Citi-wide failure

March 27, 2014

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Citigroup can now claim worst-in-class stress test performance. For the second timein three years, the Federal Reserve rejected the bank’s capital plan. Citi proposed raising its dividend from a penny to 5 cents and repurchasing up to $6.4 billion in stock. However, the Fed rejected the plan, saying it doubted the “overall reliability of Citigroup’s capital planning process”.

Embarrassingly for Citi management, Bloomberg’s Michael Moore and Elizabeth Dexheimer write that the Fed found issues in planning areas it had previously flagged. These include the bank’s “ability to project losses in ‘material parts of its global operations’ and to reflect all business exposures in its internal stress test”. In February, Citi announced it had uncovered $400 million in loan fraud in its Mexican subsidiary, forcing it to restate its 2013 earnings.

While Citi passed the Fed’s quantitative hurdles, it failed on qualitative grounds. Matt Levine explains:

The stress test is not just a test of capital; it’s a test of morality. And that’s the test that Citi failed… Citi thinks that it would have enough capital in a crisis, even after raising its dividend and doing a $6.4 billion stock buyback. The Fed also thinks that. But the Fed worries that Citi’s thought process to get to that result was wrong, even though the result was right, or at least right enough.

The FT says that Citi, and in particular CEO Mike Corbat, has put a lot of time and resources into not just improving that thought process, but explaining it. Corbat has focused on “cultivating close relationships with regulators in Washington”, report Reuters’ Emily Stephenson and David Henry. Nevertheless, the WSJ says Corbat was surprised by the decision and forced to hold an emergency board and management meeting.

CLSA analyst Mike Mayo thinks “heads should roll” at Citi. Or at least the head of CFO John Gerspach. Mayo says the result, after Citi’s dismal performance during the financial crisis and the previous rejection of its capital plan in 2012, is “strike three” against Gerspach. “Citigroup needs to change the CFO, bottom line”.

Despite taking over just a year and a half ago, Corbat shouldn’t feel too comfortable either. His $14.5 million in 2013 compensation was in part tied to improving “risk outcomes and controls” and regulator relationships. Vikram Pandit was removed as CEO in part due to his failure to get a Citi’s capital plan approved by the Fed in 2012. Pandit found out that part of a CEO’s job is to avoid surprises. That doesn’t bode well for Corbat. — Ben Walsh

On to today’s links:

Japan needs to learn to love inflation – Matthew O’Brien
And it shouldn’t raise its sales tax – Matthew Klein

China’s boom will end with a standard credit bust, not a Lehman moment – Peter Boone and Simon Johnson

Raising the minimum wage is a women’s issue – the White House

Study Says
The Federal Reserve: a modern central bank since 1951, 1975, or maybe 1995 –Cleveland Fed

685 pages in six charts: condensing Piketty’s inequality story – John Cassidy

How to turn 50% into 15%: what I learned negotiating with Steve Jobs – Heidi Roizen

Law firms trust Chinese hackers to uphold attorney-client confidentiality – Matthew Goldstein

Crisis Retro
BofA settles mortgage case with Fannie/Freddie for $9.3 billion – Reuters

Spotify wants to go public sometime this fall – Quartz

Niche Markets
Hong Kong’s neon sign industry – Laughing Squid

Yoox, the Amazon of the fashion world – Telegraph

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