DBRS: Citigroup 1Q Benefits from Lower Expenses and Credit Costs; Strategy Gains Traction

Summary:
• 1Q15 earnings of $4.8 billion up 21% over prior year quarter primarily reflect lower legal, repositioning, operating and loan provision expense
• Delivered further progress in reducing Citi Holdings and utilizing DTAs
• DBRS rates Citigroup Inc. Issuer & Senior debt at A (low) and changed the trend to Positive on March 19, 2015.

DBRS, Inc. (DBRS) views Citigroup Inc.’s (Citigroup, Citi or the Company) 1Q15 financial results as solid, with the Company controlling expenses well and executing on its objectives in a difficult operating environment featuring very low interest rates and slow, uneven global economic growth. Importantly, the Company generated positive operating leverage (DBRS-adjusted) year-over-year (YoY) in 1Q15 demonstrating tangible results on its strategic objectives as Citi continues to pull the levers within its control. DBRS notes, however, that the runoff of non-core loans are offsetting the modest loan growth being generated by Citicorp while the securities portfolio grows awaiting deployment into core lending activities. This trend will likely accelerate over the next few quarters with the sale of OneMain Financial and the consumer businesses in Japan, Peru and Nicaragua that total approximately $32 billion in assets. Legal and positioning charges, which weighed heavily on 2014 results, were much lower at $403 million in 1Q15. However, DBRS expects that these charges could remain elevated over the near-term, likely remaining a drag on performance.

Citigroup’s global franchise diversity was evident in revenue trends, with strength in some businesses/geographies offsetting weakness in others. DBRS-adjusted revenues of $19.5 billion increased 10% quarter-on-quarter (QoQ) primarily on higher principal transactions revenues despite lower interest revenues but declined 3% compared to the prior year quarter where Fixed Income, Currency and Commodities (FICC) had a very strong quarter and net interest revenues were also modestly higher. Revenues over the prior year’s quarter were supported, however, by good trends in North America Consumer Banking as well as important contributions from Investment Banking, Treasury & Trade Solutions (in constant dollars), Corporate Lending, Securities Services and the Private Bank. Revenue headwinds were felt in Markets businesses, mainly in spread products and International Consumer Banking.

Expense controls remain important, with continued regulatory spend and franchise investment masking the Company’s expense savings initiatives. Indeed, approximately half of all efficiency savings are being consumed by regulatory and compliance investments. DBRS-adjusted expenses declined 4% QoQ after remaining relatively flat over the past 6 quarters. Citi reported an efficiency ratio of 55%; the best of the largest U.S. banks. Maintaining this expense discipline is one tactic that Citi may use to mitigate its returns on capital given its higher capital requirements.

Citi is making clear progress on the streamlining of its business model and execution of strategic priorities. Sale of some of its non-core businesses in 2015 will further reshape the balance sheet and income statement and DBRS believes that adept execution and discipline will remain critically important. The Company expects to offset some of the pressure on its net interest margin from the sale of higher-yielding assets through the repayment of higher cost debt.

Importantly, Citigroup’s financial profile strengthened over the quarter with its estimated fully-loaded Basel III Common Equity Tier 1 (Advanced Approach) ratio increasing 43 bps to 11.0% and its estimated supplementary leverage ratio up 46 bps to 6.4%. Citi recently passed the 2015 DFAST/CCAR examination from a quantitative as well as qualitative perspective, indicating improvement in capital planning systems and controls. As there was no regulatory objection, Citi now has the possibility of increasing its capital distributions.

DBRS rates Citigroup Inc.’s Issuer & Senior debt at A (low) and changed the trend to Positive on March 19, 2015.

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