Stress Tests Separate Strong from Weak

WASHINGTON — Certain large banks on Tuesday emerged as stalwarts among their competitors following austere tests used by the Federal Reserve Board to measure firms' capital strength in periods of severe stress.

Moving unexpectedly two days ahead of schedule, the Fed released the annual results, which showed that the majority of banks would be able to maintain capital ratios above all four regulatory minimum levels and easily continue to issue dividends to shareholders or make share repurchases even under tough financial conditions.

In a conference call with reporters, a senior Fed official said the results of the test proved just how well capitalized banks have become since the first round of stress testing in 2009.

Banks have increased their Tier 1 common capital to nearly $760 billion as of the fourth quarter of 2011, up from $420 billion in the first quarter of 2009. At least part of that is due to the Fed's insistence that banks take steps to preserve their capital following the financial crisis.

While the results may have proved the biggest banks like Bank of New York Mellon Corp., State Street Corp., and American Express Co. would be able to show resiliency under severe economic stress — like 13% unemployment or a sharp decline of gross domestic product to minus -8% — not all fared as well.

Four of the 19 companies — Citigroup Inc., SunTrust Banks Inc., Ally Financial Inc. and MetLife Inc. — failed at least one of the regulatory thresholds under the stress test, automatically excluding them from moving ahead with their capital plans. Fed officials would not say if other firms were also blocked.

Banks were asked to show their ability to maintain a Tier 1 common ratio above 5%, as well as a 4% Tier 1 capital ratio, 8% total capital ratio, and 3% or 4% Tier 1 leverage ratio, depending on whether the company is required to pay a market risk capital charge. (For a breakdown of how firms fared under the 5% Tier 1 common test, see chart).

The results detailed how banks fared but purposefully did not disclose which quarter the banks' tapped their minimum capital levels in order to prevent the market from interpreting when a company might take a capital action.

Firms that meet the Tier 1 common ratio largely met, if not, surpassed the other regulatory thresholds. In the case of Bank of New York, State Street, and American Express, they were also the only three companies to project positive pre-tax income over the stress episode, unlike their other 16 counterparts.

Companies reacted almost instantaneously to results.

MetLife expressed their "deep" disappointment with the Fed's announcement. "We do not believe that the bank-centric methodologies used under CCAR are appropriate for insurance companies, which operate under a different business model than banks," said Steven Kandarian, chairman, president and chief executive officer of the company.

Ally Financial said several assumptions used by the Fed in its stress testing exercise were inconsistent with the company's view, including "dramatically" overstating potential contingent mortgage risk, as well as its track record in addressing legacy contingent mortgage risks.

In its statement, Citi tried to point out that while it missed the Tier 1 common capital regulatory threshold, it was able to surpass the requirement if its proposed capital actions were excluded. (Under that scenario, Citi's low was 5.9%) The Fed is still allowing the company to pay existing dividend levels, but objected to the bank's proposed return of capital to shareholders. The company plans on submitting a revised capital plan later this year.

At the time of publication, SunTrust had not issued a statement.

Banks will have 30 days to resubmit their capital plans, but could potentially have more time if they request it.

Firms have had to undergo stress tests before, but this round marks the first time since the financial crisis that the results have been made public — and it is arguably the most severe version of the test, given the harsh variables that banks had to score themselves against.

Six of the firms were also asked to run a global market shock scenario that replicates similar events that occurred during the second half of 2008.

Banks were asked to disclose their losses based on the stress scenario in six categories, including first lien mortgages, commercial and industrial loans, and credit cards.

According to the Fed, there were "significant losses" among the 19 banks totaling $534 billion over the nine-quarter horizon. The majority of those losses — 85% — came from loan portfolios and from trading and counterparty losses from the hypothetical global financial market shock.

Based on each bank's portfolio, results varied across the different categories. So, for instance, results showed that Citigroup would have the most exposure and biggest loss when it came to first lien mortgages, while Wells Fargo & Co. and Fifth Third ranked the highest when it came to credit card loss.

The Fed had initially been scheduled to release the stress test results on Thursday. While most observers assumed the Fed moved up its timetable after JPMorgan Chase & Co. announced it would raise its quarterly dividend by a nickel to 30 cents and buy back up to $12 billion of stock, a central bank official said that was not the impetus.