DBRS Comments on BNY Mellon’s 4Q12 Earnings - Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 4Q12 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 fourth quarter net income applicable to common shareholders of $622 million, down from $720 million in 3Q12, but up from $505 million a year ago.

Highlights of the quarter include continued net new business wins, albeit at a reduced rate, strong deposit growth contributing to margin compression, and solid performance fees. However, foreign exchange and securities lending revenues remain weak, while clients’ risk appetite and capital markets activity remain muted. Positively, BNY has seen inflows to equity funds pick up so far in January, which could indicate greater client risk appetite. Overall, BNY reported negative operating leverage despite exceeding Operational Excellence targets. Lastly, DBRS notes that BNY acquired the remaining 50% interest in the West LB Mellon Asset Management joint venture during the quarter.

Assets under custody/administration (AUC/A) were relatively stable at $26.7 trillion, an increase of $100 billion from 3Q12 reflecting net new business wins. Specifically, AUC/A wins totaled $190 billion for the quarter and $1.5 trillion for the year. Meanwhile, assets under management reached a record $1.39 trillion growing 2% during the quarter driven by higher market valuations, as well as net new business wins. Long-term net inflows of $14 billion (13th consecutive quarter of inflows) more than offset net outflows of $6 billion in money market funds. Nonetheless, investors’ risk appetite remained conservative with equity securities still representing a low 33% of assets under management.

Investment services fees declined 5% to $1.6 billion during the quarter reflecting significantly lower issuer services fees related to lower Depositary Receipts revenue primarily related to seasonality. All other businesses managed modest growth compared to 3Q12. Meanwhile, investment management and performance fees increased 9% to $853 million reflecting the acquisition, higher market values, net new business, and higher performance fees.

Foreign exchange and other trading revenues remain subdued at $139 million compared to $182 million in 3Q12. Foreign exchange revenue declined 12% sequentially to $106 million driven primarily by reduced volatility, and to a much lesser extent, lower volumes.

The low interest rate environment continues to pressure net interest revenue. Indeed, net interest revenue declined by 3% to $725 billion despite higher average interest earning assets, as the net interest margin (FTE) contracted 11 basis points to 1.09%. Specifically, lower LIBOR rates, lower yields on the reinvestment of securities, and lower accretion more than offset a larger balance sheet stemming from deposit growth being held primarily at the Federal Reserve. The increase in deposits accounted for 6 basis points of the margin decline.

The Company’s investment securities portfolio had a fair value of $100.7 billion and was in an unrealized gain position of $2.4 billion at December 31, 2012. Overall, 89% of the portfolio is rated at or above AA (low). DBRS notes that 4Q12 results included $50 million of net securities gains.

During the quarter, the Company was able to utilize its own loss experience on residential mortgage loans rather than aggregate industry historical data. As a result of better performance relative to the industry, the provision for credit losses was a credit of $61 million. Moreover, nonperforming assets continued to improve declining $25 million during the quarter to $249 million, which is more than covered by the Company’s $387 million allowance for credit losses.

Despite continued success with the Company’s Operational Excellence initiative that contributed to $309 million in FY12 net savings (significantly above the $260 million high-end range targeted by the Company), expenses grew 7% YoY and 4% sequentially to $2.8 billion. The Company noted that the lower interest rate environment and weak capital markets activity have contributed to a decline in low variable cost businesses (such as Depositary Receipts, foreign exchange and net interest revenue), while the growth has come from higher variable cost businesses (such as investment management, asset servicing, clearing and treasury service fees) resulting in higher expenses.

Capital remains sufficient with the Company generating $413 million of net Basel I Tier 1 common equity, which included $170 million of common stock repurchased during the quarter. With larger than expected deposit growth, BNY did not repurchase approximately $100 million of shares to protect the Company’s leverage ratio. Meanwhile, the Company estimated its Basel III Tier 1 common equity ratio improved to 9.8% from 9.3% in 3Q12 reflecting lower risk-weighted assets. Management indicated that they believe that BNY should be able to return a bit more than the 65% returned to shareholders through dividends and share repurchases in 2013.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]