Citi breaks

By Huw Thomas, Editor

A decade after it changed the financial landscape, Citigroup is falling apart. BM traces the decline of a banking giant.

“There must be a clear understanding that government support for any company is an extraordinary action that must come with significant restrictions on the firms that receive support”
-Barack Obama, Jan 2009

Where did it all go wrong for Citigroup? When it was formed by the merger of Citibank and Traveler’s Group in 1998, it was envisaged as the epitome of the modern financial services firm. A one-stop shop that rolled up credit cards, insurance, retail and investment banking and wealth management under one roof. No-one had ever seen something this big before, a financial services supermarket where you could take out a loan to buy a new car, or a new company. Speaking in 1998, Roy Smith, a professor of finance at New York University, described Citigroup’s genesis as a fundamental game changer “This new company will look more like Procter & Gamble than it will look like a bank,” he said. “That's because what is being created here is a retail-products-distribution company for people interested in financial services.”

At first this bold move seemed to be paying off. Citi became the most successful financial institution in America, reporting a profit of $24.6 billion in 2005. In that year, the company took second place in the Fortune 500 list, only beaten to the top by oil giant Exxon Mobil.

Fast forward to 2009. At the end of January, CEO Vikram Pandit announced losses of $18.7 billion for the previous year and that Citi would ‘realign’ itself into two separate sections, Citicorp and Citi Holdings. Though this is officially not yet a full-scale split, the feeling is that this is a precursor to exactly that. The fact that many of Citi’s worst performing businesses, as well as $300 billion in toxic debt, have been assigned to Citi Holdings could well be significant, particularly in light of Pandit’s stated intention to only keep the parts of the organization that ‘work.’

In any case, Citigroup’s fall from grace has been spectacular, and there is every possibility that it could yet plummet further. Was the company purely a victim of the credit crunch or one of its major architects? And exactly what were the factors that led to its decline?

”What we are doing is creating a company headquartered in the US that will be able to compete very effectively all over the world.” Sandy Weill, April 1998.

“The specific merger transaction clearly has to be seen to have been a mistake. The stockholders have not benefited, the employees certainly have not benefited and I don’t think the customers have benefited because our franchises are weaker than they have been.” John Reed, April 2008.

Upon its creation, Citigroup’s model of the all-encompassing financial supermarket was a new paradigm. In bringing together Citibank and Traveler’s Group co-CEOs Sandy Weill and John Reed redefined what a financial organization could be. Citigroup’s birth was a key factor in the repeal of the last remnants of the Glass Steagall Act, which restricted the types of services a single financial institution could offer. This in turn effectively paved the way for deregulation and the tangled financial environment we live in today. The Act was introduced in the wake of the Great Depression in order to prevent any repeat of the large-scale bank failures of 1929, a fact that will not be lost on connoisseurs of cruel irony.

But at the end of the twentieth century, the birth of this gigantic organization promised much. Economies of scale would enable huge cost reductions, while the sheer range of customers touched would provide virtually limitless options for cross selling. Citi’s share price and reported results certainly seemed to vindicate the wisdom of the model, at least at first. Nonetheless, even a decade ago, there were certain dissenting voices. “When you create these oversize companies, they become vulnerable by definition," said Porter Bibb, a senior investment banker at Ladenburg Thalmann back in 1998. For all its benefits, the size of Citigroup does present certain disadvantages. Maintaining any sort of agility in such a monumental entity is a major challenge. The ability to quickly react to changing market requirements could leave Citi trailing behind smaller, more nimble competitors. A good analogy would be that of a supertanker and a frigate. Sure, the tanker can carry more cargo, but good luck to you if you need to make a quick turn.

Weill, the architect of the Citi/Traveler’s merger dismissed such concerns. His theory was that people simply didn’t want to shop around for financial products. If they could get a mortgage, credit card, loan and current account in the same place, then that is exactly what they would do. Such an attitude now seems dangerously misguided. The way in which the internet has reshaped not only the financial services industry, but business in general, has irrevocably changed things. Quite simply, choice matters. As the web has gained in sophistication and popularity, it has become increasingly easy for customers to shop around and find the exact products they are looking for.

In fact, technology can be seen as both one Citi’s biggest achievements and one of its greatest failures. While it undeniably has some of the most advanced and best-funded IT in the industry, this hasn’t always been to its advantage. “They spared no expense,” says Ralph Silva, a  Research Director at TowerGroup. “But as a result of all this expense, the only way they thought they could make their money back was to implement this technology everywhere. Nobody had a choice.” While it might have been superior technology, it didn’t necessarily serve the specific need of every customer everywhere. When you try to make everybody happy, you often wind up making nobody happy.

