Bank of New York Mellon Corporation (BNY Mellon) — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Comparisons below are primarily with Q2 2014; balance-sheet comparisons are with Dec. 31, 2014. Amounts are U.S. dollars unless stated otherwise.
Business context and reporting period
BNY Mellon is a global financial services company focused on investment management and investment services, operating in 35 countries and more than 100 markets. At quarter-end, it reported $28.6 trillion in assets under custody and/or administration (AUC/A) and $1.724 trillion in assets under management (AUM).
The company early adopted ASU 2015-02 on consolidation, retrospectively to Jan. 1, 2015, and restated Q1 2015. This changed reported consolidation of investment funds but, management said, did not change the economic risks of its businesses.
Financial results and key metrics
| Metric | Q2 2015 | Comparable period / change |
|---|---|---|
| Net income applicable to common shareholders | $830 million | $554 million in Q2 2014 |
| Diluted EPS | $0.73 | $0.48 in Q2 2014; $0.67 in Q1 2015 |
| Total revenue, including consolidated fund income | $3.886 billion | $3.745 billion in Q2 2014; up 4% |
| Fee and other revenue | $3.067 billion | $2.980 billion in Q2 2014; up 3% |
| Net interest revenue | $779 million | $719 million in Q2 2014; up 8% |
| Net interest margin (FTE) | 1.00% | 0.98% in Q2 2014; 0.97% in Q1 2015 |
| Noninterest expense | $2.727 billion | $2.946 billion in Q2 2014; down 7% |
| Provision for credit losses | $6 million credit | $12 million credit in Q2 2014 |
| Effective tax rate | 23.7% | 26.7% in Q2 2014 |
Q2 GAAP pre-tax operating margin was 30%; reported return on common equity was 9.4% and return on tangible common equity was 21.5% (the latter is non-GAAP). Excluding specified litigation and restructuring charges, management reported non-GAAP net income of $868 million and diluted EPS of $0.77; these measures exclude items and are not GAAP results.
Six-month results: Net income applicable to common shareholders was $1.596 billion, versus $1.215 billion in the first half of 2014. Total revenue was $7.678 billion, versus $7.392 billion. Net interest revenue was $1.507 billion, versus $1.447 billion; noninterest expense was $5.427 billion, versus $5.685 billion.
- Business results: Q2 pre-tax income was $774 million in Investment Services, $265 million in Investment Management and $90 million in Other. Investment Services income rose 20% year over year; Investment Management rose 55%, benefiting in part from lower prior-year charges.
- Cash flow, six months: Operating activities provided $2.634 billion, investing activities used $18.050 billion and financing activities provided $16.829 billion. Cash and due from banks ended at $8.353 billion.
- Balance sheet and funding: Total assets were $395.3 billion, up from $385.3 billion at year-end 2014. Deposits were $284.4 billion, up 7%; loans were $63.1 billion. Long-term debt was $20.4 billion.
- Liquidity: Available funds were approximately $154.6 billion, or 39% of total assets. Consolidated HQLA was $206 billion before haircuts and $180 billion after haircuts; the reported LCR was 110%.
- Capital and returns: Transitional CET1 ratio was 10.9%; estimated fully phased-in CET1 was 9.9% under the Advanced Approach and 10.0% under the Standardized Approach. Estimated fully phased-in SLR was 4.6%. The company repurchased $1.2 billion of common stock in the first half and paid $0.17 per common share in Q2.
Material changes versus prior periods
- Q2 common net income increased substantially year over year, with diluted EPS rising from $0.48 to $0.73. Revenue grew 4%, while reported noninterest expense fell 7%; expense comparisons were affected by prior-period and current-period special charges.
- Investment Services fees rose 4% year over year, supported by organic growth, clearing activity and higher market values. Foreign exchange and other trading revenue increased to $187 million from $130 million, while Investment Management and performance fees declined 1% to $878 million as reported, but increased 5% on a constant-currency, non-GAAP basis.
- AUM rose 5% year over year, reflecting market values, net new business and the Cutwater acquisition, but declined 1% sequentially. Q2 net long-term outflows were $15 billion and short-term outflows were $11 billion. AUC/A was nearly unchanged year over year at $28.6 trillion.
