DBRS Ratings Unchanged After Q1 Earnings of Citigroup Inc. – Senior at A

DBRS is today commenting 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, remain unchanged following the Company’s release of Q1 2009 earnings. Citigroup reported net income of $1.6 billion. Income available to common shareholders was a loss of $966 million, after preferred dividends of $1.2 billion, a $1.3 billion charge to reset the conversion price on its privately issued preferred stock, and a $53 million amortization charge related to TARP warrants. Citigroup’s ratings 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 banks with short-term ratings of R-1 (middle). Given the nature of the floor, these ratings have Stable trends.

In Q1 2009, Citigroup’s revenue and income before provisions and taxes (IBPT) rebounded to levels not achieved since the middle of 2007, which DBRS views as indicative of the strength of the Company’s diverse franchise. Given the still weakening economy, sustaining this higher level of IBPT is critical, in DBRS’s opinion, if Citigroup is going to be able to absorb the elevated level of credit costs and the burden of its remaining legacy assets.

IBPT was $12.7 billion versus a negative $9.7 billion (excluding the goodwill impairment) in Q4 2008. Driving this IBPT improvement were revenues of $24.8 billion, up significantly from $5.6 billion in Q4 2008, and a reduction in operating expenses. Generating net interest income of $12.9 billion, Citigroup with its diverse loan portfolios benefited from low rates and reduced wholesale funding costs. Net interest margin (NIM) expanded 8 bps to 3.30%, the highest since Q4 2004. Higher IBPT enabled the Company to absorb rising net charge offs (NCOs) of $7.3 billion and a $2.1 billion addition to loan loss reserves (LLRs).

The key turnaround was in the Securities & Banking (S&B) division, where revenues surged to $7.2 billion versus negative revenues of $10.6 billion in the prior quarter. Net income was $2.0 billion compared to a loss of $10.4 billion in Q4 2008. As with other capital markets participants, S&B’s results reflected a more favorable trading environment, especially for many areas of fixed income, as well as a strong quarter for debt underwriting.

Legacy assets took a toll again in Q1 2009, with S&B revenues reduced by revenue marks of $4.4 billion, largely driven by subprime and monoline exposures. The Company also absorbed write-downs in private equity and equity investments of $1.2 billion. At March 31, its remaining exposure to legacy assets (including private equity and equity investments), declined 9% from year end to $101.5 billion, of which only $29.2 billion is subject to mark-to-market accounting. On the positive side of market deterioration in Q1 were a $2.7 billion credit valuation adjustment gain resulting primarily from the widening of Citigroup’s credit default swap spreads relative to counterparties and a modest $180 million gain on its own debt carried at fair value. S&B also gained $541 million of accretion of non-credit related marks on assets of approximately $29 billion, transferred to held-to-maturity in Q4 2008.

Indicative of the challenges facing Citigroup, the cost of credit in the consumer-related businesses continued to increase with consumer loan NCOs, including Global Cards and Consumer Banking, of $5.7 billion on a held basis versus $5.2 billion in Q4 2008. While 90+ day delinquencies still trended upward across consumer loan categories, management noted 30-day delinquencies showed signs of leveling off. With a $2.1 billion LLR build, the overall ratio of LLR to loans rose 55 bps to 4.82%. The ratio of LLR to nonperforming loans (NPLs) fell moderately to 121% from 133% at Q4 2008.

Despite an 18% revenue increase, lower expenses and no large goodwill charge, Consumer Banking still reported a first quarter loss of $1.2 billion, but an improvement from its $10.4 billion loss in Q4 2008. Global Cards also struggled with increasing credit costs rising unemployment, though the reserve build was down from Q4 2008. Excluding an after-tax gain of $704 million from the sale of Redecard shares, Global Cards had a net loss of $287 million in Q1 2009, still ahead of its net loss of $610 million in Q4 2008.

Citigroup’s Q1 2009 earnings benefited from a record $843 million of income from Global Transaction Services (GTS), which remains a consistent source of positive earnings. There was also a significant rebound in Global Wealth Management (GWM) earnings to $261 million, although the pace of revenues was down with lower markets and less activity.

In addition to sustaining solid revenues, expense control will be a key factor helping Citigroup cope with elevated credit costs. DBRS views positively that Citigroup delivered planned expense reductions in Q1 2009. Operating expenses were $12.1 billion, putting Citigroup on track to deliver its target for full year 2009 which is in the $50 - $52 billion dollar range versus $61.2 billion in 2008, excluding $9.6 billion of goodwill impairments.

Citigroup’s capitalization presents a challenge that the Company is seeking to remedy. Its estimated Tier 1 capital ratio of 11.8% provides a substantial cushion above the regulatory minimum to be considered well-capitalized, but its tangible common equity (TCE) of $29.7 billion provides more limited loss absorption capacity, given rising credit costs and a still weakening economy. A 6% reduction in tangible assets bolstered the TCE/tangible assets ratio 10 bps, but it remained a weak 1.67% at the end of Q1 2009. DBRS notes that management has indicated it will wait until after the Government’s stress test is completed before launching the proposed preferred stock exchange offer that will significantly strengthen its TCE levels.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.