Federal Reserve

Fed rejects Citigroup capital plan; shares down premarket

Fed rejects Citi's capital plan

The Federal Reserve has barred Citigroup from raising its dividend or boosting its stock buybacks, saying it's too hard to predict how some parts of the bank's global operation would fare in a sharp economic downturn.

The Fed announcement Wednesday caused investors to re-assess bank stocks across the board. Citi's share price was down about 4.5 percent Thursday in premarket trading. (Click here for the latest stock price.)

It was a setback for Citigroup, one of the nation's biggest banks, which has been cutting jobs and trimming some businesses in an effort to improve its finances.

Citi was the biggest of five banks whose plans the Fed rejected as part of its so-called "stress tests," an annual check-up of the nation's biggest financial institutions. This year, 30 banks underwent the tests to determine if they have large enough capital buffers to keep lending through another financial crisis.

Citi had asked the Fed's permission to buy back $6.4 billion in shares through the first quarter of next year, and to raise its dividend to 5 cents each quarter, up from a penny per quarter now.

New York-based Citigroup was blocked from raising its dividend in 2012, too, after failing its stress test. Later that year it brought in a new CEO, Mike Corbat, with a mandate to speed up its turnaround. .

Corbat said the company was "deeply disappointed" by the Fed decision. The dividend and buyback would have been a "modest level of capital" for shareholders, and Citi still would have exceeded requirements for its financial health, he said in a written statement.

CLSA analyst Mike Mayo called Citi's rejection "a shocker."

Citi dives after Fed objections

"Citi needs to make this defeat into victory by improving the pace of restructuring," Mayo wrote in a note. That would include selling off businesses and holding managers more accountable, especially after executives had offered reassurances about how the bank is monitoring its finances, Mayo said.

The Fed said that the capital plans of Citigroup fell short in some areas, including its ability to forecast revenues and losses in parts of its global operations, should they come under economic stress.

As with Citigroup, the Fed said it found deficiencies in the capital plans of HSBC North America Holdings, RBS Citizens Financial Group, Santander Holdings USA and Zions Bancorp. The central bank, however, approved requests outright from the other 25 tested banks, which included JPMorgan Chase, Wells Fargo and Morgan Stanley, in addition to Bank of America and Goldman Sachs.

Before the financial crisis, Citigroup's dividend peaked at $5.40 per quarter in 2007. After eliminating its dividend in 2009, it reinstated a payout in June 2011 at a token penny per quarter, where it remains.

The dividends and share buybacks that the Fed weighed are important to ordinary investors, and banks. The banks know that their investors suffered big losses in the financial crisis, and they are eager to reward them. Some shareholders, especially retirees, rely on dividends for a portion of their income.

But raising dividends costs money. The regulators don't want banks to deplete their capital reserves, making them vulnerable in another recession. Buybacks also are aimed at helping shareholders. By reducing the number of a company's outstanding shares, earnings per share can increase.

A handful of banks that won approval from the Fed to raise dividends quickly announced plans to reward investors.

Wells Fargo said it would raise its dividend a nickel to 35 cents per share starting in the second quarter. It also boosted its planned share buybacks. Morgan Stanley announced it would double its dividend for the second quarter to 10 cents a share from the current 5 cents. It will also buy back as much as $1 billion of its shares through March 2015. Capital One Financial expects to buy back $2.5 billion of its shares but maintain its dividend at 30 cents a share.

The announcement Wednesday follows last week's results of the Fed's annual "stress tests." The central bank determined that the U.S. banking industry is better able to withstand a major economic downturn than at any time since the financial crisis struck in 2008. The Fed said that only one of the 30 biggest banks in the country needed to take more steps to shore up its capital base. That bank was Zions.

The companies raising dividends and boosting share buybacks should have an advantage in winning investors, said Michael Scanlon, managing director at John Hancock Asset Management.

"From a total return perspective, all this is good," he said. "The Fed is recognizing that there is continuing healing that's taking place at the banks," he said. "From a capital standpoint, these institutions are in a far better position than they were a few years ago."

Citigroup and the other big Wall Street banks, as well as hundreds of others, were bailed out by the government during the crisis. The banking industry has been recovering steadily since then, with overall profits rising and banks starting to lend more freely. The banks have mostly repaid the taxpayer bailouts.

The Fed has conducted stress tests of the largest U.S. banks annually since 2009, the year after the financial crisis plunged the country into the worst economic downturn since the Great Depression of the 1930s.

Under the stress tests' "severely adverse" scenario this year, the U.S. would undergo a recession in which unemployment — now at 6.7 percent — would reach 11.25 percent, stocks would lose nearly half their value and home prices would plunge 25 percent.

—By The Associated Press.