In the latest rebuke to Citigroup (C 1.37%), the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) said that they have identified a "shortcoming" in the bank's 2021 resolution plan, or "living will," which details how the bank would be liquidated if a severe economic shock forced it into bankruptcy.
Living wills are a key provision of banking regulation implemented after the Great Recession and are required for the eight largest and most complex U.S. banks. Citigroup was the only bank to be found with a shortcoming in this latest batch of living wills. The Fed and FDIC define a shortcoming as "a weakness that raises questions about the feasibility of the plan and could result in additional requirements if not corrected, but is not as severe as a deficiency."
While I would rather Citigroup not be the only bank to have a shortcoming, I do not see this as a big surprise that changes my bullish long-term thesis on the stock. Here's why.
The issues aren't new
The Fed and FDIC noted in their letter to Citigroup that the shortcoming has to do with the bank's ability to produce the necessary financial information and data during a period of stressed economic conditions. Not being able to produce such data in an accurate and timely manner could affect the bank's ability to carry out its resolution plan, the two agencies noted.
Image source: Getty Images.
One positive is that the Fed and FDIC also said in their letter that Citigroup addressed a shortcoming the agencies identified in its 2019 living will, and other large banks have had shortcomings in the past.
Following the release of the reports, Citigroup issued a statement saying that it is making significant investments as part of its transformation plan to address the data concerns raised by regulators. "We continue to have confidence that we can be resolved without the use of taxpayer funds or an adverse systemic impact," the bank added.
While the concerns raised by regulators are certainly important issues, they aren't exactly new. In 2020, Citigroup was hit with a $400 million fine and multiple consent orders from banking regulators, which noted that the bank needed to fix long-standing deficiencies related to compliance, data, and risk management.
In its letter to Citigroup regarding the shortcoming in the living will, the Fed and FDIC said that certain issues previously stated in a cease-and-desist order issued to the bank in 2020 are related to questions they have about the living will plan.
In 2020, the Fed asked Citigroup to submit a plan discussing how management would develop an enterprise-wide program for data quality management that could produce timely and accurate data.
Media outlets earlier this year also reported that regulators weren't satisfied with the speed at which Citigroup has been addressing its regulatory deficiencies. There could be additional regulatory actions taken if the problems aren't solved in a timely manner, the news reports said, citing anonymous sources.
It's not unreasonable for regulators to be frustrated at this point because issues identified in the consent orders in 2020 now date back roughly a decade. Furthermore, it's clear Citigroup's lack of proper internal controls has resulted in big mistakes.
In 2020, before the consent orders, Citigroup accidentally wired $900 million to the wrong creditors due to a manual error and out-of-date software. Citigroup again found itself on the wrong side of headlines when one of its traders was behind a flash crash earlier this year that led to mayhem in European stock markets.
The bull case remains
While I don't know exactly how upset regulators actually are with Citigroup, I do know that I've seen the impact of the 2020 consent order on Citigroup's financial results.
The bank expects expenses in 2020 to be up 7% to 8% in 2022 on a year-over-year basis, and 2 percentage points of this number are for modernizing the bank and improving risk management, as well as data governance and remediation.
The other thing to keep in mind is that it looks like these living wills were submitted sometime in 2021, so a good deal of improvement could have been made since then. The bank now has some 10,000 employees working on its transformation plan.
Could Citigroup face further regulatory action for not moving quickly enough? It's quite possible, although it is not uncommon for bank consent orders to last three or four years. But with the stock currently only trading at 60% of its tangible book value, or net worth, I do think a lot of the downside has been priced in at this point.
