Tag Archives: Citigroup

(Revised) Citigroup in the Hot Seat

On March 24th, I wrote a post about’s the Fed’s stress test. 29 out of 30 banks passed the test, but the bank that fell below the Fed’s standards was Citigroup. To re-summarize what the stress test actually is- the Fed takes each particular bank’s balance sheet and puts it through a rigorous simulation involving high inflation and severe unemployment. The first portion of the test involves quantitative measures such as leverage ratios, capital levels, and other quantitative measures that test whether the bank can withstand an economic shock. From here, the Fed checks the bank’s capital levels over time. Each bank later proves itself to the Fed through a qualitative test, which measures how the bank would pay dividends and manage capital given that the economy is operating in a recession.

Since the Fed gave its decision on Wednesday, shareholders are not happy because Citi will not be receiving the Fed’s permission to increase dividends and share buybacks. Shareholders reacted by selling Citigroup stock, which is now down about 4%, falling $2.71 to $47.45. Mentioned in WSJ, one portfolio manager at a hedge fund “said he liquidated his Citi holdings after the failed stress test. The investor said he was frustrated because he had had discussions over the past six months with Chief Financial Officer John Gerspach and members of the bank’s investor-relations team, and had been reassured that the bank’s relationship with regulators ‘was improving every single day,’ the investor recalled”.

However, it seems that Citigroup’s capital levels aren’t the actual problem. Their capital levels were actually above the Fed’s minimum threshold of 5% (during the simulated economic recession)- at 6.5% to be exact. The concern was that Citigroup failed the second portion of the test, in which the bank failed to sufficiently prove to the Fed how it would successfully manage capital through a recession. Another reason why the 2014 test was such a big concern was because Citigroup failed to pass the 2012 stress test as well. Even though Citigroup passed the 2013 test, the Fed notified the bank that they needed to refine their risk models and loss estimates. Apparently, Citigroup underestimated its projected losses by about $15 billion in 2013.

Since the 2008 financial crisis, the second portion (qualitative portion) has became much more important. It measures how the bank would actually manage a recession, incorporates past lessons and concerns, takes into account how a bank handles its technology, and also tests how it would handle costly litigation. In my opinion, I think the Fed stepping up their game is a great thing. Even though banks may not like the tightening in regulation, it sends the message that banks need to step up their game as well. For the most part, the Fed is seeing good results. This is evident through 29 out of 30 banks passing the test and according to the WSJ article, banks have more than doubled capital levels since 2009. I think that the market’s perception is what’s most important. Even though Citigroup has ample capital, it needs to convey to its share holders that it can manage this capital throughout a recession. Although the first portion of the stress test is important, the second qualitative portion is what’s practical and relevant for shareholders.

In recent news, the topic of Citigroup failing the Fed’s stress test has become even more controversial. After reading more on the topic, my opinion of the test has also changed. Given that the test was only created in 2009 after the financial crisis, it is still an its nascent stages. Apparently, the portion of the test (qualitative portion that measures banks’ predictions about losses under stressed conditions) that Citigroup failed is considered a “building block” of the test. The Fed is still improving this portion of the test and commented that many other banks have “work to do” in these areas. According to Mr. Corbat, CEO, he believed that the bank had settled with the Fed a 2015 timeline. However, the Fed judged that Citi hadn’t made enough progress on the issues that required more attention. I think that a reason for this may be that Citigroup also failed the stress test in 2012, so the Fed may have kept this in mind while basing their decision. This also brings up the issue of the Fed incidentally failing one bank just to prove to investors that the test is actually valid- given that the stress test is still in its early stages. Also, we’ve seen asymmetric information involving the stress test in 2012 when JP Morgan publicly disclosed its stress test results before the Fed released results for all banks. Thus, their stock went up 7%, other banks were furious, and the Fed attributed the situation to a “miscommunication”. After reading more information about the actual validity of the stress test, Citi seems as if it wasn’t as worse off as the Fed projected it to be. Effectively, we cannot ignore that they still passed the capital level requirement. It seems to me as if this was a scenario where Citigroup received the short end of the deal on a test that still needs work.

