By Greg Ruel - Senior Research Associate
The abrupt departure of Citigroup's (C) CEO Vikram Pandit on Tuesday wobbled shareholders and surprised nearly everyone outside the company's own boardroom. "The sense of calamity has yet again returned to Citi," said one senior banker of the exit on a company conference call Wednesday. From a governance perspective, a sudden CEO resignation is distressing, a sign of instability, and clearly counter to any established succession planning process. GMI Ratings currently scores Citigroup with an ESG Rating of "D," citing more than 20 flagged KeyMetrics that include substantial compensation and regulatory concerns.
GMI Ratings model will not penalize Citigroup based simply on Mr. Pandit's resignation. However, the amount of churn on the executive team is troubling. President and COO John Havens, who was planning retirement at year's end, also left the company in conjunction with Mr. Pandit. Add these two key losses to the departure of former chair and 16-year board veteran Richard Parsons in April, whose resignation prompted two additional directors to leave, and you're left with an exceptional amount of instability over about a half years' time. Newly elected CEO Mike Corbat indicated there would be no more departures, stating on a Wednesday conference call that he "spent a large part of yesterday with members of our senior management and without exception they are committed to staying and continuing our progress as a firm." Mr. Corbat is a 29-year veteran of Citigroup, most recently serving as Citigroup's CEO of Europe, Middle East and Africa.
Mr. Pandit claims the decision to leave was his own even while others remain skeptical. On Thursday, author and Wall Street observer William Cohan told Yahoo! Finance that "nobody leaves these jobs voluntarily," adding that Pandit, "wasn't ready to leave, he did not want to leave. This came upon him suddenly." Others, such as the former head of the FDIC Sheila Bair, are taking the word of the board at face value. On a conference call with analysts Tuesday, Chairman Michael E. O'Neil said frankly, "well, what happened is that Vikram submitted his resignation and that we accepted it." Mr. Pandit told the Financial Times simply, "This was my decision; It comes on the heels of everything we've done."
If Mr. Pandit's departure was in fact forced by the board as some suspect, the timing is curious, with the exit coming a day after a solid earnings report . Furthermore, Mr. Corbat is not expected to implement major strategic changes, such as break-up of the bank, so it's not likely the board forced Mr. Pandit out so that his replacement could begin selling off assets. Even if we never get the full story, it's not difficult to discern what events could have led to elevated tensions between Mr. Pandit and the board in recent months. They are generally the same issues that have weighed significantly on Citigroup's governance score.
On March 15, Citigroup failed the Federal Reserve's stress test, no doubt embarrassing the company and its CEO, who stated about a week earlier that he was "confident" shareholders would be rewarded with increased dividends. The Fed found that unlike any of Citi's peers, the company did not have sufficient capital to raise its quarterly dividend payout as well as withstand a financial crisis of worse magnitude than 2008's. The Fed then objected to Citigroup's buyback plan, intended to put capital in the hands of shareholders, saying the company was too weak to launch a multi-billion dollar share buyback. It is quite possible the board pinned a failure to return capital to shareholders on Mr. Pandit. According to the FT, one top-30 investor points specifically to this event, stating "This year's misstep with the regulators was a really big deal."
In April came the highly publicized rejection of Citigroup's pay plans by shareholders. The company managed just 45% support on its pay proposals, a clear display of shareholder anger at Citigroup's thinly veiled attempt to handsomely reward executive officers immediately after a release from TARP pay restrictions, coincident with weak company performance. Mr. Pandit's total summary compensation went from $1 for the 2010 compensation year to $14.9 million for compensation year 2011; the most he earned in any one year as Citigroup's CEO. The package included $1.7 million in salary, a bonus of more than $5 million as well as nearly $8 million worth of stock options, and shareholders weren't happy about it. Days later, Citigroup's CEO and directors were sued by a shareholder accusing the company of awarding outsized pay to top executives. The lawsuit citied a breach of fiduciary duty by the board for awarding more than $54 million to five top executives though the bank's performance did not justify the payments. The shareholder lawsuit against pay plans was likely a source of contention between Mr. Pandit and the board, though it didn't scratch the surface of the company's 2012 legal issues.
