Citigroup Inc. (NYSE:C) Q2 2023 Earnings Call Transcript

Citigroup Inc. (NYSE:C) Q2 2023 Earnings Call Transcript July 14, 2023

Citigroup Inc. beats earnings expectations. Reported EPS is $1.37, expectations were $1.3.

Operator: Hello and welcome to Citi’s Second Quarter 2023 Earnings Review with the Chief Executive Officer, Jane Fraser and Chief Financial Officer, Mark Mason. Today’s call will be hosted by Jen Landis, 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 objections, please disconnect at this time. Ms. Landis, you may begin.

Jen Landis: Thank you, operator. Good morning and thank you all for joining us. I’d like to remind you that today’s presentation, which is available for download on our website citigroup.com, may contain forward-looking statements which are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our earnings materials as well as in our SEC filings. And with that, I will turn it over to Jane.

Jane Fraser: Thank you, Jen. And good morning to everyone. While this quarter wasn’t as eventful as the first quarter, it was not without its moments. The global economy continues to be remarkably resilient, although the macro backdrop differs across key markets. And while the bulk of the tightening is behind us, central banks are responding vigorously to inflation and have made it clear the cycle of hikes isn’t over. In the US the tight labor market keeps pushing the timing of this elusive recession later into this year or 2024 with the robust demand for services providing a backstop for the economy. The Eurozone has also exceeded expectations. However, most countries there are facing pressure from labor and energy costs, challenging the region’s longer-term competitiveness.

China is the biggest disappointment as growth decelerated after an initial post reopening pop. I was there last month and let’s just say few on the ground expect China to be as strong a driver of global growth this year as some had hoped. So bottom line, globally we continue to see the same quite challenging macroeconomic conditions that we [Technical Difficulty] benefits of our diversified business model and strong balance sheet. We remain laser focused on executing our strategy and simplifying and modernizing our bank. Despite the turbulence and macro backdrop of the first half, we’re on track with the plan we laid out at Investor Day and we remain committed to our strategy and our medium-term ROTCE target. Today we reported net income of $2.9 billion and an EPS of $1.33.

Our revenues ex divestitures are relatively flat to last year and we remain on track to meet our revenue guidance of $78 billion to $79 billion for the year. We’re also on track to meet the expense guidance for the year. And consistent with the plan we shared with you at our Investor Day, we are pursuing cost saving opportunities to help offset the significant investments in our transformation. In services, TTS continues to deliver with revenues up a healthy 15%. This was driven by both net interest income and noninterest revenue as we win fee generating mandates with new clients and deepen our relationships with existing large corporate and commercial clients. We’re proud of our number one ranking for large institutional clients, and this week we announced our latest innovation CitiDirect Commercial Banking, a digital platform to help our growing commercial clients tap into our global network.

Security services revenues were also up 15%, driven by higher interest rates across currencies. We’re really pleased with execution in this business as we continue to bring in new assets under custody and administration, which are up by approximately $2.4 trillion in the last year. We’ve gained 100 basis points in share year-over-year as a result of the investments we’ve been making. Markets revenues were down 13% compared to an exceptionally strong second quarter last year. From early April, clients stood on the sidelines as the debt ceiling played out and we continued to experience very low levels of volatility throughout the quarter. Despite this, our corporate client flows remained strong and we’ve achieved our medium-term revenue to RWA target again this quarter.

In banking, the momentum in investment grade debt has spread into other DCM products, but the long-awaited rebound in investment banking has yet to materialize and it was a disappointing quarter in terms of both the wallet and our own performance with investment banking revenues down 24%. We continue to right size the business to the environment whilst making investments in selected areas, such as technology and healthcare. In the US, taken together, our cards businesses had double-digit revenue growth, aided by customer engagement and the continued normalization in payment rates. In branded cards, spend is still strong in travel and entertainment, and acquisitions remain pretty healthy. This is a great franchise and we have launched a raft of new innovations from transforming our [thank you] (ph) rewards platform to our enhanced value proposition for the premium card with our long-term partner American Airlines.

