Uncle Sam gave Atlanta’s biggest bank a black eye last week.
SunTrust Banks was one of only a handful of big banks that failed the Federal Reserve’s yearly stress test of the nation’s 19 largest banks.
So more than four years after the financial crisis started, is SunTrust still not out of the woods?
Industry analysts said that’s not the way to read the latest development.
Bank analyst Chris Marinac called it “a temporary embarrassment” that will quickly go away as the bank continues reporting profits.
“I think it’s analogous to a bad call by an umpire,” said Marinac, with FIG Partners in Atlanta. “They’re still in the game.”
The test — based on a hypothetical scenario in which stock and home prices plunged and job losses soared — is aimed at seeing how well banks could weather a severe recession, worse than the 2007-09 financial crisis, if they boost dividends and other payouts to shareholders this year.
Some industry analysts said they were puzzled by the Fed’s thumbs down and said SunTrust won’t suffer as a result.
Indeed, SunTrust’s shares shot up more than most banks’ stock prices afterwards, as SunTrust officials predicted favorable first-quarter earnings results. They also said the bank will soon submit a new so-called “capital plan” for a re-run of the Fed’s stress test.
“This is not a pass-fail test,” SunTrust Chief Financial Officer Aleem Gillani said. “This was about how much capital you can start to return to your owners.”
Without higher payouts, the Fed projected, SunTrust stayed above minimum required capital levels in a severe recession.
Gillani said reaction to the results “has been very positive” among investors in SunTrust’s stocks and bonds. He said the Fed’s results will have little impact other than delaying an increase in SunTrust’s dividend or other shareholder payouts.
“This announcement has no negative implications whatsoever for our” customers, he said.
Still, the Fed’s big “no” to SunTrust’s original capital payout plan surprised the bank and industry players, and put a question mark on its recovery progress. SunTrust is the nation’s eighth-largest bank in terms of deposits.
But rather than questioning SunTrust’s progress, some analysts questioned the stress test’s methods.
Jefferson Harralson, bank analyst with Keefe Bruyette & Woods, said the Fed used a “very severe scenario” in its assumptions. It also projected a bigger hit to SunTrust’s profits in a bad recession than he expected. Even so, he added, the bank still came close to hitting the Fed’s target reserve levels.
One key capital measure is the “Tier 1 common ratio,” or the level of a bank’s common stock capital compared to a risk-adjusted measure of its assets. The Fed required a minimum ratio of 5 percent. In the worst-case scenario, SunTrust’s ratio came in at 4.8 percent if it boosted its shareholder payouts, and 5.5 percent if it didn’t.
Despite the disappointing test result, SunTrust is in good shape, Gillani said. At 9.2 percent at the end of 2011, SunTrust’s capital level is “about the highest we’ve ever had,” he said, and the bank is profitable. “The last time SunTrust lost money was in the second quarter of 2010,” he said.
Certainly, SunTrust is banking profits again. SunTrust reported profits of $836 million over the past two years.
But the bank lost almost $1.6 billion in 2009, as the housing market crash made Georgia the nation’s capital for bank failures.
Also, its annual profits are still nowhere close to the $1.6 billion it reported in 2007. And the bank still hasn’t finished working its way through some crash-related problems, including losses on flawed mortgage loans it is buying back after selling them years ago to government-backed Fannie Mae, Freddie Mac and other investors.
Now, last week’s stress test results thwart SunTrust’s plans, at least for the next few months, to boost its once-rich dividend and to send more money back to investors through stock buy-backs.
Before the crash, SunTrust paid out roughly $1 billion annually in dividends, or nearly $3 a share. During the financial crisis, bank regulators required SunTrust and other troubled banks to slash the quarterly dividend to a token penny per share.
Following last year’s stress test, bank regulators approved SunTrust’s plans to issue $2 billion in stocks and debt, and to pay back nearly $5 billion in government aid it received under the so-called TARP program during the financial crisis. The bank also was allowed to raise its dividend back to 5 cents per share per quarter, or about $100 million a year.
SunTrust has not disclosed its capital plans this time around.
But now that the Fed has rejected those plans, SunTrust will have to keep saving most of its profits for a rainy day. Unlike other banks that passed the stress test, it will have to re-write its so-called “capital plans” and re-submit them to the Federal Reserve within the next month or so. The Fed will then re-run its stress test within three months before giving SunTrust a thumb’s up or down on its revised plans.
Other financial institutions that failed to meet regulators’ requirements were Citigroup, the nation’s third-largest bank; MetLife Inc.; and Ally Financial. The Wall Street Journal reported that Fifth Third Bancorp’s capital plan also was rejected.
While acknowledging that all 19 big financial institutions are in much better shape than a few years ago, the Fed rejected the capital plans of SunTrust and the other banks after projecting that their capital reserves would fall too low in a severe recession if they were allowed to boost payouts.
The agency said the stress test scenario is “unlikely,” but needed to be stringent to ensure a robust banking system. The test simulated conditions like those during severe recessions in the 1970s, 1980s and 2007-09, including a 13 percent unemployment rate, a 50 percent drop in stock prices, and an additional 20 percent decline in home prices from currently depressed levels.
“It’s a very severe scenario,” Harralson said. “In that sort of scenario, no bank would be paying out dividends or buying back stock,” although that’s what the stress test assumed, he added.
Harralson estimates that SunTrust hoped to boost its payouts to shareholders to $900 million over two years through dividends and stock buy-backs.
“That’s a very reasonable level considering what they’re expected to make,” he said.
A spokeswoman for the Federal Reserve declined to talk about specific banks’ results.
Analyst Marinac speculated that the Federal Reserve’s tough projections for SunTrust may reflect larger-than-expected recent losses on problem mortgages that SunTrust had to buy back from Freddie Mac and other mortgage backers. He said it also may be a “referendum” on past severe real estate market losses in Georgia and Florida, where most of the bank’s lending has been concentrated.
But such losses are “old news” that SunTrust seems to be getting dinged for more than other banks, he added. “We’ve already seen heavy losses taken,” he said. “It’s a little redundant.”
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