Edited Transcript of Citigroup Q2 2014 Earnings Conference Call..
Company: Citigroup, Inc. (C)
Event Name: Q2 2014 Results Earnings Conference Call
Date: July 14, 2014 10:00 AM ET
Citigroup Q2 2014 – Webcast audio
Operator: Hello and welcome to Citi’s second quarter 2014 earnings review with Chief Executive Officer, Mike Corbat and Chief Financial Officer, John Gerspach. Today’s call will be hosted by Susan Kendall, head of Citi Investor Relations. We ask that you please hold all questions until the completion of the formal remarks at which time you will be given instructions for the question-and-answer session. Also as a reminder, this conference is being recorded today. If you have any objection, please disconnect at this time. Ms. Kendall, you may begin.
Susan Kendall – Head of Citi Investor Relations
Thank you, Regina. Good morning, and thank you all for joining us. On our call today, our CEO, Mike Corbat, will speak first, then John Gerspach, our CFO will take you through the earnings presentation, which is available for download on our website, citigroup.com. Afterwards, we’ll be happy to take questions.
Before we get started, I would like to remind you that today’s presentation may contain forward-looking statements, which are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results, and capital and other financial condition may differ materially from these statements due to a variety of factors, including the precautionary statements referenced in our discussion today and those included in our SEC filings, including, without limitation, the Risk Factors section of our 2013 Form 10-K.
With that said, let me turn it over to Mike.
Mike Corbat – Chief Executive Officer
Susan, thank you and good morning everyone. Earlier today, we reported earnings of $181 million for the second quarter of 2014. Excluding the impact of the legacy mortgage settlement CVA and DVA, net income was $3.9 billion, up slightly from last year or $1.24 per share.
Before I get into our operating performance, I want to discuss our legacy mortgage settlement. The comprehensive settlement announced today with the U.S. Department of Justice, the State AGs and the FDIC resolves all pending civil investigations related to our legacy RMBS and CDO underwriting, structuring and issuance activities. We also have now resolved substantially all of our legacy RMBS and CDO litigation. We believe that this settlement is in the best interest of our shareholders and allows us to move forward and to focus on the future in serving our clients.
During this quarter, our institutional businesses performed well outside of markets where macro uncertainty and historically low volatility reduced client activity, clearly impacting our fixed income and equities revenues. Corporate investment banking revenues strengthened, led by strong equity and debt underwriting and our treasury and trade solutions businesses again saw underlying revenue growth as volumes continued to increase.
In consumer banking, year-over-year comparisons continued to be affected by lower mortgage refinancing activity and our repositioning efforts in Korea. But we believe these businesses have now stabilized and we’re better positioned for growth in the second half of the year. We grew our consumer loans despite the uneven economic environment and saw continued signs of progress in our U.S. cards business.
Excluding the settlement announced today, Citi Holdings turned to profit for the first time since its formation and we announced agreements to sell our consumer businesses in Greece and Spain which will further reduce holdings assets in the third quarter. The holdings profit actually helped drive DTA consumption which totaled $1.1 billion in the quarter and $2.2 billion for the first half of 2014. And despite the impact of the legacy mortgage settlement on our net income, our capital position strengthened to a Tier 1 common ratio of 10.6% on a Basel III basis and our tangible book value also increased.
During the first half of this year, we generated $10 billion in capital despite today’s settlement. Throughout the organization we’re focused on strengthening our capital planning process, improving our execution and increasing our efficiency. We’re engaged in a firm-wide effort that includes improving our target client model, streamlining our structure, processes and technology platforms and optimizing our real estate footprint.
These actions create a capability to make investments in our business, regulatory and compliance activities and strength in our capital planning process. They also allow us to reduce our operating expenses both quarter-on-quarter and year-on-year.
While this effort is ongoing, we are already making some good headway. For example, during the second quarter, we reduced our headcount by 3,500 people to 244,000 and it is now down nearly 7,000 for the first half of 2014 and 15,000 people since the fourth quarter of 2012. We continued to simplify our product offerings and we further rationalized our footprint, shrinking retail branches by nearly 140 while reducing consumer support sites by another 31 locations.
Looking ahead, for the second half of this year, I feel good about how we’re positioned and I believe we should see an improved revenue picture. On the consumer side, the U.S. economy is gaining strength as job creation and consumer spending increases. Internationally, our franchise is performing well and we believe the headwinds facing our retail business in Korea are abating.
In our institutional business, while client activity has been lower in markets, business such as investment banking and trade finance are showing momentum. We’ve also demonstrated the ability to reduce the drag of Citi Holdings and utilize DTA, both of which will contribute to the strengthening of our capital positions going forward.