- Net interest revenue rose year over year, reflecting higher securities and loans, lower deposit interest expense and hedging effects. The six-month FTE net interest margin was 0.98%, down from 1.02% in the first half of 2014, mainly due to lower asset yields.
- Available funds increased from $143.4 billion at year-end to $154.6 billion, primarily reflecting higher client deposits. Deposits rose $18.6 billion; total lending exposure, including unfunded commitments, increased 33% to $130.5 billion, primarily because of secured intraday credit commitments to securities dealers.
- The net unrealized pre-tax gain on the investment securities portfolio fell to $752 million from $1.7 billion at March 31, 2015, primarily as market interest rates rose. Shareholders’ equity increased to $38.3 billion from $37.4 billion at year-end, including the $1 billion preferred-stock issuance.
Outlook, management commentary, risks and unusual items
- Management expected the effective tax rate to be approximately 26% in Q3 2015 and anticipated a higher expense run rate in the second half, reflecting continued investment in compliance, risk and control functions.
- Management estimated that a 100-point change in the S&P 500, spread evenly through the year, would affect fee revenue by less than 1% and diluted EPS by $0.02 to $0.04; actual effects could differ if global markets do not track the index. It also expected to recover approximately 70% of pre-tax income lost to money-market fee waivers following a 50-basis-point rise in the federal funds rate, assuming client behavior is unchanged.
- Q2 included a $50 million pre-tax litigation charge related to a $180 million settlement in principle of a foreign-exchange-related securities class action, subject to court approval. The filing also describes earlier settlements resolving virtually all other pending FX-related actions, with stated payments totaling $714 million. The FCA settlement fine of £126 million (approximately $190 million) was covered by pre-existing legal reserves; the firms reported no client losses from the identified compliance failures.
- For legal proceedings, BNY Mellon said it could not estimate a reasonably possible loss range for certain matters. For matters where it could estimate a range, potential losses were up to $440 million in excess of accrued liabilities, if any. The company stated that adverse outcomes could materially affect net income in a period, though it did not expect the matters, after reserves and insurance, to materially affect consolidated financial position or liquidity.
- Key exposures and uncertainties include foreign-exchange litigation and investigations, mortgage-securitization trustee lawsuits, securities-lending litigation, tax litigation, operational and cybersecurity risks, market and interest-rate sensitivity, client deposit behavior, credit and counterparty exposure, regulatory capital and liquidity requirements, and geopolitical developments. Management highlighted possible adverse effects from further Russia-related sanctions or prolonged lower oil prices; it said current Russian business had not been materially affected. Puerto Rico-linked margin-loan exposure was approximately $175 million and was collateralized with a concentration of Puerto Rican securities.
- Management expected to maintain an SLR above 5% when fully phased in, compared with its current estimate of 4.6%. It noted that capital estimates depend on regulatory interpretations and model approvals, and that the eventual G-SIB surcharge could be greater than previously estimated.
- Subsequent events included the July 31, 2015 completion of the sale of Meriten Investment Management, with approximately $23 billion in AUM, and the July 21 declaration of a $0.17 quarterly common dividend. The company also reported compliance with applicable LCR requirements on a fully phased-in basis, based on its interpretation of the final rule.
Most important facts for investors to verify
- Reconcile reported GAAP revenue and earnings with the company’s non-GAAP adjustments, especially consolidated investment funds and litigation, restructuring and other excluded charges.
- Track approval, payment timing and final accounting for the $180 million FX-related securities settlement, the broader $714 million FX settlements and remaining FX-related individual customer actions.
- Assess whether AUM outflows continue and whether organic growth, market levels and currency movements support investment-fee revenue and AUC/A.
- Monitor the rise in unfunded lending commitments and tri-party repo credit exposure, alongside credit quality, collateral coverage and allowance adequacy.
- Verify capital headroom and liquidity against changing regulatory requirements, including the G-SIB surcharge, SLR, daily LCR calculation and any effects on distributions or share repurchases.
- Follow the tax appeal and uncertain tax reserves, the forecast increase in second-half expenses, and the potential for legal losses beyond recorded accruals.