Citigroup tries to outdevil the devil (stock):
nytimes.com
Along With a Lender, Is Citigroup Buying
Trouble?
By RICHARD A. OPPEL Jr. and PATRICK McGEEHAN
WALL STREET rejoiced
last month when Sanford
I. Weill, the legendary deal-making
chairman of Citigroup, announced
that it was buying Associates First
Capital, one of the nation's largest
consumer finance concerns, for
$31 billion. Investors bet that the
deal would repeat the success of
Mr. Weill's other mergers, notably
Salomon Brothers and Citicorp,
while bolstering Citigroup's
presence in Asia, where Mr. Weill
is staking a big part of his
company's future.
"It's the perfect Sandy Weill
transaction," said Joan Solotar, an
analyst at Credit Suisse First
Boston who follows Citigroup.
"It's a business he knows, there
are real cost-cutting opportunities,
there's a consumer franchise in
Asia and it's accretive. What more
could you ask for?"
People in North Carolina might
say "plenty." Last year, legislators
there became the first to pass
tough anti- predatory lending laws,
taking aim at finance companies
that lawmakers and consumer
activists say routinely take
advantage of unsophisticated
homeowners. And, according to
people who supported the bill, the
most talked-about lender during
legislative hearings was
Associates.
"The abuses by the Associates
were the key catalyst for the North
Carolina legislation," said Martin
Eakes, founder of Self-Help
Credit Union, a nonprofit
community lender in Durham,
N.C. Mr. Eakes, who piloted
carts carrying VCR's through the
Capitol in Raleigh so lawmakers
could watch taped news
broadcasts about Associates
practices, questions whether Citigroup knows what it is getting into. "It's
simply unacceptable," he said, "to have the largest bank in America take
over the icon of predatory lending."
While the deal will give Mr. Weill the Associates' huge consumer-finance
businesses in the United States and Japan — the company has about
1,000 branches in this country alone — those gains come with some risk
to Citigroup's reputation as it marries a company that has been named in
more than 700 private lawsuits, was fined $147,000 by Georgia officials
earlier this year for violating state insurance regulations and is being
investigated by the Federal Trade Commission, the Justice Department
and the North Carolina attorney general. Consumer groups and some
former customers have accused Associates of draining the home equity
of some borrowers by deceiving or pressuring them into taking out loans
and insurance policies that they did not need, might not have understood
and could not afford.
Should Democrats retake Congress next month, the ranking party
members on the House and Senate banking committees promise to give
priority to antipredatory lending legislation that could affect Associates'
practices. Those senior legislators, Representative John J. LaFalce of
Buffalo and Senator Paul S. Sarbanes of Maryland, sent a letter to
federal banking regulators this month urging them to "closely scrutinize
this transaction in light of the disturbing allegations of predatory and
discriminatory lending practices by Associates."
For their part, Citigroup officials do not defend Associates' sales
methods, and they say Associates employees who will be absorbed by
Citigroup's consumer-finance arm after the merger will be required to
adhere to strict lending guidelines.
"We have to do whatever is necessary, because reputation is worth more
than any particular quarter or any particular year's profits," said Charles
O. Prince, Citigroup's chief administrative officer. "I am absolutely
confident we would change any practice in any part of our company to
make absolutely sure that our reputation remains intact."
On Thursday, at a meeting in Durham, Citigroup executives listened to
civil rights and community-lending leaders detail the problems they say
Associates has caused for lower-income borrowers. A half-dozen
homeowners told their stories personally. The group also gave Citigroup
officials a laundry list of changes they wanted to see made at Associates
branch offices.
Mr. Prince, the most senior official at the meeting, told the group that he
understood reputational risk, noting that he recently told his daughter to
go to Goodyear, and not Bridgestone/Firestone, to buy new tires. "We
don't want that same type of reaction to happen to Citigroup," he told the
group.
Many consumer advocates are skeptical that Citigroup will take any
action that hinders Associates' profitability, and they say Citigroup
officials have so far promised little in the way of improving business
practices. In fact, some critics fear that Associates' lending habits will be
masked by the cachet of Citigroup's franchise and its status as the
nation's largest financial institution.
But in an interview on Friday, Mr. Prince said Citigroup was considering
changing several lending practices at its consumer- loan unit, Citifinancial,
which will absorb Associates' consumer lending business if the deal
closes, as expected, by year-end. He declined to say what was being
considered, however, and added that, "I'm sure we will not make
everybody happy."
