Citigroup Test Failure an Opportunity

 | Mar 27, 2014 | 3:30 PM EDT
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The Federal Reserve released on Wednesday the results of it stress tests for the nation's financial institutions. The results all came in as expected, except for one shocker.  Citigroup (C) did not pass the Fed's requirement and therefore was not allowed to increase its dividend. Shares fell by over 5% in aftermarket trading today and looked set to continue significantly lower.  

Investors should thank the Fed.  

As expected, all the other major banks got the green light. Bank of America (BAC) passed and will see its dividend rise from one cent per quarter to five cents. Some analysts were expecting BofA to increase the payout to 10 cents, but the increase is nonetheless a significant move that really sets the stage for more future increases. In addition BofA plans to purchase $4 billion of shares.

But the Citigroup decision was a huge shock to not only the market, but to company insiders. CEO Mike Corbat took full accountability of the Fed's decision and vowed to fix it. In the end, investors should appreciate what has just happened. Citi, the third largest bank by assets, currently trades for less than 9x forward earnings and 77% of book value. Depending on how Mr. Market treats shares in the coming days and weeks, Citigroup is arguably the most compelling opportunity among the major financial firms today.  

Investors don't have to go far back to see that this same story played out with Bank of America a year ago. During the previous Fed stress test, it was widely expected that BofA would get approval to increase its dividend payout and share buybacks. The Fed declined BofA and the short -- term reaction was similar. I believe it's only a matter of when, not if, that Citigroup gets Fed clearance. CEO Corbat is more committed than ever in achieving this objective.

 At the end of 2013, Citigroup had $174 billion in net tangible equity against $1.8 trillion in total assets, a near 10% equity to asset ratio. Compare that with 2010 when net tangible equity was less than $160 billion against total assets of $1.9 trillion. During that same time period net income has also increased by 30%. Citigroup is a far stronger company today than it was a couple of years ago and it's highly likely that a dividend increase is in the near future.  

For investors, that creates an opportunity to own a dominant financial franchise at a valuation that is a significant discount to not only the overall market but in the financial industry as a whole

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