DBRS Comments on BNY Mellon’s 2Q11 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 2Q11 earnings. The trend on all ratings remains Stable.

For the quarter, BNY Mellon reported net income from continuing operations of $735 million, up from $625 million in 1Q11. Year over year, net income from continuing operations improved 10%, benefiting from the Company’s 2010 acquisitions. DBRS sees the sequential improvement as reflective of mostly positive underlying business and revenue trends. The investment servicing pipeline remains solid and in Asset Management 2Q11 long term net inflows were a very strong $32 billion. In DBRS’s view, significant deposit flows again this quarter highlight the considerable uncertainty surrounding sovereign risk, the low rate environment, and BNY Mellon’s status as a safe haven for customers globally. Nevertheless, the low-rate environment and higher expense levels remain headwinds.

Excluding net securities gains, total 2Q11 revenues were $3.8 billion, up 5% from 1Q11. Total fee revenues this quarter were $3.1 billion, about 80% of the total (excluding net securities gains) with most key fee lines showing good linked quarter growth. Benefiting from seasonally higher securities lending and new business, Asset Servicing fees increased 6% from 1Q11 to $950 million and at quarter end, assets under custody and administration (AUC/A) grew 3% to $26.3 trillion. Normal depositary receipts seasonality contributed to the 4% increase in issuer services revenue, though this was muted by lower corporate trust revenues as structured debt markets remained sluggish.

Though revenues remain pressured by the low rate environment, Investment Management had a solid quarter in DBRS’s view, generating positive y-o-y operating leverage and growing AUM to a record $1.3 trillion at June 30. Total Investment Management revenues were $912 million in the quarter, up 11% from 2Q10, and down 1% from 1Q11. Regarding foreign exchange revenues, which were $184 million in 2Q11, BNY Mellon noted that 40% of these revenues were related to standing instructions, and of that total, just 15% related to US public pension funds, which have garnered considerable attention recently. While the revenue impact surrounding these issues is clearly minimal, DBRS anticipates that reputational costs to the Company could be higher, especially if the Company’s name remains in the news cycle and litigation is protracted.

BNY Mellon’s net interest revenue (FTE) totaled $737 million in 2Q11, up 5% from 1Q11 and driven by substantially higher average deposit balances (up 9% to $169 billion). As the Company reinvested these funds conservatively, higher levels of average earning assets drove the increase in net interest revenue, as the net interest margin (NIM) declined 8 basis points (bps) q-o-q to 1.41%. The Company noted that the increase in lower yielding assets associated with the substantial deposit growth drove the NIM compression in 2Q11 and it anticipates net interest revenues will remain at 2Q11 levels in coming quarters.

Core operating expenses trended higher again in the second quarter. Year-over-year expenses increased 21% to $2.7 billion, outpacing revenue growth. Adjusted for acquisitions, non-interest expenses were up 12% from 2Q10 and relative to 1Q11 expenses increased 4%. The increase reflected the impact of annual merit increases, increased volumes as well as higher regulatory, compliance and litigation expenses. The Company expects to lay out its plan to reduce expenses later this year. DBRS notes the 2Q11 provision for credit losses was zero for a consecutive quarter as non-performing assets continued to decline.

BNY Mellon’s $68.6 billion (fair value) investment securities portfolio remained in a solidly positive position with an unrealized pre-tax gain of $770 million, an improvement from the unrealized gain of $569 million at the end of 1Q11. DBRS notes that the approximately $4.0 billion (fair value) portfolio of non-agency RMBS, 94% of which are sub-investment grade, that were previously included in the former Grantor Trust had an unrealized pre-tax gain of $601 million at the end of 2Q11. Paydowns on these securities were $330 million in the second quarter.

The Company continues to generate substantial levels of capital organically. After dividends and buybacks, BNY Mellon generated $510 million of net Tier 1 common equity in the second quarter. Combined with controlled risk-weighted asset (RWA) growth, up 2.4% to $105.4 billion, the estimated Tier 1 common ratio was a strong 12.6%, up 20 bps from the end of 1Q11. BNY Mellon’s estimated Basel III Tier 1 common ratio improved by more, increasing 45 bps to 6.6%. DBRS notes that the rundown of the sub-investment grade, non-agency RMBS portfolio lowered Basel III RWAs and added 10 bps to the Basel III tier 1 common ration in the quarter. BNY Mellon maintained its expectation that its Basel III Tier 1 common equity ratio will exceed 7% by year end.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the 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, all of 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
Approver: Roger Lister
Initial Rating Date: 2 July 2007
Most Recent Rating Update: 10 December 2010

For additional information on this rating, please refer to the linking document below.