Advanced Risk Issues “Seeing Around Corners” Summary and Conclusions Why were We Here? Miami April, 2007

1. Advanced Risk Issues“Seeing Around Corners”Summary and ConclusionsWhy were We Here?MiamiApril, 2007

2. Citi CIBAdvanced Risk Issues Revenue Growthand Risk Managementin a Complex Global Bank

4. 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 is the rock on which any contemporary bank rests….

5. Moody’s 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. • In a hotly competitive arena, fraught with litigation and regulatory risk, an investment bank needs a collective sense of right and wrong.

6. Advanced Risk Issues The Market’s View of Risk Management • “The financial innovations that have made risk transfer and hedging possible have increased the complexity of risk management, both financial and operational.” • “If a bank can establish risk management as a core competency, I think that’s something the market would value.” • “No model,, and no software package, no matter how sophisticated, can ever replace the skills of a trained, experienced and conscientious risk manager”

7. Advanced Risk IssuesThe Market’s View of Risk Management • “NAB’s internal control systems failed at every level to detect the irregular currency options trading. As long as the business unit turned a profit, other shortcomings could be overlooked.” • “Barings – There may be a temptation to view this debacle as being caused by just one individual – the “rogue trader” – but in reality the fiasco should be attributed to the underlying structure of the firm, and particularly to the lack of internal checks and balances.”

8. Private leveraged funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps • These changes in market participants have occurred in conjunction with a dramatic acceleration in number and type of derivative instruments. • These developments have likely had the important impact of allowing for a more efficient distribution and more effective management of risk. • All of these changes should move the market in the direction of fostering the efficient allocation of credit and capital formation, and thus enhancing the economy’s real growth potential. • Stress testing and scenario analysis have become central to the process of risk management

9. Credit derivatives and structured credit markets enhance the capability to manage both pricing and liquidity risks. • Price discovery in the credit derivatives market reduces the risk of mispricing loans. • Moreover, securitisation, which is another credit risk transfer instrument, offers the possibility of managing more effectively the liquidity risk of traditionally illiquid loans in the balance sheet. • Banks are moving from the traditional “buy-and-hold” model to the “originate-and-distribute” model, whereby they distribute portfolios of credit risks and assets to other market players. • Credit derivatives and structured credit markets are transforming the financial system, whereby efficient risk allocation is becoming just as important as capital allocation. • It is a valid question to wonder if we are converging towards a new “integrated” financial system, whereby the traditional categories of bank-based or market-based financial systems may have to be revisited.

11. Federal Reserve Written AgreementJuly, 2003 • “NOW, THEREFORE, Citigroup and the Reserve Bank hereby agree as follows:…….within 60 days of this Agreement, Citigroup shall submit to the Reserve Bank an acceptable written legal and reputational risk management program applicable to Citigroup and its subsidiaries.

12. Fed Ties the Hands of CitigroupNo Major Acquisitions Allowed Until Its Problems Are FixedTHE WALL STREET JOURNALPage “C1”March 18, 2005 The Federal Reserve barred Citigroup Inc. from major acquisitions until the company fixes regulatory problems that have gotten the financial-services giant in trouble around the world, raising the stakes for Chief Executive Charles Prince in his drive to overhaul the bank's ethics.

13. "CLAWS AND FANGS"Business Week October 4, 2004 "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."

17. Moody's Investors Service upgrades the ratings of Citibank N.A. to Aaa for long-term deposits and to A for financial strength September 26, 2006 • The firm has made progress on strengthening culture and improving controls, and has not suffered a major control problem since having to close its Japanese private bank. • However , management must continue to solidify cultural change, notwithstanding shareholder pressure for earnings growth • Moody's assessed the effectiveness of risk controls, measurement and information infrastructure as well as the firm's risk governance and culture.

18. Strong earnings generation from an extraordinarily diverse set of businesses allows Citigroup Inc. (Citi; AA/Stable/A-1+) 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. “Credit Matters Today” March 5, 2007

19. Citigroup Risk Management PrioritiesDave Bushnell - 2005 • 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 management’s 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

20. Citigroup Risk Management PrioritiesBebe Duke – January, 2007 • Suitability is the key risk issue • Market products are critical for revenue growth • - commodities • - credit derivatives • - "bespoke" interest rate derivatives and "exotics" • Need to raise awareness that the only way to make money is to how to get to the yes. • Client First Initiative

21. Citigroup Risk Management PrioritiesBebe Duke – 19 April, 2007 Dave Bushnell’s Priorities • To manage risk well we must be fast and responsive • We must encourage more intelligent risk taking • A significant role of the CMB, bankers and risk managers together, is to “get to yes” • People and training • Cost and efficiency of the risk process

