Analysts are weighing in positively on the big division swap between Citigroup Inc. and Legg Mason Inc. today, which saw Citi trade its asset management division to Legg Mason for its brokers. Legg followed up by buying a European fund of hedge funds manager.

Dominion Bond Rating Service has confirmed its ratings for Citigroup, saying it views the transaction as positive for Citigroup. Citigroup will add 1,354 financial advisors with US$93 billion in assets under management and 127 branch offices in 22 states, which complement its Smith Barney footprint and existing 12,189 financial consultants. “This bolsters Citigroup’s retail brokerage unit, which is a key component of Citigroup’s diverse distribution businesses, and makes it more difficult for competitors to build scale. The retail brokerage unit and other units at Citigroup are also likely to benefit from the ability to provide high-performing funds to its client base,” it says.

DBRS notes the transaction does marginally reduce Citigroup’s financial flexibility, particularly with regard to earnings diversity, as well as its ability to service the holding company obligations. “However, this reduction is largely mitigated by the fact that the transferred businesses contribute only 1% of group net income in 2004,” it says. Also, DBRS sees the benefit to Citigroup of a stronger retail brokerage unit selling better performing products more than offsetting this reduced diversity.

The rating agency believes there will be significant opportunity in redeploying the available capital from this highly capital-intensive business line into higher growth, higher return opportunities. It notes that Citigroup’s asset management business has not been among the leaders in performance in recent years, and that substantial investment and time would be needed to enhance performance. “Moreover, given heightened concerns about conflicts of interest between the internal fund providers and distribution, Citigroup is better positioned to provide its clients with the best products with this transaction,” it adds.

DBRS adds Citigroup’s other core business lines, including consumer banking, corporate and investment banking, and wealth management continue to provide significant global and business earnings diversity, each of which underpins current ratings levels

The transaction is valued at US$3.7 billion, which gives Citigroup a 14.4% ownership in Legg-Mason and an after-tax gain of approximately US$1.6 billion. Citigroup reported that businesses transferred to Legg Mason generated about US$241 million in 2004, while the businesses it is acquiring generated about US$183 million. These earnings are relatively modest at about 1% of Citigroup’s earnings from continuing operations of US$20.3 billion in 2004. Citigroup is transferring about US$437 billion in AUMs, split about evenly between retail/private bank and institutional assets.

As for Legg, Fitch Ratings has assigned a long-term senior debt rating of ‘A-‘ to the firm, noting that the rating outlook is positive. It notes that in addition to the asset swap with Citigroup, the firm is buying hedge fund of funds manager Permal for cash and stock.

Fitch says it believes the pending transactions will help realize Legg Mason’s core strategy to become a prominent global asset manager. Upon close of the transaction, Legg Mason’s assets under management will be roughly US$830 billion, making it the fifth largest global money manager. Assets under management will be diversified in terms of both asset classes and client segments, it adds.

“The new businesses produce strong cash flows and are expected to be accretive in the first year, excluding a restructuring charge,” it says. Projected debt levels will increase but will remain manageable, in Fitch’s view.

“The transaction poses potential challenges, including the integration risk inherent in such a large acquisition, and the need to retain key portfolio managers and other investment professionals. Fitch believes that should these challenges be resolved successfully, LM could merit a higher rating over the intermediate term,” it adds.