Credit normalization is happening faster in retail services given the profile of the portfolio. And overall, I’d say we’re seeing a more cautious consumer, but not necessarily a recessionary one. Wealth revenues were down 5% as the business continues to be negatively impacted by the deposit mix shift, particularly in the private bank and by lower investment revenues. However, we have seen activity pick up a bit in Asia for two quarters with growing net new assets. Referrals from the US retail banks are increasing and globally, new client acquisition in the private bank and wealth at work has grown significantly on the back of our investments in our network of client advisors and bankers. Turning to expenses. They were elevated this quarter as we expected.

This includes the additional repositioning actions we took to right size certain businesses and functions in light of the current environment. Year-to-date, severance is about $450 million, including $200 million in the quarter. Separate to repositioning, we remain committed to bending our expense curve by the end of 2024 through three significant efforts; first, we continue to make investments in our transformation and other risk and control initiatives, which are necessary to modernize our infrastructure, automate our controls, as well as to improve the client experience. As we said before, we will start to see the momentarily benefits of these investments over the medium term. Second, as part of our simplification efforts, we expect to close the sales of our remaining two Asia consumer franchises by year-end, and we plan to restart the exit process in Poland.

As you can see on the slide, we made excellent progress this quarter and the consumer businesses were winding down, aided by material asset sales, and we are now attacking stranded costs and closing out the TSAs in the markets that we have already exited. You saw our determination to execute when we decided to IPO Banamex after exploring a sale. We should complete the process of separating the two businesses fully next year in preparation for the IPO. And I’m pleased with the progress on the ground. We are about to begin acceptance testing on the new systems for the retained businesses. All this means that by year-end, considering how far the divestitures and wind-downs have progressed, legacy franchises will have materially reduced its exposures and primarily be down to Mexico, Poland, Korea and the elimination of the remaining stranded costs.

As such, as we move through the second half of the year, we will be in a position to focus on the third leg of bringing down our expense base through a leaner organizational model. Together, these three efforts are why we have confidence in saying that we will start to bend the curve on an absolute basis by the end of 2024 and continue to bring down expenses over the medium term. Let me end with capital. Well, you won’t be shocked to hear that we were disappointed with the increase to our stress capital buffer. We have engaged in active dialogue with the Fed to better understand the differences between our model and theirs in terms of noninterest revenue. And the industry awaits further clarity on capital requirements and importantly, their implementation timing from the holistic review the regulators have undertaken and the expected Basel III Endgame NPR.

There is still uncertainty as to what the final rules will be, and we, like the rest of the industry, will need to work through the implications. The exit of 14 international consumer markets, coupled with the results of our transformation investments and change in business mix will help reduce our capital ratios. In addition, we have other levers to pull over time, such as capital allocation, DTA utilization, our G-SIB score and our management buffer of 100 basis points. We are committed to returning capital to our shareholders as you saw with our decisions to repurchase $1 billion in common stock and increase the dividend. We ended the second quarter with a CET1 ratio of 13.3%. That’s 100 basis points above our upcoming requirement after returning a total of $2 billion in capital.

And we grew our tangible book value per share to $85.34. Given the environment, we will continue to look at our level of capital return on a quarter-to-quarter basis. Overall, we’re pleased with the progress we’ve made, but there remains a lot to do. We will continue to update you on the progress we are making every quarter. And with that I’d like to turn it over to Mark and then we would both be [Technical Difficulty]

Mark Mason: Thanks, Jane. And good morning, everyone. I’m going to start with the firm wide financial results focusing on year-over-year comparisons for the second quarter unless I indicate otherwise and spend a little more time on expenses and capital. Then I will turn to the results of each segment. On Slide 4, we show financial results for the full firm. In the second quarter we reported net income of approximately $2.9 billion and an EPS of $1.33 and an ROTCE of 6.4% on $19.4 billion of revenues. Embedded in these results are after tax divestiture related impacts of approximately $92 million. Excluding these items, EPS was $1.37 with an ROTCE of 6.6%. In the quarter, total revenues decreased by 1%, both on a reported basis and excluding divestiture related impacts as strength across services, US Personal Banking and revenue from the investment portfolio was more than offset by declines in markets, investment banking and wealth, as well as the revenue reduction from the closed exits and wind downs.

