Citigroup Just Blew It

 |  About: Citigroup Inc. (C)
by: Josh Arnold

Citigroup (NYSE:C) passed the Federal Reserve's stress test with flying colors, as the results that were released last week clearly show. Citi was the best capitalized of the too-big-to-fail institutions, with a minimum Tier 1 common ratio of 8.3% under simulated adverse conditions. This is terrific news for the bank and as a result, Citi shares traded up nearly 4% on Friday. The second part of the Comprehensive Capital Analysis and Review is the release, this Thursday, of the Federal Reserve's approval or disapproval of the 19 bank holding companies' capital plans. Curiously, Citi released its capital distribution plan for 2013 just after the stress test results were made public.

While it turns out that the Fed authorized the early release of what Citi requested, it seems odd that the company would try so hard to be the first to release its capital distribution plans for 2013. You would think that with such fanfare accompanying the release, the plan would be something to be proud of; you would be wrong. Instead, we saw that Citi asked the Fed for permission to buyback $1.2 billion worth of stock this year. Despite the fact that this number is laughably small for a company the size of Citigroup, it's even more so considering that Citi issues roughly this amount of stock per year just to pay its employees. In other words, Citi's "plan" is simply to stop diluting its shareholders. No effort is made to actually reduce the float, which has become bloated since the financial crisis. Citi is taking a step to reduce dilution, which occurs as more and more stock is issued, but reducing the float is apparently at least a year away.

More telling for me is that Citi did not request a dividend increase. I find this quite hard to believe since Citi is still paying just a penny per share per quarter in cash dividends. This relic from the financial crisis is a joke and doesn't count as a real dividend for me. I am quite disappointed in Citi for playing this so conservatively. We all knew Citi was well capitalized and it turns out, more so than all of its competitors. However, Citi also pays a nearly nonexistent dividend and has been diluting shareholders for years now through stock issuances. As Citi has continued to issue more stock to pay its employees, earnings per share has been reduced by a commensurate amount. As Citi issues stock, the earnings it makes are spread over more and more shares, reducing the amount of earnings available for each share.

I was hoping Citi would seize this golden opportunity and attempt to raise the dividend. Even if Citi simply increased the payout to three cents per share per quarter to start, that would be a vast improvement over today. More importantly, it would give the investing community faith that Citi's future is bright. Given that Citi's request is so timid and conservative, I'm not sure we can make that assumption. I still think Citi will be very profitable in coming years but the fact that Corbat is so unwilling to return capital to shareholders is a bit troubling.

It's great that Citi has done such a terrific job of recapitalizing itself since the financial crisis but I fail to see the payoff for investors. Shareholders will still receive a meaningless dividend and the float is still not being reduced. Moreover, I find it a little amusing that Citi was so excited about their "capital return" plan when all it does is eliminate the dilution that has been occurring for years. If I were Citi, I'd be a bit embarrassed.

Citi, and indeed all banks that were subject to the CCAR, have a golden opportunity to prove to the investing world that the financial crisis is finally behind them and offer up so actual capital returns to shareholders. Citi's stress test results are sterling but the capital plan is a joke. I am quite disappointed and I think CEO Corbat is being far too conservative. He knows being conservative is the safe way to go because the low bar he just set for himself is easy to step over. However, shareholders should demand more as Citi is the best capitalized bank on Wall Street and is apparently unwilling to return capital to shareholders in a meaningful way until at least 2014.

I still think Citi is a great long-term buy. Return on assets is still near the trough historically, the bank is obviously well capitalized and ready to lend, and the new CEO is distancing himself from Vikram Pandit. In addition, Citi has been divesting underperforming and non-core business lines and continues to do so. Indeed, shareholders will still be rewarded for buying today, even near 52-week highs. To be sure, there is plenty of room for improvement in profitability for Citi that is untapped as of yet.

However, I think you could probably buy shares more cheaply than today in the near future. After the initial euphoria of a stress test clean bill of health, I think the banks will trade down slightly. I believe the positive stress test results may have been largely priced in prior to the results being released. The big moves one way or the other should be as a result of the capital distribution plans of these banks. As Citi has already told us it is basically declining the right to distribute excess capital, there should be a small selloff as a result; that is when you should buy Citi shares. The franchise is intact, Corbat is an industry veteran and a very bright guy and Citi is nowhere near as productive as it can be, leaving tons of upside to future profitability. You just may need to reel in your expectations of a large dividend anytime soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.