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Fed Stress Tests Show Cracks in Fortress Balance Sheets

NEW YORK ( TheStreet) -- A year after having their initial 2012 capital plans were rejected by the Federal Reserve, Citigroup (C - Get Report) and Fifth Third Bancorp (FITB - Get Report) appear to be among the best capitalized banks, according to the regulator.

In stress test results released on Thursday, Citigroup and Fifth Third now are projected by the Fed to have common capital ratios in excess of 8% in a stressed economic scenario of a deep recession, 12%-plus unemployment, a 20% slump in housing prices, and a 52% drop in U.S. stock markets.

Notably, while Citigroup and Fifth Third have emerged with the Fed's imprimatur on the heels of Thursday's results, lenders such as JPMorgan (JPM - Get Report), Bank of America (BAC - Get Report) and Wells Fargo (WFC) now appear more vulnerable to a deep economic crisis, on a relative basis.

" It is a little surprising that Citi has done so well while JPM slipped," wrote Peter Tchir, the head of TFMarket Advisors and a former credit trader at Deutsche Bank and Royal Bank of Scotland, in a note to clients.

Wells Fargo's Tier 1 common equity ratio under the Federal Reserve's "severely adverse scenario" would fall to just 7%, well below those of Citigroup and Fifth Third, but still significantly above the 5% minimum threshold to pass stress tests.

Bank of America would whether the Fed's severe scenario with a projected minimum 6.8% Tier 1 common ratio, while JPMorgan's minimum stressed ratio of 6.3% indicates it's the most vulnerable of the "big four" U.S. banks to an economic downturn.

JPMorgan's underperformance under the severely adverse scenario may reflect the hit the bank took in 2012 when it recorded a trading loss in excess of $6 billion, which caused the nation's largest bank by assets to suspend a $15 billion share repurchase plan.

"Ironically (or maybe not ironically) the Whale trade had been great in the stress tests the way it was designed, and maybe that is why JPM did worse this time around," Tchir wrote, referencing a failed credit derivative trade known as the 'London Whale.'

The bank's stress-test bill of health also may signal the cost of having extensive trading and investment banking operations, where high amounts of capital are now mandated by regulators.

In a stressed scenario, Morgan Stanley (MS - Get Report) and Goldman Sachs (GS) would have capital ratios below 6%, but above the minimum 5% threshold. A press releases by Morgan Stanley shows the bank calculated 1% more capital than the Federal Reserve, a 6.7% common equity ratio, in a stressed scenario.

Roughly a quarter of overall losses in a stressed scenario would come from counterparty exposures and trading losses. Overall, in a stressed scenario, Wall Street would post roughly $194 billion in losses, according to the Fed's calculations, with Bank of America leading the way with a $51.8 billion loss.

Trading risks and losses related to loan portfolio's accounted for 90% of overall projected loses, according to the Fed.

The divergence in Citigroup's performance from large-cap bank competitors such as JPMorgan and Wells Fargo, also may indicate its cautious stance on share buybacks or dividends through 2012. In a press release after Fed results were announced, Citigroup said it wouldn't raise its 1-cent dividend, however, the bank will try to repurchase up to $1.2 billion in shares in 2013.

Only one of the big banks, Ally Bank actually failed the 2013 stress tests. The lender was seen by the Fed as having only 1.5% of tier 1 capital in a stressed scenario, meaning it remains quite weak in the Fed's eyes, years after multi-billion dollar bailouts.

Trust banks Bank of New York Mellon (BK) and State Street (STT) were seen by the Fed as having the highest capital in a stressed economic environment.

Total losses for the banks tested would come in at $462 billion over nine quarters of the severely stressed scenario, according to the Fed.

"The stress tests are a tool to gauge the resiliency of the financial sector," Daniel K. Tarullo, a Federal Reserve Governor said in a statement. "Significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty."

-- Written by Antoine Gara in New York

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