Citibank’s New Start

Citibank is confident that this is the year that its unfortunate acquisition of Mexico’s Banco Confía in 1998 will finally start paying.

The Confía saga began drawing to an end on November 30, the last day of President Ernesto Zedillo’s six-year presidency. After days of tense negotiations that stretched late into the night, Citibank and the Mexican government reached an 11th hour settlement over the future of Confía. The agreement ended a damaging showdown that reflected poorly on both sides.

Senior Citibank executives and ministers signed the new financing package for Confía hours before Zedillo handed over the sash of office to his successor Vicente Fox on December 1. That day’s edition of the government’s gazette was a 960-page volume that contained the Zedillo administration’s last-minute decrees and regulations, including the renegotiated agreement with Citibank.

At the heart of the dispute was a 1998 contract between Citibank and Fobaproa, the agency the Mexican government created in 1995 to reconstruct the country’s devastated banking system. To entice the US bank to take on Confía, Fobaproa approved a deal that amounted to an indirect $120 million annual subsidy for Citibank. But in May 2000, Fobaproa’s successor, IPAB, abruptly canceled the subsidy to the fury of Citibank’s management.

Under the original 1998 agreement, Citibank lent Fobaproa $2.5 billion in the form of a high-yielding, five-year promissory note. Annual interest of $120 million would subsidize Citibank’s integration of Confía into its much smaller Mexican retail operation. All went well until IPAB suddenly pre-paid the note, using a loan from Banamex, and stopped paying interest.

IPAB’s decision was a blow for Citibank. When the bank announced its fourth quarter and 2000 results, it said core income at its Latin American consumer division fell 16%, partly due to lower earnings in Mexico. “Results in Mexico were impacted by the loss of a subsidy related to the Confía acquisition which was partially restored as a result of the recent agreement with the Mexican Government. The agreement resulted in the recognition of $27 million of after-tax gains in the quarter.”The bank at first threatened to pull out of Mexico-where it had operated for over 70 years-if IPAB refused to reconsider its decision.

Bill Rhodes, Citigroup vice chairman and elder statesman of international finance, stepped in. “[Citigroup Chairman] Sandy Weill asked me to be the senior person, acting as player-coach with Julio de Quesada, who led our negotiations with the authorities in Mexico,” says Rhodes. The bank also sued the Mexican government. Says Rhodes, “Citi reluctantly went to court because we were not making any progress with the authorities, the statute of limitations was running out and our lawyers believed our case was very strong.”

Citibank and the Mexican government held a series of meetings to find a negotiated settlement, but they made little headway. IPAB was under heavy pressure from Congress and public opinion to revise the original deal with Citibank because it was considered too generous. José Angel Gurría, Mexican finance secretary at the time, who sat on IPAB’s board, says terminating the original deal was a difficult decision to take. “We needed to balance the interests of the taxpayers with the government’s need to maintain good relations with an important international bank,” he recalls.

Pressure to compromise grew on both sides as the December 1, 2000 deadline loomed. Citibank dreaded having to start talks with a new government team. Zedillo’s negotiators wanted to leave office leaving as little unfinished business behind as possible.

New Agreement
Under the new agreement, IPAB has issued Citibank a 28.95 billion peso ($3.09 billion) 10-year maturity note at 60 basis points over the interbank benchmark rate. In addition, Citibank said it would inject $100 million of fresh capital into Confía.

The deal damaged Citibank’s good name from the outset in 1998 and set back its plans for Mexico by several years. How could Citibank falter in Mexico, a country it knows intimately? And why did Citibank have so much trouble with the acquisition and subsequent integration of Confía when the group has a near-flawless record of integration, such as the 1998 marriage of Citicorp and Travelers Group, as well as swallowing and digesting banks in Chile and Argentina?

The Confía affair demoralized Citibank’s senior staff in Mexico and raised questions over the way the bank is managed. The bank’s retail group, which ran Confía, and its corporate arm, which negotiated with the government, were at each other’s throats in the final months of 2000 as each side blamed the other for the Confía fiasco.

Senior executives complain of tangled reporting lines and divided responsibilities. As one senior Citigroup officer comments, “I would point the finger not at Julio [de Quesada, Mexican country head] but upstairs in New York. The way consumer and corporate banks are run separately makes it hard to really know where the lines are drawn.”

The bank has divided its business in Latin America, as elsewhere in the world, into three broad groups. Alvaro de Souza, based in Fort Lauderdale, Florida, runs Citibank’s Latin American retail banking business. Michael Contreras in Miami manages the corporate bank. Alberto Verme is chairman for Salomon in Latin America. They report to Victor Menezes, who is in charge of Citigroup’s emerging market consumer and corporate businesses.

A disaffected top executive says, “Basically it does not work to have each [division] reporting to a different guy in the States when the [local country head] has lots of responsibility for what happens here but without the power to take all the decisions.

“One of the biggest reasons for the problems at Confía was here at Citibank. The bank just did not have the management structure to absorb it,” he adds. The executive, a senior officer, complains that he was called in to help clean up the mess left by ill-prepared retail bankers.

IPAB’s prepayment was a shock. The head of a rival US bank says that in 1998 Fobaproa resisted Citibank’s demands to accept a prepayment penalty clause in the sale contract for political reasons. Instead, it agreed to include this in a side agreement.

Critics say Citibank may have relied before on agreements like this, when ministers and presidents had considerable discretionary powers. But the growing power of Congress and the rise of an independent media should have alerted Citibank to the importance of negotiating a watertight contract with Fobaproa.

