Q2 2008 Citigroup Inc. Earnings Conference Call on Jul. 18 ... · 7/18/2008 · The financial...

F I N A L T R A N S C R I P T

C - Q2 2008 Citigroup Inc. Earnings Conference Call

Event Date/Time: Jul. 18. 2008 / 8:30AM ET

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C O R P O R A T E P A R T I C I P A N T S

Scott FreidenrichCitigroup Inc. - Director, IR

Gary CrittendenCitigroup Inc. - CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Glenn SchorrUBS - Analyst

Guy MoszkowskiMerrill Lynch - Analyst

Meredith WhitneyOppenheimer - Analyst

Mike MayoDeutsche Bank - Analyst

Richard BoveLadenburg Thalmann - Analyst

James MitchellBuckingham Research - Analyst

William TanonaGoldman Sachs - Analyst

Jeff HarteSandler O'Neill - Analyst

P R E S E N T A T I O N

Operator

Good morning, ladies and gentlemen and welcome to Citi's second-quarter 2008 earnings review featuring Citi Chief FinancialOfficer, Gary Crittenden. Today's call will be hosted by Scott Freidenrich, Director of Investor Relations. We ask that you hold allquestions until the completion of the formal remarks, at which time you will be given instructions for the question-and-answersession. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time.Mr. Freidenrich, you may begin.

Scott Freidenrich - Citigroup Inc. - Director, IR

Thank you, operator. Good morning. Thank you all for joining us. Welcome to our second-quarter 2008 earnings review. Thepresentation we will be going through is available on our website at citigroup.com. You may want to download the presentationif you have not already done so. The financial supplement is also available on the website.

Our Chief Financial Officer, Gary Crittenden, will take you through the presentation. We will then be happy to take any questionsyou may have.

Before we get started, I would like to remind you that today's presentation may contain forward-looking statements. Citi'sfinancial results may differ materially from these statements so please refer to our SEC filings for a description of the factors thatwould cause our actual results to differ from expectations. With that said, let me turn it over to Gary.

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Jul. 18. 2008 / 8:30AM, C - Q2 2008 Citigroup Inc. Earnings Conference Call


Gary Crittenden - Citigroup Inc. - CFO

Good morning to everyone. Thanks very much for joining with us. Please turn to the slides that are now available to you onyour website. Slide 1 shows our consolidated results for the quarter. Similar to the first quarter, this quarter's results were drivenby two main factors -- writedown and losses related to a continued disruption in fixed income markets and higher North Americanconsumer credit costs.

To summarize our second-quarter results, net revenues declined 29%, driven by the continued disruption in the fixed incomemarkets, partially offset by underlying growth in several of our other businesses. Sequentially, net revenues were better by $5.6billion. Expenses were up 9% year-over-year. Excluding the impact of acquisitions and divestitures and the press-release discloseditems from both quarters, expense growth was flat versus last year.

Sequentially, expenses were actually down $128 million. We continue to make good progress on the reengineering plan as weare very focused on managing expense levels at the company. Credit cost was up by $4.5 billion over last year, primarily dueto higher net credit losses of $2.4 billion and a $2 billion charge to increased loan-loss reserves. Both mainly in our North Americanconsumer business. These factors drove a loss of $2.5 billion for the quarter or a loss per share of $0.54. The EPS is based on abasic share count of 5.3 billion. Sequentially, we reduced our losses by $2.6 billion. On a continuing operations basis, we had anet loss of $2.2 billion or a loss per share of $0.49.

One important note on the payment schedule of our preferred dividends, the $6 billion of Series E preferred shares that weissued this quarter has a semiannual dividend declaration scheduled for the first 10 years. If dividends are declared on this seriesas scheduled, the impact from preferred dividends on earnings per share in the first and the third quarters will be lower thanthe impact in the second and fourth quarters. All other series have a quarterly dividend declaration scheduled.

Slide 2 highlights the key positive trends of the quarter and I am going to go into each one of these in more detail in thepresentation. First, sequential revenues have grown with and without the mark-to-market losses in our securities and bankingbusiness. Second, the key drivers of each of our businesses continue to grow at levels consistent with the record second quarterof 2007.

Third, net interest margin expanded very nicely this quarter, in part due to lower funding costs and also driven by substantialprogress on reducing lower yielding assets. Fourth, expenses and headcount were down sequentially. Fifth, our capital positionwas strong and as I mentioned, we made very good progress in reducing our assets, in particular our legacy positions, includingdivestitures.

Finally, we announced a number of new hires to strengthen our leadership team. To name a few, these include [Sanjay Bias],the head of our Mortgage business; Terri Dial who joined us this quarter as the CEO of the Consumer Banking North Americaand Global Head of Consumer Strategy; Richard Evans, our new Chief Risk Officer for ICG; Kate James, head of our global CorporateCommunications team; Marty Lippert, our Chief Information Officer and Chief Operating Officer for corporate O&T; and MarkRufeh, the CAO and head of productivity for the ICG team.

Slide 3 shows our reported revenues in blue bars. For the last four quarters, the area within the dotted lines is indicative of themarks that we have taken in the securities and banking business. Adjusted for these marks, our revenues have continued togrow sequentially since year-end 2007. In fact, this quarter, our revenues are about the same as they were in the record secondquarter of 2007. In fact, adjusted for the marks, the first half of 2008 is only 1% lower than the record first half of 2007. Many ofour businesses, including cards in Asia, EMEA, Latin America and Transaction Services among others recorded double-digitrevenue growth.

Turning to slide 4, this shows a five-quarter trend in some of the key drivers of our business. One key note on this slide. Manyof the drivers are showing a sharp drop-off in the growth rate as acquisitions that we made last year have [lapped] in this quarter.






In EMEA for example, the Egg acquisition contributed between 21% and 29% to loan growth, between 22% and 34% to depositgrowth and between 6% and 10% of international cards purchased sales growth in the last four quarters.

Similarly, in Latin America, Grupo Uno and Cuscatlan contributed between 11% to 15% to loan growth, between 9% to 12% todeposit growth and between 1% to 3% to additional international cards purchased sales growth in the last four quarters. So inorder to get an apples-to-apples comparison, you would have to adjust the historical numbers to reflect the impact of thegrowth rates of those acquisitions.

In Transaction Services, third-party liabilities have declined sequentially -- have declined slightly sequentially to levels consistentwith the fourth quarter of 2007, following a substantial buildup of cash given market disruptions and a flight to quality.Year-on-year operating account balances grew 24% while timed deposits were down 6%. This underscores continuing strengthin our underlying business activities.

We have seen a slowdown in our North American card purchase sales as we have tightened underwriting standards and wherediscretionary spending is declining and spending on essentials, such as gas and food, is increasing due to higher prices.

Finally, growth in investment sales and assets under management were affected by a slowdown in capital markets activity inmany regions, particularly in Asia.

Before I move on, let me give you a few examples of key successes in the quarter that are not included in the numbers that Imentioned above. For example, we advised Time Warner on its separation from Time Warner Cable in a $45 billion transaction,the second-largest separation in the media space. We had a lead role in a 20 billion rupee bond for Tata Steel, the first privateIndian company to issue unsecured domestic debt in meaningful size and recorded India's largest ever pure corporate bondissue and a number of very other compelling wins.

In Transaction Services, we have had significant wins in the first six months of this year, totaling over $1 billion. And in the cardsbusiness, we renewed our coveted partnership with American Airlines.

