(Reuters) - Citigroup and MetLife led a list of financial institutions that failed the Federal Reserve's latest round of stress testing Tuesday, a shock result for two companies that were widely expected to return billions of dollars in extra capital to shareholders soon.
MetLife, the largest life insurer in the United States, and Citigroup, the nation's third-largest bank, were among just four of 19 banks that didn't pass the latest round of tests. Ally Financial and SunTrust also failed the exam, which applied worst-case scenarios through the end of 2013.
The three listed companies - Citi, MetLife, and SunTrust - were all down more than 3 percent in after-hours trading.
"The initial reaction in the market is rather limited, but I think it is pretty negative that you had four banks fail. Citi and a few of the larger ones - it doesn't bode well for the banking sector," said Kathy Lien, director of research for GFT Forex in Jersey City, New Jersey.
Citi's result was a substantial setback, as going into the tests some analysts felt it had a better chance of a positive surprise than any other financial institution.
The bank said the Fed objected to its capital return plans but did not object to continuing its current dividend level. It added it plans to submit a new capital plan later this year.
"We plan to engage further with the Federal Reserve to understand their new stress loss models. We strongly encourage the public release of these models and the associated benchmarks and assumptions," Citigroup said.
METLIFE CRITICAL OF FED
Last October, the Fed blocked MetLife's capital plans in anticipation of the stress testing. The insurer is regulated as a bank holding company because of its online retail banking operations, though it struck a deal last December to sell them to General Electric Co.
In a statement the company condemned the stress tests as inappropriate for an insurance company and out of line with the standards used by its state regulators.
"We are deeply disappointed with the Federal Reserve's announcement," Chief Executive Steve Kandarian said, adding that MetLife had sought permission for a $2 billion share buy-back and a 49 percent increase in its annual dividend. Both were in line with what analysts had expected the company to pay out.
Ally, in a statement, said it supported the idea of stress testing but that the results were "inconsistent" with how the company viewed its situation.
FAILURES LEGITIMIZE TESTS
"The analysis dramatically overstates potential contingent mortgage risk, especially with respect to new vintages of loans," the company said in a statement, adding that it also would submit a new capital plan in the near future.
SunTrust was the last of the banks to respond, more than three hours after the Fed released the test results. It said its own models were "significantly more favorable" than the Fed's, and that it expected to beat earnings estimates for the current quarter.
While market reaction for the four was negative, some took the contrarian view, arguing that having banks fail was actually a good sign that proved the legitimacy of the testing. European bank stress tests were at one time roundly condemned when many troubled banks end up passing.
"There's so much more credibility when you actually have some of these banks fail the stress tests," said Keith Davis, a bank analyst and principal at money manager Farr, Miller & Washington. "When you actually have banks submitting capital plans and requests to return capital, and it's denied, I think that says a lot about ... how aggressive (the Fed) is being in terms of assumptions."
(Reporting By Ben Berkowitz, additional reporting by Jonathan Stempel and Walden Siew in New York and Rick Rothacker in Charlotte; Editing by Alwyn Scott and Tim Dobbyn)
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