Friday, October 29, 2000   5:00 pm Eastern Time

Company Press Release - Initial Draft Report

SOURCE: Parish & Company - Not Copyrighted.
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Citigroup "Pooling" Scheme Decapitalizes Nation's Largest Bank

PORTLAND, OR - Many would argue, myself included, that the three most important industries in the new Internet driven economy are computer related, telecom and financial services.  To realize the Internet's potential we must first, however, deal with three industry dominating financial predators, Microsoft, Cisco Systems and Citigroup.

The objective of this initial report is to begin examining what is now the nation's largest bank.  Citigroup will have a combined market value in excess of $250 billion and represent 2.2 percent of the S&P 500 when it completes its merger with Associates First Capital, a company described in a recent NY Times article as an "icon of predatory lending."

Citigroup has now become a fee mill, both in the consumer and investment banking areas, the opposite of what the Internet was expected to bring.  The primary tools used to crush new, more cost effective competition are the pooling method of acquisitions and other forms of financial engineering.

The pooling loophole allows two companies to merge, combine their financial statements and ignore the cost of the merger.  For example, if Citigroup prints up more stock to buy a company with a combined book value and valued assets (based upon future earnings) of $10 billion, but pays $30 billion, the excess $20 billion is never charged to future earnings.  This "goodwill" simply disappears and Citigroup becomes a "watered stock" due to the significant number of new shares outstanding.  The SEC fights hard to end pooling, while Citigroup and Cisco Systems counter by trying to persuade Congress to overrule them.

With a stock price of $50 or 5 times its book value of $10 per share, per Yahoo Profile Analysis, Citigroup, like Microsoft and Cisco, has adopted a short-term oriented approach in order to sustain the equivalent of a financial fee pyramid scheme.  The next 3 largest banks, Bank of America, Wells Fargo and Bank One, trade at 1.6, 3 and 2.1 times book value respectively.

Banks are simply intermediaries.  They have little key intellectual property and competitive forces generally do not allow for large gross margins, therefore book value does matter, as do dividends.  Dividends keep banks honest and surprisingly, Citigroup's dividend yield is now only 1.1 percent.  Bank of America, Bank One and Wells Fargo's dividend yields are 4.5, 2.5 and 2 percent respectively.

More important is that Citigroup is now essentially decapitalizing itself using pooling-based mergers and could pose a severe risk to the banking sector given its low book value and other peripheral risks.  Long-term oriented shareholders should be concerned and demand reform.

There is a certain irony to Citigroup being a major exhibitor at Internet World in October.  Robert Rubin, former Treasury Secretary and now Citicorp Vice-Chairman, lectured attendees on "fiscal discipline" and "cultural openness to change."   He added that older, more established firms are catching up and employing better business practices, giving them an overall edge, according to Dan Briody of Red Herring News.  This is the same Robert Rubin that moved from being Treasury Secretary to Citigroup, accepting a $50 million compensation package just before the Glass-Stegall banking laws were repealed, the major beneficiary of which became Citigroup.  We would expect these to be scenes from Jakarta, Indonesia or Russia, not Washington, D.C.  Meanwhile, Rubin travels on an international circuit lecturing countries on the importance of free market based reforms.

In Rubin's defense, he is simply taking advantage of a broken system.  Ending pooling would fix this system and stop predatory mega-mergers.  The focus would shift to genuine shareholder perspectives rather than allowing executives to leverage growth in their stock options, leaving long-term shareholders and the retirement system to deal with the consequences.

Exactly this type of activity at Citigroup poses the greatest risk to the stock market.  No one doubts Robert Rubin's capabilities, but he does not see that he has become a shining disincentive to achieve the solid work ethic he espouses.  For example, who is going to spend the energy and financial resources to launch a truly innovative Internet-based lower cost credit card program when they have to compete with a predator like Citigroup?

A few highlights in this initial report include the following:

1)  A request that Alan Greenspan of the Federal Reserve Bank publicly support ending pooling-based mergers in the banking sector because they are now decapitalizing the banking system.

One can easily forget that increased capital requirements for banks in the early 1990's played a major role in creating the subsequent strong economy.  President Bush did the right thing in pushing for this reform.  These higher ratios also helped banks survive the CMO debacle, one peripheral impact of which was Orange County losing $2 billion.  Citigroup is now securitizing and issuing a whole new mix of complex derivative-like products, making the capital ratio even more important.  Citigroup is also aggressive in leasing and syndicated lending, unlike Wells Fargo, and is indeed lead lender among several banks with respect to Xerox.

Based upon its 6/30/2000 10Q filing, Citigroup claims to have $60.4 billion in total capital, respresenting 11.2 percent of net risk adjusted assets of $543 billion.   This is a gross distortion.  Link to Citigroup SEC 10Q  Do a browser search under "Citigroup Ratios," page down to the details and notice that goodwill is an important deduction in determining Tier 1 capital.

By using pooling with its Travelers and Associates First Capital mergers, Citigroup avoids taking goodwill deductions which would greatly affect its capital ratio.  Therefore, a key component of Citigroup's scheme uses pooling to inflate its capital ratio since these ratios are an important measure of a bank's success.  If goodwill were included, Citigroup's capital would be impaired and clearly below regulatory requirements.  For Cisco Systems to use a pooling scheme to manipulate its financial results is one thing, yet for the nation's largest bank this situation should most certainly be within the purview of the Federal Reserve Bank.

2)  A request that the SEC require Citigroup to refile its 10Q and 10K reports beginning January 1, 1999 and more adequately disclose lending and deposit activity.

