Citigroup Inc. (NYSE:C)
Investor and Analyst Day
May 9, 2008 8:30 am ET
Scott Freidenrich – Director, Investor Relations
Vikram Pandit – CEO
Steve Freiberg - CEO of Global Cards
Manuel Medina-Mora - CEO of Latin America and Mexico
Don Callahan - Chief Administrative Officer
Brian Leach - Chief Risk Officer
Gary Crittenden - Chief Financial Officer
Michael Mayo - Deutsche Bank Securities
Stephen Wharton – JP Morgan
Guy Moszkowski – Merrill Lynch
Meredith Whitney – Oppenheimer & Co.
Betsy Graseck - Morgan Stanley
Glenn Shorr – UBS
William Tanona – Goldman Sachs
Shirley Leithrow – Grammercy Capital Management
Alan Kowalski – Polson & Company
Aaron Cadle – Firm unknown
Unidentified Analyst 1
Unidentified Analyst 2
Mike Holden – The Boston Company
Unidentified Analyst 3
Hal Levine – BNY Mellon
Unidentified Analyst 4
Good morning everyone and thank you for coming. My name is Scott Freidenrich and I’m the Director of Investor Relations at Citi.
We welcome you to our Citi Investor and Analyst Day. For those listening on the Audio Webcast you’ll want to download the presentation we’ll be going through this morning from our website at CitiGroup.com at the Investor Relations tab. You may want to do that now.
As I mentioned we’ll have a presentation by our Chief Executive Officer, Vikram Pandit and several members from our senior management which will then be followed by a question and answer session and Vikram and other members of the senior management team.
Before we get started I’d like to remind you that today’s presentation may contain forward looking statements. Citi’s financial results may differ materially from those statements so please refer to our SEC filings for descriptions of the factors that could cause our actual results to differ from expectations. Today’s presentations contain certain non-GAAP measures a reconciliation of the non-GAAP financial information contained in today’s presentation can be found at the end of the slides which are posted on our investor relations website.
Today’s program will feature the following: Vikram Pandit, CEO will lead the entire presentation on the strategy and direction of Citi. We will hear from Steve Freiberg, CEO of Global Cards, Manuel Medina-Mora, CEO of Latin America and Mexico, Don Callahan, Citi’s Chief Administrative Officer, Brian Leach, Citi’s Chief Risk Officer, Gary Crittenden, Citi’s Chief Financial Officer. Vikram will summarize the presentation then we’ll open up to a question and answer session.
With that said let me turn it over to Vikram to begin the presentation.
Most of our management team is here today and I want to start out by introducing a few of them. Starting with Ajay Banga, Ajay is a 22 year veteran of Citi and he is CEO of our Asia/Pacific business. Don Callahan, Don is our Chief Administrative Officer who joined Citi in 2007, he was at Credit Suisse and Morgan Stanley before. Gary Crittenden, Gary is our Chief Financial Officer, he joined in 2007 he is not only our Chief Financial Officer but also responsible for all our reengineering efforts.
[Jamie Farese], Jamie started with Solomon in 1985 and over the last 23 years Jamie has been working in our sales and trading businesses and is one of our strongest new leaders runs sales and trading right now. Steve Freiberg, Steve is a veteran of Citi for 28 years and runs our Global Cards business. Paul Gallant, Paul’s been with Citi for 10 years and runs our Global Transaction Services business which is one of our fastest growing businesses.
John Havens, John runs our seasonal client group, joined Citi in 2007 and was with Morgan Stanley before that for a number of years. Lou Kaden, Lou is Vice Chairman of Citi, Lou is responsible for government relations, HR and he provides us guidance on senior executive recruitment. Ned, Ned Kelly is one of the newest members of our team, he joined Citi in February. Ned runs alternative investments. Ned was at Carlisle he was CEO of Mercantile Bank Shares before that.
Kevin Kissinger, Kevin is a veteran of Citi and is our Chief Operations and Technology Officer. Michael Klein, Michael is currently Chairman of our Institutional Client Group. Michael has been with us for over 20 years, is a veteran of Citi and really responsible driving Citi and my client agenda. Sallie Krawcheck, Sally joined us in 2002. Sally runs our Global Wealth Management business that’s one of our most promising businesses.
Brian Leach, Brian is our Chief Risk Officer and joined Citi in 2007. Manuel, Manuel Medina-Mora is Chief Executive Officer of our Latin American business he is one of the most prominent and successful executives in the region a 37 year veteran of Banamex. Steve Volk, Steve is the Vice Chairman of Citi, he is a key advisor to us and our most important clients, he also is responsible for Citi’s own M&A activities.
Terri Dial, Terri will join us shortly, she’s officially gardening today. She’s going to be the head of our Consumer Banking efforts in North America as well as drive our global consumer strategy. She’s a 35 year veteran in the retail banking business, great bottom line results; I’m excited to have her be part of our leadership team.
We all know this is a people business; it’s a business about making sure we have the right people in the right places doing the right things. There is a broader team that is our leadership group behind the people we talked about. What I want to make sure you know is each of us in this group is jointly and personally responsible in making sure that we’re successful as an organization.
This is one of the world’s greatest entrepreneurial opportunities and I believe its one of the world’s greatest business transformations and I know this team will get it done and it’s up to us to show you that this is a championship team. Let me talk about what I’ve done over the last five months since I became CEO.
First we have established a very strong capital base for today and the future. Our Tier I pro-forma ratio is 8.8% and we raised $42 billion since the fourth quarter last year. We continue with asset sales in non-core businesses as well as by selling other financial assets we sold Citi Capital, we sold Citi Street. We’re driving asset productivity and we’re driving capital allocation. We believe that excess capital is strength in this environment.
Two, we have reduced risk and will continue to do so in the most shareholder friendly way possible. We have a new risk organization Brian Leach is our new Chief Risk Officer. We’ve hired six new senior people in Risk, nine of our fourteen senior risk managers are new to the role and each of them have over 20 years of experience in the industry. This is a world class risk organization.
We made good strides at driving efficiency last quarter for the first time we had a quarter over quarter sequential decline of headcount. We had a quarter over quarter sequential decline in costs. We have a functioning reengineering effort under Gary’s leadership. Gary is working with Don and Kevin and Carl Levinson to put us on track for substantial reductions both in costs as well as other resources and Gary’s going to talk to you about that today.
Four, we identified our legacy assets. These are assets that are not core to our mission going forward and will be sold or run off over time. This will create capital we can reinvest in our core businesses. Today almost $500 billion of our assets are such assets that’s 22% of everything we have. Gary is going to give you details on the wind down strategy.
Five, we’ve identified our core assets and our core strategy that’s really what we’re here to talk about today. We’ve arrived at this in a very dispatched and a thorough way with no preconceived notions for the right strategy, no preconceived notions for how we maximize shareholder value. Let me just say that today if we were in a normal environment we’d be generating $20 billion plus of earnings for our common shareholders which today is 16% to 18% on our total capital of $129 billion.
Over time we believe our revenues will grow at 8% to 10%. We’re planning $15 billion of reengineering benefits as part of our continuous efficiency improvement effort along with these efficiencies and everything else we’re going to talk about today our goal is to increase our ROE to 18% to 20%. By the way, we’re focused on high quality earnings. We believe these will be very high quality earnings as you will see when we talk about them today.
Six, we have re-organized the company to have an operating structure that is consistent with our strategy. We’re a client based organization with a regional structure. We are product basing organization with our global product structure and we’re an efficiency conscious organization with our centralized functions. We have clear leadership; we have clear decision making authority and collaborative partnership between products, reasons and functions.
Seven, we formed a leadership team to drive execution. Key talent continues to join us. Terri Dial, [Paul McKennon], [Mark Rafay], Richard Evans, Derek Bamber, others. Success requires having the right people in the right places doing the right things and we are executing on that. In fact, we’re delivering on the number of priorities that we talked to you about as you saw in our first quarter numbers.
Let me say that almost everything we’ve done so far or we’re executing on so far is what I consider to be stage one. Stage one to me is all about getting fit. We’re focused on exiting our legacy assets, we’re focused on returns, we’re focused on driving asset productivity, we’re focused on managing risk and we’re focused on reengineering our cost base. There are two more stages and I do consider these stages to be overlapping to some extent.
Stage two is about clear goals, strategy and structure which is what we’re going to talk about today. Every area or city has to have a business model that is consistent with the strategy. Stage two is about restructuring our business models where appropriate and executing against these models. We’re in the process of addressing every business model to make sure that we’re executing in a way that allows us to achieve our objectives. This will take some time.
Most importantly execution against these models will take some time because they can in some areas represent shifts or restructuring as we drive quality of earnings. When we are ready we don’t mind setting up other sessions like this if we believe there are some important changes to business models. Stage two is about clear goals, strategy and structure; it’s about getting the business models rights, its execution against these models in a transparent way and with accountability. In short stage two is about restructuring Citi and let me emphasize again as we do so we’re going to improve the quality of our earnings.
Let me talk about stage three. Stage three to me is about delivering the full value of Citi to each and every one of our clients and customers. It’s about leveraging and fully integrating our model from a client infrastructure and risk perspective. In this stage we’ll have made substantial progress on the following goals; one implementing a compensation evaluation system focused on execution. Two, creating a culture based on meritocracy, teamwork and integrity.
Three, creating a relentless focus on talent and building an environment where the best simply do better.
Four, linking the creativity of our people worldwide to deliver exceptional value and services ahead of any competitor. Five, harnessing Citi’s information advantage into insight that can help us get ahead of both risks and opportunities. In short, stage three is about maximizing Citi.
Let me summarize again the three stages. Stage one is about getting fit, stage two is about restructuring Citi, stage three is about maximizing Citi. Just managing down legacy assets and focusing on getting fit represents significant earnings power. Restructuring will improve the quality of those earnings and finally the power of the last stage can be very, very significant.
I do want to leave you with three important considerations still. One, these three stages can be overlapping. Two, this will take time; there will definitely be some early results but it will require patience there may be some mid course corrections. Three, the earnings power we’re going to talk about today does not fully capture the potential of Citi when we get all the three stages right.
Let me start by talking about Legacy Assets. As I’ve said I conducted an extensive review of businesses simultaneously we’ve taken some important steps. We identified about $500 billion of Legacy assets which we will reduce in an orderly fashion over the next few years. Some of these Legacy assets are those on which we have been taking significant marks and we have discussed them at length in our earnings calls.
We look to manage these down either by holding them to maturity or through orderly sales. Most of the assets we have there do not fall in these category and they’re ones that simply don’t produce acceptable returns. Such as our Prime Real Estate assets, most of these will roll off. Other assets that are up there are good businesses, these are businesses that we think would be more valuable in somebody else’s hands because they just don’t fit our strategic platform.
You’ve seen us divest Citi Capital, Diners, Citi Street, there will be more. The chart on the right gives you a sense of the composition of the products and these reductions will release capital which we could redeploy in our core businesses. Gary is going to talk about this more in detail in your presentation. That leads us to Core Citi.
Let me talk about Core Citi. Core Citi has the following attributes; Core Citi is focused on risk adjusted capital, focused on returns on risk adjusted capital, focused on stability of returns and growth that is consistent with the above two. Core Citi has 75% of earnings coming from high growth, high return annuity type businesses, and 25% coming from more volatile businesses. Core Citi has a unique global presence. Core Citi is focused on international growth particularly in the high growth emerging markets where we have a very large and significant advantage.
Core Citi has five distinct platforms; four of them are global platforms. We are a global universal bank with a clear value proposition for our clients and an unparalleled brand. The slide that’s up there right now shows that the projected growth for financial services in Asia and Latin America is about 10% to 14% which is double the rate of growth in the US. Slide nine shows you that we have a powerful presence in those emerging markets, 32% of our revenues have been driven by emerging markets.
On the right you can see that 75% of our businesses are annuity product businesses. Let me now take you through the five distinctive platforms. Global Wealth Management, Global Cards, Consumer Banking, Securities and Banking and Transaction Services. All but the consumer business will be run as global businesses because that’s how our clients are organized and that’s how they want to be served.
Consumer banking is a local business and so we’ve organized it accordingly. Each of our four global product platforms are squarely positioned against global growth in trade flows, capital flows, payments and wealth creation. Consumer banking is very well focused in the highest growth areas of the world. We’re top three in every category with a bias towards growth. Let me now talk about the wealth management business.
GWM is a great business, individual wealth is growing rapidly around the world. We’re well positioned to capture this growth because as the bottom chart shows we have leading positions in North America and in the fastest growing market in Latin America and Asia. In fact, we’re the second largest wealth management company in the world with $2 trillion of client assets. We’re number one in Asia; we’re number two in Latin America. We continue to grow this rapidly and this is a very high ROE business.
In the US Smith Barney represents the bulk of our business. Overseas of course the private bank represents the bulk of our business and that’s performing very well. In fact, our private bank serves over 30% of the Forbes Billionaires List. Sallie Krawcheck is working on strategies around different client segments for the high net worth clients her team is moving towards creating a distinctive and efficient product and service offering regardless whether you’ve been served by the Private Bank or Smith Barney.
On the high net worth side we believe there is a big opportunity to build out this segment through adding both private bankers and officers in certain parts of the world. As well by leveraging our investment bank something that we’re going to put a lot of focus on. We’re also working to create the right product and service model for our emerging affluent clients. When Terri joins us we’ll be asking her to work with Sallie to explore how we can leverage our retail bank to create a better value proposition for our Smith Barney clients.
I’ve also asked Sallie to think about how our wealth management business can provide products and services to our Citi Gold customers throughout the world. Citi Gold customers are our affluent retail banking customers and I know we can do better for them and with them if we offer them the right value proposition. The business has been performing well but we think there’s huge potential here and I consider it to be amongst our most promising businesses.
For all of us in this room here are some of the metrics we’ll be focused on in this business. In the Smith Barney business the basics are client assets, net new flows, revenues for FA, client assets in C based accounts and pre-tax margin. Over time you’ll see us adding other metrics to support our fully integrated strategy with other businesses so for instance we’ll form targets for our cross businesses with investment bank and also for capturing more retail bank business from our Smith Barney customers.
Let me turn to Cards. Cards is another great business. The top graph shows the payment industry is growing at a double digit pace. The number of transactions is projected to grow significantly faster internationally with growth rates of 18% to 19% in Latin America and Asia. We’re uniquely positioned to benefit from these trends with 8,500 global branches, 300 plus partnerships and an unmatched set of product set of product expertise and global presence.
As the bottom chart shows we are the largest as measured by managed loans and the largest outside the US. Our international position will allow us to outgrow our competition. We’ve changed how we’re managing our Global Cards business. It used to be two distinct businesses, US and International managed separately. We’re now managing this business as a Global monoline. As the global monoline we can leverage the scale and intelligence of the very successful US business and put that into the international business.
We can also make sure that we’re properly positioned to ensure that we’re at the forefront of innovation around global payments, a business that we’re very excited about. I’m convinced that this new structure will be a huge competitor advantage for us especially versus local competitors outside the US. You can see at the bottom of the chart that we are the number one card issuer in the world. Our receivable growth was 13%, second only to American Express. The international franchise of course is a jewel, its growing at over 20% and our target is to grow in the low double digit range.
The US business on the other hand has lost market share over the past few years. It looks to me like we had a lack of commitment to the business after studying the business we’ve decided not only is it an attractive annuity high return business but we think we can grow it. In a moment Steve Freiberg will come up to talk to you about the specific points on growth by I do want to highlight a few things.
First I want to tell you that we did make some mistakes. The company cut back on marketing. I think you know that if you cut back on marketing you’re going to have a tough time producing a lot of growth in your portfolio. That said I begin by telling you that you’ve got to de average the portfolio and when you do so you’ll find that there are some older portfolios that in our view are in the harvest mode and the others are having a lot success.
While in aggregate the business may seem dormant that’s not what you find when you de average it there’s a lot of growth inside the portfolio. The other thing I would say is I think that opportunities to take out cost both as a result of the global monoline as well as from our other reengineering. The mandate that Steve has is to take some of those savings and put them back into marketing where appropriate because we’re fully committed to growing the business in the US.
I also want to address this notion that somehow we have a competitive disadvantage because we don’t have 5,000 branches in the US. As you would expect I looked at this thing very carefully and sure if we had 5,000 branches we’d hand out a lot of cards. Even if we had the ability to do so it wouldn’t be large enough to support our growth strategy or for that matter anybody else’s whole growth strategy. We think we have a competitive advantage that others don’t have that compensate for that smaller branch footprint.
As far as metrics are concerned in Global Cards I would point to managed receivables growth, net account growth, net credit margin, return on managed receivables and ROE. On that note I’m going to ask Steve to come up and discuss some more of the issues.
