BNY Mellon (NYSE:BK) is the world’s largest custodian bank with $26.6 trillion worth of assets under custody and management. JP Morgan Chase (NYSE:JPM) and State Street (NYSE:STT) are its nearest competitors managing assets worth $25.2 trillion and $23.2 trillion respectively. As we briefly discussed in our article Understanding Banks: Types & Functions, custody banks manage assets for other financial institutions – generally broken down into investment servicing and investment management services. In this article, we detail the functions that contribute the most to BNY Mellon’s value.
We maintain a price estimate of $27 for BNY Mellon’s stock, nearly 26% above the current market price. We believe that this premium is largely due to the weak short-term outlook for global custody banking. The bank’s foreign-exchange related lawsuits are also a bitter pill for investors to swallow.
The 3 Most Important Sources of Value for BNY Mellon
1) Asset Servicing – represents 30% of the company’s stock value
BNY Mellon’s asset servicing unit forms a part of its investment servicing business which also includes issuer services and clearing services. The business unit makes money by charging a fee for serving as the custodian of financial assets on behalf of institutional investors such as mutual funds, insurance companies, foundations, endowments and other investment pools.
Clearly, the factors that influence the revenues for BNY Mellon’s asset servicing business are the size of the bank’s assets under custody & management (AUC) and the servicing fee normally charged as a percentage (often a single basis point) of the AUC.
BNY Mellon’s AUC has grown at well over 7% annually the last 5 years, and we estimate the growth to continue at around 5% in coming years, with consolidation in the industry and expansion in developing economies driving the growth.
2) Asset & Wealth Management – 24%
BNY Mellon’s asset management unit is ranked among the world’s leading asset managers. It serves institutional & retail clients and their advisors, including corporations, governments, pension plans, endowments, foundations, sovereign wealth funds and retail intermediaries.
The asset management business earns money by offering customers a wide range of investment products so that customers can bet their money in the market (equity, fixed income, alternative investment etc.) and product that best matches their investment goals. Revenues for the bank generally consist of two parts – a fixed part based on the size of the customer’s investment and a variable part based on the actual return from the investment.
The factors influencing this division’s revenues are the size of BNY Mellon’s assets under management (AUM) and the fee charged as a percentage of the AUM. BNY Mellon managed assets worth $1.26 trillion at the end of 2011, earning a fee of almost 0.24% of this value. We forecast the fee percentage to remain at around this value in the years to come, with increasing competition putting pressure on the fees charged.
3) Interest Income – 20%
BNY Mellon makes proprietary investments in financial securities, loans and leases financed primarily by customer deposits and other short-term borrowings. The net interest income it earns on these investment is the difference between the interest revenue on interest-earning assets and the interest expense incurred on interest-bearing liabilities.