Citigroup (C 1.41%) generated its largest profit of the year in the third quarter, but that did little to appease analysts, who spent much of the bank's earnings call questioning the bank about its recent consent order from federal regulators.

The order required Citigroup to pay a $400 million civil penalty for the bank's failure to address deficiencies with its internal controls related to compliance, data, and risk management. The bank will also need to get approval from the U.S. Office of the Comptroller (OCC) for any business or portfolio acquisitions. The order leaves the bank in a tight spot because it will need to spend time and money to correct the issues at a time when most banks are likely looking to cut expenses to help offset the margin compression caused by low interest rates.

Here are three questions dogging Citigroup.


Image source: Citigroup.

1. Is Citigroup the next Wells Fargo?

One analyst asked this question directly to Citigroup's management team on the bank's earnings call. Wells Fargo was punished severely by regulators for its fake accounts scandal, in which it opened millions of fraudulent bank and credit card accounts on behalf of its clients. Regulators fined Wells Fargo $3 billion, and then the Federal Reserve imposed a $1.95 trillion asset cap that has cost Wells Fargo some $4 billion in profits since taking effect in 2018, according to a Bloomberg report. Notably, regulators issued the asset cap two years after Wells Fargo received its first consent order related to the scandal, so who's to say more punitive actions aren't coming for Citigroup down the road?

In response to the Wells Fargo question, Citigroup CEO Michael Corbat said there was "no widespread customer harm," adding that "the company did not profit from the activities."

I tend to agree with Corbat on this. While Wells Fargo benefited from the fake accounts scandal and likely saw higher earnings as a result, I don't think Citigroup has benefited from having out-of-date software and systems, except for perhaps keeping expenses lower. In fact, we saw how Citigroup was hurt by its poor internal processes and controls when the bank accidentally sent $900 million to Revlon creditors recently because of a manual error.

I think it's also clear that Citigroup's problems are not as big a surprise to regulators as the Wells Fargo scandal was. Both the OCC and the Federal Reserve use the word "longstanding" when describing Citigroup's issues in their consent orders. The Fed states that some of the outstanding issues date back to a 2013 consent order. My guess is that perhaps the Revlon incident was the last straw, or it's been so long that regulators needed to show Citigroup, as well as the banking industry and general public, that they are taking matters seriously.

2. What do expenses look like going forward?

This is going to be one of the biggest operational questions for the bank -- if not the biggest -- because Citigroup has historically been one of the best at expense management among its big-bank peers. Its 56.5% efficiency ratio (which measures a bank's expenses as a percentage of revenue, so lower is better) edged out JPMorgan Chase and easily beat Bank of America and Wells Fargo in 2019.

However, the bank doesn't do as well when it comes to competing on revenue, so if it loses its edge on the expense front, that's taking out one of its major strengths. Corbat said on the earnings call that he couldn't fully estimate the costs associated for the multiyear transformation, but did add that "this wont be a quick or easy fix."

3. How do you show confidence to shareholders?

Although a more generic question, this could be the most difficult question for Citigroup to answer -- and one of the most important.

As Wells Fargo analyst Mike Mayo said on Citigroup's recent earnings call, "The stock is still trading at about half of book value where it was eight years ago since Citi was formed or since 2000. CEO comp is just shy of $400 million when you have worst-in-class stock price performance."

Perhaps even more frustrating for investors in all of this is that management has known about at least some of these problems since at least 2013. How do you not fully address issues you've known were serious for at least seven years, and then expect shareholders to believe you are on top of it this time around?

First, Citigroup needs to do a thorough analysis of what needs to be fixed, how much it will cost, and how long it will take. Then the company needs to follow through with the work in a timely manner, because I think the patience of major shareholders is wearing thin at this point.