"Your Citi never sleeps" :: "Where money lives":Citigroup 1

A critical evaluation ofCitigroup’s mortgage system

Course Title : Investment analysis

Course Code: 405

Under the supervision ofDr. S M Sohrav UddinAssociate PrefessorDept. of Finance & BankingUniversity of Chittagong

List of group members::

SL. No Name ID No Remarks

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01 Tanmoy Mohajan 11303008

02 Raju Kumar Barnik 11303010

03 Jabun Nahar Monika 11303027

04 Md. Anisul Hoque 11303029

05 Md. Abul Kalam 11303054

06 Mohammad Aha sanaul Karim 11303053

07 Mohammad Jamal Uddin(GL) 11303060

08 Mohammad Joynal Abedin 11303061

09 Mohammad Ismail Hossain 11303062

10 Palash Dev 11303084

11 Md Ali Newaz 11303128

12 Hasanul Karim 11303101

13 Jubaidur Rahaman Saimun 10303132

Department of Finance & Banking

University OfChittagong.

Session: 2010-2011

Date of Submission: 04/05/2015

Objectiveof the study::

Primary Objective:

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To evaluate the assessment of mortgage system and theperformance ofCitigroupduringthe economicdepression&the mechanism has to use to improve situations.

Secondary Objectives:

1) To evaluate the overall crisis scenario of financialsectorat the time of depression.2) To evaluate the performance of the Citigroup.3) To access Citigroup’s mortgage system&its impact.4)To identify the effective mechanism to improve situation of Citigroup.

Methodology:

The secondary sources of data were used for the study. The main sources of secondary data were company profile (annual report), previous research literature, national and international publications, several books, journals,newspapers etc. These data were collected from the websites such as:www. Citigroup .com/ citi /fin/data/ar08c_en.pdf http://www.Citigroup.com/citi/about/ mission_principles.html http://financials.morningstar.com/ratios/r.html?t=BAC http:// www.nytimes.com/2008/11/18/business/18citi.html

Limitation of the Study:

Due to the scarce resources and direct supervision, the co-workers of the study have been compelled to access to the secondary resources. Besides, the data generated through cultivating the secondary source of informationwere not viable and sufficient to generate the accurate scenario of our study. Therefore, the result should be viewed keeping limitation in mind.

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Mortgage System of Citigroup

Citigroup Mortgage is a Delaware corporation formed for the purpose of acquiring, owning and transferring mortgage loan assets and selling interests in them. The issuers of the various offerings (the “Defendant Issuers”) are established by Citigroup Mortgage to issue billions of dollar worth of Certificates in 2007. Two types of securities Citigroup mortgage loan trust Inc. issued:

Mortgage Pass-Through Certificates & Asset-Backed Pass-Through Certificates.

The Certificates were issued pursuant to Prospectus Supplements, each of which was incorporated into the Registration Statement. The Certificates were supported by pools of mortgage loans. The Registration Statement represented that the mortgage pools would primarily consist of loans generally secured by liens on residential properties.The Citigroup issues their Certificates based upon three primary factors:

1. Return in the form of interest payments,2. Timing of principal &3. Safety.

Residential Mortgage Loan Categories

Borrowers apply for residential mortgage loans with a loan originator. These loan originators assess a borrower’s ability to make payments on the mortgage loan based on the borrower’s Fair Isaac & Company (“FICO”) credit score. Borrowers with higher FICO scores were able to receive loans with less documentation during the approval process, as well as higher Loan to Value Ratio (LTVs). Using a person’s FICO score, a loan originator assesses a borrower’s risk profile to determine the rate of the loan to issue, the amount of the loan, and the general structure of the loan.

A loan originator will issue a “prime” mortgage loan to a borrower who has a high credit score and who can supply the required documentation evidencing their income, assets, employment background, and other documentation that supports their financial health.

If a borrower has the required credit score but is unable to supply supporting documentation of his financial health, then a loan originator will issue the borrower a loan referred to as a “low-doc” or Alt-A loan, and the interest rate on that loan will be higher than that of a prime mortgage loan and the general structure of the loan will not be as favorable as it would be for a prime borrower.