During my brief presentation I will strive to provide you with a deeper understanding of an extraordinary Citi franchise which is our Global Cards Business. Broadly we are focused on the element side of the action plan on the screen although today I will specifically focus on our unique footprint and powerful global distribution network, the positive trend of asset growth and the improved revenue momentum in our North American Cards business and the leveraging of innovation to transform our Global Cards and Payments business.
First on distribution, Citi maintains the world’s largest distribution network with an unrivaled ability to generate quality card members. Globally we have 8,000 branches in excess of 300 partnerships with 16,000 external sales agents and a strong and growing internet platform. In 2007 we acquired 38 million new accounts worldwide that was up 50% from 2005 with 18% net total account growth in open accounts over the same period.
In fact, geographically we are best positioned to outgrow our peers as we are present in approximately 50 countries and hold the top three position in over half of them. Our cost to acquire new customers is significantly lower than our peers and has actually been decreasing it has decreased by over 30% since 2005. As you can see from the bar charts in both North America and International we are over weighted towards lower cost partnerships and point of sale acquisitions as well as direct sales agents and a significantly decrease our reliance on higher costs direct mail.
In addition, we are focused on accelerating our growth on the internet and have made solid progress on that front. On to the issue of relative size of a branch footprint in North America and its competitive implications is a fact raised. While it would be helpful to have more branches in North America it should be noted that we do have 4,100 branches within this footprint 1,000 are retail bank branches, there are 2,500 Citi Financial or Consumer Finance branches and over 600 Smith Barney branches.
To put it in context Citi’s branch businesses sourced approximately $0.5 million new card members in 2007 and we expect that number to double by 2010 but that said if you look at JP Morgan they sourced $1.1 million new accounts through their branches in that same time frame. It may be a larger number but it still only constitutes 7% of their total acquisitions in that calendar year. Thus branches, whether it’s JP Morgan and/or Citi whether it’s our domestic franchise or whether it’s our international franchise tend to have a limited impact on overall cards acquisitions.
As you can see from the chart our experience in North America parallels what we have done internationally. Finally, we are very satisfied with the quality of accounts and the returns generated by this distribution model. Return on assets or ROTA after tax in the US franchise between 2004 and 2007 has raised from 200 to 250 basis points again that’s after tax. With point of sale including private label returning to same and or better than the other channels. In addition, for international our ROTA as you would expect has averaged in excess of 500 basis points over the same time frame.
Let me turn now to the North American franchise. From the chart you can see that managed revenue growth and it is managed revenue growth the growth trend in our North American franchise has been improving and has significantly improved over the past six quarters. Essentially we have underinvested in marketing relative to our peers since 2004 and as one might expect we have grown slower or at a slower pace than the market.
That said, we have taken higher returns on and in fact have invested more globally in our Cards franchise. We have worked hard to retool the North American business during this period to having that observed change in trend. Essentially we focused on four levers. We migrated acquisitions away from direct mail to other lower cost higher quality channels such as point of sale with partners, the internet and our branches as well.
In addition, we invested in higher growth, higher return segments like small business. Some of our selected partners, the travel, the affluent and in fact within North America Canada which has been growing at double digits has been a very good market for us. We have maintained and/or harvested some of our slower growing slow returning segments during this period as well and we’ll continue that.
In addition, we shifted discretionary marketing spend from new account acquisition to deepening existing relationships with very large account base in North America, spending more on leveraging that base which is more effective in finding the next new customer. Finally, we reduced our investment in acquiring lower yielding assets by significantly reducing the use of balanced consolidation where typically you’re basically giving people below market rates to get them into the franchise.
In summary, we will continue to follow this enhanced model and expect to gradually increase our investment spending with funding driven primarily through reengineering efforts where we have a proven track record. Let me turn for a moment to innovation.
Innovation is absolutely critical to maintaining our long term leadership position in Cards while enhancing our position in the more broadly defined payment space as profound changes are impacting our industry. The primary fact is that are reshaping our industry include shifting of spend to online, think Travel. Unprecedented growth in debit and electronic transactions and transfers. Mobile altering the old paradigm. The rising importance of global intermediation including the small business and the consumer.
The growth and importance of new demographic and geographic segments emerging and real time information truly become a competitive edge. We have many exciting innovation efforts underway that I will now provide you with several examples. Mobile provides the opportunity to put the full dynamic of the Cards Company and/or the Consumer Bank into our customer’s hands thus enhancing our ability to expand the payments universe, attract a passage remotely and leverage information to increase relevancy.
Specifically person to person mobile payment trials in both Chicago and Boston with Obopay have been underway for a while really setting the stage for a new market opportunity or a new universe in person to person or p-to-p payments. We also have a joint venture with SK telecom which is the largest wireless carrier in South Korea and that platform has true global applications. Technologies under development include mobile phone tap payments, budget planning and expense management on the phone. Location based advertising with real time discounts and person to person payments.
We are also partnering to improve industry leading value propositions. A few examples, with Expedia the leading online travel service the customer experience during the site visit will include inline pop up offers that provide real time discounted travel as customers apply for instantly approved Citi Credit Card which will of course include thank you points. As almost 15 million shoppers come each month to the site.
Another example with Live Nation Citi is now the official credit card partner in an alliance with the world’s largest integrated music platform which will provide actually starting in the month of May our clients, this is beyond credit cards, access to online ticketing and concerts as our customers enjoy preferred access and pre sales which gives us a point of difference and premium or VIP tickets. Live Nation just prior had been Amex’s partner in this space.
Let me spend a moment on new ecosystems. We have a venture with Smart which is Singapore Mass Rapid Transit which began in late 2006. We launched the Citibank Smart Visa Platform as the first two in one card in Singapore with contact with easy link functionality for transit payment as well as regular Visa functionality at merchants. Subsequently we launched the first three in one card with Debit ATM and Easy Link functionality in the following year which was late 2007.
We then created Singapore’s first travel rewards program where customers redeem points for free Smart tickets. The system also features tap and go technology and instant issuance. We are now and have actually recently launched a very similar effort in India and plan this summer to also launch in Hong Kong. It has great leveragability around the globe.
In summary, Citi has the largest and most profitable credit card franchise in the world. The formation of the Global Cards Group will eliminate the card product silos thus enhancing our ability to capitalize on our scale, our intellectual capital and our number one cards brand. Our global footprint and unique distribution model are clearly sources of competitive advantage with unrivaled local reach, unique global value propositions, importantly 100 years of experience in global underwriting particularly where there are no credit bureaus and rapid sharing of best practices globally.
The Global Cards market has attractive growth potential and that includes the US. The broader payment space offers even greater potential and we will continue to innovate to capitalize on these payment trends.
Let me turn to Consumer Banking, the top graph shows that the emerging market middle class is expected to grow to $1.2 billion by 2030 compared to $400 million 2005. As you can see in the graph at the bottom we’re well positioned to capture this trend. We have a leading market position in Asia and Latin America. While we’re managing our other platforms globally as you know Consumer Banking is truly a local business.
In Mexico for example the Banamex shows we have strong local franchise can be made even better by leveraging Citi’s global product expertise and global distribution. We’ve structured the Consumer Banking business to compete aggressively in the local markets; our regional CEOs are going to drive that on the ground. Ajay Banga in Asia, Shirish Apte in Central and Eastern Europe, Bill Mills in Western Europe and Manuel Medina-Mora in Latin America.
As you know Terri Dial will be heading Consumer Banking in North America as well as Global Consumer Strategy. She’ll be collaborating with our other CEOs to ensure the consistent implementation of best practices and global standards. The strategy for Consumer Banking is somewhat different in the US versus Internationally.
Let me talk about the International strategy. The Universal bank model is truly compelling and Manuel who has achieved great success with the model in Mexico will speak to it shortly. The strategy is to take Manuel’s model and replicate it in other markets with similar opportunities where one can get strong market share.
We’re also focusing on some key high growth markets where we have a very leading market position. In addition to that we’re growing in Taiwan, we’re growing in India, we’re growing in Brazil and we’re also growing in customer segments such as emerging affluent. A great example of leveraging the global franchise is the work we’re doing in Citi Gold. We’re serving over one million Citi Gold customers with our global banking footprint.
Our Citi Gold revenues abroad have grown by over 27% in the last three years. Citi Gold clients tend to have a deeper relationship with Citi. These are affluent clients and we’re squarely positioned to benefit from the significant growth this opportunity represents. A key initiative with this segment is to serve them not only with Consumer Banking but also Wealth Management products.
Let me turn to the US strategy. Actually what matters is what Terri’s going to put in place once she’s here but let me give you some initial views on the business. First I do want to remind you that in the US we do have a very successful consumer finance franchise. We have a very different credit model at Citi Financial then our other lending businesses. Over time this business generates relatively high returns and it has consistently produced good growth for us.
Our strategy for expansion retail banking is centered around key MSAs where we have or our close to having leading market positions. We want to be in those areas that leverage our total franchise. As you know our operating efficiency ratio is high. You can be sure we’re going to be focused on improving this.
Let me talk next about Securities and Banking. The top left chart shows that financial assets are projected to grow at a 9% rate in developed markets and 17% rate in emerging markets. The chart on the top right shows that the share of market capitalization of emerging markets companies is projected to increase from 6% in 2001 to 24% in 2012. We have trading flows in close to 90 countries. The opportunity is ours to capture since we are a big factor in the fastest growing areas of the world.
The bottom graph shows that our revenue share in every category is strong and we hope to grow them. John Havens recently took over as the head of the Institutional Clients Group and it’s fair to say we’re looking at everything to determine what the right strategy in the business model is for us and what we need to do to produce greatest value from this business.
The volatility in this business and the overall returns have been unacceptable and its clear to me we need to restructure our model. That said, I would also add that the entire industry in this area is transforming and searching for a future and we are positioned in the best areas the highest growth areas such as the emerging markets. Our emerging markets business is huge we have been growing at 30% to 40% for the past few years.
We also know, by the way, that the investment banking business model is likely to come our way because of changes in capital, changes in liquidity, and also the regulatory environment. As John has been in his seat for only a month we’re not ready to tell you about everything that we’d like to do here but I do want to make a few key points.
The first point is that we’ve got to protect our franchise and Brian Leach is going to talk about this. You can be reassured that we will properly understand the risks we’re taking and if we can’t get that right nothing else I’m going to say is going to matter. My second point is that we’re going to reposition our business so that it is driven by talent, execution and risk adjusted returns.
The third point is that while we have a lot of costs to take out we also believe we’ve got investments to make. Some of the investments will mean technology; some are going to be to fill some significant gaps in our product portfolio. Of course that means that we’ll invest in talent as well. We want the right people in the right seats. We do have some major product gaps. In equities our growth is weighed down by the fact we don’t have a sizable prime brokerage business, a derivatives business or a sizeable electronic trading platform.
Some of you know these are businesses that John Havens and I built at Morgan Stanley and we’ll get it right here. Commodities are another large product gap and we’ll be working on this to build it out. We must address this product gap not only to make sure we’re properly positioned for growth but because we also need the diversification in this business.
The next point is we need to optimize our balance sheet, more so in this business than in any of our other businesses. Going forward we’ll be charging for capital any time and anyone requires it for a transaction. You’ll also see us exiting unprofitable client relationships. You may hear noise about this. I think these are good noises. This is going to allow us to deploy more resources against the right clients and against the right transactions. As I said, our future model will be built on talent, execution and risk adjusted returns.
We have two goals for this business. A financial goal which is ROE our target is 18% to 20% although for us as for others it’s likely to be lower clearly for the next couple of years. We also have a franchise goal, no corporation, no government, no institution, anywhere in the world could want to make a significant financial decision without coming to Citi first.
Let me talk about our alternatives business. I’ll do it quickly. We have a large book 54 billion with 80% of this representing client assets. Over time we believe this should also be an 18% to 20% return business just like Securities and Banking. Again in the near term we could be lower than that for several reasons. First we don’t expect environment for private equity to be friendly for harvesting. Secondly, this is a business that also needs to be repositioned to generate greater profitability.
We need to increase our efficiency. Tier II will use those efficiencies to self fund new capital expenditures. We also need to strengthen our distribution and we are continuing to shift from proprietary capital model to an agency model that is client centered. Having said all that we have some really good products.
Our private equity products, the international private equity product, emerging markets products, real estate fund and we’ve got some new things that are extremely promising such as our infrastructure fund. As I said, over time this should be an 18% to 20% return business; it could be lower for the next couple of years.
Let me turn to Transaction Services. As the chart on the top left shows trade flows are projected to grow at an annualized rate of 13% until 2012. Of total multi-national companies in 2012 29% are expected to be in the emerging markets as compared with 21% in 2002. Transaction Services is amongst our highest growth and highest return businesses. It also has the unique capability that sets us apart in the marketplace.
GTS is at the center of many, many of our institutional relationships. Our strategy has been to capture the multi-national segment and top tier clients and we’re doing that. We have 479 of the top 500 global institutions. Our client’s growth strategies also are being driven in many cases by the same globalization trends as ours. We’re amongst the only global providers of the services that they need.
We’re on the ground in over 140 countries and we’re the only provider that can serve clients in these many markets with a consistently global solution. The treasure of a large multi-national whether in Hong Kong or London or New York or Sao Paulo can see the company’s cash position everywhere around the world. We serve Shell Oil in 70 countries; no one else can do this.
As a result of this as well as our industry leading technology our clients are consolidating their relationships with us and we’re gaining business as the complexity of deals is increasing. We’ve grown revenue in this business by 23% over the last four years and while the expansion in trade has contributed to this we believe that most of the growth in GTS is being driven by sales winds which have grown at 20% a year over the last five years.
Last year in the cash business alone we had business wins representing more than $1 billion of revenues. This year our pipeline tells us we’re going to exceed that. One more thing, the cash business is very fragmented and even though we are one of the largest in the business we have less than a 3.5% global market share. We’ve got plenty of room to grow in terms of market share.
Besides this natural growth and growth as a result of our global franchise and industry leading technology we’re also focused on innovating to provide high value, unique solutions for our clients and customers and we’re leveraging our distribution. We are forming innovative partnerships including wide labeling our services just last week we had a very large business win on wide labeling with a very large financial services company.
The final point I’d make on this business is we are investing in this business. As a matter of fact, as a result of business reviews we made a decision to invest an addition $300 million in GTS this year. All of you, and all of us as shareholders the metrics we’re going to be focused on in this business our growth in deposits and assets under custody as well as pre-tax margins.
Now that I’ve taken you through our five businesses let me tell you how we’re thinking about them as a whole. We’re in 106 countries; we’re a significant factor in emerging markets Asia, Latin America, Eastern and Central Europe. We have significant business and developed markets. These businesses can feed on each other. This brings me to a very, very important strategic point.
We believe the right model is a Global Universal Bank. This is a model that delivers the most shareholder value and is fundamentally different, fundamentally different than a conglomerate or a financial super market. We are neither. Universal Bank may mean many things to different people let me tell you what it means to me.
First, the Universal Bank model is the only model that creates true value in emerging markets which have less developed capital markets. The only way to fund operations is through deposits but let’s spend a minute on this. If you have deposits you’re going to have to put them to work its nice to have a corporate bank and a trading business.
You can’t have a trading bank and corporate business without knowing whether you can secure funding and these are less developed market makes complete sense that the dominant model is Universal Bank go around the world. The best ones are exactly the Universal Banks.
In developed markets while all models by the way can work in great market we’ve seen that any model works in a good market. When you look at what we’ve just gone through the Universal Banking model is the right model. Just ask our clients, for that matter our regulators. The economics are clear to me the best value created is through a globally integrated financial services structure and by operating a fully integrated company we add extra value to our clients which creates extra value to our shareholders.
It should also make it interesting and an exciting place to work and hopefully more lucrative place for our people. It’s clear that a Universal Banking model is the right model in many countries, many regions. We have unique opportunities not only to deliver against that in these countries but also to be the first real global universal bank that can implement the strategy in a way that every one of our clients can take full advantage of our global resources.
The question is what does it take to execute on a Global Universal Banking Model. One, it’s about having the right organizational structure to serve our clients optimally. We’ve just done that. Two, it’s about having the right products. Let me give you a couple examples. When you go to an emerging market the entrepreneur who is our private banking client also runs a corporation which is our investment banking client and many of those cases the entrepreneur wants to make sure that employees are served by our Consumer Bank and so we had bank at work, works beautifully well.
There are many, many, many such examples in the entire organization. Three, it’s about an efficient global infrastructure and I’ve got to say we haven’t yet seen how meaningful an advantage this is. That’s because the infrastructure of this company has never been fully integrated. In a sense the 1998 merger was never completed. Each business has been operating with its own back office, with its own middle office and Don’s going to talk to you about some of this in a few minutes.
Let me also tell you we have 140,000 people in IT and Ops. We have 16 database scanners, we have 25,000 developers. This results not only in waste but doesn’t give us any opportunity to leverage our organization. So that’s massively inefficient. We’re finally going to merge it all. Four, it’s about the right incentives and culture for our people. We have great people.
