DBRS Comments on BNY Mellon’s 3Q13 Earnings - Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 3Q13 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 net income applicable to common shareholders of $967 million in the third quarter, up from $833 million in the second quarter and from $720 million a year ago. Excluding the benefit related to the U.S. Tax Court’s partial reconsideration of a tax decision and the $109 million equity investment gain associated with ConvergEx in 2Q13, net income applicable to common shareholders would have been $706 million compared to the seasonally stronger $724 million in 2Q13.

Highlights include strong YoY growth in both Investment Management and Investment Services that have benefited from higher market valuations and new business wins. Positively, the Company was able to deliver positive operating leverage sequentially on an adjusted core basis. Nonetheless, the low interest rate environment continues to negatively impact revenues with money market fee waivers the highest yet recorded increasing an incremental $23 million sequentially.

Operational Excellence remains ahead of schedule giving the Company flexibility to make additional targeted investments in the business. Current investments include building a separately managed account business in Asia, increasing share in the U.S. retail market, growing the global collateral services business, expanding wealth management, and enhancing global market capabilities.

Assets under custody and/or administration were $27.4 trillion, up 5% sequentially reflecting higher market values and a positive impact from foreign currency rates. During the quarter, the Company estimated $110 billion of new servicing business wins. Management noted that their win rate on new servicing business has been slightly above 50%. Meanwhile, assets under management increased 7% sequentially to a record $1.53 trillion benefitting from both net new business, as well as higher market values. Long-term inflows totaled $32 billion, the Company’s 16th consecutive quarter of positive long-term flows, while short-term inflows were $13 billion.

Investment service fees of $1.7 billion were relatively stable sequentially, as seasonally higher Depositary Receipts revenue was offset by the seasonal decline in securities lending, which declined by $15 million to $35 million. Meanwhile, investment management and performance fees declined 3% sequentially reflecting seasonally lower performance fees ($10 million compared to $33 million in 2Q13), which more than offset net new business and higher market values. DBRS notes that both businesses were negatively impacted by higher money market fee waivers.

Foreign exchange and other trading revenue declined $47 million sequentially to $160 million. Specifically, foreign exchange trading revenue of $154 million declined 14% sequentially driven by lower volatility despite higher volumes, while fixed income trading declined as well. DBRS notes that the investments the Company has made to its electronic trading platform have contributed to higher volumes.

Investment and other income declined to $135 million from $269 million in 2Q13 primarily reflecting the large gain related to an equity investment in 2Q13.

Positively, net interest revenue increased $15 million to $772 million, which benefited from a modest one basis point expansion in the net interest margin (FTE) to 1.16% and higher average earning assets. DBRS notes that both items were bolstered by lower premium amortization on investment securities.

Asset quality remains strong with nonperforming assets declining $32 million to $172 million, or just 0.34% of total loans. DBRS notes that the allowance for loan losses more than covers total nonperforming loans. The provision for credit losses was a modest $2 million following a credit of $19 million in 2Q13.

The Company’s $97.9 billion investment securities portfolio was in a net unrealized pre-tax gain position of $723 million at September 30, 2013 and remains comprised of high quality securities. Indeed, 89% of the portfolio is rated AA (low) or higher. The Company did transfer $7.3 billion of agency MBS to held-to-maturity from available-for-sale during the quarter to help reduce capital sensitivity in case long term rates rise. Duration is currently just over 2 years, which is an improvement from 2Q13 that saw long-term interest rates rise.

Expenses remain well controlled. Indeed, excluding amortization of intangible assets, M&I, litigation and restructuring charges, noninterest expense declined by 1% to $2.68 billion. DBRS notes that the Company’s Operational Excellence program has reached $170 million of gross savings per quarter, or $680 million annualized, which already exceeds the high end of the targeted range of $520 million when the program began in 2011.

Positively, all capital metrics improved during the quarter reflecting primarily retained earnings with the Company generating over $1 billion of estimated Basel III Tier 1 common equity in 3Q13. DBRS notes that the Company was more cautious with its share repurchase program; repurchasing just $122 million of common stock during the quarter. Management noted that it reduced repurchases to help mitigate potential pressure/volatility in its capital ratios related to movements in the Company’s large securities portfolio, but expects to be back above $300 million of quarterly share repurchases in 4Q13. The Company estimated its Basel III Tier 1 ratio at 10.1% under the standardized approach and 11.1% under the advanced approach. Lastly, the Company estimated its supplementary leverage ratio at 4.3% and management is awaiting clarity on the rule before potentially taking action to comply.

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

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