(photo:reuters)

Citigroup Inc (C.N) on Wednesday stood by its pledge to reward shareholders, as Wall Street sought to understand why the bank failed to win approval from regulators to increase its dividend or buy back stock.

Citigroup said late on Tuesday the Federal Reserve turned down its plan to return capital to shareholders, following the latest stress test of top U.S. banks.

In the weeks leading up to the announcement, Chief Executive Officer Vikram Pandit had convinced analysts the bank had rebuilt its balance sheet to the point it had more capital than needed to weather a severe economic downturn. By late last week, several analysts had forecast the bank would win permission to raise its quarterly dividend from a penny a share to 10 cents.

Surprised investors sent Citigroup shares down 3.4 percent on Wednesday, while the KBW Index of bank stocks gained 1.3 percent. The stock rose more than 30 percent this year.

What happens next remains unclear. Pandit assured employees in a memo that the bank will continue to work with the Fed to return "meaningful capital" to shareholders.

The bank appeared to still be looking for answers. In its statement on Tuesday after the Fed released results of stress tests of 19 large banks, Citigroup suggested that executives had not been able to learn exactly how the bank would be evaluated and that they would keep trying to get a formula that would allow the bank to take the steps it wants.

"We plan to engage further with the Federal Reserve to understand their new stress loss models," the statement said. "We strongly encourage the public release of these models and the associated benchmarks and assumptions."

Citigroup spokeswoman Shannon Bell declined to comment further.

That left analysts and investors asking if Pandit had been too aggressive in his proposal or if he had misunderstood how examiners would score its potential losses in a brutal economy.

And some were critical of Pandit for apparently misreading what the Fed was seeking.

"The thing that gets me is that he didn't learn from the experience of Brian Moynihan," said bank analyst Nancy Bush.

Moynihan, chief executive of Bank of America Corp (BAC.N), was embarrassed last year after he said the bank would raise its dividend and then the Fed would not allow it.

A Federal Reserve spokeswoman said the regulator does not comment on individual institutions.

Citigroup has not disclosed how much capital it wanted to distribute. The Fed's report, however, showed the amount was enough in its stress scenario to take down the key ratio of Tier 1 common capital to as low as 4.9 percent from 5.9 percent. Five percent is the Fed's minimum for passing the test and providing "a high degree of confidence" that a bank would withstand unexpected losses.

Analysts found some hints in the numbers showing what the company was after. Citigroup may well have proposed spending $3 billion buying back its own stock, analyst Jeff Harte of Sandler O'Neill said on Wednesday in a report. He wondered if the bank had been too aggressive in its pitch to the regulators.

Or, perhaps the regulators were uncomfortable with Citigroup's high portion of international assets, analyst Glenn Schorr of Nomura said in a report. He called the Fed's rejection "embarrassing" for the bank.

Regardless, Citigroup - the third-largest U.S. bank - scored poorly in the Fed's measurements of potential losses. The Fed figured loan losses could reach 11.2 percent of average balances, more than half again as much as the 7.1 percent median loss rate for the 19 banks. Potential losses for the two biggest U.S. banks, JPMorgan Chase & Co (JPM.N) and Bank of America Corp (BAC.N), were pegged at just over 8 percent.

Citigroup's potential losses in "other consumer loans," a category that does not include home mortgages and credit cards, overshadowed those of other banks in the stress test. The Fed said the bank could lose as much as 23 percent of balances in the category - six times the median rate for all the banks. The category includes loans in the "OneMain Financial" personal lending business that Citi has been trying to sell and is a stark reminder of the difficulties it had selling off the riskier assets left over from the financial crisis.

"We all have been under the impression that Citi has spent the last three or four years really cleaning up their loan portfolio," said Bush, a contributing editor at SNL Financial. "Their view of the world and the Fed's view are obviously very different."

Citigroup is required to submit a new plan to the Fed. Bush expects Pandit will retreat, although maybe not as much as Bank of America did by not asking for dividend increase in this year's test.

"They have to get a better understanding of the Fed's process," added Bush.

SOURCE:Reuters