Bank Stress Tests: Failure Roundup (Update 1)

Updated to include the Federal Reserve's partial rejection of Fifth Third Bancorp's capital plan.

NEW YORK ( TheStreet) -- There are plenty of headlines indicating that several bank holding companies failed the Federal Reserve's annual bank stress tests, but it's not quite that simple.

The 19 large, complex bank holding companies subject to the Fed's Comprehensive Capital Analysis and Review (CCAR) for 2012 were stress-tested under a severe economic scenario that included real U.S. GDP contracting "sharply through late 2012, with the unemployment rate reaching a peak of just over 13 percent in mid-2013," while also assuming "that U.S. equity prices fall by 50 percent from their Q3 2011 values through late 2012 and that U.S. house prices fall by more than 20% through the end of 2013." In addition, under the Fed's adverse scenario, "foreign real GDP growth is also assumed to contract, with growth slowdowns in Europe and Asia in 2012."

In order to pass the stress tests, the results had to show that the group of 19's estimated Tier 1 common equity ratios would remain over 5% under the adverse economic scenario.

In order to have their capital plans approved, the companies' estimated Tier 1 capital ratios at the end of 2013 would have to be above 5%, "with all proposed capital actions through Q4 2013."

Some analysts were afraid that Bank of America ( BAC) might have failed the stress tests. The company didn't include any plans to raise dividend payouts or buy back shares, in its stress test submission to the Fed.

KBW analyst Jefferson Harralson on Monday said that Bank of America's estimated Basel 1 Tier 1 common equity ratio could have wound up at 4.66% according to the Fed's stress test scenario, which could have brought tremendous pressure on the shares.

According to the Fed's stress test results, Bank of America's estimated Tier 1 common equity ratio under the adverse economic scenario would be 5.7%, increasing to an estimated 5.9% at the end of 2013, so BAC passed with flying colors, despite the company's huge mortgage putback burden, which was also stress tested.

The only member of the group of 19 failing the stress tests outright, with no planned return of capital to investors, was the privately held Ally Financial, formerly GMAC. As of Dec. 30, the U.S treasury held 73.8% of Ally's common shares, and also $5.9 billion in mandatorily convertible preferred stock, according to Ally's annual 10-K filing. The Treasury "is entitled to appoint six of the eleven total members of the Ally Board of Directors," according to the filing.

Ally Financial reported a Tier 1 common equity ratio of 7.57% as of Dec. 30. The Fed's stress test results showed that under the adverse economic scenario, Ally's estimated Tier 1 common equity ratio would be just 2.5%.

Ally responded with a statement saying that it disagreed with the Fed's stress analysis, which "dramatically overstates potential contingent mortgage risk, especially with respect to newer vintages of loans," and also because the tests don't "reflect management's track record or commitment to address the legacy contingent mortgage risks," and because the tests don't "adequately contemplate contingent capital that already exists within Ally's capital structure that could be available at the Federal Reserve's discretion in the event there was concern about Ally's capital adequacy."

Here's a quick look at three large, complex bank holding companies that passed the stress tests, but had their capital plans rejected by the Federal Reserve, since planed dividend increases of share buybacks, would have caused Tier 1 common equity ratios to drop below 5% under the adverse scenario:

Citigroup

Amid the euphoria following JPMorgan Chase's ( JPM) announcement Tuesday afternoon of a nickel increase in its quarterly dividend to 30 cents, and a new authorization for $15 billion in share buybacks, all boats were lifted, and Citigroup ( C) saw its shares rise over 6% to close at $36.45.

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The shares were up 39% year-to-date through Tuesday's market close, but that was before the Fed released the stress test results, with the regulator moving its schedule up by two days, because JPM just couldn't wait.

While the Federal Reserve estimated that Citigroup's Tier 1 common equity ratio would be 5.9% under the adverse economic scenario, if the company were to carry out its plans for an increased dividend payout and share buybacks, the estimated Tier 1 ratio at the end of 2013 would be 4.9%.

So Citi's capital plan failed the stress tests, and the shares were down 3% in early trading on Wednesday, to $35.42.

Citigroup responded by saying it would "submit a revised Capital Plan to the Federal Reserve later this year, as required by the applicable regulations," and also that the "Federal Reserve also advised that it has no objection to Citi redeeming certain series of outstanding trust preferred securities, as Citi proposed in its Capital Plan."

Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.

