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15 March 2012 By Antony Currie

Citigroup boss Vikram Pandit undoubtedly deserves some of the digs he’s getting for his bank’s inability to pass the Federal Reserve stress test. He spent much of the past year talking up the bank’s risk-management nous and the prospect of returning capital to shareholders this year. And in fact, Pandit appears to have miscalculated and may have tried to give back too much. But it’s also hard to follow some of the logic behind the regulator’s decision to flunk the recovering mega-bank.

According to the Fed’s loan loss assumptions, only Capital One will be harder hit than Citi’s overall rate of 11.2 percent. Considering Citi’s past performance, both in the most recent financial crisis and so many others over the past couple of decades, the extra caution is warranted. And Pandit still has a bundle of crummy mortgage assets stuck in his bad bank, Citi Holdings.

Some of the haircuts nevertheless look high. The Fed model shows Citi losing more on first-lien mortgages, second-lien mortgage and home equity loans and commercial and industrial lending than virtually all its peers. And the watchdog imposed a 23 percent loss rate on “other consumer” assets. For Citi, that’s mostly loans to affluent borrowers in Asia and Latin America, and about a third related to a portfolio of OneMain loans in North America, which it’s trying to sell.

Beyond that, it’s tough to make the Fed’s capital figures add up. Revealing extra stress-tested numbers, like risk-weighted assets, would help. Absent that, assume Citi’s remain at around $1 trillion. Applying the regulator’s assumed 5.9 percent Tier 1 common ratio yields $58 billion of common equity.

But simply deducting from Citi’s current common equity the overall $50 billion pre-tax loss the Fed projects, the number comes out $6 billion higher. That would be enough to pass the stress test, distribute $10 billion of capital and be left with the same 5.4 percent ratio as JPMorgan. What’s more, based on past recessions, it’s likely that Citi’s risk-weighted assets would actually fall, adding even more of a buffer.

Of course, without more to go on, it’s hard to know for sure. But it does at least make Pandit’s push to return capital look a bit less worrisome.


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