Citi CMB Advanced Risk Issues Seeing Around Corners Why are we here? Tarrytown, NY October 1 – 4, 2007

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Citi CMBAdvanced Risk Issues Seeing Around
Corners Why are we here?Tarrytown,
NYOctober 1 4, 2007
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Citi CIBAdvanced Risk Issues
Revenue Growth and Risk Management in a Complex
Global Bank
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Basel II Federal Reserve Board Susan Schmidt
Bies 2006

• The largest institutions have moved away from the
  traditional banking strategy of holding assets on
  the balance sheet to strategies that emphasize
  redistribution of assets and actively managing
  risks.
• These dramatic changes to the risk profiles of
  many banking organizations have only accelerated
  with the continued evolution of many, often
  complex, financial tools, such as
  securtitizations and credit derivatives.

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• The changes in the financial system since 1998
  confront us with a mix of benefits and
  challenges.
• The larger size and scope of the core
  institutions, the greater opportunities for
• risk transfer and hedging provided by innovation
  in derivatives,
• improvements in risk management,
• The larger role played by a much expanded number
  and more diverse mix of private fund managers
  seem likely to have improved the stability and
  resilience of the financial system across a
  broader range of circumstances

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The Economist Survey of International Banking
May, 2006

• Banks the world over are scrambling to become
  larger
• But at some point diseconomies of scale will also
  start creeping in, with management finding it
  harder to summarize everything that is going on
  in the bank
• This includes the neglect of concealed risks and
  the failure of internal controls
• This problem afflicted Citigroup in 2002 2005
  when it was rocked by a string of compliance
  problems
• Risk management, the rock on which any
  contemporary bank rests, scarcely existed as a
  profession outside the insurance industry until
  the 1970s

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The alchemists of finance May, 2007
Global investment banks are taking ever more
risk, and are devising ever more sophisticated
ways of spreading it
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• International banking May 2007
• Risk and reward

Worried about credit risk? You should fret more
about pension funds than banks
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The alchemists of finance
INTERNATIONAL BANKING A discussion with Henry
Tricks, Finance Editor of The Economist May
17, 2007                    Investment banking
is highly competitive. Everyone is following each
other down the same path there's a herding
instinct. With your competitors, you take bigger
and bigger risks. The trick is not to be left
holding the hand-grenade at the end, and we're
not sure when the end will come.
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Survey of International Banking, May 2007The
alchemists of finance

• Thanks to technological and financial wizardry,
  loans are now made with little contact between
  borrower and lender, and are shuffled around the
  financial system like so many cards at a poker
  table.
• international investment banks have become vast
  financial-liquidity factories, turning loans into
  tradable securities, selling them on and earning
  record profits as a reward
• Thanks to the relentless deal-making between
  financial institutions, if (or rather when)
  liquidity dries up, risks that the banks think
  they have outsourced to hedge funds, insurance
  companies and pension funds might cascade back
  onto their books.

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Fed, Other Regulators Turn Attention to Risk in
Banks LBO Lending May 18,2007  Page C1

• The leading arrangers of leveraged loans have
  exposure that is far smaller than the total
  because they typically "syndicate" the loans.
  What they keep, they often hedge with
  credit-default swaps.
• But banks are still exposed to default in the
  period before they have syndicated or hedged a
  loan. Even a short-term bridge loan exposes the
  lender to the risk that the borrower won't be
  able to find longer-term financing, or will
  default.
• One worry for regulators is that an abrupt
  deterioration in the markets could suddenly leave
  many banks with long-term exposure they hadn't
  counted on.

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Federal Reserve Board of GovernorsCredit Risk
Supervision Sabeth SiddiqueMay, 2007

• It is unsafe and unsound to be in credit risk
  trading without an understanding of the risks
  being traded
• Banks should not be trading credit risk on
  technical factors
• There is a large, new risk Pipeline Risk.
  The risk that a market event will dry up
  liquidity in the middle of a syndication or
  creation of credit default protection

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Banks in trouble The game is up Aug 16th 2007
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Securitisation life after death
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A New World Disorder for Debt Traders System of
Risk DispersalProves to Be a Bit Erratic WSJ
August 10, 2007 Page C1

• Welcome to the new world of finance.
• Markets have taken on an increasingly important
  role since the financial crises of the 1980s and
  '90s.
• When banks make loans, they are now often bundled
  into securities that are sold in pieces to
  investors around the world, changing hands many
  times. It spreads risk, which policy makers
  believe keeps the overall financial system sound
  and stable.
• But the downsides to this system could be
  serious. A financial architecture that dispersed
  risk also helped to create it. And when troubles
  emerge -- as they have in the U.S. housing market
  -- they can show up just about any place in the
  world and in ways nobody predicted.

