Reprinted from July 2010

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Volume 41, Number 495

Pandit knocks Citi into shape

BANKER OF THE YEAR

For a man who was supposedly doomed to fail, Vikram Pandit has done a pretty good job in transforming Citigroup. Few, if any, bank chief executives have faced a tougher set of challenges over the past two years or been the subject of as much criticism. He has come through many battles, and has many more to come. But perhaps its time to start giving Pandit some credit. Clive Horwood reports
BEING A SUPERMARKET is not a strategy. That simple sentence sums up everything that went wrong with Citigroup, and everything that Vikram Pandit is trying to do to make Citi one of the worlds best banks again. Citi isnt back just yet, but its on its way. First-quarter 2010 earnings, announced in mid-April, were some of the most impressive in the industry. Citigroup produced net income of $4.1 billion. Compare that with Bank of America, which is widely thought to have emerged from the crisis faster and stronger than Citi, but made $3.2 billion over the same period. Or Barclays, a bank that supposedly came out of the crisis a clear winner, but has first-quarter net income of about $2.2 billion. Or JPMorgan, the bank least impacted by the credit crunch, but which had first-quarter 2010 net income of just $3.3 billion. One quarter does not make a recovery. Citi posted a loss for six of the nine previous quarters and a loss in Q4 2009 of $7.6 billion. Most analysts had expected the bank to break even for this one at best. It was the first good piece of news Pandit had been able to present in almost two-and-a-half years as chief executive of the group. His has been one of the most challenging tenures the banking industry has seen. Few thought he would survive. Fewer still thought he was the right man to restore Citi. He might just be proving his critics wrong. Those critics have included Federal Deposit Insurance Corp chair Sheila Bair who, last summer, had angled for Citi to be broken up quickly and for Pandit to be replaced as chief executive. At the time, Euromoney was sitting in the office of another leading Wall Street banker. On the TV screen, a caption with two photos flashed up: Pandit vs Bair. Well, said the chief, we all know who is going to win that battle. And its not Vikram. They have included Sandy Weill, the creator of the Citi supermarket, who let it be known that he was unhappy with the way Pandit was running Citi, and that he had not been consulted having publicly backed the bank through a share purchase in January 2008. Pandit is still there. Those that dismissed him, who underestimated him, might now have to eat their words. He has seen through one of the most dramatic bank restructurings in history. And now, he thinks, he and his team deserve some credit. We dont always get credit for some of the tough decisions we have made: decisions which have enabled us to take $13 billion a year off our cost base, he says. And this at a company that tried and failed many times to get costs under control in the past, and has now achieved this without hurting revenue significantly. Those cost savings equate to $3.25 billion a quarter: thats most of the net income Citi made in its first quarter. And that revenues were maintained tells its own story. Think about it: we cut our workforce of 370,000 people by 110,000. We sold a lot of assets. We raised a lot of capital. And yet we have maintained revenues. That tells you a lot about how far we have come from the old Citigroup, Pandit says.

a whirlwind debut
Pandit joined Citi in July 2007, just as the bank was about to realize the extent of the losses it had suffered in the sub-prime and leveraged finance sectors. It was a whirlwind six months for Pandit. He joined to run Citi Alternative Investments. Before long, he had been asked to come in and sort out the problems within Citis banking and markets divisions, since renamed the institutional clients group. I was running our alternative business in midtown. One day Chuck [Prince] called and said: Vikram, I need you downtown [at the banks Greenwich Street banking and markets hub] to help sort out our market positions. Put the right people in place and then go back to doing what you were doing before. Pandit felt compelled to leave the job he had been brought in to do. I respected Chuck, and could not turn him down. And once I had made the decision to go downtown, I owned it. There was no going back. Citi unravelled very quickly in the autumn of 2007. One minute chief executive Chuck Prince was still dancing; the next he was gone, as Citi revealed it would post sub-prime losses of $11 billion and sought a $7.5 billion capital injection from the Abu Dhabi Investment Authority under an interim leadership team of Citi veterans Robert Rubin and Win Bischoff. At the same time, the board was looking for a new chief executive. Rumours were rife about who would get the job: could Josef Ackermann be tempted to leave Deutsche Bank? Would Barclays president Bob Diamond fulfil his dream of running one of the biggest US banks? Could Jamie Dimon be persuaded to return to the bank that he had once been heir apparent to, before his falling out with Sandy Weill? Few people picked Pandit as a potential leader. He had only been at the firm a few months. Citi was a universal banking behemoth, employing not far short of 400,000 people; Pandits pre-Citi management experience had peaked at Morgan Stanley, where he managed a few thousand people in the institutional securities group. He had no experience of the consumer and commercial banking businesses that had been the bedrock of old Citicorp. Rubin said at the time: The combination of his deep executive experience and long history as a strategic thinker makes Vikram the outstanding choice to be Citis chief executive. Few people thought those credentials would suffice for one of the toughest jobs in banking history.

