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Is Citigroup Plan Rejection Trouble for These ETFs?

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One of the five U.S. banking biggies – Citigroup (C - Free Report) – has been hard hit by the rejection of its capital plan by the Fed in the 2014 Comprehensive Capital Analysis and Review (CCAR) stress test. This is the second time in three years that Citigroup has faced the Fed’s rejection for its capital plan.

Citigroup had proposed an increase in its buyback program from $1.2 billion to $6.4 billion shares through the first quarter of next year and a dividend hike of a penny to 5 cents per share. Though the company successfully cleared the first round of the stress test requirements related to capital ratio threshold of 5% last week, the Fed rejected the capital plan on concerns over the reliability of the bank’s capital planning process  (read: 3 Financial ETFs to Play the Bank Stress Tests).

This is because the Fed still found number of deficiencies in the company’s risk management and control practices even though it is making sufficient progress in improving these metrics. In particular, the company showed its incompetency to project revenues and losses in an adverse scenario for major parts of its business. Further, a $400 million loan fraud at its Banamex unit in Mexico last month raised doubts over the internal controls of the third largest U.S. bank.

Market Impact

The move was extremely shocking for Citigroup and the broader market including investors and analysts. Disappointed by the Fed’s rejection, two analysts downgraded the stock from Outperform to Market Perform and other analysts are revisiting their outlook. This move suggests bearish sentiment on this big bank and rough trading in the coming days.

In fact, shares of Citigroup tumbled nearly 5.4% on elevated volumes of nearly 4 times than the average daily volume. The plunge represents the biggest drop since November 2012.

Sluggish trading has also been seen in the ETF world, as financial ETFs having the largest allocation to this banking giant suffered a blow following the news. Investors should watch these funds for further weakness in the days ahead and take advantage of the lower price (see: all the Financial ETFs here).

PowerShares KBW Bank Fund ((KBWB - Free Report) )

This fund tracks the KBW Bank Index and has AUM of $164.4 million. Volume is good as it exchanges around 112,000 shares a day while expense ratio came in at 0.35%. The product holds 24 stocks in its basket with the in-focus Citigroup occupying the third position in the basket with nearly 8%.

Large caps dominate the fund at roughly 78% of the total assets, while the portfolio definitely has a value tilt. From a sector look, banks account for 88% share, followed by consumer finance (8%) and investment companies (4%). KBWB has lost about 2.5% in the trailing five-day period.

iShares U.S. Financial Services ETF ((IYG - Free Report) )

This product follows the Dow Jones U.S. Financial Services Index, holding 110 stocks in its basket. Of those firms, Citigroup takes the fourth spot, making up 7.28% of assets. Banks dominate the fund’s portfolio with 57% share from the sector look while financial services make up for the remainder (read: Bank on Dividends with These Financial ETFs).

IYG is a large cap centric fund with a tilt toward value stocks. It has amassed $641.6 million in its asset base and sees moderate average daily volume of over 70,000 shares. It charges a slightly higher fee of 45 bps from investors. The product lost about 2.6% in the past five trading sessions.

RevenueShares Financial Sector Fund ((RWW - Free Report) )

This ETF tracks the RevenueShares Financial Sector Index, a benchmark that gives exposure to about 81 stocks that are weighted by revenues instead of market capitalization. Citigroup takes the fourth position in this ETF at 6.47%. Here again, the fund is skewed toward large cap and value stocks.

In terms of industrial exposure, bank and insurance make up for the top two sectors at 34% and 31%, respectively, while financials services, investment companies and asset management round off to the top five. RWW was down nearly 2.6% over the past five days.

Bottom Line

Though more pain might be in store for the company and these ETFs in the near term, the longer term seems bright as they have a top Zacks Rank of ‘1’ or ‘2’, suggesting long-term outperformance. Further, the banking stocks are poised to benefit from a rising interest environment and an improving U.S. economy (read: Play Rising Rates with These ETFs).

Given this, investors could wait for the stock and the ETFs to bottom out and then tap the opportunity of beaten down prices with the above-mentioned funds.

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