Signs of improvement at Citigroup
Last week, the bank announced its long-awaited plan to reduce expenses, which lately have been growing faster than its revenues. According to the plan, Citigroup intends to streamline its organization by eliminating 17,000 positions through layoffs and attrition. As a result, the bank is taking a $1.38 billion charge against earnings in the first quarter, and it expects to generate savings of $2.1 billion in 2007, $3.7 billion in 2008, and $4.6 billion in 2009.
While the cuts seem to have temporarily appeased many of Citigroup's critics, the actual impact of the reductions may turn out to be less significant than expected. After all, Citigroup's operating expenses were more than $52 billion last year, and the company employs more than 325,000 people. In that context, the cutbacks probably amount to something less than radical surgery on an inefficient operating structure, instead resembling a speed bump in the projected rate of expense growth.
The positive spin that surrounded Citigroup's first-quarter earnings announcement, which was released a few days after the expense reduction plan was announced, may also have been overhyped. Citigroup reported record revenue of $25.5 billion, a 15% increase over the previous year. Net income measured $5.01 billion, or $1.01 per share. Excluding the effect of charges related to expense reductions, net income would have been $5.88 billion, or $1.18 per share.
CEO Chuck Prince sees the first-quarter results as evidence that his vision for Citigroup is beginning to take shape. While many critics have pushed for the separation of Citigroup's U.S. retail unit, investment bank, and international operations, Prince has argued that the company is greater than the sum of its parts. Unfortunately, the first-quarter results do not provide unequivocal support for that position.
First, Citigroup's markets and banking unit provided for much of the improvement in overall results. Net income at the investment bank increased by 36%, driven by higher equity underwriting activity and higher advisory fee income. But investment banking revenues are very much a reflection of underlying market conditions, and consequently, the unit's increase hardly indicates the kind of steady, sustainable income that Prince wants Citigroup to generate.
Second, Citigroup's giant global consumer unit still seems to be a source of trouble. Net interest revenue increased despite the flat yield curve, but expenses and loan provisioning grew at a faster rate of 18%. Perhaps ominously, the unit increased its provision for loan losses by 61%. Should shareholders be concerned that the bank's credit quality is being swept into the downdraft of so many subprime lenders?
All areas of global consumer operations posted declines in income, with international consumer finance and U.S. retail distribution showing the sharpest declines. While non-recurring events may explain much of the decline in income -- the restructuring of Citigroup's Japanese operations is one notable example -- the breadth and complexity of the unit's operations mean that discrete, non-recurring events often seem to be a recurring problem for the unit. Overall, the global consumer unit's income fell by 14% to $2.6 billion.
Third, the value of Citigroup's international expansion is not supported by recent financial results. Intuitively, it makes sense for Citigroup to expand into markets that have higher growth rates than the United States, and the bank now generates nearly 50% of its profits outside the United States. Nevertheless, the bank generates much lower returns on invested capital from its international consumer operations than it earns from its activities at home. Prince begs for patience, arguing that relatively new international investments require more time to pay off. In any case, it's still early to conclude that Citigroup's global sprawl can deliver the level of profitability that Prince has promised.
In the meantime, the market's positive response to recent developments at Citigroup has perhaps given Prince more time in the CEO's office. It will be interesting to see whether he can achieve the profitability and growth targets he has set for the bank.
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