BNY Mellon Well-Positioned Despite Lukewarm Q4 Results

Bank of New York Mellon’s (NYSE:BK) performance for the fourth quarter of 2014 came in below market expectations late last week as the world’s largest custody bank saw its top line figure being squeezed by the continuing reduction in net interest margin as well as from a sharp reduction in fees from issuer services. ^[1] While net interest income of $712 million for Q4 2014 was the lowest since Q1 2011, BNY Mellon’s fees from issuer services (which includes corporate trust and depositary receipts) fell to below $200 million for the first time since The Bank of New York’s merger with Mellon Financial in July 2007. Investors reacted by leading the bank’s share price lower by more than 4% over trading on Friday, January 23, after the results were announced. We believe that this was an overreaction.

To begin with, it must be remembered that shrinking interest margins have been plaguing the banking sector as a whole, so it is not unique to BNY Mellon. At the same time, the steady increase in the bank’s interest-earning assets over the years will allow it to gain significantly once the Fed hikes benchmark interest rates. Also, the reduction in activity for BNY Mellon’s depository receipts unit appears to be a one-time event which is unlikely to be repeat itself in the near future. Finally, the bank remains the leader in the global custody business with $28.5 trillion in assets under custody and administration (AUC/A), and is also garnering a strong share of the global asset management business with a record $1.71 trillion in assets under management (AUM). Taking these factors together with the notable effort put in by BNY Mellon over recent quarters to cut costs, we see the Q4 2014 results as a minor hiccup for the bank’s stable business model.

This is why we maintain our $40 price estimate for BNY Mellon’s stock, which is about 10% ahead of the current market price.

See our full analysis for BNY Mellon here

Interest Incomes Will Not Weigh On Top Line For Long

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 generated on its interest-earning asset base of around $320 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 0.91%. This disparity between the figure then and now is significant. To put things in perspective, if BNY Mellon’s NIM figure for Q4 was 1.9% instead of the 0.91% it witnessed, then its net interest revenues for the period would have been a little over $1.5 billion instead of the reported figure of $712 million.

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

Benefits Of Lower Operating Costs Likely To Continue

BNY Mellon reported adjusted non-interest expenses of $2.65 billion for the fourth quarter of 2014 – the lowest since Q3 2012, when the figure was below $2.6 billion. A key factor behind this cost-cutting drive has been investor pressure on BNY Mellon to take a hard look at expenses in an environment not conducive to growing revenues. It must be mentioned that the bank generally incurs the highest costs from third-party services in the fourth quarter of the year, and its efforts to reduce operating costs quarter-on-quarter as well as year-on-year are commendable. While a reduction in jobs over the year helped staff costs fall to the lowest level in ten quarters, overhead expenses clubbed under “other costs” were also at the lowest level in at least four years.

You can understand how sensitive BNY Mellon’s share price is to its non-interest expenses by making changes to the chart below.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. Fourth Quarter 2014 Earnings Release, BNY Mellon Financial Releases, Jan 23 2015 [↩]