The new organizational structure is nominally designed to encourage collaboration but to require it. Those who don’t collaborate and behave as team players will not likely be successful at this company. That is how we think about the Universal Bank, this is a model that provides us with the opportunity to maximize Citi and over time I believe it will change the game in global financial services.
I’m going to ask in a minute Manuel Medina-Mora to come up and speak about how this model works particularly in our emerging markets. I believe Manuel in many ways embodies what we mean by the Universal Bank. He’s the Universal Banker, he has successfully executed on this model, and we’re going to translate that around the world.
Over six years ago Banamex became a part of Citigroup. At that time we decided to merge all the different business units of Citi in Mexico into Banamex under its Universal Bank Model. How does this model work? What are the key elements that define it? To start, all business work together to provide financial solutions to our clients. We align all our resources across businesses and across products to offer integrated services to our customers.
A key element, common distribution network, from branches to bankers. All channels serve our customers in an integrated manner. We were able to successfully leverage on Citi’s global capabilities. In less than two years we were the leaders in private banking, capital markets and investment banking, areas in which Banamex was never a leader in Mexico.
Universal Bank is a relationship driven model in which we always strive to deepen the client relationship. Therefore, naturally builds a strong deposit base from consumers DDAs to transaction based deposits. A key driver generating new customers and deepening through cross marketing the relationship with our clients. By nature introduced a balanced business portfolio, diversified earnings.
How does it work? In the six years since the integration we have more than tripled our earnings in Mexico. Two years after we joined Citi we were invited to run the Latin American operations. We have gradually developed them into the Universal Banking Model. To start we focus on those countries that had the best risk return profile in the region. Over the recent years we have used different approaches to accomplish our goal, create Universal Banks in the best strong economies in Latin America.
In Central America through acquisitions, Uno and Cuscatlan and the integration of them with our own operations we are creating one of the leading Universal Banks in that region. In Brazil and in Colombia through an organic growth strategy we have multiplied by more than four times our footprint and our business volumes in just four years. In Chile through our joint venture with Banco de Chile we are transforming our participating of 3% market share in that country to a 50% control stake on a Universal Bank that commands 20% of that banking market.
Three different ways to get to the same goal. That of creating Universal Banks in our priority. As the strategy has to go, we become not only a more relevant player in several local markets we have came also the leading corporate and investment bank in the whole of Latin America. What have we accomplished? What are the results?
We have increased our branch network by 50% in the last five years, 700 branches by organic growth and 200 branches by acquisition. By about the same percentage our sales forces and the number of our bankers in the region. We have consistently invested in the future. In the same period we have increased by more than 10 million our customer base. Our franchise in Latin America where we now serve more than 30 million customers, a significant number for that region of the world.
We have also expanded our loans and deposits, our business volumes by close to 80% in these five years, with a strong core deposit base. In terms of our results I’m not including the gain on the sale of our Redecard we had in the same period double our revenues and more than triple our earnings. As you go down you see the model working. Expansion on business platform bankers, expansion on business volume and much more expansion on revenues and bottom line.
How do we get these results? What are the financial drivers behind the model? First it improves significantly our asset productivity. Since it’s not a risk intensive model but rather a relationship intensive one it has allowed to significantly increase our revenue to us at ratio. Transaction based deposits, fees on capital market transactions, advisory assignments, consumer business generated by CD at work, private banking business, products, a whole array of financial services that increases revenues faster than assets.
On top of all this a key advantage of the Universal Banking Model, the regional CEO has a unique observation platform. He or she has the view of all business opportunities across products or market segments, in a country and in a region. Capital allocation is simpler when you have the view of all risk adjusted returns of different products.
Secondly, a Universal Bank Model brings significant operational synergies from common distribution networks, a unified treasury, and the integration of middle and back offices and shared support service. It runs as one bank not as a collection of diverse businesses. It has positioned Citi Latin America as the most profitable international bank in the region, by size of profits, by return on assets, by return on capital.
Let me finish by stating again what we aim for with this model. A customer centric relationship driven bank with a balance and diversified portfolio in high roll marks which implies a simpler, leaner and more efficient organization that delivers consistent earnings growth.
Manuel’s been executing on the Universal Banking Model in Mexico, is exporting it to Latin America, its working and we’re going to export it around the world. That’s why we’ve set up the organization structure with our regional CEOs; everybody’s spending time with Manuel to do that. Others have done it as well. On a broader basis how are we going to do it as a company? As well, what are the changes that have been made and what is different today to allow Ajay and Shirish and Bill and the entire company to execute against this model that Manuel executed on versus where we were before.
I’m fairly new to Citi but one of the first things I was told is never follow Manuel and now I know why. I could summarize my discussion of the organization by saying whatever he just said that’s the organization in living color. Let me give you an understanding of the new organization by stepping back to December and telling you what happened really within the first few days of Vikram becoming CEO.
Really the first thing that happened is we called our families and said we had to take a pass on this years holidays, we jumped in some planes, we started going around the world and we started this passionate business review. I hear him called this passionate business review I was in all of them. They were passionate; we found the business leaders loved their businesses and the deeper we got into these businesses we could understand why.
We had to step back and say what’s wrong? How come it’s not hanging together? It was very clear to us it was how we were organized. We didn’t leave adjusted our view; we started talking to clients really listening to clients and asking them to tell us what they thought we needed to change. We also listened intensely to our people and we came up with some very common themes that could not be ignored.
The first theme was that we are silo driven organization and in some cases sub-silo. We also came up with the fact that the decision rights were not clear and at some points confusing. It turns out that the farther you were away from New York the harder those decisions rights became. In fact some of them were quite candid saying the decision rights are coming all the way back to where you’re sitting today 399 and they don’t have the power to drive on behalf of their clients. We knew this wasn’t the right model.
The last thing in terms of a broad observation was around culture. We listened hard when it came to culture. Sure there were great cultures within the entire Citi organization. There was Solomon a traders trader, there was Schroeder’s the service level of client relationship second to none. There was our banking culture of a client relationship. There wasn’t one culture that you could feel across Citi. We knew we had to address that.
Perhaps the best way to think about addressing that was to step back even further and look at an organization and this is not meant to be an organization chart but more as a concept of how was Citi organized. It may be familiar to you. It was a set of silos by design it was a set of business leaders in each one of these where they had responsibilities for their revenues and expense and overall profitability and they ran them well.
In fact, if you think about Citi, when Sandy was leading it each of these businesses had very strong returns and the economics to the shareholder was quite nice. There was something that was being left on the table that was clear to us is that it wasn’t integrated and we felt that the environment we are in right now we really believe that was part of what we needed to do to un-harness it.
The first thing as we started to look at the organizational construct we had an understanding of our strategy and how we had to put the structure in place we looked at what is our competitive advantage. It was clear our global footprint was second to none. We’ve been in most of these countries and now we’ve been traveling around throughout the winter and the spring and being in them and you’re struck with we’re not just in China, we’ve been in China for 100 years.
We know everyone in China, the relationships are very deep and that’s true in India, and every corner of the world. Really the question we asked ourselves is how can we get the clarity to the organization and still manage on a full global basis? In listening to our clients they told us that certain products need to be global because that’s how they wanted to be served. We took four of these and we decided for Global Wealth the Card business, the Securities and Banking and Transaction services we would render the decision rights crystal clear to these business leaders.
They own these businesses, they have the responsibility for making the formal decisions and they have the responsibility to for the P&L. That wasn’t enough. That wouldn’t leverage the idea that Manuel just talked about of how you get close to the client. We overlaid this with a regional structure and we took what you just heard here of transformation of what was done in Mexico and spread throughout Latin America and we are not going to do that on a global basis.
With strong regional leaders like Ajay Banga who is in the process of moving his family to Asia. He now has the decision rights as close to his client set as we could possibly get. He works in coordination with the product leaders that are there. At times there may be agreement and other times disagreement but we have put in place a decision process where there are very clear rules of the road.
By using those rules of the road we can get the very quick resolution. I don’t think there’s going to be much dispute. I actually think there’s a real sense from what we’ve seen already of a working partnership of picking up the phone and having very good conversations. We’re very pleased with how this is designed and more importantly how it’s actually working today.
The third and perhaps the most bold, Vikram mentioned how many people we have inside our organization from a function point of view. We collapsed the organization together and we recognized that there’s a great opportunity for efficiency and effectiveness as we run it as one organization. Almost half the organization is in the functions that have now been centralized. We talked about the number inside of 140,000 in ONT alone. We have 25,000 developers, that’s understandable, it’s a very large number, I believe it’s a large number but it’s understandable with how we’re organized.
Where we believe the efficiency is going to come is understanding how we can develop something in one part of the organization and make sure that that’s being replicated throughout. We believe there is tremendous savings there. Kevin Kissinger and his team of operations and technology took me through two solid days of business reviews. They said here is the benefit we get from centralization. When we added it all up it was $3 billion targeted savings over three years.
I can understand why, Vikram mentioned 16 different data bases. I know something about databases, I’m not an authority but I can name a few like DB2, Teradata or Oracle. Can anyone else name the other 13? That’s a lot of databases. Not only that one three of them were authorized under the old structure. Now with Kevin in control he can say these are not permitted, get rid of them and organize them.
If you look at Vikram’s charge on stage three he talked about getting to while maximizing Citi an information advantage. We can’t get there with the information compartmentalized but we can when we start to put it together. That’s not that hard to do any more. It would have been 10 years ago but that’s not that hard to do. Although it’s going to take a little bit of time to get that right.
In addition to what we’re doing on the integrated function I’m actually more excited about what you get when you start to integrate the clients facing Citi. The reason I’m so excited there is yes there are efficiencies we can get out. In fact, one of the mandates that’s been put out by Vikram is for each of the business heads to take a look at their businesses under the new construct and lay out the value that they are creating for the client and work backwards. Understand exactly who needs to be inside their organization by value and come back to us.
Already, Shirish Apte has come back and said he believes in Eastern Europe in one country where he’s finished the exercise that he can get a 15% to 20% improvement in efficiency. I believe the rest of the business heads are coming back to us before the end of the month. We’re excited by the early return. That’s not the reason I’m as excited about the integration of the client facing model it’s really getting to the other side of it. It’s getting to the side where we can actually go to market and serve our clients in a way none of our competitors can.
I know some of our competitors, I’ve worked there, they like to talk about we’re going to have a united front into the client base. The only way you can do that is when you’re organized to do that and that’s what this organization is designed around. We do have some digital problems still, I asked how many client relationship management system we had it turns out its 33, one better than the next.
The one in Asia is terrific but it works for only one business and it is constrained. I can see how we get to 33, we need to change that so we have a common system so we can have a common dialogue with our clients and that’s achievable.
The other exciting part about the client interface being brought together is we’re going to see real revenue opportunities in front. Sallie just yesterday told me that in Eastern Europe we just won a mandate, an investment banking client who just put in our care $2.2 billion and that we believe there’s going to be many more dividends along these lines. Michael Klein as Vikram has talked about has been charged with taking that from a concept and bringing it to reality and we’re taking one of the most important leaders and saying make this work. It’s a very difficult job and I’m sure its going to be effective.
The third part of the client integrated model that I like is innovation. As you get close to the client you’re now able to really listen to the needs, maybe more importantly the unmet needs and that’s what we plan to do. Citi has a heritage of innovation and we need to restore that. You heard from Steve the type of innovation that he’s talking about within the Card business. Steven Bird and I when we were in Korea went to SK telecom to the opening of that joint venture and its absolutely fascinating because you realize in Korea a phone half the size of this is really how people pay.
Korea being the most online country in the world we’re putting our innovation in the leadership country and then being able to harness that across the board. To help us in the innovation we just hired as a senior advisor to us Irving Wladawsky-Berger. I have to admit we couldn’t get him full time because he’s still working advising IBM and Google in their computing and two other days a week he’s teaching innovation at MIT. He is giving us three days, actually one of them is Sunday and he doesn’t miss a Sunday and we are excited by how he’s organizing us.
In fact, today he’s down in Mexico visiting Banamex and he was sending me notes as late as last night as you have to get down here and see what they’re doing. That’s the way we’re approaching innovation here.
I’ve talked about most of the topics of the early observations but I haven’t addressed culture. It may be the most important of all of the topics that we have. If you step back and look at, and you understand the Citi culture as we’ve been trying to you have to realize that something needs to change. What we’ve done here with this new organization is we’ve been very explicit. We’ve been explicit about decision rights and accountability.
With accountability we can really measure both the performance of a group and an individual. With that measurement we can build a culture of meritocracy which is the cornerstone of the new Citi culture. Meritocracy alone won’t get us there we need more than that. We need a shift in behavior and we’re beginning to do that. I can feel it already. One of the things Vikram has announced to the Executive Committee is he is realigned our compensation so that we collectively are going to be judged on the value we bring to you as our shareholders.
In addition to that he has told us that he is going to evaluate individually each one of us on our partnership like behavior of what we’re doing to drive Citi together. Last night Vikram hosted a senior leadership dinner. It was the first time he pulled this group together. No one knew who they were in terms of who was in part of this leadership team until they came together. We talked about what we need to change and he gave us our mandate of what we need to do for the transformation.
He then broke the group up into five different tables and asked them to talk about risk, talk about capital, talk about clients and talk about innovation and growth then get up at the end of the dinner and talk about what they believe the right action plan was. Two a table the person who got up said what we need to do is change our culture. Two a table. The risk table got up and said what we need to do to change risk is to become personally owning the risk culture.
I was most encouraged with the dinner. You can actually see the organization go from theoretical to execution and I think it’s a great start.
The only thing I would add is we may have 33 client management systems around the world but not in Mexico. We talked to you about legacy assets, we’ve talked to you about core Citi, what core Citi means, we’ve talked to you about our five platforms, we’ve talked to you about what we’re doing to execute against the strategy.
When I started as CEO I said together with Gary we’ve got three important priorities, capital, costs and risks. You saw that in our stage one of getting fit so let’s talk about risk and before I bring up Brian Leach who is our new Chief Risk Officer let me briefly tell you how we’re thinking about risk. The first point I would like to make is we must protect the franchise. We create tremendous value in our core businesses that we’ve talked about. We must avoid negative outcomes that destroy value.
Obviously what that means is we need to manage the size of negative outcomes. Diversification in itself is necessary but not sufficient to manage risk. The second point is that for every one in our business not only hear but around the world recent events require to philosophically rethink our approach to risk and capital. The markets are shifting from just in time liquidity, just in time capital environment; in addition we and our competitors may not be able to count on distribution of risk, securitization of risk as risk mitigants which changes the game in many ways.
The future model may require need for balance sheet and capital beyond what it’s been in the past which of course makes our model extremely valuable. It’s up to us to figure out how we manage that optimally. We also think about risk as an opportunity. Don talked about data; I talked about harness our information. We do, we have tremendous amount of data and intelligence in this organization and a lot of natural client flow business all of which creates an opportunity for us to harness and take intelligence risks.
We’re going to leverage capacity to the full and think about risk not only from the perspective of managing our franchise but also allowing us the opportunity to capitalize on our franchise. With that let me turn it over to Brian Leach.
I’m Brian Leach and I was appointed as Citi’s Chief Risk Officer in February of this year. It’s a pleasure to be here today. As Vikram noted it’s been an unprecedented three quarters for Citi and the Financial Services industry as a whole. I know that you’re anxious to hear about the changes we’re making to the management of risk at Citi and I’m anxious to share these with you.
I am taking these steps with the support of Vikram, Gary, the entire senior management team and the Board of Citi we all share the same goal to strengthen and enhance the management of risk thereby creating a competitive advantage for Citi and ensuring long term value for our shareholders.
The first step I’ll describe to you is how I am changing the risk management function, creating new roles and bringing new talent to complement the existing team. I believe that with an organization the size and complexity of Citi we need to approach risk management from three dimensions. We have risk managers aligned against each business, against each region and against the critical products at Citi.
I’d like to spend some time describing my expectations for the roles shown here. I’m holding every member of each of these groups ultimately accountable for the management of risk in Citi. However, each group has a separate but complementary role to play in the process.
Starting at the top of the slide each of the businesses ICG, Consumer and Global Wealth Management have a Business Chief Risk Officer. These businesses have unique complex challenges; the Business Chief Risk Officer understands these risks. These individuals will be the focal point for risk decisions for example limit setting and transaction approvals and will manage the majority of our experienced risk management professionals already in place.
For the ICG Chief Risk Officer role Richard Evans is joining on June 1st. I’m certain many of you are familiar with Richard given his two decades of experience in risk management most recently as the Deputy Chief Risk Officer of Deutsche Bank. I look forward to him joining our team.
Going to the right hand side of the slide the Regional Chief Risk Officers are in direct response to Vikram’s new regional business model aligning Citi’s resources more closely with our clients. The Regional Chief Risk Officers are accountable for the risks in their region and will be the primary contact for the regional business heads. They will also engage with the regional regulators to ensure that our governance structure has the highest level of integrity.
