Citigroup’s global expansion is starting to yield some choice dividends, but headwinds still exist. The latest mark in the win column comes courtesy of the Chinese government, which last week authorized Citi to offer credit cards to the nation’s rapidly growing consumer class. That would make Citi the first non-Chinese bank to offer a credit card there on its own.
The move expands the bank’s international retail and commercial footprint as it seeks revenue growth from outside the United States. It also further expands the chasm between it and its big rival, Bank of America, which is focusing more on rightsizing its domestic retail operations as opposed to growing overseas.
Citigroup’s chief executive, Vikram Pandit, was all smiles as he touched down in Asia last week. After making his way through Korea, Pandit landed in China to celebrate the bank’s 200th anniversary. It was a birthday that just a couple of years ago looked unattainable as the bank teetered on the edge of collapse after absorbing tens of billions in losses connected with the bursting of the housing bubble.
But now it’s all about the future. The U.S. megabanks that survived the 2008 tumult have somewhat recovered and are now trying to readjust and refocus their business for the current operating environment. For example, Bank of America (BAC) is concentrating on solidifying and rightsizing its domestic retail banking operations, while Morgan Stanley (MS) is looking to expand its domestic retail brokerage services.
For Citigroup (C), the answer has been to become a truly global retail and commercial bank, diversifying its revenue stream in an attempt to limit its exposure to the U.S., where the market was maturing and profit margins were being squeezed from increased regulations. Citi already derives more than half of its revenues from outside the United States, so it knows how to expand in new markets. It has spent the bulk of its capital expenditures over the last few years on building out its operations in Asia, Latin America, the Middle East and Eastern Europe, with a major focus on expanding its retail presence in China.
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The results so far have been mixed. There has certainly been an increase in business for Citi overseas compared to North America, at least in the commercial banking group. Citi’s lending to corporations and people abroad is up 22% in the last two years, while it is down 6% in North America. Meanwhile, deposits grew 14% abroad in the last two years and fell 2% in North America.
But overall revenue and net income from Citi’s international operations has been less than stellar. International consumer banking revenue was up a slight 2% to $4.7 billion in the fourth quarter of 2011 versus the same period last year. Meanwhile, overall international net income fell 16% to $788 million during the same time period.
Dig deeper into the numbers, however, and it doesn’t look so bad. The steep drop in net income was due in part to a $72 million build in credit reserves needed to cover all the new loans made during the year. Revenues then perk up a bit when you strip out Europe and the Middle East — especially in Asia, where there was a 5% increase in revenue. Operating expenses remained elevated throughout the year but the net operating leverage for the international segment turned positive for the first time in a while during the third quarter, meaning that revenues were finally outpacing expenses.
Citi believes that its future clearly lies in Asia and Latin America and seems prepared to put in the investment dollars to get it done. It spent around $600 million investing in its operations abroad last year, with the bulk centered in Asia. That helped the bank open new branches and hire new workers. In Beijing, Pandit said that while the bank was paring down its workforce in the U.S., it was ramping up hiring in Asia, especially China.
Citi has been in China for a while and maintains close and cordial relations with the government. It has new branches in 13 major Chinese cities along with 46 consumer outlets. The bank branch is very important in China, as it’s the only place where a person can obtain a credit card. Since 2003, Citi has issued a credit card in cooperation with a local Chinese partner.
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But Citi’s expanded physical presence is still but a small fraction of the total Chinese consumer banking market. Foreign banks hold just 1.8% of the market, with Citi a small sliver of that. The number of credit cards in circulation in China has exploded to 270 million, up five fold since in the last five years. The big Chinese banks have gotten most of that business, but there seems to be a lot more market to share. MasterCard (MA) estimates that China will have 1.1 billion credit cards in circulation by 2025, with spending on those cards estimated to reach $2.5 trillion. Based on China’s population and rising personal incomes, that number sounds modest.
Allowing Citi to market its own card will raise its brand recognition among the status-driven Chinese, especially the urban, educated and rich consumers that Citi wants to target. Tapping just a fraction of that market could be very lucrative.
But what if the Chinese economy falls off a cliff and the banking system runs aground? Pandit said this at an analyst meeting in December:
There’s no question that there are likely to be cycles in the emerging market areas. There are always questions of moving a little too fast, moving a little too slow. Having said that, when you look at the underlying trends, the secular change is real. And so if you think they’re going to grow at 6%, well, maybe they don’t. If they grow at the Fed’s stress test of 4% or 5%, so what? At the end of the day, that’s where the growth is, and so I think we’re pretty well positioned to capture that.
So even if the growth rate isn’t stellar, it is bound to be better in China than in the U.S. or Europe. Having a toe in the Chinese market, however small, will be a net positive.
Of course, growth in credit can end up reversing really fast if the economy tanks and people lose their jobs. The Chinese real estate market is thought to be in a bubble similar or worse than what the U.S. was in a few years ago. Meanwhile, a slowdown in Europe has taken a toll on China’s export market. The Chinese tend to spend all cash on large items, but that’s changing as the younger, post-Mao generations grow more comfortable with the idea of taking out loans and using plastic. A crash in housing could quickly spread to consumer credit cards, delivering a one-two punch to Citi’s bottom line.
It is unclear how big Citi will be allowed to get in China. The government keeps close tabs on the financial sector and holds up its national champions. But even a small sliver of this explosive market could mean a lot for Citi, especially if the government keeps other foreign players out of the market.