John will now go through the deck and then we will be happy to take your questions. John?
John Gerspach – Chief Financial Officer
Okay, thank you, Mike and good morning everyone. To start, I’d like to highlight two items which affect the comparability of this quarter’s results to last year. First as Mike described, this quarter, we took a $3.7 billion after-tax charge related to the mortgage settlement for a negative impact on EPS of $1.21 per share. And second, CVA and DVA was a negative $33 million pre-tax this quarter or $0.01 per share after tax compared to a positive $477 million pre-tax or $0.09 per share in the second quarter of last year.
Adjusting for CVA, DVA and the impact of the settlement, we earned $1.24 per share in the recent quarter, compared to $1.25 per share in the second quarter of last year. Throughout today’s presentation, I’ll be discussing our results excluding these two items to provide comparability to prior periods.
On slide four, we show total Citigroup results. We earned $3.9 billion in the second quarter and $8.1 billion for the first half of 2014, both up slightly from prior periods as lower revenues were offset by lower operating expenses and a decline in credit cost. Citigroup end-of-period loans grew 4% year-over-year to $668 billion as 8% growth in Citicorp was partially offset by the continued decline in Citi Holdings and deposits grew 3% to $966 billion.
On slide five, we show more detail on expenses. Legal and related costs were roughly $400 million in the second quarter, mostly incurred in Citicorp. Repositioning costs were also around $400 million, including approximately $270 million of repositioning costs related to our consumer franchise in Korea.
Excluding these items, core operating expenses of nearly $11 billion in the second quarter declined by over $225 million in constant dollars, driven by continued cost reduction initiatives and the decline in Citi Holdings’ assets, partially offset by higher regulatory and compliance costs as well as the impact of business growth. Sequentially, core expenses were down versus last quarter, reflecting lower incentive compensation and continued efficiency efforts, again partially offset by higher regulatory and compliance costs.
On slide six, we show the split between Citicorp and Citi Holdings. In Citicorp, earnings declined 18% year-over-year as lower revenues and higher legal and repositioning costs were partially offset by lower core operating expenses and an improvement in credit. In Citi Holdings, we earned over $240 million this quarter, compared to a loss of nearly $600 million last year.
Citi Holdings revenues increased significantly from last year driven by the absence of rep and warranty reserve builds in the recent quarter, higher gains on asset sales and lower funding costs. Core expenses continued to decline in line with a 15% year-over-year reduction in assets. Citi Holdings ended the quarter with $111 billion of assets or 6% of Citigroup assets.
Turning to Citi Corp on slide seven, we show results for international consumer banking in constant dollars. Revenues grew 1% year-over-year in the second quarter. Core operating expenses, excluding legal and repositioning costs also increased 1% from the prior year, driven by business growth and higher regulatory and compliance costs, partially offset by ongoing efficiency savings. Including legal and repositioning costs, total operating expenses increased 12% from the prior year, mostly due to the repositioning charges in Korea.
International consumer revenues continued to reflect spread compression as well as the impact of regulatory changes and the repositioning of certain markets. Korea remained a headwind year-over-year, however the franchise was broadly stable quarter-over-quarter and we believe we should begin to see sequential revenue growth in Korea as we go into the second half of the year.
Aside from Korea, the most significant challenge for Asia consumer revenue this quarter was a decline in investment sales revenues both year-over-year and sequentially. While this business has grown over time, quarterly investment sales revenues tend to reflect the overall capital markets environment and in the second quarter we saw a weaker investor sentiment.
We provide more details on Asia consumer revenues on Appendix slide 25. Despite these headwinds, most underlying drivers remained positive with average loans up 7% and average deposits up 3% from last year. International credit costs grew 10% year-over-year mostly reflecting portfolio growth and seasoning in Latin America while the net credit loss rate remained broadly favorable at below 200 basis points.
Slide eight shows the results for North America consumer banking. Total revenues were down 5% year-over-year and flat sequentially. Retail banking revenues of $1.2 billion declined by 26% from last year mostly reflecting lower mortgage refinancing activity and were up 3% sequentially as higher mortgage revenues and improved deposit spreads offset the absence of a onetime $70 million gain in the prior quarter.
Branded cards revenues of $2 billion were up 3% versus last year, as we grew purchase sales and lower average loans were partially offset by an improvement in spreads driven by a reduction in promotional rate balances. And retail services revenues grew 7% from last year, driven by the Best Buy portfolio acquisition. Ongoing cost reduction initiatives drove total operating expenses down by 4% year-over-year to $2.3 billion even after absorbing the impact of the Best Buy portfolio acquisition.
