Citi shares slump after bank fails stress test

The troubled company didn't have enough capital on hand to satisfy the Federal Reserve.

By InvestorPlace Mar 14, 2012 10:22AM
By Jeff Reeves

During the financial crisis and for months afterward, the entire banking industry seemingly moved in lockstep. But that has changed significantly in the past 12 months. Consider that since early 2011, Wells Fargo (WFC) is up slightly while Bank of America (BAC) is down 40%.


This week, the Federal Reserve released stress test results that once again showed a widening disparity between good and bad banks. At the head of the class: JPMorgan Chase (JPM), which raised its dividend and will buy back shares.


The biggest flunky? That old laggard Citigroup (C), which didn't pass and saw shares sell off sharply Tuesday morning as a result.


Broadly speaking, there are several  big challenges the financial sector right now. On the negative side are regulations like the proposed Volcker rule, the weight of bad debt and the growing backlash against the financial industry in general. On the plus side, there are hopes of dividend increases and a broader recovery spurring lending. (Read a complete list of the 5 biggest risks and 5 biggest opportunities for bank stocks)

But it's crucial for investors to realize that every bank is different. And right now, Citi is one of the worst of the group.

Citi didn’t meet the 5% Tier 1 capital requirement that was a necessary element of the Fed's testing method. This capital cushion is a kind of rainy-day fund in case of market turmoil and is a ratio instead of a lump sum. The reasoning is that the bigger a bank is, the more exposure it could have in a crisis and thus the larger its reserves should be.

Makes sense, right?

The capital threshold was raised as part of a global regulatory push in 2010 and 2011, including the so called Basel III accords in conjunction with America's Dodd-Frank reforms. So Citigroup had more than enough time to adjust its strategy in anticipation of these higher thresholds.

It just hasn't done so yet.

Does this mean Citi is a bad bank? Not necessarily. It just means that Citigroup doesn't have a rainy day fund to fall back on in the event of catastrophe. But given the uncertainty in the global economy and the very real fears of a Greek debt default, investors aren't willing to stick their necks out in a financial stock that doesn't have the vigor to withstand crisis.

It's worth noting that some banks actually passed the Federal Reserve's tests with flying colors.

Consider JPMorgan Chase, which continues to prove that it has made the most of the turmoil in the financial sector. The financial stock, run by the shrewd but sometimes abrasive CEO Jamie Dimon, on Tuesday announced plans to increase its quarterly dividend by 20% and will buy back as much as $15 billion of its shares.

This is a year after the Federal Reserve authorized a 500% increase in the JPM dividend — from a nickle a share to 25 cents quarterly — after similar stress tests in early 2011. As a result of its recent strength, JPM actually is trading around the same levels it was in 2007 before the financial crisis gripped Wall Street.


In case you're curious, Citi is off more than 90% since 2007.


So while these stress tests are not necessarily a sign that a bank is doomed, they are certainly indicators of overall bank health.


And judging by both the Fed's negative reading on Citi and the sell-off in shares, investors appear to be avoiding Citi like the plague.


jeff reeves msn

Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.






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