In January 2012, Loreley Financing sued Citigroup in a New York court, seeking nearly $1 billion in compensation for collateralized debt obligations purchased in 2006 and 2007. Citigroup stands accused of defrauding Loreley into purchasing "fraudulent investments that are now worthless," Loreley said in its statement filed in the State Supreme Court in Manhattan. In February, Citi and four other U.S. banks agreed to pay the U.S. government $25 billion to end an investigation into abusive foreclosure practices in connection with the collapse of the housing bubble. Citigroup issued a press release in February explaining its portion of the settlement was approximately $2.2 billion. February also saw a home-loan insurance settlement of more than $158 million for Citigroup as well as a new $949 million lawsuit levied against the company and other major banks.
According to the GMI Litigation Risk Model, Citigroup has spent 10 of the past 12 months in the first percentile of all companies we score, indicating higher shareholder class action litigation risk than 99% of companies we cover. Other litigation in 2012 includes a May scandal at Citigroup Indonesia, where a private banker was convicted of fraud, fined $4.4 million, sentenced to eight years in prison. The outcome of this case ultimately hampered Citigroup's expansion in Southeast Asia. Also in May, the U.S. government filed three lawsuits against a group of banks, including Citigroup, seeking $92 million. In August, the company was subpoenaed for manipulation of the Libor benchmark and closed out the month by paying $590 million to settle claims of misleading shareholders during the financial crisis. Citigroup has been ordered to pay at least two additional penalties since August.
In September, Citigroup took a $2.9 loss on a joint venture with Morgan Stanley. After months of back and forth, the company agreed to a $13.5 billion valuation, a discount from where Citi listed the asset on its books. Shareholders were again left disappointed, likely resulting in an irritated board.
It's also likely that Richard Parson's April departure affected Mr. Pandit significantly. The FT describes Mr. Parson as Mr. Pandit's protector-in-chief while also noting that it's "fairly obvious that the no-nonsense Mr. O'Neill and the intellectual, detached Mr. Pandit did not get along."
As far as pay policy changes, it's important to note that Mr. O'Neil was already on the board when Mr. Pandit's pay package was rejected in the spring. In fact, the three year board veteran is one of three compensation committee members to approve this pay package. Thus it seems unlikely then that pay policy would drastically change. Elimination of the profit-sharing plan for executives, seen as a driving force behind this year's "No" vote, does not seem likely just because Mr. O'Neil has been named chair. Mr. Corbat has his own set of challenges as Citigroup's newest Chief Executive. While speculators debate a break-up of Citigroup's $900 billion in assets, Mr. Corbat says he doesn't want "to alter the strategic direction" of Citigroup and that he can't speak to what he'll do differently than Mr. Pandit. Mr. Corbat laid out some general goals in a memo to shareholders Tuesday, stating "We must deliver sustained profitability, improved operating efficiency and shareholder returns."
Though sudden and confusing, the exit of Mr. Pandit might not be bad for Citi's long-term sustainability. Things were certainly not good from a governance perspective under Mr. Pandit. However, shareholder class action lawsuits, regulatory issues, investigations, fines, losses on asset sales, and poor pay plans are just some of the issues that pose long-term sustainability threats. Citigroup combines capital markets and lending operations backed by taxpayers, meaning that regulators will continue to watch the bank closely. Shares of Citigroup stock have essentially flatlined in the mid-30's for the past three years, doing little for shareholders.
As far as a Ratings change, we are inclined to wait and see what happens as a result of the sudden managerial changes. Citigroup's ESG Rating will be upgraded if the board improves pay policy and sees a reduction in regulatory fines and investigations. However, the sudden departure of several key executives signals a lack of management stability and cohesion that is too troubling to overlook.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. I have no business relationship with any company whose stock is mentioned in this article.