On the left side of the slide I’ve created the role of Senior Product Specialist. Product Specialists have demonstrated market expertise in management experience in areas of critical importance to the organization. They have accountability for the risks within their specialty. They will focus on problem areas looking across geographies and business lines. Most importantly they will review the underlying business model to ensure the sound use of capital based on the risks incurred.
The Product Specialists are a resource to me as I focus on areas of greatest concern and of equal importance are a resource to the Business and Regional Risk Officers giving them greater ability to focus on the day to day management and responsiveness business flow.
Finally there is the Business Management Team. The common foundation shown across the bottom of the page. It keeps the risk organization functioning effectively with the right infrastructure processes and management reporting. This also includes managing our very critical regulatory relationships. The enhancement of Citi’s risk capital model and the integration of the model into the decision making process is among my top priorities.
We need to ensure that our risk capital model is intellectually consistent across all activities regardless of the accounting treatment, the booking vehicle or the business line. We also must be aware of off balance sheet risks and liquidity risks and ensure that these are sufficiently captured. We also need to measure the fat tail risk appropriately.
Risk architecture is needed to ensure integrated systems with common metrics facilitating the aggregation and stress testing of exposures across the institution. In my opinion this is a necessary condition for the achievement of our goal of best in class risk management. Infrastructure risk is what I look to in order to improve our processes across businesses and geographies. It will be closely aligned with our operational risk managers to ensure that best practices are identified and shared.
I will rely on these experts to help me manage what is arguably Citi’s greatest asset. But also the biggest challenge, the sheer vastness of the franchise.
My goal today is to describe to you the steps we are taking to strengthen and enhance management of risk at Citi. I have described the changes we have made in the risk function itself to build talent and ensure accountability. Of equal importance are the steps being taken in conjunction with my partners in business and finance to reduce risk in areas of greatest concern to enhance the risk management framework itself and to affect the necessary changes in the risk taking culture at Citi.
We actively managing areas of greatest concern to us. These are referred to as our focus positions. You won’t be surprised by any of the items on my list. It includes super senior CDO positions, residential real estate and highly leveraged financing as well as others. This is not simply an aggregation exercise although identifying and dimensioning all of the pieces is a critical element of the process.
We are in active dialogue within risk and across the businesses to analyze the underlying exposures and weigh alternative courses of action. Let me take just a few minutes to talk to some of these positions. We have $23 billion of ABS CDO super senior exposure which is in marked assuming a 20% peak to trough decline in housing prices. Two billion of this exposure is backed by riskier mezzanine portfolio which during the first quarter was partially hedged by using credit default swap.
Sixteen point eight billion is composed of ABCP super senior exposure whose underlying over vintage securities benefit from substantial credit support and as of today have experienced minimal credit losses. This ABCP exposure is generating approximately a 500 basis point credit adjusted net return. We have a residential first and second mortgage portfolio in our US Consumer Business of approximately $220 billion. Gary spoke about this in some detail on the first quarter earnings call as well.
From a risk standpoint, we have made significant changes in our origination strategy and standards, including stopping third-party originations in second mortgages and significantly tightening our underwriting standards across first and second mortgages, for example, lowering maximum loan to value ratios.
These changes are improving the quality of new business we are booking. We are also proactively managing those portions of portfolio that we are most concerned with and we continue to augment our collections and resources and programs to work with our customers.
We are also very closely managing our other consumer portfolios such as cards and autos by implementing a series of policy and actions an ensuring that we have the right collections effort against it.
Finally, we have $28 billion in highly leveraged financing underwriting exposure after taking into account the substantial sale we just completed in April. That sale, as well as the hedging of a portion of our super senior exposure, are specific examples of the type of analysis and action we are undertaking with respect to our focused positions.
In addition I want to assure you that Citi takes the lessons learned from recent events and makes critical enhancements to its risk management framework and to its business framework to ensure that we are integrating risks systematically into our decision making process.
This includes the following steps: we are conducting a comprehensive systemic stress testing of the entire balance sheet. This includes mark to market and accrual positions and produces output based on both historical, such as the fall 2007 subprime crisis and hypothetical scenarios such as stagflation.
We have begun to rationalize the limit structure, particularly in markets and banking. This includes reducing limit sizes in some cases, simplifying the limit structure in other cases and formalizing stress limits across all the products. As I mentioned earlier, I believe that enhancement to Citi’s risk capital model are needed in order to create a risk base against which reward decisions can be consistently evaluated.
The stress testing I just mentioned is critical to ensuring that that is happening. Once we have the risk capital base, we need to look at returns on our risk capital on a transaction level as well as an aggregate portfolio level. We need to ensure that we are being compensated for individual transactions appropriately and that our portfolio of businesses is generating appropriate returns to our shareholders.
Those risk reward assessments lead me to my last and arguably most critical point and likely the point that many of you have questions about. A change in the culture is required at Citi in order to fully achieve the goals that Vikram has set out for me, for himself and for the organization.
I see two critical aspects of that cultural change. First, we need to harness the incredible global information set that is unique to Citi to help us make better risk decisions. That information set is a competitive advantage, one that we need to do more with. It requires working across the traditional business silos, not just with systems but with analytical resources and dialogue.
Vikram’s regional business model will facilitate that change. Second, business, finance and risk working in concert need to more rigorously assess risk return tradeoffs and incorporate such analysis into the business decision process in a disciplined manner. Doing each of these things requires a mindset change on the part of risk management and on the part of business management.
I support that mindset change. I view the evaluation of risk reward tradeoff as part of my job and I fully expect my risk management team to look across the business, region and products areas to achieve optimal results for Citi. I know that we have Vikram’s full support on this change as well.
I’m confident with the willingness of our entire senior management team to lead by example, we will be successful in fostering a risk taking culture that creates a competitive advantage for Citi and long term value for our shareholders.
With that final point I’ll pass it back to Vikram and I look forward to answering your questions during the Q&A session later today. Thank you.
Brian thank you very much. I want to introduce Gary. Gary is going to talk about three things: one, with his reengineering hate he’s going to talk about the reengineering state. He’s going to talk about the legacy assets again, we wanted you to understand what we’re doing with them. And lastly he’s going to talk about our financial model. Gary.
Thanks very much Vikram, it is nice to be with you all, we certainly appreciate you taking the time to be here this morning and I hope this is a useful review for you. As Vikram said, my primary job today is to ensure that you walk away with a very good understanding of what the earnings power of this franchise is and so I’m going to go through business line by business line and give you that perspective and then he’ll sum it up for the total company as a whole when we come to the end.
But I thought it might be worthwhile to spend just a minute talking about the history and to take the time period from 2001 to 2006 as kind of a period that was instructive and helps us learn what we need to change about the company going forward from a financial standpoint.
I would imagine that you would be surprised to think that from the time period from 2001 to 2006 that our compounded annual growth rate in earnings was actually above 13%. Obviously it was a little volatile during that time period but on average our compounded growth rate in earnings was above 13%.
Our return on equity as a company averaged just over 19% all during this entire time period. And yet, interestingly enough, if you look at the way our share price performed during that time, it was absolutely flat. We had a period when it dropped, we had a period when it increased but if you went over the entire five year time period, there was essentially no shareholder value created by that growth in earnings.
And I think the real question is, why did that happen and what can we do going forward to ensure that the next five years are not a repeat of the five years that existed between 2001 and 2006. And there’s a couple of different charts on productivity that I’d like to show that relate to this. There’s actually a very simple and straightforward answer to that question.
The answer is that to achieve the additional revenue, we spent increasingly more in terms of expense and we dedicated more in terms of assets so that there was no shareholder value created. If you look at the chart that’s on the right hand side of the board here, if you look at the first time period from 2001 to 2003, and you look at our efficiency ratio, remember on an efficiency ratio, low is good, high is bad.
On an efficiency ratio basis, during that first three year time period, our efficiency ratio averaged 54%. If you take the last three year time period it went up by 4 full percentage points, it averaged 58%. If you look at our use of assets, so what was the revenue return to assets during that time period, it dropped by 23% over that five years.
And because of this additional consumption of expenses, the additional consumption of assets, we did not create economic value and as a result our share price didn’t improve. And what I’d like to talk a little bit about is what about this is going to change going forward, and I’m going to use a very simple model to do this.
Now as I do this, I say this with a couple of cautions. I’m going to give some very precise numbers. The numbers I’m about to use are not precise, by very definition I’m talking about what’s going to happen over the next two to three years and certainly the environment we’re currently in is characterized by a lot of uncertainty. So think of these as targets that we’re thinking about internally for the individual business lines in which we compete.
The second thing is, I’m going to talk about GAAP assets and all of you who follow us closely know that we do not allocate GAAP assets down to product lines, we allocate risk capital down to product line. But I thought that you could more easily triangulate back to GAAP capital, so we would use GAAP capital.
So we have used risk capital, we’ve used regulatory capital and total invested capital to triangulate on the way we’ve allocated GAAP capital to each of these individual product lines. So just keep that in mind as I go through the material that I’m going to cover today.
Now I’m going to focus on our earnings power and I’m going to explicitly talk about that in terms of the return on equity of the company and our individual business lines. To make it simple, I thought I would dissect it into the buckets that you see here on the chart. So obviously return on equity is the product of margin times asset productivity times leverage.
And for our purposes today, I’m not going to talk about leverage, I’m going to ask you to assume that we’re going to be thoughtful about that and we’re going to manage our leverage in a wise and conscientious way.
So I’m going to focus on the first two of these which I think will probably be the ones of most interest to you, starting with net income divided by revenues and our revenue productivity. And I’m going to specifically go through each of the business lines first in the same order that Vikram has reviewed these business lines to put financial parameters around the specific strategies that he described in his presentation.
So let me start with global wealth management as the first example. The top part of this charge on the left hand side is efficiency ratio in this business in the time period from 2005 to 2007. I show you our efficiency ratio and for obvious reasons I’ve averaged the rest of our competitors.
On the bottom part of the chart I have our asset productivity during the same time period. I show our asset productivity, I’ve averaged that of our competitors and each of the charts that you’ll see have essentially the same information in them.
If you look at this business and you focused on both the efficiency ratio and asset productivity, you can see that we’re better actually than our competitive set in both of these measures. From an efficiency ratio perspective, that’s driven by the fact that particularly in the brokerage business in the United States, when you take the average we have a slightly better cost structure than the average of that competitive set.
Over time, we believe there’s an opportunity for us to improve that efficiency ratio over the next two to three years to something like a target of 75%. Now just a couple of factors that underlie that: one is we’re making a significant technology investment in that business and secondly as Sallie announced about six weeks ago, we are unifying the support platforms in the company behind the various product lines that we have, behind our private banking business, behind our Smith Barney business.
By taking those steps, in aggregate, we target to save something like $100 million in support costs across those two platforms. Those two actions taken together in large measure contribute to the accomplishment of a better efficiency ratio going forward.
We have one other advantage and that is we operate outside the United States and we have terrific returns associated with that business. As that business grows faster than our business outside the US, that mix change over time also contributes to the improvement in returns that you see at the bottom of the page. And these are the kind of targets that we have for the business over the next two to three years.
Let me now move from this business and I’ll talk a little about the card business and I’m going to ask you to focus on the column that is right in the center of the chart here which is the Citi average. We often talk to people about this and they say that our cost position in the card business is high relative to our domestic competitors.
As you can see, if you compare against our largest competitors in the US, that average, that would be a correct conclusion. However, it is really somewhat obscured by the fact that we operate internationally and we operate domestically and we have different cost positions in those two markets.
If you look on the far left hand side, you can see that in the US our efficiency ratio is 36%, higher than our competitors. When Steve spoke, he spoke about integrating the silos that exist within the US card business today, we have a bankcard business, we have a private label business and we have an opportunity to integrate those silos in a way that should generate substantial benefits for us as a company.
That in combination with gaining scale as a result of the globalization of the card business we believe will allow us to have a targeted improvement in our efficiency ratio to something like 33% if you go out two to three years from today. Now that’s the blended efficiency ratio of the international card business and the US card business run as a global card company just as Vikram and Steve described it.
We believe at the same time that will result in a modest improvement in our return to assets, so our asset productivity will improve. The reason it’s not improving more is that those markets become increasingly competitive over time. But as our business continues to shift internationally in spite of the increased competitive nature of those markets, we anticipate that we’ll see improvements in our average revenue as a percentage of our assets as we’ve shown here on this chart as our target.
Let me turn now to consumer banking. Again you can’t think about consumer banking as one entity across the world. Vikram talked about the fact that we’re organizing this business on a regional basis. So you really have to split it into its component parts. And let me talk about the US.
Again if you just look at the superficial analysis and took the entire consumer bank segment and you took our efficiency ratio and compared it to our competitors, we would look like world beaters. My guess is that’s not the impression that you have. We would look like world beaters.
The reason why that is, is that over time we have grown a very significant mortgage business with enormous revenues and those revenues taken against our cost base give us a relatively low efficiency ratio. However, those same revenues have caused us to have a penalty in asset productivity. You can see that our asset productivity when compared to our competitors lagged.
As we talked about both in the press over the last couple of months and then more today, we intend to wind down a significant portion of the legacy assets that are in our mortgage portfolio. As we wind those assets down, two things will happen. One is our efficiency ratio will actually deteriorate, not a bad thing because our returns are going to go up more than commensurately because of the reduction in mortgage assets as a percentage of our total.
But just to give you an idea of the magnitude of the opportunity, if you looked at our retail bank alone as a single entity, our retail bank alone has an efficiency ratio of 79%. And you’ve heard Steve and others talk about consolidating our expansion efforts into markets around the US where we have a leading or a near leading market position.
As we accomplish that, we think we can significantly improve our cost position and all of that is baked into the improvement in the target. We will grow outside the United States more rapidly than in. We added 300 branches last year outside the United States in the retail banking business, my guess is that pace is going to continue very strongly outside the US.
And because of the more rapid growth rate outside the US, we expect also our returns to go up overall. So our asset productivity should improve both as a result of shrinking our commitment to the mortgage business in terms of the total amount of investment that we had there but also because of the continued shift to our position internationally to strong markets outside the US.
Let me now move from talking about the three consumer businesses that Vikram talked about and I’m going to talk about our two institutional businesses, securities and banking. Again, if you focused only on the raw numbers, on the efficiency ratio of the securities and banking business, again the conclusion you would walk away with is that we have the lowest costs if you compare us to our competitors on average over the course of the last couple of years, we do have a lower efficiency ratio.
However, the same phenomenon that existed in the retail mortgage business is also present in this business. That is to say we grew a very large fixed income as we had very large positions as Brian described which over time generated revenues, generated a significant amount of revenues but consumed a disproportionate amount of assets.
The net result of that was we had the appearance of a low efficiency ratio but as you can see compared to our competitors, we had a relatively low asset productivity. Our intention is to reduce the exposure that we had in the fixed income business while we over tie diversify our portfolio in the business lines where we’ve had success growing those businesses more rapidly over the last few years: our equity business, our prime brokerage business and the potential expansion further in the commodity businesses.
The net result of that will be very similar to the ratio change that you saw in the consumer banking business. Our efficiency ratio will actually deteriorate. We expect a target something like two to three years out of something like 55%. But importantly, our asset productivity will improve. Now if you look carefully at this chart, you might say that looks like a very, very small improvement for all of that effort.
But it turns out because the asset base is so large here that relatively small improvements are very significant. So if we went back to the first quarter of 2001, just to put it in perspective and we actually achieved the efficiency ratio that we’re targeting here two to three years out, we could have done $6 billion more in revenue on exactly the same asset base.
This is a material change in the way we’re thinking about managing the assets in the securities and banking business and we hope this will have obviously a very positive impact on our capital ratios.
This will be the last detailed slide I’ll go through and talk a little bit about transaction services and I’m going to start this time on the far right hand side, this business obviously consists both of our securities business and our cash business, but both businesses have very common kinds of characteristics.
This would show that we’re at a significant disadvantage relative to our target or that we’ve got a long way to go relative to our target. I should point out that there’s been very significant progress made in this business over the last three years, so even though this is the average, we actually finished last year at 58%.
That’s because of the growth that has happened in the business and the investment that we’ve made to improve our technology. And those commitments to technology and growth remain unabated as we continue to focus on this business going forward.
You can see down below again because of our strong international presence, generally we’ve had outperformance relative to our competitors, particularly on the cash side of the business. But we’re going to make a very important change, and that is we have 5,000 clients around the world that are large, very successful multi-national companies, the kind that Vikram, when he used the Shell example a little bit earlier, that use our services very broadly.
Those are the kinds of clients that we as a company should serve, they fit right in the heart and soul of what we’re best at and those 5,000 clients have tentacles in their supply network that we also need to serve. That’s the kind of heart of what we should do from a business perspective.