22. Getting the balance right between efficient risk analysis and local competitive pressure Pricing Pressure from local banks Systems to monitor and manage complex structured derivatives and deals Regulatory risk – deals leading to franchise risk in local markets Integration of recent acquisitions – systems and operations Dealing with the pendulum of business / risk / business Higher risk associated with new businesses Advanced Risk IssuesTuesday, 17 April – Participants’ Risk Issues • Commodity volatility • Systems constraints – operational capabilities vis a vis new products • Current market – excess liquidity and competition • Franchise risk related to complex structured transactions • Financing conditions – “covenant lite” deals • RAU migration and loss of control of local analytic resources • Political / geopolitical risk • Proper model for middle market growth

23. Advanced Risk IssuesCourse Overview Basic Credit Risk Analysis • Industry Structure and Company Risk Analysis • Balancing Business Risk and Financial Risk (Key Success Factor Exercise) • Identifying Winners and Losers. • Early Warning Signs / Problem Recognition • Avon Pharmaceutical Case

24. Advanced Risk IssuesCourse Overview Assessing management ability, business strategy, and controls • Management Competence and Business Strategy (Corning Case) • Business Controls (Citibank Dublin Case)

25. Advanced Risk IssuesCourse Overview Deal Structure and Risk - Poland A2 Motorway Case Converging Risk Issues – Credit Risk, Market Risk, Country Risk, Derivatives Risk How Does Citi “do risk”? • Underwriting risk and conflict management • Market risk / Convergence Risk • Global portfolio management • Operational risk • Country risk

26. Advanced Risk Issues Presentations to Illustrate How Citi Risk Management is a Driver of Revenue Growth • CIB Risk Management – Bebe Duke • Global Portfolio Management – Bill Hartmann • Market Risk / Convergence Risk – Murray Barnes • Operational Risk – Eva Leighton • Country Risk - Doug Smee • Risk Management in EM – Andy Roy • Problem Recognition / Early Warning Signs - Austin Erwin, Jose Luis Michel • Derivatives Risk – Patrick Pancoast • Conflict Management / Franchise Risk – Bob Martin

27. Advanced Risk IssuesQuotes of the Week • It’s not marked to market, it’s marked to guess! • Patrick Pancoast • I have a crystal ball, but I don’t really know how it works • Bill Hartmann • Don’t mix high business risk with high financial risk • Arnie Ziegel • The losses we’ll take on the credit are a multiple of the fees we earned on the IPO • Austin Erwin • Risk Management isn’t about controlling the business, it’s about DOING business • Patrick Pancoast • If you every hear the word “miracle”, it’s time to sell • Doug Smee • The reasons covenants are disappearing is that what investors are willing to accept • Bill Hartmann

28. Advanced Risk IssuesQuotes of the Week • Revenue up, cost down, complexity up, and risk up • Andy Roy • Breaking down the silos is a critical step to getting the company to where we want to be • Bebe Duke • If there is a party, keep the dogs away, but if there’s a problem, please bring in the dogs • Jose Luis Michel • If the numbers you see scare you, then it’s the numbers that you don’t see that should terrify you. • Doug Smee • There is tremendously more appetite for market risk taking and credit risk taking, zero appetite for franchise risk taking, and very low tolerance for loss • Murray Barnes • In almost every one of our deals we have two sets of clients • Bob Martin • Why do sophisticated investors like commercial loans as an asset class? • Bill Hartmann

29. Advanced Risk IssuesQuotes of the Week • Many or most major business problems or losses are the result of a flawed business strategy • Arnie Ziegel • Is it credit risk or market risk? YES! • Patrick Pancoast • You are our clients! • Bebe Duke • We live in very different neighborhoods, but we manage the risks very, very well • Andy Roy • How much can we lose on a bad day? What’s the worse that can happen? • Murray Barnes • Unlike credit risk or market risk, we don't yet know how to dimension our portfolio • Eva Leighton • Every time we raise the idea, we get twenty reasons why we can’t sell loans • Bill Hartmann

30. Advanced Risk IssuesQuotes of the Week • Companies go bankrupt because they 1) run out of cash, 2) fear that they’ll run out of cash, or 3) their suppliers of liquidity fear that they’ll run out of cash • Arnie Ziegel • History doesn’t necessarily repeat itself, but it does have a very good memory • Murray Barnes • There’s no such thing as bad risk, it it’s priced correctly • Patrick Pancoast • Whose fault is it? You gave me the money / let me do it / told me to do the trade • Arnie Ziegel • Do we have a tolerance for a higher level of operational risk in order to pursue a business opportunity? • Eva Leighton, Murray Barnes • We’re creating tomorrows’ problems today, we just don’t know where they are • Bill Hartmann • It’s almost like the credit default swap market is bypassing the bond market and going directly to the loan market • Murray Barnes

