Alexandria, VA (June 25, 1998) --As we saw in yesterday's brief look at the profitability of Citicorp's (NYSE: CCI) various lines of business, the credit card business and emerging markets side of the company's corporate banking business are the heavyweights. That's why Citicorp shares took such a beating, falling from around $140 to near $100 per share, late last year. Investors were worried that credit quality would decrease to the point that Citicorp would have to boost loan loss reserves, which would hurt the company's earnings. If the loans are bad, though, you've got to do it. The other worry is that loan losses don't happen right away.
In December, the media was wondering what the big deal was all about with the Asian crisis. It hasn't been until lately that the media has focused once again on the Asian problem. That's because it takes while for borrowers and creditors to realize the effects of the crisis. A company can limp along for a while before its capital really starts to get thin, and that's when problems happen. A bank has to look forward and adjust its reserves for these problems.
The Asian financial crisis has been a boon for Citicorp in many ways, though. First, the company can acquire other banks in emerging markets for a good discount to their intrinsic value, and it can do so with appreciated dollars. Both of those allow the company to expand its franchise at prices that make very good economic sense. Citicorp has also benefited from a "flight to equality" in troubled emerging markets, as both corporations and consumers in these countries perceive Citicorp to be a much safer holder of their deposits. As a consequence, the company has been gaining market share, which benefits margins through operating leverage and through better pricing. (Not only have interest rates gone up, but Citicorp can charge a premium to the market on lending and services and offer a discount on deposit rates of interest.) In addition, companies dealing with a turbulent foreign exchange picture need Citicorp's services possibly more than in placid times.
Despite the turmoil in Asia, Latin America appears to have avoided the problems associated with a de facto increase in debt-service costs as the dollar has appreciated. This is especially surprising given the crash in oil prices that has affected Mexico and South American countries like Venezuela. In the first quarter of this year, net charge-offs for the global consumer business actually decreased 1% before the effect of securitization of credit card receivables. It was really corporate banking credit quality that decreased year-over-year, as Citicorp didn't take a provision for corporate loan losses last year. Rather, it took a negative provision for loan losses. While one can't tell from the company's disclosures, that was probably due to previously delinquent loans coming current and being taken off the problem loan list. When recoveries are larger than loan loss provisions for new loans going into delinquent or overdue status, charge-offs and credit loss provisions actually go negative, increasing operating earnings.
Coming out of the S&L crisis, the 1990s recession, and the concomitant real estate problems earlier this decade, companies like Wells Fargo (NYSE: WFC) and Fleet Financial (NYSE: FLT) saw net income grow at prodigious rates in 1993 and 1994 as problem loans were resolved and provisions for loan losses were lightened up or totally eliminated for a number of quarters. (If this is a bit too technical, check out the glossary for a discussion of loan loss provisions and credit quality.)
Overall, the company's net charge-offs increased 21% year-over-year for the first quarter, which most likely results from the end of the one-time boost that the company took in unwinding some of last year's reserves as well as a bona fide increase in charge-offs (or write-offs). At the same time, loan loss provisions increased less than that, increasing 20% year-over-year. However, the company's loan loss provision for the quarter was $507 million while net charge-offs were $482 million, which is a sign that the company is girding the balance sheet. One would expect that loan loss provisions would be growing at an increased rate with the troubles in Asia. Watch the second quarter earnings for this. I am not sure whether analysts have built this into their estimates, but it certainly does set up Citicorp for a negative earnings surprise if the analysts haven't taken a conservative stance here.
More on credit quality tomorrow as we wrap up this preliminary look at Citicorp.