Here's How State Street Fared in the Stress Tests

Going into the Federal Reserve's first round of stress tests, there seemed little for State Street  (NYSE: STT  ) investors to worry about. And they were absolutely right. Even under the "severe" stress case, State Street's projected capital levels were nowhere near worrisome.

Unlike the Federal Reserve's Comprehensive Capital Analysis and Review -- which comes out next week -- the Dodd-Frank stress tests do not determine whether or not the banks involved can pay higher dividend or pay out stock. But since they use essentially the same modeling and stress-case scenarios, they're a good way for investors to get a sense for how the banks will perform in the CCAR and whether they'll be able to increase capital distributions.

Capital ratios
Perhaps the key metric that the Fed and investors are looking at in the results of the stress tests is the Tier 1 common capital ratio, and, in particular, how that low that ratio falls under the hypothetical stressed conditions. 

Here's a look at how that ratio looked for State Street -- both pre-test actual and under stressed conditions -- as compared to similar numbers during last year's CCAR tests.

Source: Federal Reserve.

If I wanted to get picky, I could point out that State Street's Tier 1 common ratio fell more under the stress scenario this year versus last year. But given that State Street's minimum Tier 1 common ratio under the stressed conditions is the second highest -- after Bank of New York Mellon -- I'm not going to bother getting too picky.

Projected net income
How do the regulators get to the stressed capital ratios? A big piece of the puzzle is using the stress-scenario inputs to estimate how much of a profit the bank will register over the nine-quarter test period.

It's actually unusual that we can look at State Street's net income under stressed conditions. Most banks included in the tests reported a net loss under the Fed's stress scenario. In fact, overall, the group produced a collective $194 billion loss over the nine-quarter period.

However, a few banks like State Street -- and again, BoNY -- were able to pull off a projected profit. Here's what the breakdown looked like:

Source: Federal Reserve.

Because State Street is more of a bank for banks, as opposed to lending to consumers and businesses, its exposures are far more to the investments securities on its books than residential or commercial loans. And since the bank maintains such a low-risk portfolio, even a significantly stressed economic environment isn't expected to put a crippling hit on its books.

Now what?
There shouldn't have been too many sleepless nights for State Street investors leading up to these stress tests. With the results out, we can see that it does indeed have one of the most stable balance sheets of the major U.S. banks.

Following last year's CCAR results, State Street both boosted its dividend and announced a new share buyback program. Is that in the cards again this year? We'll have to wait and see, but it certainly looks like the bank is well positioned to continue doling out cash to its shareholders.

An arch-rival ripe for investment?
State Street competitor Bank of New York Mellon is another 800-pound gorilla in the custody and asset management business, and likewise well positioned to perform through a range of economic environments. But is this banker's bank be a buy today? To help figure that out, I invite you to check out The Motley Fool's new premium research report on BoNY. Click here now to claim your copy.


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