Citigroup: Disappointed By Cowardly Management But Maintaining 'Buy'

Jul.28.14 | About: Citigroup Inc. (C)

Summary

Citigroup's settlement over MBS was egregiously expensive.

Precedent was thrown out the window and Citi was fined three to four times what its competitors were on a relative basis.

The positive is that this event removes uncertainty from the stock.

A couple of weeks ago, I published an article about how I wanted Citigroup (NYSE:C) to fight the DoJ on its proposed mortgage settlement. The figure of $7 billion is highly disproportionate to the settlements that Bank of America (NYSE:BAC) and JPMorgan (NYSE:JPM) had to pay on the same issue. The others were around 2% of stated losses on securities sold but Citi's figure was more like 7%+. I argued at the time that Citi should fight the DoJ because the figure was so egregiously disproportionate to very recent precedent. However, we've now received confirmation that Citi has laid down and groveled its way to an enormous settlement with the government, wasting billions of shareholder dollars in the process.

I am extremely disappointed in Citi's management team. I still think the right course of action was to reserve for the $7 billion but tell the DoJ to stick their extortion where the sun doesn't shine and go to court. I suspect that after a couple of years' worth of litigation a prudent judge would've let Citi off the hook for half or less of the $7 billion. Yes, Citi would've spent likely hundreds of millions to litigate but the savings would have been massive. Instead, the company has taken the easy way out so that it wouldn't have to be dealt with henceforth.

I've been a defender of Citi and I'm long so I want things to go well for shareholders. We saw the stock move up after a great quarter that was combined with the settlement announcement but I think it could've been better. I suspect, and I have no evidence of this, it's simply my opinion, that the CCAR failure earlier this year had something to do with management cowering in the corner and taking the $7 billion settlement. Citi has gotten its hand slapped more than once in the CCAR process and management is probably tired of being embarrassed.

With the many problems Citi management has faced this year between litigation, multiple instances of fraud and the embarrassing CCAR failure, I suspect the motive to simply settle was pretty strong, regardless of the price tag. That is the only way I can see this settlement as being reasonable; management didn't want another very public defeat on its hands and perhaps the risk of losing a drawn out court battle was more than management could bear.

In addition, when Citi goes to apply for its capital returns next year as a part of the 2015 edition of CCAR, having this monkey off of its back is a large positive, despite the fact that the actual number was way out of line. This is great news for shareholders as it means the Fed is more likely to approve capital returns given that this large uncertainty has been taken care of. So, I suppose, it isn't a complete loss.

Citi will also be permitted to deduct nearly half of the settlement from its tax bill which will help defray some of the true cost of this travesty. All told the pre-tax charge taken as a result of the settlement in the quarter was $3.8 billion, still far too much for my taste given that Citi could have fought and likely reached a much lower number.

I still like Citi very much because I think the management team is talented, driven by CEO Corbat, and the stock is just plain cheap. We are still ~12% below tangible book value after the sharp earnings-related rally and with metrics improving every quarter, there is no reason for this company to trade under tangible book. I like that this settlement removes Citi's largest uncertainty but I hate that management gave in and just handed over billions in additional shareholder money to get it done quickly. Management took the easy way out and not the right way and that action disappoints me greatly…but I'm not selling.

Disclosure: The author is long C. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.