Citigroup: Serious Subprime Risk, Serious About Shoring Up Capital

With more than 300,000 employees serving 200 million accounts in over 100 countries, Citigroup (C) is a financial services supermarket. But the collapse of the subprime mortgage market erased about $125 billion from the company’s market capitalization.

The company operates five segments. The Global Consumer Group [GCG] produced 69.75% of 2007 net revenues. It provides credit cards,consumer loans (e.g., mortgages, student loans, and auto loans), small and middle-market business financing, and retail banking services.

The Markets & Banking [M&B] segment, which accounted for 12.88% of 2007 revenues, offers investment banking and advisory services, debt and equity trading,and institutional brokerage services. M&B revenues plunged 61% from 2006 due to writedowns.

Global Wealth Management [GWM] generated 15.9% of 2007 revenues. It includes the Smith Barney brokerage firm. It also provides equity and fixed-income research and private banking services to high net worth clients.

Alternative Investments,which produced 2.57% of revenues,includes private equity, hedge funds, real estate, structured products, and managed futures.

Finally, the Corporate/Other segment, which includes unallocated corporate expenses and discontinued operations, trimmed 1.1% from the top line.

Many financial institutions got burned by the subprime mortgage meltdown. Banks holding mortgage-backed securities [MBS] and collateralized debt obligations [CDO] were particularly hard hit. C suffered massive writedowns. On Oct.15,the company said it was writing down $3.8 billion and increasing loan loss reserves by $2.2 billion because of rising delinquencies in consumer loans. Its Tier 1 capital ratio—a key solvency measure monitored by regulators—fell to 7.3%.

C disappointed investors again just a few weeks later when it said it would writedown an additional $8-11 billion in Q4. CEO Charles Prince was soon replaced by Vikram Pandit and foreign investors began pouring money into the company on favorable terms With Pandit at the helm, C revealed a subprime-related writedown of $18.1 billion in Q4 and increased the loan loss reserve by an additional $3.85 billion. On a firm wide basis, net revenues fell 70% to $7.22 billion, overshadowing a 45% gain in international consumer revenues and a 27% jump in GWM revenues. Credit costs ballooned 231% to $7.76 billion. C also took a $539 million charge for a 4,200 headcount reduction. Operating expenses increased 18% to $16.5 billion. Q4 saw a net loss of $9.83 billion or $1.99 per share,which compared to net gain of $5.13 billion or $1.03 per share in the prior year quarter. C’s Tier 1 capital ratio fell to 7.1%.

C still holds $37.3 billion in assets with direct exposure to subprime mortgages and the consumer lending business is likely to deteriorate further. However, the company is serious about shoring up capital. It slashed the cash dividend by more than 40% and raised an additional $18.65 billion through private and public placements of convertible and straight preferred stock. It is also selling non-core assets. These actions will dilute earnings per share,but they also improve the balance sheet and give the company the flexibility it needs to navigate through this difficult period. Management believes the Tier 1 capital ratio has already improved to 8.8%,well above its 7.5% long term target.

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