BNY Mellon’s Q4 Results Were Better Than They Appear

Investors were not thrilled when Bank of New York Mellon (NYSE:BK) failed to meet market expectations with the Q4 performance figures it released on Friday. ^[1] And not surprisingly, shares of the world’s largest custody bank lost almost 4% of their value over trading that day. But there is more to BNY Mellon’s results than meets the eye, and once you adjust the figures for one-off factors, a rather different picture emerges.

To begin with, revenues for the global custody business are quite cyclical – especially for the issuer services unit – with the last quarter seeing the lowest investment services fee revenues each year. That would explain the roughly 4% reduction in the bank’s investment services fees between Q3 2013 ($1.74 billion) and Q4 2013 ($1.68 billion). Sequentially, revenues also suffered from the continued pressure on net interest margins which led to lower net interest revenues in Q4 compared to Q3.

But the single biggest factor that dragged down revenues for the last quarter is a one-time loss from an equity investment which resulted in the bank’s reported “Investment and other income” falling from gains of $116 million in Q4 2012 and $135 million in Q3 2013 to a loss of $60 million in Q4 2013. The equity investment in question was BNY Mellon’s stake in ConvergEx, which saw a loss of $115 million. ^[2] In fact, BNY Mellon’s total fee revenue for the quarter without including the “Investment and other income” head was $2.82 billion which is the third highest in at least three years (after Q2 2013 and Q2 2011).

The better-than-expected asset management performance and the anticipated interest margin improvements in the near future led us to revise our price estimate for BNY Mellon’s stock upwards from $33 to $35.

See our full analysis for BNY Mellon here

Asset Management Unit Complemented Asset Servicing Performance

As we detailed above, the fourth quarter is a slow period for asset servicing each year, but that did not stop BNY Mellon from pocketing some healthy asset servicing fees. The asset management business also contributed with a record performance – generating an all-time high $904 million in revenues. This figure is 6% higher than what the unit made in Q4 2012 and 10% higher than the figure for the previous quarter.

The strong overall performance for both business units can be attributed to the healthy inflows as well as improved equity market values, which helped the bank’s assets under custody/administration (AUC/A) and assets under management (AUM) reach record levels of $27.6 trillion and $1.58 trillion, respectively.

Pressure On Interest Margins Should Ease This Quarter

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 1.09%. The figure had reached this all-time low figure in Q4 2012, but bounced up to 1.16% in Q3 2013 before settling back to the depressed level again this time around.

Interest revenues form a very important part of BNY Mellon’s total value, as can be seen from the chart above. 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 where the NIM figure remains at the Q1 2010 figure of 1.9% for the rest of our forecast horizon, this represents a 10% upside to our current estimate for the bank’s share price.

While this is likely too aggressive an assumption, the chart captures a more realistic forecast with interest margins expected to begin improving as early as this quarter once the effect of the Fed’s tapering plan kicks-in.

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1. Quarterly Earnings Review, BNY Mellon Investor Relations, Jan 17 2014 [↩]
2. BNY Mellon takes blow from ConvergEx failure, Financial Times, Jan 17 2014 [↩]