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Issues arising out of the sale of risky mortgage-backed securities (MBS) are far from over for Citigroup Inc. (C - Analyst Report). The company is now entangled in a lawsuit filed by Sealink Funding Ltd., for damages related to its investment in residential MBS worth $513 million, according to a Bloomberg report.

Sealink has accused Citi of presenting misleading facts and withholding information regarding the underwriting criteria adopted while issuing the loans that were further pooled together, securitized and sold to investors. The suit was filed in New York State Supreme Court in Manhattan yesterday and Sealink is demanding damages over and above the principal amount.

The Back Story

As a matter of fact, mortgage loans which were pooled together and securitized constituted a significant part of the housing bubble. So when the bubble burst, it sent the economy clambering. The MBS suffered severe losses and ultimately their market dried up.

Investors incurred losses worth billions on such MBS and accused the sellers on grounds of fraud for not making adequate disclosures about the risks associated with investments on such securities. This resulted in several lawsuits against the biggest Wall Street firms by investors. Further, the companies had to confront the wrath of the regulators and are facing several investigations as well as penalties.

However, Citi is not the only one countering such MBS related issues. In addition to filing suit against Citi, Sealink pursued other big banks including the likes of Deutsche Bank AG (DB - Analyst Report), Goldman Sachs Group Inc. (GS - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report) and UBS AG (UBS - Analyst Report) for its investments in MBS. Bank of America Corp. (BAC - Analyst Report), which too was sued by Sealink over the same issue, has resolved these allegations recently, as per regulatory filing.   

Our Take

Citi, being hit hard by the impact of the financial crisis, had to seek refuge in government bailouts to stay afloat. Its market value suffered a significant fall since the crisis and the company is still battling the aftermath of the crisis. Citi’s conduct related to MBS has been questioned several times and the Sealink lawsuit has further piled up its litigation issues.

However, as litigation overhangs need to be lessened, Citi has engaged its resources to resolve them. Yet, the settlement results exhaust the company’s financials, which could have been steered towards the company’s growth initiatives, had it not been subject to such litigations.

Citi, otherwise, boasts of an impressive global footprint and attractive core business. The company has restructured its business and overhauled its risk management. It is reducing its risky exposures by trimming the problem assets, which in turn frees up capital to be invested in its core business. Yet, a low interest rate environment, regulatory headwinds and litigation risks remain our concerns.

Citi currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering its fundamentals, we have a long-term Neutral recommendation on the stock.
 

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