Citigroup Inc. (NYSE:C)
Q3 2014 Earnings Conference Call
October 14, 2014 11:30 am ET
Mike Corbat – Chief Executive Officer
John Gerspach – Chief Financial Officer
Susan Kendall – Head of Investor Relations
Jim Mitchell – Buckingham Research
John McDonald – Sanford Bernstein
Glenn Schorr – ISI
Brennan Hawken – UBS
Guy Moszkowski – Autonomous Research
Matt O’Connor – Deutsche Bank
Mike Mayo – CLSA
Betsy Graseck – Morgan Stanley
Gerard Cassidy – RBC Capital Markets
Steven Chubak – Nomura Securities
Erika Najarian – Bank of America
Ken Usdin – Jefferies & Company
Matt Burnell – Wells Fargo Securities
Chris Kotowski – Oppenheimer & Co.
[Brian Klein-Hansel] – KBW
Hello, and welcome to Citi’s Q3 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. (Operator instructions.) Also this call is being recorded today. If you have any objections please disconnect at this time. Ms. Kendall, you may begin.
Thank you, Brett. 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, www.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 in 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.
Thank you, Susan. Good morning, everyone. Earlier today we reported earnings of $3.4 billion for Q3 2014. Excluding the impact of CVA/DVA net income was $3.7 billion or $1.15 per share.
Before I address the quarter I’d like to discuss the actions we announced regarding Global Consumer Banking. As you know, we’re committed to simplifying our company and allocating our finite resources to the business where we can generate the best returns for our shareholders. Consistent with these priorities we intend to exit our consumer businesses in eleven markets – among them Japan, Egypt and Peru. We’ll continue to serve our institutional clients in these markets which remain important to our global network.
While these consumer franchise have real value we didn’t see a path for meaningful return. We believe our Consumer business will achieve stronger performance by focusing on the countries where our scale and network provide a competitive advantage. Sales processes are already underway in most of these markets and I expect these actions to be substantially completed by the end of 2015. At that point we’ll have reduced our Consumer footprint by 19 markets since 2012 and Global Consumer Banking will be serving 57 million clients across 24 markets.
I’d also like to address the announcement we issued earlier this morning regarding a legacy Banamex unit which provided personal security and protective services. While the fraud is not financially material, in light of the conduct we found in the interest of transparency we thought it was best to inform you. As you know we’ve been reviewing our franchise in Mexico and have already made meaningful changes to strengthen our processes and controls, and will continue to take whatever steps are necessary to make sure that every part of our global franchise lives up to the standards all of us rightfully expect.
Now turning to the quarter: we achieved solid performance across our Institutional businesses. Both Banking and Markets saw improved revenue from prior-year period assisted by a better trading environment and a strong M&A pipeline. Treasury and Trade Solution revenues increased slightly despite spread compression.
Global Consumer Banking had a strong quarter as well and saw loan growth throughout the regions. In North America we had revenue improvement in each of our businesses both quarter-on-quarter and year-on-year while we continued to optimize our branch network. Internationally we saw revenue improvements across every region compared to Q3 last year.
Overall these results show solid business performance which has helped increase Citigroup net income by 5% year-to-date over 2013. We also continue to be focused on reducing the drag on earnings caused by Citi Holdings and consuming DTA. These have been execution priorities and we again made progress on both fronts.
In Citi Holdings we closed the sales of our Consumer businesses in Greece and Spain which helped reduce assets during the quarter by 7% to $103 billion. Holdings assets now constitute only 5% of Citigroup’s balance sheet.
The Holdings profit of $272 million again helped drive DTA consumption. We utilized $700 million of DTA in the quarter, bringing the total to over $5 billion for the last seven quarters. This contributed to our generating nearly $4 billion of regulatory capital this quarter and growing our Tier One common ratio to 10.7%. Our tangible booked value also increased to $57.73.
While we’re pleased with our ability to generate capital we’re equally focused on our ability to return it to our shareholders. During the quarter we continued to make progress on our efforts to strengthen our capital planning process.
Most important our capital planning process is being fully embedded in the way we run the firm. This must impact everything, from increased business engagement and enhancements to our forecasting models and scenario design processes – all of which lead to an improved approach to risk and controls. This work will continue as we get closer to receiving the 2015 stress test scenario from The Fed at which point we’ll prepare a strong submission which reflects the work that has been done.
As we finish out 2014 we’re very mindful of the challenging macro environment. Geopolitical tensions, uneven growth and concerns over the timing of interest rate increases have increased volatility. While the economy in the US seems to be slowly gaining strength, the Eurozone is not yet in growth mode and emerging market growth has slowed.