While nothing that Citigroup is contemplating would have a material effect
on its financial performance, he said, "most all of the things we're talking
about here would be new for Citifinancial as well as for Associates."
Associates' way of doing business is "strikingly" different than Citigroup's,
he added, in part because many of Associates' consumer loans are
originated through brokers.
After listening to the Associates' customers tell their stories, Mr. Prince
told the group that he would investigate their cases personally. "These
were very sad cases, and there was no way to come away from
yesterday's session without being deeply moved," he said.
An Associates official referred all questions about the merger and
Associates' business practices to Citigroup. In the past, Associates,
based in Irving, Tex., has said it has done nothing unethical and is a
source of credit for many people who would otherwise be unable to
borrow. While it has acknowledged misconduct by some employees,
Associates has denied accusations of widespread problems, and said
those accusations have been fanned by opportunistic lawyers.
Some community-lending advocates say they have been encouraged that
Citigroup has been willing to listen to their concerns and has offered to
make a few, if minor, changes.
"I'm trying to be an optimist through this whole process, because what's
at stake here is changing the modus operandi of how these big banks
respond to community protests and demands for better products and
services," said John Taylor, president of the National Community
Reinvestment Coalition.
Mr. Taylor said he wanted to avoid the pattern of past mergers, in which
banks held news conferences announcing big-dollars, but unspecific,
commitments to community lending and donated money to a few activist
groups. He said Citigroup last month offered a $1 million grant to his
group, a Washington-based coalition representing more than 600 local
and regional organizations. But he said it chose not to consider the offer
until the issues surrounding the Associates merger were resolved.
Mr. Prince said that Citigroup officials did meet with coalition officials to
talk about the Associates acquisition, and that there was a discussion of
Citigroup paying for a financial literacy program through the organization.
But he said no specific monetary offer was made.
According to community-lending activists, Citigroup officials have
discussed several steps with them to curb overly aggressive lending
practices. These include eliminating loans with large "balloon" payments;
starting a pilot program to have branch offices "refer up" customers with
good credit ratings into less-expensive conventional loans; limiting
prepayment penalties to the first three years of a loan; and limiting the
amount of certain up-front fees to 9 percent of the loan value.
Mr. Prince confirmed that those were among the subjects under
discussion, but he declined to say what else was being considered.
Yet the activists also say Citigroup officials have indicated that they are
not willing to halt what critics consider to be the most serious abusive
practices. Those include aggressively selling single-premium credit life
insurance, a highly profitable product that a borrower pays up front for
and which pays a benefit only if the borrower dies or is injured, and the
repeated refinancing, or "flipping," of loans, which results in new fees and
other charges that often deplete homeowners' equity.
Mr. Eakes, for one, calls the proposed 9 percent limit on up-front fees
shockingly high and a testament to how little Citigroup appears willing to
do. "Citigroup has stated that they would solve the problems in
Associates by bringing Associates up to Citigroup's standards, but it's not
totally clear that Citigroup's standards are tighter," he said.
Mr. Prince, referring to the assertions of flipping and credit insurance
abuses, responded: "Those two issues are key issues in this debate, and I
would not feel comfortable if our business model did not in some way
address those two issues."
Earlier this year, he added, Citifinancial began using "mystery shoppers"
to drop in on branches to check on compliance and sales practices. That
will be continued at the newly acquired Associates branches, he said. In
any large sales force, he said, "you're going to have some people who
don't do the right thing."
Officials at the F.T.C. and Justice Department declined to comment on
the status of their investigations into Associates. Mr. Prince said that one
of his first orders of business after the acquisition closed would be to
meet with both agencies to "resolve those matters pretty promptly."
He said he had already blocked off time on his calendar. "Our practice
has been that it is not a smart way to run a business to be cross-wise with
the government," he said.
According to several analysts, Citigroup pursued Associates for almost a
year, starting when Associates' stock slumped as more mobile-home
buyers stopped repaying their loans and fewer truck drivers borrowed to
update their rigs. "They were in a number of businesses that basically
blew up on them," said Moshe Orenbuch, at Credit Suisse First Boston.
"Mobile homes blew up clearly, unequivocally."
