Record Fee Revenues Help BNY Mellon Post Strong Q3 Results Despite Shrinking Interest Margins

Bank of New York Mellon (NYSE:BK) comfortably beat investor expectations for its Q3 results on Friday, October 16, when the banking giant revealed a jump of more than 20% in total revenues year-on-year as well as quarter-on-quarter. ((Q3 2014 Earnings Release, BNY Mellon Press Releases, Oct 16 2014)) While BNY Mellon’s top line received a one-time $836-million boost from the bank’s sale of the One Wall Street building as well as its investment in Wing Hang, the bank reported a record $1.8 billion in investment servicing fees for the quarter – a testament to its strong position in the global custody banking business. This, coupled with the bank’s continued focus on keeping costs under control, allowed it to post net earnings in excess of $1 billion for the period. Notably, the higher revenues helped operating margins breach the 35% mark for the first time since 2006. Adjusting for one-time items, operating margins were a strong 29.3% for the quarter – well above the 26.6% figure for the previous quarter and also better than the 28.6% seen for the year-ago period.

Although falling valuation and unfavorable foreign exchange movements dragged down BNY Mellon’s assets under custody and administration (AUC/A) from the record $28.5 trillion in Q2 2014 to $28.3 trillion in Q3 2014, strong inflows in its investment management operations more than offset the negative impact of these factors to notch record assets under management (AUM) of $1.65 trillion at the end of the period.

We maintain a $35 price estimate for BNY Mellon’s stock, which is slightly ahead of its current market price.

See our full analysis for BNY Mellon here

Asset Servicing And Clearing Fees Lead Revenues Higher

Our analysis of BNY Mellon shows that the bank draws 30% of its value from its asset servicing business (detailed in chart above). After all, it is the world’s largest custody bank with a comfortable lead in the industry from its two biggest competitors – State Street and JPMorgan. While a decline in market valuation across asset classes and a considerable shift in foreign exchange rates have hit asset values for all U.S.-based custodians as well as asset managers in Q3 2014, the industry has benefited from strong fee-driven revenues over the period. BNY Mellon cashed in on this to report asset servicing fees of more than $1 billion for the third consecutive quarter. Also, the bank’s clearing services fees for the quarter were $337 million – the highest figure since the economic downturn of 2008. These revenues represent a 46% jump over Q2 2014 and a 7% improvement over Q3 2013.

Shrinking Interest Margins Weigh On Results

An important thing to note in the chart above is the fact that the third biggest source of value for BNY Mellon is the interest it earns on its interest-earning asset base of almost $312 billion – responsible for almost 20% of the bank’s share value, according to our estimates. While the interest-bearing assets have grown considerably over recent years, the prolonged low-interest rate environment has put considerable pressure on interest margins across banks. BNY Mellon has seen a particularly sharp revenue hit from shrinking net interest margin (NIM) figures.

Current economic conditions have squeezed BNY Mellon’s NIM figure from a high of almost 1.9% in early 2010 to its current all-time low figure of 0.94%. This disparity between the figure four 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 less-than-half figure of 0.94% it witnessed, then its net interest revenues for the period would have been roughly $1.5 billion instead of the reported figure of $721 million.

While we expect margins to pick up next year once the Fed raises benchmark interest rates, you can estimate the impact of falling margins on BNY Mellon’s total share value by making changes to the chart below.

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