While our expense reduction efforts have been productive we continue to face pressure related to legal costs and the need to invest in regulatory and compliance, as well as the critical need to protect our network from cybercrime. We’ll remain vigilant along each of these fronts to ensure the safety and soundness of our institution.
John will now go through the deck and then we’d be happy to take your questions. Thank you. John?
Okay, thank you, Mike, and good morning everyone. Let me briefly review the results of the quarter and then I’ll go into more detail on the strategic actions we announced earlier today.
To start, I’d like to highlight two items that affect the comparability of this quarter’s results to prior periods. First, CVA/DVA was a negative $371 million pre-tax, or $228 million after-tax this quarter including a $474 million one-time charge due to the implementation of funding valuation adjustments related to certain derivatives. Together these charges had a negative impact on EPS of $0.08 per share this quarter, similar to the CVA/DVA charge last year.
And secondly, last year we recorded a tax benefit of $176 million or $0.06 per share related to the resolution of certain tax audit items. Adjusting for these items, we earned $1.15 per share in the recent quarter compared to $1.02 per share in Q3 last year. Throughout today’s presentation I will be discussing our results excluding these items to provide comparability to prior periods.
On Slide 4 we show total Citigroup results. We earned $3.7 billion in Q3, a 13% increase from last year. Pre-tax earnings of $5.9 billion grew 28% driven by revenue growth and lower credit costs, partially offset by an increase in operating expenses mostly driven by higher legal and repositioning charges. However, our tax rate was higher this quarter at 36%, reflecting a higher level of non-tax deductible legal accruals versus last year as well as higher tax costs related to the sales of our Consumer operations in both Greece and Spain.
On a year-to-date basis, we generated positive operating leverage with modest revenue growth and flat expenses, and our return on assets improved to 83 basis points. In constant dollars, Citigroup end-of-period loans grew slightly year-over-year, to $654 billion, as 4% growth in Citicorp was partially offset by the continued decline in Citi Holdings. And deposits were flat at $943 billion.
On Slide 5 we show more detail on expenses. Legal and related and repositioning costs totaled over $1.3 billion in Q3, mostly incurred in Citicorp. We also incurred $59 million of operating expenses related to the sales of our Consumer operations in Greece and Spain this quarter. Excluding these items core operating expenses of nearly $11 billion in Q3 increased by roughly $100 million versus prior periods, primarily reflecting an adjustment to incentive compensation expense driven by better-than-anticipated performance year-to-date in our Institutional franchise.
Higher regulatory and compliance costs, including those related to CECCAR and the impact of business growth were more than offset by continued cost reduction initiatives as well as the decline in Citi Holdings assets.
We expect to incur an incremental $150 million to $175 million of costs in full-year 2014 as we work to enhance our capital planning process. We estimate that about one-third of that amount will be non-recurring. In 2014, the incremental CECCAR-related costs will be more heavily weighted to the back half of the year. In Q3 we spent an incremental $60 million related to the CECCAR process and we expect this amount to increase further in Q4.
On Slide 6 we show the split between Citicorp and Citi Holdings. Citicorp’s pre-tax earnings grew 13% as higher revenues across the franchise and lower credit costs were partially offset by an increase in operating expenses. Citicorp expense growth was mostly driven by higher legal and repositioning costs, the adjustment to incentive compensation and ICG, and higher regulatory and compliance costs partially offset by efficiency savings.
In Citi Holdings we were profitable again this quarter with over $270 million in net income compared to a loss of over $100 million last year, driven primarily by lower legal and related expenses. Citi Holdings ended the quarter with $103 billion of assets or 5% of total Citigroup assets.
Before I go into more detail on Citicorp I’d like to cover the strategic actions Mike discussed earlier which will streamline and simplify our Consumer operations. We are exiting our Consumer operations in eleven markets plus our Consumer Finance business in Korea. As you can see on Slide 7 these actions include markets across Latin America, Asia and AMEA.
Substantially all of these operations were previously classified as “optimized markets” in our country bucketing framework, and while we have made steady progress in many of these businesses we ultimately determined that our scale did not provide for meaningful returns.
We already have active sales processes underway for over half of the businesses and we currently expect the strategic actions to be substantially completed by the end of 2015. We expect to report these Consumer operations as part of Citi Holdings as of Q1. We will continue to serve our Institutional clients in these countries which remain important to our global network.
On Slide 8 we provide details on the financial impact of these actions, showing Citicorp on the left and Global Consumer Banking on the right. Over the last twelve months these businesses contributed over $1.6 billion of revenues and $34 million of net income. Total assets were $29 billion as of the end of Q3 including $7 billion of consumer loans; and total deposits were $26 billion.