Says one European banker: “There was a tremendous degree of hubris. Citi knew Mexico, but the old Mexico it knew was changing. The lesson is that nothing can be taken for granted.”

Many people are critical of de Quesada. However, the Cuban-born de Quesada, who has worked at Citibank for a quarter of a century with previous postings in Europe, Asia and the Middle East, is respected within the bank as an effective manager and corporate banker. He simply had the misfortune to preside over Citibank’s Mexican operations at a particularly difficult time.

Not a Family Concern
De Souza says, “Citi is not a family concern. A decision like [buying Confía] is not taken by a single person. The risk is analyzed and checked over and over. Julio was the guy in Mexico managing the process because he was a country head and senior contact with the Mexican government.

“The actual closing was conducted by the corporate bank because it had the experience of dealing with the government and the consumer bank was responsible for managing the business,” de Souza says. “It was like a joint venture.”

De Souza says Citibank’s segmented management structure works well throughout the world and is here to stay: “Do you think we would replicate the same model in all these countries if it did not work?”

Carlos Fedrigotti, president of Citibank in Argentina, says his 1998 acquisition of Banco Mayo, an ailing retail bank like Confía with an attractive middle-market franchise, proceeded smoothly largely because both the retail and corporate sides of the bank worked together as a team. The appointment of Menezes in July is intended to foster greater team spirit between the corporate and retail divisions.

Contreras, Citibank’s head of corporate banking in Latin America, says “Working in difficult times creates an esprit de corps. We are not talking about the retail or corporate bank, but Citigroup. We are talking about being one business.”

A Rough Start
The Confía acquisition seemed ill-fated from the beginning. In May 1998, just as Citibank was concluding its acquisition of the bank, the US Customs Service announced its largest-ever drug money laundering investigation.

Operation Casablanca led to the seizure of over $98 million in illegal funds from Mexican banks. Confía was one of the three banks that customs officials accused of money laundering and Confía settled the indictment with a civil plea and forfeited $12 million.

This scandal finally destroyed the Confía brand, already damaged by charges of embezzlement against its previous controlling shareholder, Jorge Lankenau. He was accused of bankrupting Confía, forcing the government to take it over and prevent its collapse.

Citibank had to scrap its original plan to keep the upscale Citibank and downscale Confía brands separate. Instead it eliminated Confía altogether and re-branded its branches with the Citibank logo. However, incompatible systems and inadequate staff training have prevented Confía from providing the level of service some Citibank clients expected.

Citibank can now turn its attention to Confía, which continues to lose money despite the radical restructuring Citibank has undertaken in the last two years. De Quesada says that in spite of all the trouble it has caused, the Confía acquisition still makes perfect sense. “It was the right decision, period. It gave us an opportunity to expand our balance sheet activities which were constrained by Nafta,” he says.

Under Nafta, foreign banks were limited to holding 8% of the Mexican banking system’s capital. De Quesada says Confía “gave us access to an adequate branch network with national coverage which we did not have before, which would have taken us many years to build organically.” Confía’s checkered past looked bad, but few Mexican banks up for sale had emerged from the 1995 peso crisis unblemished.

Citibank has successfully acquired downscale banks in Argentina and Chile. These businesses are flourishing, and are helping Citibank further its aim of “embedding” itself in the local financial system. Mexico is Latin America’s second-largest economy, but accounts for only 10% of Citibank’s revenues in the region.

Alvaro de Souza, who runs Citibank’s retail division in Latin America, says Confía’s controls, branches and systems were a mess. He says Confía originally had 120,000 accounts and 400 branches, 17 regional offices, 25 data centers and 320 different databases. Now there are three regional offices and 196 branches, and two data centers, one for Citi and one for fía. Citibank’s Mexican retail operation is its second-largest retail operation in the world outside the US.

De Quesada says, “The main thing was to put the controls in place. We put in risk controls, auditors, anti-money laundering systems and we have trained literally everyone at Confía.” De Souza says that by the second quarter, Confia’s systems will be compatible with Citibank’s. However, a top Citibanker stated confidently a year ago that, “We are pretty much on target. Full integration of systems and products will be ready by the end of 2000.”

De Quesada says that once this happens, the retail and corporate banks should be able to work together closely, as they do in most other Citibank franchises. “We can develop local cash management, collect and make payments, handle international cash management, finance our client companies and their suppliers, provide credit cards for employees, make car loans. We want to insert ourselves into the production chain.”

Wholesale Profits
In spite of Citibank’s troubles in Mexico, de Souza says, “Overall the consumer franchise is profitable. We are making money on credit cards but the branches would be losing money without the IPAB note. I expect the branches will be making money by 2002 even without the income on the IPAB note.”

De Quesada adds that Citi’s other divisions-corporate banking and investment banking through Salomon Smith Barney-are highly profitable in Mexico. Citibank and Salomon thrive on their close links to US multinationals, Mexican blue chip companies and the federal government. Salomon clinched two of the most important Mexican corporate transactions of 2000. It advised Cemex on its $2.9 billion acquisition in September of Southdown, the second-largest US cement company. And together with Morgan Stanley, it managed a $1.84 billion equity offering by Telmex in June. In March, Salomon launched a $1 billion bond for the sovereign, at the time the largest-ever such issue.

Citibank’s management structure probably is fundamentally sound, in spite of all the crabbing in Mexico. The bank is certainly feared and admired by its competitors. This is why so many inside and outside the bank scratch their heads in wonder at the catalog of errors committed at Confía. Now Citibank has a chance – probably a last chance – to prove its critics wrong by making its Mexican retail operation as brutally effective as it is elsewhere.