A borrower will be classified as “sub-prime” if the borrower has a lower credit score and higher debt ratios. Borrowers that have low credit ratings are unable to obtain a conventional mortgage because they are considered to have a larger-than-average risk of defaulting on a loan.

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The Secondary Market

Traditionally, the model for a mortgage loan involved a lending institution means loan originator extending a loan to a prospective home buyer in exchange for a promissory note from the home buyer to repay the principal and interest on the loan. The loan originator also held a lien against the home. Under this model, the loan originator held the promissory note until it matured and was exposed to the concomitant risk that the borrower may fail to repay the loan. Under the traditional model, the loan originator had a financial incentive to ensure that-------

(1) the borrower had the financial wherewithal and ability to repay the promissory note &(2) The underlying property had sufficient value to enable the originator to recover its principal and interest if borrower defaulted on the promissory note.

Beginning in the 1990s, persistent low interest rates and low inflation led to a demand for mortgages. As a result, banks and other mortgage lending institutions took advantage of this opportunity, introducing financial innovations in the form of asset securitization to finance an expanding mortgage market. These innovations altered: (1) The foregoing traditional lending model, severing the traditional direct link between borrower and lender & (2) The risks normally associated with mortgage loans.

Unlike the traditional lending model, an asset securitization involves the sale and securitization of mortgages. The loan originator sells the mortgage in the financial markets to a third-party financial institution. By selling the mortgage, the loan originator obtains fees in connection with the issuance of the mortgage. The mortgages sold into the financial markets are typically pooled together and securitized into what are commonly referred to as mortgage backed securities (MBS). The loan originator is no longer subject to the risk that the borrower may default; that risk is transferred with the mortgages to investors who purchase the MBS.

In a mortgage securitization, mortgage loans are acquired, pooled together or securitized, and then sold to investors in the form of MBS, whereby the investors acquire rights in the income flowing from the mortgage pools:

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When mortgage borrowers make interest and principal payments, the cash-flow is distributed to the holders of the MBS certificates in order of priority based on the specific tranche held by the MBS investors. The highest tranche is first to receive its share of the mortgage proceeds and is also the last to absorb any losses should mortgage-borrowers become delinquent or default on their mortgage.

In this MBS structure, the senior tranches received the highest investment rating by the Rating Agencies. After the senior tranche, the middle tranches next receive their share of the proceeds. In accordance with their order of priority, the mezzanine tranches were generally rated from AA to BBB by the Rating Agencies.

The process of distributing the mortgage proceeds continues down the tranches through to the bottom tranches, referred to as equity tranches. This process is repeated each month and all investors receive the payments owed to them so long as the mortgage-borrowers are current on their mortgages.

In the typical securitization transaction, participants in the transaction are (1) The servicer of the loans to be securitized, often called the “sponsor”, (2) The depositor of the loans in a trust or entity for securitization, (3) The underwriter of the MBS, (4) The entity or trust responsible for issuing the MBS, often called the “trust,” &(5) The investors in the MBS.

The securitization process begins with the sale of mortgage loans by the sponsor (the original owners of the mortgages) to the depositor in return for cash. The depositor then sells those mortgage loans and related assets to the trust, in exchange for the trust issuing certificates to the depositor. The depositor then works with the underwriter of the trust to price and sell the certificates to investors:

Thereafter, the mortgage loans held by the trusts are serviced, i.e. principal and interest are collected from mortgagors, by the servicer, which earns monthly servicing fees for collecting such principal and interest from mortgagors. After subtracting a servicing fee, the servicer sends the remainder of the mortgage payments to a trustee for administration and distribution to the trust, and ultimately, to the purchasers of the MBS certificates.

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Crisis Scenario of financial sector:

In 2008 the world economy faced its most dangerous crisis since the Great Depression of the 1930s. The contagion, which began in 2007 when sky-high home prices in the United States finally turned decisively downward, spread quickly, first to the entire U.S. financial sector and then to financial markets overseas. The casualties in the United States included - a) the entire investment banking industry, b) the biggest insurance company, c) the two enterprises chartered by the government to facilitate mortgage lending, d) the largest mortgage lender, e) the largest savings and loan, and f) two of the largest commercial banks.

