How Citi's $12.7B Asset Sale Fits Into Its Long-Range Capital Plans

Implementation of Basel III remains years away, but Citigroup Inc. is wasting little time in unloading assets that will look a lot less attractive under the new regulatory framework.

At the end of the first quarter, Citi reclassified $12.7 billion of assets that it previously planned to hold to maturity, transferring them to the trading book to hasten their roll-off from the balance sheet. To date, the company has sold nearly three quarters of those assets, mainly at or above their marked prices.

The reclassified assets — a mix of mortgage securities, auction-rate securities and corporate loans — would carry higher-than-average risk weightings under Basel III, requiring that more capital be held against them.

"As you start to move into a Basel III environment, we were able to make the case to transfer those assets out of hold-to-maturity and into trading," Citi Chief Financial Officer John Gerspach said on a conference call Monday with reporters. "It wasn't necessarily a pricing type of decision. It really was more of a Basel III decision than anything else."

But improvements in pricing no doubt made it an easier decision to sell the assets. It also helps that Citi finds its standing in the market sufficiently rehabilitated to withstand the $709 million impact against first-quarter earnings that was caused by the assets' reclassification.

"When we looked at where the markets are today, it seemed to be a time when we could take a hit, but it was worth taking the hit now in order to get the Basel III risk-weighting benefit in the future," Gerspach said.

Including the charge related to the asset transfer, Citi's first quarter net income was $3 billion, or 10 cents a share, more than double the net income reported for the fourth quarter, but down 32% from the first quarter of 2010.

Versus the year-ago period, revenue was lower by 22%, expenses were higher by 7% and the company failed to grow the average loan balance for its North American retail banking business.

But loan growth elsewhere was impressive, particularly in Asia and Latin America. Within Citicorp, the collection of businesses and assets that the company looks upon as its continuing, core operations, loans grew 10% year over year, with a 6% increase in consumer lending and a 16% increase in corporate lending.

Revenue for the Citicorp division was $16.5 billion, up 16% from the fourth quarter but 11% lower than in last year's first quarter. Revenue from Citi Holdings, the assets and businesses that Citi plans to sell, discontinue or allow to run off through maturities, has been cut in half in the past year, to $3.3 billion. At the end of the first quarter, assets in Citi Holdings totaled $337 billion, down a third from the same period a year earlier.

The remaining assets in Citi Holdings represent "17% of Citi's [total] assets, or 31% on a risk-weighted basis," Standard & Poor's equity analyst Erik Oja wrote in a note to clients.

The bulk of the assets in Citi Holdings come from the company's North American consumer lending businesses, mainly in the form of mortgages, personal loans and credit cards that Citi administers on behalf of major retailers. The "special asset pool" portion of Citi Holdings, which included the $12.7 billion of assets transferred into the trading book, stood at $73 billion at the quarter's end, down 9.4% from the fourth quarter.

By speeding up its timetable for shedding assets that will be assigned higher risk weightings, Citi is in a better position to meet its goal of achieving a Tier 1 capital ratio in the 8% to 9% range, under Basel III rules, next year. That would put the company well ahead of the requirements laid out in September by the Basel Committee on Banking Supervision.

Basel III would not officially take effect until 2013, when banks would have to show a minimum Tier 1 capital ratio of 4.5% and a minimum common equity ratio of 3.5%. Tighter standards, along with a capital conservation buffer, would be phased in over subsequent years, so that by January 2019 banks would have to have a Tier 1 capital ratio of at least 6%, a common equity capital ratio of at least 4.5% and a capital conservation buffer of 2.5%.

Citi officials would not reveal how its Tier 1 capital ratio looks today under Basel III standards. Under the current framework, it has a Tier 1 common ratio of 11.3%.

Showing a strong capital position in 2012 will be especially important for Citi as it aims to return more capital to shareholders — beyond the penny-a-share quarterly dividend it will be allowed to pay out this year following a regulatory review that concluded in March. Speaking to analysts Monday, Citi Chief Executive Vikram Pandit said the return of capital could come in the form of share buybacks as well as higher dividend payouts.

"I think our preference would be to do both," Pandit said. "We completely appreciate the value of the stock and the fact that it's trading below book value — that will be a significant influence in our decision" about how to deploy capital.

Citi shares had risen 5 cents in late trading Monday to $4.47.

International operations accounted for 62% of the Citicorp division's revenue, and 72% of its profit. Citi has long played up the value of its strong presence overseas, particularly in markets where the economy has been faster to recover. Pandit trumpeted Citi's geographic breadth when an analyst on Monday's call asked him to comment on Standard & Poor's reducing its outlook on the United States' triple-A credit rating.

"We're glad we're in 100-plus countries to start with, because there is a level of diversification that goes with that," Pandit said. Admitting he had no special insight into S&P's analysis — he said he hadn't yet read the credit rating firm's report — he offered that he has "full confidence in our administrative and our legislative policies to get our country to the right place."