We continued to resize our North America retail banking business in the second quarter, taking cost out of our mortgage operations and rationalizing the branch footprint all while continuing to grow our franchise. Over the past 12 months, we have sold or closed over 70 branches in North America. During the same period, we grew average retail loans by 11% and average deposits by 4%, including 11% growth in checking account balances.
In branded cards, we also saw momentum. While total average loans have continued to decline modestly, this mostly reflects the runoff of promotional rate balances. Full rate balances have growth year-over-year for five consecutive quarters, reflecting account growth and increased card usage primarily in our proprietary rewards and travel co-brand products, including American advantage where new account growth for our executive card has exceeded our expectations.
Credit remained favorable in the second quarter with net credit losses and delinquencies both improving more than what we had anticipated in branded cards and retail services contributing to a loan loss reserve release of nearly $400 million. At quarter end, our loan loss reverses in North America cards represented roughly 16 months of concurrent NCL coverage.
Slide nine shows our global consumer credit trends in more detail. Overall, global consumer credit trends remained favorable in the second quarter with net credit losses and delinquencies both improving as a percentage of loans. In North America, the strong credit trends I just mentioned drove an improvement in our outlook and we now anticipate the full year NCL rate to be roughly in line with first half results or slightly better than our previous estimate of around 3%. Asia remained stable, and in Latin America, we saw a modest uptick in both NCL and delinquency rates.
These trends were driven primarily by Mexico cards as that portfolio continued to season and consumers continued to adjust to fiscal reforms as well as the impact of slower economic growth. We continue to expect the full year NCL rate in Latin America to be roughly in line with first half levels. This rate could be higher of course if we incur any losses related to our exposure to homebuilders in Mexico. However, we would expect these losses to be charged against our reserves and therefore they should be neutral to the overall cost of credit.
Slide 10 shows the efficiency ratio for global consumer banking on a trailing 12-month basis. Total franchise results are shown on the light blue line, while the dark blue bars represent the efficiency ratio excluding North America mortgage and Korea. As I’ve mentioned before, revenues have declined in both North America mortgage and Korea over the past year, in addition, we incurred significant repositioning charges in Korea in the second quarter creating a drag on our reported operating efficiency.
Outside of these businesses, we have made steady progress reducing our efficiency ratio to just under 54% as we have exited underperforming markets and simplified our operations.
Slide 11 shows our total consumer expenses over the past five quarters, split between core operating expenses and legal and repositioning costs. Legal and repositioning costs were elevated in the second quarter driven by Korea, while core operating expenses continued to decline. We expect to make further progress in reducing core expenses in the second half of the year as we remain on track to achieve or exceed our year-end goals for headcount reduction, card product simplification and branch and support site rationalization.
Turning now to the institutional clients group on slide 12. Revenues of $8.5 billion declined 7% from last year and 8% sequentially. Total banking revenues of $4.5 billion grew 6% from last year and 9% from the prior quarter. Excluding the one-time $50 million gain in the prior year, treasury and trade solutions revenues of $2 billion were up 3%, both year-over-year and sequentially as growth in fees and volumes were partially offset by spread compression.
Investment banking revenues of $1.3 billion were up 16% from last year and 27% from the prior quarter, driven by particularly strong debt and equity underwriting activity. M&A revenues improved from the prior quarter and we continued to increase our share of announced M&A volumes in a growing market. Private bank revenues of $656 million grew 2% from last year as growth in client volumes was partially offset by the impact of spread compression and were down 2% sequentially on lower capital markets activity.
Core lending revenues were $454 million, up from prior periods mostly due to higher average loans. Total markets and security services revenues of $4.1 billion declined 16% year-over-year and 21% sequentially. Fixed income revenues of $3 billion declined 12% from last year as historically low volatility and continued macro uncertainty dampened investor client flows particularly in rates and currencies. In addition, the prior year period benefited from gains as we paired back risk positions given increased volatility in emerging markets.
Sequentially, fixed income revenues declined 22% reflecting seasonal trends. Equities revenues of $659 million were down 26% year-over-year and 25% sequentially reflecting lower client activity, as well as weak trading performance in EMEA in part driven by macro and geopolitical uncertainties in the region.
In securities services, revenues were roughly flat versus last year as increased client activity was offset by a reduction in high margin deposits and up 7% sequentially due to increased client balances and higher activity from new accounts.
Total operating expenses of $4.9 billion were down 2% versus the prior year driven by lower incentive compensation, partially offset by higher regulatory and compliance costs and legal and related expenses in the recent quarter. On a sequential basis, expenses decreased by over $100 million mostly reflecting lower incentive compensation.
