Citi's Bloat Prevents More Effective Risk Management

What to do with Citigroup (C), which has seen the value of its stock cut in half since the credit crunch began last summer?

This was exactly the question contemplated yesterday by Dealbook, the New York Times blog, which offered several valuable suggestions. In this post, however, I’ll address some of those suggestions and present my own.

Don’t Smash It Up

Dealbook suggested that because the "promised synergies never materialized" at Citi, and "there are lingering doubts about how exactly an investment bank, a retail bank, and an insurance company could ever cross-market effectively," Citi should be dismantled.

I disagree. Besides the fact that, as Dealbook suggests, Citi won’t get full value for its assets in today’s economy, this is not an issue of cross-marketing, but of profitability. The three vast arms of Citigroup don’t have to be cross-marketed (see JPM). They need to be profitable. And that brings us to operational efficiency.

"Finally, we recently announced the formulation of an end-to-end U.S. residential mortgage business that includes organizational servicing, it includes origination, servicing, and capital market securitization execution under one manager. This structure supports a comprehensive view of the mortgage business across the firm, will increase both the effectiveness and efficiency with which the business is managed, enhance risk management and allow us to better serve clients."
-Gary Crittenden, CFO, Citigroup, Jan. 15, 2008

Herein resides Citi’s true problem: operational madness. First, let’s take a step back and consider what Crittenden is talking about. Essentially, it was only earlier this year that Citi put the front end and back end of its mortgage operation under one management structure. This is a remarkable admission of previous operational inefficiency.

For a bank of Citi’s size not to synchronize its originations and servicing is akin to a doctor caring for his patient only before a surgery. The need for a holistic mortgage enterprise is not just mandated by a need to control risk, but simply to maximize marketing performance. Citi missed that in mortgage, and it no doubt misses that elsewhere in its vast banking operations.

There are no quick fixes here, but Citi should focus on the basics. It should make its operations great. It should make sure that each unit does not have such mindless operational idiocies. And it needs a Ford-like Way Forward program that reviews and improves each unit of the bank from a war room operating on a strict deadline. Simply doing this would improve Citi, improve its risk management, and improve its profitability.

Shore It Up -- By Focusing On Expenses

Dealbook made much of Citi’s decision not to cut its dividend, and instead opting to raise capital to shore up its balance sheet. It’s a valid arguement. But what Dealbook did not mention was Citi’s need to dramatically cut its expenses. A commentator to the Dealbook blog wrote:

With the next program to reduce costs we have only seen a glimpse of the future. Results are what counts. Citi despite the expense reduction program under the previous management still continues to have compensation expenses increasing. Headcount is still rising as a result of mergers and additions. The complex customer, product, geography and corporate matrix management still exists. It adds several costly layers of unnecssary expense to a very competitive cost conscious business.

Citi needs to end this. It needs to find a way to become a much more efficient operation. This certainly harkens back to the need for operational greatness that I wrote about above, but cost-cutting has additional elements. This too demands Citi’s dramatic attention.

Call It What It Is

"Citigroup still derives a large portion of its revenue from risky activities," Dealbook wrote. Why is that a bad thing? Citi’s involved in some risky businesses and some less-risky businesses. So what? What is critical is the way it manages those risks, and clearly it has not done an effective job doing that. The problem is Citi tries to be too many things. It tries to be that conservative bank that pays out an iron-clad dividend (that’s why it won’t cut the dividend, I believe) while it still owns the trading unit Phibro. Bank observers feel that conflict, as exemplified by this blog commentator:

Citigroup has gone far beyond the bounds of a “financial institution” as the investing public seems to generally understand the business. As such there needs to be far more disclosure in an understandable form which can be used to provide more about decisions of owners and potential owner alike.

Let Citi be what it is. It’s a bank that likes risk. It must do a far better job managing its risk, however. My suspicion is that the bloatedness of its operation prevents more effective risk management. In other words, it is fixable.

Citi is a remarkable enterprise. Any organization that can generate $159 billion of revenue in a year, as it did last year, has profound import. To me the bottom line is, the opportunity for Citi to soar is before it. It only needs to muster the internal political will to transform.

Disclosure: None

Comments

[IFreeCash.Net]

Go Citigroup! :-) Got 300 Shares there :)

[ResourceWise]

Citi’s Board of Directors need to explain why they have not been able to build strong processes, systems and controls in proportion to the size and complexity of the business. By repeatedly appointing trusted but relatively clueless senior management who have squandered the wealth of Citi over the past 10 years and done little to integrate businesses – front-end with back end and product with customer. Virtually all parts of the business are fragmented into fiefdoms that do little for the customer. It is inevitable that management teams that focus only on their own interests will drive a business to destruction. Reliable sources indicate that even as people are being laid-off, senior management are building a gym for themselves at 399 Park Avenue costing $5million. No doubt this is small change in view of the massive write-offs. However appearances matter when you’re trying to build confidence with all stakeholders.

[User 68127]

Yeah. Hey, and maybe we could get the U.S. government to be efficient and well-run too!

[Sedan]

Expense focus yes, no doubt...... However, the bank's problems, both in early 1990's and today, largely came from real estate, a demand for earnings growth and being a slave to the league tables. It will happen again because management can't stand the thought of being number 2 or 3 in a business.

[venividivici]

This is an organisation with a shocking track record. In all honesty, they don't deserve to survive but they will and that's why nothing will change.