Shares of Citigroup Inc. dropped 3 percent Wednesday after the company was one of only four banks to fail the Federal Reserve's so-called stress test.
THE SPARK: Late Tuesday, the Federal Reserve released results of its annual stress test of 19 major U.S. banks. The test evaluates whether the banks have enough money on hand to withstand another severe economic and financial crisis. The results were mostly positive, indicating that the financial sector is recovering after the financial collapse of 2008.
Citigroup was a notable exception. The Fed said Citigroup was in danger of failing during another steep downturn, in spite of having received billions in government assistance during the crisis.
J.P. Morgan analyst Vivek Juneja downgraded Citigroup's stock Wednesday, saying that failed stress test "hurts management credibility."
Failing the test can also hurt investors in a more concrete way, Juneja wrote in a note to clients. The failure means that the Fed didn't approve Citigroup's plan to return capital to shareholders through share buybacks or dividends.
Other banks that passed the stress test announced late Tuesday that they would boost dividends and buy back stock. Those actions can put cash in shareholders' pockets and give them a bigger share of profits.
THE BIG PICTURE: Citigroup is the nation's third largest bank. And it appears to be one of the more troubled.
After the crisis of 2008, Citigroup received two bailouts totaling $45 billion, and guarantees worth hundreds of billions more.
The bank posted about $40 billion in losses in 2008 and 2009 combined. For a time, it was majority-owned by the U.S. government, and it was the last major bank to repay the bailout money, at the end of 2010.
While it posted an $11.3 billion profit for 2011, the bank's troubles persist. Many investors worry that the bank is exposed the financial crisis in Europe. At the end of last year, Citigroup held $33.4 billion in debt issued by European countries and loans to businesses in debt-hobbled countries such as Greece, France, Belgium and Ireland.
THE ANALYSIS: Juneja said failing the stress test makes Citigroup look like an "outlier" among major banks.
Juneja downgraded Citigroup to "Neutral" from "Overweight." Juneja also cut J.P. Morgan's forecast for Citigroup's profit in 2012 and 2013 because Citi won't be buying back as many shares as it could.
When a company buys back shares, it means the remaining shares on the market get a bigger slice of profits when they are divvied up.
Juneja cut the earnings per share estimate for Citigroup to $4.25 per share from $4.28 per share, still above the average prediction for $3.98 per share, according to FactSet. For 2013, Juneja now expects profit of 4.75 per share, down from his prior forecast for $4.90, but still ahead of the Wall Street's average projection of $4.73 per share.
Juneja cut his price target on Citigroup's stock to $42.50 from $46.50.
SHARE ACTION: Shares of Citi fell $1.34, or 3.7 percent, to $35.11 in late morning trading.
The stock has been slowly climbing since it traded for $23.51 in late November, when fears about the financial crisis in Europe were heightened. But the stock is still struggling to regain its trading value from last summer, when it traded above $42 a share.
Trading was mixed for bank stocks after the Fed released its stress test results.
Shares of MetLife Inc., which also failed the test, dropped $1.92, or 4.8 percent, to $37.54. SunTrust Banks Inc., which failed the test, gained 63 cents, or 2.7 percent, to $23.21.
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