Something didn’t quite seem right to Citigroup earlier this week.
The banking behemoth could show that it had enough capital to ride out an economic storm, but a regulator was refusing to approve its plan to increase dividends and stock buybacks, steps intended to please shareholders and build confidence in the bank’s turnaround.
Inside Citigroup, board members and senior executives expressed bafflement and anger as they prepared for the rejection to be announced by the Federal Reserve Wednesday afternoon, people briefed on the matter said.
Was the Fed punishing Citigroup for a costly fraud last month at its Mexican unit? Was the regulator trying to look tough? Or was the Fed subtly pressing for a breakup of the bank â€" a goal of some regulators, investors and analysts for years? A day after Citigroup’s capital plan failed the Fed’s stress test for the second time in three years, bank executives were still struggling to understand the decision and how best to respond, these people said.
Yet the regulator’s displeasure shouldn’t have been a total surprise. In its report, the Fed noted that Citigroup had failed to sufficiently correct deficiencies that the regulator had flagged to the bank previously. And it was the only one of the nation’s five top banks that failed to persuade the Fed to bless its capital plan. Upon passing their tests, Citigroup’s rivals JPMorgan Chase and Bank of America swiftly announced plans to increase dividends and buy back shares.
Since the rejection, some analysts and investors have been pushing for a management shake-up, specifically calling for a new chief financial officer. After all, the Fed criticized the “reliability†of the bank’s financial projections under hypothetical situations aimed at testing the bank’s resilience during times of financial stress. Investors were quick to register their disappointment, and Citigroup’s shares tumbled 5.4 percent on Thursday.
The broader question hanging over Citigroup is the one that has dogged it since Sanford I. Weill created the sprawling global conglomerate in a burst of merger and deregulation fervor nearly two decades ago: that the bank may be simply too big to manage.
“It is a huge challenge at a company that is as big and as everywhere as Citigroup,†said Fred Cannon, a banking analyst with Keefe, Bruyette & Woods.
In its rebuff of Citigroup’s capital plan, the Fed singled out shortfalls in the bank’s financial projections in “material parts of the firm’s global operations.â€
While most of the nation’s largest banks operate globally, few banks have the reach of Citigroup. The bank has a physical presence in more than 100 countries, drawing roughly half of its total revenue from countries outside the United States. By comparison, Bank of America operates in 40 countries, but draws only about 14 percent of its revenue from overseas.
More than many of its peers, Citigroup also lends directly to consumers and homegrown companies outside the United States. That strategy may have contributed to Citigroup’s recent stumbles in Mexico, where bank officials said they uncovered a fraud involving a local oil services company called OceanografÃa.
The $400 million fraud forced Citigroup to restate its earnings and raised questions about whether the bank had consistent risk controls across its many global business lines.
Citigroup also runs a payment business in which the bank transfers money between different nations on behalf of large companies. That business can pose risks that could be hard to quantify for the Fed, former financial regulators say.
Federal prosecutors are looking into a Citigroup unit that was involved in transferring money between the United States and Mexico. Regulators have previously said Citigroup lacked effective governance and internal controls to oversee compliance against money laundering at the particular unit, Banamex USA.
Over all, the Fed said in its report that “Citigroup had made some considerable progress in improving its general risk management and control practices over the past several years, but its 2014 capital plan reflected a number of deficiencies.â€
The drumbeat from analysts seeking a breakup of the large bank is likely to grow louder now that Citigroup has failed another stress test. Since the financial crisis, Citigroup has shed about $600 billion of assets and exited undesirable businesses, but some read the Fed’s ruling as a signal that the bank needs to sell more units.
Michael Mayo, an analyst with CLSA, said that Citigroup should sell Banamex, its highly profitable Mexican unit that until recently has been considered a crown jewel. But carving out other distinct business for sale is difficult in a company assembled through multiple, disparate acquisitions.
“There are a lot of pieces to the puzzle,†said Mr. Cannon of Keefe, Bruyette.
As if to illustrate the sprawl of Citigroup’s international operations, Michael L. Corbat, the chief executive of Citigroup, was in a hotel room in South Korea when he learned that the Fed had rejected the bank’s capital plan again. Fed officials called Mr. Corbat before dawn on Wednesday to break the news.
It was a personal blow to Mr. Corbat, who has been lauded for improving the bank’s relations with regulators. He came to the helm of the bank, not long after his predecessor, Vikram S. Pandit, failed to pass the stress test in 2012.
Mr. Corbat has vowed to restructure the bank by cutting costs and shedding unwanted businesses. This year, the bank submitted what Mr. Corbat called a “modest†capital plan, which included a dividend increase to 5-cents a quarter, from the current penny.
Even after paying that proposed dividend and buying back $6.5 billion in shares, Citi would still have had a comfortable capital cushion, according to the test. But the Fed objected to the bank’s plans on “qualitative†grounds.
In South Korea, Mr. Corbat cut short the next leg of his trip and immediately flew back to New York, arriving in Citigroup’s Park Avenue headquarters a few hours before the Fed released the results on Wednesday.
After discussing the results with Citigroup’s board by phone, the chief executive traveled downtown to the Federal Reserve Bank of New York, people briefed on the matter said. He wanted to talk over the results with the New York Fed president, William C. Dudley, who did not vote on the stress test rejections.
The decision came from all four Fed governors in Washington, including the new chairwoman, Janet L. Yellen. It was the first time the Fed governors voted on any “qualitative†objections to banks’ capital plans.
This year, Citigroup was one of five banks that failed to receive the Fed’s blessing to increase dividends and buy back stock. The Fed governors’ vote was unanimous. Three of the other rejected banks were American units of large foreign banks â€" HSBC, Royal Bank of Scotland and Santander â€" taking part in the test for the first time.
In the next few weeks, the Fed plans to send Citi a letter detailing the deficiencies cited in its report, a person close to the process said. But until then, the regulator doesn’t have much more to say to the bank on the matter, the person said.