Late last year, Associates decided to pull out of mobile-home lending
altogether. But by then, growth in the company's domestic consumer
lending business had also stalled, leaving its foreign operations as the
main source of growth. Moreover, Associates was falling behind
competitors in automating its operations, a long and costly process
required to make it more efficient, analysts said.
On Aug. 2, Mr. Hughes of Associates came to Mr. Weill's office to
negotiate a takeover. They eventually agreed on a tax-free swap of stock
that represented a big premium over Associates' share price but still
allowed Mr. Weill to crow that it would immediately bolster Citigroup's
per-share earnings.
Talking to analysts during a conference call after the deal was announced,
Mr. Weill sounded a wistful note about the origins of the financial empire
that he had built over the last 15 years.
In 1986, Mr. Weill was hired as chief executive at the Commercial
Credit Corporation, a struggling outfit in Baltimore that lent money to
working people of modest means. He took that company public, and
through aggressive selling and a series of ever-larger acquisitions, he
created the Citigroup conglomerate that now spans consumer lending,
insurance, stock brokerage and investment banking.
Long ago, in fact, Commercial Credit's original business of lending small
amounts at high rates was eclipsed by other lines of business at Citigroup.
In the first nine months of this year, Citifinancial, the Citigroup unit that
absorbed Commercial Credit, contributed less than 3 percent of
Citigroup's $50 billion in revenue and less than 4 percent of its $9.72
billion in profit. Citifinancial has $18.5 billion in loans outstanding, or
about one-tenth of Citigroup's total portfolio of loans around the world.
The business is neither the riskiest nor the most profitable within
Citigroup. Citifinancial's borrowers default at a higher rate than do typical
Citibank customers, but at a lower rate than holders of the bank's credit
cards.
Compared with Associates' strategy, Citifinancial's actually implies
considerably more risk. Roughly one-half of the money lent at a typical
Citifinancial branch is to borrowers who pledge no collateral, for
example, while a significantly higher share of Associates' loans are
secured by equity in the borrower's home or some other asset.
But because borrowers are more likely to default on unsecured loans,
Citifinancial, by and large, can charge higher interest rates than
Associates, and collect more profit: Citifinancial's annual return on its
assets, or the money it lends, is about 2.5 percent, compared with about
1.8 percent at Associates. Citigroup officials have told Wall Street to
expect the mix of lending at Associates branches to shift toward
unsecured, higher-interest-rate loans.
The most contentious point between community-lending activists and
Citigroup officials appears to be the sale of single-premium credit
insurance to borrowers. The premium is paid to Associates by the
borrower in one lump sum that is usually added to the loan balance.
Several government agencies and consumer groups have called for
legislation banning single-premium credit insurance, including the Treasury
Department, whose former secretary, Robert E. Rubin, is now chairman
of the Citigroup executive committee. The Treasury, in a joint report on
predatory lending released in June with the Department of Housing and
Urban Development, called lump-sum credit life insurance "unfair,
abusive and deceptive."
Critics say lenders often pack the insurance into loans without telling
borrowers what it does, or even that it is optional, and that it is rarely of
any benefit to them. The Treasury report said these products also
"unnecessarily increase consumers' total borrowing costs, and disguise
the true cost of the insurance on a monthly basis."
Yet this insurance reaps huge profits: During the last five years,
Associates' principal subsidiary, Associates Corporation of North
America, has collected $1.8 billion in insurance premium revenue — half
of it from credit insurance — and earned $397.5 million in investment
income on those premiums. But it has paid out just $713.1 million in
insurance benefits over that period.
Internal Associates documents produced in court during previous
lawsuits suggest that the pressure on Associates employees to sell credit
insurance has been intense at times. One interoffice memo, written to
group managers in 1988, instructed Associates employees to "insist that
the insurance offer is written on every application, NO EXCEPTIONS."
Another internal memo, titled "The Roadmap to Continued Record
Profits in 1995," stated that Associates agents sold credit insurance on
57 percent of real estate loans and 61 percent of consumer loans, and it
implored them to raise those levels. In the past, lawyers for Associates
have said the memo circulated only in one region of the country.
Citigroup officials say the problem is not with the product, but in the way
that it is sold. Unlike Associates, Citifinancial discloses how much the
insurance raises a customer's monthly payments and makes clear that the
customer is not required to buy the insurance as a condition of getting the
loan, said Robert Willumstad, Citigroup's head of consumer lending.
Disclosure practices at Associates branches will be improved, he said.