SunTrust

SunTrust ( STI) saw its shares rise over 3% on Tuesday, to close at $22.58. The shares were up 28% year-to-date, before the stress test results were announced.

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In early trading on Wednesday, the shares were up another 4% to $23.39.

The Federal Reserve estimated that under the severe economic scenario, SunTrust would pass the stress tests, with an estimated Tier 1 common equity ratio of 5.5%, however, if the company were to go through with all of its proposed capital actions, the Tier 1 common ratio would drop to an estimated 4.8% at the end of 2013.

SunTrust said in a statement that it would "not be increasing its return of capital to shareholders at this time," and that it would maintain its current quarterly dividend of five cents a share, and "redeem certain trust preferred securities at such time as their governing documents permit, including when these securities are no longer expected to qualify as Tier 1 capital."

The company's CFO Aleem Gillani said that "using our own modeling techniques -- which have shown to have a high level of predictability -- SunTrust's estimates for loan losses and pre-provision net revenue in the Supervisory Stress scenario are significantly more favorable than those made by the Federal Reserve."

Interested in more on SunTrust? See TheStreet Ratings' report card for this stock.

MetLife

Shares of MetLife ( MET) rose 5% on Tuesday to close at $39.46, however, following the release of the stress tests after the market close, the shares were down 5% in early trading on Wednesday morning, to $37.53.

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MetLife is in the midst of a transition from being considered a bank holding company, hoping to escape regulation by the Federal Reserve later this year. The company agreed in November to sell "most of the depository business" of its MetLife Bank subsidiary to General Electric ( GE) unit GE Capital. In January, MetLife announced it was exiting the forward residential mortgage business.

MetLife continues to originate reverse mortgages and to service existing mortgage loans.

The sale of the MetLife Bank depository business is expected to be completed during the second quarter, after which the company plans to deregister as a bank holding company.

Under the Federal Reserve's adverse economic scenario, the regulator estimated that MetLife's estimated Tier 1 common equity ratio would be 5.4%, falling to 5.1% at the end of 2013 if the company were to follow through with its capital plan.

However, the company's estimated Tier 1 leverage ratio would be as low as 3.4% under the stressed scenario and MetLife's capital plan.

The Federal reserve rejected MetLife's capital plan, after rejecting the company's previous capital plan submitted in October. Metlife CEO Steven Kandarian reacted by saying the company was "deeply disappointed with the Federal Reserve's announcement," and didn't "believe that the bank-centric methodologies used under the CCAR are appropriate for insurance companies, which operate under a different business model than banks."

Kandarian added that "the established ratios used to measure insurance company capital adequacy, such as the NAIC's risk-based capital ratio, show that MetLife is financially strong," with "a consolidated risk-based capital ratio of 450%, well in excess of regulatory minimums," as of Dec. 30.

The CEO also said that "at year-end 2011, MetLife had excess capital of $3.5 billion," which was projected to "grow to $6 billion to $7 billion at year-end 2012, before any capital distribution actions," and that in the capital plan we submitted, we requested approval for $2 billion in stock repurchases and an increase of MetLife's annual common stock dividend from $0.74 per share to $1.10 per share."

With it painfully obvious that MetLife's foray into the banking business is costing it dearly, and with the company continuing to originate reverse mortgages, despite the pending sale of MetLife Bank, it may be best for the company to truly exit the banking business by exiting all of its mortgage origination and servicing businesses

Interested in more on MetLife? See TheStreet Ratings' report card for this stock.

Fifth Third Bancorp

Shares of Fifth Third Bancorp rose 4% on Tuesday, to close at $14.16. The shares were up 11% year-to-date.

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Following the company's announcement that the Federal Reserve had rejected part of its capital plan, Fifth Third's shares were down 2% in early trading on Wednesday, to $13.90.

The Fed estimated that Fifth Third's Tier 1 common equity ratio under the adverse economic scenario would be 7.7%, falling to an estimated 6.3% if the company followed through with its plan to return capital to investors.

However, Fifth Third announced that although the Fed didn't object to the company's plan to redeem up to $1.4 billion in trust preferred securities, it would only approve common stock repurchases "in an amount equal to any after-tax gains realized by Fifth Third from the sale of Vantiv, Inc. common shares by either Fifth Third or Vantiv," which has made preliminary filings for a public offering.

The Fed objected to a dividend increase beyond the company's current quarterly payout of eight cents and also objected to share buybacks beyond those described above.

Interested in more on MetLife? See TheStreet Ratings' report card for this stock.

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-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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