There are also in addition to that, tens of thousands of small companies that are frankly not best served by Citi direct where we can white label our products and services to be served in those markets at a much lower cost. That shift in our focus by customer should allow us to increase our total penetration of the market, maintain the network that we need for our large clients, but improve both our cost position and the asset productivity that we have over all as an organization.
And that’s what’s reflected in the targets that you see on these charts. So that was kind of a little bit of a view of the stepping through each one of the individual businesses. What I’d like to do now is come back up out of the businesses and come up to the total company level and step you through the elements of this little model in a way that gives you a bit of a perspective that covers the entire organization.
So again, we’re heading towards the path that’s going to take us to return on equity. I’m going to focus first on net income margin and then secondly I’m going to talk about revenue productivity. Now net income margin obviously consists of a couple of major factors, one is the cost of credit and the second is efficiency rate.
Now in terms of the cost of credit, obviously this is something very, very difficult to predict. I’m going to give you some average numbers here in just a minute. But one thing I will say is that the next few quarters are unlikely to be characterized by averages.
I said in the third quarter earnings conference call that there’s obvious deterioration continuing to take place both in the credit card business and in the residential mortgage business and we expect increases in credit cost as we go through the next several quarters.
But if you take the average over a cycle, this chart represents the cost of credit that we’ve actually experienced divided through by our average loans in each of our individual product lines on average in the period of 2003 to 2007.
We think that’s probably a reasonable time period to use as a basis, we had the release of some reserves because of the benign credit environment that existed in 2006, we had an increase in reserves that existed during the course of 2007 and because of that change in the environment, we think this is a relatively good representation of what the cost of credit might be over time.
I should point out, however, that the 2.5% again is a bit of a misleading average. Typically, when credit is deteriorating, net interest margin is improving because the economy is weakening and there are offsetting elements in the income statement that you have to consider when you’re modeling.
Conversely, when credit is improving, generally interest rates are increase and there’s offsetting effects that go the other way. So as you think about this 2.5%, it’s probably not right to think about it being applied kind of blindly without a little bit more intuition about what’s happening to interest rates at the same time for the company going forward.
But this, for our purposes, is what we have assumed on average given that was representative of the time period over the course of the last four years. Now, the thing that is probably most in our control and the thing that we’re focusing most of our attention on is what our efficiency rate is going to be going forward. And I’ve gone through specific targets for each of the individual business lines and I mentioned in a couple of cases what we think the primary factor is that drives that.
But very importantly here, we intend to make significant progress on reengineering. Let me talk just a little bit about some of the specific parameters that Vikram talked about just a minute ago. So we think about ourselves today as having something like a 62% efficiency ratio. That adjusts for the fact that we had marks that we took in the first quarter, we tried to take what was I think a $16.2 billion expense base and annualize it.
If you take that $16 billion expense base and annualize it, we have something like $64-$65 billion worth of total expenses, that would give us on a more or less normalized basis something like a 62% efficiency ratio as kind of a benchmark of where the company stands today if the environment weren’t quite as volatile as it is.
Now Vikram talked very specifically about the fact that we’re targeting over the next three years, including this year, so 2008, 2009 and 2010, a total reengineering benefit for the company of $15 billion, most of that $15 billion will come as a direct reduction of expenses.
You’ve heard lots of examples of how that will come over time. It’s important also to realize that when we think about reengineering as a team, we think about the entire income statement. We think about opportunities for revenue reengineering, that is permanent changes in increasing the value capture that we get from revenue.
We think about it in terms of cost reduction, we talked about some examples of that. We think about it in terms of credit improvement, reducing fraud, reducing credit for every dollar of billings that we had and we think about it in terms of improving our tax effectiveness. There’s four kind of major buckets to shoot against. We expect, however, the majority of what we do will come out of our cost base over time.
And so we’ve expressed this as an efficiency ratio relating to that cost basis. Now we’re targeting, if you take the blend of everything that I just showed you on the next page and you take the growth rates for these businesses which I’m going to go through in just a minute, we’re targeting an efficiency ratio two to three years out of something like 58%.
Now if you think about that 58%, you could think about it in a couple of different ways. One of the things we could do is we could take the $15 billion out and not make any reinvestment back into the business. That’s certainly a choice that we could make over time.
Another possibility would be the business would grow in line with what I’m talking about here and we would make investments back in the business. If you make some assumptions about the growth in the business, the target of 58%, you could conclude that we could invest something like $20 billion back in the business and given our expectations for growth, still have our efficiency ratio improve from 62% down to 58%.
But there’s many other combinations of scenarios that you could think of. Our reengineering actually might be higher than the numbers that I’m talking about here. We may choose to reinvest more or less than the number that I just talked about. It depends highly on what our revenue growth rate actually turns out to be which is a function of both our competitive success and what happens in the environment.
So there’s a number of ways that you would have to think about these numbers, but if you think about what we’re targeting to try and achieve, this is what we’re targeting to try and achieve given the assumptions that I’ll talk about here for revenue growth rate in just a minute.
So let me just give you a couple examples of the things that we’re currently working on that I think will give you a flavor of the kind of opportunities we have ahead of us. Don talked a little bit about bringing together the functional areas of the company. If you take finance as an example, we’ve operated finance just the way Don described it, that is each individual business had its own finance infrastructure.
We have the opportunity to bring that financial infrastructure together and operate it in large financial centers around the world. We’ve opened three of those centers, one in Tampa, one in Costa Rica and one in Manila. By just bringing those people into those centers, we’ve been able this year to eliminate 5% of the 8,800 people that work in finance.
We also have moved 15% of the total jobs in the organization into those centers. This year, before severance costs, we’ll achieve a $65 million benefit associated with doing that and we have strong expectations of being able to increase that savings as we go through the next two to three years.
Another example, you know we’ve been working on data center consolidation. Last year we had 52 data centers. This year we’ll finish the year with 32 data centers. Next year we’ll finish the year with 14 data centers, reflecting the fact that Kevin has had the capability and the control to drive the consolidation of those data centers over time.
I mentioned revenue and it’s interesting, revenue reengineering actually turns out to be improvements in cost efficiency and let me give you one example to explain how. We did a test earlier this year of changing the incentives that we have in our consumer finance business. We used to offer in each one of our locations a total incentive that would be paid to the entire team based on the growth in loans in that particular center.
We decided to test this scenario where instead of paying the total center based on total loan growth, to pay based on individual loan growth so that you would get an individual incentive rather than an incentive for the total store. We tested this, we tested it against kind of normalized samples, finished that analysis and concluded that we should roll it out.
We’ve now rolled it out over the course of the last nine months. We’ve had an incremental $1.4 billion in loans that have been generated, $100 million increase in revenues and when you take that $100 million increase in revenues and factor into the efficiency ratio, now as the denominator, we’ve had a 94 basis point improvement in our efficiency as a result of this aspect of revenue reengineering.
So the primary source of our savings here is going to be cost driven but we intent to attack the entire balance sheet and through that effort generate something like $15 billion worth of total benefit from a reengineering perspective over the next few years, some portion of which may be invested back in based on the growth rate that we see in the business and the opportunities that we see going forward.
Now I think it would be right for you to ask the question, what’s going to be different about your success in reengineering this time? And let me just mention a few factors that I do think are different. One is we have a centralized reengineering team with competent people who have skills and capabilities in this area to work with and advise the businesses.
Secondly, our senior executives will now have this as a significant portion of their compensation. It’s going to be our wallets and our hearts are going to be in the same place on this topic. Third, we’re doing this over a longer timeframe. We’re not trying to get this done as a one quarter wonder. We’re trying to make this happen over a longer time period and with a longer time period, you can take on projects that have a longer time period associated with them.
Now it’s important to say that against this $15 billion, I have not calculated what the severance implications are. I don’t know today exactly what the severance implications are and there will be some, we’ve had severance last year, we had severance in this quarter, there certainly will be some.
My guess is there will be roughly a commensurate reduction in headcount associated with this activity over time. Although, the headcount reductions may come more quickly than the cost reductions because we have opportunities for divestitures, we have opportunities for outsourcing activities and then we have the normal productivity enhancements.
So you’ll see those first potentially evolve at a somewhat different rate. But I think you’ll see that with the changes in approach here and focus that we have an opportunity to reduce these costs.
The final element that makes it different is we have regional CEOs. They now have the responsibility over their local infrastructure. And as Manuel described, that gives us an opportunity to bring those infrastructures together in a way that simply was very difficult for us to achieve before. So all of that taken together we hope will give us an improvement that is akin to the target that I showed you.
Let me now move from talking about net interest margin and talk about aggregate company asset productivity. Now obviously this is a function of a couple of things, how fast is our revenue going to grow and what’s going to happen to our assets during this same time period.
And let me start by talking about the revenue side of this equation. Now this is a set of numbers on the left-hand side of this chart, it looks like we just kind of wrote down what would be kind of the revenue side of this equation. Now, this was a set of numbers, on the left hand side of this chart and it looks like we just kind of wrote down what would be kind of a possible number for each of these segments.
What we’ve actually done is go through a pain-staking process at looking at each of the product lines in which we compete, we’ve looked at the countries in which we operate, the regions in which we operate, and we’ve taken the growth rate, our current success in those product lines in each of those regions and then the weighted average calculation for those numbers. And that’s what’s represented on the left-hand side of this page.
Again, these are targets. We may do better than this, we may do worse than this, but these are targets that reflect what we think is achievable given the geographic positions that we have as an organization. The revenue to asset rate, on the right-hand side represents the targets that I showed you from the prior page. This assumes our legacy assets are completely wound down, and I’ll show you how that wind-down may take place in a chart or two. This assumes our legacy assets are wound down over time. And so obviously, as our business grows, the mix of revenue to assets will change as our business mix grows. It’s one of the fundamental factors that will drive our asset intensities going forward.
If you focus on where the legacy assets will come from, not surprisingly, it will come from where the assets are. So we have most of our assets tied up in our consumer banking business, a large hunk of that obviously in the mortgage business today, and a big hunk tied up in securities and banking. Most of the nearly $500 billion in legacy assets that Vikram talked about are in those two businesses and that’s where our attention and focus is going to go, to work those assets down over time.
Now, Vikram showed you one split of these legacy assets. Let me give you another split, on the left-hand side of the chart. This now shows you by type of asset, the way we think about it, the way we manage these assets. So, the blue portion here are low-return assets. In your mind you can put residential mortgage portfolio against that bucket. You saw on a prior chart with that business, that’s a relatively lower returning part of our total portfolio and either through selling, or through having those assets actually mature over time, that portfolio will wind down. We’re going to manage it down as quickly as we can, but we’re very susceptible, obviously, to market conditions and being able to do that. But that portfolio eventually matures. It has an average maturation life and it will roll off over time.
Secondly, we have mark-to-market assets. Brian talked about that. That’s the CDOs, the SIVs, the leverage loans, the things where we’ve taken significant marks. We’d actually like to have lower overall positions over time against some of those asset categories to reduce our concentration.
And then we have non-core assets. These are things like CitiCapital, CitiStreet, Diners Club International, the businesses you have seen us sell over the course of the last little while. That process will continue. The total assets represented by that is roughly 18% of the total number.
Now we think, again on a targeted basis, that we will be able to do something like a reductions from somewhat less than $500 billion to somewhat lower than $100 billion over a five-year time period. We can do better than that. If markets suddenly became much more active for some of these securities, we could do it much more quickly than that. It could also take longer, if markets were tighter than they are today. But this is kind of a best guess of what we think a reasonable target is, of the length of time that it will take us to work through out of these assets.
Now let me roll this all together across all of our individual business lines. The left-hand side of the chart shows the percentage of our assets that will be wound down out in a two-to-three-year time period. We believe that most of the security and banking assets will be done by that time period, again as a target.
From a consumer banking standpoint, it depends highly on what the markets actually do but something north of 50%. I showed you the revenue growth numbers from the prior slide; I gave you what our efficiency targets are; I talked about our asset productivity, again, remembering that this is under the assumption that our legacy assets are worked out of the system. And all of that then results in the return on equity targets that you see on the far right-hand side of the page. I think if you benchmark these returns on equity numbers against our competitors, you would find that they hunt. They’re in the same zip code as those of our competitors.
Where we have unique advantages is because of the footprint of the company and the growth rate that is going to be associated with these returns going forward.
Now, if you took the weighted average of these, you would come up with a number that is much higher than the number that Vikram started his presentation with this morning. And you have to ask yourself, “Why is that? Why is there a disparity between those two?” And let me just kind of take you through the way we thought about that.
As Vikram said, if you take a pro forma 2:1 ratio and the company, as we finished the first quarter, we were at 8.8%. That’s how we would have finished the first quarter with all the capital raising that we’ve done. Over the next few years, we will have, as you go through and do the modeling, I think you will calculate that we will have a significant pool of retained earnings beyond the dividend that we plan to pay. There is also somewhere, you know, $400 billion-$500 billion worth of targeted asset reductions that will come during that time period, and as those assets roll down there is real capital that is generated back into the system from that. And then we have the normal exercise in employee stock options, the exercise in restricted stock, which predictably over the years has added to our capital rate. If you sum that up end-to-end, how much capital is implied about this kind of 8.8% current level, you would conclude that there is well over $40 billion worth of capital during this time period that is above that level.
And the question is, what happens to that capital. Does that capital go to cover a shock scenario that happens in the future, like Brian talked about? Does that capital go for a share repurchase program? Does that capital go for investment in the business lines that we’ve talked about, given the opportunities that they have? Does that capital go to enable us to increase our dividend? Those are decisions that we will make over time, obviously, as our business evolves.
But the key is we have very strong businesses that have very strong rates of return associated with them, that if we are able to achieve these targets, will generate capital above our current pro forma ratio, over we have a great deal of latitude about how it’s spent.
Let me summarize the numbers for the day. We think we can grow our revenue at 8%-10%. Gary talked about an efficiency ratio of 58%. As I said when we first started, if this were a normalized environment today, today we could earn $20 billion plus, as a company. And that on our total equity, which is about $129 billion, is 16%-18%.
We think that ROE grows overtime, $15 billion of re-engineering saves on a $64 billion cost base, redeployment of capital, Gary’s talking about, giving back to you, put into our business to grow, we should be able to get to 18%-20%.
Now, let me step back again to our strategy. There are some people who may walk away and decide that what they’ve heard today is similar to what they’ve heard before, on the company. It’s really not much different. Let me tell you, what we’ve talked about today is fundamentally different. On the asset side, a $500 billion asset number is not a trivial number. And what we’ve done to clarify our businesses, in terms of looking at non-core businesses and making sure that we keep those we’re fully committed to, and they are growth businesses, great quality businesses in areas of growth, that is different.
On the strategy side, it is different. We’re going to be driven by risk-adjusted returns, on capital, stability, and growth consistent with that. The capital focus we have, the cost focus we have, risk focus we have, all those are part of a different risk model. Our structure is different. We are now designed, finally, to deliver against the objectives with the full might of the company. And our people. We have the right team, we have a new team, I’m committed to making sure I have the best team in the business, they have my full support. Each and every one of us are jointly and separately accountable and I believe we are going to get it done.
So as I close my remarks, I would like to sum up with what’s going to differentiate us, the five points that are going to differentiate us over the years, as a company.
The first is capital efficiency, which is self explanatory. We can generate higher returns over time because if we properly manage risk, we can operate with less capital than would be implied just by adding the businesses together.
The next is operational efficiency. I think we’ve just skimmed the surface here. We should be able to redefine best-in-class margins in financial services.
Third is our culture and talent. We’ve talked a lot about these issues today. Well, you should know that we will be very focused on this because we understand, as you do, that we can’t be successful if we don’t have the best people and a culture built around teamwork and meritocracy.
Fourth is our ability to leverage our company. We have a tremendous opportunity to increase revenues by focusing on linkages between our businesses for our clients and by leveraging our information advantage and our ability to innovate.
And fifth, we will be the first truly global universal bank with an unparalleled brand.
So towards that end, let me introduce to you our new tag line, which I believe is completely appropriate for the new Citi.
Every night that you sleep, but your dreams are wide awake, because visions never sleep, aspirations never sleep, goals never sleep, hope never sleeps, opportunities never sleep, the world never sleeps. That’s why we work around the world. That’s why we work around the clock. To turn dreams into reality. That’s why Citi never sleeps.
Thank you all for joining us today. We’re going to now go to our question and answer session. I’m going to ask all of our senior executives to come up and there will be people with mics in both alleys. And I hope this is a robust session.
By the way, I might turn to other members of our management team that are in the audience. If you have some specific questions, Mike, we’ll call in for the best help our business managers.
We’re going to try and be as candid with you as possible. I hope you can walk away with one thing. We’ve done a lot over the last four to five months. We’ve accomplished a lot. And we’re set up to execute, we really are. And the wonderful thing about this company is every day I come to work, while I’m dealing with some of the issues that we wish we didn’t have, I walk away every day even more positive about the power of the franchise and what we can accomplish as a group.