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Cover story

Being the biggest is no longer a definition of success here. I dont want to be number one in everything. But I do want my clients to think we are the best at what we do
John Havens, Citi

to take the bank through the crisis and then forward into the future; and to rebuild a culture of execution. Pandit and his team immediately got to work, but nine months later the problems they faced were no longer Citi-specific: Lehman Brothers collapsed and the crisis became systemic. Lehman changed the rules of the game for us and every other bank. The markets had given us the capital we needed up till that point, says Pandit. Now, as Citi faced collapse, the markets could not give Pandit what he needed to survive. So he was forced instead to turn to the US government. The mighty Citigroup, not long ago the biggest bank in the world, was on its knees begging for help. That culminated in a third bailout for Citi in February last year, when the US government agreed to convert $25 billion of preferred stock into common equity. Citis tangible common equity had plummeted to just $29 billion at the time. Its stock was trading at just $1.50. Our decisions on raising capital, particularly relating to the investments by the US government, were tough but necessary, says Pandit. Our early capital raises, though important, turned out to be insufficient in the light of the collapse of Lehman and subsequent events. Getting our capital position strong, and our operating company in order, was critical.

Seeking a new strategy

All the way through the crisis, while Pandit was raising capital and dealing with a share price that had been wiped out, the new chief executive and his team were trying to define a new business model for Citi. We had to get our strategy right, and then we could make some informed decisions, says Pandit. Citis new chief executive actually had some previous experience in helping Citi through a crisis, as his colleague, John Havens, now chief executive of the institutional clients group, explains: Vikram and I first walked into Citi when we were at Morgan Stanley together in the early 1990s. We worked with John Reed on the restructuring of the business. The thing that Reed did best, and which we always remembered, is that he believed in Citis platform and would not sell off any of the core businesses. And those core businesses are still vital to the platform today, even after everything that has happened. As they looked at the way the bank was run, Pandit and his team discovered that many of the jibes thrown at Citi that it was too big to manage, disjointed, a series of businesses bolted together but with little interaction were true. Everything in Citi was in silos. Each business had everything replicated from buying the coffee to doing the accounting. We even had three different ways of taking part in US Treasury auctions: the Citi platform, the old Salomon system and the Smith Barney system. No one ever paid attention to it, says Pandit. Pandit also had to instil a cultural change in the bank if his strategy was to succeed: Its interesting: speak to the people who were here in the 1990s, and theyll tell you that the old Citi knew how to execute a strategy. Somewhere along the line, we lost that. But we are back to that now. Citi is now a remarkably different business to what it was two years

Pandit knew he had his doubters. Sure, I was relatively new to the company, but at least I had had a few months here and was familiar with the issues we faced, unlike any candidate that may have come in from the outside, he says. And given that Citi was involved in so many parts of banking, it would have been hard to find a candidate with experience across all of them. Remember most of the problems stemmed from issues in the investment banking and trading parts of Citi, businesses which I had a great deal of experience in from my career at Morgan Stanley. It was clear that the world had changed. The previous environment of seemingly limitless pools of liquidity and capital had come to a sudden end. Citi had to change too.