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For Banks, a 300 Billion Hangover By JACQUELINE
DOHERTY August 27, 2007 IN EVERY BUST THAT
FOLLOWS A BOOM, embarrassing details emerge
showing just how eager the players were to
participate in the insanity. In the current bust,
these revealing nuggets are buried in the lending
commitments of some of the largest pending LBOs.
In their bid to win LBO business amid the boom,
lenders surrendered many of their exit options to
private-equity shops.
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Heading for the rocks Will financial turmoil sink
the world economy?
Has dispersing risk really made the world safer?

• Events of the past month have shown that while
  risk can be dis-intermediated by banks, it cannot
  be eliminated.
• Arguably, it migrates to elements of the
  financial system, such as hedge funds, insurers
  and pension funds, which are less qualified to
  manage it.
• And banks, which had been thought to have become
  safer as a result of the disintermediation of
  risk, now face increased risk exposure.
• Some are being forced to assume responsibility
  for the liabilities of off-balance-sheet vehicles
  which cannot be refinanced. Others have been left
  holding large loans for leveraged buy-outs which
  they underwrote but cannot syndicate in current
  market conditions.

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August 12, 2007 Fair Game A Week When Risk Came
Home to Roost By GRETCHEN MORGENSON FOR
something that everybody assured us was
contained, the sub prime mortgage mess
certainly has spread.
As a result, risk models are miscalibrated for
the current market environment,
The only trouble is, financial markets do not
always trade in a way that is typical or
predictable. And when they deviate from the norm,
all the wonderful and smart trades stop behaving
according to plan. ANALYSTS CALL IT MODEL
MISBEHAVIOR
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Moodys 2005 Securities Industry Outlook

• For all global trading and market-making firms,
  highly-skilled risk management - broadly defined
  - is an absolute necessity for the business
  model.
• A robust corporate culture remains critical for
  balancing short-term competitive pressures and
  the long-term interests of a franchise.

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Moodys 2005 Securities Industry Outlook

• A firm needs to know when to say no. One manager
  described his firm's business philosophy in this
  way, "It is not about this trade -it is about the
  next trade".

• Firms that fail to achieve this balance expose
  themselves to open-ended risks and jeopardize
  their credit ratings.

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World comes to an end. Goldman Sachs net income
surges September 20 2007

• It verges on the unseemly to achieve a nearly 20
  per cent increase in fixed-income trading from
  the previous quarter after stripping out a
  one-off gain on a disposal.
• That means Goldman was able to increase
  fixed-income revenues even after taking its lumps
  on leveraged loan write-downs a painful 1.5bn,
  after its fee cushion.
• There were a couple of other nuggets that
  underscore how good Goldmans risk management
  appears to be. For instance, leveraged loan debt
  that it sold in the market recently fetched
  prices in line with or slightly above the
  negative marks Goldman had pencilled in. That may
  be so for others as well, but Goldman has said it
  publicly.

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Why are we here?
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Moodys 2005 Securities Industry Outlook

• A firm needs to know when to say no. One manager
  described his firm's business philosophy in this
  way, "It is not about this trade -it is about the
  next trade".

• Firms that fail to achieve this balance expose
  themselves to open-ended risks and jeopardize
  their credit ratings.

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Whose fault is it?
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BMO warns on large natural gas losses May 17 2007

• BMO Financial Group, parent of the Bank of
  Montreal, has sharply lifted its estimate of
  losses from natural gas trading, dismissed two
  commodity traders, and is investigating possible
  fraud in the trading and valuation of the
  portfolio.
• The losses are now estimated at C680m (US619m)
  before tax, or C327m after tax. Last months
  estimate was between C350m-C450m.
• Standard Poors placed the banks ratings on
  review, saying the loss is disproportionate to
  its total trading revenues, and does not reflect
  BMO's stated strategy of being a low-risk bank.

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JP Morgan misled Athens over bondMay 20 2007

• The bond was arranged by JP Morgan for the Greek
  government to fund military expenditure. After
  its issue, it was sold to four pension funds at
  an unfavorable price, via a chain of pre-planned
  deals
• Seven weeks ago, JP Morgan wrote to the Greek
  government saying that it had sold the entire
  bond issue to North believing the fund would be a
  buy and hold investor. It denied any knowledge
  of the planned chain of transactions.
• Its allegations threaten to fuel a growing
  political scandal in Greece about structured
  bonds arranged by investment banks. This
  controversy has already triggered mass strikes in
  Greece, forced the removal of a cabinet minister
  and prompted a government investigation into the
  issue.

