DBRS Comments on BNY Mellon’s 1Q13 Earnings - Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 1Q13 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 a first quarter net loss applicable to common shareholders of $266 million, down from net income applicable to common shareholders of $622 million in 4Q12 and from $619 million a year ago. The loss was a direct result of a previously disclosed adverse tax ruling that resulted in a charge of $854 million. Excluding the charge, net income applicable to shareholders would have been $588 million.

Highlights of the quarter include record long-term investment management flows, improved foreign exchange revenues, and modest net interest margin expansion. In addition to the previously disclosed STARS ruling, BNY also had to provision $48 million for potential tax liabilities related to certain offshore funds. Overall, total adjusted revenues were down 1% sequentially, while adjusted noninterest expense increased 1% resulting in negative operating leverage for the quarter.

Even with improved market values, assets under custody and/or administration were stable during the quarter at $26.3 trillion, as net new business was flat and changes in foreign exchange rates hurt overall levels. Specifically, BNY did lose one significant client during the quarter, but was able to offset the loss with other new business wins. Management also noted that the pipeline is strong and up year-over-year. Meanwhile, assets under management reached a record $1.4 trillion increasing 3% sequentially. DBRS notes that BNY has reported 14 consecutive quarters of long-term asset management inflows including a record $40 billion in 1Q13.

Investment services fees increased 4% during the quarter to $1.7 billion reflecting increased client activity and improved markets. Improved issuer and clearing service revenues were the primary drivers in the increase.

After recording strong seasonal performance fees in 4Q12, investment management and performance fees declined by 4% to $822 million. However, lower interest rates caused higher money market fee waivers and the strong U.S. dollar also contributed to the decline.

Positively, the Company’s foreign exchange revenue jumped 41% sequentially to $149 million driven by higher volumes and volatility. Other trading revenue declined by $21 million to $12 million, as the Company had losses on interest rate hedges and weaker trading results.

Investment and other income also had a notable decrease sequentially with revenues declining $44 million to $72 million reflecting lower leasing gains, lower foreign currency remeasurement, and lower net gains on loans held for sale retained from a previously divested bank subsidiary.

With two fewer days in the quarter and modest average earning asset contraction, net interest revenue decreased $6 million to $719 million. Positively, the margin did modestly expand two basis points to 1.11%.

At $106.6 billion, or 30% of total assets, the investment securities portfolio was comprised of mostly high quality, highly liquid securities. Indeed, 89% of the portfolio is rated AA (low) or higher. DBRS notes that the securities portfolio was in an unrealized gain position of $2.2 billion at March 31, 2013.

The provision for credit losses was a credit of $24 million, as credit quality continues to improve and the Company reduced its qualitative reserve in the quarter. Moreover, BNY does not expect to have a provision for credit losses in 2Q13.

With a higher provision for administrative errors in certain offshore tax-exempt funds ($48 million in 1Q13) and higher pension costs, adjusted expenses (excludes amortization of intangibles, M&I, litigation and restructuring) increased 1% sequentially to $2.7 billion. The administrative errors relate to questions about the resident status of certain offshore funds and these funds could expose the Company to additional tax liabilities beyond what has been reserved. Management noted that the Company anticipates generating gains of approximately $200 million in 2Q13 from various asset sales, which should offset any potential additional future provisions. Positively, the Company has reviewed all similar funds with no additional issues identified, so the problems appear contained.

As a result of the loss related to the adverse tax ruling, capital metrics declined during the quarter, but remain strong. Indeed, the Company’s estimated Basel III Tier 1 common equity ratio was 9.4%, down from 9.8% in 4Q12. DBRS notes that BNY’s CCAR results were very strong with the Company having the highest tier 1 common ratio among the 18 institutions subject to the stress tests at 13.21% under the severely adverse scenario. After the Federal Reserve’s non-objection to the Company’s capital plan, BNY announced that it plans to repurchase up to $1.35 billion of common stock over the next four quarters. Moreover, the common dividend was raised 15% to $0.15 per share. DBRS notes that following the adverse tax ruling, the Company did not repurchase any shares the remainder of the quarter.

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

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