BNY Mellon Shares Jump As Improved Revenues And Lower Costs Boost Q1 Results

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Bank of New York Mellon

Bank of New York Mellon (NYSE:BK) posted strong performance figures for the first quarter of the year on Wednesday, April 22, as a notable improvement in fee-based revenues coupled with reduced operating expenses helped pre-tax income jump 24% year-on-year. ((Q1 2015 Earnings Release, BNY Mellon Press Releases, Apr 22 2015)) The bank reported $1.75 billion in investment servicing fees for the quarter – slightly lower than the record $1.82 billion figure for Q3 2014, but a 3% improvement compared to the previous and year-ago periods. Foreign exchange and other trading revenues also reached their highest levels since early 2010. This, coupled with BNY Mellon’s continued focus on keeping costs under control, resulted in the bank posting one of its best quarters since the economic downturn in terms of operating performance. Adjusting for one-time items, operating margins exceeded 30% for the quarter – well above the 27% figure for the year-ago period and also better than the 28% seen for the previous quarter.

Despite the negative effect of unfavorable foreign exchange movements, BNY Mellon maintained assets under custody and administration (AUC/A) at a record $28.5 trillion in Q1 2015 thanks to improved market valuations as well as additional mandates for the period. Strong inflows in its investment management operations also helped the bank notch record assets under management (AUM) of $1.74 trillion at the end of the period.

The better-than-expected performance by the bank’s forex trading desk as well as the marked improvement in the operating margin led us to hike our price estimate for BNY Mellon’s stock from $40 to $44. The new price target is roughly 5% ahead of its current market price.

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See our full analysis for BNY Mellon here

Asset Servicing And Clearing Fees, Forex Trading Revenues Drive Top Line Growth

Our analysis of BNY Mellon shows that the bank draws almost 45% of its value from its investment servicing business, which includes asset servicing, as well as issuer, clearing and treasury services as detailed in the chart above. After all, BNY Mellon is the world’s largest custody bank with a comfortable lead in the industry from its two biggest competitors – State Street and JPMorgan. The bank’s strength in the custody industry is evident from the fact that its asset servicing fees were a record $1.04 billion for Q1 2015 – having stayed above the billion dollar mark for the fifth consecutive quarter. Also, the bank’s clearing services fees for the quarter were $344 million and foreign exchange trading fees touched $229 million – both figures being the highest since the economic downturn of 2008. This helped mitigate the impact of lower clearing fees on the total revenue figure for the period.

Interest Margins Witness An Unexpected Improvement

Notably, the third biggest source of value for BNY Mellon is the interest it earns on its interest-earning asset base of almost $310 billion – responsible for just under 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.

BNY Mellon’s NIM figure has fallen from a high of almost 1.9% in early 2010 to an all-time low figure of 0.91% in Q4 2014. However, the interest margin saw an uptick this time around, increasing 6 basis points (0.06%) to 0.97%. The importance of a healthy NIM figure for BNY Mellon’s value can be easily understood from the fact that a 1 basis point increase or decrease in the NIM figure can raise or lower the bank’s total revenues by roughly $31 million. This is just under 1% of the bank’s total average quarterly revenues of $3.8 billion over recent years.

We expect margins to pick up further later this 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.

Cost Cutting Measures Continue To Play An Important Role

BNY Mellon has been under considerable pressure from some of its biggest investors over the last couple of months to cut costs and improve its returns. Earlier this month, one of the investors – Marcato Capital Management – called for major changes to the top management team based on claims that the bank has been performing below par over recent years. [1] Marcato estimated that the bank has roughly 10,000 more employees than it needs (representing 20% of the total headcount) based on comparisons made with several competitors.

The pressure may have been alleviated to a great extent by the fact that BNY Mellon reported non-interest expenses of just $2.7 billion for the first quarter of 2015 – the lowest in the last four years. This helped operating margins touch 30% this quarter – the highest for any quarter in the last four years without any benefit from one-time gains. You can understand how sensitive BNY Mellon’s share price is to its non-interest expenses by making changes to the chart below.

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Notes:
  1. Presentation, Marcato, Apr 7 2015 []