Fitch Ratings has affirmed Citigroup, Inc.'s (Citi) long-term Issuer Default Rating (IDR) at 'A'. The Rating Outlook is Stable. The affirmation reflects an improving risk profile, and solid capital and liquidity profiles. This also incorporates a forward-looking view of Citi's earnings profile, and that its performance will improve and converge to peer averages over time. A full list of rating actions is at the end of this rating action commentary.
The rating actions have been taken as part of a periodic review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. On balance, Fitch's outlook for the sector is stable. The 12 banks have continued to strengthen their balance sheets in 9M14. Capitalisation has improved materially over the past two years and liquidity remains sound. This strengthening balances continued pressure on earnings, particularly in securities businesses, and remaining material but unpredictable exposure to conduct and regulatory risks.
Fitch forecasts weak growth in the eurozone during 2015 while growth in the US and UK is expected to be somewhat stronger, which should help the GTUBs with a significant presence in these regions. Spikes in market volatility, most recently in October 2014, show that uncertainty remains over how expectations of rising interest rates in the US will affect financial markets. Our expectation is that rises in interest rates will be gradual and would follow improved prospects for the economy, which should help business volumes. Sharp and unexpected hikes in US interest rates would likely result in increased market volatility and, consequently, additional pressure on banks' earnings, although we believe that the GTUBs' risk appetite has declined.
Lower risk appetite should help the banks avoid material losses on trading positions but an adverse operating environment could result in a change of our outlook if earnings prospects suffer materially. For eurozone-focused banks, a prolonged deflationary scenario would put pressure on earnings and could result in a changed outlook.
KEY RATING DRIVERS - IDRS, VRs AND SENIOR DEBT
Citi's ratings are supported by its solid liquidity and capital levels. Citi's fully phased-in CET1 under Basel III improved to 10.7% at Sept. 30, 2014, higher than many of its U.S.-based GTUB peers. The company's liquidity profile is much improved with a large percentage of high quality liquid assets (HQLA) as a percentage of assets at Sept. 30, 2014 (22%). The company's capital and liquidity are much improved from pre-crisis levels, and key rating drivers.
Citi has also made considerable progress in winding down legacy higher risk assets in Citi Holdings, with non-core assets now comprising just 5% of consolidated assets. Citi has also de-risked its balance sheet in other ways, with a few examples including lower balances of trading assets, reduced volume and extended tenor of repos, and reduced and manageable exposure to leveraged lending.
The company also continues to make progress in meeting its strategic objectives. Fitch views the planned exit of consumer operations from 11 markets and the consumer finance business in Korea favorably as it helps to reduce future operational, compliance, and credit risk. Fitch views Citi's strategy as appropriate in light of the evolving regulatory and economic environment. Given the breadth and complexity of its global operations, continued streamlining of business operations and legal entities is viewed favorably from a risk management and creditor perspective.
Through the first nine months of 2014, Citi has made modest progress in improving its core earnings profile despite a challenging economic and operating environment. Despite this, the company's reported return on assets (ROA) in the third quarter of 2014 (3Q'14) period was 59 basis points (bps), which lags peer averages, and is below its 90bps ROA target for 2015. This takes into account the additional legal-related charges that were disclosed after earnings were first released.
Fitch's rating actions incorporate a forward-looking view of Citi's ability to execute on its strategy, including its ability to successfully meet financial targets, over the near- to intermediate-term. Although not currently assumed nor incorporated in today's rating action, Fitch is sensitive to increased risk taking on the company's part in order to meet its 2015 financial targets. As such, any perceived changes to the company's risk appetite will be monitored closely.
Fitch notes that Citi also compares favourably to many of its peers with regard to compliance with various regulatory rules, including compliance with fully phased-in requirements for Basel III capital ratios, the U.S.-based Supplemental Leverage Ratio at both Holding Company and Bank-levels, and the U.S.-finalized LCR rule. Its compliance is well ahead of phased-in timelines for these pending rules, and as such, its balance sheet and earnings profile have likely also already incorporated the impacts of all these rules. While Citi's higher relative reliance on short-term funding may translate into a higher G-SIB buffer when the U.S. rolls out its rules, this would be viewed favorably from a creditor perspective as it would entail even greater loss protection for unexpected losses.
Citi made significant strides in addressing some of its material mortgage-related issues. However, Citi is still exposed to potential litigation risk stemming from its role in setting interbank offered rates, foreign currency trading, credit default swaps and private-label securitizations. As such, Citi is still exposed to elevated legal risk and associated costs. Fitch's ratings incorporate an expectation that legal charges will remain manageable in the context of Citi's capital profile, though visibility into future legal-related costs is very limited. The restatement of earnings in the third quarter resulted from ongoing discussions with regulatory agencies related to previously-disclosed matters.