The carnage was not limited to the financial sector, however, as companies that normally rely on credit suffered heavily. The American auto industry, which pledged for a federal bailout, found itself at the edge of an abyss. Still more ominously, banks, trusting no one to pay them back, simply stopped making the loans that most businesses need to regulate their cash flows and without which they cannot do business. Share prices plunged throughout the world—the Dow Jones Industrial Average in the U.S. lost 33.8% of its value in 2008—and by the end of the year, a deep recession had enveloped most of the globe. In December the National Bureau of Economic Research, the private group recognized as the official arbitrator of such things, determined that a recession had begun in the United States in December 2007, which made this already the third longest recession in the U.S. since World War II. Each in its own way, economies abroad marched to the American drummer. By the end of the year, Germany, Japan, and China were locked in recession, as were many smaller countries. Many in Europe paid the price for having dabbled in American real estate securities. Japan and China largely avoided that pitfall, but their export-oriented manufacturers suffered as recessions in their major markets—the U.S. and Europe—cut deep into demand for their products. Less-developed countries likewise lost markets abroad, and their foreign investment, on which they had dependent for growth of capital. With none of the biggest economies prospering, there was no obvious engine to pull the world out of its recession, and both government and private economists predicted a rough recovery.(Joel Havemann)

The U.S. subprime mortgage crisis was a nationwide banking emergency that coincided with the U.S. recession of December 2007 – June 2009.It was triggered by a large decline in home prices, leading to mortgage delinquencies and foreclosures and the devaluation of housing-related securities. Declines in residential investment preceded the recession and were followed by reductions in household spending and then business investment. Spending reductions were more significant in areas with a combination of high household debt and larger housing price declines.

The expansion of household debt was financed with mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which initially offered attractive rates of return due to the higher interest rates on the mortgages; however, the lower credit quality ultimately caused massive defaults. While elements of the crisis first became more visible during 2007, several

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major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.

When U.S. home prices declined steeply after peaking in mid-2006, it became more difficult for borrowers to refinance their loans. As adjustable-rate mortgages began to reset at higher interest rates (causing higher monthly payments), mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by financial firms globally, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt and other securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe.

The collapse of Lehman Brothers, a sprawling global bank, in September 2008 almost brought down the world’s financial system. It took huge taxpayer-financed bail-outs to shore up the industry. Even so, the ensuing credit crunch turned what was already a nasty downturn into the worst recession in 80 years. Massive monetary and fiscal stimulus prevented a buddy-can- you-spare-a-dime depression, but the recovery remains feeble compared with previous post-war upturns. GDP is still below its pre-crisis peak in many rich countries, especially in Europe, where the financial crisis has evolved into the euro crisis. The effects of the crash are still rippling through the world economy: witness the wobbles in financial markets as America’s Federal Reserve prepares to scale back its effort to pep up growth by buying bonds.

Low interest rates created an incentive for banks, hedge funds and other investors to hunt for riskier assets that offered higher returns. They also made it profitable for such outfits to borrow and use the extra cash to amplify their investments, on the assumption that the returns would exceed the cost of borrowing. The low volatility of the Great Moderation increased the temptation to “leverage” in this way. If short-term interest rates are low but unstable, investors will hesitate before leveraging their bets. But if rates appear stable, investors will take the risk of borrowing in the money markets to buy longer-dated, higher-yielding securities. That is indeed what happened.

