Four financial companies actually fail the Federal Reserve's stress test

03/13/2012 6:36 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The Fed speaks: Lots of surprises.

In contrast to the don’t disturb the waters statement from the Fed’s Open Market Committee earlier in the day on interest rates and the U.S. economy, the Fed’s 4:30 p.m. (New York time) announcement of the result of its annual stress test of 19 big U.S. financial institutions blew a couple of smoking holes in the banking sector.

Yes, 15 of the 19 financial companies tested passed. They’ll now be able to increase share buy backs and dividends. In fact, JPMorgan Chase (JPM) has already announced that it will increase its quarterly dividend to 30 cents a share from 25 cents a share. (Record date for that dividend is April 5.)

But four financial companies failed and won’t be allowed to increase their dividends or buyback plans. And from the market’s reaction in afterhours trading nobody was expecting those results.

The four companies that failed the test include Citigroup (C), Ally Financial, MetLife (MET), and SunTrust Banks (STI). In afterhours trading Citigroup fell 3.4%; MetLife was down 3.7%, and SunTrust Banks dropped 4.8%. (Ally Financial, formerly, the financing arm of General Motors (GMAC) isn’t a public company; the U.S. Treasury is its majority shareholder.)

What does “failed” mean in this case? The Fed looked at the Tier One Capital Ratios at these 19 companies in the event of a jump in U.S. unemployment to 13% and a further 25% drop in home prices. To pass a company had to show a Tier One Common Capital Ratio of 5% or better.

And then the Fed looked at the capital ratios these financial companies would have under that scenario and if the company pursued its proposed plan of capital management. (Capital management in this case means the company’s plans for dividends and stock buy backs.) Any company that didn’t show a capital ratio above 5% under the Fed’s scenario and after its capital management plan did not get the Fed’s permission to go ahead with plans to increase dividends and stock buybacks. (MetLife apparently failed a different part of the test for total risk-based capital. The company, an insurer regulated by the Fed because of its banking activities, has protested that the test isn’t suited to an insurance company.)

Citigroup, for example, showed a 5.9% capital ratio under the Fed’s scenario but only a 4.9% capital ratio if the Fed’s scenario was combined with the banks plans for dividends and buybacks. So Citigroup didn’t get the Fed’s permission to go ahead with its widely expected plan to increase its current 1-cent a share quarterly dividend. SunTrust Banks showed a 5.5% capital ratio for the stress test without an increase in payouts but a 4.8% ratio with its proposed increased payouts. Ally Financial showed the same, group-low 2.5% capital ratio in both situations.

Among big banks that passed the test were Wells Fargo (WFC) with ratios of 6.6% and 6%; US Bancorp (USB) with ratios of 7.7% and 5.4%, and, surprisingly Bank of America (BAC) with a ratio of 5.7% and 5.9%. (Don’t ask me why the bank’s capital ratio is higher with any Fed’s system is a black box at this level of detail.) Bank of America hadn’t proposed any plan for increased dividends or stock buybacks to the Fed. Perhaps because it didn’t want to run the risk of getting turned down again. (US Bancorp is a member of my Jubak’s Picks portfolio http://jubakpicks.com/  )

For banks that didn’t get permission to raise dividends or stock buybacks, the process is now to submit a new plan to the Fed for approval. Citigroup has already said that it remains committed to returning capital to shareholders this year.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of US Bancorp as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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