CEO’s Job at Stake as Citigroup Awaits Fed Stress Tests

Michael Corbat.

Michael Corbat.

Photographer: Simon Dawson/Bloomberg

Michael Corbat will know in less than two weeks if he should start looking for new work.

That’s when Citigroup Inc.’s chief executive officer will hear whether the Federal Reserve has blessed his 2015 capital plan after rejecting last year’s. Corbat has said he should be held accountable, and analysts and investors say he might lose his job if the New York-based firm fails a second time.

With stakes so high, most analysts expect Citigroup has taken the necessary steps -- including spending more than $180 million to improve its capital-planning processes -- to ensure it passes. Instead, attention turned last week to bigger rival Bank of America Corp. after a filing that showed regulators had demanded changes to some of that lender’s models.

“Investors should be very cautious of any red flags which surround capital planning,” Brennan Hawken, an analyst at UBS Group AG, said in a research note that cut his share-price target for Charlotte, North Carolina-based Bank of America.

The Fed began stress tests on the nation’s biggest banks in 2009 after the financial crisis raised doubts about the stability of the U.S. financial system. The first round analyzes whether companies have enough capital to withstand nine quarters of stressful economic conditions. The second assesses their ability to weather losses and still pay dividends, buy back stock or make acquisitions.

The first results arrive later this week, though the March 11 second-round decision is the one that will probably decide 54-year-old Corbat’s fate. Mark Costiglio, a Citigroup spokesman, declined to comment on possible consequences of the Fed’s review.

Pandit’s Fate

“If you asked Corbat himself, he would tell you outright that the entire executive-management team is on the line,” Jason Goldberg, an analyst at Barclays Plc in New York, said in an interview. Goldberg said he expects the CEO to get good news.

Corbat’s predecessor, Vikram Pandit, lost his job seven months after the Fed rejected the bank’s 2012 capital plan. Citigroup directors concluded Pandit’s mismanagement contributed to that failure and other setbacks, a person with knowledge of the discussions said at the time.

While Corbat may be the only bank CEO whose job is on the line, none of his counterparts will rest easy until they get the results. Repercussions for getting it wrong have included swooning share prices, angry investors and grilling from analysts.

Citigroup dropped 5.4 percent the day after the Fed’s rejection last year, and its 4.5 percent advance during the 11 months after the announcement lagged behind a 10 percent gain for the Standard & Poor’s 500 Financials Index.

McQuade’s Assignment

Corbat moved swiftly to contain last year’s fallout. By the next week, he asked Eugene McQuade, a veteran executive with close regulatory ties, to put off retirement and lead preparations for this year’s submission. The company said roughly one-third of the more-than $180 million it spent on better processes in the second half of 2014 will be a continuing expense.

That response, and what a second straight rejection might say about the Fed’s opinion of the firm’s business model, has given many investors and analysts confidence the firm will pass this year.

“A second consecutive fail on qualitative grounds would be seen as a direct condemnation by the Fed of Citi’s business model and management team, which we do not believe the Fed wants to signal,” John McDonald, an analyst at Sanford C. Bernstein & Co., said in a Feb. 27 research note. “We would be surprised if Citi does not pass.”

Mayo’s Advice

Citigroup failed last year on what the Fed calls a qualitative basis, not because its capital was too low. That meant that regulators found the bank’s ability to project revenue and losses across its global footprint lacking.

If it were to fail again, Corbat should sell the Mexico unit known as Banamex to the highest bidder, according to Mike Mayo, an analyst at CLSA Ltd. Mayo has written a series of notes counting down the days until the Fed’s announcement.

“We’re days away from finding out if Mike Corbat still has a job,” Mayo said in an interview last week. He rates the shares a buy, and expects Corbat to remain CEO. “Citi has simplified by country, distribution, products, systems and staff,” Mayo said. “Directionally, there is little question they are going in the right direction.”

BofA’s Error

The Fed’s qualitative analysis can result in a failure for a bank if examiners find risk management, corporate governance or internal controls lacking. In addition to Citigroup, the U.S. units of Royal Bank of Scotland Group Plc, HSBC Holdings Plc and Banco Santander SA came up short on that basis last year.

Bank of America, the second-largest U.S. lender, had to resubmit its capital plan last year because it discovered an error in its calculations after initially passing the test. That delayed Chief Executive Officer Brian T. Moynihan’s plan to raise a 1-cent dividend that the bank had been paying since the financial crisis. He boosted it to 5 cents a share in August.

UBS’s Hawken wrote last week that “a qualitative failure is a real risk this year” for Bank of America because of last year’s error and regulators’ request this year for modifications to the bank’s internal models. The bank’s filing last week disclosed that the changes “would likely result in a material increase in our risk-weighted assets resulting in a decrease in our capital ratios.” Jerry Dubrowski, a spokesman for Bank of America, declined to comment on Hawken’s note.

KBW’s Estimates

The U.S. units of Deutsche Bank AG and Spain’s Banco Santander SA are among those that will probably fail on the qualitative basis this year, the Wall Street Journal reported on Feb. 20, citing unidentified people familiar with the matter. That would limit the U.S. units from paying dividends to their European parents or other shareholders, the report said. Spokesmen for Santander and the Fed declined to comment.

“Deutsche Bank Trust Corp., which represents less than 5 percent of Deutsche Bank AG’s total assets, was pleased to participate” in the Fed tests,’’ Michele Allison, a spokeswoman for Deutsche Bank in New York, said in an e-mailed statement on Feb. 20. “We will know our results after the Federal Reserve’s announcements on March 5 and March 11.”

If every one of the 25 U.S. lenders in the stress test pass, they would pay out about $98 billion in capital through dividends and share buybacks in 2015, according to estimates from Keefe, Bruyette & Woods. Citigroup’s total would be $7.4 billion, KBW analysts wrote in a Feb. 10 report. JPMorgan Chase & Co. would pay out $15.4 billion and Wells Fargo & Co. would distribute $21.2 billion, according to the estimates.

John Crowley, a money manager at Boston-based Eaton Vance Corp., said success for Citigroup this year isn’t a sure thing even though the bank has billions of dollars in excess capital. With retail branches in more than two dozen countries, the firm’s sprawling global footprint is difficult to monitor.

“The math is undeniably in their favor,” said Crowley, whose firm oversaw more than 5.8 million Citigroup shares at the end of 2014. “Qualitatively it’s still a big, complex financial institution.”

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