RATING SENSITIVITIES - IDRS, VRs AND SENIOR DEBT
Fitch sees limited near-term upward rating momentum given a relatively high and absolute rating. The company's complex organizational structure and reliance on more volatile capital markets revenues act as a key constraint to further upward movement to ratings.
Any unforeseen outsized fines, settlements or other legal-related charges could have adverse rating implications for Citi. Litigation charges have weighed down earnings for the largest banks, and will likely continue to impact earnings over the near term. Fitch notes there is very little visibility into legal-related risk for Citi or the industry, though Fitch's ratings action expects litigation costs will remain manageable relative to capital for Citi. However, a fine that was to deplete capital in a material way may lead to negative rating action.
Fitch still views Citi's risk management infrastructure as enhanced since the financial crisis, notwithstanding the CCAR qualitative objection and the risk management failures in the Mexican subsidiary. Citi's ratings could be vulnerable to a large operational loss or if an operational event calls into question Fitch's assessment of Citi's risk management function and its ability to accurately identify, monitor, and mitigate risks throughout the organization. In addition, a second CCAR objection due to qualitative reasons may result in a downgrade of the VR.
Downward pressure on the VR may also result from a material deterioration in capital or liquidity levels. It is the strength of the liquidity and capital profiles that underpin Citi's ratings. Fitch's ratings action incorporates an expectation that Citi will manage its capital and liquidity profiles relatively conservatively, and although capital distributions will likely increase over time, they will still be governed by regulatory stress testing and as such, remain reasonable. Fitch also expects a relatively conservative capital profile is appropriate in light of economic uncertainty, potential volatility in AOCI, and limited visibility into future legal risks.
KEY RATING DRIVERS - SUPPORT RATING AND SUPPORT RATING FLOOR
Citi's Support Rating (SR) and Support Rating Floor (SRF) reflect Fitch's expectation that there remains an extremely high probability of support from the U.S. government (rated 'AAA'/Outlook Stable by Fitch) if required. This expectation reflects the U.S.'s extremely high ability to support its banks especially given its strong financial flexibility, though propensity is becoming less certain. Specific to Citi, our view of support likelihood is based mostly on its systemic importance in the U.S., its global interconnectedness given its size and operations in global capital markets, significant deposit market share and its position as a key provider of financial services to the U.S. economy. Citi's IDRs and senior debt ratings do not benefit from support because Citi's VR is now equal to its SRF.
However, in Fitch's view, there is a clear intention to reduce support for G-SIFIs in the U.S., as demonstrated by the Dodd Frank Act (DFA) and progress regulators have made on implementing the Orderly Liquidation Authority (OLA). The FDIC has proposed its single point of entry (SPOE) strategy and further initiatives are demonstrating the U.S. government's progress to eliminate state support for U.S. banks going forward, which increases the likelihood of senior debt losses if its banks run afoul of solvency assessments.
RATING SENSITVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF are sensitive to progress made in finalizing the SPOE strategy and any additional regulatory initiatives that may be imposed on the G-SIFIs, including debt thresholds at the holding company. Fitch's assessment of continuing support for U.S. G-SIFIs has to some extent relied upon the feasibility of OLA implementation rather than its enactment into law (when DFA passed). A key hurdle that remains is whether sufficient contingent capital exists at the holding company to recapitalize without requiring government assistance.
Fitch expects that the SPOE strategy and regulatory action to ensure sufficient contingent capital will be finalized in the near term, but regardless of its finalization Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to revise Citi's SR to '5' and its SRF to 'No Floor' likely during the first half of 2015.
KEY RATING DRIVERS - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by Citi and by various issuing vehicles are all notched down from Citi's or its bank subsidiaries' VRs in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.
RATING SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of subordinated debt and other hybrid capital issued by Citi and its subsidiaries are primarily sensitive to any change in Citi's VR.
KEY RATING DRIVERS - HOLDING COMPANY
Citi's IDR and VR are equalized with those of its operating companies and banks, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries.
RATING SENSITIVITIES - HOLDING COMPANY AND OPERATING SUBSIDIARY
Fitch is now considering introducing a rating differential between the holding company and bank in the U.S. due to structural changes in the sector and the evolving regulatory landscape, as described in the special report 'U.S. Bank HoldCos & OpCos: Evolving Risk Profiles', dated March 27, 2014. This may result in a possible downgrade of Citi's holding company rating, an upgrade of operating company ratings, or no changes to ratings if Fitch's views the long-term debt requirement assigned to Citi as providing an insufficient amount of bail-in capital at the operating company level.