So with that, why don’t we open up.
Michael Mayo - Deutsche Bank Securities
So the bottom line is, I guess you’re selling off businesses that equal about $100 billion on a $2 trillion balance sheet, it seems like you’re embracing the business mix that you’ve inherited. Basically you’re just getting rid of maybe 5%, from a business standpoint. So if you could validate that assessment.
And then secondly, if all the businesses that, I thought you might think about shedding more, would be the kind of developed market consumer. I mean, you highlighted five platforms, one of which is regional, and then you talked about exporting Mexico to emerging markets. What about developed markets consumer as an idea of maybe shedding down the room.
Let me start with this. I’ve told you what businesses I’m going to be in. Okay. They’re great businesses. I told you about the advantage we have, the positioning we have around the world. Focus on that. Focus on what we have. Focus on the fact that we did have a lot of assets. A lot of them wonderful assets. Even the assets that are not going to be here are wonderful. They just belong with somebody else.
So, the asset mix that we have selected is the asset mix that we believe we excel at, that we believe we add special value for the client at, and we believe we can do something special with.
But the asset mix is like the computer. Let me use a technology analogy, I do that with my son all the time. He wants the latest and greatest hardware. But the asset mix is like hardware. We’ve got great hardware. The real question is the software and the operating systems that we’re going to put in place. And that really is a fundamental difference, on that.
You talked about U.S. consumer. You know, the big parts of the U.S. consumer business, a) the U.S. credit card business. I like that business, it’s a high-return business. It’s an annuity business, and I believe it’s a growth business when we manage it that way. More importantly, that card business is critical to driving our growth internationally in even a higher way than it came in before and it’s part of the competitive advantage versus a local people in those markets could do that. That is absolutely clear. So that’s the U.S. card business. It’s a great business, when you look at the global monoline, one to the other plus what we can do here, cost re-engineering, etc.
The second major business is our consumer finance business. You know that business, CitiFinancial. It’s a great business. Maria runs it. You know, it’s a high-credit quality business, it’s got great underwriting standards and it is growing. It’s a wonderful business. Why do I want to, you know, it’s part of what makes us special in this country.
And the third is the retail bank. We’ve talked about that. I’m waiting for Terry to come in. She’s going to help us took at that. The efficiency ratio is higher than a lot of, we know how to change that. And that is exactly the right MSAs, affluence MSAs, and we’re going to leverage our entire network. This is going to be part of making sure that it leverages the best of Citi. We’re going to make it work.
That’s the U.S. consumer business. I believe each of these have true value in them and we can unlock it for you.
Stephen Wharton – JP Morgan
So, first of all I want to thank you for the information you’ve given and I think that providing metrics of success by line of business is crucial. You’ve laid out some goals. I know it’s early days for the lines of business where you’ve got new executives running them, but I do think that it would be extremely helpful, for this analyst anyway, if you would provide more clarity on GAAP capital by line of business. Because what you have laid out essentially is ROE by line of business for the whole firm, but all I get is your economic capital disclosure in the supplement, which doesn’t translate to GAAP capital by line of business, and I think that is very, very important for this time.
You know what? I completely empathize with that. I agree with it. Give it time. We’ll get there.
Stephen Wharton – JP Morgan
The other thing, it is along the capital question again, though, where you had a 7.7% ratio at the end of the quarter, which was actually a very low capital line and you went out and raised a lot more capital to get to 8.8%, and yet you’re telling us you’re going to leverage by $500 billion, generate what $40 billion in capital over a period of time. It just seems a little strange to me the need to raise so much capital here recently, in light of what’s coming.
Let me start by saying you’re absolutely right. We’re well capitalized. Everybody is entitled to their opinion, but we know we were well capitalized. We saw an opportunity in the market to take that from 7.7% to 8.8% with some dilution. Dilution is bad, I understand that. But small amount of dilution. I made that decision to do it because I believe in this environment excess capital is absolutely a strength. It’s a strength because the opportunities we’re seeing and where we’re going. That’s the reason why we did it. And we’re committed to having excess capital in this kind of an environment.
Stephen Wharton – JP Morgan
Follow up to that, how much re-intermediation do you envision near term as to your next year as a result of this stress that we’re experiencing in the capital market?
You know, we’re all asking that question. We’re also asking the question, what our capital market is going to look like. And this is something, obviously, I’ve been close to for a number of years with my partners, John and a number of people here, Jane Farrese, and I meant it when I said the industry is looking for what that transformation is and the industry is looking for what the future is.
We know that we’ve been in a 20-year cycle of disintermediation, particularly strong over the last five years where risk transfer is a major, major part of water acid productivity de-leveraging, or rather re-leveraging. And the need for less and less risk capital. You saw it, if you did nothing over the last five years, just buy any asset, if you bought any asset in the end of 2001 and held on to it, you came out looking beautifully well. Particularly if you financed it short term. And particularly if you kept taking equity out of it.
Well, that cycle is gone. We know that. That’s not the right cycle. We’re going to return to normalized risk premiums. What normalized risk premiums come down to understanding what the risk premium mechanism that’s going to exist out there and how does that translate into financing and liquidity. We don’t know the answers to that.
The only thing I do have an answer to is wherever it’s going, we’re better positioned than anybody else with the capital that you saw and our ability to earn a lot of returns for you.
Guy Moszkowski – Merrill Lynch
We heard a lot about systems integration and some of the opportunities that can be unlocked from taking advantage of the information that you’ve got locked up all over the world in silos. Presumably there is a cost to making that happen and as we saw with J.P. Morgan over the last 4 years or so, it can be a very significant cost. Which in their case certainly seems to have pushed back the achievement of the type of returns that they probably would have like to show earlier. Can we get a sense for what type of systems investment spending is incorporated within some of your expectations?
So I’ll frame it in kind of the way we thought about it in aggregate. So the position we’re at today, as I mentioned, is something like the 62% efficiency ratio and we’re targeting something like 58% if you kind of take those revenue growth rates that I talked about on the prior charts. And if you make some reasonable assumptions for revenue growth, you create a fair amount of spending capacity in the company. So that paradoxically, even though your efficiency ratio improves, the total amount of dollars that you’re actually spending goes up relative to this year’s expense rate.
And you can figure out kind of what that math is, but I think it goes up at not a inconsequential pace, if all of those kind of things triangulated in a way they needed to. And so, we obviously don’t know if all of those assumptions will come to pass in the way that we need to, and importantly, the numbers that I mentioned, you know, underline did not include severance, for example, to make that kind of thing happen, but I think there’s a fair amount of capacity for us in terms of expense growth, to provide the platform that is necessary for Kevin and Don to make the investments necessary to kind of bring some of these platforms together.
The reason I have such confidence in the number that I talked about when I was up here earlier, the $3 billion as a target over the next three years, is there really is a tremendous amount coming in our favor. Some of these are the Internet, which is really now starting to move towards what some people are calling 2.0, the ability to put together the systems by not trying to take traditional pipes and put them together, but really leveraging platforms and using outside providers to help us do that. That’s something that we don’t have a heritage of but something that’s going to shift in the model.
So that $3 billion number I have real confidence in, I own it with Kevin and his team. And why don’t I throw it to Kevin to give you some more granular details.
When we look at the $3 billion, about $1.3 billion of that that is in the IT space, and when we think about the spend that we have there today, it reflects how the business has grown up. So the silos that you’ve seen and the number of developers that have been talked about exactly reflect how we’ve grown up in the businesses.
What we’ve begun, even as we’ve only had this centralized from the application development side for a very short number of weeks, is we’ve begun the process of looking at how can we look at a prioritization, a framework, more globally around the place, when we benchmark or spend on IT as a percentage of revenues with Gartners. We tend to benchmark in line with industries. So it’s not so much we don’t spend enough but because of the complexity of the silos that we have in the background, that efficiency of that spend is not what we think it needs to be.
By taking some of the spend and deemphasizing legacy and non-core, non-strategic build, and putting that more squarely into building the bank, going forward with the type of services Don talked about, we think we can shift that spend in a way that will be quite effective.
So, Guy, every company has its own issues on opportunities. We have our own. The numbers we put up are our best judgment of what we can achieve.
So if we then roll up everything you showed us to ROE, I guess what’s going to be counter-intuitive for a lot of us, even though I know you’re looking at this sometime out, is that given the increased demand for capital in the industry, probably not just near term but longer term as well, the increase requirement that you’d be extremely well-capitalized, and the fact that we know that one of the ways that we know that the old Citi achieved a much higher than peer group ROE was through what I think we can now look at as having been somewhat excessive leverage, how do we reconcile the fact that you’re talking about getting the ROE right back to where it was?
One, 75% of our businesses are annuity businesses. Those things really don’t require that much capital. And they’re very high growth businesses. They throw off a lot of returns. That’s a very important fact.
The second consideration is we do believe risk premiums are going to go up. We only put capital to work to the extent that returns are there. You have an equilibrium. The equilibrium will come about. And it’s not that you’re going to put more capital to work against the same returns you have. No, the returns are going to equilibriate in our capital markets. That is going to happen. When you put the two together, it’s completely consistent.
The only thing I would add is that the number I showed on the chart was the number above kind of an 8.8% tier one ratio, Guy. Which happens to be the pro forma number that we use today. And there’s lots of things that could happen with that capital going forward. I mean you could, there’s no guarantee that all that capital can be used to drive excess returns or returns that are higher than the level that we talked about on the third line on that chart. We hope that it will be that way. We hope that we will have the opportunity to invest behind the [inaudible], we hope we have the opportunity to strengthen our share repurchase program. We hope we have the opportunity to do those things.
But the way we think about that is there’s a core earnings power of the franchise today, as it exists today, current business lines, normalized environment, that is really pretty good. And if you gook forward, with a reasonable set of assumptions, it looks like there is going to be a fair amount of excess capital.
Now none of us know as we’re sitting here today exactly how that excess capital will be used, and how it’s used will have a big influence on what that number actually is a few years from now. But there is going to be, I believe, a fair chance that there will be excess capital generated.
And one thing we will promise you is a completely disciplined capital budget process.
Meredith Whitney – Oppenheimer & Co.
I just need some help getting to the $20 billion target. There’s so much of this presentation that is predicated on the $20 billion target. Number one, in 2006 when you achieved the $20 billion, we were in a benign credit environment. And I don’t know what normal is, because this past 12 months has been so massively destructive. So can you actually normalize the $20 billion to today’s environment because of the resizing of the markets and banking segment?
And then also, in 2006, such a benign credit environment. And then just to add on to Guy’s question. J.P Morgan ran redundant systems and literally ran at half of its normalized earnings for 3 years, as well as did Wells Fargo when they integrated Norwest. So, if you could give me a linear progression to how you get to $20 billion I would really appreciate it.
First of all, I don’t believe everything’s predicated on the $20 billion, as we went through the presentation. As a matter of fact, that’s an important number but it’s not what the whole presentation.
It’s fairly straightforward. You assume that we have revenues that are roughly in the kind of range that we saw in 2006 or so, normalized in 2007 before March. You kind of assume that kind of an environment. You assume that our credit cost is kind of a normal cycle credit cost. No, 2006 was an unusually low credit environment. If you take the normal cycle numbers that I showed on the chart. I think it was 2.4% or something like that, as a percentage of average loans, and you take that, you make some assumptions about interest rates that would potentially prevail in an environment for a normal cycle like that, as an offset, and you assume efficiency ratios kind of in the ranges that we’re talking about here, and you come around and you assume a tax rate that is a reasonable tax rate, kind of what we think we can use going forward, you can come around to a number that looks something like that.
So, that’s fundamentally what we’re trying to do. We’re trying to say what do we think kind of normalized revenue would be in the environment if the environment were normal, what do we think the revenues would be, what do we think the cost of credit would be, what do we think the efficiency ratio would be in that kind of environment, and that gives you the $20 billion.
And be rest assured, we spent a lot of time with this. I’m not about to throw out a number, knowing that the fundamental thing we need to accomplish with this group is credibility of what we do. We’re not about to do it without having put a lot of thought to it.
Meredith Whitney – Oppenheimer & Co.
Credit is nothing like it was from 2001 to 2006 and it’s getting worse.
The time period we used, Meredith, was 2003 to 2007. Do you remember, in 2006 we had a big relief and in 2007 we had a big add. And I think we finished 2007 with an average, coincidence month coverage, not the debt, because of the way we do our analysis, but a coincidence month coverage of about 12 months. So I think it was down in 2006, it was up in 2007. And you obviously have to make your own assessment.
That’s the way we thought about it. We thought about it as kind of credit over the cycle, you saw the number that I showed up here on the chart. That was the fundamental assumption about credit. We made an assumption about what we thought interest rates would be in that environment. We looked at what the tax rate would be. We looked at what we anticipated the efficiency ratio to be. And it’s roughly in the range after taxes.
Meredith Whitney – Oppenheimer & Co.
And also could you comment on last Friday’s proposal of the OTS changes? The unfair lending practices and what that’s going to do to your card business.
The OTS came out first, followed by the Fed, as well as the OCC. And we’re in the common period, as you know, right now. Three big elements to it.
One, I think most people in the audience will be familiar with, which is universal default. As you probably are aware, we were the first major issuer to give that up, about 18 months ago. That would have less impact on us and probably a more profound impact on other parts of the industry.
Two other areas that I think are significant and we’re working with the regulatory bodies right now. First is the proposal that when you reprice a client, an existing customers, you would only be able to reprice prospectively, but not on the existing balance. That’s a big issue. Clearly we are looking for more flexibility there but this is the common period which will end probably end six months or so out.
And then the third component of that, which is beyond the repricing, is payment hierarchy, which is how you apply payments to the outstanding balance. Typically today payments are applied to low APRs, middle APRs, high APRs. It could be transformative for the industry if it would basically prevail in its current format. I would say it would have the most profound impact on things like user rates because it would be much, much more difficult for an issuer then to pursue that strategy.
So each of these items, from universal default to repricing of existing balance relate to payment hierarchy. They do have strategic offsets if they would to against the industry substantially. On the other hand, we are quite concerned because it does add a dimension of risk that is higher then than today and we have to work through that. But again, we’ve modeled businesses, we’ve looked at alternative strategies, we’re real concerned, not so much for Citi, but broadly would be if in fact, people pushed certain strategies forward, what happens to the availability of credit, which I think would be a particular issue.
And that’s a big deal and we’re working that with both the regulators as well as the legislators because beyond the regulators there is a lot of legislation out there that parallels this. Some of it basically lighter, some of it a bit more heavy.
Steve, isn’t it true that over time all these things equilibriate, whatever the structure? Everything equilibriates over time.
I agree. Just to give you the broadest picture, because I have spent, over the years, a lot of time in conversation with regulators as well as legislators, if you take the credit card business, you know if you make it oversimplified, what is it, you know, it’s a business that if we lend $100 to an individual that we’ve never met and that gives us no security, and at the end of the year everything works out, as an industry, you get back $102. And it give us fairly good returns because it’s a fair amount of leverage within the business, but it’s an actuarial business that really is quite predictable.
The problem, though, is lots of folks, I think, usually misinterpret the APR, or the interest rate we charge the customer, with the profitability of the business. But this is a business, again, that typically we talked about, say, would you lend $100 to somebody you’ve never met with no security but if it all works out at the end of the year you would get back $102? Most people say no. That is our business model. That’s what we’re trying to protect because it’s symmetrical. If we get back minus $2, $98, instead of making $4 billion, like in North America, we could lose $4 billion.
So I think, speaking to your point, it has to meet an equilibrium in order to keep the industry compelling and viable. And the industry is very innovative. So, as this landscape changes, it will both adjust systemically, but also it will be pushed by the issuers for those types of adjustments.
Betsy Graseck - Morgan Stanley
Maybe I could ask you to just give us all a little bit more color as to your comments on the capital where you saw the opportunity to be opportunistic. You know, we’re obviously in a fluid environment and I think the question around the room is how much excess capital is enough and why do you have the amount you have today. So if you could just give us an understanding as to what you’re seeing in the environment, what you are anticipating, and how much more opportunity there may be in front of you.
We raised about $13 billion in capital since the 7.7% number. A lot of it was preferreds. A smaller amount of it was common. I think we had 3% dilution, 3% to 4% dilution, something of that sort. And the question was the cost of 3% to 4% dilution versus getting the $13 billion and getting to a ratio of 8.8%, which opens up a number of different opportunities for us as we see this environment roll forward. It’s pretty clear to me, as we all thought about it, is that we made that decision on your behalf, the shareholders. We thought that was the right thing to do, to have that excess capital.
Now, I think there’s no question that we are living in not a risky time but uncertain time. We know the risks. But there’s also uncertainty on top of that. And there are, obviously as Gary talked about before, there are negative aspects of it but we’re not necessarily focused on that. We were well capitalized as we started.
