Citigroup Q2 2011

We announced earnings of $3.3 billion for the second quarter, which brings our total net income for the first half to $6.3 billion

Loans grew throughout our core businesses in the second quarter at a level that more than offset the reduction in Citi Holdings. The revenues from our International Consumer Banking operations increased from the previous quarter and year, as did the net income from the North American Consumer Bank

"The bank reported a first quarter net income of $3 billion, or 10 cents per share. Citi Holdings revenues declined 50 percent from last year to $3.3 billion. Net interest revenues fell by over 40 percent due to lower consumer lending. Net losses for Citi Holdings was $608 million compared to $886 million in the first quarter of 2010.

"Citi Holdings will be a drain on our revenue for a while. Eventually, growth in Citi Corp will overtake the growth in Citi Holdings," said CEO Vikram Pandit on the first quarter earning conference call.

Citigroup was able to divest $22 billion in assets in the first quarter, leaving total assets in the entity at $337 billion.

"Citi Holdings assets are now at 17% of our total balance sheet," said Pandit. "Citi Holdings' loss was $608 million, down 31% from the prior year."

Last quarter, Citigroup divested $106 billion in asset sales, and $49 billion in net run-off and amortization. Of those asset sales, $10 billion came from Citi's mortgage books with $6 billion being delinquent loans.

"The assets in Citi Holdings will continue to decline," said John Gerspach, CFO, on the first quarter earnings conference call. "However as you can see those will be moderated over the next year."

In our Institutional Businesses, Investment, Corporate and Private Banking revenues improved. Global Transaction Services performed very well, as net income increased from the previous quarter, despite continued low interest rates. However, our Markets business was clearly impacted by the trading environment.

In Citi Holdings, we continued the reduction of assets in an economically rational manner. Our Holdings assets were reduced by $29 billion during the quarter, from $337 billion to $308 billion, and now make up less than 16% of Citigroup's balance sheet.

We remain on track to meet the Basel III capital requirements through both the optimization of our assets and the generation of capital. We continue to expect that Citi will be in a position to return capital to shareholders in 2012 and still have an 8% to 9% Basel III Tier 1 common capital ratio at the end of that year (more than BAC, hence why BAC is trading a larger discount to book, more liklihood of a capital raising).

our earnings and utilization of deferred tax assets create a multiplier effect on regulatory capital formation. In the first half of this year, this generated $9 billion of Basel III regulatory capital on $6.3 billion of earnings and $1.5 billion of DTA utilization

Revenues of $20.6 billion were down 7% versus the prior year, as strong growth in International Consumer Banking and Transaction Services was more than offset by lower revenues in Citi Holdings, Securities and Banking and North America Consumer Banking.

Expenses were up 9% year-over-year to $12.9 billion. But excluding the U.K. bonus tax of roughly $400 million in the second quarter of 2010, expenses were up nearly 13%. Approximately 1/3 of this 13% increase resulted from the impact of foreign exchange, and another 1/3 was related to higher legal and related costs. The remaining 1/3 was driven by the net impact of investment spending, partially offset by ongoing productivity savings. All other expense increases, such as higher volume-related costs in Citicorp, were largely offset by a reduction in Citi Holdings expenses

Net credit losses declined again in the second quarter to $5.1 billion, 35% lower than the second quarter of 2010. We also released $2 billion of net loan loss reserves compared to a $1.5 billion net release last year and a $3.3 billion in the first quarter. On a sequential basis, end-of-period loans grew 2% for Citigroup, as strong loan growth in Citicorp more than offset the decline in Citi Holdings

Citicorp reported revenues of $16.3 billion and net income of $3.7 billion in the second quarter is down slightly versus last year. Sequentially, we grew end-of-period loans in every business in every region in Citicorp, and the same holds true year-over-year with the exception of North America branded cards. Versus last year, Citicorp loans grew 16%, including 11% growth in consumer and 22% growth in corporate loans.

Citi Holdings reported revenues of $4 billion and a net loss of $218 million, which included over $0.5 billion of pretax realized gains on the sale of assets transferred out of held-to-maturity in the Special Asset Pool in the first quarter. Citi Holdings ended the quarter with $308 billion of assets, down $29 billion during the quarter and $157 billion year-over-year.

