DBRS Comments on BNY’s 3Q12 Earnings; Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 3Q12 earnings of the Bank of New York Mellon Corporation (BNY or the Company). DBRS rates the Company’s Issuer & Senior Debt at AA (low) with a Stable trend. The Company reported third quarter net income applicable to common shareholders of $720 million, up from $466 million in 2Q12 and from $651 million a year ago. Excluding the large $212 million (after-tax) litigation charge in 2Q12, net income applicable to common shareholders increased a solid $42 million sequentially. 3Q12 results did have a benefit of approximately $47 million from a lower than expected tax rate related to the completion of several audits, but the effective tax rate of 23.1% was still higher than 2Q12’s 15.8% effective tax rate.

Positively, BNY reached record levels of assets under custody/administration (AUC/A), as well as assets under management (AUM). Specifically, AUC/A increased 3.0% during the quarter to $27.9 trillion reflecting its best new business wins quarter ($522 billion in asset wins) since 4Q08 and market appreciation. Meanwhile, AUM increased 4.6% to $1.359 trillion benefiting from both long- and short-term net flows of $18 billion. Excluding money market funds, long-term net flows have increased for 12 consecutive quarters. Other highlights of the quarter include positive core operating leverage and strong investment management results which included several prestigious industry awards. Nonetheless, the low interest rate environment, client risk aversion and depressed market-sensitive revenues continue to pressure revenues, making expense control imperative to maintain BNY’s solid results.

Investment services fees increased a modest 1% to $1.7 billion with stronger seasonal Depositary Receipts revenue more than offsetting lower Clearing Services revenues (lower volumes), weaker Corporate Trust fees (continued net run off of structured debt securitizations), and seasonally lower securities lending revenues.

Foreign exchange revenues remain under pressure reflecting lower volatility and volumes. Indeed, foreign exchange revenue of $121 million declined 23% sequentially. Other trading revenue of $61 million benefited from better fixed income trading results.

Reflecting vastly improved seed capital gains and higher equity investment revenue, investment and other income increased to $124 million from $48 million in 2Q12. As noted previously, this line item is volatile, but over time, the Company expects investment and other income to average $80 million to $100 million per quarter.

While investment management and performance fees declined 2% sequentially to $779 million, given outsized performance fees realized in 2Q12. Excluding these performance fees, investment management fees increased 3% during the quarter to $775 million reflecting higher market valuations and new business. DBRS notes that the asset composition of AUM remained relatively unchanged with investors remaining risk adverse.

Even with net interest margin compression of five basis points to 1.20%, the Company was able to grow net interest revenue 2% sequentially to $749 million. Reflecting strong deposit growth, BNY was able to increase average earning assets by 6% through higher securities balances. DBRS notes that interest on deposits held at the European Central Bank has been eliminated contributing to margin pressure. Management indicated that net interest revenue in 4Q12 should remain relatively stable and that the margin will remain pressured.

Expenses were well controlled with core non-interest expenses relatively stable at $2.6 billion. DBRS notes that the Company’s Operational Excellence Initiative remains on track to achieve at least $240 million in annual 2012 savings with BNY already achieving $223 million in net savings year-to-date.

The Company’s $103.6 billion investment securities portfolio is primarily comprised of high quality securities. Indeed, 89% of the portfolio is rated AA (low) or higher. Moreover, the unrealized pre-tax net gain on the portfolio increased over $1 billion during the quarter to $2.5 billion. Management estimated the portfolio’s duration at around 1.75 years.

Capital remains strong with BNY generating $518 million of net Basel I Tier 1 capital in the quarter, which included $155 million in dividends and $288 million of common stock repurchases. Overall, the Company’s Tier 1 capital ratio was 15.3%, while the tangible common equity ratio was 6.3%. DBRS notes that BNY’s estimated Basel III Tier 1 common equity ratio increased to 9.3% from 8.7% during the quarter. Management is focused on organic growth opportunities rather than acquisitions at this time.

Notes:
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 DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

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

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Driscoll
Approver: Roger Lister
Initial Rating Date: 18 January 2006
Most Recent Rating Update: 5 April 2012

For additional information on this rating, please refer to the linking document under Related Research.