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Performance Evaluation of Citigroup

Performance evaluation of Citigroup Inc. for the year 2004-2008

2004 2005 2006 2007 2008Revenue (USD Mil) 86,190 83,642 89,615 81,698 52,793Operating Income (USD Mil) 24,182 29,433 29,639 1,701 -53,055Operating Margin (%) 28.1 35.2 33.1 2.1 -100.5Net Income (USD Mil) 17,046 24,589 21,538 3,617 -27,684Earnings Per Share (USD) 32.6 47.5 43.1 7.2 -55.9Dividends (USD) 16 17.6 19.6 21.6 11.2Payout Ratio (%) 49.1 46.1 46.1 300 -Shares (Mil) 521 516 499 500 580Book Value Per Share (USD) 208.23 216.04 241.74 207.12 125.12

Common size statementMargins % of Sales 2004 2005 2006 2007 2008Revenue 100 100 100 100 100Gross Margin - - - - -SG&A 31.92 34.84 37.72 46.89 68.45R&D - - - - -Other 32.8 20.49 21.68 29.7 68.95Operating Margin 28.06 35.19 33.07 2.08 -100.5Net InterestInc. & Other -7.23 -9.48 -7.52 -21.33 -63.1EBT Margin 28.06 35.19 33.07 2.08 -100.5

Profitability 2004 2005 2006 2007 2008Tax Rate (%) 28.57 26.53 27.07 - -Net Margin (%) 19.7 29.32 23.96 4.38 -55.72Asset Turnover (Average) 0.06 0.06 0.05 0.04 0.03Return on Assets (%) 1.24 1.65 1.27 0.18 -1.43Financial Leverage (Average) 13.72 13.41 15.86 19.26 27.32Return on Equity (%) 16.56 22.33 18.66 3.08 -31.88Return on Invested Capital % 9.4 13.39 13.94 9.03 0.81

Liquidity/Financial Health 2004 2005 2006 2007 2008Financial Leverage 13.72 13.41 15.86 19.26 27.32Debt/Equity 1.92 1.95 2.43 3.76 5.07Asset Turnover 0.06 0.06 0.05 0.04 0.03Source: Citigroup Inc. 2008

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2004 2005 2006 2007 2008

-60

-50

-40

-30

-20

-10

0

10

20

30

40

NetMar(%)ROA(%)ROE(%)ROIC(%)

Fig: Trend of Net Margin, Return on Asset, Return on Equity, Return on Invested Capital

Performance evaluation:

As we see in financial performance of Citigroup Inc. for the year 2004-2008, there was a reflect of world economic slowdown in the year 2007 & 2008. Though this was alarmed in the year 2006 but however the management of Citigroup might not or could not take message of boom and bust of home financing, sub-prime mortgages. In consequences of these events there we see a upward trend of selling, general and administrative expenses and other expenses whereas the revenue generation and profit making ability of Citigroup was continuously facing downward movement from the year 2006. In 2008 its performance was so bad that its net loss exceeds its revenue generation during 2008. With a negative operating income and net margin all the indicators of company’s health and wealth were trending downward and negative indications. This all was happened due to inefficient management of assets as we see the asset management ratio, asset turnover, was continuously decreasing from 0.06 in year 2005 to 0.03 in year 2008, reduced by 50%, that means assets were not generating revenue as it was generate in 2005. Moreover the return from assets was more than 200% reduced from year 2006 to year 2008. All these indicated that its non-performing assets were gradually increasing day by day. Return on equity was also reflects the inefficient management of assets as Citigroup faced the largest negative returns on shareholders’ equity. Citigroup’s financial health was also becoming more risky day by day. Its financial leverage ratio and debt to equity ratio supports our statement. There was $5.07 debt in year 2008 against $1 shareholder’s equity and 27.32% of company’s

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assets were financed by debt; the worst from the last four years. Moreover Citigroup has $1.1 trillion off-balance sheet assets most of which was in inferior quality. If these included the financial leverage will be increased and the profitability ratios will be reduced to a shocking extent.

There was no good sign in the financial position of Citigroup in year 2007-2008. However these two years were the beginning of world crisis. The other company may also face the same problem. This will examine in the next analysis.