Growing write-downs
By the time Pandit had become chief executive, two weeks before Christmas in 2007, those write-downs were growing; in early January 2008, he was forced to announce they had become $25 billion over two quarters and Citi was compelled to sell $12.5 billion of convertible preferred securities to investors such as Singapore and Kuwaits investment arms, and long-term shareholders such as Prince Alwaleed bin Talal and former Citigroup chief executive Sandy Weill. When you need to raise capital, the first question to consider is why should people finance you, says Pandit. We had four immediate needs: to deal with our financial stress; to define our strategy, and what makes this bank different; to put in place the right team

Reprinted from EUROMONEY July 2010

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ago. In fact, it is two businesses. Pandits biggest decision was to place businesses and assets that were no longer core to the banks strategy in a separate entity, Citi Holdings. Into these Pandit put the banks remaining holdings of the iconic brand of Smith Barney, one of Sandy Weills biggest buys, after Citi sold a 51% stake and management control of the business into a joint venture with Morgan Stanley. Pandit also prepared to say a long farewell to one of Citis key building blocks of the past, local consumer lending, which included residential and commercial real estate loans, auto and personal loans and consumer banking in western Europe. Also dumped into Citi Holdings was a special asset pool made up of many of the illiquid non-core assets that had helped bring Citis future into question. Run by former Salomon veteran Mike Corbat, Citi Holdings aims to reduce assets as quickly as possible while providing the best return possible for shareholders. Total assets at the end of the first quarter of 2010 were $503 billion, compared with $662 billion when Citi Holdings first reported at the end of Q1 2009. Its first-quarter revenues for 2010 were $6.6 billion, on which it contributed a loss to Citigroup of $887 million.

Core considerations
That left Citi with what Pandit considered its three core businesses, which exist under the old Citicorp banner: global transaction services, securities and banking, and regional consumer banking. Citi has a unique take on consumer banking: Our core retail strategy is to be an urban bank, serving customers in the top 100 cities around the world. In the US were in the 10 biggest metropolitan areas. People in these bigger cities have much more in common as customers than they do necessarily by nationality: from a banking perspective, So Paolo has more in common with London than it does with San Juan. Regional consumer banking contributed $1.01

billion of $5.16 billion of net income for Citicorp in the first quarter of 2010. Global transaction services is a powerhouse business, which leverages off Citis presence in more than 100 countries, contributing $941 million of net income in the first quarter. That leaves securities and banking, which includes the investment bank and markets business or institutional clients group and which made $3.2 billion of net income in the first quarter. Pandit had put his long-time colleague John Havens, with whom he had worked closely at first Morgan Stanley and then Old Lane, in charge of rationalizing Citis banking and markets effort, leveraging its strengths, and correcting its mistakes. We understand that we are defined by our global network. The value we bring is clear: our ability to provide access to markets, people and ideas. And our network is our huge advantage, says Pandit. Once we have established that platform, we can be a traditional business. We cover clients as clients in cash, custody, advice, liability management and so on. And we trade with them and history proves that in banking the best money is made over time from bid-offer spreads, and not on proprietary trading. Getting back to those basics was a huge task. Like the whole bank, much of ICG had become unfocused and wasteful. Did we need to cover 40,000 clients? No, covering 5,000 properly is the right number. Does market share matter? Sometimes, but certainly not always, says Pandit. As Havens puts it: Being the biggest is no longer a definition of success here. It doesnt work it costs money, and it leads to hubris. I dont want to be number one in everything. But I do want my clients to think we are the best at what we do. Big cuts in some areas were inevitable.

Cut and thrust

We had some mighty battles internally about what would happen to revenues if we made some of these cuts, says Pandit. But once we had made the decisions, the system responded. One of the questions Pandit posed to his businesses was: how many salesforces do you need? Citis sales efforts were divided in every which way, to the point that the bank even had teams selling the same product but under different management in its midtown and downtown offices. Some managers argued that moving to a relationship manager model would reduce the size of the salesforce and hence revenues. It hasnt been the case. Regional silos would each have their own chief financial officer, accounting team and technology groups. These were combined into one. Some internally complained that such a move would increase operating risk. Again, the fears were unfounded. Perhaps the biggest battles were around the use of Citis balance sheet. Pandit made it clear that the bank would no longer provide balance sheet to clients that did not give it other business. That meant coverage officers were faced with losing multiple clients. They fought hard to keep them. If they couldnt prove they could change a relationship that did not meet the new criteria, they lost the battle. But the scrutiny applied to the way Citi deals with clients has transformed some of the firms relationships. Havens takes up the story: I had a group of bankers complaining to me about a big client, a major multinational. They said the company only wanted