KEY RATING DRIVERS - SUBSIDIARY AND AFFILIATED COMPANY
The IDRs and VRs of Citi's bank subsidiaries benefit from the cross-guarantee mechanism in the U.S. under FIRREA, and therefore the IDRs and VRs of Citibank, N.A. and Citibank Banamex USA are equalized across the group.
The IDRs and VRs of Citi's other major rated operating subsidiaries are equalized with Citi's IDR reflecting Fitch's view that these entities are core to Citi's business strategy and financial profile. These entities include: Citigroup Global Markets Holdings Inc., Citigroup Global Markets Limited, Citigroup Global Markets Inc., Citigroup Derivatives Services LCC, Citibank Canada, Citibank Japan Ltd, CitiFinancial Europe plc, and Citibank International Limited (formerly known as Citibank International PLC), whose IDRs would be sensitive to the same factors that might drive a change in Citi's IDR.
RATING SENSITIVITIES - SUBSIDIARY AND AFFILIATED COMPANY
As the IDRs and VRs of the subsidiaries are equalised with those of Citi to reflect support from their ultimate parent, they are sensitive to changes in the parent's propensity to provide support, which Fitch currently does not expect, or from changes in Citi's IDRs.
To the extent that one of Citi's subsidiary or affiliated companies is not considered to be a core business, Fitch could also notch the subsidiary's rating from Citi's IDR.
KEY RATING DRIVERS - LONG- AND SHORT-TERM DEPOSIT RATINGS
Citi's uninsured deposit ratings are rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default. However, Citi's uninsured deposits outside of the U.S. do not benefit from rating uplift because they do not typically benefit from the U.S. depositor preference unless the deposit is expressly payable at an office of the bank in the United States. Since Fitch cannot determine which foreign branch deposits may be dually payable, they do not get the rating uplift.
KEY RATING SENSITIVITIES - LONG- AND SHORT-TERM DEPOSIT RATINGS
The ratings of long- and short-term deposits issued by Citi and its subsidiaries are primarily sensitive to any change in Citi's long- and short-term IDRs.
Fitch has affirmed the following ratings:
Citigroup Inc.
--Long-term IDR at 'A' with a Stable Outlook;
--Senior unsecured at 'A';
--Short-term IDR at 'F1';
--Support at '1';
--Support floor at 'A'.
--Subordinated at 'A-';
--Preferred at 'BB+';
--Market-linked notes at 'A emr'
--Viability Rating at 'a'.
Citibank, N.A.
--Long-term IDR at 'A' with a Stable Outlook;
--Long term deposits at 'A+';
--Viability rating 'a';
--Short-term IDR at 'F1';
--Short-term deposits at 'F1';
--Support at '1';
--Support Floor at 'A'.
Citibank Banamex USA
--Long-term IDR at 'A';
--Long-term deposits at 'A+';
--Short-term IDR at 'F1';
--Short-term deposits at 'F1';
--Support at '1';
--Support Floor at 'A';
--Subordinated at 'A-';
--Viability Rating at 'a'.
Citigroup Funding Inc.
--Senior unsecured at 'A';
--Short-term debt at 'F1';
--Market linked securities at 'A emr';
Citigroup Global Markets Holdings Inc.
--Long-term IDR at 'A';
--Senior unsecured at 'A';
--Short-term IDR at 'F1';
--Short-term debt at 'F1'.
Citigroup Global Markets, Inc.
--Long-term IDR at 'A'
--Short-term IDR at 'F1'
--Senior Secured at 'A';
--Short-term debt at 'F1'.
Citigroup Global Markets Limited
--Long-term IDR 'A';
--Short-term IDR 'F1';
--Senior unsecured long-term notes 'A';
--Short-term debt at 'F1'.
Citigroup Derivatives Services LLC.
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Support at '1'.
Citibank Canada
--Long-term IDR at 'A';
--Long-term deposits at 'A'.
Citibank Japan Ltd.
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Long-term IDR (local currency) at 'A';
--Short-term IDR (local currency) at 'F1';
--Support at '1'.
CitiFinancial Europe plc
--Long-term IDR at 'A';
--Senior unsecured at 'A';
--Senior shelf at 'A';
--Subordinated at 'A-'.
Canada Square Operations Limited (formerly Egg Banking plc)
--Subordinated at 'A-'.
Citibank International Limited (formerly known as Citibank International PLC), --Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Support affirmed at '1'.
Commercial Credit Company
--Senior unsecured at 'A'.
Associates Corporation of North America
--Senior unsecured at 'A'.
Citigroup Capital III, XIII, XVIII
--Trust preferred at 'BBB-'.
Additional information is available at www.fitchratings.com.