Citigroup in the Hot Seat

Earlier this week, I wrote a post about’s the Fed’s stress test. 29 out of 30 banks passed the test, but the bank that fell below the Fed’s standards was Citigroup. To re-summarize what the stress test actually is- the Fed takes each particular bank’s balance sheet and puts it through a rigorous simulation involving high inflation and severe unemployment. The first portion of the test involves quantitative measures such as leverage ratios, capital levels, and other quantitative measures that test whether the bank can withstand an economic shock. From here, the Fed checks the bank’s capital levels over time. Each bank later proves itself to the Fed through a qualitative test, which measures how the bank would pay dividends and manage capital given that the economy is operating in a recession.

Since the Fed gave its decision on Wednesday, shareholders are not happy because Citi will not be receiving the Fed’s permission to increase dividends and share buybacks. Shareholders reacted by selling Citigroup stock, which is now down about 4%, falling $2.71 to $47.45. Mentioned in WSJ, one portfolio manager at a hedge fund “said he liquidated his Citi holdings after the failed stress test. The investor said he was frustrated because he had had discussions over the past six months with Chief Financial Officer John Gerspach and members of the bank’s investor-relations team, and had been reassured that the bank’s relationship with regulators ‘was improving every single day,’ the investor recalled”.

However, it seems that Citigroup’s capital levels aren’t the actual problem. Their capital levels were actually above the Fed’s minimum threshold of 5% (during the simulated economic recession)- at 6.5% to be exact. The concern was that Citigroup failed the second portion of the test, in which the bank failed to sufficiently prove to the Fed how it would successfully manage capital through a recession. Another reason why the 2014 test was such a big concern was because Citigroup failed to pass the 2012 stress test as well. Even though Citigroup passed the 2013 test, the Fed notified the bank that they needed to refine their risk models and loss estimates. Apparently, Citigroup underestimated its projected losses by about $15 billion in 2013.

Since the 2008 financial crisis, the second portion (qualitative portion) has became much more important. It measures how the bank would actually manage a recession, incorporates past lessons and concerns, takes into account how a bank handles its technology, and also tests how it would handle costly litigation. In my opinion, I think the Fed stepping up their game is a great thing. Even though banks may not like the tightening in regulation, it sends the message that banks need to step up their game as well. For the most part, the Fed is seeing good results. This is evident through 29 out of 30 banks passing the test and according to the WSJ article, banks have more than doubled capital levels since 2009. I think that the market’s perception is what’s most important. Even though Citigroup has ample capital, it needs to convey to its share holders that it can manage this capital throughout a recession. Although the first portion of the stress test is important, the second qualitative portion is what’s practical and relevant for shareholders.

Citigroup Hits Another Snag

Going into this week holding option positions in the financial sector I assumed this afternoon would be an interesting one as the Federal Reserve released its latest findings from their stress tests which take a closer look at how both commercial and investment banks would be able to continue their business practices in the event of a severe economic turn down. These tests have been big deals in the investment communities during the last couple of years especially because as economic conditions have improved and banks capital and leverage ratios have followed suit, they have raised dividends and buy back programs. (Obviously investors love this)

After the market closed today the FED released the results of the tests and all notables but one passed; Citigroup was that one. This botched capital plan and stress test is just the latest of some surprising mistakes for the bank. At the end of February Citigroup announced that they would be taking around a $400mm loss from their lending arm in Mexico due to some accounting gaps. The Mexican company Oceanographia was a government contractor that had stopped doing business with the government, but obviously this did not stop Citigroup from continuing to lend to them to the tune of $400mm that could not be repaid and went down as a loss on earnings that already missed last quarter. (WSJ)

While the details of what exactly the proposal was that was rejected by the FED this year, investors have reason to be concerned I think, as this is the second year in a row that the FED has rejected the banks capital redistribution plans and when added to their recent issues in Mexico and with earnings make one wonder what exactly they are doing to lag behind the rest of the big name banks. Due to this rejection, Citi will also not be able to make any changes to their capital redistribution program until next year! (WSJ) The stock traded as far as 6% down in the after hours market, and I fully expect it to trade around there tomorrow.