Slide 5 shows the nine-quarter sequential trend in net interest margin for the Company. Net interest margin for the quarter isat 3.18%, up 34 basis points sequentially and 77 basis points over the prior period. The primary driver of this improvement isfrom significantly lower funding costs driven by deposits in Fed funds, which is reflected -- which is reflecting the benefit of theFed's rate cuts. The full impact of the January and March cuts and the two-month benefits from the April rate cuts are manifestingthemselves in the current quarter's net interest margin.

In a sequential quarter comparison, total assets were down by $99 billion this quarter with approximately two-thirds driven bya reduction of legacy assets. Consumer and corporate loans and trading assets were all down significantly. Obviously to theextent that we benefited this quarter was -- obviously the extent to which we benefited this quarter was highly dependent onthe rate cuts in the first and early part of the second quarters. Our ability to continue reducing low-yielding assets will dependon the liquidity that we have in the markets.

Slide 6 shows the trend in our expense growth. Expenses for the quarter grew 9% versus last year. The key components are fourpercentage points from acquisitions and divestitures, three percentage points from $446 million in repositioning charges relatedto a number of activities such as headcount reductions and branch closings, including an expected reduction in force of 2900people in addition to the expected reductions of 13,200 that we have announced over the last two quarters. We will continuethis process as we make progress in our productivity and reengineering program.

Third, two percentage points were accounted for by $300 million of a litigation reserve release that took place in last year'ssecond quarter. That results in business-as-usual expenses being flat in a year-over-year comparison. Foreign-exchangecontributed three percentage points to our expense growth as reflected across the categories that I just mentioned. Sequentially,






in spite of the higher activity levels in most of our businesses that I described earlier, expenses declined for the second quarterin a row and we were down 1%, evidence that our reengineering efforts are taking hold.

A word on our efficiency ratio. On Citi Day, we showed you that our first-quarter efficiency ratio adjusted for the disclosedsecurity and banking marks and press-release disclosed items was 62% and that our target, two or three years out, is 58%. Aftermaking the same adjustments in the quarter, the efficiency ratio has stayed at 62%. However, further adjusting the impact ofthe net loss from the mark-to-market on the mortgage servicing right and related hedge, which I will discuss later in theconversation this morning, our efficiency ratio would have been at 60%.

Slide number seven shows the trend in our headcount growth. The graph indicates that we have significantly slowed theyear-over-year headcount growth from 12% -- from the 12% to 16% range last year to 1%. This 1% growth was primarily drivenby acquisitions net of divestitures. This quarter's repositioning charges relate to nearly 3000 headcount reductions.

In the last three quarters, we have recorded cumulative disposition charges of approximately $1.6 billion relating to approximately16,000 heads. Of that 16,000, almost 7000 have already been reduced from our headcount with the remainder expected to berealized over the next 12 months. Since the end of the quarter, headcount has come down by another 2500 due to the closingof the Citi Street divestiture. Year-to-date, that brings our net headcount reduction to 14,000. Once the CitiCapital and Germanretail banking transactions close, headcount will be reduced by approximately an additional 7000.

Slide number eight shows a historical trend of our asset balances on the left and a number of our key capital ratios on the right.As the left-hand graph shows, we added over $470 billion in assets from year-end 2006 to the third quarter of 2007. Since then,we have reduced assets by over $250 billion in the last three quarters.

As the graph on the right shows, all of our capital ratios declined during 2007, driven primarily by acquisitions, organic assetgrowth and the negative earnings impact of the fourth quarter. This quarter, due to additional capital raising and the diligentmanagement of our balance sheet, our Tier 1 capital ratio was 8.7%, well in excess of our internal target. The TCE ratio was 6.9%,also in excess of our internally stated target of 6.5%.

In the last four quarters, we have added $10.4 billion net to our loan-loss reserve levels. In the last three quarters, we have addedapproximately $50 billion to our capital base through capital raises. Both of these actions combined have strengthened thebalance sheet of the Company. The total allowance for the Company currently stands at $22 billion and total capital, includingTier 1 and Tier 2 was $150 billion.

Further strengthening our balance sheet is our ongoing effort to reduce assets. As I said, this quarter, we reduced assets by $99billion and made particularly good progress in reducing legacy asset positions as is shown in the information that I describedearlier.

Just a week ago, we announced the sale of our German retail banking operation to Credit Mutuel for approximately $8 billionin cash. The closing is scheduled for the fourth quarter of this year. With an estimated gain of approximately $4 billion, thistransaction is expected to add approximately 60 basis points to the Tier 1 ratio on a pro forma basis and would be added to thenumbers that I described earlier. This transaction is evidence that our international franchises are coveted and that the valuationsof these franchises, even in the most developed markets, are substantially different than the current valuations of the US market.

We talked to you about asset productivity at Citi Day and we set a target of approximately 7% two to three years from now atwhich point the majority of the legacy asset portfolio is targeted to be wound down. Excluding the disclosed marks in securitiesand banking and the press-release disclosed items, the asset productivity for the Company was 4.9% this quarter versus 4.5%in the first quarter.






shows a number of [add] items, which negatively impacted the results in the quarter. First, net credit losses were higherby $2 billion and we recorded a $1.8 billion in incremental charges to increase our loan-loss reserves in the consumer bankingand card businesses with the majority of that being recorded in North America.

Second, a $740 million net loss resulting from mark-to-market on the mortgage servicing right and its related hedge. Third, a$3.5 billion writedown in credit costs on subprime-related direct exposures in our fixed income markets business. This is asignificant sequential improvement in the amount of writedowns as we continued to lower our risk positions on our subprimeexposures. Fourth, $2.4 billion in the credit market value adjustments related to our monoline exposure.

On our January 19 call, I had mentioned that, based on the current spreads at the time of the call, we expected the credit valueadjustment of a similar size to the first quarter. I had also said that with volatile spreads, this could change significantly beforewe close out the quarter. That is exactly what happened. Monoline spread widened substantially in the last few days of thequarter, contributing to a substantially larger credit market value adjustment than we recorded last quarter.

In addition, the market value direct exposure to monolines increased due to the decline of the value of hedges. This alsocontributed to the increase in the credit value adjustment. Additionally, $428 million in net writedowns on our highly leveragedfinance commitments were recorded in the quarter.

I think I might have misstated the date on which I did the Mike Mayo call earlier this quarter. It was June 9.

On slide number 10, we have the description of our cost of credit. It shows the year-over-year growth components and our totalcost of credits and the key drivers within each component. The total cost of credit increased by $4.4 billion, with $2.4 billiondriven by higher net credit losses and $2 billion driven by net incremental loan-loss reserve builds.

First, higher net credit losses were driven primarily by mortgages and cards in North America, which together comprised $1.8billion or 40% of the total NCLs in the quarter. In North America residential real estate, net credit losses were higher by $876million over last year.

In North America cards, net credit losses were up by $234 million, reflecting higher net writeoffs and lower recoveries. Delinquencylevels were higher and the increase in writeoffs reflected higher bankruptcy filings and the impact of customers that aredelinquent advancing to writeoff at a higher rate. The personal loan portfolio in North America also continued to deteriorateas NCLs were higher by $171 million over the last year.