Our results include expenses of $13.6 billion, up 9%, both on a reported basis and excluding divestiture related costs. Cost of credit was approximately $1.8 billion, primarily driven by the continued normalization in cards net credit losses and ACL builds, largely related to growth in card balances. Our effective tax rate this quarter was 27%, primarily driven by the geographic mix of our pretax earnings in the quarter. Excluding current quarter divestiture related impacts our effective tax rate was 26%. At the end of the quarter, we had over $20 billion in total reserves, with a reserve to funded loans ratio of approximately 2.7% and through the first half of 2023 we reported an ROTCE of 8.7%. On Slide 5, we show the quarter-over-quarter and year-over-year expense variance for the second quarter.

Expenses were up 9%, driven by a number of factors, including investment in risk and controls, business-led and enterprise-led investments, volume growth and macro factors, including inflation, as well as severance. And all of this was partially offset by productivity savings and expense reductions from the exits and wind downs. Severance in the quarter was approximately $200 million and $450 million year-to-date, as we took further actions across investment banking, markets and the functions. We’re investing in the execution of our transformation and continue to see a shift in our investments from third-party consulting to technology and full-time employees. And as we said last quarter, our transformation and technology investments span across the following themes: platform and process simplification; security and infrastructure modernization; client experience enhancements; and data improvements.

And across these themes, technology spend was $3 billion in the quarter, up 13%, primarily driven by change the bank spend. Despite the higher expense base sequentially, we remain in line with our full-year guidance of roughly $54 billion, excluding divestiture related impacts and the FDIC special assessment. On Slide 6, we show net interest income, deposits and loans where I’ll speak to sequential variances. In the second quarter, net interest income increased by approximately $550 million, largely driven by dividends. The increase in net interest income ex markets was largely driven by higher rates and cards growth, partially offset by the mix shift that we’ve seen to higher rate deposit products within PBWM. Average loans were flat as growth in PBWM was offset by the wind-down markets and a decline in ICG as we continue to optimize the loan portfolio, including a further reduction in subscription credit facilities.

Average deposits were down 2%, largely driven by TTS, as we saw some non-operational outflow, as expected in light of quantitative tightening. However, underlying this we did see strong growth in operating accounts as we continue to win new clients and deepen with existing ones, and our net interest margin increased 7 basis points. On Slide 7, we show key consumer and corporate credit metrics. We are well reserved for the current environment with over $20 billion of total reserves. Our reserves to funded loans ratio is approximately 2.7%, and within that US cards is 7.9%. In PBWM, 44% of our lending exposures are in US cards, and of that exposure 80% is to customers with FICOs of 680 or higher. And NCL rates are still below pre-COVID levels and are normalizing in line with our expectations.

The remaining 56% of our PBWM lending exposure is largely in wealth, predominantly in mortgages and margin lending. In our ICG portfolio, of our total exposure approximately 85% is investment grade. Of the international exposure, approximately 90% is investment grade or exposure to multinational clients or their subsidiaries. And corporate non-accrual loans remained low at about 44 basis points of total loans. As you can see on the page, we breakout our commercial real-estate lending exposures across ICG and PBWM, which totaled $66 billion, of which 90% is investment grade. So, while the macro and geopolitical environment remains uncertain we feel very good about our asset quality, exposures and reserve levels and we continuously review and stress the portfolio under a range of scenarios.

