We previously published our report based on our thesis that the Federal Reserve should let Citigroup (C) increase its dividend 10-fold and to return $1B to Citigroup’s long-suffering shareholders. We understand why the Federal Reserve failed Citigroup during the first CCAR Stress Test Examination scenario in March 2012. The Fed failed Citigroup because it objected to Citigroup’s original plans to increase its capital returned to shareholders. The Fed didn’t object to keeping Citigroup’s current quarterly payout at its whopping $.01/share, which we think is mighty big of the Fed in doing so. Citigroup decided to resubmit to the stress test examination however in its makeup examination, it decided to not seek to return capital to shareholders in 2012. That enabled Citigroup to pass the makeup exam and this was formally announced on August 23rd.

The Fed required that banks maintain at least a 5% capital ratio after undergoing the stress scenarios, which is a measure of a bank’s equity capital relative to its risk-weighted assets. Bill Ackman elaborated that if Citi had been allowed to return the amount of capital to shareholders that it proposed, it would have achieved a 4.9% capital ratio, 10 basis points below the required minimum. Unfortunately, the Fed took a “thumbs-up” or “thumbs-down” approach to the capital return request – if the bank’s request was one dollar above the minimum as determined by the Fed, its request was denied. Even though Citi has a higher tangible equity ratio thanJPMorgan Chase (JPM), JPM had performed better during the crisis and was able to use its previously ethereal reputation to pass the stress test. JPM was allowed to boost its dividend by 20% and authorize a new $15B share repurchase program.

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