Citigroup (C) posted second quarter net revenue of $19.3 billion compared to $20.5 billion the previous year, primarily due to lower fixed income markets revenue. Net interest margin increased to 2.87%, credit losses declined 16% while deposits grew 3% and loans grew 8% all from prior year.
Fundamentally, the operating performance of the banking franchise appears strong but Citigroup’s performance is not what is driving stock price. As the financial giant continues its strategy of divesting away from a financial supermarket platform it has been dealing with legal problems as a holdover from the financial crisis, fraud and regulatory issues that will keep the stock depressed for some time.
Citigroup stock investors would be well advised to wait out this turnaround process — it could get ugly.
Citigroup Makes Deal With DOJ
Citigroup announced that it reached a $7 billion deal with the Department of Justice (DOJ). Compared to Bank of America’s (BAC) settlement of $16 billion, this is a relatively easy pill for Citigroup to swallow. The deal includes $4 billion in civil penalties, $500 million to the FDIC and several states, and $2.5 billion in consumer relief. The consumer relief requirement allows Citigroup to count loan modifications and principal forgiveness as part of the settlement. These activities will aid in strengthening the company’s asset and servicing portfolio anyways and should be looked upon as more favorable than cash out the door.
Although the settlement resolves any claims with these agencies, it does not absolve Citigroup of potentially facing criminal charges. If Citigroup fails to cooperate fully it may face additional financial recourse, but that’s unlikely.
Many Other Problems Remain for Citigroup
Although the DOJ settlement provides a certain degree of relief, Citigroup CEO Michael Corbat’s ability to continue the company’s turnaround is still in question due to several negative announcements earlier this year. In February, Citigroup announced that its Banco Nacional de Mexico (“Banamex”), was hit with financial fraud that cost Citigroup $360 million in earnings due to fraudulent receivables. The fraud brings into question Citigroup’s reliance on internal controls and procedures that should have prevented such a significant loss.
Internal controls may be a systemic problem at Citigroup. In February, Federal Reserve officials told Citigroup that it had failed its stress test. As a result, Citigroup is unable to raise its dividend or increase its stock buyback program until after a review of updated plans are filed which are due to the Federal Reserve by July 2015.
In its comprehensive report, the Federal Reserve said that Citigroup’s plan reflected a number of deficiencies, including in areas that had been previously identified but for which “there was not sufficient improvement”. Cited in the report are Citigroup’s inability to project revenue and losses under stressful scenarios and its inability to stress test the full range of its business activities and exposure. With operations in 100 countries, the need for increased costs and higher reserves related to compliance and regulatory issues will most likely remain high into to near future.
With the failure of the stress test, Citigroup’s request to raise its dividend from $0.01 a share to $0.05 a share was rejected.
Avoid Citigroup Until Uncertainty is Lifted
As of this writing, Kenneth Fick did not hold a position in any of the aforementioned securities. Email him at kfick@piercethefog.com or follow him at www.piercethefog.com.