On Slide 8, we show our summary balance sheet and key capital and liquidity metrics. We maintain a very strong $2.4 trillion balance sheet which is funded in-part by a well-diversified $1.3 trillion deposit base across regions, industries, customers and account types, which is deployed into high quality diversified assets. Our balance sheet reflects our strategy and well diversified business model, we leverage our unique assets and capabilities to serve corporates, financial institutions, investors and individuals with global needs. The majority of our deposits, $818 billion, are institutional and operational in nature and span across 90 countries. These institutional deposits are complemented by $427 billion of US retail consumer and global wealth deposits as you can see on the bottom-right side of the page.

We have approximately $584 billion of HQLA and approximately $661 billion of loans and we maintain total liquidity resources of just under $1 trillion. Our LCR was relatively stable at 119%. And our net stable funding ratio was greater than 100%. We ended the quarter with the 13.3% CET1 ratio and our tangible book value per share was $85.34, up 6% from a year ago . On Slide 9, we show a sequential CET1 walk to provide more details on the drivers this quarter. Starting from the end of the first-quarter. First, we generated $2.6 billion of net income to common, which added 22 basis-points. Second, we returned $2 billion in the form of common dividends and share repurchases, which drove a reduction of about 18 basis-points. And finally, the remaining 14 basis-point decrease was primarily driven by RWA growth as we continue to grow card balances partially offset by optimizing RWA in markets and corporate lending.

We ended the quarter with the 13.3% CET1 capital ratio, which includes a 100 basis point internal management buffer. We expect our regulatory capital requirement to be 12.3% in October of 2023, which incorporates the increase in our stress capital buffer from 4% to the preliminary SCB of 4.3% we announced a couple of weeks ago. And we will continue our dialog with the Fed to better understand the differences between modeled results and ours, specifically in non-interest revenue. That said, our strategy is designed to further diversify our business mix to have a more consistent, predictable, and repeatable revenue stream as well as reduce risk and simplify our firm by exiting 14 international consumer markets. The strategy and the simplification, coupled with the benefits of our transformation investments will allow us to improve RWA and capital over time.

The continued optimization of our balance sheet should not only help FCB but reduce RWA. This will offset some of the anticipated headwinds and capital requirements and RWA. And we will continue to reassess how and where we deploy capital and we will continue to reassess the appropriate level of our management buffer overtime. On Slide 10, we show the results for our Institutional Clients Group for the second quarter. Revenues were down 9% this quarter, as growth in services was more than offset by markets and banking. Expenses increased 13%, primarily driven by continued investment in TTS and Risk and Controls, as well as approximately $120 million of severance in investment banking and markets, partially offset by productivity savings. Cost of credit was $58 million as net credit losses were partially offset by an ACL release.

This resulted in net income of approximately $2.2 billion, down 45%, primarily driven by lower revenues and higher expenses. ICG delivered an ROTCE of 9.2% for the quarter and 11.4% through the first half of 2023. Average loans were down 6%, reflecting discipline around our strategy and returns. Average deposits were up 1% as we continue to acquire new clients and deepen relationships with existing ones. On Slide 11, we show revenue performance by business and the key drivers we laid out at Investor Day. In Treasury and Trade Solutions revenues were up 15%, driven by 18% growth in net interest income and 8% in noninterest revenue. It’s also worth noting that TTS revenues were up 20% on an XFX basis. We continue to see healthy underlying drivers in TTS that indicate consistently strong client activity with US dollar clearing volumes up 6%, both in the quarter and through the first half, cross-border flows up 11%, outpacing global GDP growth, again, both in the quarter and through the first half and commercial card volume up roughly 15% led by spend in travel.

