DBRS Confirms Citigroup’s Senior Debt at “A”; Trend Stable

DBRS, Inc. (DBRS) has today confirmed all ratings of Citigroup Inc. (Citigroup or the Company), including its Issuer & Senior Debt rating of “A”, the Deposits & Senior Debt rating of Citibank, N.A. of A (high) and the Short-Term Instruments rating of R-1 (middle) on both entities. The ratings action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

DBRS’s intrinsic assessment (IA) for Citigroup and Citibank N.A., A (low) and “A” respectively, have also been confirmed. The IA reflects the strength of Citigroup’s extensive global franchise and a strengthening financial profile, but also considers the Company’s pressured earnings as it continues to refine and refocus its business model. While its core Citicorp businesses are proving resilient, the Company continues to struggle with the drag created by Citi Holdings. DBRS sees both credit and operating expenses as being elevated and constraining performance. Positively, Citigroup has improved its liquidity and funding profiles, while bolstering capital over the near to medium term. The Company still faces a number of challenges, however, in operational and regulatory areas along with legacy mortgage and legal issues. DBRS is encouraged to see an engaged and active Board of Directors along with a new CEO working on implementing changes with a renewed energy, purpose and sense of urgency.

Underpinning DBRS’s IA of Citigroup is the Company’s broad array of strong core businesses through which it meets the wide-ranging needs of retail, business, corporate and institutional customers under a global brand in over 100 countries. These businesses include successful retail banking and credit card businesses in many countries around the world, as well as extensive capital markets businesses and its wide-ranging wholesale banking services. The Company is well-positioned to benefit from the expanding role of the emerging market economies in the global economy that will drive growth in trade and financial activity. As the most globally diversified U.S. banking organization, DBRS sees Citigroup, through its core Citicorp franchise, as one of two banking organizations worldwide with the brand and infrastructure to provide such a broad range of banking services globally. Indeed, over 58% of Citicorp’s $71.0 billion of net revenues and 56% of its $14.5 billion of income from continuing operations in 2012 were generated outside North America. These results support DBRS’s view that these businesses have the ability to generate substantial income before provisions and taxes (IBPT) that is well diversified by customer segment, product and geography.

Citigroup’s ratings reflect its designation 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 banks with short-term ratings of R-1 (middle). Given the nature of the floor, these ratings have Stable trends. With the IA’s for Citigroup and Citibank N.A. at A (low) and “A” respectively, application of the floor rating elevates the final ratings by one notch each.

DBRS comments that strengthening IBPT, which is benefiting from well-controlled expenses, along with continued progress in reducing legacy assets and further improvement in credit metrics would likely lead to a one notch upgrade of Citigroup’s IA, thereby equalizing the IA and the final rating. Significant revenue and earnings pressure arising directly or indirectly from the European crisis and/or a material increase in mortgage-related costs that slows the progress the Company is making in improving earnings and reducing legacy exposures could negatively pressure the IA. Negative rating pressure on the final rating could arise, if DBRS concludes that recently enacted legislation, as it is put into practice, is highly likely to reduce the benefit to the Company of being a CIB.

Importantly, the Company has made considerable progress working down the non-core balances in Citi Holdings. At YE2012, Citi Holdings’ assets, at $156 billion, were 8.4% of total assets and were down $69 billion, or over 30% from the prior year, and $671 billion, or 81%, lower than at their 1Q08 peak of $827 billion. In DBRS’s opinion, the runoff of this entity will continue to weigh on its balance sheet and earnings. For example, the Company estimates that Citi Holdings generated $1 billion in after-tax losses per quarter in 2012 and accounted for $283 billion in Basel III risk-weighted assets (RWA), or 23% of Citigroup’s total RWA. Moreover, it is likely that the more saleable assets have already been sold leaving the Company with harder to sell assets that will likely take more time to work through. As such, DBRS expects non-core assets to continue to produce disproportional underperformance and losses, but sees the Company as adequately reserved in this respect.

The Company’s ability to generate resilient revenues and earnings in the difficult operating environment is an important factor supporting DBRS’s IA for Citigroup. For 2012, DBRS-adjusted IBPT was $30.3 billion, up 5.3% from $28.8 billion in 2011, but credit costs and expenses remain stubbornly high, while revenue needs to be further strengthened. The Company’s 44% (DBRS- calculated) provision-to-IBPT ratio underscores that the relationship between credit expense and core earnings has a way to go until it reaches the 25% or below range that DBRS considers healthy.

Given the challenging environment for revenue growth that has resulted from lower client activity and the persistent low rate environment, DBRS expects expense reductions will need to play a key role in sustaining IBPT going forward. Citicorp is targeting a mid-50% efficiency ratio by 2015; ambitiously lower than the almost 64% level recorded in 2012. In addition, DBRS anticipates that the benefit of lower credit costs will diminish in coming quarters, further pressuring the bottom line. Complicating the task of lowering operating expenses and generating positive operating leverage are increasing regulatory requirements, which have not only impacted revenues and expenses, but are also altering business practices, especially in North America RCB and S&B.

