DBRS Ratings Unchanged After 2Q13 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 Instruments Rating, are unchanged following the release of the Company’s 2Q13 earnings. 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). DBRS’s intrinsic assessment for Citigroup remains at A (low) indicating that it benefits by one notch as a result of the application of the rating floor in the U.S. On July 8, 2013, DBRS announced that it is assessing the applicability of rating floors for CIBs on a country by country basis over the next 90 days.

Excluding after-tax CVA/DVA gains of $293 million ($477 million pre-tax) in the quarter, the Company’s 2Q13 net income was $3.9 billion. This was slightly down from similarly adjusted net income of $4.0 billion in 1Q13. On a DBRS-adjusted basis, the Company generated strong positive operating leverage YoY, but was flat QoQ. Positively, the core Citicorp franchise reported a sixth consecutive quarter of positive (YoY) operating leverage (excluding CVA/DVA losses), but reported negative operating leverage sequentially. Notable events in the quarter were the completion of the sale of the Company’s remaining 35% stake in the MSSB joint venture, an agreement with Fannie Mae to resolve remaining repurchase claims, a lawsuit settlement with the FHFA, an agreement to sell its Brazilian credit card business, and the consolidation of $7 billion in government guaranteed trade loans from a conduit onto its balance sheet.

DBRS sees Citigroup’s improved quarterly performance as consistent with senior management’s immediate focus on continuing to wind down Citi Holdings (down 12% QoQ to 7% of Citigroup assets) and utilizing its DTAs (utilized $1.3 billion in 1H13 with $45.3 billion excluded from Basel III Tier 1 Common Capital). The quarterly results reflected solid progress in many of its businesses, as well as material reductions in credit costs and adjusted operating expenses. Moreover, the Company reported solid deposit growth and a strengthened balance sheet. Nonetheless, the operating environment remains challenging with constrained loan demand, pressured margins, high regulatory, legal, and compliance expenses, and the continued, albeit diminishing, drag of Citi Holdings. DBRS also notes that the Company’s earnings will likely be less impacted from the mortgage banking slowdown compared to other large banks given its smaller contribution as a percentage of total revenues.

Citigroup’s DBRS-calculated adjusted income before provisions and taxes (IBPT), (excluding CVA/DVA, legal and related costs, repositioning charges, regulatory assessment and gains/losses on securities) was up 23% to $8.6 billion compared to 2Q12, but declined 1% from 1Q13. DBRS continues to view Citicorp’s earnings capacity as enabling the Company to cope with its declining credit costs and the burden of legacy assets.

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. Nonetheless, the focus on expenses is proving effective with some repositioning savings already achieved. DBRS notes that Citigroup has targeted a 4Q13 goal of $300 millon in expense savings measured from 4Q12, which would equate to an approximate $11 billion operating expense run-rate. Reflecting steady improvement, Citi Holdings reported a net loss of $579 million in the quarter, down from a $788 million loss in 1Q13 and a $923 million loss in 2Q12. Highlighting the continuing cost of legacy issues, however, the Company had legal and related costs of $832 million in 2Q13, up 17% from 1Q13 and 73% higher than 2Q12.

In terms of earnings, Global Consumer Banking contributed 38% of Citicorp’s total income from continuing operations (ex-Corporate/Other segment) with Securities and Banking (S&B) and Transaction Services contributing 46% and 16%, respectively. In the core Citicorp businesses (excluding CVA/DVA), revenues declined 3.6% from the first quarter to $18.9 billion, while adjusted net income fell 6.8% to $4.5 billion. S&B turned in a good performance, but was coming off a strong first quarter. Within S&B, total revenues (excluding CVA/DVA) of $6.4 billion, were down 13% QoQ. Revenues in Equity Markets were up 14% and Lending was up 21%, but were unable to offset the $1.2 billion (27%) decline in Fixed Income Markets from the robust first quarter. YoY comparisons were favorable, however, as revenues rose 21% (ex-CVA/DVA) and net income was up 57%.