A lot leFt to get rid oF Citi Holdings assets Q2 2009 to Q1 2010

700 Special asset pool Local consumer lending 600 Brokerage and asset management

500

400 $bln 300

200

100

0 Q2 2009 Q3 2009 Q4 2009 Q1 2010

Q1 numbers include $43bln of assets brought on balance sheet due to adoption of SFAS 166/167 Source: Citi

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Reprinted from EUROMONEY July 2010

Cover story

Mike Corbat (l) and Don Callahan: key members of the team that have resurrected Citi with Pandit our balance sheet; that we never got any other business; and that we should stop dealing with them. So I asked a few questions: are they one of the biggest clients in their industry group? is that industry group important to us? is it important to know the client better? do they do a lot of business? and finally, do we have our best people covering this client? The answers to the first four questions were all yes. The answer to the last one was no. So we put some of our best people on coverage, and now were the number one counterparty to that company. Last time I went to see the CFO, he took me in to see his chief executive. He told me that since Citi had done a lot for his company, he wanted to find ways to do more with Citi. And to think we were discussing whether we should bother to cover them! Citi has also had to get its own house in order. Perhaps because of the old silo mentality, the bank had failed to put systems in place to compete in the age of electronic trading. That is now changing. If we are going to be client-centric, then we must have all the products and the capability to deliver them to our clients, says Havens. We were sorely lacking in some areas. For example, we took an inventory of our equity and rates platforms and clearly we werent where we needed to be. We found we had been disintermediated by technological advances in the market. Wed made some investments in tech in FX, but we had completely ignored banks as a client segment. Well, how can you claim to be a leading firm if you are not in that market? So we made the right investments in people and technology, and now we are seeing some good results from that.

When Pandit joined in July 2007, the Maheras and Klein camps were briefly united in saying that the new arrival had no chance and no credentials for being the next chief executive. Maheras and Klein were soon gone. Pandit, with no constituency, was left at the helm of the whole business. Perhaps that helped Pandit. In any case, he says the problems at Citi were more due to the inherent conflicts within the business than they were due to clashing personalities. If you have a supermarket, offering all things to all people, then you cannot expect it to operate as one team, he says. But if you define the strategy of being a global bank, then you can create a structure that works. One of Pandits key measures was to bring in regional chief executives. Take our Asia business as an example. We used to have five silos operating independently of each other in Hong Kong. Now our regional CEOs Stephen Bird and Shirish Apte make sure the business operates as one. Pandit is remarkably self-effacing for the leader of one of the worlds biggest banks. Hes determined to make sure that credit for Citis turnaround is shared with his senior management. Every team has a captain but I view leadership and manage-

Pandit defends his Old Lane legacy

Old Lane is, to many outsiders, the biggest blot on Pandits career at Citi. After being forced out of Morgan Stanley in 2005 by its then chief executive, Philip Purcell, Pandit and a group of close colleagues, who included now-Citi senior executives such as John Havens and Brian Leach, joined the legion of former bankers who set up hedge funds. Old Lane began operations in March 2006. Within 13 months, Citi had bought Old Lane for what seemed even then an inflated price of $800 million. By then it had $4.5 billion of assets under management. Pandits share of the sale was estimated to be around $165 million, of which he reinvested about $100 million into Citigroup stock. But Old Lane, like many hedge funds, struggled in the downturn. By June 2008, Citi had taken the decision to shut down Old Lane, rather than injecting a $1 billion-plus sum of new capital, and took most of the hedge funds assets on to its balance sheet. As Citi continued to struggle, Pandit was hammered by the media. His payout, and the demise of Old Lane, came to typify for many the worst excesses of executive compensation and the banking crisis took hold. Pandit knows its a sensitive subject, but he comes out fighting. Im confident that in the fullness of time, people will see that Old Lane brought a lot to Citigroup. We have a number of private equity funds and trading businesses that are performing well. But most of all it brought talent to the bank: people like Brian Leach and John Havens that are now taking this company forward. And you have to remember that as the senior management moved into the Citis executive team, there were key-man clauses that triggered and we had to offer investors the chance to take their money out.

