Custody Banking Fees, Lower Operating Costs Help BNY Mellon Post Strong Q3 Results

Bank of New York Mellon (NYSE:BK) reported a strong performance for the third quarter of the year earlier this week, with the banking giant leveraging its strength as the world’s largest custodian to grow revenues even as it implemented sizable cuts to its operating expenses. ((Third Quarter Earnings, BNY Mellon Financial Releases, Oct 20 2015)) BNY Mellon faced notable headwinds over the period, as the low interest rate environment continued to weigh on interest revenues, and as increased volatility in capital markets adversely affected trading revenues. However, the bank mitigated the impact on its top line to a great extent by churning out fee revenues in excess of $3 billion for a second consecutive quarter. The performance of BNY Mellon’s asset servicing arm stands out in particular, as it reported record revenues of $1.85 billion in Q3.

Sharp reductions in market valuation across asset classes resulted in a reduction in the size of assets under custody and administration (AUC/A) from the record $28.6 trillion in Q2 2015 to $28.5 trillion this time around. The bank’s investment management arm also saw a reduction in total assets under management (AUM) due to net outflows and lower valuations to end the period at $1.63 trillion – marking a decline for the second consecutive quarter from the record high of $1.72 trillion reported in Q1.

The highlight of BNY Mellon’s results for the quarter, though, was the notable reduction in non-interest expenses. The bank reported costs of less than $2.7 billion for the quarter – the lowest for any period since Q1 2011. Adjusted for one-time costs, these expenses were identical to the figure for the previous quarter, and were 3% lower compared to what BNY Mellon reported a year ago.

We maintain a $46 price estimate for BNY Mellon’s stock, which is slightly ahead of the current market price.

See our full analysis for BNY Mellon here

Fees From Asset Servicing, Issuer Services Drives Revenue Growth

Our analysis of BNY Mellon shows that the bank draws nearly 45% of its value from its asset servicing business (detailed in chart above). It is the world’s largest custody bank with a comfortable lead in the industry over 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 and asset managers in Q3, the industry has benefited from strong fee-driven revenues over the period. BNY Mellon cashed in on this to report asset servicing fees of $1.06 billion for the quarter. This was only marginally lower than the figure for the previous quarter and 3% higher than the figure a year ago. There was also a sizable jump in the bank’s issuer services fees, which swelled 34% quarter-on-quarter from a seasonally higher level of activity. Taken together, revenues for BNY Mellon’s investment servicing division (which also includes clearing and treasury services) reached a record high of $1.85 billion.

No Respite From Shrinking Net Interest Margins

One of the biggest source of value for BNY Mellon is the interest it earns on its interest-earning asset base of around $320 billion. While the size of these assets has grown considerably over recent years, the prolonged low-interest rate environment has put considerable pressure on interest margins across the banking industry – resulting in a decline in net interest margin (NIM) for BNY Mellon from almost 1.9% in 2010 to an all-time low of 0.91% by Q4 2014. The NIM figure has been around 0.98% over the last three quarters, but there will be no sizable improvement in this figure until the Federal Reserve hikes benchmark interest rates.

With the rate hike likely to follow in the near future, BNY Mellon is poised to realize solid gains on its large interest-earning asset base early next year. You can see how an increase in the margin figure impacts the bank’s share value by making changes to the chart below.

BNY Mellon Cut Costs Despite Growing Employee Base In Q3

BNY Mellon has been under considerable pressure from some of its biggest investors since early this year to cut costs and improve its returns. In April, 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.

Although the sequential increase in the number of BNY Mellon’s employees from 50,300 at the end of Q4 2014 to 51,300 now (an increase of 2%) is contradictory to the demands voiced by activist investors, the bank has done a commendable job of reducing costs over this period. Total non-interest expenses fell to below $2.7 billion for the first time in more than four years despite the increase in headcount, with the bank maintaining costs across categories at levels almost identical to those in the previous quarter. 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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1. Presentation, Marcato, Apr 7 2015 [↩]