Citigroup: Stressed OUT

On Wednesday the 19 largest banks in the United States had to undergo a stress test. The stress test was designed to see how the capital of the banks would hold up through a deep recession in a second housing crisis.  While most of them passed, there were a few that failed the minimum requirements.  The most notable of these was Citigroup Inc. whom received the largest bailout from the US government during the financial crisis ($45 billion).  Citigroup had planned on paying out higher dividends but since they failed the stress test they must now revise and resubmit their capital plans for approval by the fed.

The stress test was based on the Basel III accord which is to be implemented in 2013.  Basel III requires that the total Tier 1 capital be 6%, however during the test Citigroup’s was only at 4.9%.  Not only did this fail to meet the Basel III accord but it also failed their own requirement of 5%.

If Citigroup had not planned to pay out higher dividends they would have passed the stress test however their plan to pay it out caused them to fail the stress test and put their Tier 1 capital below the requirement of the central bank.  Citigroup scrapped their dividend payout in 2009 when they received the federal bail out.  It was only last year that they reinstated a 1 cent payout.  Citigroup would like to increase their dividends to return capital to the shareholders.  If they were to follow through with this plan it would drive their capital even lower putting them and all of the stocks at higher risk.  Paying out higher dividends would cause their owners’ equity to decrease therefor capital would decrease as well.  Lower capital results in Citigroup having less money to lend out.

By depleting the banks capital they’re creating a similar situation to what occurred in the crisis of 2007 when mortgages went bad and banks like Citigroup needed a bailout.  Citigroup will now have to revise their capital plan and pursue a lower dividend as they’re still looking to return funds to their shareholders.  If Citigroup doesn’t revise their plan they will have trouble balancing their need to meet the Basel III requirements as well as maintaining the interests of the shareholders.

Cavan Lungren
Karsten Gulbransen
Joel Francis
Andrew Nemeth
Alex Dupuis
Patrick Ascue

with articles from Bloomberg and International Law