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Fitch: Citigroup's Rating Outlook Remains Negative
Citigroup Inc.'s (Citi) Rating Outlook will remain Negative until profitability is restored, exposure to topical areas is further reduced, and asset quality stabilizes, according to
Fitch Ratings
. Overall, Citi's financial issues remain manageable in Fitch's opinion. Citi's ratings also continue to be supported by its enormous and diversified franchise, as well as its improved capital base. The following commentary reviews Citi's fourth-quarter 2007 (4Q'07) results and provides an update on key topical areas including CDO exposure, capital raising initiatives, U.S. consumer and real estate loan exposure, leveraged finance and structured investment vehicles (SIVs). In early November, Fitch downgraded Citi's long-term IDR to 'AA' from 'AA+' with a Negative Rating Outlook following the bank's announcement of massive charges for subprime-related CDOs. Since that time, Citi has raised sizable Tier I capital, more than offsetting the capital impact of its CDO charges. Aggressive capital raising efforts have alleviated pressure on Citi's ratings. In fact, capital raising efforts went well beyond Fitch's expectations at the time of the downgrade, while actual CDO charges were generally in line with Fitch's expectations. Citi's charges for subprime-related securities totaled $18 billion for 4Q'07, generally in line with Fitch's expectations. This total includes $15 billion in charges for super senior CDO exposure and $3 billion for exposure in the lending and structuring area. Given the composition of Citi's exposures by type and vintage, its charges appear to be at least as conservative as those taken by other major U.S. financial institutions. Nevertheless, further market erosion could naturally result in additional charges. Ultimately, Fitch believes that some of the recognized losses may eventually be recovered as current mark-to-market charges reflect very dire assumptions about default probabilities and loss severity for U.S.-based mortgages. 4Q'07 charges have resulted in reduced super senior CDO exposure (to $29.3 billion net compared to $42.9 billion at the end of 3Q'07). Exposure in the lending/structuring business has been reduced to $8 billion from $11.7 billion. For 4Q'07, CDO charges were by far the largest factor contributing to bottom line losses of $9.8 billion. Other considerable factors were a $3.3 billion reserve build for the U.S. consumer portfolio and fixed income trading losses. In contrast, the international consumer segment and global wealth management continued to record solid performances. For the full year, Citi recorded net profits of just $3.6 billion versus $21.5 billion in 2006. Given earnings and capital pressure, Citi slashed its common dividend by 40%, representing a $1.1 billion reduction per quarter. This action increased the prospect of internal capital generation in future periods. In the aftermath of its November announcement, Citi has aggressively raised fresh Tier I capital. In 4Q'07, Citi sourced $7.5 billion from the
Abu Dhabi
Investment Authority combined with $4.3 billion from trust preferred issues. Today, Citi announced an additional infusion of $12.5 billion from private investors bringing the total raised to $24.3 billion since November. An additional $2 billion will likely be raised through a public issue of preferred stock. These issues boost Citi's Tier I ratio to over 8% pro forma from 7.3% at the end of 3Q'07. Disciplined balance sheet management also helped Citi's capital ratios. Recent preferred equity issues are relatively high cost, given the current financial environment and the scope of Citi's challenges. Nonetheless, capital raising efforts are considered a sizable net positive. On a pro forma basis, Citi's Tier I ratio is above management's targeted minimum of 7.5%. In 4Q'07, Citi dramatically boosted loan loss reserves for its U.S. consumer business following a reserve build in 3Q'07. This action reflects higher delinquencies, a difficult outlook for U.S. real estate as well as a potential economic slowdown. For the consumer portfolio overall, loan loss provisions continued to exceed NCOs resulting in a 48 basis point increase in consumer loan loss reserves to 2.09% of consumer loans (172% of consumer NPLs). Higher delinquencies mostly emanated from the mortgage portfolio, including home equity loans. On the other hand, credit card delinquencies remained comparatively stable, exhibiting only a modest increase in 4Q'07. However, the credit card portfolio will likely face greater credit headwinds in 2008. Relative to many
U.S. Bank
s, Citi's loan exposure to U.S. real estate is proportionally more moderate, thanks to its geographic breadth and diverse product mix. Nevertheless, U.S. real estate remains an important asset quality issue for Citi. Direct subprime mortgage exposure was $23 billion or 1% of total assets and total home equity exposure is $63 billion or 3% of total assets. Despite the rise in delinquencies in recent periods, Citi's subprime mortgages continue to exhibit lower default levels compared to the industry average. Citi's subprime mortgage portfolio has benefited from a relatively low portion of low doc loans and avoidance of riskier products. Looking at the home equity portfolio, $21 billion has a combined LTV greater than 90%. This piece of the home equity portfolio has been the most problematic (in common with many other banks). Despite the considerable reserve build in 4Q'07, Fitch remains concerned that housing market weakness and a possible economic slowdown could necessitate further provisioning needs. On a positive note, Citi has proportionally lower construction loans and
Commercial
real estate loans compared with many
U.S. Bank
s. Since peaking out at mid-year 2007, leveraged finance exposure (including commitments) has declined considerably. However, exposure remains a sizable $43 billion at the end of 4Q'07, compared to $57 billion at the end of 3Q07 and $69 billion at the end of 2Q07. Of the fourth quarter total, $22 billion is funded and $21 billion is unfunded. Citi and other banks were able to sell down exposure early in 4Q'07, but since that time buyer appetite has generally decreased. Fitch's concern in this area has diminished to an extent, owing to a reduction in gross exposure and mark-to-market charges taken to date. However, any significant slowdown in the U.S. economy could result in additional charges and continued difficulties in selling down exposure. Relative to other topical issues, Citi's exposure to its seven Citi-advised SIVs has been comparatively moderate. In mid-December 2007, Citi announced it will consolidate these SIVs and commit to a liquidity support facility. The Tier I capital impact is only 16 basis points (bps) from SIV consolidation. SIV assets of $49 billion (net of cash) consist of highly-rated debt instruments with a minimal U.S. subprime component. Through asset sales, SIV assets have been reduced from $87 billion in August 2007. Continued asset reductions are expected to be the first source of repayment for the SIV obligations. If insufficient asset sales take place, then the SIVs can draw on the Citi facility to meet obligations. To date, third party capital (market value: $2.5 billion at mid-December) has been more than sufficient to cover charges on asset sales and portfolio markdowns. Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
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