On slide 13, we show expense and efficiency trends for the institutional business. On a trailing 12 month basis we have lowered our operating expenses every quarter for over two years, driving the full year efficiency ratio from 66% two years ago to 60% as of the second quarter, even as the revenue environment has remained challenging. Our comp ratio for the most recent 12 months was 29%, consistent with the full year of 2013.
Slide 14 shows the results for corporate other. Revenues declined year-over-year driven mainly by hedging activities, while expenses increased on higher, legal and related expenses, as well as higher regulatory and compliance costs. Assets of $326 billion included approximately $104 billion of cash and cash equivalents and $167 billion of liquid investment securities.
On slide 15 shows Citi Holdings’ assets which totaled $111 billion at quarter-end, with roughly 60% in North America mortgages. Total assets declined $3 billion during the quarter mostly driven by net pay downs. Roughly $3.8 billion of asset sales were in process during the quarter, but not yet closed as of June 30. These include $2.7 billion of assets from the announced sale of our retail operations in Spain and Greece, as well as nearly $1 billion of mortgage loans, each of which should close in the third quarter.
On slide 16, we show Citi Holdings’ financial results for the quarter. Total revenues of $1.5 billion were up year-over-year primarily driven by the absence of rep and warranty reserve builds in the recent quarter, higher gains on asset sales and lower funding costs. Citi Holdings’ expenses decreased significantly with core operating expenses down 15% in line with the reduction in assets. Net credit losses continued to improve and we released $254 million of loan loss reserves, the vast majority of which was related to North America mortgages.
Looking at the past five quarters of Citi Holdings results on Slide 17. The operating margin in Citi Holdings remained at roughly $700 million this quarter driven in part by gains on asset sales. Credit remained fairly stable and on an adjusted basis, legal costs declined significantly driving Citi Holdings to a profit in the second quarter.
On slide 18, we show Citigroup’s net interest revenue and margin trends. Net interest revenue was $11.9 billion in the second quarter, up from last year on higher interest earning assets and an improvement in net interest margin and up sequentially driven by day count. Our net interest margin declined sequentially to 287 basis points in the second quarter driven by lower loan and investment yields, partially offset by lower cost of funds. We currently believe our net interest margin should remain roughly flat to second quarter levels for the remainder of the year.
On slide 19, we show our key capital metrics. Despite the impact of the settlement, our Basel III tier one common ratio grew to 10.6% as we benefited from DTA utilization during the quarter. Our supplementary leverage ratio also improved to 5.7% and our tangible book value grew to $56.89 per share.
So in summary, our results in the second quarter demonstrated further progress on several fronts. While markets revenues reflected the challenging environment, we showed continued momentum in our investment banking franchise and Treasury and Trade solutions continued to grow all while we continued to reduce our total expense base in ICG.
On the consumer side, we continued to grow loans, deposits and card purchase sales while reducing our core operating expenses and maintaining overall favorable credit performance. And in Citi Holdings, excluding the impact of the settlement, we achieved our first profitable quarter and we believe Citi Holdings should remain profitable for the remainder of this year, although with some variability quarter-to-quarter.
Looking to the second half of the year, in markets our results will likely reflect the overall environment. Although we would certainly anticipate that market conditions should be somewhat more favorable than in the second half of 2013. In investment banking, revenues will also reflect the overall market, but we feel good about the quality and momentum of our franchise as demonstrated by our performance not only in the second quarter but over the past year. And in treasury and trade solutions we believe we can continue growing our revenues in the second half of the year driven by continued volume growth and abating spread headwinds.
Turning to consumer banking. In North America we believe revenue should grow in the second half of the year, both versus the first half of 2014 as well as year-over-year with positive operating leverage. And in international consumer revenue should also grow in the second half of the year as we move past our repositioning efforts in Korea and the underlying growth of the remaining franchise becomes more apparent.
Turning to expenses. In Citicorp our core operating expenses should continue to decline, although we expect to face ongoing higher regulatory and compliance costs. Repositioning expenses in the second half of the year should be roughly in line with the first half levels and legal costs will likely remain somewhat elevated and episodic in nature.
We continue to have an overall favorable outlook with regard to our credit performance. While we saw an increase in loan loss reserve releases in our North America cards business this quarter, driven better by better than anticipated credit performance, we do expect the reserve releases to be lower in the second half of the year and nominal credit costs in Citicorp could increase as we continue to grow our loan portfolios.
And finally we expect our tax rate for the remainder of the year to be broadly in line with the first half in the range of 32%. And with that, Mike and I would be happy to take any questions.