January 15 2008: 2:55 PM EST
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Credit card worries plague Citi

On top of the subprime woes, Citi's consumer lending unit has swung to a loss - will other banks also get hit with bad credit card debt?

By Colin Barr, senior writer

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Citi's credit card losses suggest that other consumer banks may be hurting as well.

NEW YORK (Fortune) -- Citigroup's big subprime-related writedowns are grabbing headlines, but the bigger worry for other big banks could reside in Citi's souring consumer business.

Citi's new chief Vikram Pandit said Tuesday that Citi would cut its dividend and raise more than $14 billion in new capital to strengthen its balance sheet. Citi also recognized $18 billion in losses on its holdings of mortgage-related securities that have lost much of their value amid a sharp decline in the U.S. housing market. All told, the bank lost $9.8 billion, or $1.99 a share, for the quarter - nearly twice as much as analysts were expecting.

But if the mortgage-related bloodshed came as no great surprise on Wall Street, what was eyebrow-raising was the degree to which the bank's consumer lending portfolio showed signs of strain. And while rivals such as Bank of America (BAC, Fortune 500), JPMorgan (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500) have largely sidestepped the mortgage mess, they do have substantial domestic consumer businesses - which could mean they'll have a tough time avoiding a hit as the economy stumbles toward recession.

Citi said Tuesday that its U.S. consumer lending business swung to a $1.2 billion loss from a year-ago profit of $484 million, as the firm added $2.42 billion to its reserves for future loan losses. Profit at its U.S. cards business dropped 60 percent from a year ago to $398 million, hit by a $493 million pretax charge to increase loan loss reserves, "reflecting a weakening of leading credit indicators in the portfolio and trends in the macro-economic environment," Citi said.

The sharp rise in consumer-related expenses at Citi - along with a drop in government retail sales numbers that suggests a recession may be under way - led to a sharp pullback in financial stocks Tuesday, with Citi leading the way, down 7 percent. Problems in the consumer business could signal troubles ahead for Pandit as he seeks to rebuild Citi. "There was ... significant deterioration in consumer credit quality this quarter and the reserve build signals that tougher times are ahead in the U.S. consumer channel, which has accounted for 30-40 percent of Citi's recent profits," analysts at Goldman Sachs wrote Tuesday morning.

Analysts at Sandler O'Neill wrote that Citi's hefty additions to loan loss reserves "implies that the outlook for U.S. consumer credit is deteriorating more rapidly than we expected." The comments came just days after two other big credit card issuers, Capital One (COF, Fortune 500) and American Express (AXP, Fortune 500), issued their own profit warnings tied to rising consumer delinquencies. Earlier Tuesday, Friedman Billings Ramsey downgraded Wells Fargo to underperform from hold, "based on its leverage to the consumer and recent indications of greater-than-anticipated deterioration in consumer credit quality." The firm pointed specifically to weakness in the housing market and rising delinquencies in car loans and credit cards.

Ratings agency Fitch warned last month that credit quality may deteriorate this year, though it also pointed to the banks' secret weapon heading into a downturn: a steepening yield curve. Investors expect the Federal Reserve to continue cutting short-term interest rates in coming months. That fattens banks' bottom lines by expanding the spread between the short rates at which the banks borrow and the long rates at which they lend.

The prospect of a steeper yield curve is one reason relatively healthy financial companies stepped in to rescue struggling E*Trade and Countrywide (CFC, Fortune 500) - and it's why investors will continue to be tempted by stocks like Citi, even as clouds gather over a slowing economy.  To top of page

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