Germany-Based Citigroup Subsidiary Citigroup Global Markets Deutschland AG Rated Preliminary #A+/A-1#; Outlook Stable

Stocks and Financial Services Press Releases Thursday April 26, 2018 17:01
FRANKFURT--26 Apr--S&P Global Ratings

FRANKFURT (S&P Global Ratings) April 26, 2018--S&P Global Ratings said today that it had assigned its preliminary 'A+' long-term and 'A-1' short-term issuer credit ratings to Germany-based Citigroup Global Markets Deutschland AG (CGMD). The outlook is stable.

The final ratings will depend on the successful execution of the proposed transformation (in line with the announced plans of de-banking and change in control) and the operational readiness of CGMD in accordance with its extended products and services offering.

Accordingly, the preliminary ratings should not be construed as evidence of the final rating. If the transformation does not proceed within the next 90 days as we expect, or if operational conditions are materially different from the assumptions we are considering, we may withdraw or revise our ratings. Factors that could influence a revision include, but are not limited to, the significant revision of the transformation plan by Citigroup.

We expect CGMD will be directly owned by Citigroup Global Markets Ltd. (CGML; A+/Stable/A-1) effective on April 27, 2018, with the ultimate shareholder being Citigroup Inc. (BBB+/Stable/A-2). Our preliminary rating on CGMD is 'A+' because we consider CGMD to become a core operating subsidiary of the Citigroup group ('a+' group credit profile).

Our preliminary ratings on CGMD are based on our expectation that the transformed company will become a closely linked and fully integrated subsidiary of the ultimate parent, Citigroup, with a strong, long-term commitment of support from the group's senior management. We expect CGMD would be provided with a sufficient, intragroup long-term debt facility from the parent and that it is highly unlikely to be sold. We believe that CGMD will demonstrate strong capitalization and performance in line with that of the Citigroup group, and will share the Citigroup brand.

The main rationale behind the transformation of CGMD is Citigroup's precautionary assumption that from the first quarter of 2019 the U.K. could lose its "passporting" abilities within the European Economic Area (EEA), and therefore be required to operate under a third country regime without a granted equivalence under EU legislation. To shield itself and its EEA clients from any potential disruptions, Citigroup has decided to transform the CGMD established in 1986 into a new, non-banking broker-dealer financial institution. Although the legal conversion through de-banking and change of control is scheduled to take place on April 27, building the required capabilities (including access financial market infrastructures) may take several more months. CGMD anticipates that it will be operationally ready as an investment firm in the fourth quarter of 2018. The change of control has already been approved by The Federal Financial Supervisory Authority (BaFin) in Germany, and, following its successful completion, CGMD will become a wholly owned subsidiary of London-based CGML.

In its new form, we assume CGMD will retain its existing equity warrants trading business, as well as capital markets origination, including foreign currency and equity research sales coverage. Over time, we expect CGMD could provide additional investment and ancillary services to Citigroup's markets and securities services or capital markets origination clients within the EEA. The company currently generates 80% of its revenues with German clients, 10% with French clients, and 10% with other EU clients, but expects to diversify over the next few years to be more equally spread across the EEA. CGMD also has a plan to open new branches in France, Spain, Italy, and Ireland.

Prior to the transformation, CGMD posted pre-tax profit of EUR67 million in 2017 (2016: EUR45 million), in accordance with German Accounting Standards. Its balance sheet size amounted to EUR10 billion, consisting predominantly of warrants-related positions, and was approximately in line with the level of previous years. We estimate its market share in the German investment banking at about 5.6% over 2017, slightly behind the No.3 and No.4 market leaders.

We expect CGMD's revenue components over 2018-2020 will consist mainly of investment banking fees, warrants sales, and trading, but also of intermediation fees for rates, derivatives credit, and foreign exchange.

Following migration of its banking business to Citibank Europe PLC, we expect CGMD to continue to repatriate its profits annually to its new direct shareholder, CGML. We initially estimate the balance sheet of the transformed CGMD to significantly drop following the 2018 transformation and gradually increase to the currently reported size (2017: EUR10 billion) towards 2020 on new business generation or re-direction of existing Citigroup customers. CGMD's currently very high capitalization (Tier 1 ratio of over 50% as of Dec. 31, 2017) is expected to drop from 2019, below 20%, due to a planned increase in risk-weighted assets.

The bank does not plan to take on any external debt financing, thus liquidity and funding are expected to solely include high quality liquid assets consisting mainly of the EUR and US$ government papers; repurchase agreements and reverse repurchase agreements; a multi-year, long-term loan facility provided by U.S.-based Citicorp LLC; or direct capital injections from CGML.

We equalize the preliminary ratings on CGMD with the ratings on Citigroup's core operating subsidiaries for which we recognize additional support from the group's additional-loss absorbing capacity (ALAC), as we assume that CGMD would be recapitalized by group resources in the hypothetical event of a bail-in resolution concerning Citigroup.

On April 19, 2018, we published new criteria for assigning resolution counterparty ratings (RCRs) to certain financial institutions. We consider that there is an effective resolution regime in Germany, and that an RCR may be relevant to CGMD under these criteria. In coming weeks, we will be reviewing our analysis of the resolution regime across countries, including Germany. This review will identify liability categories, if any, that are protected from default risk by structural or operational features of a given resolution framework. Upon completion of this review, we may assign RCRs under our new criteria to banks located in Germany, including CGMD.

The stable outlook on CGMD reflects that on core operating bank entities of the Citigroup, and our view that Citigroup has both the capacity and willingness to provide full support if needed.
Therefore, a rating action over the next 12-24 months on CGMD would most likely follow a revision, upward or downward, of the 'a+' group credit profile of Citigroup.

We could also lower the ratings on CGMD if we no longer considered it to be a core subsidiary of Citigroup, for example because the purpose and plans of its transformation had changed, or if we thought that CGMD would be unable to benefit from support in a bail-in resolution of the group. However, we consider such developments as remote. The U.K.'s impending exit from the EU in March 2019 requires Citigroup to reorganize its activities servicing EU clients, particularly in investment banking and sales and trading. This may require reallocating activities from the U.K. to other EU countries. Therefore, we think it is unlikely that CGMD's role would be weakened.

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