The Hindu Business Line : S&P keeps Citi on credit watch

The long-term `AA-' counterparty credit rating assigned by Standard & Poor's Ratings Services to Citigroup Inc will continue to be on credit watch with negative implications and the same is unlikely to fall more than one notch by the yearend, the rating agency said in its update on the US-based banking giant.

The present rating to Citigroup was assigned by S&P on September 29. S&P said it will incorporate asset-quality issues into its stand-alone assessment of Citi, which excludes expectations of extraordinary government support.

Thus, the stand-alone assessment of Citi will likely be lower than the final rating reflecting the government support.

Bailout package

The rating agency is of the view that the immediate package is sufficient to limit the downside risk represented by the troubled assets and also remove the causes of a crisis of confidence that could have overtaken the organisation.

Standard & Poor's credit analyst Ms Tanya Azarchs said, while Citigroup continues to have substantial untapped access to the Federal Reserve Bank's lending facilities, at issue are the problem assets that raised concerns about further deterioration and write-downs.

"We believe that the markdowns for the collateralised debt obligations of asset-backed securities that initially led to large losses are largely behind the company.

"However, the bank has $42 billion of commercial real estate loans and securities, and $13 billion Alt-A mortgage securities that could suffer further market-value erosion. In addition, the consumer loan portfolios are deteriorating rapidly," she said.

"We believe that losses on these assets would preclude a near-term return to profitability, although the decision no longer to mark the securities to market will reduce reported losses," she said.

"We expect the Government support to reduce the impact of deteriorating asset quality on the ratings and help to restore confidence in the company. As a result, we no longer believe that ratings would fall more than one notch by the yearend. However, we will provide our stand-alone assessment of creditworthiness, which excludes government support. This assessment could be lower than the issuer credit rating, to reflect the potential for substantial asset-quality deterioration," the analyst added.

Message of support

The guarantee package on $306 billion of assets provided by the US Government as well the equity investment are, according to the rating agency, a clear message of support for Citigroup and other systemically important banks.

"In particular, we believe the statement by the US Government that it will "use all of our resources to preserve the strength of our banking institutions" is an unprecedented and powerful expression of implicit support during at least the next two years, in our opinion, even if more than the current package were to be needed, which we do not expect. In our view, the immediate package is sufficient to limit the downside risk represented by the troubled assets. It should also remove the causes of a crisis of confidence that could have overtaken the organization," said the analyst.

Govt guarantee

The US Government is investing in $20 billion of preferred stock that is redeemable at Citigroup's option for common stock or cash. In return for the guarantee, Citigroup is issuing an additional $7 billion of preferred shares (8 per cent yield) to the Government, and granting warrants for 254 million shares at a strike price of $10.61 each. The warrants associated with both this new preferred stock and the $25 billion issued earlier are equivalent to an estimated 7.8 per cent Government stake in Citigroup.

The guarantee covers 90 per cent of losses in excess of existing reserves plus $29 billion of losses on $306 billion of largely commercial and residential real estate-related securities. The guarantee remains in place for five years for commercial and 10 years for residential real estate assets.

S&P is of the opinion that most of the problematic real estate-related assets and other assets are covered by the guarantee, even though they represent a modest part of Citigroup's $2-trillion balance sheet.

For regulatory capital calculation purposes, the $306 billion of assets will carry a risk weighting of 20 pr cent (down from 100 per cent). This frees up an additional $16 billion of regulatory capital. As a result of these various actions, Citi's Tier-1 capital ratio will be very strong at 14.8 per cent.

Citigroup will carry the mark-to-market securities in the available-for-sale or held-to-maturity portfolios, which do not require changes in market value to be reflected in income. This should cushion the volatility arising from valuations that would deviate from these assets' economic value.

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