In the regions, higher NCLs were driven primarily by Mexico consumer and the India consumer banking portfolios. For bothportfolios, we have taken a number of actions to mitigate our losses. The net loan-loss reserve coverage was higher this quarterversus the prior period by $2 billion. We had a total $2.5 billion net loan-loss reserve charge, primarily in North America mortgagesand cards. Approximately 54% or $1.4 billion of the total build was in the North America residential real estate portfolio to reflectour estimate of the losses inherent in the portfolio as credit and economic indicators, such as unemployment rates, continuedto deteriorate. With the addition to our reserves in our North American mortgage business, we are at a 15.9 month coincidentreserve coverage ratio for the residential real estate portfolio, 15.7 months and 16 months of coincident reserve coverage inour first and second mortgage portfolios respectively.

In North American cards, we added $334 million to our loan-loss reserves. The build reflects recently observed trends whichpoint to an expectation of higher losses in the near term. As I mentioned, the rate at which delinquent customers advance towrite-offs has increased. This is especially true in certain geographic areas where the impact of events in the housing markethas been greatest, driving higher loss rates.

Bankruptcy filings have also increased from historically low levels. These trends and other portfolio indicators led to a buildupin the reserves for North American cards in the quarter. In North America we are also seeing continued stress in the personalloan portfolio where losses have been rising. We added $106 million in reserves for this portfolio.






Turning outside North America, the three businesses which accounted for the largest reserve builds were Mexico and Brazilcards and India consumer bankings. ICG credit costs increased by $637 million. NCLs were higher by $394 million driven primarilyby loan sales of $11 billion in the quarter. Loan-loss reserves increased by $243 million net reflecting is slight deterioration inleading indicators of losses in the corporate loan portfolio.

Now slide 11 shows the consumer net credit losses and loan-loss reserves as a percentage of loans for the North Americaconsumer business in the top box and the same data combined for all of the consumer businesses outside North America atthe bottom of the slide. Looking at the top, the loan-loss reserves and NCLs as a percentage of the consumer loan portfoliohave risen sharply reflecting all of the factors that I have discussed. The largest contributor to the increase in North America isthe consumer mortgage portfolio.

As the bottom graph shows, the two credit ratios in international consumer are starting to increase. The increase is driven inlarge part by our cards business in Mexico and the consumer banking business in India.

Turning now to slide number 12, the two grids at the top show the FICO and LTV distribution of our North American first andsecond mortgage portfolios. The two grids on the bottom show the 90-day delinquencies in each of the two portfolios by FICOand LTV distribution. You have seen these grids before and there has been no material changes to this information.

As you know, this data is shown at origination. While we generally can collect robust FICO data on a refresh basis through creditbureau and other sources, LTVs are a significantly greater challenge as collecting home appraisals on each home in a largeportfolio is expensive and cumbersome.

Instead, we have made an estimation of the LTV scores by using a mathematical model, which takes into account home pricedepreciation in each geography in which we have exposure. Based on the geographic distribution of our portfolio, we applythe relevant home price depreciation statistics and calculate a proxy for refreshed LTVs.

By using this cross-section of largely refreshed FICO scores and a model-based refreshed LTV scores, the grids would show thefollowing. If you look at the last column on the first mortgage grid, which has loans with FICO scores that are below 620, thepercentage would move from 16% as is shown on the page to 23% as shown on a refreshed basis. The bottom right-hand cellof that grid is FICO less than 620 and LTV that is greater than 90%. That would stay at 6% on an origination and refreshed basis.

For second mortgages, if you were to look at the bottom row of the grid, which is LTVs that are greater than 90%, the percentagewould move from 31% as is shown in the grid to 34% on a refreshed basis. The bottom right-hand cell, which is FICO less than620 and LTV greater than 90%, would move from zero on an origination basis to 4% on a refreshed basis.

On slide 13, the top graph shows a historical trend of losses and delinquencies for the first mortgage portfolio and the bottomgraph shows the same data for the second mortgage portfolio. The first mortgage delinquency trend shows that delinquencylevels are well in excess of their 2003 peak. A further breakout of the below 620 segment, which I have shown here in the yellowbox indicates that delinquencies in this segment are over twice as high in the overall first mortgage portfolio.

Similarly, delinquency rates in our second mortgage portfolio are at historically high levels, particularly 90% or in the higherLTV segment as is shown in the yellow box. This segment has a delinquency rate that is also twice as high as the rate as theoverall second mortgage portfolio. Losses in both the first and second mortgages continue to increase as housing prices decline,unemployment rises and the economy in general continues to worsen. Our reserve actions for the mortgage portfolio primarilyreflect this significant deterioration.

Turning to slide 14, it is the slide that I showed last quarter with a 20-year trend of net credit losses in our North American cardsbusiness as shown by the red and blue line. It also shows unemployment rates over the same time period, which is the blackline. Historically, as you can see, the two have been closely correlated.






What I have added to this chart is the difference in NCL rates, that is up in the top yellow box, for our retail partners versus thebank card portfolio, which is shown in that box on the right-hand side of the chart.

The mix of our card portfolio has changed substantially over time. Prior to 2004, when we acquired the Sears portfolio, our cardsbusiness was primarily a bank card business, which historically has had a very different loss characteristic from our retail partnercards. Since 2004, we have continued to add retail partner cards to our portfolio of cards, which have higher losses and veryimportantly, higher yields than bank cards. At the end of the second quarter, retail partnered cards comprised approximatelyone-third of our portfolio.

Given the mix, the historical correlation of unemployment rates and loss rates -- I am sorry. Given this mix, the historical correlationof unemployment rates and loss rates and the typical six to eight-quarter rise in losses during periods of rising unemployment,it is possible that we may see loss rates that exceed their historical peaks. We are watching these trends very closely and havetaken a number of actions to address the increasing delinquencies and losses.

We have reduced our marketing expenditures, particularly on new accounts, reflecting the current environment. At the frontend, among other things, we have tightened underwriting criteria, including initial line assignments, particularly in certaingeographies and where we can use mortgage data to enhance our decision-making capabilities.

For existing customers, we are implementing a new series of limits and tighter criteria such as rising minimum score requirementsfor cash advances. We have added a large number of new collectors in the last year in the North America cards business andwe have increased the calling frequency to delinquent customers. We also have expanded forbearance programs to early-stagedelinquent customers and we are offering targeted settlement programs to those in late-stage delinquency. Many of ourcollectors are experienced, higher level representatives who are handling many of our delinquent customer accounts.

Now slide 15 shows the result of our global cards business. Managed revenues were up 18% due to 11% growth in managedreceivables, primarily in full-price loan balances, spread expansion and gain from the portfolio sale. Expense growth was 9%with a three percentage point contribution from foreign exchange and 1% from acquisitions. The remainder is primarily relatedto volume growth outside North America and the cost of managing deteriorating credit such as adding collectors in NorthAmerica.

On a managed basis, the business had 9% positive operating leverage. On a reported basis, revenues were up 3% and includeda $170 million benefit from the sale of a portfolio. Excluding this, revenues were down by 1%, driven primarily by the impact ofhigher funding costs and higher credit costs flowing through the securitization trust in North America, including a downwardadjustment in the valuation of the [IO] reflecting the same trends.

Higher managed funding costs are due to a significant widening of credit spreads in the asset-backed and commercial papermarkets. Higher credit costs reflect deterioration in the consumer credit environment. The decline in net income results primarilyfrom higher credit costs.

Slide 16 shows the results in our consumer banking business. Revenue growth was just 1%. But if you were to exclude the impactof Japan consumer finance, revenues were up 3% as a shown on the bottom of the page. Revenues in North America wereaffected by an approximately $745 million in a pretax net loss resulting from mark-to-market on the MSR and related hedge.We hedge the value of the MSR to minimize earnings volatility and we did not achieve that objective in this quarter. The impactof the MSR and related hedge had a nine percentage point impact on the reported revenue growth globally.