31. Advanced Risk IssuesQuotes of the Week • Bankers and Clients often rationalize away the signs of weakness • Austin Erwin • We all collectively need to be concerned that we are responding to our customers • Bebe Duke • Active portfolio management, which has been discussed for years, is now a global, industry-wide, activity • Bill Hartmann • By identifying early we both protect the balance sheet and create opportunities • Austin Erwin • A really good risk manager is a partner to the business who actually helps to solve a client’s problem • Bill Hartmann • We do too much too late, after doing too little too early • Doug Smee

32. Advanced Risk Issues Quotes of the Week • Anything that is unsustainable will end. The longer it takes to end, the bigger the crash will be when it happens. • Doug Smee • The “known unknowns” and “unknown unknowns” • Murray Barnes • We could go in with the axes and the knives, or we could make the decision that the company could be a viable client • Austin Erwin • In the long run, treating customers fairly has proved to be good business • Bob Martin / Stephen Cutler • Credit default swaps allow us to bring liquidity to a market that is not liquid • Bill Hartmann • Do not try to rationalize away increasing danger signals – instead, try to find out why. • Doug Smee

33. Advanced Risk Issues Themes from the week….. • Credit Risk is becoming a Traded Product • Effective Risk Management is a tool for business growth • Risk Management is becoming a driver for business growth • The banking industry model is changing from “originate and hold” to “originate and distribute the asset or the risk” • All risks are converging, the boundaries are evaporating - Operational Risk, Franchise Risk, Market Risk, Country Risk and Credit Risk • Suitability and Appropriateness are increasingly becoming major risk factors

34. Advanced Risk IssuesThemes from the week….. • Growing complexity of the business is accelerating and inevitable • Reputation risk and Franchise risk are inherent in almost every business activity of Citigroup • Every aspect of our business has potential of creating a loss due to an execution problem in the system • Good planning and risk identification can minimize the over-reaction to a risk event and the potential impairment of the value of a particular franchise

35. Advanced Risk Issues Themes from the week….. • Don’t add Financial Risk where there is high Business Risk - industry and business risk drives a company’s capital structure • Choose clients carefully • Many business problems arise from inadequate, inappropriate, or ill managed strategies • Citigroup is held to a higher standard, and not expected to “aid or abet” improper or inappropriate loans, investments, trades, etc.

36. Advanced Risk Issues -Themes from the week….. • Active portfolio management mitigates risk • Citi has multiple constituents when considering risk – issuers, investors, regulators, rating agencies • Skepticism is an inherent part of risk assessment • Why do smart bankers sometimes do things that, in retrospect, just don’t make sense?

37. Advanced Risk IssuesBankers and Risk Management • Bankers Manage Client Relationships in order to provide insight, early warning, and preferred positioning • Bankers are “client experts” • Bankers are Advocates – For Issuers and Investors • Bankers must be Client Advisors rather than Responders • Bankers must be Skeptics (Seeing Around Corners) • Bankers are Responsible to Multiple Constituencies: • shareholders • clients • regulators • Investors

38. Why Were We Here? • Excellent risk management creates shareholder value and can be a major driver of high quality revenue growth • Excellent risk management for revenue growth requires: • “Seeing around corners” - finding risk where we didn’t know or think it existed, and the convergence of types of risks • Skepticism to balance risk with the need to generate revenue growth • Identifying potential flaws of business strategies – internal and clients • A framework for choosing clients very carefully • Understanding the increasing complexity of products

39. Why Were We Here? Excellent risk management for revenue growth requires: • Understanding the reputation and franchise implications of business decisions • Understanding that we will never see all risks, so we • Structure away from risk • Choose clients carefully • Pursue active portfolio management • Create and maintain a superb control culture and business culture • Create and maintain systems for monitoring risk

40. Why Were We Here? • To review how Citigroup is managing risk, including active portfolio management and reputation / franchise risk • Growth demands MORE risk and MORE reward, and it’s up to you to get the balance right • We can grow and still “stick to the fundamentals”, often using new means of distributing risk • To remind you that excellent bankers don’t hesitate to say “I’m sorry, but I just don’t understand….” • To recognize that we’re held to a higher standard, not just because Citi is big, but because Citi is the leader……………

41. Advanced Risk Issues 2007 Seeing Around Corners Revenue Growth and Risk Management in a Complex Global Bank

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