As shown on the far right, on a pro forma basis our Global Consumer Banking business would continue to capture more than 95% of our existing revenue base while further simplifying our operations and improving our performance.
Now, turning back to Q3, on Slide 9 we show actual results for International Consumer Banking in constant dollars. Net income grew 22% year-over-year in Q3 driven by higher revenues and lower credit costs, partially offset by higher legal and repositioning charges. Revenues grew 5% year-over-year in Q3 driven by continued volume growth across the franchise with average loans up 5% and average deposits up 3%; a rebound in investment sales revenues in Asia; and a reduced impact from our repositioning efforts in Korea.
Core operating expenses excluding legal and repositioning costs were roughly flat as ongoing efficiency savings offset the impact of business growth as well as higher regulatory and compliance costs. International credit costs declined 13% year-over-year driven by a net loan loss reserve release in the current quarter, while the net credit loss rate remained broadly favorable at just under 200 basis points.
Slide 10 shows the results for North America Consumer Banking. Net income grew 33% year-over-year this quarter driven by higher revenues, lower operating expenses, and continued favorable credit trends. Total revenues were up 5% year-over-year.
Retail Banking revenues of $1.2 billion grew 9% from last year, reflecting continued volume growth and abating spread headwinds as well as a mortgage repurchase reserve release of roughly $50 million this quarter.
Branded cards revenues of $2.1 billion were up 1% versus last year as we grew purchase sales and an improvement in spreads mostly offset the impact of lower average loans. And Retail Services revenues grew 8% from last year, mostly driven by the BestBuy portfolio acquisition.
Ongoing cost reduction initiatives drove total operating expenses down slightly year-over-year to $2.4 billion even after absorbing the impact of the BestBuy portfolio acquisition and higher legal and repositioning expenses. We continued to resize our North America Retail Banking business in Q3, taking costs out of our mortgage operations and rationalizing the branch footprint, all while continuing to grow our franchise.
Over the past twelve months we have sold or closed nearly 90 branches in North America. During this same period we grew average retail loans by 9% and average deposits by 2% including 10% growth in checking account balances. We also continued to see momentum in branded cards. While total average loans have continued to decline modestly this mostly reflects the runoff of promotional rate balances.
Full rate balances have grown year-over-year for six consecutive quarters and we continue to see strong growth in accounts and purchase sales in our proprietary Rewards and Travel co-brand products. We also launched our Double Cash card this quarter, which rounds out our product portfolio in the important cash-back segment.
Slide 11 shows our Global Consumer Credit trends in more detail. Overall Global Consumer Credit trends remained favorable in Q3, with net credit losses and delinquencies both improving as a percentage of loans. In North America the NCL rate continued to improve while 90+ day delinquency rates were flat. Asia remained stable, and in Latin America we saw a modest uptick in the NCL rate while the delinquency rate improved slightly.
Net credit losses grew broadly in line with our expectations in Q3 driven by portfolio growth and continued seasoning in the Mexico cards portfolio as well as the impact of both slower economic growth and fiscal reforms in that market. However, our overall loan growth was slower than anticipated which had a negative impact on the NCL rate for the quarter. This slower loan growth reflected the overall economic environment as well as a higher level of prepayments in our mortgage portfolio. Looking to Q4 we expect the dollar amount of net credit losses in Latin America to be more or less stable.
Slide 12 shows the expense and efficiency trends for Global Consumer Banking on a trailing twelve-month basis. While annual expenses increased in late 2012 and early 2013, driven in part by higher North America mortgage activity, we have driven down the core expense base over the last five quarters even as we have absorbed the impact of higher expenses associated with the BestBuy portfolio acquisition. Including roughly $800 million of legal and repositioning charges over the last year, our total efficiency ratio for Global Consumer Banking was 56%.
Slide 13 shows our total Consumer expenses over the past five quarters split between core operating expenses and legal and repositioning costs. Core expenses continued to decline on a sequential basis in Q3 as we made further progress towards 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 14, net income grew 29% year-over-year driven by higher revenues partially offset by higher operating expenses. Revenues of $8.7 billion grew 13% from last year and 2% sequentially. Total Banking revenues of $4.3 billion grew 11% from last year and were down 3% from the prior quarter.
Treasury and Trade Solutions revenues of $2 billion were up 1% year-over-year as growth in fees and volumes was partially offset by spread compression. Sequentially, revenues declined by 2% driven by lower trade assets and spreads.
Investment Banking revenues of $1.2 billion were up 32% from last year driven by strong M&A and equity underwriting activity, and down 7% from the prior quarter as continued momentum in M&A was more than offset by seasonally lower underwriting volumes. Private Bank revenues of $663 million grew 8% from last year as growth in client volumes was partially offset by the impact of spread compression.