In fact, similar to the last few quarters client wins are up approximately 41% across all client segments. These include marquee transactions where we are serving as the client’s primary operating bank. In Security Services, revenues were also up 15%, driven by higher net interest income across currency. We are pleased with the progress in security services as we continue to onboard assets under custody and administration which are up approximately 11% or $2.4 trillion, and we feel very good about the pipeline of new deals in security services. As a reminder, the services businesses are central to our strategy in our two of our higher returning businesses with strong synergies across the firm. Markets revenues were down 13%, driven by both fixed income and equities relative to an exceptional quarter last year coupled with low volatility this quarter.

Fixed income revenues were down 13% as strength in our rates franchise was more than offset by a decline in currencies and commodities. Equities revenues were down 10%, primarily reflecting a decline in equity derivatives. But consistent with our strategy, we continue to grow prime balances driven by client wins. Corporate client flows remain strong and stable, and we continue to make solid progress on our revenue to RWA part. And finally, banking revenues, excluding gains and losses on loan hedges were down 22%, driven by investment banking as heightened macro uncertainty continue to impact client activity, as well as lower revenues in corporate lending. While we continue to have a strong pipeline and are seeing green shoots of activity, we recognize there’s more work to do in ECM and M&A.

That said, we believe the investments that we’ve made in health care and technology coverage will benefit us over time. So overall, while the market environment remains challenging and there is more work to be done, we’re making progress against our strategy in ICG. Now turning to Slide 12. We show the results for our Personal Banking and Wealth Management business. Revenues were up 6%, driven by net interest income growth of 7%, partially offset by a 6% decline in noninterest revenue, driven by lower investment product revenues in wealth. Expenses were up 5%, predominantly driven by risk and control investments. Cost of credit was $1.6 billion, driven by higher net credit losses as we continue to see normalization in our card portfolios and a reserve build of approximately $335 million, primarily driven by card balance growth.

Average loans increased 7% driven by cards, mortgages and installment lending. Average deposits decreased 1%, largely reflecting our wealth clients putting cash to work in fixed income investments on our platform. And PBWM delivered an ROTCE of 5.5%, both for this quarter and through the first half of 2023, largely reflecting the challenging environment for wealth and higher credit costs. On Slide 13, we show PBWM revenues by product as well as key business drivers and metrics. Branded cards revenues were up 8%, primarily driven by higher net interest income. We continue to see strong underlying drivers with new account acquisitions up 6%, card spend volumes up 4% and average loans up 14%. Retail services revenues were up 27%, driven by higher net interest income and lower partner payments.

For both card portfolios, we continue to see payment rates decline and that combined with the investments that we’ve been making contributed to growth in interest-earning balances of 17% in branded cards and 12% in Retail Services. Retail banking revenues decreased 9%, reflecting the transfer of relationships and the associated deposits to our wealth business. In fact, consistent with our strategy, we continue to leverage our retail network to drive 25,000 wealth referrals year-to-date through May, up 18% year-over-year. Wealth revenues were down 5%, driven by continued investment fee headwinds and higher deposit costs, particularly in the private bank. However, Wealth at Work revenues were up over 30%, driven by strong lending results primarily in mortgages.

Client advisers were down 1%, reflecting the repacing of strategic hiring. And new client acquisitions were up nearly 40% in the Private Bank and approximately 60% in Wealth at Work in the second quarter. While there’s clearly more work to do in wealth, we are seeing good momentum in the underlying drivers. On Slide 14, we show results for legacy franchise. Revenues were down 1% as the benefit of higher rates and volumes in Mexico was more than offset by the reductions from closed consumer exit and wind downs. It’s worth noting that Mexico’s revenues were up 22% and 10% ex-FX. Expenses decreased 2%, primarily driven by closed consumer exits and wind downs. Excluding divestiture related impacts, expenses decreased 8%. On Slide 15, we show results for Corporate Other for the second quarter.