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Russia reopens 22 billion lawsuit against Bank
of NY

• The claim was for unpaid taxes on money taken out
  of Russia via an illegal scheme facilitated by
  the Bank of New York, more than 10 years ago
• At the time of the scandal, there were rumors
  that Russian officials and businessmen had
  benefited from the scheme.
• Two Russian emigrants - one of whom was a Bank of
  New York vice-president - admitted laundering at
  least 7bn through the bank, using accounts at
  the bank to channel funds from Moscow to parties
  all around the world. They were sentenced to five
  years probation last year.

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Market Cap (intraday)245.18B
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Wall Street Journal 9 Feb, 2004Size, Smiles and
ScandalsA Question of CredibilityEnron.
Worldcom. Adelphia. HealthSouth. Parmalat.

• The list of companies tarnished by scandal over
  the past couple of years contains many of the
  same names that banks were tripping over one
  another to do business with not long ago.
• Money-center banks lost millions of dollars on
  loans to these companies. Settling multiple
  regulatory inquiries cost banks billions.
• So these days, theres a new phrase on the
  tongues of bank executives reputational risk.

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May 10, 2004Citigroup to Pay 2.65 Billion in
Deal With WorldCom Investors

• Citigroup, said today that it would set aside
  4.95 billion in the second quarter to cover
  legal costs, including a pretax payment of 2.95
  billion to settle claims with investors in
  Worldcom Inc.
• The payment will go to investors who bought
  WorldCom bonds at public offerings made in 2000
  and 2001, as well as securities purchased in the
  open market between April 29, 1999, and June 25,
  2002.
• The balance of the second-quarter reserve will go
  toward a potential settlement of class-action
  lawsuits filed by investors in the Enron
  Corporation
• To provide itself additional cushioning to deal
  with suits still pending, Citigroup said that
  after settling the WorldCom matter, it would have
  a "litigation reserve" of 6.7 billion on a
  pretax basis.

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Citigroup's Japan MisstepMay Bruise Bank's
Global ImageWSJ September 22, 2004

• The forced closure of Citigroup Inc.'s
  private-banking business in Japan likely will
  have little direct impact on its bottom line, but
  the bank's reputation is taking yet another hit.
• The banking colossus has lost 8 billion, or 3,
  of its market value since Japan's Financial
  Services Agency last week ordered subsidiary
  Citibank N.A. to shutter the business
• So far this week, a prominent Wall Street analyst
  has downgraded the stock and credit-rating
  company Moody's Investors Service Inc. has warned
  that Citigroup must keep squeaky clean in order
  to receive ratings upgrades in the future.

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Business Week 4 October, 2004"CLAWS AND FANGS"

• "The constraint on Citi's growth is not its
  market size, nor its capital," says Bernstein's
  Mason. "It may well be that Citi can't achieve
  its growth ambitions because it cannot safeguard
  itself properly from regulatory and reputation
  risk."
• "Citi has become so large that it is simply not
  possible to mandate behavior. The challenge now
  is to create a culture, to inculcate a shared set
  of values that guide employee behavior."

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July, 2003
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Moodys US Banking CommentaryJanuary, 2006

• Before discussing Citigroup's quarter we would
  like to remind you that we recently assigned a
  positive rating outlook to Citibank's Aa1/A-
  ratings.
• Finally, to achieve an upgrade to Aaa at the
  banks, management's efforts to instill more
  robust controls and a more effective culture must
  succeed.
• Management will need to maintain its focus on
  strengthening business practices, despite
  shareholder pressures for growth, since we see
  cultural change as a multi-year process.
• We would interpret a major new reputation or
  regulatory problem as a failure of management's
  control initiatives. This could preclude an
  upgrade of the banks.

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New York, September 26, 2006 -- Moody's Investors
Service upgraded the ratings of Citibank N.A. to
Aaa for long-term deposits and to A for financial
strength Citigroup has a well-recognized
brand, and management has built leading global
franchises in credit cards, consumer finance,
international consumer banking, wealth management
and wholesale banking. These businesses have
produced strong and consistent earnings even
during difficult economic or market conditions.
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NEW YORK (Standard Poor's) Feb. 14,
2007--Standard Poor's Ratings Services said
today that it raised its counterparty credit
rating on Citigroup Inc. (Citi) to 'AA/A-1' from
'AA-/A-1'.

• The long-term counterparty credit rating on
  Citibank N.A. was raised to 'AA'..
• Strong earnings generation from an
  extraordinarily diverse set of businesses allows
  Citi to cover some of the high risks that it
  incurs.
• Citi has also achieved a substantial change in
  its control environment in the aftermath of a
  wave of heavy litigation expenses and criticism
  of its business practices from regulators around
  the world. The period of adjustment is over, and
  Citi has been investing heavily to stimulate
  organic growth.

