Citigroup Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Unaudited results. Citi operates through Citicorp, its core consumer and institutional businesses, and Citi Holdings, portfolios it intends to exit over time.
Financial performance and position
| Metric | Q2 2012 | Prior comparable period |
|---|---|---|
| Revenue, net of interest expense | $18.642 billion | $20.622 billion; down 10% |
| Net interest revenue | $11.593 billion | $12.148 billion; down 5% |
| Net income | $2.946 billion | $3.341 billion; down 12% |
| Diluted EPS | $0.95 | $1.09 |
| Operating expenses | $12.134 billion | $12.936 billion; down 6% |
| Provisions for credit losses and benefits/claims | $2.806 billion | $3.387 billion; down 17% |
- Management reported adjusted net income of $3.1 billion and diluted EPS of $1.00, excluding CVA/DVA and the impacts of minority investments; adjusted EPS was $1.02 a year earlier. This is a non-GAAP comparison.
- Six-month revenue was $38.048 billion, down 6%; net income was $5.877 billion, down 7%; diluted EPS was $1.91 versus $2.08.
- Q2 net interest margin was 2.81%, down 1 basis point year over year and 9 basis points sequentially. Management expected it to remain fairly stable near Q2 levels, absent significant items.
- Q2 net credit losses were $3.576 billion, down 31% year over year. Citi recorded a $984 million net reserve release, versus $2.0 billion a year earlier.
- For the six months, operating cash flow was $4.133 billion, investing cash flow was negative $13.992 billion, and financing cash flow was positive $15.364 billion. Cash and due from banks ended at $33.927 billion, up from $28.701 billion at year-end 2011.
- At June 30, assets were $1.916 trillion; deposits were $914.3 billion; loans before allowance were $655.0 billion; and the allowance for loan losses was $27.6 billion, or 4.3% of loans. Total allowance including unfunded commitments was $28.7 billion.
- Long-term debt was $288.3 billion, down from $352.5 billion a year earlier. Short-term borrowings were $58.7 billion. Citi expected further long-term debt reductions during the rest of 2012.
- Regulatory capital ratios were 12.71% Tier 1 Common, 14.46% Tier 1 Capital and 17.70% Total Capital. Estimated Basel III Tier 1 Common was 7.9%. Aggregate liquidity resources were $412.2 billion; estimated Basel III liquidity coverage ratio was 117%.
Material changes and business trends
- Citicorp net income rose 6% to $4.3 billion, with revenue essentially flat at $18.0 billion; lower expenses and credit costs supported earnings. Citicorp loans grew 10% year over year to $527 billion.
- Citi Holdings reported a $920 million net loss, versus a $661 million loss, as revenue fell 62% to $924 million and reserve releases declined. Its assets fell 28% year over year to $191 billion, about 10% of Citi’s GAAP assets.
- Securities and Banking revenue fell 1%; weaker investment banking, equity and credit/securitized markets were partly offset by lending. Transaction Services revenue grew 5%, supported by deposits and trade activity.
- Consumer credit costs continued to improve, particularly in North America cards and Citi Holdings. However, mortgage portfolio performance remained exposed to delinquencies, re-defaults and slow foreclosures. North America cards balances and revenues faced consumer deleveraging and regulatory/margin pressures.
- Total deposits rose 6% year over year to $914.3 billion. Long-term debt fell as debt matured and was not fully refinanced; $17 billion of remaining TLGP debt was due to mature by year-end 2012.
Outlook, unusual items and risks
- Q2 results included a $424 million pretax loss on the partial sale of Citi’s Akbank stake; Q1 included a $1.181 billion impairment charge. Q2 also included $219 million of positive CVA/DVA. The prior-year quarter included a $199 million gain on a partial HDFC stake sale.
- On July 19, 2012, Citi disclosed a possible significant non-cash Q3 impairment of its 49% Morgan Stanley Smith Barney joint venture interest. Morgan Stanley’s valuation was about 40% of Citi’s valuation; an independent appraisal was required, with results expected by August 30 and the 14% stake sale scheduled to close by September 7.
- Q2 legal and related costs were $480 million and repositioning charges were $186 million. Citi said legal costs remained elevated and difficult to predict, and additional repositioning charges could occur.
- Mortgage repurchase reserves reached $1.476 billion after $242 million of Q2 additions. Citi estimated a simultaneous 10% adverse change in key whole-loan reserve assumptions could increase that reserve by about $500 million. Private-label claims remained volatile and difficult to predict.
- Citi added $76 million to UK payment-protection-insurance reserves and expected to begin customer outreach in August 2012; potential claims and refunds remained uncertain. Consent-order borrower outreach costs were expected to remain elevated during the rest of 2012.
- The national mortgage settlement requires $1.4 billion of delinquent-borrower relief and $378 million of refinancing concessions over three years. Citi said it expected to meet its commitments; missed targets could require additional cash payments. Estimated forgone interest from refinancing concessions was about $40 million annually.
- Management cited macroeconomic and European debt uncertainty, subdued client activity, regulatory changes and possible further credit-rating downgrades. Moody’s downgraded Citi in June 2012; Citi estimated a hypothetical one-notch downgrade across agencies could create $6.2 billion of aggregate cash and collateral requirements.
- Citi estimated reasonably possible litigation losses in excess of accruals at approximately $4 billion, materially unchanged from year-end 2011; actual outcomes could differ significantly. A July 2012 interchange-litigation settlement memorandum contemplated $6.05 billion paid by all defendants, subject to final documentation and court approval.
- Basel II.5 market-risk rules were expected to raise risk-weighted assets; Citi estimated its June Tier 1 Common ratio would have been about 11.32% under those rules, 139 basis points lower. Basel III rules and any systemic-capital surcharge remained subject to regulatory finalization.
Important facts for investors to verify
- Reconcile reported and adjusted earnings, including the Akbank loss, CVA/DVA, and the prior-year HDFC gain.
- Track the independent MSSB JV appraisal, the Q3 impairment outcome and proceeds from Morgan Stanley’s 14% purchase.
- Review credit-loss trends, reserve coverage and mortgage delinquency/foreclosure developments against Citi’s assumptions.
- Assess mortgage repurchase claims, the $1.476 billion reserve and the sensitivity estimate; monitor PPI and consent-order expenses.
- Confirm liquidity and capital after debt maturities, rating changes and implementation of Basel rules; distinguish estimated Basel III measures from current regulatory ratios.
- Follow litigation developments and the interchange settlement, including final terms, approvals and Citi’s ultimate allocated cost.