Revenues increased, largely driven by higher net revenue from the investment portfolio. Expenses also increased driven by inflation and severance. On Slide 16, I’ll briefly touch on our third quarter and full year 2023 outlook. We are maintaining our full year revenue guidance of $78 billion to $79 billion, excluding 2023 divestiture related impacts, although the mix has shifted somewhat. We are increasing our net interest income guidance from $45 billion to slightly above $46 billion for the full year, excluding markets, offset by lower noninterest revenue, largely driven by investment banking and wealth. We’re also maintaining our expense guidance of roughly $54 billion, excluding 2023 divestiture-related impacts and the FDIC special assessments.

Net credit losses in cards should continue to normalize in the remainder of the year with both portfolios reaching normalized levels by year-end. And we now expect the full year tax rate to be approximately 25%, excluding discrete items and divestiture related impacts. As it relates to the third quarter, we expect continued momentum with clients, including fees and benefits from US and non-US rates on NII. We also anticipate a sequential increase in expenses, driven by continued investments in transformation and risk and controls. Net credit losses in cards should continue to normalize in line with expectations. And our effective tax rate for the quarter should be approximately 25%, excluding discrete items and divestiture-related impacts. And as it relates to buybacks, we will continue to make that decision on a quarter-by-quarter basis.

Before we move to Q&A, I’d like to end with a few points. We continue to execute on the strategy to simplify our firm, improve our revenue mix and bring both expenses and capital down over time. We’re seeing solid momentum in the underlying drivers of the majority of our business. And as we said at Investor Day, the financial path will not be linear, but we remain focused on achieving our medium term ROTCE target. And with that, Jane and I would be happy to take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Glenn Schorr with Evercore.

Glenn Schorr: Hi. Thanks very much. So I’m very curious on the whole revenue to RWA topic, especially with some of the changes coming in. So maybe you could give a little more color on — let’s say for instance, the further reduction in the subscription credit facility. I think I read somewhere that was like an $80 billion book down to $20 billion. You can correct that if that’s wrong. But just usually those things are big important clients that have relationship lending things attached to them. So I’m curious on how you balance the capital benefit — the clear capital benefit versus the client impact and how you think about that? Are there other blocks of business that are in motion right now? Thanks.

Mark Mason: Thanks, Glenn, and good morning. Thanks for the question. Look, a couple of points on that. One is, we’ve been very focused on the revenue to RWA metric in our markets business in the ICG more broadly as well. And we’ve made considerable progress on that. And that’s important because how we use the balance sheet and ensuring that we’re optimizing the use of the balance sheet contributes to how we improve returns over time. You’re right to point out the subscription facility, credit facility lending that we do. We brought that down pretty significantly. The numbers you highlight are a lot higher than the portfolio. But what’s important here is that, as we look at that, we look at a couple of things. So one, the nature of the relationship and whether clients are taking advantage of the breadth of what we have to offer; two, the profitability and returns associated with the product to the extent that it is in a broader relationship, and where that — those returns are low, subpar and the prospect for doing more has proven to be fruitless, we take it down.

And that’s what we’ve done with a large part of that book just as we juxtapose it against other opportunities to use balance sheet where clients are taking advantage of the broader franchise and therefore are generating higher returns. And we’re going to continue to do that. We’ve done that to drive the revenue to RWA metric. We’ve done it selectively on pieces of the portfolio like SCF. We’ve also looked at our broader corporate lending portfolio and where those promises for higher relationship returns aren’t manifesting themselves. We’ve not renewed those loans. And as we think about pending regulatory changes proactively making these efforts becomes critically important. When I look back on the activity that we’ve done over the past couple of years, we’ve reduced RWA by approximately $120 billion over the last two years.

And about 75% of that is predominantly driven by balance sheet optimization and looking at client activity that has low margin business. And so, this is important for us to do what we keep doing.

Glenn Schorr: I appreciate that, Mark. Maybe just a quick follow-up. On NII, I had asked this last quarter too. And your first half annualized ex market is running about $1.5 billion ahead of the guide. Is that just unpredictable nature of all the moving parts trying to be conservative or anything else in the back half that you’re thinking about?