Citicorp's net credit losses were $2.2 billion, down 27% from the prior year, driven by Citi-branded cards in North America. We released $914 million in net loan loss reserves, up from $665 million last year, due to higher net releases in Citi-branded cards, partially offset by lower releases in International Consumer Banking and the corporate portfolio

emerging markets contributed nearly half of Citicorp's revenues and over 60% of earnings before taxes in the second quarter. Emerging markets revenues have grown year-over-year for 5 consecutive quarters, driven by both our consumer and institutional businesses. This growth reflects consistent strength in underlying business drivers, with average deposits up 13% year-over-year and loans up 27%.

North America Consumer Banking business. Revenues of $3.4 billion were down 9% versus last year, mainly due to a decline in average card loans, lower mortgage revenues and the impact of CARD Act. Sequentially, revenues were up 1%. Expenses of $1.8 billion were up 17% year-over-year and 5% sequentially as we continued to increase investments largely through higher marketing and technology spending. Credit costs declined 74% from last year to $552 million. Net credit losses were down 39% to $1.3 billion, driven by Citi-branded cards. And the reserve release was $757 million this quarter. Net credit margin grew by 32% year-over-year to $2.1 billion. Sequentially, we grew both end-of-period retail and card loans, although average card loans declined modestly

International consumer banking. Sequentially, we have grown average loans and deposits every quarter for over 2 years, and card purchase sales have increased year-over-year for 7 quarters. We have also increased our net credit margin and our earnings before taxes, excluding the impact of loan loss reserves, year-over-year for 7 consecutive quarters.

In investment banking, revenues of $1.1 billion were up 27% sequentially with strength in both advisory and underwriting activities. x CVA, equity market revenues of $776 million were down 30% sequentially, mainly due to lower market volumes and a challenging trading environment, particularly in derivatives. Fixed income market revenues x CVA were down 27% sequentially to $2.9 billion, driven by credit-related and securitized products.

The $29 billion reduction in the second quarter was comprised of nearly $21 billion of asset sales and business dispositions, over $7 billion of net runoff and paydowns and roughly $1 billion of net cost of credit and net asset marks.

net credit losses and loan loss reserves. NCLs continued to improve in the second quarter, down 18% sequentially to $5.1 billion. And the net LLR release was $2 billion versus $3.3 billion in the prior quarter. We ended the quarter with $34.4 billion of total loan loss reserves and our LLR ratio was 5.4%. Consumer NCLs declined 11% sequentially to $4.8 billion, and we released $1.5 billion in net loan loss reserves.

nternational consumer credit trends. In Citicorp, as our loan portfolios grew, dollar NCLs were up modestly from the first quarter in Asia and Latin America, but remain stable to improving on a rate basis. 90-plus-day delinquencies also increased sequentially in dollar terms in Asia and Latin America, but remain fairly stable as a percentage of loans. We also saw a continued improvement in international consumer credit in Citi Holdings.

the North America mortgage portfolio in Citi Holdings, split between residential first mortgages and home equity loans. NCLs and 90-plus-day delinquencies improved in both portfolios in the second quarter. In residential first mortgages, we ended the second quarter with $73 billion of loans, down 19% from a year ago. Sequentially, 90-plus-day delinquencies declined by 13% to $3.9 billion and were down more than 50% from last year. Net credit losses were down 17% sequentially to $461 million. The sequential decline in first mortgage delinquencies again was primarily due to continued asset sales, as we sold nearly $800 million in delinquent mortgages in the quarter.

We ended the quarter with a Tier 1 capital ratio of 13.6% and a Tier 1 common ratio of 11.6%. Our total risk-weighted assets were $992 million -- $992 billion, with roughly 28% attributable to Citi Holdings.

Over the past few quarters, Citigroup's risk-weighted assets, as reported under Basel I, have been fairly constant, as growth in Citicorp has been offset by a significant reduction in Citi Holdings. We currently expect risk-weighted assets under Basel I to grow slightly by low single digits as of the end of 2012. Based on our initial analysis, last year we estimated that Basel III would result in an increase in risk-weighted assets in Citicorp of approximately 30% to 35%. Today, we believe the increase in risk-weighted assets for total Citigroup will be in the range of 35%, with Citicorp's risk-weighted assets increasing in the range of 20%. The refinement in our estimate of the risk-weighted asset impact is based on several factors, including greater experience with Basel III risk models and key drivers and more clarity on the impact of mitigating actions. We believe our businesses in Citicorp are inherently Basel III-friendly.

