Bank Of New York Mellon Corp quarterly report, Q3 FY2014

Business context and reporting period

The Bank of New York Mellon Corporation filed this unaudited Form 10-Q for the quarter ended September 30, 2014. BNY Mellon operates Investment Management and Investment Services businesses, alongside an Other segment. At quarter-end, it reported $28.3 trillion of assets under custody and/or administration (AUC/A) and $1.646 trillion of assets under management (AUM).

Financial and operating highlights

MetricQ3 2014Comparable period / change
Revenue$4.611 billionUp 22% from Q3 2013; includes significant asset-sale gains
Net income applicable to common shareholders$1.070 billion; diluted EPS $0.93Q3 2013: $962 million; diluted EPS $0.82
Adjusted net income / diluted EPS (non-GAAP)$734 million / $0.64Q3 2013: $713 million / $0.61
Net interest revenue$721 millionDown 7% year over year; FTE net interest margin was 0.94%, versus 1.16%
Noninterest expense$2.968 billionUp 7% year over year; adjusted non-GAAP expense was $2.673 billion, slightly lower year over year
Credit provision$19 million benefitCompared with a $2 million provision in Q3 2013
Effective tax rate33.5%Gains, litigation and restructuring charges increased the rate by 7.1 percentage points
Pre-tax operating margin36% GAAP; 29% adjusted non-GAAPQ3 2013: 26% GAAP; 29% adjusted non-GAAP
AUC/A and AUM$28.3 trillion / $1.646 trillionUp 3% and 7%, respectively, year over year

For the first nine months of 2014, revenue was $12.003 billion, common net income was $2.285 billion, and diluted EPS was $1.97. Net interest revenue was $2.168 billion, down 4%; FTE net interest margin was 0.99%, versus 1.14%. Operating cash flow was $3.298 billion, investing cash flow was a use of $10.659 billion, and financing cash flow provided $7.411 billion.

Balance sheet, liquidity and capital

  • Total assets were $386.3 billion at September 30, 2014, versus $374.5 billion at December 31, 2013. Deposits were $264.9 billion, up from $261.1 billion.
  • Available funds were $146.4 billion, or 38% of total assets, compared with $155.3 billion, or 41%, at year-end 2013. Management said the reduction reflected lower interbank placements and a shift toward high-quality liquid securities. The filing states internal liquidity ratios exceeded minimum guidelines.
  • Long-term debt was $21.6 billion, up from $19.9 billion at year-end; $1.45 billion was due to mature in Q4 2014. Shareholders’ equity was $38.5 billion.
  • Transitional Basel III CET1 was 11.4%. Estimated fully phased-in CET1 was 10.2% under the Advanced Approach and 10.8% under the Standardized Approach. Estimated fully phased-in supplementary leverage ratio (SLR) was 4.6%; management expected to meet future requirements as phased in, while noting the enhanced G-SIB standard calls for an SLR above 5%.
  • In Q3, the company repurchased 11.0 million shares for $431 million and paid a $0.17 quarterly common dividend. Nine-month repurchases totaled $1.2 billion.

Material changes, outlook, risks and unusual items

  • Reported Q3 revenue and earnings benefited from the July sale of the Wing Hang investment, generating a $490 million pre-tax gain ($315 million after tax), and the September sale of One Wall Street for $585 million, generating a $346 million pre-tax gain ($204 million after tax). Excluding these gains and specified charges, adjusted common net income was $734 million.
  • Net interest revenue and margin declined year over year, primarily due to lower asset yields and lower accretion. Management planned to reduce interbank placements and increase high-quality liquid assets, aiming to mitigate pressure from low reinvestment rates and negative euro deposit rates.
  • Q3 noninterest expense rose, largely reflecting litigation and restructuring charges. The company recorded $220 million of merger, litigation and restructuring charges; management expected litigation costs to remain elevated, while anticipating that growth in compliance and control expenses would begin to slow.
  • Management expected a Q4 2014 effective tax rate of approximately 27%. Following IRS approval of a tax carryback claim, it estimated a Q4 after-tax benefit of $160 million to $190 million; the financial-statement impact was still being determined.
  • BNY Mellon agreed to acquire Cutwater Asset Management, with approximately $23 billion in AUM; closing was expected by the beginning of Q1 2015, subject to customary conditions and regulatory approvals. The company also announced it would exit derivatives sales and trading over several years.
  • New U.S. liquidity coverage ratio requirements begin phasing in January 2015, reaching 100% in 2017. Management expected compliance without material business impact. Capital and liquidity estimates depend on regulatory rules, model approvals and implementation.
  • Legal and regulatory exposures include foreign-exchange standing-instruction litigation and inquiries, securities-lending litigation, mortgage-securitization trustee claims, Sentinel-related proceedings, Stanford-related claims, an FCA review and Postalis litigation in Brazil. The company said reasonably possible losses could total up to $940 million in excess of related accruals, where estimable; it could not estimate a range for certain matters. An adverse tax-litigation outcome could require approximately $100 million of additional tax expense.
  • Other risks include low interest rates, market and currency movements, litigation and regulatory costs, credit and counterparty risk, and geopolitical developments in Russia and Ukraine. The company disclosed $370 million of net on- and off-balance-sheet Russia exposure and less than $1 million of Ukraine exposure; it said further sanctions could adversely affect Russian-related businesses.

Important facts for investors to verify

  1. How much of reported earnings growth was attributable to the Wing Hang and One Wall Street gains, and whether adjusted results are a better indicator of recurring performance.
  2. Whether net interest margin and revenue respond as expected to low rates, euro-area policy, deposit levels and planned changes to liquid assets.
  3. Progress on litigation, especially foreign-exchange matters, Sentinel, securities lending and mortgage-securitization claims, and any changes to accruals or the disclosed potential-loss range.
  4. The amount and timing of the IRS carryback benefit, and the outcome of the appeal concerning foreign tax credits and the related interest deduction.
  5. Regulatory model approvals and the company’s ability to meet the enhanced SLR and phased-in liquidity requirements.
  6. Whether AUM inflows, AUC/A growth and fee trends persist, including the effects of market movements, structured-debt maturities and money-market reforms.