There were two main drivers for this loss. The first piece relates to the value of the mortgage servicing asset. In a typicalenvironment when mortgage rates increase, prepayment rates tend to slow as people do not pay off their mortgage as frequently.This results in a lengthening of the maturity of the mortgage portfolio and an increase in the value of the mortgage servicingasset.






This quarter, too, the value of the MSR asset increased. However, as many of you know, there continues to be significant illiquidityin the market. The way in which this affects the mortgage servicing assets is we use internal models and third-party benchmarkas inputs to mark the servicing asset. Third-party benchmarks prove to be a constraint to further upward valuation of themortgage servicing asset.

The second piece is related to the hedge, which is used to offset any changes in the value of the asset to protect against earningsvolatility. As we went through the quarter, extraordinary volatility in the markets caused us to continually rebalance the hedgeas many of the assumptions diverged from market indicators. For example, the two-year to 30-year swap curve narrowed from230 basis points at the end of March to 170 basis points at the end of April.

The extreme volatility in the market and the continued recalibration of the hedge positions resulted in a larger loss than wewould have otherwise expected. Historically, we have not experienced this magnitude of divergence in our hedge position andin the mortgage servicing right asset valuation. The loss on the hedge combined with the depressed value of the servicing assetresulted in a $745 million net loss on the mortgage servicing asset and related hedge.

Expenses were up 12% with foreign exchange contributing four percentage points and acquisitions contributing two. Theremaining expense growth relates to continued investment spending and spending on managing credit costs. Excluding Japanconsumer finance, we added 114 branches net in the last 12 months. In our residential real estate business in North America,we have added over 750 collectors in the last 12 months. Net income was affected primarily by higher credit costs in the NorthAmerican residential real estate business, India consumer banking and net loss resulting from mark-to-market on the MSR andrelated hedge.

Slide number 17 shows results in our securities and banking business. Revenues were $539 million versus a negative $7.3 billionlast quarter. We reported a net loss of $2.7 billion versus $7.1 billion a quarter ago. Partially offsetting the severely affectedbusiness were strong results in certain areas.

In equity markets, the cash business in North America had its strongest quarter since 2001. Prime brokerage business generatedrecord revenues driven by increased customer activity. North American derivatives had its second strongest revenue quarterin this quarter.

Within fixed income markets, the interest rate and currency trading business posted record revenues as volatility and interestrates drove strong results. The commodities business also posted record revenue driven by historic volatility in leadingcommodities such as oil and natural gas, as well as strong activities in the power sector.

Expenses increased by 6% versus last year. Excluding the $257 million from this quarter's expenses related to repositioning anda $300 million benefit from a release of a litigation reserve related to the WorldCom research matters in last year's secondquarter, expenses were actually down by 6%. Lower compensation costs in securities and banking were offset by higher costsfrom acquisitions and foreign exchange.

We continue to focus our efforts on realigning certain of our businesses. This effort is embedded in our current reengineeringplans. As a result, there was a headcount reduction, over 1900, in securities and banking this quarter. Credit costs in securitiesand banking were up $632 million versus last year. NCLs were higher by $386 million due to loan sales as we focus on reducingassets on our balance sheet and de-risking the portfolio. Loan-loss reserves increased by $227 million net reflecting a slightdeterioration in the leading indicators of losses in the corporate loan portfolio. Net income was a negative $2.7 billion drivenby marks and write downs in the business.

Slide 18 shows the writedowns taken against each category of the direct subprime exposure. The total writedowns includedrelated higher credit costs -- I'm sorry. The total writedowns, including related higher credit costs for the quarter, were $3.5billion as shown towards the bottom of the slide, including $324 million taken against the lending and structuring positions of$6.4 billion. With the lending and structuring positions, the CDO positions are virtually entirely written off.






Moving to the top of the table, we recorded a $3.2 billion writedown against the net super senior direct exposure of $22.7 billionshown in the middle of the first column. We started the quarter with a total exposure of $29.1 billion shown at the bottom ofthe first column.

As to the $22.7 billion of net super senior direct exposures and the associated $3.2 billion writedown, these exposures continueto be subject to valuation based on a discounted cash flow methodology other than liquidations, which I will discuss in amoment.

As to the discounted cash flow methodology, it remains consistent with what we did last quarter, which I described in detailon the last earnings call and then I would refer you to that information. There has been one change in the inputs in the model,which are worth noting. The [HIPAA] numbers that we use in our valuation methodology for this quarter have changed fromthe last quarter and now reflect a cumulative price decline from peak to trough of 23%. Our assumptions reflect price declinesof 12% and 3% respectively for 2008 and 2009 with the remainder of the 23% decline having occurred before the end of 2007.

During the quarter, we initiated two CDOs -- we liquidated two CDOs that were marked at $919 million at March 31. We liquidatedthese CDOs close to their marks at the time of liquidation. The aggregate decline in value and loss on liquidation is part of the$3.2 billion reported in the second column on slide 18. The liquidation proceeds are included in the $1.5 billion of other reductionsin the third column of slide 18.

In connection with the liquidations, we purchased a portion of the liquidated securities and have been managing and sellingthese assets in our trading books. As of June 30, we held $319 million of these securities in our trading books.

As to the $2.4 million incremental loss taken with respect to the credit value adjustment with hedge counterparties, we havenow taken $4.9 billion in cumulative credit value adjustments related to our monoline exposure over the last three quarters.The market value direct exposure to monolines increased from $7.3 billion through the end of the first quarter to $8 billion atthe end of this quarter.

Slide 19 provides you vintage and ratings data for each of the exposure types. We showed you this table last quarter and aswell the distribution here has remained generally consistent. Let me highlight a couple of changes. First, in the ABCP category,there has been a shift in ratings in the 2005 vintage where the AAA to AA tranche moved down from 31% this quarter to 27%this quarter and the BBB or below tranche moved up from 3% last quarter to 7% this quarter.

Second, in the high-grade category, there has been a shift in the ratings of the 2006 vintage where the AAA to AA tranchemoved down from 33% to 22% this quarter and the BBB and below tranche moved up from 40% last quarter to 52% this quarter.The extent of this shift in the 2006 vintage continues to reflect the point that I made last quarter, which is that we view our ABCPtransactions where most were issued between 2003 and 2005 to be of a higher credit quality than later vintage high-gradeasset-backed commercial CDOs.

Let me remind you, as Brian said on Citi Day, that our high-grade and mezzanine positions are largely hedged through positionsin our trading books.

Slide number 20 provides more detail on four other major drivers of our negative results in securities and banking. We showedyou this slide last quarter so let me cover it quickly. For highly leveraged transactions on the top left, our commitments forhighly leveraged transactions totaled $24 billion at the end of the quarter with $11 billion funded and $13 billion in unfundedcommitments. During the second quarter, we had a $428 million pretax write-down on these commitments.

In Alt-A mortgages, we were down to $16 billion this quarter. Of that $16 billion, we have a $4.3 billion mark-to-market portfoliowhere marks for the quarter were $193 million net of hedges. The remaining $12.1 billion is held as available-for-sale securitiesin which we recorded 132 impairment charge in the quarter. As the graph on the bottom left shows, our commercial real estate






exposure is split into the same three categories we showed last quarter. Excluding interest earnings, we recorded a $545 millionwritedown net of hedges on the portfolio subject to the fair value assessment.

