Citigroup Says It Will Miss Profit Targets. Will Shares Plummet When It Announces Earnings on Monday?

The nation's third largest bank by assets is purportedly warning institutional investors that it could come up short of its own self-imposed profitability targets. Should shareholders be concerned that its stock is about to fall?

Apr 9, 2014 at 7:31AM

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Much to its shareholders' lament, Citigroup (NYSE:C) is back in the spotlight with news that could send its shares falling even further.

On Tuesday, The Wall Street Journal reported the nation's third largest bank by assets is warning institutional investors that it could miss self-imposed profitability targets over the next two years.

The issue isn't about earnings per se. It's rather about a specific metric that analysts and sophisticated investors use to ascertain how profitable a bank is compared to its peers.

Known as return on tangible common equity, the metric measures how much money a bank is making relative to the highest quality sliver of its capital. Here's how it's calculated:

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In Citigroup's case, the bank had earlier announced that its target was a 10% return on common equity ratio by 2015. Now, that goal appears to be in jeopardy.

The problem isn't with the numerator -- that is, the earnings. It's rather with the denominator -- the tangible common equity.

As you'll likely recall, two weeks ago, the Federal Reserve rejected Citigroup's request to raise its dividend and repurchase stock. The central bank's concerns revolved around so-called qualitative issues related to compliance and risk management.

The outcome means Citigroup will now accumulate more tangible common equity than it had originally modeled for. As a result, because this figure is in the denominator of the equation above, any increase in it will necessarily reduce Citigroup's tangible common equity ratio.

Added to this, on Monday, the bank reported it had entered into a legal settlement to pay $1.12 billion to resolve claims stemming from the sale of mortgage-backed securities prior to the financial crisis. According to the press release announcing the deal, it will shave $100 million off Citigroup's first-quarter earnings.

While there's no question that all of this is unwelcome news, the flipside is that it's also out in the open.

Analysts have already tempered their estimates. Investors know earnings will be hit by the legal settlement. And Citigroup itself has now warned that it could miss its own profitability projections. It seems reasonable to assume, in other words, that these issues are already priced into the bank's stock.

Does this mean Citigroup's shares won't fall further when the bank reports earnings on Monday? No. However, if they do fall, it'll likely be for a reason other than these.

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John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup. 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.

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