Ready for the next recession; Citicorp, just now recovering from foreign loans that almost sank it, has put a system in place to help keep it from making the same mistakes again.

November 08, 1994, 2:00 a.m. EST 6 Min Read

Citicorp, just now recovering from foreign loans that almost sank it, has put a system in place to help keep it from making the same mistakes again.

Citicorp vice chairman William Rhodes styles himself a banker-cum-diplomat.

But his job over the last decade has been more like that of a maid in charge of cleaning up the mess.

As chairman of no less than nine bank advisory committees, Mr. Rhodes oversaw painful restructurings involving billions in loans to countries like Brazil, Argentina, and Mexico that nearly drove his own bank and others under.

He, better than anyone else, knows what sloppy credit evaluation can mean.

And after successfully seeing through the last of the big Latin debt restructurings and managing to recover a sizable portion of Citicorp's money, he has every reason to relax.

"We're benefiting from loan recoveries in the corporate and real estate sectors," Mr. Rhodes says.

This year alone, Mr. Rhodes estimates, Citicorp's credit portfolios will improve by about $1 billion covering both the consumer and corporate side.

As recoveries continue, Citicorp's bottom line is also continuing to improve, setting the stage for record profits this year.

But, sitting surrounded by photos, news cartoons, and other mementos of the international debt crisis in his second-floor office overlooking Park Avenue, the 58-year-old banker is again worried.

"We sense a weakening in terms and conditions in the market as some lenders try to increase income on the corporate banking side," Mr. Rhodes says.

"We're very conscious this has to be watched carefully."

As the biggest bank in the United States and the one most heavily involved in commercial banking around the world, Citicorp could suffer greatly from a deterioration in credit quality.

Only this time around, the bank thinks it has a system in place that will prevent major problems.

Known as Windows on Risk, the Citicorp system regularly monitors the state of the economy in different countries and the extent to which the bank's exposure to lending, underwriting, or trading might be affected according to 12 key risk factors.

If Brazil introduces a new currency to stabilize inflation, Citicorp will look at what consequences that might have for its own operations in the country.

If the price of oil suddenly goes up or down, the bank will check into its lending to the energy sector.

The system tracks both short-term and medium-term risk and covers everything from minor price changes to the collapse of an entire economy. It can also help the bank to increase its exposure, if events in a given country prove further investment is warranted.

"The credit monitoring process has trip wires built into it," says Mr. Rhodes, one of the architects of the system.

To reduce risks from sudden changes in the market or economic downturns, Citicorp "stress tests" its exposure to different markets and market segments.

Risks are monitored continually, first on a biweekly basis at management committee meetings attended by Robert Martinsen, head of credit policy, and then at monthly meetings of the bank's 15-member operating review committee under Citicorp chairman John Reed.

Lastly, the bank's management committee meets every three months to take an overall look at Citicorp's portfolio.

The buck stops with Mr. Rhodes, head of credit risk, and five other members of the bank's management committee: Mr. Reed; Pei-yuan Chia, vice chairman and head of consumer banking; Christopher J. Steffen, senior executive vice president and head of accounting and auditing; Paul J. Collins, vice chairman and head of capital markets and market risk; and H. Onno Ruding, vice chairman and head of corporate banking for industrialized countries.

To be sure, Citicorp is not the only bank that has set up an internal alarm system over the last few years.

J.P. Morgan, for example, last month trotted out its own black box. Known as RiskMetrics, the system measures trading and securities risks, as well as those related to derivatives.

It operates by monitoring movements in currency, commodity prices and interest rates.

However, Citicorp officials say they are unaware of any system structured just like its own. Citicorp's system is critical, executives say, because the bank has a broader, more diversified and more international range of business than almost any other institution.

"What they've created is a system that they argue keeps track of cumulative risk in different mechanisms," says Lawrence W. Cohn, a banking analyst at PaineWebber Inc.

"They've cut the portfolio into different risk factors and tried to manage risk by concentration and sensitivity to certain factors," adds Frank DeSantis, a banking analyst with Donaldson, Lufkin & Jenrette.

But observers note that Citicorp was one of the last of the big banks to put in place a comprehensive risk-monitoring system.

"They were late in coming to the portfolio management issue," says Diane Glossman, a banking analyst with Salomon Brothers, Inc.

"They weren't ahead of other American banks, but you can argue that they're certainly in the forefront relative to their foreign peers when it comes to assigning risk capital to their various businesses," she adds.

Does this mean that Citicorp has got a foolproof system for avoiding the problems it ran into in the past?

Not necessarily, says Mr. Rhodes.

"Nothing replaces good individual credit judgment," he says. "However Windows on Risk helps us manage proper credit balance.

All that a system like Citicorp's can do, he points out, is collect critical information needed to make a decision. The decision itself, however, still rests with somebody.

Analysts commend the bank for its efforts. But they remain somewhat skeptical as to just how many new problems "Windows on Risk" will be able to prevent.

"Systems per se don't interest me," says Mr. Cohn. "If you had talked to Citi in 1989, they would have talked about a system that protected their organization from all of the things that subsequently occurred."

"It's management's desire and interest in making them work that makes the difference." he adds.

Still, Mr. Rhodes and analysts agree that banks are basically in business to take financial risks.

"Credit risk is a cyclical part of business and the competitive nature of the industry requires banks to take credit risks that might come back to haunt them," Mr. Cohn observes.

"Experience tells us that new problems will come," Mr. Rhodes says. "This suggests you must carefully monitor your portfolio while continuing to raise capital and reserves.

"The real question is whether the next economic downturn will be a hard landing or a soft landing and what steps we can take to reduce the scope of the problem and any concentrations in our portfolio."

Analysts like Mr. Cohn are less flexible in their judgments.

"It's not possible an institution can go through the kind of stress and near-death experience Citi went through not having learned some lesson," he says.

"One would assume, having seen what happened in the last cycle, management has become a lot more diligent in looking at risk," he adds.

"If they're not, they deserve to be shot."

"They're doing something they never did before and that has some benefit," says Mr. DeSantis.

"But there's no way of knowing whether it will make them better than average until we go into the next recession."

What Citicorp's "Tripwire" System Tracks:

1. Client credit worthiness and Citicorp's risk vs. its return

2. Industry risks

3. Regional risks

4. Consumer banking risks, by product and country

5. Global real estate risk

6. Country risk

7. Counterparty trading risks