Interview with Gary Crittenden, CFO of Citigroup Inc

Last July, just months after joining Citigroup (C) as chief financial officer, from American Express (AXP), Gary Crittenden addressed the analyst community in his first earnings conference call. It was a particularly upbeat event, given that the bank had just turned in record quarterly profits of $6.23 billion. Ever since, however, it has posted nothing but losses. Worse, Citi has been fighting for survival. After Citi's share price plummeted to values not seen in 15 years, Crittenden recently became a key player in talks with the government about a deal to not only backstop some $306 billion in the bank's assets, but also bolster the institution with more capital. 

Here's an edited version of the interview:

Honestly, I'd have to start with "tired." Anyone who has my job in a period like this has been working a lot of hours. The world is a different place. We're challenged, and we have to find creative solutions to this situation. There's an interesting balance between the unknown and the exhilaration of figuring out the right answers. 

What are the right answers? 

Right now there's a lot of encouragement for banks broadly to lend to consumers for cars and mortgages and credit cards, and we are certainly doing our part within proper risk parameters to make sure that happens. The consumer is weak but there are a couple of things that are positive. Consumers are saving more and gas prices are falling. If there is a stimulus package of size over the next year, that could have a positive impact on employment and bank earnings. And to the extent that you have positive impact on earnings, banks will be increasingly interested in participating in the market. 

What is the best argument for keeping the bank intact? 

The argument that monoline financial-services businesses can succeed is difficult to sustain. There aren't many freestanding mortgage companies or freestanding credit-card companies. There aren't many investment banks that haven't become bank holding companies. All of those have morphed one by one to have deposit funding. Although I think it makes for interesting reading, you have to ask yourself a very sober question about splitting up Citi: If we spun off a stand-alone wholesale business, would it have the ability to fund itself wholesale in today's environment? The universal bank model also is the predominant model in the developing world. We think about options and alternatives in the context of the fundamental strategy that [CEO] Vikram Pandit laid out. 

What is the right size for Citi? The mandate to cut costs is huge. 

We've made a lot of progress already. In the fourth quarter of last year we had $16.1 billion in expenses, and in the quarter we just reported they were $14.4 billion, so that means since the end of last year we have taken 11% of our expenses on a reported basis. We just announced that we will cut our expenses to between $50 billion and $52 billion next year. If you take the last four quarters, our expenses were about $60 billion, so that would be a 15% reduction. We've already made substantial progress this year, and we have every intention to continue to cut expenses. After years and years of growing head count and peaking at 375,000 employees, we are down to about 350,000 and we aim to get below 300,000 in the first part of next year. That's obviously a change in direction. This has come through just plain old hard work, changing compensation plans, widening the spans of control and cutting out layers, eliminating redundant technologies. 

Our total assets peaked at $2.3 trillion in the third quarter of last year, and we've cut $300 billion of relatively low-returning assets. Again, that was after years and years of increasing assets. We have bent that growth curve and now obviously we are coming down the other side, which should lead to a better return on assets. 

We have also cut the absolute amount of exposures we had to mark-to-market securities. If you look at the magnitude of our collateralized debt obligations, structured investment vehicles, the size of our Alt-A trading portfolio, and the amount of auction-rate securities that we hold, [and] the magnitude of the leveraged loan portfolio -- we've sold some and we have written some of these down. In May, Vikram laid out the actions we would need to take to "get fit": cutting costs, reducing unproductive assets, lowering risk exposure, and increasing the quality of our talent pool. On all four of those, the progress is noticeable and there's more we intend to do. 

Where are you going to find the most cost cuts? 

We've identified 11 themes that cut across the company that represent opportunities for cutting costs. We are universally applying an approach to reduce layers and expand spans of control. That's business by business, and every quarter we review the progress of each business against the targets for that particular theme. My own team in finance over the course of the last year has moved backroom activity out of the U.S. into Manila and Costa Rica. So that's a theme that we apply across the operational activities like customer service, transaction processing, and accounting. 

Citi investors are an antsy lot. How will you give investors the assurances that you can turn this thing around? 

There are a couple of things. You have to be very transparent about the results you are achieving. What can we control? We can control costs, capital, head count, risk concentrations, and ensure the business is well positioned when the cycle changes. What we can't control are the legacy positions that existed with the company when we got here. We can't control the magnitude of investments in mortgages or the dependence on the consumer. 

Citigroup struck an unprecedented deal [BusinessWeek.com, 11/24/08] with the government to backstop $306 billion in assets on which the bank takes the first $29 billion in losses. What are the chances you'll blow through that $29 billion? 

I would say what we were trying to ensure was that Citi would execute its strategy regardless of this dislocation in the market. This deal generated $40 billion in capital in a fairly innovative structure which allowed for the ring-fencing for assets. I think it is relatively remote but not impossible that we would blow through the first $29 billion. We have a loss-sharing arrangement with the government, and since they now have the lion's share of the second loss on these assets, we can reduce the capital that we hold against them. 

The second thing that the deal did that was equally important was that it reinforced the commitment of the government to the stability of the financial system and the important role that Citi plays in it. The government invested capital in a way that preserved the common shareholder. 

There have been other deals where the preferred shareholders have been wiped out or the senior debt holders have been wiped out. This deal is interesting and instructive in that the government made a capital investment in Citi, but at the same time was very thoughtful about the support that it would provide to the common shareholder. The government took warrants for a portion of the payment that represents 4.5% of the company, but importantly preserved the common shareholder which I believe is essential to the long-term recovery of the financial system. I think it represents an evolution in thinking of the regulators. 

Is this deal backstopping the most toxic stuff on Citi's books? 

No, the $306 billion portfolio is a mixture of assets. We agreed that the asset classes of what goes into this pool is broadly applicable to other institutions, such as residential or commercial mortgages. So there's a spectrum of quality in these pools: Good mortgages tend to be prime mortgages originated within your own banking system, while poorly performing ones are generally second mortgages originated by brokers. This represents the entire class of mortgages and so all of that is part and parcel of this pool. 

Many have remarked that Citi had the highest Tier One capital, yet it required this infusion from the government. What's a good measure of capital strength, then? 

I think it goes back to the uniqueness of this transaction. What this says is that, in transactions like this, the government uses preferred stock, as they did with TARP [Troubled Assets Relief Program]. There's two capital benefits: Tier One and Tangible Common Equity to Risk-Weighted Managed Assets. Those are the measures that are generally used by rating agencies and the regulators. 

Does the government drive a hard bargain? 

I would say that it was clear that we had a common objective: the stability of the financial system. It wasn't a negotiation; it was more of an iteration.