Citigroup Is the New Bank of America

Updated with additional analyst commentary and closing prices.

NEW YORK ( TheStreet) -- Citigroup ( C) "failed" the bank stress tests, while Bank of America ( BAC) "passed."

That was the instant verdict delivered by the markets following the results of the Federal Reserve's CCAR (Comprehensive Capital Analysis and Review) announced after the bell on Tuesday. Shares of Bank of America have risen nearly 16% since Monday's close, while Citigroup has gained about 5.7%.

But if one sets aside Citi's request to return capital, which may have proved to be overly ambitious, the banks actually fared roughly the same in the hypothetical stress scenario. Citi's "minimum stressed capital ratio with no capital actions" was 5.9%, above the Fed's required minimum of 5%. Bank of America's stressed capital ratio was 5.7%.

What sets them apart is that Bank of America CEO Brian Moynihan learned from his mistake last year when he submitted a request for a modest dividend increase and was denied. This time the bank said it would not submit a request to return more capital, thus saving it from the embarrassment of being turned down.

Now Citigroup CEO Vikram Pandit is feeling the pain of having been too eager to return capital to shareholders in 2012. Pandit has repeatedly said that the bank will be in a position to reward shareholders with more dividends and buybacks in 2012, so the rejection has delivered a serious blow to investor confidence and Citi's credibility.

"One would think Citi would operate beyond reproach, whether it is with accounting conservatism, adherence with regulations, executive compensation or items such as the announcement of a return of capital before authority is granted," Mike Mayo wrote in a note cited by Bloomberg News. "The capital mishap is one more sign that the culture has not changed.

Oppenheimer analyst Chris Kotowski estimates that Citigroup must have asked to return $10 billion over the next 9 quarters or about 1% of its $1 trillion risk-weighted asset base, based on the difference between the minimum capital ratios before and after the request. That works to about $4.5 billion per year.

Had Citi asked for half of that, Kotowski calculates, its minimum stressed ratio after all proposed capital actions would have been 5.4%, in line with JPMorgan Chase's ( JPM) and US Bancorp ( USB), which positively surprised.

The bull case for Citigroup then is that the management got too optimistic on the proposal and this is a temporary setback. The bank can make a request for a lower capital return program later in the year and could win approval from the regulator.

"We believe significant capital returns remain a matter of when, not if. While we believe that the Fed's objection to C's 2012 capital return plan is embarrassing, it is likely not indicative of an underlying capital problem," Sandler O' Neill analyst Jeffrey Harte wrote in a report. "We continue to expect C to generate more than $60B of excess regulatory capital over the next few years and to return the vast majority of that regulatory capital to shareholders."

Is Citi Still Too Risky?

But what is troubling is the Fed's calculation of theoretical losses at Citigroup in the event of a severe economic downturn.

Several analysts noted that the Fed seems to have taken a much harsher view of Citigroup relative to peers and relative to the bank's own historical loan loss experience.

Its projections even seems to have taken the bank by surprise. "We plan to engage further with the Federal Reserve to understand their new stress loss models. We strongly encourage the public release of these models and the associated benchmarks and assumptions," the bank said in a statement following the results.

Projected loan losses at Citigroup in the hypothetical supervisory stress scenario stood at $50.3 billion, in line with Bank of America's projected loss of $51.3 billion. But projected loss rates across portfolios at Citigroup are actually much steeper. For instance, projected loan losses as a percent of average loan balances is 11.2% at Citigroup versus 8.3% at Bank of America.

Analysts attribute some of the higher loss projections to the Fed's somewhat more conservative view on international consumer loans. The projected loss rate for "other consumer" loans at Citigroup is 23.4% for instance, versus 5.6% at Bank of America and 5.9% on an average for the 19 bank holding companies.

Citi's international presence has often been touted as its biggest advantage over its rivals, so the fact that its global business is viewed as a big risk is disconcerting to say the least.

But analysts don't know quite what to make of the Fed's projections. "In general loss estimates in the supervisory stress scenario appeared high, and in some cases, arbitrary and difficult to reconcile by bank," wrote Moshe Orenbuch at Credit Suisse.

Oppenheimer's Kotowski notes that Citi's historical loan losses were much lower than that projected in the tests. The bank's actual First Lien Mortgage delinquency and non-accruals, for instance, were lower than that of Bank of America and JPMorgan last year.

"This test is not a methodical apples-to-apples comparison," said David Konrad, analyst at KBW, who was not too surprised by the loss rate projections. "A lot of it is qualitative."

Konrad does not believe investors should rush to any conclusions based on the Fed's loss projections about Bank of America and Citigroup one way or the other, noting that it is an academic exercise and not indicative of future performance.

He does believe, however, that the stress tests have put capital adequacy concerns for both banks to rest.

"For both Bank of America and Citigroup to be above 5% at the end of the stress tests means it is time to move past concerns about the risk of the balance sheet," said Konrad, noting that Citigroup entered the crisis with less than 5% in capital and has come a long way in building its balance sheet.

The more immediate concern for investors then would be whether Citi will actually get approval for a revised plan.

Citi Investors in "Penalty Box"

Citigroup has said it plans to resubmit its capital plans to the regulator later in the year. But it remains unclear what level of capital the Fed would currently be comfortable with for Citi to allow a buyback.

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

Oppenheimer's Kotowski believes the stress test results was just the Fed's way of telling Citi, "This is not your year."

"The fact that Citi "failed" with a 4.9% projected ratio after "proposed capital actions" is an interesting point," Kotowski wrote in a report. "Our take here is that the Fed simply wanted to keep Citi in the penalty box for another year because it had been among the worst performers in the crisis and caused the most embarrassment to the Fed. It is hard to read the numbers any other way."

If that's the case, then investors might have to tone down their expectations for a dividend increase or buyback later in the year.

"It's going to be smaller or zero as they resubmit," said Credit Suisse's Orenbuch in an interview to Bloomberg Television. "The key question is can they work with the Fed to get them to understand the actual loss characteristics of those assets."

KBW's Konrad believes that future approval of dividends or buybacks might be dependent upon Citigroup's ability to show that it is well on its way to meeting Basel 3 capital standards. "Citi still has a lot of heavy lifting to do," says Konrad, who believes that the bank will have to make headway in winding down some of the riskier assets in Citi Holdings. "As they sell them, there will be a multiplier effect on how they perform on the next stress test."

Konrad remains constructive on Citigroup from a long-term perspective and believes Citi will fare well in the next stress test.

Investors may want to focus on earnings power rather than balance sheet as they go forward. That is an area of concern both for Bank of America and Citigroup.

Analysts have been concerned that Bank of America lacks the earnings generation potential as it shrinks its balance sheet.

Citigroup's recent performance meanwhile has been uninspiring, with expenses continuing to climb and the bank losing market share in its securities banking business, which is already going through a turbulent phase.

Bank of America has significantly outperformed Citigroup in 2012 and the latter may have a lot of catching up to do. But both have some ways to go before they are completely out of the woods.

Bank of America shares rose 4.5% to $9.24. Citigroup shares finished higher by 3% at $36.27.

--Written by Shanthi Bharatwaj in New York

>To contact the writer of this article, click here: Shanthi Bharatwaj.

>To follow the writer on Twitter, go to http://twitter.com/shavenk.

>To submit a news tip, send an email to: tips@thestreet.com.
Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.