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Banking Stress Test Results Not What They Seem: Citigroup Inc. (C), SunTrust Banks, Inc. (STI), Metlife Inc (MET)

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With some fanfare, the Federal Reserve’s “Stress Tests” have been released as concerned to the nation’s largest bank holding companies. For most part, the numbers are open for all to peruse, and the purpose of this article is to point out that things are not quite what they may seem.

The popular press, upon the release of the 2013 results, hailed the improved health of most of the nation’s large banks. Well, much of the improvement had more to do with a change of methodology than an explosive improvement in capitalization levels. I am going to look specifically at some of the themes demonstrated by the 2013 Stress Test.

Citigroup Inc. (NYSE:C)

The loser

The great loser, both last year and this year, is Ally Financial (NASDAQOTH: ALFI). This former GMAC is still 74% government owned as a vestige of last decade’s government bailout extravaganza, and still faces enormous uncertainty due to its relationship with its former unit, Residential Capital, currently in Chapter 11 Bankruptcy.

Shockingly, its common ratio falls to a paltry 1.5% in the hypothetical economic crisis. That is even worse than the 2.5% under the slightly shallower hypothetical crisis in the 2012 stress test. The Federal Reserve obviously has little faith in Ally’s primarily automobile related loan portfolio in an economically stressful environment. I have never looked carefully at Ally, and it is still too soon to look at this troubled former unit of General Motors Company (NYSE:GM) as an investment option.

The others

At this time last year, apart from Ally, the three most troubled large banks in the country, from capitalization standpoint, were SunTrust Banks, Inc. (NYSE:STI)Citigroup Inc. (NYSE:C), and Metlife Inc (NYSE:MET). Metlife Inc (NYSE:MET) in particular is easy to dispense with as it is no longer a bank, having had its bank charter, which it first gained in order to take advantage of government largess in 2008, voluntarily relinquished in February, 2013.

A casual observation of stress test results shows that in 2012, SunTrust Banks, Inc. (NYSE:STI) and Citigroup Inc. (NYSE:C) had bottom line common ratios of 4.8% and 4.9% respectively. Bottom line 2013 results showed the two banks had common ratios of 7.3% and 7.4%, respectively. In the 2013 test, the assumptions included draconian economic conditions, including a 50% drop in their equity portfolio values, a housing price decline of 20%, and a 5% drop in gross domestic product, among other conditions.

So did SunTrust Banks, Inc. (NYSE:STI) and Citigroup Inc. (NYSE:C) really grow their common ratios by 250 basis points in one year? Of course not. The 2012 bottom line included the companies’ capital distribution plans, whereas the 2013 test only dealt with common capital under an adverse scenario; capital returns would wait for another day. If the bottom line of 2012 had excluded planned capital returns to shareholders, SunTrust Banks, Inc. (NYSE:STI) and Citigroup Inc. (NYSE:C) would have had 2012 common ratios of 5.5% and 5.9%, respectively, still impressive improvements.

Much of those two banks’ capital improvements are due to the fact that they were either not allowed in 2012, or eventually chose not to return any capital to shareholders other than token dividends. There were no competitive yields, nor multi-billion dollar share buybacks. Therefore, the vast majority of Citigroup Inc. (NYSE:C)’s $7.5 billion in 2012 profit, and SunTrust Banks, Inc. (NYSE:STI)’s $1.9 billion, flowed directly toward boosting capital. SunTrust’s restructuring in September 2012 also aided its capitalization levels.

The winners

The biggest winners in the 2013, much like the 2012 stress test, were the nation’s large trust banks. State Street Corporation (NYSE:STT) and The Bank of New York Mellon Corporation (NYSE:BK), with Tier One Common ratios of 12.8% and 13.2% under the most adverse criteria. This strength befits their status as custodial banks, which in many ways form the backbone of the financial system of the United States.

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