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Performance comparison of CitigroupInc, Bank of America Corporation(BAC), JPMorgan Chase & Co(JPM), Deutsche Bank AG(DB) for 2007-08

Citigroup

Citigroup BAC BAC JPM JPM DB DB

Financials 2007 2008Change(%

) 2007 2008 Change(%) 2007 2008 Change(%) 2007 2008 Change(%)

Revenue (USD Mil) 81,698 52,793 -3566,31

972,78

29.74532185

371,37

267,25

2

-5.77257187

730,79

413,52

2-

127.732583

Operating Income (USD Mil) 1,701 -53,055 NM20,92

4 4,428

-78.8376983

422,80

5 2,773

-87.8403858

8 8,763-

5,754 NM

Operating Margin (%) 2.1 -100.5 NM 31.6 6.1

-80.6962025

3 32 4.1 -87.1875 28.5 -42.6 NM

Net Income (USD Mil) 3,617 -27,684 NM14,98

2 4,008

-73.2478974

815,36

5 5,605

-63.5209892

6 6,484-

3,844 NM

Earnings Per Share (USD) 7.2 -55.9 NM 3.3 0.55

-83.3333333

3 4.38 1.37

-68.7214611

9 11.37 -6.6 NM

Dividends (USD) 21.6 11.2 -48 2.4 2.24

-6.66666666

7 1.48 1.522.70270270

3 3.47 3.9 11.02564`

Payout Ratio (%) 300 - NM 72.7 404.2455.983493

8 33.8 181435.502958

6 30.5 - NM

Shares (Mil) 500 580 16 4,480 4,6122.94642857

1 3,508 3,6052.76510832

4 571 5811.72117039

6

Book Value Per Share (USD) 207.12 125.12 -40 32.05 27.77

-13.3541341

7 36.68 36.16

-1.41766630

3 94.13 65.03-

44.7485775

Profitability: Margins % of Sales 2007 2008 2007 2008 2007 2008 2007 2008

Revenue 100 100 100 100 100 100 100 100

Gross Margin - - - - - - - -

SG&A 46.89 68.45 46 31.83 28.49

-10.4932453

7 34.69 36.675.70769674

3 44.64 59.04 24.3902439

Other 29.7 68.95 132 23.98 28.5619.0992493

7 23.74 28.0218.0286436

4 24.91 75.54 67.0240932

Operating Margin 2.08 -100.5 NM 31.55 6.08

-80.7290015

8 31.95 4.12

-87.1048513

3 28.46-

42.55 NM

Net IntInc& Other -21.33 -63.1 NM-

12.64-

36.86 NM -9.62-

31.19 NM -1.99 -7.97 NM

EBT Margin 2.08 -100.5 NM 31.55 6.08

-80.7290015

8 31.95 4.12

-87.1048513

3 28.46-

42.55 NM

Profitability: Ratios 2007 2008 2007 2008 2007 2008 2007 2008

Tax Rate (%) - - 28.4 9.49

-66.5845070

4 32.62 - 25.59 -

Net Margin (%) 4.38 -55.72 NM 22.32 3.51

-84.2741935

5 21.53 8.33

-61.3098002

8 21.06-

28.43 NM

Asset Turnover (Average) 0.04 0.03 -25 0.04 0.04 0 0.05 0.04 -20 0.02 0.01 -100

Return on Assets (%) 0.18 -1.43 NM 0.93 0.14

-84.9462365

6 1.05 0.3

-71.4285714

3 0.41 -0.18 NM

Financial Leverage (Average) 19.26 27.32 42 12.05 13.058.29875518

7 12.68 16.1227.1293375

4 54.54 71.7323.9648682

6

Return on Equity (%) 3.08 -31.88 NM 10.77 1.81

-83.1940575

7 12.86 4.34

-66.2519440

1 18.55-

11.33 NM

Return on Invested Capital % 9.03 0.81 -91 11.08 7.12-

35.7400722 13.07 6.77

-48.2019892

9 20.62 10.17-

102.753195

Financial Health 2007 2008 2007 2008 2007 2008 2007 2008

Financial Leverage 19.26 27.32 42 12.05 13.058.29875518

7 12.68 16.1227.1293375

4 54.54 71.7323.9648682

6

Debt/Equity 3.76 5.07 35 1.39 1.9338.8489208

6 1.85 2.9961.6216216

2 4.83 4.36-

10.7798165

Efficiency Ratios 2007 2008 2007 2008 2007 2008 2007 2008

--

12.1365360

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Performance comparison:

What we have assumed in the last performance evaluation of Citigroup was completely wrong. It was seemed that the financial and economic slowdown in US economy was only for Citigroup. As we see in the above comparison the two similar investment company Bank of America corporation(BAC) & JP Morgan Chase(JPM) had managed to make profit from their operation but Citigroup and Deutsche Bank AG(DB) incurred loss. Between these two loss companies the deviation of Citigroup income and loss was the largest. Citigroup’s performance however was similar to the DB where it should be similar to the BAC & JPM. Due to conservative approach of mortgaging assets BAC and JPM survive in the recession or economic slowdown but aggressive approach leads to a big loss for Citigroup. Book value per share is a strong factor affects the market value per share. In this slowdown where BAC lost only 13.5% and JPM, a very little amount, 1.5% of their book value, Citigroup lost 40% of its book value per share. This resulted in 60% reduction of market price per share.

Comparing to BAC, JPM & DB Citigroup’s performance was the worst among them. Its profitability, asset management, financial health all were below the mark of industry average. This was happened only for the low grade collateral, inefficient asset management, aggressive mortgage decisions etc.

Underlying Causes of Citigroup’s Distress

Over-reliance on Collateralized Debt Obligations (CDOs)Citigroup had been widely criticized for its excessive issuance of CDOs- complex financial tools that involve the repackaging of financial assets such as fixed-income securities and individual loans into products which can be sold to external investors on the secondary market, which were instruments without a comprehensively assessed level of risk at that time. Subsequently, this over-reliance on CDOs was pinpointed to be one of the main causes leading to its crippled state during the subprime mortgage crisis. Reasons behind Citigoup's overreliance on CDOs were- risk reallocation, regulatory capital relief and greater profitability. (Barnett-Hart, 2009)

Citigroup’s overreliance on CDOs was largely driven by an incentive to boost earnings in the trading operations of the bank. Short term interest rates were low from 2000 to 2004, bolstering the attractiveness of issuing CDOs which yielded relatively higher fees (Crouhy, Jarrow, &Turnbull, 2007). Citigroup increased its issuance of CDOs threefold from 2003 to 2005, from $6.28 billion to $20 billion, ultimately owning a grand total of approximately $43 billion of mortgage-related assets by 2007, which indicated a huge exposure to the downside risks associated to CDOs (Dash & Creswell, 2008).

Shadow Banking and Mortgage SecuritizationThe shadow banking system comprises of non-banking financial intermediaries including hedge

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funds and Structured Investment Vehicles (SIVs) which are subject to less scrutiny by central banks and other federal regulators. The shadow banking network under Citigroup, especially in the form of Structured Investment Vehicles (SIVs) played a major role in creating liquidity issues for the group at the height of the crisis.

A key risk resulting from this arrangement is that due to lower regulatory oversight, these entities have incentives to boost short-term profits by leveraging far more than traditional banks. This can create systemic risk through the system since they have much lesser equity to cushion any “runs” that might result on these entities by their creditors in the event of expectations of a downturn. In the event of a “run” on the shadow institutions, however, the banks are required to provide them support in terms of credit and liquidity, and are accountable to creditors for any loans made by them to these shadow institutions.

Although Citigroup was required to disclose these activities and hold sufficient capital under the aforementioned third pillar of Basel II, this requirement was largely circumvented in two ways. Firstly, the group took advantage of the fact that under the existing accords, stand-by loan commitments with rolling maturities of up to a year were assigned zero weights. The group artificially created agreements in which the legal tenure of these loan commitments was less than a year, but regularly renewed these agreements on expiry (Pomerleano, 2010). When the ABCP market plunged in the summer of 2007 due to the housing downturn, there was a resulting "run" on the Papers issued by the SIVs, forcing them to sell under duress their illiquid MBS investments and suffer large losses in the process. Citigroup was not contractually obligated to support these SIVs; however, since the majority of SIVs’ investors were also the bank’s primary institutional clients, Citigroup risked undermining important business dealings bhand a potential loss of reputation. With regard to these concerns, Citigroup, according to a 2007 press release (Citigroup Inc., 2007), ultimately decided to provide liquidity support to these shadow companies, resulting in them having to re-transfer $45 billion worth of troubled assets back onto their balance sheets.