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January 29, 2007 -- Shopaholic Citigroup WSJ

• London-based Prudential announced that it would
  sell its troubled Egg online banking business to
  Citigroup for roughly 1.13 billion
• Citigroup has been on a shopping binge ever since
  the Federal Reserve let it out of the penalty box
  in April.
• The central bank decided to bar Citigroup from
  making any deals back in March 2005 after a
  parade of regulatory tangles, including an uproar
  over a European bond gambit the company's traders
  lovingly christened "Dr. Evil" and Japan's
  decision to yank Citigroup's private-banking
  license.

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Citigroup in Japan retail expansionFT.com, Jan
29 2007

• Citigroup on Monday said it would significantly
  expand its retail and corporate banking
  operations in Japan, just a few weeks after
  scaling back its consumer finance business.
• The move follows a tumultuous time for Citigroup
  in Japan.
• In 2004, the bank was ordered by the authorities
  to close its private banking business, and last
  year it was hit with a business improvement order
  for customer data processing errors.

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The dark side of debtThe Economist Sept 23,
2006

• Lending is a sober business punctuated by odd
  moments of lunacy..

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In an Uncertain World by Robert E. Rubin
However, the global financial crisis (1997) was
far from solely the fault of the countries that
got into trouble.. I do believe that a
significant share of blame for the crisis should
go to private investors and creditors. They
systematically under-weighted the risks of
investing in and lending to underdeveloped
markets over a number of years, and consequently
supplied capital greatly in excess of what would
have been sound and sensible.. For every bad
borrower, theres a bad lender
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Open Secrets Enron, intelligence, and the
perils of too much informationThe New Yorker
Jan 7, 2007

• There have been scandals in corporate history
  where people are really making stuff up, but this
  wasnt a criminal enterprise of that kind
• Enron was close to having complied with the
  accounting rulesthey were going over the edge
  just a little bit
• And this kind of financial fraud, where people
  are simply stretching the truth, falls into the
  area that analysts and short-sellers are supposed
  to ferret out.

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Open Secrets Enron, intelligence, and the
perils of too much informationThe New Yorker
Jan 7, 2007

• In order for an economy to have an adequate
  system of financial reporting.it is vital that
  there be a set of financial intermediaries, who
  are at least as competent and sophisticated at
  receiving, processing, and interpreting financial
  information as the companies delivering it.

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Jaime Caruana - Chairman Basel IIBack to the
Future

• Despite the significant progress made in the
  banking industry in the use of models and new
  technologies, banks still depend largely on risk
  managers expert judgement.
• Quantifying risk involves making assumptions and
  judgements. And no model, and no software
  package, no matter now sophisticated, can ever
  replace the skills of a trained, experienced and
  conscientious risk manager.
• That is why we have made sure that the Basel II
  framework is much more than numbers and models.
  Such judgement should be reinforced, however,
  with the best possible information, techniques
  and tools for processing that information.

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Sandler ONeill Equity ResearchDave Bushnell

• A recurring theme in Bushnells comments was
  the need to balance effectively between risk and
  reward
• The real key to superior performance is to
  effectively manage risk, not try to eliminate it
• No is an unacceptable answer when evaluating
  the commitment of resources to a new project
  (deal). No, because and Yes, if are much
  better answers
• Changes in managements appetite for and approach
  to the management of risk in recent years have
  been focused on operational risk, not market or
  credit risk
• As long as management is making the right
  specific (local) risk related decisions, global
  risk is a manageable task

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Advanced Risk IssuesWhy are We Here?

• Industry Structure and Risk Analysis
• Management and Strategy Assessment
• Global Portfolio Management Running a Modern
  Bank
• Operational Risk
• Market Risk and Convergence Risk
• Country Risk
• Deal Structure Risk
• Problem Recognition
• Derivatives Risk
• Underwriting Risk and Conflicts

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Lessons Learned.Why do smart bankers sometimes
do bad deals?

• Mistakes about the use of Citis capital risk /
  reward
• Missing the most important risk decision -
  Choose clients very carefully
• Lack of understanding of industry dynamics and
  risks
• Lack of understanding of clients motivation for
  doing a deal
• Pressure to generate revenue
• Going along with the herd

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Lessons Learned.Why do smart bankers sometimes
do bad deals?
It is difficult to get a man to understand
something when his salary depends upon his not
understanding it. Upton Sinclair (from An
Inconvenient Truth)
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Citi CIBAdvanced Risk Issues
Revenue Growth and Risk Management in a Complex
Global Bank