- Citigroup has been sued by PIMCO and other investors over sale of crummy mortgages that resulted in hefty losses for the investors.
- The current situation is eerily reminiscent of 2014 when Citigroup was fined a hefty $7 billion for the same practice.
- Citi shares trade at a considerable discount to the book value.
- Is Citi stock still a safe investment?
Citigroup (NYSE:C), the third-largest U.S. bank by total assets, just cannot seem to be able to keep out of trouble. The Consumer Financial Protection Bureau fined the bank $770 million in July for, among other things, enrolling customers in deceptive credit card add-on products.
Source: Consumer Financial Protection Bureau
Citigroup now faces another potentially bad situation that could see the company fined hundreds of millions, if not billions, of dollars. Pimco and other investors have now sued Citigroup over billions of dollars in mortgage debt losses. This group of investors have alleged that Citigroup failed to properly monitor bad securities that were backed by more than $13.8 billion in mortgage loans, which resulted in the investors losing a total of $2.3 billion.
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What is particularly disconcerting about this allegation is that it appears to be eerily reminiscent of the bad mortgage fiasco of the pre-financial crisis era that saw Citigroup and JP Morgan Chase (NYSE:JPM) fined billions of dollars each. In July of 2014, Citigroup was ordered to pay a hefty fine amounting to $7 billion for selling crummy mortgages. The huge fine involved $4 billion in penalties, another $2.5 billion in mortgage modifications and $500 million paid to five states and the Federal Deposit Insurance Corp. Although the $7 billion was at the time the largest civil penalty in corporate history, the general consensus was that Citigroup got off the hook quite lightly and things could have been a lot worse.
JPMorgan was not as lucky as Citigroup. JPM was accused of selling sub-prime and Alt-A mortgage-backed securities to Freddie Mac and Fannie Mae between 2005 and 2007, many of which later soured after the housing bubble collapsed leading to losses amounting to about $14.6 billion for both companies. Both Fannie Mae and Freddie Mac later had to be bailed out using taxpayers’ money. JPM was slapped with a huge $13 billion fine for its role in the fiasco.
Between 1995 and 2007, Citigroup managed to grow its book value per share from $60 to $260 mainly through a combination of healthy earnings and massive share buybacks. When the financial crisis of 2008 hit, Citigroup’s book value tumbled below the 1995 level to around $50. The bank has over the last couple of years managed to slowly grow its book value to ~60, still far below its pre-crisis high.
Companies grow their book value per share through retained earnings and also via share buybacks. Over the past couple of years, Citigroup has probably fared a lot worse than any other bank in the U.S when it comes to fines for financial impropriety. In 2008, the company suffered a massive $27.7 billion loss linked to bad securities and derivatives as well as a $14.7 billion loan loss provision. This coupled with fines linked to bad mortgage securities that it paid in 2014 has led to Citigroup booking large losses. To cover its large losses, Citigroup might be forced to issue new shares like it did after the financial crisis. Share dilution of course leads to a decline in book value.
Citigroup shares have trailed both JPM shares as well as S&P 500. Citi shares have gained 52% over the last three years vs. 59.6% for JPM and 44.8% for the S&P 500.
Citigroup stock price (Blue Line) vs. JPMorgan Chase stock price (Black Line) 3-year performance
The biggest attraction of Citigroup shares right now for investors is that they are trading at a sizable discount to book value. Citigroup shares are trading at $54, implying a 10% discount to book value. Citigroup is a much-improved bank from the outfit that teetered on the brink of collapse in 2008. It’s key capital metrics have been gradually improving as the quarters roll on. The company has also been unloading its unwanted assets which reduces some of the risk associated with investing in the shares. Citigroup’s ROA of 0.99% is just a shade below the 1% that banks generally aim for.
But it’s hard to ignore the fact that the bank is still struggling. Despite the fact that net income rose by $1.1 billion, Citigroup recorded a drop of $1 billion in revenue. Meanwhile total loans and deposits declined in mid-single digit percentages, which is a bad trend.
Given the latest round of bad news, Citigroup might find itself slapped with another hefty fine that will eat into earnings and wipe out some of the progress the company has made. Citigroup stock does not appear to be primed for good long-term gains.