In compliance with regulations, Citigroup Inc. (C) and several other Wall Street banking giants have released 2014 Mid-Cycle Stress Test results, projecting their ability to cope with the most adverse economic scenarios.
Covered Companies rule, which has been issued by the Board of Governors of the Federal Reserve System (Federal Reserve), applies to large bank holding companies (BHCs). The rule has been issued for implementation of stress testing and disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFAST).
As described in the rule, a stress test is “a process to assess the potential impact of scenarios on the consolidated earnings, losses, and capital of a company over the planning horizon, taking into account its current condition, risks, exposures, strategies, and activities.”
Based on banks’ own models and assumptions about probable stressed scenarios, the banks conduct the test. However, the tests reflect banks’ views on their economic well-being and the associated risks that could impact their financial outlook.
The latest stress test follows the Federal Reserve’s stress test round for 30 BHCs released in Mar 2014.
The Citigroup Part
Citigroup, in its midyear stress test disclosure released on Monday, stated Basel I Hybrid Tier 1 Common Ratio to be minimum 8.4% and Common Equity Tier 1 Capital Ratio to be minimum 8.6% in the event of an economic downturn in the upcoming two years (till second-quarter 2016).
The company’s hypothetical adverse scenarios take into consideration a global recession and significant decline in Asian GDP, led by a severe economic downturn in the emerging markets. Also, it includes intense geopolitical tensions, which might result in sanctions on certain energy-exporting countries.
Stress tests have been one of the most challenging areas for Citigroup. Though the company satisfied the stress test requirements in March, the Federal Reserve’s rejection of its 2014 capital plan marked its second failure in the last three years.
The Federal Reserve rejected its 2014 capital plan based on certain ‘qualitative reasons’. The Fed held the opinion that Citigroup has loopholes in its risk management practices under stressful scenario. Though Citigroup has worked upon improving its risk management and control practices, the bank’s capital plan reflected certain flaws.
Notably, in the latest conference held on Sep 8, Citigroup CFO John Gerspach specified that the foremost aim of the bank is to work on its plans to pass the latest stress tests. He confirmed that the company is working on the qualitative aspects of the 2015 Capital Plan (read more: Citi Focus on 2015 Capital Plan; Trading Revenues to Improve).
Others
Other banks that released their midyear stress test results include Wells Fargo & Company (WFC), The Goldman Sachs Group, Inc. (GS), JPMorgan Chase & Co. (JPM), Morgan Stanley and Bank of America Corporation.
Bottom Line
As we look forward to Citigroup’s 2015 Capital Plan, we believe the company is working on its internal inefficiencies. Also, the company’s streamlining initiatives should bolster its capital position, reduce expenses and drive operational efficiencies.
Citigroup currently carries a Zacks Rank #3 (Hold).
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