SA-CCR halts Citi’s buybacks plan

Bank will pause stock buybacks until new year to mitigate new methodology impact and create extra capital headroom

The adoption of the new standardised approach to counterparty credit risk (SA-CCR) is set to shave 50 to 60 basis points off Citi’s Common Equity Tier 1 (CET1) ratio, forcing the bank to temporarily pause stock buybacks until the new year, its chief financial officer Mark Mason said at the Goldman Sachs 2021 US Financial Services Conference on December 8.

Risk-weighted assets (RWAs) – the ratio’s denominator – are projected to inflate by between $60 billion and $65 billion due to the new rules on how to calculate capital charges for derivatives.

 

 

Citi’s standardised RWAs totalled $1.3 trillion at end-September. Mason’s forecast implies that, had the new methodology already been in place, the figure would have been as much as 8% higher and its CET1 ratio as low as 11.1%, and barely 60bp above the bank’s current minimum requirement.

The bank reported a standardised CET1 ratio of 11.7% in the third quarter, down 18bp from three months prior.

What is it?

SA-CCR replaces the Basel Committee on Banking Supervision’s previous standardised CCR methodology. It is intended to be a risk-sensitive methodology that differentiates between margined and non-margined trades and recognises netting benefits.

Broadly speaking, SA-CCR aims to capture a firm’s exposure to the default of one or more of its trading counterparties. It uses a formula that calculates the potential future exposure of any defaulted trades and the cost of replacing the trades. The replacement cost of the derivative can be significantly reduced within the formula if a portfolio is collateralised. Offsetting trades within a netting set can also cut the potential future exposure.

However, on top of these two elements of the formula, a so-called ‘alpha’ scalar of 1.4 is applied, adding 40% to whatever the sum of the replacement cost and potential future exposure is. The final figure is the total exposure-at-default.

Unlike European Union banks, which adopted SA-CCR at the same time at the end of June 2021, US regulators allowed individual lenders to adopt the new framework ahead of the 2022 deadline.

Why it matters

For those US dealers that, unlike Morgan Stanley and Bank of America, didn’t adopt SA-CCR early, the writing’s on the wall. They now need to pull all levers to create capacity to absorb SA-CCR in a way that doesn’t trip up capital distributions too much.

Aside from pausing buybacks until January, Citi has been looking to lower capital pressure by jettisoning low-yielding RWAs and compressing trades, Mason said.

All eyes are now on the other top swap dealers that are yet to adopt SA-CCR – which include Goldman Sachs, JP Morgan, Wells Fargo and the US unit of Barclays.

Their decision to delay the switch until the January deadline means any tailwind SA-CCR may have provided in upcoming stress tests – Morgan Stanley’s main rationale for the early switch – won’t manifest until late 2022, two rounds of tests from now.

At Citi, saddled with one of the toughest stress test-based capital buffers, executives may have to tread carefully so that the halted buybacks don’t look like they could have been prevented through early action.

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