Insufficient Risk Management Citigroup’s MBS assets were not classified as subprime and were not included in risk calculations because they were deemed by credit agencies to have a risk or default of less than 0.01%, indicating little chance of default. It can be deemed inexcusable for institutions like banks, which specialize in credit risk assessment, to rely on ratings agencies to assess the risk of their assets. By the time Citigroup disclosed the full extent of its subprime holdings in November 2007, the value of the securities had plunged.

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The role of risk managers is crucial in the long-term sustainability of a bank because they are expected to monitor trading floors and flag potential problems that could result in large-scale losses. However, such independence of the risk management function was absent in the Citigroup context because of the cronyism that existed between Thomas Maheras, Head of Trading, Rudolph Barker, the chief MBS trader and David Bushnell, the senior risk manager. In fact, employee testimonies during federal inquiries revealed that traders presumed that the senior risk manager could be persuaded to accept any exotic trades that they wished to perform (Gerth, 2009).

Impact of subprime mortgage crisis on Citigroup:

The crisis of subprime mortgage system affects Citi group very badly. it incurred a huge amount of financial losses and induce it to restructure its financial proposition and huge job cut.

Financial losses and asset impairmentCitigroup incurred huge financial losses as a result of the crisis. The financial statement of Citigroup shows that Citigroup incurred gross $53055 million and net $27684 million losses in the year 2008(Citigroup Inc. 2008). The market value of Citigroup’s stock had also fallen to a great extent in responses to the reduction of profitability ratio, financial health ratio and efficiency ratio. Due to the high mortgage default Citigroup faced difficulties in the form of credit crunch and the write downs of bad investment and other assets. Overall, Citigroup had incurred losses of more than $27 billion, causing severe liquidity problems.

Large scale job cutIn order to reduce losses and bolster underperforming stock, Citigroup decided to reduce the number of employees on their payrolls. In 2007, Citigroup eliminated 5% of their global workforce which was around 17,000 jobs (Spencer, 2007). In 2008, Citigroup retrenched 52,000 employees which was another 14% of their workforce (Dash, 2008) . This was done to recover and restore investor confidence; however, this was not successful since widespread job cuts created dissatisfaction and skepticism about Citigroup’s future.

Loss of CredibilityThe large losses and write-downs created a loss in confidence and fear of collapse of the bank among stakeholders. The bad bets on repackaged debt securities, consumer loans and other assets forced Citigroup to take three Government rescue packages which totaled an amount of around $45 billion and was the largest package given to any bank (Drawbaugh, 2008). There was a cut in the credit ratings of Citigroup by Moody’s and Standard & Poor's. On 19 December 2008, Moody’s downgraded the financial strength rating of Citigroup by three notches to C from B which implied a change in the baseline credit assessment to A2 from Aa3 (Moody's Investors Service, 2008). S&P credit rating services placed revised their rating to A/A-1 rating and revised its outlook as negative (Chang, 2009) and Fitch cut Citi’s preferred rating to BB from BBB and individual rating to C/D from C (Witkowski, 2009).

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Recommendation and Conclusion

•In order to determine whether borrowers had sufficient income to meet their monthly mortgage obligations the originators implemented policies designed to extend mortgages to borrowers regardless of whether they were able to meet their obligations under the mortgage such as:

›› Coaching borrowers to misstate their income on loan applications to qualify for Mortgage loans under the underwriters’ underwriting standards, including directing Applicants to no-documentation (“no-doc”) loan programs when their income was Insufficient to qualify for full documentation loan programs;

›› Steering borrowers to loans that exceeded their borrowing capacity;›› Encouraging borrowers to borrow more than they could afford by suggesting No

Income No Assets (“NINA”) and Stated Income Stated Assets (“SISA”) loans when they could not qualify for full documentation loans based on their actual incomes;