factions and fiefdoms

The common accusation levelled against pre-crisis Citi is that it was simply too large, and too unwieldy, to manage. Theres a great deal of truth in that. But Citi had another, entrenched problem. The business was factional. Fiefdoms proliferated. The heads of different businesses did not get on. Their businesses barely talked to each other. This was epitomized by the atmosphere at Citis Greenwich Street offices. You were either in the camp of Tom Maheras, who ran the markets business; or that of Michael Klein, who ran banking. As Citi faltered in 2007, all the talk in New York and beyond was which of the two would take over if Prince left the bank.

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I was running our alternative business in midtown. One day Chuck [Prince] called and said: Vikram I need you downtown to help sort out our market positions. I respected Chuck, and could not turn him down
Vikram Pandit, Citi

ment as very much a team sport, he says. He gives some examples: chief administrator Don Callahan, who runs the operations and technology side of the group and whose division bore a large share of the cuts burden as Citi rationalized its platforms and systems. He praises the risk-management team, run by his old colleague from Morgan Stanley and Old Lane, Brian Leach, which undertook a root-and-branch review of the entire business. Leach had some experience in crisis management: in October 1998, he was seconded to Long-Term Capital Management to oversee the orderly unwinding of the hedge funds positions, which had threatened a systemic crisis almost exactly a decade before Lehman caused one. Leach had also worked closely with Mike Corbat, who combines his role as head of the groups brokerage and asset management unit with the chief executive position of Citi Holdings. And Pandit also mentions Bill Mills, whom he describes as one of the unsung heroes of our turnaround, a real hands-on manager, a 26-year Citi veteran who as chief executive of Europe, Middle East and Africa had to oversee the withdrawal of Citi from consumer banking in western Europe while pulling disparate silos together. We heard all the comments that the management team was no good. But the strongest management teams are those that get through the bottom of the cycle. Its not always easy to ignore, but you get caught up in what you need to do, says Pandit. We had a good team and a common sense of purpose. But the key thing was to make sure we had a credible plan that we all believed in, that we would stick to and that we could communicate to our colleagues and our clients. If you cant do that, then youre dead. And at the end of the day, this is a fantastic company. Yes, weve had some strategic issues, but the underlying quality of the business was always there.

Black mark
The US government is still a shareholder in Citi. At the start of the year, its stake was around 27%. The Treasury has stated that it plans to reduce its stake to zero by the end of this year, a process it is achieving through incremental sales of blocks of shares. That it still owns Citi stock is held as a black mark against Pandits tenure by some, and he admits the day the US government is no longer a shareholder will be a milestone for the bank. Getting closure on US government ownership will be an important psychological point. The Treasury should recover all of its investment and then some. Perhaps more important is the continuing reduction in the size of Citi Holdings. Weve sold a lot of assets. As we sell more, the story transitions from Citi Holdings to the future of the bank, which is Citicorp. Pandit is targeting a sustainable return on assets of between 1.25% and 1.5%, something the bank achieved in the first quarter of 2010. Return on equity was also healthy for that period, at 12%, but Pandit says its not a measure of performance that he can run the business by in the foreseeable future, given the discussions about bank capital among regulators. You cant talk about ROE when you dont know what the E is going to be, he says. At the end of the first quarter, Citi had tier 1 common equity of $97 billion and a tier 1 capital ratio of 11.2%. Whether Citi can repeat that performance in the more difficult markets of the second quarter and beyond remains to be seen. But the future excites Pandit. Im looking forward to getting back to what excited me about joining this firm in the first place. We have a great opportunity here. There are not many 198-year-old bank franchises out there. More importantly, there are very few that can have a real impact on the economic potential of the world. This business fits perfectly with where the world is going.

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Reprinted from EUROMONEY July 2010