total loans, net of unearned income, were $622.2 billion. The allowance for loan losses was $36.4 billion, or 5.85% of loans, versus 5.60% at June 30. The quarter included a net reserve build of $802 million.
- Non-accrual loans increased to $32.7 billion from $28.2 billion at June 30, 2009; consumer non-accrual loans were $17.9 billion and corporate non-accrual loans $14.8 billion. Consumer delinquency was 4.70%, up from 4.24% in the prior quarter and 2.66% a year earlier. Over two-thirds of corporate non-accrual loans were current on contractual payments.
- Regulatory ratios at September 30 were 9.12% Tier 1 Common, 12.76% Tier 1 Capital, 16.58% Total Capital and 6.87% leverage. The company reported that it met the regulatory definition of “well capitalized.” Tangible common equity was $102.3 billion and its ratio to risk-weighted assets was 10.3%; these are non-GAAP measures.
Material changes and significant events
- Preferred-security exchange offers: Approximately $58 billion of liquidation value of preferred stock and trust preferred securities was exchanged for common stock; other government-held preferred stock was exchanged for 8% trust preferred securities. Citigroup issued approximately 17.4 billion common shares through the transactions, and the U.S. Treasury held approximately 33.6% of outstanding common stock after the exchanges. The transactions substantially increased common equity and Tier 1 Common capital, but reduced income available to common shareholders, including a $3.055 billion third-quarter retained-earnings impact. A separate $1.4 billion gain from extinguishment of debt contributed to revenue.
- Revenue quality: Management attributed the year-over-year revenue increase chiefly to improved marks and gains in Citi Holdings versus the prior-year quarter and the debt-extinguishment gain. Securities and Banking recorded $1.7 billion of credit valuation adjustment losses, including losses associated with improved Citigroup credit spreads. Citi Holdings’ Special Asset Pool reported $1.5 billion of significant positive revenue items, including $2.0 billion of positive marks on subprime-related direct exposures, partly offset by commercial real estate and other losses. The quarter also lacked approximately $2.0 billion of Smith Barney revenue following the joint venture transaction.
- Segment performance: Citicorp earned $2.3 billion from continuing operations, down 36% year over year; its revenue fell 19%. Citi Holdings lost $1.8 billion, an improvement from a $6.9 billion loss, largely reflecting more favorable marks; Local Consumer Lending continued to report substantial losses. Transaction Services income was $939 million, up 2%, while Securities and Banking income fell to $755 million from $2.2 billion.
- Deleveraging and costs: Assets declined from $2.050 trillion a year earlier, with most of the reduction in Citi Holdings. Operating expenses fell amid divestitures, headcount reductions, re-engineering and expense control. Headcount was 276,000, down 76,000 year over year.
- Liquidity and government support: Management said structural liquidity—equity, long-term debt and deposits—as a share of assets rose to 72% from 66% at year-end 2008. At September 30, the liquidity portfolio and broker-dealer cash box totaled $76.0 billion; bank subsidiaries had $148.8 billion on deposit with major central banks and $59.4 billion of liquidity value in liquid securities. Management described the company as largely pre-funded for 2010. The FDIC Temporary Liquidity Guarantee Program ended October 31, 2009, and Citigroup elected not to use an extension; approximately $54.6 billion of long-term debt remained covered at September 30.
- U.S. government loss-sharing agreement: The covered asset pool was approximately $250.4 billion at September 30, down from $301 billion initially. Citigroup bears the first $39.5 billion of qualifying net losses; approximately $8.1 billion of GAAP losses had been recorded to date. The final pool composition and the government’s review of the first-loss position remained subject to final approval/review.
- Divestiture: The sale of Nikko Cordial Securities closed October 1, 2009 for total cash value of approximately $8.7 billion. It was reported as discontinued operations at September 30 and was expected to yield an immaterial after-tax gain after hedges.
Outlook, risks and contingencies
- The filing provides no specific consolidated earnings or revenue guidance. Management said recovery in North American consumer businesses would likely depend on credit improvement and identified ongoing customer engagement, deposit gathering and lending as priorities.
- Credit remains a central risk: consumer delinquencies and non-accruals rose, credit losses were elevated, and management cited unemployment, bankruptcies, mortgage-foreclosure delays and continued deterioration in some international portfolios. HAMP trial loans may be reported delinquent despite reduced trial payments; future mortgage losses depend in part on borrowers completing the program.
- The $38 billion net deferred tax asset depends on future taxable income and tax planning. About $17 billion was represented by tax-return carryforwards; Citigroup estimated approximately $85 billion of taxable income would be needed to realize its U.S. federal, state and local deferred tax assets. An ownership change under tax law could limit utilization; future transactions, including government share sales, could pose a risk.
- Adoption of new consolidation and securitization accounting standards, expected January 1, 2010, was estimated to cause an approximately $7.8 billion after-tax charge to retained earnings and a 132-basis-point reduction in Tier 1 and Total Capital ratios under the company’s then-current assumptions. The filing cautions that estimates could change; a proposed regulatory capital-rule change could further increase risk-weighted assets.
- Ratings downgrades could increase collateral and cash requirements. A one-notch downgrade of Citigroup Inc.’s long-term rating together with its short-term rating was estimated to trigger approximately $15.9 billion of funding requirements; a one-notch downgrade of Citibank, N.A.’s long-term rating was estimated at $4.4 billion.
- Other exposures include Level 3 and other illiquid assets, monoline insurers, commercial real estate, derivatives, securitization and off-balance-sheet commitments. Total potential future payments under disclosed guarantees were $281.2 billion; this contractual maximum is not an estimate of expected losses. The company also reported ongoing securities, auction-rate securities, structured-product and other litigation and regulatory investigations. Management did not expect the ordinary-course proceedings to materially adversely affect consolidated financial condition, but stated that monetary outcomes could be material to results in a particular period.
Most important facts for investors to verify
- How much of reported earnings and revenue reflects recurring business performance versus valuation marks, transaction gains, tax effects and discontinued operations.
- Whether consumer and corporate credit deterioration, rising non-accrual loans and the reserve balance are consistent with the eventual loss experience, especially in U.S. mortgages and cards.
- Whether the deferred tax asset can be realized and whether future ownership changes or tax-law developments could restrict its use.
- Citigroup’s access to funding after the FDIC guarantee program ended, including rating-triggered collateral needs and the maturity profile of guaranteed debt.
- The final government-covered asset pool and loss-sharing terms, and the actual capital and retained-earnings effects of the 2010 securitization-accounting changes.