But what we’re really focused on is there are a number of different opportunities to put the capital to work. And so, the point on that is that we think that there are going to be changes in the financial markets, either that result in assets that we can put the capital against, and/or there are operating assets we can put our capital against and/or a variety of different things that can happen, in our judgment, that suggest to having the excess capital is a real sign of strength in the marketplace and a real sign of strength in the sense that we can move fast if we need to.
The only thing I would add to that is if you look over the last 6 weeks or so and you look at the broad range of capital raising that has taken place by a lot of different people, I think for the large financial institutions that play a critical role in the stability of the way financial systems and processes work around the world, the standard for being strongly capitalized has gone up. So well capitalized is a different question. We were well capitalized to begin with.
But I think strongly capitalized in this environment means a different thing. And I think, at least our view was, that when a customer is asking, “Who am I going to do business with? Who do I want to have underwrite my deal? I want to do business with someone who is strongly capitalized.” And that standard for being strongly capitalized is higher than it was even just several weeks ago.
Betsy Graseck - Morgan Stanley
And so how are you allocating that capital back down to the business lines? That excess. Is it just pro rata?
Betsy Graseck - Morgan Stanley
Could you just describe that a little bit?
As many of you know, we now have centralized our treasure function in the company, which is a big step forward in terms of our ability to allocate capital. We have capital targets that exist in each one of our business lines that then go down to the sub-business lines in each of those businesses. We make the decisions about the total amount of capital that’s going to be allocated consistent with what you just saw here.
So we obviously have a plan for this year and we have a strategic plan that goes out. In future years when we make the general allocation decisions according to that plan, and those are tough targets.
Those are tough targets because we want to improve our after-productivity, but we clearly recognize the areas where we want to provide more capital in the areas but we want to pull capital back.
So we of the leadership team meet once a month, this coming Monday is our next Finalco meeting, we discuss the allocation of that capital, where we have disagreements. We resolve those disagreements in that meeting about who’s going to get exactly what in the context that we have overall. But it’s all headed towards the overall targets that you saw here today, that mix of businesses, with that level of asset intensity, over a two to three-year time period, as we kind of melt down these legacy assets.
Betsy Graseck - Morgan Stanley
And so the excess capital is at least all parceled out to the business units. Does the top of the house sit with any of the excess capital to use on a forward basis?
Well, I can assure you that the businesses do not feel like they have more capital than they need. So, it’s part of that process. We hold the target very tight. I think my colleagues will agree with me, we didn’t increase anybody’s capital allocation because we just went out a raised a significant amount of additional capital. So, our powder is dry on that capital is the way you should think about it. And we will opportunistically use it, just as Vikram said, as we see the right opportunities evolve in our businesses to serve customers.
Betsy Graseck - Morgan Stanley
Could you just comment on your thoughts on the FAS 140 proposals that are out there.
On FAS 140, obviously we don’t know exactly how it’s going to evolve. It will have a substantial impact, depending on how it evolves, it will have a substantial impact on financial institutions. We are deeply involved in the development of the policy, so we have, at least in my view, one of the best accounting policy groups in the world. They are really talented, capable people who are involved with discussions with our regulators on a day-to-day basis on important topics like this.
And we will see exactly how it evolves when the time comes. You know, we have discussions all the time back and forth about this. But there are ways in which it could evolve that could be very benign, and I can describe those ways, and there are ways it could evolve that would be less benign. My guess is in the capital-constrained environment that the entire industry is operating in, that the likelihood is that there would be some kind of catastrophic change or some kind of crazy change is pretty low. But we are actively engaged in the dialogue to ensure that people understand our view on this.
Glenn Shorr – UBS
On reconciling comments made about the investment bank, on the one hand when talking about the goal of 18% to 20% over time, you just made the comment of not getting there in the next couple of years, which I agree. You’ve got de-leveraging, you’ve got lower volumes. You mentioned reducing limit structures and certain debts and things like that and that makes sense. But there are two slots that we also talked about, 9% revenue growth over 2006 levels, which was a pretty awesome year. Maybe just help in reconciling those comments.
Gary L. Crittenden
I must have led you to believe something that wasn’t accurate. So what we think is going to happen, with the numbers that I showed here, is that we will actually step down, obviously volumes are lower this year than they were in the prior year, so we’re actually going to have a step-down this year, and the number that I referred to, the 9% revenue growth rate, was the targeted growth rate two to three years out, in that business. So obviously the fixed income business is going to go down, we’re going to diversify outside of fixed income by growing the businesses into stronger businesses, and the then revenue growth rate, the two-to-three-year out revenue growth rate, industry wide 9%, we think we will be growing industry wide.
Vikram S. Pandit
And we have a very strong margin market franchise which is growing even as we speak. And with a lot of our revenues coming from there, that’s a very important factor.
I think you’ve heard about how we’re going to try and diversify our securities and banking business and it really is along the line of equities, it’s along the lines of utilization of technology across all of our asset classes and our position in some of the flow businesses. It’s along the lines of building a much bigger and broader prime brokerage business, and it’s along the lines of building out our commodities business. And I think that the plan is that if we are successful in doing all those things, over the next two, three, four years, you’re going to see us be able to grow at least as fast as the industry.
So there’s that diversified model, you then overlay that onto the emerging market platform that we have here, and others would, very frankly, dream about, and that that’s where you are going to see increased market capitalizations, increased flows from all of our clients, and the multiple touch points that we have either because of our GTS business, because of our corporate bank and the investment bank, as well as our sales and trading businesses, we think we can get to those industry growth rates.
Vikram S. Pandit
And we’re long the world and heavily overweight in the emerging markets, as a company.
William Tanona – Goldman Sachs
Can we go back to the $500 billion of lines that you guys expect to do over the course of the next 2-3 years? If you weren’t going to sell any of those assets, how much of those assets would actually mature over the course of 2-3 years?
Gary L. Crittenden
You know, I honestly don’t know the number off the top of my head, but having the ability to [inaudible] those assets is an important part of the total number. So, as I think I said when I actually went through it, that if we were unable, if the environment got tougher, it would be a longer tail than the number that I showed there. That was our best guess kind of given the current environmental conditions of what the run off rate would be. Frankly, just off the top of my head, I don’t . . .
Vikram S. Pandit
Excuse me, Gary, on that one based on current conditions, that’s our guess. Number one. That’s an important point. And second is, you showed that there may still be some assets left at the end of 2007. Those are maturing assets in the sense we are assuming that there are longer tailed assets that may remain on our balance sheet.
Gary L. Crittenden
So we obviously think we are going to be able to sell the businesses that we intend to divest. And then we have a pretty good perspective on our ability to either sell and/or have the assets mature in the securities and banking businesses. The biggest wild card, obviously, is what happens with the mortgage portfolio and how that mortgage portfolio matures over time, how much of that business could actually be sold.
So, these were rough targets, is the way you should think about it. And there is obviously some range around that, depending on exactly what the market environment is. But this assumes roughly today’s market environment.
William Tanona – Goldman Sachs
I guess the reason I was asking that is just to understand what type of liquidity discount you might be incorporating. Obviously liquidating $500 billion of assets is not a small sum and when you think about the assets that you have, whether it’s AVS, CDOs, leveraged loans, mortgages, that are not necessarily assets that are in high demand right now, so as we think about a liquidity discount, if it’s 10% on $500 billion it’s not an insignificant number so that’s what I was trying to understand, is what you guys are incorporating in, in terms of a liquidity discount as you unwind the balance sheet.
Gary L. Crittenden
If you think about where they’re currently marked, many of these assets are priced at very attractive prices. Brian went through some quick math on the CDO portfolio, for example. The liquidity portion of the CDO portfolio. And so, they are relatively attractively priced today. I guess the big question is would we even want to sell them today, given the attractiveness that they have and given the rate at which those assets are expected to mature off of the portfolio anyway.
And I think those are questions that we will look at and we will deal with that on a case-by-case basis. Obviously we just sold some leveraged loans in the market and made a decision to hold other leveraged loans at the same time. And I think we will continue to act what we believe is in the best economic interest of the company. So, where we believe is the right economic choice or the right risk-reduction choice, we’ll take action on those assets. And that’s really what’s embedded in this. Because when you’ve got a stack of assets that high, you have to make assumptions about each one of those asset classes and we’ve taken what we think are reasonable assumptions for the either maturation or [inaudible].
William Tanona – Goldman Sachs
And then the second question on the investment bank is you think about improving your, are we even in that business. You know, Vikram, you and John, both of your guess were obviously at Morgan Stanley, the areas that you highlighted, commodities, electronic trading, prime brokerage, serious investment businesses, so what gives you the confidence that you guys can achieve those type, or are those the businesses you are looking to expand into?
Vikram S. Pandit
Well, there are two different questions in there. I will turn it over to John. One is auto-ease, the other is drawing those businesses. Right? And we have confidence on both. You can lick them, but you can answer them on an unlicked basis. And they can 20% ROE even with everything we have today the normal growth we’re going to have in the businesses and the restructuring of a lot of the financial markets, we think that going forward actually the risk premiums are going to go up. So there’s a lot of thought behind the 18%-20%. On that side. Do you want to talk about growing the businesses?
I think each one has a different story. So if you look at our prime brokerage, for instance, we have new leadership. There’s obviously a technology investment that has to be made. And as I’ve looked at the business in my first sort of 5-6 weeks here, it’s not so much that we necessarily didn’t invest in the technology, it wasn’t a focused investment in the technology. So we think that with the new leadership, with an integrated sales platform across equities and fixed income, in order to gain client market share, if the product really is right for a greater penetration with the client base.
Secondly, again, if we look at that client base and we look at their growth, we see emerging markets. Again, that is a leg up that we have in that particular business, to gain market share with those clients. So, continued and far more focused investment in technology, much more integrated distribution of the product across the asset classes, and a real focus on the emerging markets. And all of the things that we bring to that client base that others just can’t compete with.
Again, each of these businesses has a different story. And so we can go through each and every one if you wish, but that’s really how we’re going about it. Electronic trading, we just brought in new leadership in that group. First on the equity side. But this is a platform that we are going to continue to build out, again, across asset classes. Some businesses, we do extraordinarily well. If we look at our rates business, for instance, especially in the EM/FX area, this is the business which has extraordinarily high market share, extraordinary high efficiencies, and a superb utilization of that global platform. There are stories within our business of best-in-breed.
One of the things that we’re going to do as an overall business is take those areas of best-in-breed, share those best practices across various asset classes, and drive home a focused approach, be it investment in distribution, investment in technology, across the area.
Shirley Leithrow – Grammercy Capital Management
This is in regards to your risk management, your incentive and accountability. My question is, how do you enforce the change in mind set? Or strategic action? And how do you eventually guarantee that it will happen? Because unless a mindset changes, you may be focused on return of equity and it is fantastic but it will not prevent a future financial crisis from happening.
Vikram S. Pandit
Well, anyone of us can answer that. Having talked about it so long, so often, knowing what needs to happen, knowing that it starts right here and moves all the way down. It starts here. Changes in culture, starts right at the top. Accountability, understanding what the right culture is, what we want to get done. Don talked about the smallest group of leaders in this company that we got together yesterday, we are jointly and separately accountable. The only discussion we are having is one of making sure we permeate the culture all the way through the entire organization.
And culture is one of those things where you kind of know it’s happened when you see it. And it’s one of those things where you can look back and say, “Boy, this is different than what it was.” Don and I just walked up from the 12th floor to here and we walked by a couple of people in the bond trading area of Smith Barney, and unsolicited said, “You know what? The place feels different?” And it used to be positive, over the last couple of months. These are the kind of things that happen.
And so, you know, if there were a formula to drive that change, you wouldn’t find it that uncommon to have great cultures. But there isn’t a formula. The formula we think starts top down, starts with the people, starts with accountability, starts with compensation systems that reinforce it, starts with evaluation systems, promotion systems, all the way down that enforce the right culture, starting with clarity amongst ourselves as to what that is. And what I would say, I guess, and I’ll stop there unless any of my partners want to chime in, is that ultimately, ultimately, cultural transformations happen pretty fast. They take a long time and then they turn on a dime. And let’s see.
Gary L. Crittenden
I would add to that in one case. Again, highlighting last night, and I’ll throw it to Brian, because you asked about the risk culture. At the table where I was last night, and we were talking about growth and innovation, and we quickly turned to what needs to change in the culture, and Bill Mills said, “What needs to change is we can’t talk about a it, we need to do it.” So Alberto Verme, which was just announced two days ago, in Europe he is the co-head of Investment Banking, and he volunteered to ship himself and his family to Dubai to start to get close to the client, towards this regional structure. It’s a whole shift in talking about it versus actually doing it. And we said that’s the type of change we need. It’s a behavioral-based change that will permeate throughout Citi.
I think the ability to have a conversation between all of the people who run the businesses is critical and we have to be able to keep a common language in mind in terms of looking at what sort of risk capital there is being employed and what the returns look like for that risk capital. The risk organization can obviously support that goal and that’s what we’re trying to do in terms of the structure that we have.
Vikram S. Pandit
And risk culture is part of the overall culture. I want to make sure everybody here understands we have great people around the world. We have people actually doing the right thing. We also have some great cultures. Banamex is a very important case in point. Locked off that and the job is really one of unification and uniformity, in many ways, across the organization. Which is a lot easier than if you didn’t have the basics in the first place to work on. We think we have all the basics.
Alan Kowalski – Polson & Company
Just a quick question on the QSP issue. It looks pretty imminent that QSPs will go away. Have you calculated your pro forma capital ratios based on that?
Gary L. Crittenden
Obviously we looked at this issue in detail, in the context of the other questions that was raised. We looked at this issue in some detail, and as I mentioned, you could paint a very dry pony and scenario associated with that. We have very significant QSPEs that are part of our kind of off-balance sheet financing structure. Like I said, the way this will actually evolve is by no means decided in any form or fashion. And our current working hypothesis is that there will be some kind of a transitionary rule that will exist for financial institutions that we will work around what would be, I think, otherwise a very unfortunate decision. If all QSPs were to come on to the balance sheet at December 31 at the end of this year.
Alan Kowalski – Polson & Company
But what would your pro forma capital ratio be if that were to happen?
Gary L. Crittenden
I don’t know if that’s anything that we would disclose. We have significant QSPs. You can see those if you go to our 10-Q. We detail better than I think any other company exactly what the total size of our QSPEs are. I know something like $800 billion.
Alan Kowalski – Polson & Company
In sort of looking at your company, the first thing I tried to do was get an idea of what your loan vault looked like. So, I started, with your consolidated Y9 at year end and was frustrated pretty quickly that I was not able to reconcile Y9 total loans to your 10-K. Total loans to the tune of about $40 billion. And it seemed to relate somehow to how you consolidated associates and CitiFinancial. So. Just quickly, what is the difference between the consolidation method in the Y9 versus the 10-K?
Vikram S. Pandit
Why don’t we let somebody in investor relations work with you on that?
Aaron Cadle – firm not known
What is the return on assets of the $500 billion that you are intending to divest and is the kind of normalized earning figure digested for the sale of those divestures/run-offs?
Gary L. Crittenden
The return of assets of those business is substantially below the return on assets that we’ve had as a company overall. And the return on assets of that number is included in the total number that we would have today.
Aaron Cadle – firm not known
Would that also include the increased interest expense or preferred interest expense of that would have been incurred?
Gary L. Crittenden
Unidentified Analyst 1
You’ve raised a ton of capital based upon accounting treatment and right down to securities. We talked today about you actually feeling comfortable with your capital. And quite comfortable with the mark downs of your securities. Do you actually envision today where some of these securities could either be sold, obviously above where you’re carrying them, or writing them back up again, i.e. having more capital?
And secondly, you know, given the capital that you’ve raised, do you envision over providing some more in some of the other businesses that people anticipate, such as the consumer, maybe having some more credit issues down the road?
Vikram S. Pandit
Yes, and I always dream of those time where can mark up . . . so I don’t think I’ll dwell on that situation.
Yes, I think we’re going, Gary has talked about it, we are going through a very thorough capital allocation process, as you would expect us to, as if you were in the room with us when we are making decisions about where we should put capital to work, how we should put capital to work, knowing fully well, as you all know, some businesses, when you make those decisions, they are longer tailed. Others are day-to-day kind of decisions.
We are in the process of doing all of that, so I think the net answer to that it, what Brian talked about, we like our many of the positions we actually have that have been marked down. We think that they are great positions. We really do. Okay? And they are 2004, 2005 positions. They’re not the later stuff. And we see exactly what is going on and either the market improves or these will mature. Well, that’s one thing I’m sure of. These positions will mature either way. We feel more optimistic about them than where they are marked. But that’s our view. You could have a different view on that. Okay?
