Fitch Affirms Citibank Korea at 'A-'; Outlook Stable
KEY RATING DRIVERS
IDRS AND SUPPORT RATING
The affirmation of CKI's IDRs and Support Rating reflects Fitch's view that there is an extremely high probability that the bank would be supported by its ultimate owner, Citigroup Inc. (A/Stable/a), if required. This view is based on the strategically important role CKI plays in Citigroup's extensive international banking operation; uncertainty about CKI's long-term performance prospects amid the challenging operating environment in South Korea, which is a non-core consumer banking market to Citigroup; the two entities' integrated risk management; and reputational risk to Citigroup if it allowed the Korean subsidiary to default.
CKI is an indirect subsidiary of Citibank, N.A. (A+/Stable/a), which is a material legal entity (MLE) of Citigroup. It operates more independently than some of Citigroup's other international subsidiaries, with a good franchise in South Korea in its own right. Its Long-Term IDR is notched down once from the VR of Citigroup and its operating entities in the US to reflect the lower integration and independent franchise.
Like most of Citigroup's international subsidiaries, CKI is not specifically named as a MLE of the group, and as a result Fitch believes it will be less of a priority for Citigroup to support CKI in the event the parent undergoes a resolution. Global standards for bank recovery and resolution plans, the designation of MLEs and the positioning of internal total loss-absorbing capacity (TLAC) continue to evolve, and Fitch may reassess parent and subsidiary linkages as these issues become more permanent.
The Stable Outlook reflects the Stable Outlook on its ultimate parent Citigroup (see "Fitch Affirms Citigroup's L-T IDR at 'A'; Outlooks Stable; Upgrades Citibank, N.A." dated 19 May 2015 at www.fitchratings.com).
The 'bbb+' Viability Rating (VR) mainly reflects CKI's very strong capitalisation and strong ordinary support from Citigroup, especially in risk management and foreign-currency funding/liquidity. The VR also takes into account its weakening local franchise, which contributes to noticeably higher reliance on wholesale funding than its peers, pressure on profitability, and loan quality that is well below the industry average (a function of above-peer risk appetite).
CKI's performance in recent years has been below that of its peers and long-term prospects will depend on whether it can successfully realign its business, given the challenging operating environment in Korea - especially for foreign bank subsidiaries.
Fitch expects CKI's loan quality to improve gradually if it successfully repositions its retail portfolio to target top-tier consumers. CKI's precautionary-and-below loan (PBL) ratio of 4.2% at end-1H15 was still significantly worse than the commercial banks' average of 2.3%. The PBL ratio has improved from the peak 7.2% at 1Q14, mainly through rapid reduction of poor-quality credit card receivables and expansion in relatively higher quality unsecured consumer loans.
CKI's loan portfolio has shifted significantly towards unsecured household loans. Over the last four years it reduced corporate loans, with property rental loans (8% of its total loan book at end-2014) the only corporate segment to post growth. About 40% of its total loans at end-2014 were non-mortgage consumer loans (about 30% after adjusting for BIS unqualified mortgages), compared with the commercial banks average of 18% (about 10%).
CKI cut its staff by 15% and branch network by 30% in 2014 to reduce personnel and G&A expenses. But the cost-saving efforts have been more than offset by the decline in net interest income, which was driven by policy rate cuts and the shift in its loan portfolio from the high-spread credit card receivables to higher quality household loans.
Fitch estimates CKI's underlying profitability, as measured by return on assets (ROA), will be 0.3% for the foreseeable future, which is significantly short of the target of about 1% ROA set by the parent. It has a limited buffer against unexpected shocks. Fitch does not rule out further downsizing at CKI in a few years. The relatively strong 0.7% ROA in 1H15 was mainly because of the sizeable realised gains from its available-for-sale securities portfolio and a sharp decline in credit costs, which might have resulted from CKI's unseasoned unsecured consumer loans.
Fitch expects CKI to maintain its Fitch Core Capital ratio of 16.7% at end-1H15, given limited asset growth and internal capital generation prospects. Unlike most other local banks, CKI uses the standardised approach to measure credit risk, which is consistent with the global group's practice.
The on-going business realignment has resulted in a smaller retail deposit base. CKI's loans/customer deposits ratio has been deteriorating since 2011. It rose to 141% at end-1H15 from 119% at end-2013, and compared with the local commercial bank average of about 124%. However, its sizeable liquid securities portfolio and liquidity support from the group provide a large cushion for any reasonable amount of challenges to its liquidity/funding in the future. Almost all of CKI's foreign-currency funding comes from the group.
IDRS AND SUPPORT RATING
The IDRs and Support Rating are sensitive to any change in assumptions around the propensity or ability of Citigroup to provide timely support to the Korean subsidiary. CKI's ratings would be directly affected if Citigroup's ratings or its relationship with its parent were to change. They would also be affected by the evolution of Citigroup's recovery and resolution plan.
The bank's VR is sensitive to a change to Fitch's assumptions around CKI's underlying profit structure, company profile, and operating environment.
Fitch may downgrade the VR if CKI's realignment strategy is unsuccessful or if there are prolonged delays to the execution of the strategy, which could manifest in further weakening in its local franchise and key financial metrics. This includes underlying profitability, loan-to-deposit ratio, and loan quality remaining noticeably weaker than those of its peers.
Fitch does not expect to upgrade the VR in the near future because of CKI's shrinking franchise and weakening underlying profitability and liquidity/funding profile. The VR is also limited by CKI's large exposure to non-mortgage retail loans.
The rating actions are as follows:
Long-Term Foreign-Currency IDR affirmed at 'A-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1'
Viability Rating affirmed at 'bbb+'
Support Rating affirmed at '1'.