Finally, on auction-rate securities at the second quarter, we held ARS securities with a par value of $6.9 billion in our inventory,down from the peak of $11 billion in mid February. After accounting for a gain of $197 million this quarter, the inventories stoodat $5.6 billion as is shown on the chart.

Turning now to slide 21, in our global transaction services business, revenues increased 30% to a record $2.4 billion, driven byhigher customer volumes, stable net interest margins, and the acquisition of BISYS Group, which closed in August 2007. Keyrevenue drivers continued to grow at strong double-digit rates. Foreign-exchange contributed four percentage points to revenuegrowth and acquisitions contributed five percentage points. Expenses were higher by 22%, well below the rate of revenuegrowth as we continue to invest in our global platform. FX contributed four percentage points and acquisitions, nine percentagepoints to the expense growth. Outside North America, every region had double-digit revenue and net income growth. Andrecord revenues and net income in Latin America and in EMEA.

Slide 22 shows our results in global wealth management. Revenues were up 4%, primarily driven by Nikko. Fee-based andrecurring revenues were up slightly as higher banking and lending revenues were partially offset by lower investment advisoryrevenues. Transactional revenues were down due to a slowdown in capital markets activity, particularly in Asia.

Assets under fee-based management were down 8%, due mainly to the adverse impact of market action. Revenues in the privatebank were up 2%, reflecting strength in lending and banking products. Expenses were up 7% driven primarily also by Nikko.Headcount in GWM is down by approximately 280 this quarter. Net income declined due to an absence of a $65 million APB 23tax benefit in last year's second quarter, lower revenues in Asia and higher credit costs in North America.

And finally on slide 23, we show our results in corporate and other. Revenues were down significantly due to two major items.First, higher funding costs related primarily to an increase in the deferred tax asset, hedging and our enhancement of ourliquidity position and second, intercompany transaction costs related to the capital raising that we have done and the sale --the capital raising we have done and to the sale of CitiCapital. The offset to this was recognized as revenues in the securitiesand banking business. Net income reflects tax benefits during the quarter.

So to wrap up, let me first address the area where we continue to see risks. The fixed income markets continue to be disruptedand investors remain wary, resulting in continued illiquidity in many product areas. However, as you have seen, we are aggressivelymanaging our position to reduce our exposures. You have seen our positions come down resulting in sequential improvementin our financial results.

We have exposure to monoline issuers, the commercial real estate industry and to Alt-A mortgages in our securities and bankingbusiness. Our exposures in each of these categories have generally declined as well.

With respect to expenses, we look to the second half of the year. The year-over-year comparisons will be challenged by the factthat compensation costs in last year's second half were low due to the market disruption that took place during that period.While there is still uncertainty related to the markets, this is an important factor to consider.

Credit costs in our consumer business may continue to rise through the year as I mentioned earlier. You have seen us buildreserves and if trends continue such that the rate at which delinquent customers go to writeoff increases, we believe thatconsumer credit costs could have a meaningful impact on our results for the remainder of the year.

And as we wind down our Japan consumer finance business, the situation there remains difficult.






We talked to you at Citi Day about the annual earnings power of this franchise and we said it was over $2 billion two to threeyears from now. Let me give you a sense -- at Citi Day, we talked about the annual earnings power of our franchise and said itwas over $20 billion and let me give you a sense of what we are doing to get there.

So looking at this quarter's results from continuing operations, we expect the impacts of two items will likely reduce over timeresulting from a less disrupted market environment. First, the marks that we record in our securities and banking business as Idiscussed earlier and second, credit costs in particularly North American cards in the consumer and banking business. Netinterest margin in the quarter was up very nicely both sequentially and year-over-year. Expense management is taking hold asour reengineering efforts gain momentum and we have made very good progress on reducing our headcount.

Additionally, we continue to focus on achieving our asset productivity targets that we laid out on Citi Day and this quarter,assets were down by $99 billion. We are particularly pleased with the reduction in our legacy asset portfolio. We remain diligentin managing our capital and allocating it to our highest return and highest growth opportunities. Overall, the sequentialimprovement that we have seen as we have cut our losses in half in the first quarter from the fourth quarter and now in halfagain from the first quarter to now, our franchise remains strong and delivering growth to the Company overall. We alsostrengthened our leadership team by announcing a number of new key hires.

That concludes our financial review of the quarter. Let me now turn the time back to the operator for the question-and-answerperiod.

Q U E S T I O N S A N D A N S W E R S

Operator

(OPERATOR INSTRUCTIONS). Glenn Schorr, UBS.

Glenn Schorr - UBS - Analyst

Hi, thanks, Gary. Maybe just a drop more color on the net interest margin. I look back on the comments from last quarter andit wasn't expecting obviously such a huge big jump and neither was I. How much relates to the -- you mentioned the rate cutversus some balancing and pruning and getting rid of low-yielding assets. Can you give us just a little bit of a weighting thereand maybe that will help us give our guesstimates going forward?


Yes, most of it was related to the rate cuts. So if you look at the gross yields, the gross yields actually for the entire Companywere pretty flat in the quarter. There were puts and takes in that. There were some things obviously that positively impactedthat -- the reduction in some of the legacy assets, offset by some deterioration in yields in some other categories. But most ofthe improvement that we saw in the quarter was related to the cost of funds improvement.

And what happened obviously as it rolled in gradually as we have come through the course of the year. So we frankly didn'texpect quite this magnitude of impact in this quarter as well and obviously sustaining the cost of funds benefit is related to thestructural position that we have around our funding and how the Fed funds' levels perform over the next little while. So obviouslywe are at an attractive level now relative to many of the last several quarters, but a big hunk of that is related to the cost of fundsimprovement.







Okay, cool. On the consolidated balance sheet, not too much of a surprise, the OCI lines up maybe almost threefold in the lastyear. If you could help with the assets that are running through an OCI adjustment versus the ones that we are seeing actuallosses on and was anything actually impaired through the bank line this quarter?


Yes, so we did take some impairments. Off the top of my head, I don't know the exact number that we actually impaired in thequarter, but we did impair some things that took place in the quarter. There is a FAS 115 impact in this line item, which obviouslyhas to do with the AFS books that we hold as an organization. There is a FAS 113 impact from cash flow hedges that we hold.But we carefully review this category obviously each quarter and ensure that the increases that result here, particularly in ourAFX book, relate to things that are temporary impairments, that are not other than temporary losses in the quarter. The aggregateamount of that, other than temporary, was about $1.3 billion in the quarter, obviously offset by other positives that went theother way that contributed to the roughly $650 million or so increase in OCI in the quarter.


Okay. Then two last quickies is, one, the BCE debt on your books, is it all in the leverage lending commitment from slide 20?


I think for the most part. So if we count the -- I want to make sure I am answering your question right. When we think about ourleverage loan portfolio here, we think about that as the leverage loan portfolio to financial sponsors. And if that is the definition,that is the number that we have shown here in the earnings deck.


Okay. And that is not yet marked, right, meaning it's sitting on your books?


Well, it is a split. So if you go to the chart that I had in the deck -- let me just flip over to there real quickly. Yes, if you go to thedeck. So the good news is that we have taken it down by $14 billion in the quarter and we took just over a $400 million markto make all of that happen. But you can see the split between funded and unfunded.

