Since the happening of the great recession in 2008, central banks across the globe have aggressively revamped their regulatory measures and among them, Fed has been quite active in maintaining a tight grip over banks. While there have been far-reaching implications of these events, the recent rejection of Citigroup’s (C, Financial) capital plan by the Fed is sure a reason for investor disappointment and considering that it is a major concern for a banking company, it makes sense to understand the implications of this event on the stock.
The history
In 2012, Citigroup’s Ex-CEO Mr Vickram Pandit was fired after the Fed rebuffed its capital plans and in spite of constant efforts, the company failed to negotiate its position with the Fed. Due to Citi’s failure to meet the stress test standards set by the Fed, a strong indication that the Bank was not in a healthy capital position was sent out to all its stakeholders. Back then, The Fed objected to Citigroup’s capital plan, which included a request for a higher dividend. It is significant for investors to understand that Fed administers these stress tests in case there are requests for higher dividends and share buybacks. By way of the stress tests, the Fed aims to see how the capital of U.S. banks might hold up through a deep recession or another round of housing crisis.
The bolt strikes again
The common phrase that “History repeats itself” would have been heard by you umpteen number of times. Well, for Citigroup investors, this phrase has come true. In the year and a half since Mr Michael Corbat (the current CEO, who took over from Mr Pandit in 2012) has made strides, but expectations that he would reshape the company’s risk management and regulatory structures have faced a setback in recent weeks. On Wednesday Citi’s 2014 capital plan was rejected by the Fed for “qualitative reasons.” This is the transcript of the statement made by the Federal Reserve:
“While Citigroup has made considerable progress in improving its general risk-management and control practices over the past several years, its 2014 capital plan reflected a number of deficiencies in its capital planning practices, including in some areas that had been previously identified by supervisors as requiring attention, but for which there was not sufficient improvement.”
Hence, it is clear that the Fed has taken a clear stance against Citi’s capital plan and therefore, there the company will have to shelve its plan of declaring a dividend and put a pause on the authorized share buyback plan. Also, investors should not forget that Citi’s peers have been approved to go ahead with their dividend and share buyback plans thereby, making it more difficult for Citi to appease its investors.
There is no doubt about the fact that Citigroup will attempt hard to resolve the issue with Fed and as an outcome of the process, return meaningful capital to its shareholders. However, the Bank will definitely take time to restructure a number of deficiencies in the plan and because of that, the dividend yield of the company will take a hit. In the past few quarters, Citigroup’s shares have not seen any considerable upside and therefore this dividend declaration and share buyback was a big chance for the company to return value to its shareholders.
However, this recent rejection by Fed has compelled the Bank to withdraw its plans. As a consequence, there will be a continued outward movement of dividend-seeking investors (a drop of 4 percent in price after Fed’s statement is a testimony). In such a scenario, the stock price will face downward pressure in the coming quarter and in fact, till the time it corrects the deficiencies in its capital plan.
Losing brand value
To top that, Citigroup’s brand value has been marred by a series of frauds and allegations in the recent time. Most recently, Citigroup agreed to pay $15 million as dictated by FINRA, to resolve allegations that it shared information selectively with clients, at times hosting “idea dinners” in which analysts offered opinions on stocks that diverged from their published views.
Just before the payment of this heavy fine, Citigroup was also involved in a fraud allegation in its Mexican unit. The Bank’s Mexican unit, known as Banamex, has its private-security unit. Citigroup said it discovered that the private-security unit in its Mexican bank engaged in illegal and unauthorized activities that included working for people outside of the bank and using intercepted phone calls. The magnitude of fraud has been pegged at about $15 million.
Takeaway
In the recent years, most of the US Banks have been under the scanner of regulatory authorities and other stakeholders in the aftermath of 2008 financial crisis. Of them, Citigroup has been facing serious troubles. Fundamentally, Citigroup is a sound company with robust operations but a series of setbacks will limit the upside on the stock. As such, my advice would be to refrain from investing in the stock for a duration of at least 2-3 quarters.