Regarding operating expenses. The impact of the weakening U.S. dollar, as well as higher legal and related costs, total roughly $1.6 billion out of the $1.9 billion increase in our expense base in the first half of 2011 as compared to the first half of last year. These factors will likely continue to affect our expenses in the second half of this year and will remain difficult to predict. Therefore, we expect operating expenses to remain elevated for the remainder of the year. As a result, our full year operating expenses will likely exceed the $48 billion to $50 billion guidance that we had communicated previously.

Can you maybe give some help on how to think about the risk-weighted asset? What is heavier, I guess, in Citi Holdings in terms of the risk-weighted assets under Basel III versus what are lighter? So is it mortgages that are the biggest hit, or is it the Special Asset Pool? And we can kind of do our own conclusions on the pace of runoff on the individual assets.

John Gerspach

Well, Basel III certainly puts a premium on any type of asset that's resulting from a securitization. And so that would sort of draw your attention to more of assets that are in Special Asset Pool.

James Mitchell - Buckingham Research Group, Inc.

Right. So to the extent that you can move those down more quickly, that could be helpful?

John Gerspach

That would be the logical conclusion, yes.

continue to drive down the Citi Holdings expenses as we drive down assets. And I think we do have a pretty good track record. And you should assume that as we continue to drive down the assets in Citi Holdings, we will get expense saves coming out of the business. That is clearly the way that we are operating Citi Holdings. And to your point, we had a little bit of a bump on the road this year -- this quarter due to some legal and related costs.

That's a great question. I mean obviously, as we continue to drive down yielding assets in Citi Holdings, and in this quarter as you said, we got rid of that $13 billion of securities that we had in the hold-to-maturity. That is certainly going to impact the net interest income coming out of both the Special Asset Pool as well as Citi Holdings in total.

Now we began investing last year. We called out the fact that we were beginning to invest in our consumer businesses in Asia and Latin America. When you start investing in your consumer businesses, you've got roughly a 12- to 18-month lead time before you really begin to see something positive in operating leverage coming out of those investments. And in both of those geographies, as we said in the call, our expectation is that, beginning in the fourth quarter of this year, you will see positive operating leverage in both the Regional Consumer Banking businesses in Asia and in Latin America.

Again, we're very conscious of -- you guys are very focused on expenses. I got to tell you, so are we. But we're also trying to make sure that we're putting the right expense dollars into the businesses to grow operating margin


Citi Holdings

Citi Holdings will be a group of non-core businesses that include attractive long-term businesses with strong market positions. However, they do not sufficiently enhance the capabilities of Citi's core business, and in many ways compete for its resources.

The Citi Holdings management team will seek to maximize the value of these businesses by running them well, restructuring and managing them through this tough economic cycle, and taking advantage of value-enhancing disposition and combination opportunities as they emerge. These businesses and assets will initially include:

Brokerage and asset management: including the 49 percent stake in Morgan Stanley Smith Barney, as well as Nikko Cordial Securities, Nikko Asset Management and Primerica Financial Services. Brokerage and Asset Management is mostly related to the Morgan Stanley Smith Barney JV. Morgan Stanley has calls to purchase our stake in the JV in 3 tranches beginning in 2012, and either party has the right to cause an IPO after 2015. We have also roughly $12 billion of margin loans and other assets, the majority of which should transfer to the JV by the end of 2012.

Local consumer finance: including CitiFinancial and CitiMortgage in the U.S., and consumer finance operations in Western Europe, Japan, India, Mexico, Brazil, Thailand and Hong Kong. Local Consumer Lending is a mix of operating businesses and runoff portfolios. Two sizable operating businesses remain. First is retail partner cards with $45 billion of assets. Second is Citi Financial with $32 billion of assets, including both the one main business and Citi Financial servicing. On Slide 15, these assets are included in both mortgages and personal loans. The majority of assets in Local Consumer Lending will either run off or be reduced by smaller sales. Over half of the assets are mortgages with a roughly 6-year expected average life.


Special asset pool: will manage the assets covered by the loss-sharing agreement with the U.S. government parties in the ring-fenced portfolio; and other non-strategic assets. Roughly $19 billion are trading assets or available-for-sale. $13 billion are held-to-maturity securities with an expected average life of 7 years. $7 billion are loans and leases which we currently expect to reduce significantly by the end of next year. And the remainder is other assets, including private equity positions, targeted for sale.