As a major financial services provider, Citigroup (NYSE:C) has exposure on many fronts. To be specific, it has come under more scrutiny over the financial crisis of late, and now is subject to exposure based on decisions it made prior to the crisis. Ironically, it is also involved in purchasing the same type of assets from the government as it is being brought to task for selling to consumers during the run up to the crisis. Mortgage-backed securities are showing their good and bad side to Citigroup.
On the good side, mortgage-backed securities, the same ones that tanked during the crisis, are now outperforming the market due partly to the high interest rates on many of these mortgages and partly to the low interest rate in the economy. Citigroup just recently purchased $1.67 billion worth of mortgage-backed securities from the United States. These securities were inherited by the government through a bailout, and now the government wants out.
These mortgage-backed securities have seen high demand as many believe the housing market is beginning to stabilize. Thus, they are significantly less risky today than they were the last time the government sold them. Citigroup was among six other investors interested in buying this portfolio.
However, there is another side to this. First, among lawsuits is South Korean Woori Bank, which is now suing Citigroup over mortgage-backed securities and other CDOs that it was sold. According to Woori Bank, Citigroup purposely sold it toxic CDOs in order to move them from its balance sheet to Woori's. Woori had to sell these assets at a loss shortly thereafter.
The second lawsuit is significantly larger. The FDIC is suing Citigroup, JP Morgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Deutsche Bank (NYSE:DB) on behalf of two failed banks. The claim is the exact same as Woori Bank's claim; the FDIC alleges that these four banks misled the two failed banks into investing in toxic CDOs in an effort to move them from its balance sheets to the smaller banks. Overall, the FDIC is suing for $77 million in damages.
The outcome of these lawsuits will be huge. If Citigroup and the other banks lose, I would expect many more lawsuits to be filed on similar grounds. A lot of people and institutions were on the losing end of the financial crisis and many of them would like to recoup their losses. If the courts find the banks responsible for misleading investors, Citigroup and others could be on the hook for multimillions of dollars in payouts.
This is all in addition to the $25 billion mortgage settlement that was intended to stop allegations of shady practices by big banks during the financial crisis. In fact, it is said that Citigroup set aside an additional $720 million to deal with costs of this litigation. Shareholders are no doubt annoyed that they have to deal with even more lawsuits regarding these practices.
On the plus side, Citigroup will be getting a huge influx of cash due to selling its stake in Turkey's Akbank. The sale will bring Citigroup about $1.27 billion, helping to boost its assets. Since its capital failed stress tests by the Federal Reserve previously, it does not exactly have a choice. Due to new regulations, it must boost capital, and selling its stake in Akbank is one way to do this quickly and effectively.
Citigroup isn't the only bank mired in lawsuits however. JP Morgan Chase will likely face many lawsuits due to its $2 billion loss due to risky derivatives bets. Recently, a former employee filed the first lawsuit on behalf of the Shareholders Foundation. This loss also led to a roughly $8 loss in share price in the span of 11 days. There will be many more shareholders joining the lawsuit and you can expect it to grow into a large class action suit on behalf of the shareholders.
Bank of America, like Citigroup and JP Morgan Chase, is facing steep litigation, specifically from American International Group (NYSE:AIG). AIG is suing for $10 billion to recover losses due to investment in mortgage-backed securities. A U.S. district court judge has dismissed some of the claims from AIG, stating that time limits on some of these claims have run out. This suit was filed at in mid-2011 and has a long way until it is resolved. AIG remains firm on receiving settlement, so don't expect this suit to be settled any time soon.
Unlike the other banks on this list, Wells Fargo (NYSE:WFC) has stayed out of the litigation over mortgage-backed securities. It has not been held down by lawsuits and should see above average growth for the near future. In light of the JP Morgan Chase debacle, Wells Fargo became the safest bank in America. Due to its relatively small level of proprietary trading, it is unlikely to lose this ranking anytime soon.
Also in a similar position as Wells Fargo is U.S. Bancorp (NYSE:USB). Seen as a consistently safe bet, U.S. Bancorp shares little similarity with Citigroup or JP Morgan Chase. U.S. Bancorp is putting a lot of stock in tablet and smartphone apps, rolling out a new tablet banking app this past week. Instead of engaging excessively in proprietary trading, U.S. Bancorp has been focusing on the consumer banking experience and it has been paying dividends for the regional bank.
After weathering the financial crisis, Citigroup will likely be able to handle the lawsuits coming its way. Don't expect the lawsuits to be brushed off though. The lawsuits might be a thorn in its side, but many banks of similar scale are in the same boat. The only major banks that seem to be avoiding lawsuits are the ones that do not rely on proprietary trading as heavily in the first place. This all means that, while there might be safer bets in the industry, keep an eye on Citigroup. It is not in a bad position, it just needs to handle a few hiccups.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.