DBRS Comments on BNY Mellon’s 4Q10 and 2010 Earnings; Sr. Debt at AA (low) Unchanged; Trend Stable

DBRS, Inc. (DBRS) has today commented that its ratings for The Bank of New York Mellon Corporation (BNY Mellon or the Company) including its AA (low) Issuer & Senior Debt rating and its R-1 (middle) Short-Term Instruments rating, are unchanged following the release of the Company’s 4Q10 financial results. The trend on all ratings remains Stable.

BNY Mellon’s earnings from continuing operations improved in the fourth quarter in line with expectations for its rating range. Despite the challenging operating environment characterized by persistently low interest rates, the Company reported net income from continuing operations available to common shareholders of $690 million in the fourth quarter, increasing 10% sequentially compared to $625 million in 3Q10 and down 3% from the $712 million reported a year ago same quarter. Full-year 2010 net income from continuing operations was $2.6 billion, up from a negative $1.1 billion in 2009. The sequential improvement in the quarter’s results reflected a 9% improvement in total revenue to $3.7 billion, adjusted for net securities gains, partially offset by an 8% increase in expense (adjusted) from higher volume driven seasonality and new business. DBRS notes that both assets under custody and administration (AUC/A) and management (AUM) grew during the quarter, to $25 trillion and $1.2 trillion (excluding securities lending assets) respectively, after having reached record levels in the prior quarter benefiting from the GIS and BHF acquisitions and from market improvement and inflows.

In the quarter, BNY Mellon’s underlying trends in its core businesses were mostly favorable, despite certain revenue items being pressured by unfavorable market conditions in 4Q10. Market shares continued to grow across most businesses and the Company maintained strong credit fundamentals. In 4Q10, 38% of the revenue was sourced from outside the U.S. and total fee revenues improved to $2.97 billion (excluding net securities gains), recognizing 12.0% sequential growth, while net interest income stayed relatively flat, growing 0.27% to $720 million.

More specifically, fee revenue trended upwards with a 12% sequential improvement in its issuer services fees from increased depositary receipts revenue and a 10 % increase in clearing services fees from increased daily average revenue trades, higher market values and new businesses. Securities lending revenue, however, continued to face headwinds driven by lower spreads and loan balances, remained relatively flat to the prior quarter. Asset and wealth management fees were up 15% sequentially with $15 billion in net inflows. Foreign exchange and other trading revenue jumped 77% from the prior quarter as they regained momentum benefiting from growth in both volume and volatility.

BNY Mellon’s net interest revenue (FTE) totaled $724 million in 4Q10 and was flat to the prior quarter and declined 1% from 4Q09. Average earning assets grew 9% while margins narrowed by 13 bps to 1.54% pressured by lower rates and shifting investor preferences, which temporarily increased short-term deposits in the quarter. NIM recorded was below the range forecasted in the prior quarter (1.60% to 1.75%); however, management anticipates NIM to be in the forecasted range for 2011 as the Company applies its conservative approach to credit risk in both lending and in the securities portfolio.

Core operating expenses, at $2.6 billion, grew over the quarter (excluding restructuring charges, M&I expenses, and amortization of intangible assets) from $2.4 billion in the prior quarter. Expenses grew 8% from 3Q10 and 16% from 4Q09, primarily reflecting the sequential increase in professional, legal, and other purchased services driven by re-engineering efforts and higher legal expense, and from the impact of acquisitions for year-over-year. Noninterest expense also included approximately $50 million in expense for compensation adjustments to market levels, equipment write-offs, and expenses related to a proposed tax settlement. In the quarter, restructuring charges totaled $21 million and merger and integration expense was $43 million. Positively, credit costs improved in the quarter, crediting $22 million in reserves from a 32% decline in criticized assets and from the repayment of a loan to an asset manager that filed for bankruptcy. Nonperforming assets trends improved marginally (0.5%) from the prior quarter but notably from 4Q09 (27.5%). Net charge-offs were $15 million at 4Q10 compared to $33 million at 4Q09.

BNY Mellon’s $66.4 billion investment securities portfolio remained in a solidly positive position with an unrealized pre-tax gain of $353 million but compared unfavorably to the sequential unrealized gain of $629 million at 3Q10. Nonetheless, the position was much improved compared to an unrealized pre-tax loss of $1.0 billion a year ago. Through organic capital growth and a 4.8% reduction in risk-weighted assets, capitalization remains solid at 4Q10. Tier 1 capital ratio increased 120 bps to 13.4%, Total capital ratio grew 60 bps to 16.4% and leverage capital ratio declined 10 bps to 5.8%. BNY Mellon’s Tier 1 common equity grew 110 bps to 11.8%, while the TCE ratio improved to 5.8% after declining to 5.3% in 3Q10 as a result of acquisitions. The Company anticipates Basel III Tier 1 common equity ratio to exceed 7% by year-end given its capital generation and limited need for risk-weighted assets in its business model. Also, BNY Mellon holds $4 billion of sub-investment grade securitizations that, upon divestment, would raise Tier 1 common equity by 250 bps. Although the Company has no intention to sell these securities, it adds comfort to the Company’s ability to comply with the proposed Basel III capital requirement. DBRS notes that the Company had $1.68 billion in Trust Preferred Securities (corresponding to 160 basis points of Tier 1 capital as of 12/31/10) that will be phased out over a three year period in accordance to financial reform legislation beginning in 2013.

BNY Mellon is one of the 19 banks subject to a second round of Federal Reserve stress tests to ensure capital adequacy. The stress tests will test a bank’s ability to absorb losses over the next two years under at least two scenarios (baseline and adverse) and will take the proposed Basel III capital requirements into account. Test results will also determine whether an institution may resume capital distributions (stock dividends and/or repurchases). The stress test results are expected to be communicated to BHCs (not publicly) no later than March 21, 2011. Given its generally robust capital levels, DBRS expects a positive result.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Initial Rating Date: 2 July 2007
Most Recent Rating Update: 10 December 2010

For additional information on this rating, please see linking document below.