In the categories where it is unfunded, if we have a good sense of what the actual commercial relationship is going to be whenthe loan is funded, then we have to mark that loan even though it is not funded and so we would be carrying those at theappropriate value on our books now even if they are not funded.


Okay. And then this one is going to be impossible, but how is the tax rate work when you have such a big loss?







What happens is -- it is actually not as impossible as you might think. Most of the losses that took place took place in high-taxenvironments. So the reason why you see a much higher tax rate on the losses than you would typically see on the Companyon a blended basis in kind of a more normalized environment is you obviously take the tax against where either the loss or theincome was earned and much of the loss associated with these particular categories were losses that were in high-tax jurisdictionsand so that is why you see that very high tax rate in the quarter.


Okay, so the tax deferred asset will sit mostly in North America then?


I think that is generally true, yes.


And that -- I'm guessing, but does that mean you can eat through it and use it and have a lower tax rate in the out years prettyquick?


It does and as you know, that has a very positive implication for Tier 1 capital as well.


Yes, yes, cool. All right, thank you very much, Gary.

Operator

Guy Moszkowski, Merrill Lynch.

Guy Moszkowski - Merrill Lynch - Analyst

Good morning. I was wondering if you could, just related to one of the prior questions, first of all, tell us what percentage of theimprovement in the net interest margin came from securities and banking versus the other businesses. And related to that also,if you could maybe give us a little more granularity on the legacy asset or the total asset reduction of $99 billion. You said abouttwo-thirds is legacy assets. Maybe you can give us a sense more for what those asset reductions were and then the other $33billion or so, what type of assets were they?


Yes, so on the first question, I am afraid I can't provide more color on that. I don't have it and we typically don't split out theimprovement between the various productlines. I can give you more color on the asset reductions though and let me just turnto that real quickly and I will provide it to you.






So if you look at the major balance sheet categories, so consumer loans were down by $26 billion. Corporate loans were downby about $17 billion and trading account assets were down by about $73 billion. So those are some of the kind of major categorieswhere we had overall reductions. Obviously, in aggregate, the reductions added up to about the $99 billion that we talkedabout.

We had -- you could -- as you walk through the supplement, you will be able to see the categories where we actually had primaryreductions that were related to our legacy category, some of which I have already mentioned. So our leverage loan categoryfor example was down by $14 billion. Our SIVs were down by $12 billion in the quarter. Our residential real estate portfolio wasdown by $11 billion in the quarter and then against these major asset categories, we are obviously making pretty good progress.In fact, here is the way I would think about it. We said that we had somewhere between $400 billion and $500 billion worth oflegacy assets that we wanted to remove and that two to three years out, we thought we would be somewhere below $100billion in total assets. So we had to take out something like $350 billion over the next two to three years in order to meet ourtargets.

In this quarter, we took out roughly 67% of $99 billion, somewhere in that range, so say $65 billion of legacy assets and so weare well on our way against that roughly $350 billion target over the next two to three years of reducing that asset base down.Now if we are fortunate and markets become more liquid, we will obviously move more aggressively against that. But this wasa, I think, a very nice down payment on our asset performance in the quarter.

And just to put things in perspective a little bit, we peaked in terms of total assets at $2.36 trillion in the third quarter of lastyear and from that peak, we are now down $257 billion in total assets to $2.1 billion. So there was a very significant reduction,not only in this quarter, but in future quarters.

One other thing that we don't typically embed in the financial statements is that the risk capital actually went down as aggressively-- in fact, slightly more than we actually had reduction in [gap] capital during the quarter and the good news is that that actuallyhas freed up more hybrid capacity for us as an organization. So as our risk capital has come down, it has provided additionalhybrid capacity for the Company going forward.

And so there is all kinds of knock-on benefits associated with managing our assets better obviously. It improves our liquidityposition. It does very good things for our returns over the long haul. It increases the flexibility that we have in terms of the waywe manage our capital as an organization and all of that is reflected in this what I think very fine performance on the managementof assets.


So you raise a very good point on the hybrid capital capacity. Is that something that you could articulate a little bit for us of howyou think about that?


What I can tell you is that as against each of the buckets -- so there is a 15% bucket that will be eventually put in place in thefirst quarter of 2009, a 25% bucket and a 50% bucket. As against each of those pockets in this quarter we have outstandingcapacity and the outstanding capacity that we have is not trivial compared to the total amount of capital that we have raisedhistorically. And so although I don't want to quantify it specifically for you, as our risk-weighted assets have come down, wehave freed up capacity here that provides additional flexibility for the Company going forward.







That is helpful. Thanks. Can I ask a little bit about this -- the FIN 46, FAS 140 exposure draft on the potential for having to onboardmore off-balance sheet assets? Can you give us some range as to how you are thinking about how that might affect you?


Well, we obviously have looked at it in real detail and have a lot of internal involvement in the process of thinking through theimplications of this. There are three primary things you have to think about as you think about this potential change in regulation.

The first is who has the primary responsibility for the assets and in our case, the primary responsibility for what we currentlytalk about is the total VIEs that we have on our balance sheet. The primary responsibility for the majority of those assets wouldprobably lie elsewhere. I think the best example of that is in our mortgage assets. So our mortgage assets at the end of the thirdquarter we disclosed at $517 billion and the majority of that, say more than 90% of that, the primary responsibility or the powerover those assets would probably reside elsewhere. And that's kind of the first test that you have to think about.

The second question that I think the FASB and the SEC are grappling with is what the timing of implementation is going to beand it looks like it's going to be spread out over time. There's going to be some implications probably for asset-backed commercialpaper that happened earlier, credit cards are probably going to be a little later in the cycle and so the timing is important.

And then the third factor is what the capital weighting is going to be. And although we don't have any real detail on what thatimplies, today with asset-backed commercial paper, there is essentially very, very low capital weighting associated with thatand it is unclear why an accounting change would result in a higher capital weighting associated with those securities.

So as we look at it overall, we anticipate the largest impact is likely to be in the credit card area. That will have an impact on ourTier 1 capital. It will probably happen over time as the full implementation of that rule is not likely to happen for a while. Butwe are really at a very early stage here. We are at a very early stage in terms of thinking about what this is going to be.

We will have a draft probably here in the next few weeks. We are going to have an opportunity to make comments on that draftover a 60 day time period and then the actual rules will be issued as we go towards the end of the year. But as we look at it inthe overall scheme of things, we think the largest impact is likely to be against our credit card positions and that is likely to beover a longer time period.


Okay, that helps. Let me ask one more question, which is going to be on global wealth management and the net flows, whichwere quite negative, $11 billion net outflow from a combination of Smith Barney and the private bank. Were there any biglumpy movements there or was it just driven by the departure of very productive FA teams or what happened there?


Well, we did have the increase that you talked about in the quarter and there wasn't anything that was lumpy there in particular.I mean this was a difficult quarter overall obviously in equity markets and we have a particular concentration in our equitymarkets in Asian markets. We are very strong in the Asian markets. And just to give you a little perspective on that. As you know,the Indian market was down double digits. I am talking about now on a trailing 12-month basis. The Chinese market was downvery substantially, I believe 28% on a trailing 12-month basis. So there was pretty significant market action in the parts of theworld where we have a very strong market position. And that obviously impacted what our clients are doing with their investmentdollars and we were impacted by that in the quarter.







Okay, thank you, Gary.

Operator

Meredith Whitney, Oppenheimer.

