DBRS Ratings Unchanged After 3Q12 Results for Citigroup Inc. – Senior at A

DBRS, Inc. (DBRS) has today commented that its ratings for Citigroup Inc. (Citigroup or the Company), including its Issuer & Senior Debt Rating of “A” and its R-1 (middle) short-term rating, are unchanged following the Company’s 3Q12 earnings. Excluding the previously announced $2.9 billion after-tax loss on the sale of the a portion of the Morgan Stanley Smith Barney (MSSB) JV and an OTTI charge on Citigroup’s remaining stake, as well as after-tax CVA/DVA losses of $485 million in the quarter, the Company’s 3Q12 net income was $3.3 billion. This was up from adjusted net income of $3.1 billion in 2Q12. Inclusive of these charges, 3Q12 net income was a modest $468 million and included a $1.5 billion income tax benefit. Citigroup’s ratings continue to reflect its status as a Critically Important Banking organization (CIB) in the United States. CIBs benefit from DBRS’s floor rating of “A” for bank holding companies and A (high) for operating banks with short-term ratings of R-1 (middle).

Excluding the MSSB-related charges, DBRS sees Citigroup’s third quarter earnings as solid. Results reflect a strong fixed income trading performance and sustained underlying momentum in most core business drivers as the Company continues to benefit from its globally diverse franchise. Importantly, from DBRS’s perspective, the Company also generated positive operating leverage in the quarter (excluding the MSSB charge), and the core Citicorp franchise reported a third consecutive quarter of positive (YoY) operating leverage.

Citigroup’s DBRS-calculated income before provisions and taxes (IBPT), excluding CVA/DVA and the MSSB loss, grew 7% from 2Q12 to $7.2 billion. IBPT in the core Citicorp franchise was $8.1 billion, up 9% from 2Q12, and pre-tax income for Citicorp (ex-CVA/DVA) was $6.6 billion for 3Q12, up $695 million from 2Q12. DBRS continues to view Citicorp’s earnings capacity as enabling the Company to cope with credit costs and the burden of legacy assets. Still, DBRS’s intrinsic rating for Citigroup remains at A (low). Counterbalancing the strengths of the Company are the still considerable, though declining, balances and contingent risks related to legacy mortgage lending and other legacy asset exposures. DBRS notes that Citi Holding reported a net loss (excluding MSSB charges) of $679 million in the quarter and the Company had legal and related costs of $529 million in 3Q12.

In the core Citicorp businesses, revenues increased 3.5% from the second quarter to $18.4 billion. Securities and Banking (S&B) total revenues were $5.8 billion, up 15% QoQ, driven by fixed income market revenues that increased 31% from the second quarter to $3.7 billion. In Global Consumer Banking (GCB), revenues were $10.2 billion, up 4% from 2Q12. Another strong mortgage banking quarter in the U.S. bolstered North America revenues, while Mexico showed continued positive momentum in Latin America. In Asia, a rebound in investment sales was offset by lower card and retail revenues and total revenues were essentially flat QoQ. Positively, DBRS notes that across GCB regions, on a constant dollar basis, average loan and deposit balances were mostly higher on a YoY and QoQ basis. In terms of earnings, GCB contributed 49% of Citicorp’s total pre-tax earnings (ex-CVA/DVA) with S&B and Transaction Services contributing 32% and 19%, respectively.

Excluding the impact of new OCC guidance pertaining to consumers that have gone through a Chapter 7 bankruptcy, credit trends were similar to recent prior quarters. After releasing $984 million in 2Q12, Citigroup released $1.5 billion of reserves in 3Q12. The increase in the release was entirely due to the new OCC guidance, which resulted in the release of approximately $600 million of specific reserves. In North America Cards the pace of reserve release declined from 2Q12, though DBRS notes that losses and 90+ day delinquencies declined further and remain quite low by historical standards. Internationally, for 3Q12, the net credit loss ratio on Citicorp’s consumer lending was 1.9%, up from 1.8% in the second quarter. Considering the nature of its borrowers, net credit losses (NCL) are not likely to be materially impacted by somewhat slower economic growth in emerging markets. Overall, the Company’s allowance for loan losses was a solid $25.9 billion at quarter end, equivalent to 3.97% of total loans and 213% of nonaccrual loans.

With regard to North American mortgage lending within Local Consumer Lending (in Citi Holdings), DBRS notes that Citigroup did not release any material general reserves in the third quarter, though the aforementioned release due to the OCC guidance was reflected in this segment. Charge-offs related to the new guidance were $635 million in the quarter, however Citigroup noted that the vast majority of affected loans are current. With further evidence of stabilization in housing markets along with continuing declines in delinquencies, losses and balances, DBRS believes general reserve releases against this portfolio are possible in coming quarters, though not likely before 2013. At quarter end, the Company held $8.5 billion of reserves for this $95 billion portfolio. Current reserves against this portfolio represent 30 months of coincident net NCL coverage. Mortgage repurchase losses in 3Q12 were $167 million, up $21 million QoQ and the repurchase reserve balance was $1.5 billion at quarter end, up slightly from 2Q12. DBRS notes that repurchase claims (in terms of number of loans) from GSEs increased sharply in the quarter which may result in materially higher losses.

Citigroup’s regulatory capital ratios remain solid. At quarter end, the Company’s estimated Basel I Tier 1 Common ratio was 12.7%, unchanged QoQ. The Company’s estimated Basel III Tier 1 Common increased to 8.6%, from 7.9% at June 30, 2012, ahead of its expectations for a ratio above 8% by the end of 2012.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 24 July 2001
Most Recent Rating Update: 23 November 2011

For additional information on this rating, please refer to the linking document under Related Research.