Somehow, as they became the nation's largest bank, Citigroup forgot to report their results like a bank.  An example of adequate disclosure is available from Bank of America's 10Q.  Do a browser search for "Balances and Interest Rates," then page down to view a summary of the average balance and yield or rate for all major loan and deposit product categories.

This is an important source of disclosure because afterall we taxpayers are guaranteeing the banking system.  Microsoft and Cisco's financial engineering is one thing, yet Citigroup is the largest bank in the country and affects all industries.

Citigroup does not disclose the average rates charged for its various categories of loans, nor the cost of funding these loans.  Instead they report a net interest margin, loan rate less cost of funds, what would be equivalent to a gross margin percent.  Can you imagine Cisco Systems getting away with reporting gross margins in their 10Q, net of its cost of sales, and not showing their gross revenues by business area?

Citigroup is clearly trying to disguise what many might consider abusively high interest rates and fees.  Its revenue growth has not come from innovation but rather a short-term emphasis on fee gouging.  New economy workers should be concerned about this because these excessive fees remove a valuable source of investment capital.

3)  How Citigroup is pilfering the pension system, in particular small company 401K plans.

Citigroup now represents more than 2.2 percent of the entire S&P 500 (with Associates First Capital), a rather surprising development for one bank.  The next 3 largest banks have a combined market value of $182 billion compared to Citigroup's $250 billion.  See the listing of top holdings in the Vanguard Index 500 mutual fund to confirm Citigroup's share of the S&P 500, noting that Associates First Capital is not included in Vanguard's data.

Since most state and federal public pension plans are indexing to the S&P 500, more than 2 cents of every dollar of new pension contributions to stocks is going to the purchase of Citigroup stock.  An early leader in indexing to the S&P 500 was Wells Fargo and it is ironic that, while Wells Fargo is charging low index-level fees in many excellent 401K plans, their competitor, Citigroup, is able to successfully pilfer the very same funds by leveraging in its own stock.  Microsoft and Cisco have also leveraged their stock into these funds by inflating earnings to capture a larger percentage of index-based investments.

Even more surprising is how successfully Citigroup is pilfering the small business 401K market through the aggressive use of high-fee annuity contracts.  To quote Citigroup's 6/30/2000 SEC 10Q filing (do a browser search for "small company segment of the 401K market"), strong annuity sales reflect "penetration of the small company segment of the 401K market."

In summary, with respect to pensions, Citigroup pilfers the large plans by leveraging in its own stock.  This additional investment increases the value of employee stock options and related company tax deductions for wages when the options are exercised, even though these wages were never paid in cash and are not charged as an expense to earnings.

Citigroup now owes its employees more than $8 billion in stock option wage debt.  Also noteworthy is that Citigroup changed its 401K plan in 1999 from a 3 percent match in stock or cash to a Citigroup stock only match, according to their annual 10K report.  The new plan's name is "Citibuilder 401K Plan," formerly the Savings Incentive Plan.

Small company plans are being pilfered more directly in the form of excessive annuity fees.  As an investment advisor, it is sad to see smaller companies roped into these plans because it takes enormous courage to admit a mistake, take the losses, shut it down and start over with a good plan.

This illustrates why a safe harbor provision for employers offering certain types of low-cost, diversified plans can be so powerful and my motivation for having tried to get both Microsoft and Cisco Systems to support such a concept.  Pension investment is important to the overall market and we can't afford to alienate the public due to a loss of confidence from being in plans with confiscatory fees.

Summary of Goals

Many excellent alternatives to Citigroup exist in the financial services area for both consumers of such services and investors.  I will explore these in detail in subsequent reports.  Please listen to the Zacks radio interview on Citigroup conducted by Richard Peal of Zacks Investment Research on October 24, 2000. Any media coverage that helps create a dialogue on these topics would be most appreciated.

1)  Federal Reserve Bank (FRB):  Support ending pooling for banks by 12/31/2000 in order to prevent Citigroup and other banks from decapitalizing.

2)  Securities and Exchange Commission (SEC):  Request that Citigroup refile all 10Q and 10K reports since 1/1/99, disclosing lending and deposit rates by product line, as well as more specific fee disclosure.  Bank of America's format noted above seems most appropriate.

3)  Department of Labor (DOL):  Support an expanded safe harbor provision from being sued for employers that offer a certain type of low cost plan featuring 3 indexed equity funds and 3 indexed fixed income funds. This will help many employers, in particular smaller companies, set up plans that encourage more saving and avoid the annuity fee mill Citigroup is exploiting.

4)  Federal Reserve Bank (FRB):  Block the Associates First Capital merger if it is accounted for as a pooling due to its impairment of Citigroup's capital.  It is noteworthy that Fidelity Investments, per Yahoo Ownership Analysis, owns $2.9 billion or almost 10 percent of Associates First Capital.  In addition, Fidelity is the largest holder of Citigroup, owning approximately $10 billion of the stock.

5)  Bush, Nader and Gore Campaigns:  Work toward a public statement from each candidate on whether or not they will support an end to pooling.

An expanded report outlining Citigroup's activities will be issued shortly.  It will address many specific areas including the following:  Investment Banking, Student Loans, Credit Cards and Loan Loss Provisions in addition to Citigroup's aggressive support of a new bankruptcy law.

Any helpful criticism or links would be most appreciated.

Parish & Company is an independent fee based investment advisor to individuals, pensions and trusts based in Portland, Oregon.  No fees are accepted, either directly or indirectly, from any provider of investment products.

Bill Parish
Parish & Company
10260 SW Greenburg Rd., Suite 400
Portland, OR  97223
Tel:  503-643-6999  Fax: 503-221-3161
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