Corporate Lending revenues were $442 million, up 17% from last year reflecting growth in average loans and improved funding costs partially offset by lower loan yields and down 3% from last quarter on lower gains from asset sales. Total Markets and Securities Services revenues of $4.3 billion grew 8% year-over-year and 5% sequentially.
Fixed Income revenues of $3 billion grew 5% from last year driven by strength in securitized products as well as an increase in foreign exchange volatility and volumes which benefited our Rates and Currencies business in the month of September. Sequentially, Fixed Income revenues were down slightly as a seasonal decline in spread product revenues was mostly offset by strength in rates and currencies.
Equities revenues of $763 million grew 14% year-over-year driven by improved client activity in derivatives, and were up 16% sequentially on better trading performance. In Securities Services revenues grew 8% year-over-year driven by an increase in client balances and activity.
Total operating expenses of $5 billion grew 3% over prior periods, driven by the compensation adjustment, higher regulatory and compliance costs, and higher repositioning charges partially offset by ongoing efficiency savings.
On Slide 15 we show expense and efficiency trends for the Institutional business. On a trailing twelve-month basis, the efficiency ratio declined to 59% this quarter despite continued elevated legal and repositioning charges. And our comp ratio for the last twelve months was 28%, down from 29% last quarter.
Slide 16 shows the results for Corp. 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, including those related to the CECCAR process. Assets of $332 billion included approximately $97 billion of cash and cash equivalents and $180 billion of liquid investment securities.
Slide 17 shows Citi Holdings assets, which totaled $103 billion at quarter-end with over 60% in North America mortgages. Total assets declined $8 billion during the quarter driven by net pay downs and divestitures including the sales of our Consumer operations in both Greece and Spain.
On Slide 18 we show Citi Holdings financial results for the quarter. Total revenues of $1.6 billion were up year-over-year, primarily driven on gains on the sales of our Consumer operations in both Greece and Spain and lower funding costs, partially offset by losses on the redemption of debt used to fund Holdings assets.
Citi Holdings expenses decreased significantly, driven by the lower level of assets as well as lower legal and related costs partially offset by $59 million of episodic expenses related to the sales of our Consumer operations in Greece and Spain. Net Credit losses continued to improve, down 45% year-over-year, driven by North America mortgages.
And we offset all of the mortgage net Credit losses with loan loss reserve releases. The net loan loss reserve release of $144 million includes the impact of roughly $75million of losses on assets moved to held for sale this quarter. Excluding these losses, the reserve release would have been close to $220 million.
On Slide 19 we show Citigroup’s net interest revenue and margin trends. Our net interest margin improved to 291 basis points in Q3 reflecting lower cost of funds. Looking to Q4, given the sale of Consumer loans with attractive margins in Greece and Spain we could see our net interest margin decline by a basis point or two.
On Slide 20 we show our key capital metrics. During the quarter our Basil-3 Tier One common ratio grew to 10.7%, driven by net earnings and continued DTA utilization. Our supplementary leverage ratio also improved to 6.0%, with about half of the sequential increase due to the impact of the revised final US Rules. And our tangible book value grew to $57.73 per share.
In summary, our results in Q3 demonstrated momentum across the firm. In Consumer Banking we grew revenues, loans and deposits in every region resulting in positive operating leverage and strong income growth over last year. And in our Institutional franchise we saw broad revenue growth across Markets, Investment Banking and Treasury and Trade Solutions, also resulting in positive operating leverage and significant growth in net income.
In Citi Holdings we were profitable again this quarter while continuing to wind down the remaining assets in an economically rational manner. And we continued to grow our book and regulatory capital.
Looking to Q4, in Consumer Banking we expect to continue growing our revenues while maintaining positive operating leverage year-over-year. In Markets our results will likely reflect the overall environment as well as normal seasonal trends. In Investment Banking, revenues should also reflect the overall market but we feel good about the quality and momentum of our franchise as demonstrated by our performance. And in Treasury and Trade Solutions we believe we can continue growing our revenues year-over-year in Q4 driven by continued volume growth and abating spread headwinds.
Turning to expenses, in Citicorp our core operating expenses should be relatively flat to Q3 levels as we expect to continue to face ongoing higher regulatory and compliance costs, including those related to our enhanced capital planning process. Repositioning expenses should be more or less in line with the roughly $400 million we incurred in Q3, and legal costs will likely remain elevated and episodic in nature.
We continue to have an overall favorable outlook with regard to our Credit performance. And finally, we expect our tax rate for Q4 to be broadly in line with the first half of the year in the range of 32%.
With that Mike and I would be happy to take any questions.
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