At Associates, "the consumer has not always understood what he or she
is buying," he said.
"We feel we have operated at a much higher standard," he added.
As with credit insurance, internal documents from Associates suggest that
employees have been pressured to encourage homeowners and other
borrowers to refinance loans; the emphasis was usually on how this
would benefit the company, not on how it might help the customer. In the
"Roadmap" memo, for example, a chart showed how the profitability of a
consumer loan decreases as it ages. "You can see how the earnings
decline over time," the memo said. "Your controller can provide lists to
you of aged personal loans to target for renewal."
Another memo, sent in 1991 to "all branch managers," concerned
Associates' practice of acquiring consumer loans made by other lenders
or retailers. "The principal reason we purchase an acquisition is to
convert it to a more profitable loan," the memo stated. "If we cannot
convert acquisitions, we cannot continue to purchase them."
The memo then stipulated that employees who renewed such loans, if
secured by real estate, would receive a $100 bonus for each loan.
Last month, in an investor conference call, Keith W. Hughes, the chief
executive of Associates, who will join Citigroup as a vice chairman after
the merger, cited the strong cultural similarities between the companies.
But in an interview last week, Marge Magner, a Citigroup executive who
previously oversaw Citigroup's consumer finance business, stressed what
she said were big differences, particularly in how the sales staff is paid.
Associates bases pay on the volume of loans that employees generate, a
"count your transactions" approach, Ms. Magner said. At Citifinancial,
she said, "we deal with the business as a whole, the whole branch and
how it's growing."
She also emphasized that the Citifinancial computer system used by the
sales staff automatically rejected products and interest rate levels that did
not seem suitable for a specific customer, giving Citifinancial a measure of
centralized control over lending practices. "A lot of the compliance issues
are built into the system," she said.
Bill Brennan, a lawyer with the Atlanta Legal Aid Society who has
testified before Congress and represented many Associates borrowers,
said the changes proposed by Citigroup were not enough. "It's crazy to
say you will stop balloon abuse and maybe one or two other abuses but
keep the credit life abuses and the flipping abuses and the other abuses,"
he said. "That means the whole process is just as polluted as before. You
can't just clean up part of the river."
In North Carolina, some Associates practices are being investigated by
Michael Easley, the attorney general, for possible violations of lending
laws. Officials in Mr. Easley's office said they had become more
determined after learning that some homeowners' zero-interest loans from
Habitat for Humanity, the nonprofit housing group, had been refinanced
with high-interest loans from Associates.
And Mr. Easley's office has received complaints from borrowers,
including Benny and Linda Mackey of Chocowinity, about 100 miles east
of Raleigh. The couple were paying $519 a month on their mortgage but
had fallen behind in their payments, according to their complaint last year
to Mr. Easley's office. Associates "said the only way they could help us
was to refinance it again," they wrote in their complaint.
Their monthly payment rose to $592 after Associates refinanced the
$37,117.76 they already owed — in part because a $4,231 "loan
discount" fee and $4,910.08 in credit life insurance were added to their
balance, according to documents from Mr. Easley's office. The note
carried a 14.99 percent interest rate on the new principal balance of
$46,541.08.
The Mackeys complained of receiving harassing phone calls from the
Associates after they missed some payments on the refinanced loan.
They said that callers would even curse at their sons, and that they were
eventually told that foreclosure proceedings had begun. But last year,
three months after Mr. Easley's office received the complaint, Associates
agreed to lower their interest rate to 9 percent, reducing the Mackey's
monthly payment to $370, according to a letter sent by an Associates
lawyer to the attorney general's office. Mr. Mackey, in an interview, said
he filed for bankruptcy protection from creditors last year after he
received the foreclosure notice and had not made any payments to
Associates since then.
Alan Hirsch, a deputy attorney general in North Carolina, declined to
comment on the state's investigation of Associates, although he said it
was not the only lender under scrutiny.
Speaking generally, Mr. Hirsch called single-premium credit insurance
"perhaps the most egregious practice" by lenders. "Many borrowers
don't understand it's been included in the loan," he said.
His office has found numerous cases of borrowers whose loans were
flipped, resulting in costly refinancing fees and insurance charges. In one
example, he said, a borrower received $6,000 in cash through a
refinancing but was charged more than $20,000 in additional financing
fees and credit insurance by the lender.
"It's legalized robbery," Mr. Hirsch said. |
