Citigroup Suffers Stress Test Fallout But Cleans Up Legal Woes

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Noting that Citigroup (NYSE:C) had failed to correctly measure potential risks to its operations during a severe economic recession, the Federal Reserve rejected the bank’s capital redistribution plan last week, meaning management will be unable to increase the quarterly dividend from one penny to 5 cents or repurchase $6.4 billion worth of stock. The decision was seen by some market watchers as a sign that the central bank believed the institution was too big to be managed effectively.

Instead of being able to build investor confidence in the bank’s restructuring efforts through a redistribution of capital, the bank disappointed investors. Through sources familiar with the financial institution’s concerns, The Wall Street Journal learned that Citigroup — the third largest U.S. bank by assets — has warned investors that the bank may miss a key profitability target next year. That miss can be directly linked to the bank’s failure of this year’s annual stress test.

In March 2013, just five months after being appointed chief executive officer, Michael Corbat told shareholders he planned to increase the bank’s return on tangible common equity to 10 percent or more by 2015. At the time, the bank’s adjusted return on tangible common equity stood at 7.9 percent, and it rose to 8.2 percent last year. While that measure is not a headline earnings figure like revenue, the ratio of profit to equity owned by shareholders does allow investors to compare banks’ profitability. If more capital was distributed to shareholders, that key measure of profitability would have risen.

While it is possible that Citigroup could achieve the promised adjusted return on tangible common equity by improving overall profit, investors will still not see a dividend increase until 2015 at the earliest.

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