Compared to some of its contemporaries, Citi’s ability to respond to changing market requirements often seemed lacking. “Look at some of their competitors,” says Silva. “Often they use the same middleware software but each implementation has the ability to add in something unique to their region. Citi never had that.” While it had a far better efficiency ratio in its IT, it also had far worse customer satisfaction because it lacked the ability to make changes. These problems are only compounded by current events. Due to its sprawling technology infrastructure, making even small changes can be a slow process, often leaving it lagging behind its peers. “When the economic conditions are like they are, you need to have the ability change quickly. I don’t think Citi have that now,” confirms Silva.

But Citi’s structural problems aren’t purely a question of technology. Culturally too, it has often seemed disjointed. According to one former Citi employee now working at Deutsche Bank, Traveler’s and Citi didn’t really come together following their merger. “That the two firms were never truly integrated, and that the resulting entity become too large and cumbersome for senior managers to really understand the ground realities and operating environments, is a view that is shared by many Citibankers,” he says. “After John Reed's departure, I doubt there remained a senior manager who really understood the firm. So long as the tide was rising, it kept lifting Citi's boat, but at some point in time, the tide starts going out.” Considering Citigroup’s ceaseless appetite for expansion through mergers and acquisition, this scenario certainly has the ring of truth. “Citi was a huge beast, devouring very many businesses in a very short time,” agrees Bob MacDowall, another Research Director at TowerGroup. “While the legal and regulatory issues were addressed, culturally I don’t believe they were ever fully integrated.”

The risk for merging institutions that fail to take differing cultures into consideration is that they simply end up running different brands. Quite simply, time and effort has to be made stitch disparate elements together, otherwise you wind up with a single entity in name only. “When HSBC bought CCS in France, they allowed it to run independently for seven years, because they felt that that was the length of time required for the cultures to merge, “says Ralph Silva. “Citi’s mentality was ‘I’ll buy you on Friday and you’re Citi on Monday.’ They didn’t give a lot of opportunity for that change.”

“We see a lot of people on the Street who are scared. We are not scared. Our team has been through this before.” Charles Prince, Aug 2007

“It is my judgment that given the size of the recent losses in our mortgage-backed securities business, the only honorable course for me to take as chief executive officer is to step down.” Charles Prince, November 2007

Any institution of Citigroup’s size requires an extremely firm hand on the tiller particularly in trying times. When the bullish Sandy Weill anointed his protégé Chuck Prince as his successor, it was generally seen as a fairly uncontroversial move. The company was riding a wave of huge profits and strong share prices and Prince had been a loyal servant. It was only his lack of a heavyweight financial background that gave any pause. Besides, Prince would be backed up by plenty of people who did know the money game inside out, not least Director Robert Rubin, who boasted credentials as a former Treasury Secretary under president Clinton.

But as the economic winds shifted, Prince’s suitability for the job became less certain. Reports from insiders suggest that he was unaware of the full extent of Citi’s exposure to the subprime market, only learning that the bank owned $43 billion in such assets as late as September 2007. No one was necessarily expecting him to be checking up on every calculation made by his subordinates, but such an oversight made his ousting from CEOs office a question of ‘when’ rather than ‘if.’ “Prince understood the business but I don’t think he was the right man for the job,” says Silva. “He’s the perfect strategic thinker, in a good economic situation he was great. But in this situation what Citi needs is a three star general with battlefield experience.” What they got was Vikram Pandit, undoubtedly a competent and experienced candidate, but perhaps not one to rally the troops in such a dire climate. Since his appointment, he has continually been called upon to justify himself, both to shareholders and the industry at large.

“It would be a shame to see Pandit go because I think the bank would do very well with him but in a different economic situation,” says Silva. “I think they should put him one step down, just for a while and get a Norman Schwarzkopf-type figure who has nothing to lose on a short year contact and just get it done. Right now they seem to be changing their minds as often as I change my shoes.”

New chairman Richard Parsons, who succeeds Sir Win Bischoff, certainly has experience of turning failing companies around, as demonstrated by his recent work at Time Warner. However, his lack of experience in the financial space does raise some concerns. It is here that Pandit has the opportunity to prove his worth. “Parsons background might supply leadership skills but I don’t think is going to lead the strategic initiatives,” says Bob MacDowall. “I see him almost as mollifying figure. He has a had a glittering career but not in banking so will have to work closely with the chief executive on the strategy.”

This article was originally published on FST US.