Unidentified Analyst 1
[inaudible] provision of credit over providing?
Gary L. Crittenden
Well, we’ve added significantly to our reserves and I think one of the important things to think about is in the overall amount of capital that we’ve raised we have at the same time added a lot to reserves. And I kind of think about the strengthening of the capital and the strengthening of the reserves as being total additive improvements to the balance sheet. You know, I think, as we think about reserves going forward, we do have the ability to exercise a significant amount of judgment about what the economic environment implies. And we’re going to exercise that judgment going forward. You know, as you know, we had a time when we had the opportunity where we had significant reserves because it was a very benign credit environment. But I think any time, if that environment to reoccur, I think we would be very careful to think about how the economic environment could change to ensure that the amount of reserves that we kept were appropriate for the environment that we might fact down the road.
Unidentified Analyst 2
Going back to the U.S. after the developed consumer businesses, can you talk about how you think about your funding disadvantage that you have, the lack of the deposit base, particularly in the U.S. and how you factor that into your thinking about whether you should be in this business or not, or if you are, how you intend to fix that?
Vikram S. Pandit
The view of the U.S. model is that it’s the most developed capital market in the world. And I want to distinguish that clearly from the emerging markets, where there is a clear advantage of having both sides there. And that clear advantage, we take a lot of advantage of because of thousands of branches we have there. And we think, by the way, that if you really wanted to have a deposit advantage of funding, the advantage still is there. Because that’s really going to grow, per se.
In the U.S. it’s a matter of what price deposits. It’s as simple as that. Because there is a market. You can fund it. There’s all kinds of models with people with no deposits, all kinds of models with people with deposits. And we all know there is an advantage and a disadvantage. We have some advantage for the deposits we have but we don’t make money on the deposits we don’t have and we fund them at a different rate. But that’s all factored in to the model. I guess what I’m saying is it’s a financial issue. I don’t see that to be a strategic issue.
Unidentified Analyst 2
Given back to the markets demanding a higher risk premium now, does that financial issues become more of a negative over time?
Vikram S. Pandit
You know, you could argue both ways on that. And we’ve thought about it a lot. Actually, we’ve spent a lot of time sort of thinking through exactly where all that goes. And a lot of that is really also a matter of what kind of currency translation risk that you want to run, as well. I mean, we’ve got plenty of deposits around the world, $285 billion only in GTS.
Unidentified Executive 1
Another $100+ billion of consumer deposits, a number of them are in high currency in dollars in Europe, which we actually bring into the U.S. from time to time depending on our funding needs. In the United States for growth of business there. And actually I think a huge competitive advantage for us, both there and here.
Vikram S. Pandit
We’ve got plenty of capability of generating deposits around the world, as importantly, we think, if we wanted to, and we’re thinking about it. My guess is we’ll do it. I think we have more capability of creating deposits through Smith Barney.
Unidentified Executive 2
We’ve got, within [inaudible] we’ve got $128 billion dollars of deposits that we’ve got in place and a good chunk of those cost $53 billion-$54 billion if through Smith Barney. There’s actually been a group of deposits not having grown very much over time, but on which we’ve begun to focus. And as we begin to focus I think you will see those numbers begin to increase and move. So as we go forward, understanding the importance of not just in terms of funding for the company, but also more importantly, in many cases, the relationship with the client.
Focusing on, first you’ve already got the wealth management business, which is the most emotionally close to the client, so to bring in deposits as well is a pretty easy sale, after you’ve already got the wealth management business for them. So we’re going to be working more on that. And importantly as well, working with Terry when she gets in to continue to link up the relationship between Smith Barney and the retail bank going forward.
Vikram S. Pandit
Did you want to add something else?
Unidentified Analyst 2
The $15 billion re-engineering business, the benefits. Can you talk a little bit about the priming of that. You’re talking about 2-3 years out. And give us any sense of progression there that we should think about, benchmarks, or anything, Gary?
Gary L. Crittenden
I could, Vivek, but I don’t think we should, so we have a very aggressive program. You know, we have targets for each of the businesses for this year. We’re going to finalize our targets by business line for 2009 on June 30 of this year. And so we obviously have in mind what that roll out looks like and we have a very granular detail on all the projects that are teed up for accomplishment for this year and are very much in flight on the projects for next year.
But I think we purposely stayed with a kind of number over a three year time period because by its very nature we think we have uncertainty [inaudible].
Mike Holden – The Boston Company
I actually have two questions. The first one is on credit. I want to ask that reserve build question again. Relative to the first quarter reserve build, do you anticipate building reserves more or less or the course of the second quarter to the fourth quarter.
Gary L. Crittenden
What I said on the analyst call is that, obviously our expectation was that there could be some significant deterioration in the back half of this year. And if deterioration continued at an accelerated pace, that there would be significant additional reserves that we would take in the back half of this year. So what I said on the analyst call, we still believe today. It’s a little more difficult for us to bracket exactly what’s going to happen on the residential mortgage side compared to what we’ve got on the credit card side. On the credit card side there’s been enough cycles that you can predict with a little bit more certainty than you can on the mortgage side.
Having said that, as we sit here today, we have 15 months worth of reserves on our balance sheet, on a coincidence basis, against the NCLs, that we had in the first quarter. So, we did, I think, $3.4 billion worth of reserve building in the fourth quarter in residential mortgages, we did I think $600 billion and change of reserve building in the first quarter, but I think there’s a very real possibility that if things continue to deteriorate that you would see more reserve building towards the latter half of this year and into next one.
Mike Holden – The Boston Company
And then on compensation, recognizing there’s a lot of factors you take into account when you determine management incentive compensation at the end of the year, if you look at the financial targets that you laid out for us on page 50 of the slide deck, how and when are you going to incorporate those specific targets into compensation incentives?
Vikram S. Pandit
I can take a crack at that. We incorporate our financial targets into compensation in the annual performance review. We’re going through the process now of establishing our approach to compensation, we have talent review process through the summer, and to the Board in September, and then we make final compensation decisions at the end of the year. Financial metrics are an important part of that but so too are the cultural measures. Teamwork and looking across businesses and participation and a full range of both.
Mike Holden – The Boston Company
Just a follow up there. But you’re not going to hit any of these metrics this year. I would assume that they won’t be a part of 2008. Will they be a part of 2009, 2010? Again, because you’re looking at these targets over time. I’m just curious what you’re going to get paid on matches up what you’re promising to shareholders.
Vikram S. Pandit
I think that’s definitionally correct.
I was going to say, we always have measures, including financial measures as I said, and they are a reflection of the environment in which we sit, the competitive situation in the market, and our own goals as we’ve developed and discard them.
That’s true in 2008, it will be true in 2009, and ongoing.
Unidentified Analyst 3
Two questions if I may. First one is even in normal times there seems to be some tension between your auditors and your supervisors about appropriate levels of capitalization provisioning. These are not normal times so the tension is probably fairly acute. In choosing the path that you have, which way have you chosen to err? Towards the auditors side, towards the supervisors side? How have you made your choice?
Vikram S. Pandit
How about if I said all are in perfect agreement?
Unidentified Analyst 3
I wouldn’t believe you.
Vikram S. Pandit
Then you have to step back and really say that running good business is about long-term relationships with people. Like our auditors, our regulators, and everybody else, who understand, all of who understand the business, what we’re doing, what we need to be. And I don’t think that we have the same incentives when we think about it that way for a company of this sort, that you might find at other smaller businesses, who do anything than make sure that you have to have those relationships all come together and say, “You know what? This seems right.” And at least, to me, that’s the answer.
Gary L. Crittenden
I know you say the regulators would always want you to be more heavily reserved and the auditors want you to be properly reserved and I think that tension potentially can exist. I don’t think this is kind of the time when that kind of situation really exists. I think it’s pretty good harmony, I think, from the regulatory environment and certainly what the auditors would think. And so I actually, I agree completely with what Vikram said. This is a time when there’s kind of an unusual symmetry.
Unidentified Analyst 3
Second question. In choosing the mix of businesses that you want to take forward, particularly in the U.S., at least a couple of those major businesses face major, sweeping regulatory change. Are there changes in prospect that would alter your evaluation of the attractiveness of those businesses?
Vikram S. Pandit
Well, if there are sweeping changes you’ve got to look at everything again. I completely agree with you. I mean, you know, you would expect us to look at everything we have, look at our strategies, here and around the world, in a very active manner and make active decisions. That’s going to happen. Sweeping changes not only affect us, they also affect everybody in the industry who is U.S.-based. Particularly more so if when you look at where our revenues and our growth is coming from, it’s not only here, but in the emerging markets around the world. So we feel we are advantages if that happens.
But I have a much more philosophical perspective on that, which I think everybody here who are students of capital markets should understand. Sweeping changes usually equilibriate somewhere. Unless you want to completely say no credit cards, you can do that, but any changes that are sweeping, any regulation that is put in place, will have consequences that will ultimately equilibriate to something, somewhere, close enough to the business that we’re in will drive a different return profile.
And I think what we are going to say to all of you is we have confidence that we can move to those areas faster than not. And by the way, if it turns out that there are certain businesses around the world where the rules have really changed and there are businesses that we shouldn’t be in, we’ll make that decision at that point. It’s very hard to answer a hypothetical of that sort.
Hal Levine – BNY Mellon
I am looking at the risk management construct chart, chart 36, and particularly in light of the fact that there are several new people there and probably still in the process of figuring out how to talk to each other, this little item in the middle, the risk, is that going to be the repository of all the comments coming in, or is that going to be Brian sending out messages to all the different regions, businesses, and products, as far as what an overall risk posture is going to be? Is it incoming, is it outgoing, and how would you plan to coordinate that, if you will, or is it a matter of just managing the overlap?
It’s really mean to be that there’s an overlap by all three. We’re trying to triangulate on risk. And the idea is that the distance unit group will obviously be responsible for the risk that is sitting inside the business units. The regional people are going to be responsible for what the risks are inside the region and then the product specialists have to be able to know the risks that sit within their products. And that concept is that all three of them actually focus on the risks, each of them probably brings a little bit different look to it. Regional side will understand how that risk sits within diversified portfolio within the region, the business unit is going to look at it within the business, and the product specialist will be able to take apart the underlying structures and make sure that those are being appropriately analyzed.
There’s a combination on that. What we are doing is we’ve set up limit structures that work both by regions and by products and by business units, and so you’ve got to got through an example of what each one of those would be and each one will have a different concept. But everybody is actually subject to the same generic limit structure. So if there is a deal that comes in that is going to push up against a business unit line risk limit, the business line person certainly has that responsibility. If it’s going to push up against the regional structure, it’s going to push up against the regional one.
Bu the idea is to have a significant overlap and have those groups be able to take the best of each of them.
Vikram S. Pandit
The risk manager has the ability to say no to anything he wants to say. That’s the answer.
Can I ask one question?
Michael, talk a little bit about what you’re doing in the client side.
Actually, I think one of the most exciting parts of today’s presentation was the discussion of embracing fully, systemically, and throughout all of Citigroup’s universal bank model, the concept of taking away that which was the option and making it an embedded part of our business is a very, very big change. We haven’t discussed it in full detail. You’ve seen one country in the form of Mexico, one region in the form of Latin American, but already we have about $10 billion of what our competitors will define as cross sell already in our business before we’ve even fully embraced this.
Now, before we can even earn the right to do this, we have had to go through a period, as all of you know, of 9-10 months of financial challenges and 30 months of real estate market challenges for our clients, and we’ve spent a lot of time with our clients on the issue of confidence, first and foremost. Sally and John and their whole areas have spent a tremendous amount of time on information help. This front row seat that we have to give them confidence and insight in the markets have been critical.
Secondly, we’ve stood up and provided liquidity for our clients and we’ve honored all of our commitments.
And third, as Gary described, raising $40+ billion means we are in a position to truly drive what are the answers for our clients. Having done that, in the long run, the real question for us is how do we maximize the business across all of our clients. And to do that, it’s fundamentally to change our clients, to change our products, to change our structure, and to change our technology. Which is a lot at once.
First on clients. We’ve got to focus the clients we serve. In institutional clients we would be up 70,000 clients, but as you heard from Gary, the top clients, the top 3,000 clients generate over 80% of the revenue. That’s a very, very concentrated force. That’s actually already a good cross sell model, and those clients today within that business generate about $13 of revenue for every dollar of interest revenues. We serve them in 18 countries, we serve them in 5 products. Each are fantastic partners. But we have to take some of the capital, some of the headcount, some of the resources, applied against the bottom tier and refocus them.
We do very well cross-selling within businesses. In Sally’s world, already the FAs understand that if you get to 4 products per client, your production increases 12-fold. That already exists. In Steve’s U.S. consumer business, outside of credit cards, we already understand that if you can get to 4 products per customer, you have dramatically more profitable business and you have greater longevity of client relationships.
Where we have not done very well, though, historically, is go across the silos that Don mentioned. I think Manuel gives you a sense of how powerful that is, but let me try to define that even more. Manuel’s business generated 600,000 bank-at-work retail relationships just last year. The entire corporate bank on the rest of the globe generated 30,000 last year. Think about what happens with the degree of focus. We have 70,000 clients which have hundreds of millions of employees, we generated 30,000 bank-at-work retail clients. The opportunities are immense.
So first, we focus on our clients. They become Citi clients across the board. The regional heads manage Citi clients, not divisional clients, across the board.
Second, product and product sweeps. The product sweeps that we have today are not just about bank-at-work, but total employee relationships. Remittances is a product, in addition to bank-at-work, are major elements we can serve our corporate clients. We have to change structure. Structure is not just corporate bank and investment bank working together, which we’ve been working on for 4 or 5 years. But for the mega-wealth clients, Sally, Alberto, Ray, John, have agreed to have one point of contact for our mega-wealth clients across the private bank and the investment bank. And then we’ve got to get the technology.
Because from top down we can serve the best, but from bottom up we have to recognize that 90% of our credit card clients still buy one product from 89%. The best way to fix this is as Don has described, technology on tagging. CRM systems, identifications that Manuel has in Mexico and Latin America that we don’t have locally. If we can do all of these things, which I know we can, by the way, we have an ability to take what’s already $10 billion of cross sell that others would covet and drive something dramatically more. But it requires embracing fully this overall one-city complete look at this model, which is a very, very big change for all of us.
Our clients, when we come out of this crisis, want to do more business with us because we stuck by them, and as we provide more solutions to them, more concentrated relationship management, we will be that much better off.
Vikram S. Pandit
The leverage we have is enormous, which is why we have one of our best focused on.
Unidentified Analyst 4
This concerns your future plans in the U.S. residential mortgage market. The $500 billion of legacy assets, which will mature in or be sold off, it seems like a lot of those are U.S. residential mortgages, both in consumer banking and in the securities side. Does this mean you’re going to be moving more towards more of a service or not holding these on your books? In other words, making only conforming loans, selling them to Freddie Mac and Fannie Mae, or when the securitization market opens up, securitize them with sending them into the market, eliminating mortgage brokers, higher metrics 700 or above credit scores? Could you comment on that?
Vikram S. Pandit
Yes. With the caveat that everybody is looking at the mortgage business and the real estate business, where it’s going to go, right from the Fed to other regulators to everybody else on the Hill, so we’ll talk about where we are today.
A few comments. As the business is operated today, just about 90% of what we originate is in fact sold. Either to the GSA or the investors. So the model actually has been evolving because that number was substantially less if you go back one year, two years, three years back. And if you think about the mortgage business, particularly in North American, three parts of the model. You’re either in the origination business, and either you make a decision to basically sell or hold your portfolio. You typically are then in the servicing business, as well. And then clearly you have your portfolio.
We remain, actually, a very large originator but with an emphasis more strongly today on holding much less of what we originate and if you look at that proportionality, that book, which probably has a duration, but it clearly changes with the environment of 4 or 5 years, is in fact, net rolling off quite nicely and we expect that trend to happen for a while. We will, over time, reassess the servicing business, but we have one of the largest services in North American.
And then finally, from the standpoint of portfolio, the portfolio will shrink and a large part of what you have seen up on the screen earlier today is in fact, the shrinkage, but not essentially the exiting of the business within North America. But the stratification of the model does change and how you make money.
Vikram S. Pandit
So let me sum up. First of all, I want to thank you all for coming.
We’ve made a decision on the assets we want to keep. We’ve made a decision on our strategy. We made that on the basis of the highest value for you, our shareholders. We’ve made a decision on the structure to execute against that strategy.
Today we’ve given you some metrics that we think are important and the goals we believe we can achieve. The assets we have in this company, the position we have around the world, is unique. Many of you know that. Go around the world, what the Citi brand stands for and what we do and we are extremely long the highest growth parts of the world.
I believe this is one of the world’s greatest franchises with tremendous intrinsic and aspirational value. And I believe we have the management team that’s going to unlock it. And they have my full support and I look forward to interacting with all of you in the future.
Thank you for coming.
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