What's Killing Citigroup—Slowly

04/27/2010 9:58 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

It turns out that survival, which was no small feat, may have been the bank's easiest task. Has it, as the finance chief says, “Turned a corner?” Go to a branch to check.

"We have turned the corner," Citigroup (NYSE: C) chief financial officer John Gerspach said as he announced Citigroup's first quarter 2010 financial results on April 19.

But I have to ask: What corner is he looking at?

Can't be the corner of 40th and Broadway near my office in Manhattan. There, a dingy Citigroup branch with beat-up ATMs is barely hanging on in competition with a refurbished JPMorgan Chase (NYSE: JPM) branch down the block (with ATMs that deposit checks without a deposit slip) and a new Capital One (NYSE: COF) office up the block.

Can't be the corner of 104th and Broadway, near my house, where a new Sovereign Bank branch is siphoning off accounts from local small businesses that used to be Citigroup customers.

Can't be the corner of my desk, where I've got my JPMorgan Chase mortgage bill stacked near my Fidelity credit card bills. I get regular annoying phone calls from Chase asking me whether I want to refinance my mortgage. I can't remember ever getting a mortgage marketing call or letter from Citigroup. And my wife and I once had a Citigroup mortgage, and we have an account with the bank.

And this is what's happening in the bank's home market and what was once its core business of consumer and commercial banking. If Citigroup has trouble on this turf, you know it's in trouble everywhere.

The truth is that Citigroup has indeed survived. As hard and desperate as that struggle was, it may have been the easy part.

What's Left and What's Leaving

It's hard to see a future in which Citigroup is anything more than an also-ran. Just name me one line of business where, within five years, it's plausible that Citigroup will be one of the best ten banks in the world. While the global financial system is better off today because Citigroup didn't fail in 2008, the world of 2010 and 2011 doesn't need Citigroup for much of anything. With apologies to Irving Berlin, anything Citigroup can do, some other bank can do better.

On April 19, Citigroup reported its first operating profit—14 cents a share—since the third quarter of 2007. The bank charged off only $8.4 billion in loans in the quarter—a huge number, but still 16% lower than in the fourth quarter of 2009. Its Tier 1 capital common ratio, a measure of the strength of a bank's most conservative kind of capital, stood at a huge 9.1%. It was just 3% at the depths of the financial crisis.

I don't think there's any doubt that the bank will survive. And that's a huge achievement. This is a bank that required $25 billion in capital from US taxpayers in October 2008 and an additional $20 billion in December of that same year.

But look at the bank still left standing.

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Citigroup's strategy has been to split itself in two.

All the really bad businesses—and some simply outside Citigroup's core business—have been sold already or lumped into a group called Citigroup Holdings for eventual disposal. The list of businesses that Citigroup has sold includes the Smith Barney brokerage unit, rolled into a joint venture with Morgan Stanley (NYSE: MS) but headed for eventual sale; Nikko Securities, the third-largest brokerage company in Japan; and insurance company Primerica, partly spun off in an initial public offering in March.
 
But Citigroup Holdings still contains about $500 billion in assets. That's about 25% of Citigroup's total assets, and it includes subsidiaries the company wants to unload, including CitiMortgage, consumer-lending business CitiFinancial, and various toxic mortgage, credit card and loan assets.

The Citi of Tomorrow

But let's not focus on the stuff Citi is jettisoning. Instead let's look at the business it wants to keep. There will be a scaled-back investment bank, a private banking business, branded credit cards, and the big core business of global consumer and commercial banking.

I can name the current leaders in most of these businesses. And it's hard to see how Citigroup will effectively compete with most of them. In investment banking, for example, I don't see Citigroup even in the same league with Goldman Sachs (NYSE: GS), JPMorgan Chase, or Bank of America (NYSE: BAC), especially now that B of A owns Merrill Lynch. In credit cards, I expect Citigroup to lose share against the other big banks, including B of A—which bought credit card giant MBNA in 2005—JPMorgan Chase, and Capital One Financial. And it's hard to see how Citigroup's travails have burnished its brand in private banking.
 
No, when it comes down to the future of Citigroup, it pretty much hinges on global consumer and commercial banking.

That was once Citigroup's glory. And I'm sure that if I were in CEO Vikram Pandit's shoes, I'd build my strategy for Citigroup's future around these areas. The business is certainly still formidable, with about 4,000 consumer banking branches in 39 countries. In 2009, 68% of revenue came from outside North America, so you'd have to say that Citigroup has a good chance at grabbing a big hunk of the banking business in the world's developing economies.

That was once the plan for the bank's future. Back in the days when John Reed, who pioneered consumer banking innovations such as the ATM, was CEO of what was then Citibank. Before a merger with Sandy Weill's Travelers Group ushered in the era of the financial supermarket—and ushered Reed out the door in 2000.

But the world has changed. And new and stronger competitors have emerged in consumer and commercial banking while Citigroup took its strategic detour into the financial supermarket.

NEXT: Identifying Citigroup's Strongest Competitors

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So, for example, while Citigroup's global network of 4,000 consumer banking branches in 39 countries seems formidable, competitor HSBC (NYSE: HBC) now has 8,000 branches in 88 countries, and hard-charging Banco Santander has 13,600 branches, including those of Sovereign Bank. According to the Brand Finance Banking 500 study of the world's top bank brands, released in February, HSBC is, for the third year running, the top bank brand in the world. Bank of America is number two, Banco Santander (NYSE: STD) number three, Wells Fargo (NYSE: WFC) number four, and Citibank No. 5.

I think that rating is deceptively high. Trends are running strongly against all the developed-market banks, and the next few years are likely to see top-20 developed-economy banks such as Société Générale (OTC: SCGLY), Credit Suisse (NYSE: CS), or Citigroup giving way to rising developing-economy banks like Brazil's Banco Bradesco (NYSE: BBD), Industrial and Commercial Bank of China (OTC: IDCBY), or Bank of China (OTC: BACHY). The survey notes that Industrial and Commercial Bank of China is already the world's largest by bank deposits.

US and European banks face another stiff challenge over the next decade due to regulatory changes that are going to limit the amount of capital that banks can raise or borrow in the financial markets—the preferred source of funds for developed world banks before the financial crisis—and raise the importance of gathering deposits from customers as a way to raise funds. That will penalize banks that have neglected their consumer networks and reward those that have built deposit-gathering machines such as Banco Santander and HSBC. (For more on the regulatory changes facing developed-economy banks, see this recent post.)

That, of course, brings me full circle to the Citigroup branches in my work and home neighborhoods in Manhattan. These are the kinds of branches that a company pinning its future on consumer and commercial banking runs. They look like the branches of a bank that's going to give up market share point by point over the next decade.

If I'm wrong, you'll be able to see it physically in Citigroup's branches in the not-so-distant future.

There's quite possibly a branch near you. Take a walk or drive over. Does that branch look like the future to you?

At the time of publication, Jim Jubak owned shares of the following company mentioned in this column: HSBC.

See the complete Jubak Picks Portfolio here

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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