Meredith Whitney - Oppenheimer - Analyst

Good morning, Gary. I had a couple of quick questions. If I try to, and I am having difficulty because every number seems to berestated, but if I try to look for a run rate exclusive of writedowns and exclusive of the tax benefit in the fixed income line onthe securities and banking segment, can you help me out there in terms of what was the tax benefit for the quarter and Iobviously can get there net of marks?


Are you talking about the tax rating in securities and banking?


Well, you had said that the tax benefit had been reversed through the revenue line in securities and banking.


No, I don't think I said that. So there are a couple of factors here. So we -- in terms of -- I think the only comment I made aboutthe tax rate was the tax rate as it impacted the corporate and other account and in the corporate and other account, we had alower tax benefit than we typically would have because that tax benefit or tax implication had already been distributed to thebusiness. But I think that is the only comment I made.


Okay. Was there any other color that I should look into for that line item?


There were fees that were paid by the Company on capital raises. Obviously our markets and banking business did our capitalraising for us.


That would be underwriting, right?







Yes, they did the underwriting.


But that would be in the underwriting segment, not the fixed income.


Yes, and so there would be an implication associated with that, but in the overall scope of the Company, it is a very, very minorfactor.


Okay. And then just some clarifications on the marks. I know you stated this, but can you go over again how you came to marksome of your positions, particularly the mark up in those and some of the other marks? Because if I took the just correlative,and I know you are using (inaudible) data, correlative AVX data, either AAA or BBB, I come up with different numbers. And thenparticularly with the monoline, I would love some more elaboration in terms of how you came up with the monoline mark andthat is it. Thanks.


As you know, we extensively reviewed our methodology last quarter about how we mark the CDOs. So I won't reprise all that,but I will give just a very brief summary. We obviously look at the credit ratings associated with each of these underlyingstructures and then we apply a discount rate associated with the cash flows based on what we expect the housing pricereductions to be in the future.

And so as one thinks about this, there are really two very important factors. One factor is what is the housing price decline goingto be and companies make different assumptions about those. Some companies, for example, have a higher housing pricereduction assumption. They might assume something like 30%, but then they would discount those cash flows at a risk-freerate.

We have a different approach. We take -- right now, we are using [K. Schiller] and then we modify that on a forward projectionbasis based on the input of our internal economics team. We take that 23% and against that 23%, we apply a very high discountrate that is associated with either the COO spread or the AVX spread. It is really the combination of those two things that youhave to add together to have a complete understanding of how effectively the securities are marked.

And so once again, in this quarter, as the spreads have widened and as we have increased our assumption about the deteriorationin housing prices, that has had an impact on our financial performance. Now I think it is important to say that the housing pricereduction assumption is much less leveraged than the spreads. Because the housing price reduction assumption is alreadyquite large, a 1% increase or 2% or 3% really doesn't make a whole lot of difference in terms of the total mark.

What is really quite critical is what happens with spreads over time and as you know, during the course of this quarter, therewas a widening of spreads and as a result of the widening of the spreads, you saw the marks that we took in the quarter. Althoughimportantly, those marks were sequentially reduced.






I might also add that our team has done an excellent job I think at managing the exposure, as Brian said during the course ofthe Citi Day, done an excellent job of managing the overall exposure that we have on the mezz and high-grade CDO portfoliosso those positions are largely hedged at this point. So the team has done a nice job.

On the monoline exposures that we have, we have a very simple process there. The simple process that we follow is that we --the simple process that we follow is that we look at their spreads. And so it is very, very easy. We have a well-disclosed positionin each of the monolines. We take whatever their spreads happen to do. We discount the value of the contract that we havedue to us from the monolines based on what those spread changes are and we calculate the position.

What you saw happen there is exactly what I described on the call. So when I did a call three weeks or so ago and I talked aboutthe fact that our monoline exposure was expected to be flat, that was before the downgrade that happened. There was adowngrade that took place for a couple of the monolines in the last quarters of the -- last couple of weeks of the quarter. Thatresulted in a widening of the spreads and as a result of the widening in the spreads, there was an impact on the valuation thatwe have.

In terms of the ARSes, some parts of that market became a little bit more liquid during the course of the quarter, so we wereable to get good benchmark data on that. We actually had some of those assets move from level three to level two and as thosemovements took place, we were able to do a bit of a revaluation there so we actually had I think a $200 million benefit in thatcategory. So that is a bit of a walk through the major exposures, but that is essentially where we are marked as we finish theend of the second quarter here.


Okay, Gary, just for point of clarification, can you remind me your peak to trough in the house price decline assumptions in thefirst quarter and then what they are now?


It was 20% in the first quarter and 23% now.


Got it. Okay, thank you very much.

Operator

Mike Mayo, Deutsche Bank.

Mike Mayo - Deutsche Bank - Analyst

Hi, Gary. You reported a loss for the quarter, you're selling off assets to improve capital. Why not just cut the dividend and Iguess embedded in that question is your expectations for future writedowns?


Well, Mike, we have tried to talk about this a fair amount, but the way we think about this is based on what we think the long-termearnings performance of the Company is. And as I finished my comments today, I tried to go back and talk about the $20 billion






that we talked about at Citi Day and how we think about the ongoing operations of the business relative to the current reportedperformance.

So if you kind of step through what happened during the course of the quarter, we had revenue that was roughly equivalent-- away from the marks now -- revenue that was roughly equivalent to the best revenue performance that we had had in ourhistory, the last -- the two quarters at the end or in the middle of last year. We had strong organic growth across most of ourcategories and I step through each of those categories. So loans were up nicely, deposits were up nicely, good momentum inGTS, good underlying growth in each of those categories.

We are doing a good job on the management of our expenses. Sequentially, our expenses are down. Our headcount is improving.In fact, it is kind of interesting. I did some quick math here on our productivity of headcount. If I look in the fourth quarter andjust look at the number of heads that we had and what our reported revenue would have been away from the marks, we hadabout -- we had annualized revenue per head of about $262,000.

By the time we got to the second quarter, because of the reduction in heads that we have had and because of the managementof the expenses, that number has improved by about 8% to $285,000 per head. So there has been good improvment in theproductivity of our team as headcount has come down and we have been able to constrain expense growth.

Credit, obviously, continues to be an issue. We are actively managing our credit line items. They may deteriorate in the future,as I have talked about on many different occasions, but we have a sense of the credit card cycle. We have a sense of what thecredit card cycle will look like and I disclosed that pretty clearly in the material today. We are, obviously, aggressively reservingfor the potential deterioration in the -- for residential mortgages.

So if you wrap all of that up, I don't think anything is different about the way we felt about the underlying earnings power,which Vikram kind of clearly stated was about $20 billion. We don't feel anything different about the underlying earnings powertoday than we did at the time we did Citi Day. Obviously, our dividend is set in the context of thinking about what we believethe fundamental earnings power of the franchise to be.

Mike Mayo - Deutsche Bank - Analyst

Then a related question, in the past you said you are taking these write-downs even though cash flows are still fine. Is that stillthe case or has that changed?


Yes, no, for the asset-backed commercial paper, which is the category that I have always talked about, the $14.2 billion or $14.4billion. For that category, again, I assembled the team two nights ago and we had a very detailed discussion. There has not beena single American dollar cash flow loss against the asset-backed commercial paper as of today. So I believe the magnitude ofthe markdown there is roughly $10 million that has taken place over the course of the last couple of quarters and as we sit heretoday, there has been no cash flow loss in terms of the remittances.

Now I rush to add that that is not a forecast for the future. It is possible that that could change, but as of now because of thecash flow tiering, the underlying collateral that we have there, there has not been any cash flow loss associated with that.