DBRS views Citigroup’s reorganization as a key step, having refocused the Company on its comparative advantages. Reducing proprietary risk taking and more carefully allocating balance sheet capacity, Citigroup is focusing on leveraging its global reach, product capabilities and global brand to meet the needs of its institutional clients. Recent period results, especially in Citicorp, have validated the strategic shift, though markets remain volatile and the interest rate environment remains challenging. DBRS views continued success with the reorganization and continued investment in Citicorp as important, as competitors continue to improve their ability to operate globally.

Appointed in October 2012, Citigroup’s Chief Executive, Michael Corbat, along with the Board of Directors, have demonstrated a much higher level of engagement and oversight than previously seen at the Company. Citigroup joins many banks that are undergoing strategic change to focus and refine their business models in order to adapt to the new economic and regulatory environment. Also noteworthy was the fact that the first major announcement following the management change was an explicit cost saving target, as cost control and generating positive operating leverage have been stubborn challenges for Citigroup. The Company also announced a return on tangible equity target of 10%. While DBRS sees these changes as positive, they mark a point of inflection for Citigroup and it will be the execution on these initiatives that matters in improving performance and unlocking the full potential of the Company’s franchise. DBRS notes that these changes will take place over the next few years rather than quarters. Evidence of the lack of traction or eroding market positions during this time could pressure the IA.

In confirming the Company’s ratings, DBRS’s view is that the current earnings trajectory of the Company and its solid financial profile will enable it to absorb risks associated with legacy mortgage exposures and the ongoing crisis in Europe.

While down, credit costs in consumer lending remain elevated. In 2012, net credit losses on Citigroup’s $142 billion local consumer lending portfolio (including about $92 billion in residential mortgages) were 4.72% of average loans, down only marginally from 4.69% in the prior year (but included $635 million relating to OCC guidance) and 44 basis points (bps) below 2010 levels. Delinquencies on this portfolio have improved markedly from peak levels and continue to improve incrementally. Positively, Citigroup has added significantly to capital while loan loss reserves are being gradually reduced as credit quality improves. The loan loss reserve for consumer lending was $22.7 billion, or 5.57% of total consumer loans, at the end of 2012.

As Citigroup navigates the current environment, DBRS sees the Company as benefiting from a considerably strengthened financial profile that has been improving since the beginning of 2009. Complementing the rebound in its core IBPT, Citigroup has improved its funding, liquidity and capitalization. With a proportionately greater reliance on wholesale funding than other comparably sized banking organizations, the Company has reduced the stress from its funding needs by shrinking Citi Holdings, growing deposits and improving its funding mix. Liquidity resources have been strengthened at the parent company, the broker-dealer and the bank subsidiaries. Aggregate liquidity resources, including unencumbered cash, liquid securities and assets that can be pledged at central banks totalled $354 billion at the YE2012, up 40% from the end of 2008, but lower than their 2010 peak, as the Company is gradually putting some of its excess liquidity to work. Citigroup’s LCR ratio has also declined, but, at 118%, remains comfortably above the proposed minimum regulatory requirement and represents $55 billion of excess liquidity.

Capitalization has also been strengthened, as results from recent supervisor stress tests validated. Tangible common equity (TCE) as a percent of risk-weighted assets was 15.96% as of YE2012, up 102 basis points over the year and dramatically above a low of 3% at the end of 2008. Citigroup’s other capital metrics, including a Tier 1 Common ratio of 12.7% and a Leverage ratio of 7.5% compare well to those of its large diversified bank peers. The Company also believes it will achieve a fully-compliant (under current proposals) 9.5% Basel III Tier 1 Common ratio (currently 8.7%) by YE2013. This metric includes an additional core capital buffer of 2.5% of risk-weighted assets above Basel III minimums that globally systemically important financial institutions like Citigroup are required to maintain, which could impact its competitiveness. DBRS anticipates that solid earnings generation will also be important to allow further utilization of deferred tax assets, as well as continued progress working down assets in Citi Holdings, especially those that receive substantially higher risk weightings under Basel III, all of which will help Citigroup meet its year-end 2013 target.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other applicable methodologies include the DBRS Criteria – Intrinsic and Support Assessments, DBRS Criteria: Bank and Bank Holding Company Trust Preferred Securities, DBRS Criteria: Rating Bank Subordinated Debt & Hybrid Instruments with Discretionary Payments and DBRS Criteria: Rating Bank Preferred Shares & Equivalent Hybrids. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on August 29, 2014 to reflect actual methodologies used.]

The sources of information used for this rating include company documents 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
Rating Committee Chair: Alan G. Reid
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.