DBRS: Citigroup 2Q14 Settlement Consumes Earnings As Legacy Issues Are Addressed; Revenues Weaker

Summary:
• 2Q14 net income of $181 million negatively impacted by a $3.7 billion mortgage settlement charge that resolves all pending civil investigations related to Citigroup’s legacy RMBS and CDO underwriting, structuring and issuance activities. Criminal charges are still possible.
• DBRS-adjusted revenues of $19.3 billion down 3% quarter-on-quarter (QoQ) and 2% year-on-year (YoY), but some positive underlying performance was evident in the quarter.
• DBRS ratings remain unchanged; Citigroup Inc. Issuer & Senior debt at A (low) with a Stable trend.

DBRS, Inc. (DBRS) views Citigroup Inc.’s (Citigroup or the Company) 2Q14 earnings as reflecting mixed results. The $7 billion mortgage settlement, which includes $4.5 billion in cash and $2.5 billion in consumer relief, led to a $3.7bn (after-tax) charge that nearly eliminated quarterly net income. DBRS sees the settlement as significant in clearing a large legacy exposure for the Company. Nonetheless, the possibility of criminal prosecution remains with its associated reputational risk and potential for business disruption. DBRS is also mindful that other significant headwinds remain for the Company including the Oceanografía fraud issue in Mexico, restructuring of its Korean business, FX and LIBOR litigation, the Fed’s objection to its capital plan, as well as the still sizeable level of legacy assets at Citi Holdings.

Citicorp revenue (adjusted for CVA/DVA) was down 4% QoQ and 5% YoY, as market-driven (more volatile) revenue was weaker and mortgage originations, while up in the quarter, were down 64% YoY.

DBRS notes that many underlying performance indicators trended positively in the quarter, which may underscore momentum for its core businesses. These included 8% loan and deposit growth, lower core (excluded legal, repositioning and settlement costs) operating expense, better credit metrics, utilization of some deferred tax assets, and improved liquidity. Moreover, Citi Holdings generated its first ever profitable quarter, while its assets declined modestly (with a solid 3Q14 asset sales pipeline).

Importantly, Citigroup’s financial profile remains strong with an estimated Basel III Tier 1 (Advanced Approach) common ratio of 10.6% and an estimated supplementary leverage ratio of 5.7% at the Company-level. These ratios remain comfortably above regulatory minimums and are above the average of other large capital market players.

DBRS rates Citigroup Inc.’s Issuer & Senior debt at A (low) with a Stable trend.

Note:
All figures are in U.S. Dollars unless otherwise noted.