Lukewarm Q4 Results Do Not Affect $46 Price Estimate For BNY Mellon’s Stock

Bank of New York Mellon (NYSE:BK) managed to beat investor expectations with its earnings for the last quarter of the year late last week – a commendable feat given the negative impact of a stronger U.S. dollar on its international operations, and also taking into account notable headwinds from weak debt and equity market conditions over the period. ^[1] While the fourth quarter of the year is generally the weakest period for the custody banking industry, BNY Mellon’s bottom line also took a $170 million hit due to a recent court ruling that forced the bank to charge-off a loan to the now-bankrupt Sentinel Management Group ^[2] This resulted in the bank reporting a pre-tax income figure of $871 million for Q4 2015 – well below the average of $1.15 billion for the first three quarters of the year.

With BNY Mellon securing additional mandates over the last quarter, and with equity valuations improving considerably since the dismal Q3 2015, there was an increase in the size of assets under custody and administration (AUC/A) from $28.5 trillion in the previous quarter to a record $28.9 trillion this time around. The bank’s investment management arm, however, did not do so well, as it witnessed net outflows of $11 billion. Total assets under management (AUM) remained at the same level as it was in the previous quarter.

BNY Mellon also announced plans to acquire independent investment manager Atherton Lane Advisors alongside its earnings update. The deal, financial details of which were not revealed, will add roughly $2.7 billion in assets to the bank’s investment management division when it is completed in Q2 2016. ((BNY Mellon to Acquire Assets of Atherton Lane Advisers of Menlo Park, California, BNY Mellon Press Releases, Jan 21 2016))

As the world’s largest custody bank, BNY Mellon is well poised to report a sharp increase in interest-related revenues over the coming months as the Fed continues to hike interest rates. Also, the steady rate at which it has acquired small investment management firms over recent years highlights the bank’s strategy of increasing its share of the asset management industry by a combination of organic growth and focused acquisitions. That is why we maintain our $46 price estimate for BNY Mellon’s stock, which is roughly 30% ahead of the current market price.

See our full analysis for BNY Mellon here

Net Interest Margin Nudges Higher; More To Come In The Near Future

One of the biggest sources of value for BNY Mellon is the interest it earns on its interest-earning asset base of around $310 billion. While these assets have 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 the bank’s net interest margin (NIM) from almost 1.9% in 2010 to an all-time low of 0.91% by Q4 2014. The NIM figure was around 0.98% over the first three quarters of 2015, and increased slightly to 0.99% in Q4. As a custody bank, BNY Mellon’s interest margins should improve the fastest among all U.S. financial institutions as benchmark rates rise. With the Fed initiating its rate hike in December, the impact on margins – and hence on BNY Mellon’s revenues – will be noticeable over subsequent quarters.

You can see how an increase in the margin figure impacts the bank’s share value by making changes to the chart below.

Fees From Asset Servicing, Issuer Services Fall On Lower Activity Levels

Our analysis of BNY Mellon shows that the bank draws nearly 45% of its value from its asset servicing business. It is the world’s largest custody bank, with a comfortable lead in the industry over its two biggest competitors, State Street and JPMorgan. Weak equity market activity for the seasonally slow fourth quarter resulted in asset servicing fees for the bank falling to $1.03 billion from an average of $1.05 billion over Q1-Q3 2015 despite the growth in custody assets. The bank’s issue services unit also saw fees fall from $313 million in Q3 to under $200 million in Q4 – primarily due to the seasonal nature of the business. Trading revenues also fell for the fourth consecutive quarter to settle at $173 million.

As the first quarter of the year sees a spurt in custody banking as well as trading activity, we expect the fee revenues to increase considerably in Q1 2016.

BNY Mellon Also Seems To Be Doing Well On The Cost Front

BNY Mellon has been under considerable pressure from some of its biggest investors since early last 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. ^[3] 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 bank, however, has increased its headcount from 50,300 at the end of Q4 2014 to 51,200 now. While this represents a 2% increase in employee strength, BNY Mellon’s staff-related costs increase by more than 4% year-on-year. The reason for this was a one-time $55 million severance expense incurred in Q4 2015, and an additional $30 million in costs related to employee benefits. Taking these two factors into account, employee costs actually fell compared to the year-ago period – partially due to the positive impact of a stronger U.S. dollar on operating expenses.

We believe that the steps BNY Mellon is currently implementing to reduce recurring costs will have a positive impact on operating margins over the coming quarters. 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 Earnings, BNY Mellon Financial Releases, Jan 21 2016 [↩]
2. Bank of NY Mellon is dealt setback in Sentinel bankruptcy, Reuters, Jan 8 2016 [↩]
3. Presentation, Marcato, Apr 7 2015 [↩]