The stock itself is the most glaringly undervalued of all of the big name banks and has been cited as a top investment idea for 2014 by numerous voices in the industry, but with stories like these recently, investors are being shown why the stock commands the valuation that it does. I think that Citigroup could be hurt badly this upcoming quarter by the weakness in the emerging markets as well as continued weakness in fixed income trading as well (part of the reason they missed last quarter). I also think that Citi is being made a bit of an example of by the FED in an attempt to show that their programs have some sort of bite to them. For now, I would absolutely stay away from Citigroup unless I was taking it for a quick trade, otherwise the executive board of the company needs to show that they have things under control and have the FED jump on board too; until then the stock remains a “what could be” story.

Citigroup’s Stress-Test Mess

After the most recent series of bank stress test results released by the fed this week, several banks faced greater scrutiny over their financial practices. Out of 30 banks tested, five banks, including Citigroup Inc., Zions Bancorp, and the U.S. units of HSBC Holdings PLC, the Royal Bank of Scotland Group PLC, and Banco Santander SA did not receive the FED’s approval. Citigroup Inc. in particular faced the largest setback after the Federal Reserve rejected the bank’s proposal to reward investors with higher dividends and stock buybacks. According to the Wall Street Journal, the bank’s second rejection in three years was the result of the bank’s deficiency in it’s ability to project revenue and losses under stressful scenarios in parts of the firm’s global operations. This comes even after the results showed that Citigroup’s Tier 1 common capital ratio was above regulatory thresholds, and at 6.5% above many other banks that did receive approval.As the Fed pointed out, this rejection was based on qualitative problems with the stress tests, such as with internal risk management which oversees tasks including financial risk audits and organizational risk assessment. At the end of the day, while the quantitative measures looked good on paper, the Fed did not appear satisfied with the level of safety and foresight Citigroup has shown in the past few years after the financial crisis. As a result, Citigroup and the other four banks must submit revised capital plans and suspend any increased dividend payments, the latter of which will likely cause disappointment to shareholders.

While Citigroup’s rejection certainly is not a great outcome for the bank, as it may damage its reputation and credibility as a lender and insurer. And it’s certainly an embarrassment because this recent development makes Citigroup only the second bank, aside from Ally Financial, to have its capital plan rejected twice by the Federal Reserve. But overall it isn’t necessarily a bad thing for the firm. First, the firm has a strong store of capital set aside, which could act as a buffer in case of a strong negative shock to unemployment or the stock market. Second, Citigroup’s rejection is a signal by the Fed that the firm needs to correct perceived deficiencies in its operations. Like in a first submission of an article to an academic journal, the Fed, like the peer reviewer, can send back Citigroup’s capital plan with harsh critiques, edits, and an outline of the necessary requirements. This may serve to point out potential problems in risk management or governance that Citi had previously missed. Since these problems may eventually hurt the firm down the line, if uncorrected, it’s in Citigroup’s best interest to, like an academic economist, take the critiques with a grain of salt and use them to form a plan to fix the company’s risk management. This may mean a reorganization of managers and executives, and the employees in the deficient departments may face layoffs, but if Citi can fix their deficiencies they may come out of this a healthier company.

On the other hand, the people who will face the most problems as a result of the Fed’s rejection are the shareholders (Citigroup’s stock fell 5% after hours today), and the firm’s new CEO Michael Corbat. As a consequence of Citi’s failed capital plan, it has been refused the ability to raise its dividend, which currently sits at a quarterly penny-a-share, and to engage in a share buy-back program. This doesn’t bode well for Corbat, since pleasing shareholders is one of the main goals of a modern CEO. The inability to issue a dividend means that the shareholders won’t be rewarded directly, and the inability of Citi to issue a stock buyback means that shareholders won’t enjoy the benefits of “concentrated” stocks (after a buy-back a shareholder will essentially own a larger share of the company). And the lack of confidence by the Fed in Citi’s risk procedures may make investors wary of the company in the near future, meaning that the company may face negative returns in the shortrun, which may further agitate some shareholders. Overall, this is hardly a pleasant start for the new CEO.