If you had any doubt about whether the Bank of New York Mellon (NYSE:BK) was an ordinary bank, with its first-in-class custodial operations, then doubt no more. Yesterday, the Federal Reserve released the results of its most recent round of stress tests, and BNY Mellon came out on top. The charts and discussion below examine how the company's capital and earnings held up under the Fed's "severely adverse" economic scenario.
The purpose of the stress tests is to gauge how the capital bases of the nation's largest financial institutions hold up in the face of economic and financial turmoil. Among other things, the most extreme case assumes that real GDP declines an average of 4% this year, unemployment ratchets up to 12.1% by the second quarter of next year, and that home prices plummet by 20% over the next 24 months.
As you can see in the chart below, BNY Mellon's Tier 1 common capital ratio was hardly varnished despite the extreme assumptions. Starting from 13.3% at the end of last September, it bottomed out at 13.2% over the hypothetical time period extending from the fourth quarter of last year through the end of 2014. By comparison, the average Tier 1 common capital ratio of the 18 institutions tested fell by a third, from 11.1% down to 7.4%.
The asset-management giant fared equally well when it came to net income. Its hypothetical pre-tax earnings for the nine-quarter time period came in at $5.5 billion. This greatly exceeded the 18-institution average loss of $10.8 billion, and made BNY Mellon the most profitable institution tested in this regard.
Breaking this down a bit further, as you can see in the figure above, BNY Mellon's $6.8 billion in pre-provision net revenue was hit by $1.1 billion in loan loss provisions -- that is, money set aside to cover future losses from soured loans -- and $200 million in losses associated with securities holdings.
Suffice it to say, BNY Mellon's performance on the stress tests is a testament more to its business model than anything else. As I touched on here, unlike, say, a USB or Bank of America, both of which hold massive amounts of loans on their balance sheets, BNY Mellon's principal function is to serve as a custodian and/or asset manager for others. As a result, any decline in asset prices is felt by the owners of the underlying assets as opposed to BNY Mellon.
At the end of the day, the stress tests are meant to do exactly what the name implies: stress you out. And while this year may be no exception for many, investors in BNY Mellon certainly needn't be among those with any fears.
John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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