›› Approving borrowers based on “teaser rates” for loans despite knowing that the borrower would not be able to afford the “fully indexed rate” when the loan rate adjusted;

›› Allowing non-qualifying borrowers to be approved for loans under exceptions to the underwriters’ underwriting standards based on so-called “compensating factors” without requiring documentation for such compensating factors.(CITIGROUP MORTGAGE LOAN TRUST INC)

• A modification agreement is used when the customer has a significant reduction of income that impacts his or her ability to pay and will last past the foreseeable future. In this situation the customer's loan terms are modified in order to resolve the mortgage delinquency which makes the mortgage more affordable for the customer. •A repayment plan is a written agreement between the borrower and the lender to implement a payment moratorium due to unforeseen circumstances wherein the property or employment status is affected. It can also include a repayment plan under which the customer pays the regular monthly payment and an additional amount each month to catch up delinquent payments over time.

•A short sale is when the customer does not have either the desire or ability to keep the property and is willing to sell the property to satisfy the debt. This option is utilized when the amount owed less acceptable closing costs to sell the property is more than the value of the property.

•Deed in lieu of foreclosure is when the customer does not have either the desire or the ability to keep the property and is unable or unwilling to sell the property but is willing to sign the property over to Citi in exchange for stopping the foreclosure action. Deeds in lieu of foreclosure are generally accepted only after all other options have been exhausted.

•An extension is when the customer has experienced a temporary hardship and is unable to bring the loan current. The customer has the ability to continue making future payments, but does not have the funds to completely reinstate the loan. An extension may re-amortize the loan or defer the interest to the back of the loan.

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•A reinstatement occurs when a customer that is 90+ days past due is able to pay all of the delinquent fees, interest and principal owed to the bank with a single payment. This brings the customer’s account current immediately and allows him or her to continue to pay off the loan according to the original amortization schedule.•In the event of a breach of its representations and warranties, Citi could be required either to repurchase the mortgage loans with the identified defects (generally at unpaid principal balance plus accrued interest) or to indemnify (make-whole) the investors for their losses on these loans.

•On Citi’s analysis of its most recent collection trends and the financial viability of the third-party sellers (i.e., to the extent Citi made representation and warranties on loans it purchased from third-party sellers that remain financially viable, Citi may have the right to seek recovery from the third party based on representations and warranties made by the third party to Citi(a “back-to-back” claim)).

•Citigroup and Related Parties were named as defendants in a variety of class and individual securities actions filed by investors in Citigroup’s equity and debt securities in state and federal courts relating to the Company’s disclosures regarding its exposure to subprime-related assets.

•Citigroup obtained an amount of $25 billion by selling preferred stock to the U.S. government through the Troubled Asset Relief Program (TARP). TARP was initiated as part of the government’s package in 2008 to address the subprime crisis which allowed the US government to purchase assets and equity from troubled financial institutions in a bid to strengthen the company.

•Citigroup initially turned to elimination of about 14% of its global workforce on 17th November 2008 (Dash, 2008) as a part of internal restructure to face the problem of insolvency and was compelled to seek governmental aid. As a result, Payouts beyond the fixed limit (nominal compensation of US$1 per year and the maximum salaries $500,000 in cash) could only take the form of restricted stock and could not be sold until the emergency government loan was repaid in full (Dash, 2008). With the rescue agreement, Citigroup was severely crippled as the US government gained control of half the seats in its Board of Directors that the senior management had limited decision-making control since they were more exposed to governmental checks.

Citigroup suffered disastrous financial losses and was extensively affected due to issues such as its over-reliance of CDOs, poor risk management and shadow banking, resulting in long-term implications such as loss in investors’ confidence and a dampening of their credibility. Even though Citigroup managed to alleviate the impacts of these problems with its reliance on bailouts and accumulation of capital, this report highlights certain alternative measures that Citigroup could have adopted such as alterations to its incentive system and improvement to its risk management processes. Besides Citigroup’s efforts, regulators should also ensure strict abidance to the regulations and risk measurement. As such, the future stability of Citigroup will depend heavily on the effectiveness and efficiency of new reforms in the corporation and banking regulation.

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