Solid Performance Masks BNY Mellon’s Sensitivity To Interest Rates

Bank of New York Mellon (NYSE:BK) did well to exceed investor expectations with its earnings in the admittedly soft third quarter, with the global custody bank bringing in roughly the same amount of revenues as it did last quarter (excluding the one-time equity investment gain of $109 million in Q2). ^[1] Aided by a continued focus on expense management as well as a partial reversal of the charges the bank incurred in Q1 related to a tax-related lawsuit, the bank reported earnings growth of 16% compared to the previous quarter and 34% over the figure for the same period last year. Steady inflows of assets into its Investment Management and Investment Services business segments, coupled with a marked appreciation in equity market valuation for the period, also helped the bank reach its highest levels of assets under custody & administration (AUC/A) and assets under management (AUM), of $27.4 trillion and $1.53 trillion respectively.

And while the results portray a positive picture overall, there is one major revenue stream that has remained depressed for several quarters now – the bank’s interest income. The prolonged low-interest rate environment has put considerable pressure on revenues across banks. BNY Mellon has seen a particularly sharp revenue hit from shrinking net interest margin (NIM) figures; in this article, we highlight the degree to which BNY Mellon’s share value is sensitive to its NIM.

We maintain a $33 price estimate for BNY Mellon’s stock, which is slightly ahead of its current market prices.

See our full analysis for BNY Mellon here

Our analysis of BNY Mellon shows that the bank draws nearly 30% of its value from its asset servicing business and another 25% from its asset management business. It is the world’s largest custody bank and also a key player in the global asset management business. But as can be seen from the chart above, the next biggest source of value for the bank is the interest it earns on its interest-earning asset base of a little more than $270 billion. While the size of these assets have grown considerably over recent years, interest margins have been declining which has pressured interest income.

The current economic conditions have squeezed BNY Mellon’s NIM figure from a high of almost 1.9% in early 2010 to its current figure of 1.16%. The figure has bounced back from the all-time low of 1.09% seen in Q4 2012, but the disparity between the figure 3 years ago and today is quite large. To put things in perspective, if BNY Mellon’s NIM figure for Q3 was 1.9% instead of the 1.16% it witnessed, then its net interest revenues for the period would have been roughly $1.25 billion instead of the reported figure of $780 million – a good 60% higher.

You can understand the impact of this on BNY Mellon’s total share value by making changes to the chart below. Considering the hypothetical scenario discussed above where the NIM figure remains at 1.9% for the rest of our forecast horizon, this represents a 10% upside to our current estimate for the bank’s share price.

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1. Third Quarter 2013, BNY Mellon Website, Oct 16 2013 [↩]