Activist ValueAct played a key role in speeding up Citigroup CEO Michael Corbat’s retirement, sources say

Three years ago, Michael Corbat strode onto the stage of a midtown Manhattan ballroom in midtown Manhattan and proclaimed that a new day had arrived at Citigroup.

The bank had set up the July 2017 event, its first investor meeting since the 2008 financial crisis nearly sank the firm, as a splashy reset for the shareholder community. Held within a grand limestone building that once housed the Greenwich Savings Bank, the message from Corbat was clear: Despite missing previous performance goals, the bank had completed an expensive overhaul and could now be trusted.

“You have been patient with us,” Corbat told the audience, sounding almost apologetic. “And I want you to know that we don’t take that patience for granted and we don’t think it is inexhaustible.”

But Corbat and his management team have largely disappointed investors since that 2017 meeting, and that was a key factor in the CEO accelerating his retirement plans, according to people with knowledge of the matter. Last week, Citigroup said that Corbat, 60, was stepping down in February, and that his lieutenant Jane Fraser would become the first female head of a major Wall Street bank.

In particular, the activist hedge fund ValueAct was “very disappointed” in the bank’s performance under Corbat and his deputies since it built up a stake in 2018, primarily because the bank continually missed or changed its performance targets, according to the people, who declined to be identified speaking about the matter.

CNBC reported Thursday that Corbat had moved up his retirement date because of pressure from regulators over the firm’s internal controls and as investors including ValueAct lost patience. On Monday, the Wall Street Journal reported that bank regulators are set to issue a consent order to Citigroup over the bank’s risk management systems.

But details of the pressure the New York-based bank faced from its activist investor hadn’t been reported until now. The lessons from this episode will likely inform how Corbat’s successor Fraser interacts with the bank’s large investors.

ValueAct never called for the removal of Corbat, according to the people with direct knowledge of their interactions. Instead, the firm, led by partner Dylan Haggart, was vocal with the bank’s board and management on the company’s shortcomings, creating tension internally and a situation where the company’s operators knew they were underperforming.

The best analogy for this was the role ValueAct had in prompting Microsoft CEO Steve Ballmer to retire after it took a stake in the tech giant in 2013, paving the way for Satya Nadella’s successful tenure, according to one of the people.

ValueAct prides itself on a reputation within the industry for working with management in a transparent way, giving feedback and getting more involved only when necessary. The hedge fund has had a data sharing agreement with the bank since early 2019, giving it access to board members and non-public information.

After CNBC reported last week that investor patience with the bank had worn thin, ValueAct managers were concerned that other CEOs who worked with the activist would get the misimpression that they had explicitly pushed for Corbat’s removal.

Instead, what had happened at Citigroup was out of the standard playbook for the activist investor, which is to get involved with the company’s board and managers to accelerate change and hopefully improve the stock price over time.

Since ValueAct built its stake in 2018, Citigroup has replaced most of its top executives, including Corbat, the firm’s long-time chief financial officer, and several division and regional heads. In particular, ValueAct had a dim view of former CFO John Gerspach and former consumer banking head Stephen Bird, according to one of the people.

The hedge fund seeks to “create accountability, and with that boards tend to be sharper, more on their game,” the person said. “If it works, that extra urgency drives performance. The CEO becomes lauded and everything works out great. If it doesn’t, it helps you arrive at decisions earlier.”

ValueAct spokesman Drew Stroud said in response to the details in this story that the investment firm has “provided our perspectives on strategic priorities, budgeting, and performance expectations” to Citigroup.

He added that they “appreciated our open and constructive dialog with Mike, the entire Citi management team, and the board.”

Citigroup spokeswoman Jennifer Lowney said that the bank had a “constructive relationship” with ValueAct and “they continue to be an important partner. We have benefited from their expertise and value their perspective.”

She added that “as far is Mike is concerned, his decision to retire was entirely his own and he always planned to do so in 2021.”

Here’s the source of ValueAct’s disappointment in Citigroup: Under Corbat, the bank missed key performance targets for returns and expenses that it had set in that 2017 investor meeting.

At the time, the bank said that it would reach a return on tangible common equity of 11{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} by 2020. When adjusted for the subsequent Trump tax cuts and the impact of deferred tax assets, investors had expected a return closer to 14{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f}.

In January, Corbat declared that the bank had achieved a 2019 return of 12.1{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f}, just ahead of an adjusted goal of 12{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} for that year. But analysts immediately questioned if they had indeed met their goals, factoring in one-offs that made the figure closed to 11.6{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f}.

Making matters worse, the bank also said in January that because of lower interest rates and a slowing global economic outlook – factors that all banks were dealing with – Citigroup was walking away from its original return targets, saying they would likely be lower.

Altogether, it was part of a pattern of constantly shifting goalposts and moves that the source had deemed “sleight of hand” that obscured a deeper truth: Just like before 2017, Citigroup was still missing its targets, if only modestly.

“It’s unacceptable to fall short on your own numbers, which are cushioned numbers to begin with, these targets are set to be beaten,” said one of the people with direct knowledge of ValueAct’s thinking. “The fact that they didn’t even hit their sandbag numbers is the disappointment.”

In fact, Citigroup missed a key target for returns a total of ten times since Corbat became CEO in 2012, according to a research note this week from Mike Mayo, the bank analyst with a long history covering the lender.

The returns measure is a key metric for ValueAct and other bank investors because the broader market assigns a valuation multiple to that figure; an improving ROTCE usually results in a higher stock value.

ValueAct owns about 27 million shares of Citigroup. While the firm typically thinks in terms of a five to seven year horizon, the Citigroup stake hasn’t been a winner so far. The hedge fund is underwater on the investment as of this week, according to people with knowledge of the matter.

The activist’s information-sharing agreement with Citigroup ends next year, at which point the firm will decide whether to renew it or seek a board seat, said the person.

The overall picture at Citigroup was one of progress that was happening too slowly, and of missed opportunities compared to rivals JPMorgan Chase and Bank of America. The fact that investors couldn’t have complete faith in Citigroup’s targets is a key reason that the bank merits the lowest stock valuation of the six biggest U.S. banks.

Perhaps it all goes back to that ill-fated 2017 shareholder meeting, held in a ballroom under the 70-foot vaulted ceilings of a former failed bank. Instead of proving that the bank’s leaders would “be known for doing the things we say we’ll do,” as Corbat said at the time, he is stepping down in February. That will allow him to shut the books on the bank’s regulatory filing for 2020, which was supposed to be the year they closed the performance gap with rivals.

It’s a lesson that can’t be lost on Fraser. When her promotion was announced last week, she had this to say:

“I will do everything I can to make all of our stakeholders proud of our firm as we continue to build a better bank and improve our returns,” Fraser said. “I am excited to join with my colleagues in writing the next chapter.”

With contributions from CNBC’s Nate Rattner.