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Citigroup Tumbles on Fed Rejection

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Following the Federal Reserve’s rejection of Citigroup Inc.’s (C - Free Report) capital plan under the Dodd-Frank Act supervisory stress test 2014 (DFAST 2014), the company’s shares crumbled in the after-hours trade. The stock price toppled 5.2% to $47.55.

The stress test results have been disappointing for Citigroup. The company could not manage to pass the stress test with its proposed plan to return capital to shareholders. Notably, this is the second time in the last 3 years when Citigroup’s plan has been rejected by Fed. It had resubmitted its capital plan in 2012 as well.

Citigroup’s 2014 plan included a request for approval of a $6.4 billion common stock repurchase program through the first quarter of 2015 and a hike in quarterly common stock dividend to 5 cents per share. However, the bank has been allowed to continue with its existing $1.2 billion common stock repurchase program and payment of 1 cent per share as quarterly common stock dividend.

According to its press release, though Citigroup satisfied the stress test requirements, the Fed objected to its plan to deploy capital to shareholders based on certain “qualitative” reasons. As a result, Citi will need to submit a revised capital plan to the Fed later this year.

The Fed holds the opinion that Citigroup has loopholes in its risk management practices under stressful scenario. Though Citigroup has worked upon improving its risk management and control practices, the bank’s latest capital plan reflects certain flaws.

Particularly, Citigroup exhibited incompetence in projecting revenue and losses in a severely adverse scenario for major parts of its business. These factors along with other reasons raise questions over the bank’s capital-planning process, which led to the rejection. Recently, Citigroup reported a loss of around $400 million in its Banamex unit, following the detection of fraud in its Mexico-based subsidiary, which raised suspicion over the internal controls of the bank.

Michael Corbat, Citigroup’s Chief Executive Officer offered fully cooperation to the Fed and is working hard to meet Fed’s expectations and clear the doubts over the bank’s capital planning process.

Unlike Citigroup, the other Wall Street biggies such as JPMorgan Chase & Co. (JPM - Free Report) , Morgan Stanley (MS - Free Report) and Wells Fargo & Co. (WFC - Free Report) passed the stress test well and have already declared increases in dividends and share repurchases. The Fed’s approval of capital plans for most of the major U.S. banks reflects stability in the banking system to a great extent.

On the flipside, the news comes as a disappointment for Citigroup and its shareholders. Besides Citigroup, the four other banks which have failed the stress test this time are U.S. units of London-based HSBC Holdings plc, The Royal Bank of Scotland Group plc and Spain’s Banco Santander, S.A. along with UT-based lender, Zions Bancorporation. Notably, Zions was the only bank which failed to meet the minimum requirement of 5% Tier 1 common capital ratio.

Citigroup has come a long way since 2008, when it had to accept $45 billion as bailout money to survive the economic downturn. One can consider a strong brand like Citigroup to be a sound investment option, given its global footprint and attractive core business. It is also among the best reserved banks. However, the prevalent regulatory pressures and litigation issues remain concerns.

Nevertheless, the approval from the Federal Reserve to increase dividend payment and accelerate the share buyback program will definitely help Citigroup attract more investments going forward and boost shareholders’ confidence.

Citigroup currently carries a Zacks Rank #3 (Hold).

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