Operator

Richard Bove, Ladenburg Thalmann.






Richard Bove - Ladenburg Thalmann - Analyst

Hi, Gary. I notice in the past six quarters that your revenues, ex marks, is running between $25 billion to $26 billion a quarter.And it would appear that to pay the dividend, you need roughly about $2 billion in net income per quarter. A little less thanthat, but somewhere in that rough range. And I am wondering, given the budgeting process at Citigroup, when you thinkCitigroup is going to reach that level on a consistent basis?


Well, Dick, obviously I can't provide a forecast for you. We have, I think, very good confidence about the objectives that wetalked about for Citi Day and at Citi Day, we talked about kind of a two to three-year timeframe in which we would make anumber of things happen. And those things related to revenue growth. They related to how we would manage our assets andthey reflected the efficiency ratio that we would achieve.

If you combine all of those things, then obviously we would solidly be in the category where that dividend would be well-coveredby the earnings of the Company. So without giving a point estimate for when we think that is going to happen, I think we havebeen as clear as we could be about where we think the trajectory is headed over the next two to three years. And I think ourjob here is to demonstrate sequential improvement each quarter in the direction of the objectives that we set for you all on CitiDay and then to report how we are performing against the objectives that we set.


Well, if you go two years without running a profit, I think the control of the currency requirements would suggest that youwould have to cut the dividend. You have now gone three quarters with negative numbers. So presumably you would assumeif you are not cutting the dividend that you're going to break into profit territory within the next few quarters. I would assumethat that is the case.


Well, again, Dick, we really don't make a short-term forecast of any kind for what we think our financial performance is goingto be.


Okay, thanks.

Operator

James Mitchell, Buckingham Research.

James Mitchell - Buckingham Research - Analyst

Hey, good morning. Getting back to maybe the fixed income trading results and I am just trying to -- if I can normalize for allthe writedowns, it looks like, and maybe I am crazy, but it looks like the trading revenue might have been close to $6 billion runrate.







Yes, I think you're right. I mean we actually had a very strong month of June in our markets and banking business and it wasn'tisolated. I mean I did step across a few of the categories where we saw particularly strong performance, but the month of Junewas a good month for us overall and obviously we are up against very large numbers from the prior year. But generally, it wasa strong performance.


I mean it was dramatically better than even your record quarters. I mean it was literally across the board. Any particular areasstick out?


Well, there were a few that I mentioned. Let me just go back and kind of spike those out one more time. So in the equity markets,we had our strongest quarter since 2001. Our prime brokerage business had record revenues. That was all driven by increasedcustomer activity. I said our North American derivatives business had the second strongest revenue quarter that it has ever had.

Within our fixed income business, our interest rate and currency trading businesses had record revenues. There was a lot ofvolatility in the quarter, as you know, and that was helpful those businesses. Our commodities business posted record revenues.Again, there was a lot of volatility in oil and natural gas and strong activity that we had in the power sector. And so we had avery good month in the month of June and that really did help the overall results in that business in the quarter.


Okay, fair enough. On the reserve side, you are now at $22 billion.


Correct, yes.


At what point does the law of large numbers start to come into play? I mean $22 billion is a large amount. I think on a reserveto loans basis, you are even higher now than when you were at the telecom crisis in '01 when you are getting $0.10 on thedollar. So how do we think about where reserves could eventually go?


Well, obviously it's a very good question. There is a couple of things. We obviously would want to be able to see some type oftopping of the exposures that we potentially have before we would stop the process of adding reserves if things are deteriorating.And I think a good example of that, if you look on slide 13 in our deck, for the second mortgage category, if you look at the90-day past-due line, it looks as though the 90-day past-due line is starting to moderate out in the later quarters.

Now we don't know if that is a real moderation. If you go back, one might argue that because of the incentive checks that havecome that there has been some improvement in the payments that have taken place, but if someone were relativelyunsophisticated, they could say, gee, I have seen moderation in the second mortgage portfolio, maybe I can slow down on the






reserving that I am doing in that category. We want to make sure that what we see is real improvement that is sustained andwhen we see real improvement that is sustained, then we will begin the process of moderating this.

But I think if you take the two pieces together, if you take the additions that we have made to the reserves, over $10 billion, andyou take the additions that we've made to the capital base, we really have done a lot to strengthen the capital base of theCompany. I really do think about those two things as working hand in hand to ensure both that we can take advantage ofbusiness opportunities that come down the road, as well as ensure that we have the ability to weather difficult storms. And sofor now, we don't see any real change in the policy that we have had, but obviously as soon as we have conviction that thattrend is moderating in some way, we will be talking about it.


I guess I understand that formulas dictate if trends continue to worsen, you have to add to reserves, but I was just sort ofquestioning at some level, I mean that is a pretty pro-cyclical policy. At what point does just large numbers start to say, hey, weare just going to start matching charge-offs because they are reserved on an absolute basis is pretty large. But you are saying--


Not yet, not yet.


Okay, fair enough. Thanks.

Operator

William Tanona, Goldman Sachs.

William Tanona - Goldman Sachs - Analyst

Good morning, Gary. Jamie Diamond was out there yesterday indicating that the prime portfolio was not doing so well andthat you could even possibly see losses tripling from this type of level. Just kind of wanted to get your thoughts in terms of howyou kind of see your prime portfolio, particularly over these next couple of quarters.


So, the prime portfolio is obviously deteriorating. You can see that on page 13 in our deck. So there was a pretty significantacceleration in both our NCL ratio and in our 90-day past-due. We have seen no change in that trend whatsoever. You don'tsee the same kind of dip on that line item like you do on second mortgages. And so from our perspective, we have obviouslyreserved for the losses that we believe are embedded in the portfolio. But to the extent that you see higher flows, higherdeterioration and delinquency buckets, we will continue to add to that reserve over time as necessary.

And it is very difficult I think as we sit here today to forecast exactly where that is going to go. If I compare that, the card portfolioon the next chart, we can look back over history and say, gee, we have been through cycles like this before and they have anaverage duration and they have an average amount of magnitude associated with the deterioration. I think that is harder tosay in the overall mortgage portfolio.






Now having said that, the numbers that we work on are much more granular than the numbers that are shown on this page.So we look at individual geographies, how individual geographies are trending, the entire country doesn't move together. Somegeographies are deteriorating, some are improving a bit from where they were before and you have to take the overall aggregateto kind of get to the picture that we have here.

So we have a more nuanced view of where this goes from the detail that we look at as we actually manage our credit. But I thinkit is safe to say that it would be difficult to project right now. It would be difficult for us to actually call a point where we thinkthe peak will happen or the timeframe in which it will actually happen.

What we have tried to do is ensure that we have obviously prepared ourselves from a capital and from a reserve perspective toweather difficult numbers in this category going forward and to work very hard on all of the other measures of our business --the management of capital, the management of our expense so that in spite of how this comes as we go through the next fewquarters, we are able to deliver what our expectations are.

William Tanona - Goldman Sachs - Analyst

Okay, that's fair. And then I guess in terms of slide 18, just so I understand, is the CVA that you took for the monolines specificallyor is that all for just the ABS CDOs or is that across your overall monoline exposure throughout the firm?


It was all monolines. So again, it was a very straightforward process. We simply look at how the

Q2 2008 Citigroup Inc. Earnings Conference Call on Jul. 18 ... · 7/18/2008 · The financial...

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