Since Michael Corbat was named CEO of Citigroup (NYSE:C) in October of last year, he has emphasized his intent to cleanse the global behemoth of its struggles stemming from the financial crisis and implement a numbers-driven approach to right the ship he has sailed on for his entire 30-year career. Corbat is supposedly aiming to use scorecards to gauge the performance of the bank's upper management, and tomorrow at 4:30 p.m., Corbat will receive his first scorecard: the results from the Federal Reserve's annual stress tests.
Crushed under pressure
Despite being at the helm of the recovering bank for only four months, investors will not show any patience if the bank fails to meet minimum capital requirements under the Fed's "severely adverse scenario," as it did last year. Despite posting a Q3 2011 Tier 1 common ratio of 11.7% at the time of the last stress tests, the highest ratio among Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), and JPMorgan Chase (NYSE:JPM), when the harsh hypothetical economic conditions were applied, Citi's Tier 1 common ratio crippled to below 6%. The main driver of the theoretical deterioration was losses in Citi's consumer credit card and mortgage portfolios. This year, the conditions in the Fed's most drastic scenario include:
- Real GDP decline by between 4%-5% by the end of 2013
- Unemployment rises another 4% from current levels
- Housing and commercial real estate decline more than 20%
- 50% decline in equity prices over the course of the hypothetical recession
As previously mentioned, although Citi has built stronger capital ratios throughout 2012, investors will be watching how those ratios stand up when the global economy is waning.
Good things come to those who wait
The most important thing for Citigroup investors may be patience. Unlike the three other major U.S. banks, Citigroup is much more of a global institution with only around 30% of its revenues coming from North American operations. Therefore, a Citi recovery is not as a correlated with a continued U.S. economic recovery as success at Wells Fargo is. It hasn't been all bad news for the bank as allowance for credit losses as a percentage of total loans has declined for nine consecutive quarters as high quality loans are bought onto the books.
The results set to be released tomorrow are based on how the institution would fare under the adverse scenario based on its current capital deployment plan, which for Citi is a $0.01 quarterly dividend. While investors will surely use these stress tests results as a measurement of the bank since last year, forward-looking shareholders will undoubtedly be placing a greater emphasis on the Fed's release of the Comprehensive Capital Analysis and Review (CCAR) results next Thursday, March 14.
Stay the course, Michael
Banks' submissions for the CCAR incorporated planned strategies to return capital to shareholders. As a forward-looking mechanism, the market responds to future strategy changes. Michael Corbat is undoubtedly eager to leave his mark on the company that he has called home for three decades. However, a rejected capital plan could be disastrous for Citi's reputation and share price, which has already advanced over 12% in 2013. Based on experience from previous stress tests and the recent shake-up of upper management, investors may be justified in supporting Citi's decision if management chooses not to drastically increase the dividend or initiate any share buybacks.
David Hanson has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. It owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.