Last week, the Federal Reserve released the first part of the annual banking stress test results, which examined the impact of a severe economic downturn on the largest U.S. banks. While it stood out as one of the strongest banks during last year's stress tests, Bank of New York Mellon (NYSE:BK) posted perhaps the strongest results among the participants institutions. The results highlighted the strength and sustainability of Bank of New York Mellon's custodial operations.
How it fared last week
In addition to posting a higher actual Tier 1 common ratio in Q3 in 2012 compared to 2011, Bank of NY Mellon posted an impressive minimum Tier 1 common ratio of 13.2% under the severely adverse scenario. During the previous year's tests, the bank's minimum Tier 1 common in the doom-and-gloom scenario was a staggering 13.3%. Regardless of some investors clamoring about the ease of the tests this year, it is hard to deny Bank of NY Mellon's ability to withstand economic turmoil.
These strong results have driven investors to tune into the Comprehensive Capital Analysis and Review results, which will be released on Thursday afternoon. Within this release from the Fed, investors will know if the participating banks sought and received approval for any increases in dividends or share buyback programs. Investors will also get to see the impact of any new capital plans on stressed ratios.
Should Bank of New York Mellon request a bump?
Last year, the bank did not request approval of an increase of its $0.13 quarterly dividend payment. However, the Fed approved the company's proposal for a new common stock repurchase program authorizing the purchase of up to $1.16 billion of stock. Bank of NY Mellon ultimately repurchased roughly 50 million shares of common stock in 2012 for $1.12 billion, around $500 million more than it distributed in the form of common stock dividends. Given the substantial strength of its balance sheet under a stressed scenario, the bank seems to have plenty of leverage in negotiating any additional actions to return more capital to shareholders.
While it seems that Bank of NY Mellon is strong enough to request a substantial increase in dividend, I believe investors should expect a modest dividend increase coupled with additional stock buyback capacity. The Fed has explicitly said that dividend payout ratios above 30% will receive "particularly close scrutiny." Bank of NY Mellon's dividend payout ratio was around the 26% level in 2012, suggesting room for marginal growth. If the Fed and the bank cannot agree on a substantial dividend increase, the bank will likely request an boost of share repurchases, which was its more significant capital action in 2012.