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On Tuesday, Moody's Investors Service, the ratings arm of Moody’s Corp. (MCO - Analyst Report) reduced Banco Nacional de Mexico’s (Banamex) debt and deposit ratings, while it placed C – standalone bank financial strength rating (BFSR) on review for downgrade. Notably, Banamex is the Mexican unit of Citigroup Inc. (C - Analyst Report).

The rating agency reduced Banamex’s long-term local-currency senior debt rating to A3 from A2, while the baseline credit assessment was downgraded to baa2 from baa1. The downward revision was propelled by the uncertainty over ongoing investigations and enquiry by federal and financial prosecutors in Mexico and U.S. along with Citigroup's internal reviews over the $400 million fraud at Banamex.

Rationale Behind Downgrade

With the anticipation of a further deterioration in the situation, Moody’s downgraded the ratings stating that further revelation might lead to new charges on Banamex, denting its financials. According to Moody’s, disclosure of the fraud reflects Banamex incompetence in its risk management and auditing functions.

In Feb 2014, Citigroup detected fraud, which also involved Oceanografia S.A. de C.V. (OSA), a Mexican oil services company, and a key supplier to the Mexican state-owned oil company, Petroleos Mexicanos (Pemex).

Since April, FBI and prosecutors from the United States attorney's office in Manhattan have been looking into the matter. They are skeptical about Citigroup’s internal controls over its operations, which led to such fraud. Though Citigroup believes that the fraud is isolated, the regulators are examining whether the bank is equally accountable.

The regulators are also conducting probe to ascertain whether Citigroup ignored warning signals related to its controls. According to the law, following warnings related to any illegal activity, banks must address such activity and initiate compliance programs to examine the matter. If the banks fail to abide by such laws, it is considered a criminal violation.

In May, the US Securities and Exchange Commission also initiated a formal investigation into the matter. Additionally, the Department of Justice sought information related to Banamex’s dealings with Oceanografia. Moreover, the issue is being reviewed by the Mexican National Banking and Securities Commission.

Following internal investigation spanning over two months, Citigroup dismissed 11 employees in Mexico. The sacked staff members, which included two business heads in Mexico, were fired owing their failure to safeguard the bank from such fraudulent activities.

However, Moody's action on Banamex's BFSR will depend on the results of ongoing probes into the matter and the resulting impact on Citigroup’s risk profile, reputation and financials.

Our Viewpoint

The rating revisions are valuable for companies as this plays a major role in preserving investor confidence in the stock and help boost its creditworthiness in the market.

Though Citigroup has come a long way since 2008, when it had to accept $45 billion as bailout money to survive the economic downturn, we believe the unsettled economy, prevalent regulatory pressures and litigation issues remain concerns.

Currently, Citigroup carries a Zacks Rank #3 (Hold). Some better-ranked finance stocks include Midsouth Bancorp Inc. (MSL - Snapshot Report) and Middleburg Financial Corporation (MBRG - Snapshot Report) with a Zacks Rank #1 (Strong Buy).

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