Citi - 'A History Of Mishaps And Poor Judgment'

Credit Agricole Securities analyst Mike Mayo had his couple of hours with Citi executives Friday (after waiting for almost 2 years to be summoned).

But the meeting doesn't appear to have done much to change Mayo's rather pessimistic views of Citi's prospects.

Here's part of the note Mayo issued Monday:

'After our first meeting with Citigroup management (CEO and CFO) in almost two years, a key question is whether Citi can reclaim legacy Citicorp's decent performance from the mid 1990s prior to the 1998 merger. Citi articulated a better strategy, especially with emerging markets and global transaction businesses, leading us to raise our target price to $4 (from $3.50). Yet, ongoing concerns about Citi's ability to execute and its risk management lead us to maintain our Underperform rating.

The not so new "New Citi"

On the positive side, Citi looks to become like the "old Citi" in terms of a slimmed-down version that looks more like legacy Citicorp than the Citigroup of the past decade. On the negative side, we are not convinced that there has been enough improvement in risk management, a huge consideration for this reason: for each $3 that Citi made last decade, it gave back $1 due to poor risk management. Citi still seems to have aggressiveness with financial targets (well above historical), accounting (tax credits), and corporate governance. Also, the strategy does not always seem in sync with execution and/or financial reporting.

A history of mishaps and poor judgment

Citi mentioned that it has a new team. Yet, we've heard this before. Since 1998, Citi has had 30 major reorganizations or senior management changes, a disruptive lack of continuity that increases the chance for mishaps. Not surprisingly, over this same time Citi has had about 20 significant events that reflect breakdowns in risk management, ranging from fines and settlements for dealings with Enron and WorldCom to exceptional reserve builds and writedowns. All told, these events have added to over $100bn in pretax losses. Thus, the issue for Citi is less about squeezing out extra growth versus not messing up.

Underlying core franchise has its strengths

Citicorp ($1.5tn in assets; three-quarters of total as of 2Q10) includes the company's three flagship businesses: securities and banking; global transaction processing; and consumer banking. Each benefits from Citi's global reach, especially in Asia and other emerging markets where Citi maintains a longstanding, premium brand. Collectively, these areas give Citicorp a unique franchise in terms of breadth and depth if management can fix risk management. Citi Holdings ($0.5tn of non-core assets and businesses; declining towards $0.4 by year-end) should remain a drag on performance (diluting ROA)'.

And here's part of Citi's statement on the meeting:

'Mr. Mayo has .... asserted that Citi's discussion of our future growth prospects is a source of concern. According to Mr. Mayo, Citi will be tempted to take inappropriate short-term risk to meet what he describes as a growth target. Again, we disagree with his conclusion. Citi remains very comfortable with its previously disclosed future growth expectations that were first stated by CEO Vikram Pandit on March 11 at the Citi Financial Services Conference. Mr. Pandit said: "Over time, we believe that a compound annual growth rate for these assets [in our core Citicorp businesses] of around 5 percent is not unreasonable, particularly given our growth opportunities in emerging markets." We believe this comment on future growth is prudent and reflects the uniqueness of our global footprint, which we believe to be a source of significant future growth. For example, approximately one-third of Citicorp's assets are in emerging markets, where GDP growth is expected to be 2-3 times that of developed economies. Citi believes providing management's perspective about our long term growth prospects is helpful to investors and is in line with industry practice. Mr. Mayo's assertion that our providing this perspective will somehow encourage inappropriate risk taking does not add up.

In summary, and as Mr. Pandit and Mr. Gerspach noted in the meeting, Citi continues to make steady progress in 2010. Despite a challenging market environment, we have earned $7.1 billion in net income year to date. Our capital strength remains very strong with a Tier 1 Capital Ratio of 12 percent, one of the highest ratios amongst our peer group. We have also continued to make progress on Citi Holdings, which we are unwinding in an economically rational way - these assets made up less than 25 percent of our balance sheet as of June 30 - and we expect them to be less than 20 percent by year-end with the sale of The Student Loan Corporation. Throughout Citi, we are executing our strategy to serve our clients with a singular focus on our three core businesses - Transaction Services, Securities and Banking, and Regional Consumer Banking - while taking advantage of our global footprint and ability to innovate'.

Sources include The New York Times

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