BK Bank of New York Mellon Corporation

By Sarah Krouse 

The U.S. Federal Reserve approved capital plans at State Street Corp. and Bank of New York Mellon Corp. in the regulator's annual stress test released Wednesday.

State Street and BNY Mellon's plans were approved after the Fed found that the custody banks could each weather a severe economic downturn. The approval clears the way for the Boston and New York banks to reward investors by returning capital either through dividend payouts, buying back stock or both.

Northern Trust Corp. also had its capital plan approved Wednesday. It is another bank that focuses on custody services, a crucial component of Wall Street's plumbing.

At the low point of a hypothetical recession, State Street's common equity Tier 1 ratio, which measures high-quality capital as a share of risk-weighted assets, would be 6.6%, above the 4.5% level the Fed views as a minimum. The new ratio, unlike the one reported last week by the Fed in a related test, takes into account the bank's proposed capital plan.

The common equity Tier 1 ratio for BNY Mellon at the low point of a hypothetical recession would be 8.4%, also above the 4.5% level the Fed views as a minimum. Last week, the Fed said BNY Mellon has the capital to keep lending in a severe economic downturn, in the first stage of its annual stress tests.

The latest stress-test results incorporate quantitative factors assessed in data released by the Fed last week. These included a simulation of how the bank's capital buffers would hold up under a world-wide recession. The Fed's "severely adverse" scenario of financial stress this year included a 10% U.S. unemployment rate, significant losses in corporate and commercial real estate lending portfolios, and negative rates on short-term U.S. Treasury securities.

This second part of the test also included a qualitative assessment by the Fed of a bank's capital-planning process and internal controls. The Fed has the ability to object to a bank's capital plan on either quantitative or qualitative grounds.

The Fed's results on Wednesday are arguably the more important part of the testing since they dictate how much capital will be returned to shareholders. Increased dividends and buybacks can help to bolster a bank's share price.

State Street's common equity tier 1 ratio in this year's test was similar to last year's, which was 6.5%. BNY Mellon's common equity tier 1 ratio was lower this year than last year's 11.1%.

After passing the 2015 test, State Street and BNY Mellon both announced share buybacks. State Street at the time said that it would increase its quarterly dividend by four cents per share to $0.34, while BNY Mellon left its quarterly dividend unchanged at $0.17 per share.

Write to Sarah Krouse at sarah.krouse@wsj.com

(END) Dow Jones Newswires

June 29, 2016 16:44 ET (20:44 GMT)

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