North American Consumer Banking (NACB) revenues weakened 1% over the quarter to $5.1 billion primarily from lower mortgage revenues, retail banking spread compression, and lower average card loans. NACB did benefit from 2% lower expenses and 5% lower credit costs in the quarter, resulting in a 1% increase in net income. In International Consumer Banking (ICB) constant dollar basis revenues were $4.7 billion, up 2% from 1Q13, as average loans grew 2% and positive operating leverage was achieved with expenses only growing 1%. Management is optimistic that both Latin America and Asia will achieve positive operating leverage for FY2013. Average retail loans ticked up 2% in ICB over the quarter, but average card loans declined 1% (excluding Credicard agreement) and average retail deposits were off 2%. Meanwhile, Transaction Services (TS) revenues rose 5% over the quarter to $2.7 billion, while expenses rose only 1%; generating positive operating leverage in the quarter. Average assets grew 9%, or $13 billion, in the quarter including the aforementioned $7 billion conduit consolidation. TS assets under custody fell 0.7% in the segment, while average deposits grew 2% in the quarter to $424 billion.

Overall credit trends continued to reflect good-paced across-the-board improvement with few exceptions. After releasing $650 million in 1Q13, Citigroup released $784 million of reserves in 2Q13, of which 60% was from Citi Holdings and 40% was from Citicorp. Total Citigroup non-accrual loans declined almost 9% over the quarter to $9.7 billion, or 1.51% of total loans, from 1.65% at 1Q13. Consumer non-accruals in Citi Holdings accounted for 64% of the improvement and the Company sold $3.1 billion of loans in the quarter, of which $700 million were delinquent mortgages. Meanwhile, consumer near term delinquencies continued to decline with 90+ day delinquencies declining 15 basis points (bps) to 1.57% and 30 to 89 day delinquencies falling 11 bps to 1.65%; both historically low levels. Overall, the Company’s allowance for loan losses was a solid $21.6 billion at quarter end, equivalent to 3.38% of total loans and 222% of nonaccrual loans.

With regard to North American mortgage lending within Citi Holdings, DBRS notes that Citigroup released $475 million in reserves in the second quarter most likely primarily associated with the aforementioned asset sale. At quarter end, the Company held $6.4 billion of reserves for this $80 billion portfolio. Current reserves against this portfolio represent 35 months of coincident net NCL coverage. Mortgage repurchase losses in 2Q13 were $37 million, down $101 million QoQ and the repurchase reserve balance was $719 million at quarter end, down $696 million from 1Q13.

On July 1, 2013, Citigroup announced an agreement with Fannie Mae to resolve potential future repurchase claims for breaches of representations and warranties on 3.7 million residential first mortgage loans sold to Fannie Mae that were originated between 2000 and 2012. The Company agreed to pay Fannie Mae $968 million under the agreement, substantially all of which was covered by Citi’s existing mortgage repurchase reserves as of March 31, 2013. DBRS notes that $913 million was charged to the reserve balance in 2Q13 and that repurchase claims were unchanged at $1.8 billion in the quarter largely due to the pending agreement.

Citigroup’s regulatory capital ratios remain solid. At quarter end, the Company’s preliminary Basel I Tier 1 Common ratio (incorporating Basel 2.5 market risk capital rules) was 13.3%, up 21 bps over the quarter. Meanwhile, the Company’s estimated Basel III Tier 1 Common increased to 10.0%, from 9.3% at March 31, 2013. Both ratios were improved from the sale of the aforementioned MSSB JV, DTA and retained earnings. The Basel III ratio increase is especially noteworthy in a quarter where the sudden long-term interest rate rise contributed to a $2.9 billion OCI reduction. Additionally, Citigroup enhanced it’s aggregate liquidity resources 2.7% to $380 billion. Moreover, Citigroup’s Basel III LCR ratio at quarter end was estimated at 110%, and remains comfortably above the proposed requirement.

On July 9th, U.S. regulatory agencies proposed a rule requiring a supplementary leverage ratio of 5% for the largest bank holding companies and 6% for their banking subsidiaries to be considered “well capitalized” phasing in to be fully effective on January 1, 2018. Citigroup estimates its supplementary ratio at 4.9% for the quarter end, based on a three month average. The estimated bank-level ratio was 6% for the month of March 2013.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]