Business context and reporting period
The Bank of New York Mellon Corporation (BNY Mellon) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. Its principal businesses are Investment Management and Investment Services; the Other segment includes credit-related activities, leasing, corporate treasury and overhead. BNY Mellon reported $25.9 trillion in assets under custody and administration and $1.2 trillion in assets under management at quarter-end.
In the first quarter, the company realigned its business reporting; prior periods were reclassified without changing consolidated results. Robert P. Kelly stepped down as chairman and CEO on August 31, and Gerald L. Hassell became chairman and CEO.
Key financial metrics
| Metric | Q3 2011 | Comparison |
|---|---|---|
| Net income applicable to common shareholders | $651 million; diluted EPS $0.53 | $622 million and $0.51 in Q3 2010; $735 million and $0.59 in Q2 2011 |
| Total revenue | $3.694 billion | $3.423 billion in Q3 2010; $3.850 billion in Q2 2011 |
| Fee and other revenue | $2.887 billion | Up 8% year over year; down 6% sequentially |
| Net interest revenue | $775 million | Up 8% year over year and 6% sequentially |
| Noninterest expense | $2.771 billion | Up 6% year over year; down 2% sequentially |
| Pre-tax operating margin | 26% | 24% in Q3 2010; 27% in Q2 2011 |
| Net interest margin, FTE | 1.30% | 1.67% in Q3 2010; 1.41% in Q2 2011 |
| Return on common equity | 7.6%, annualized | 7.7% in Q3 2010; 8.8% in Q2 2011 |
For the first nine months, revenue was $11.190 billion versus $10.124 billion in 2010; common net income was $2.011 billion versus $1.839 billion. Fee and other revenue rose 13%, while net interest revenue was essentially unchanged at $2.204 billion.
Balance sheet, cash flow and capital
- Total assets were $322.2 billion at September 30, up from $247.3 billion at December 31, 2010, primarily reflecting client deposit growth. Deposits rose to $210.9 billion from $145.3 billion.
- Available funds totaled $132.1 billion, or 41% of assets, compared with $77.6 billion and 31% at year-end 2010. The filing says monitored liquidity ratios exceeded minimum guidelines.
- Loans were $45.3 billion; total loan and unfunded-commitment exposure was $81.6 billion. The allowance for credit losses was $498 million; nonperforming assets were $344 million, with a 0.76% nonperforming asset ratio.
- Long-term debt was $19.4 billion, up from $16.5 billion at year-end, including $2.6 billion of senior-note issuance in Q3. Total shareholders’ equity was $33.7 billion.
- Estimated Basel III Tier 1 common equity ratio was 6.5%; Basel I Tier 1 and total capital ratios were 14.0% and 16.1%. Management said it expected the year-end 2011 Basel III ratio to be below its previously indicated 7% level, citing the larger balance sheet and timing of business sales.
- For the first nine months, operating cash flow was a use of $683 million, investing cash flow a use of $69.1 billion, and financing cash flow a source of $73.1 billion. Deposit growth was a significant source of financing; investments in bank and central-bank deposits and securities were major investing uses.
Material changes versus comparable periods
- Quarterly earnings increased year over year but declined sequentially. Higher fee revenue and net interest revenue versus Q3 2010 were offset in part by higher expenses.
- Q3 noninterest expense included $80 million of litigation expense and a $22 million executive-management change charge. Management also cited higher legal costs and variable costs supporting business growth.
- Investment services fees increased 11% year over year, including seasonally higher Depositary Receipts revenue and net new business. Investment management and performance fees increased 5% year over year, but fell 6% sequentially.
- Foreign exchange and other trading revenue was $194 million, versus $146 million in Q3 2010 and $222 million in Q2 2011. Foreign exchange revenue increased to $221 million; wider credit spreads reduced revenue by $40 million through credit valuation adjustments.
- Assets under custody and administration increased 6% year over year to $25.9 trillion, but fell 2% sequentially; assets under management increased 5% year over year to $1.20 trillion, but fell 6% sequentially as market declines and short-term outflows outweighed long-term inflows.
- The filing attributes much of year-to-date revenue and expense growth to the 2010 GIS and BAS acquisitions, as well as net new business. The company acquired Talon Asset Management’s wealth-management operations for $11 million in July 2011.
Outlook, risks and unusual items
- Management announced an expense-reduction initiative affecting approximately 1,500 positions, about 3% of the global workforce, and expected a restructuring charge in Q4 2011. It also said litigation costs were expected to remain above historical levels.
- Management cited continuing uncertainty in Europe and the United States, including sovereign credit concerns and the August 2011 U.S. government downgrade. Net on- and off-balance-sheet exposure to Italy, Ireland, Spain, Portugal and Greece was $965 million after specified mitigants; the filing reports $956 million on-balance-sheet and $9 million off-balance-sheet exposure.
- The investment securities portfolio had a fair value of $76.5 billion and an unrealized pre-tax gain of $863 million. European floating-rate notes had a $3.657 billion fair value and a $397 million unrealized loss. Q3 included approximately $6 million of credit impairment charges.
- A broker-dealer holding-company customer filed for bankruptcy after quarter-end; BNY Mellon expected a loss of approximately $15 million.
- The company agreed to sell Shareowner Services for $550 million, with closing expected in late Q4 2011 or early Q1 2012; management expected a modest after-tax loss due mainly to nondeductible goodwill. It also agreed to sell most of its ConvergEx stake, with closing contemplated before the end of Q1 2012.
- Legal contingencies include foreign-exchange standing-instruction investigations and lawsuits, securities-lending claims, Madoff-related matters, and other proceedings. For certain matters, the company estimated reasonably possible losses of up to $950 million above accrued liabilities, where estimable; for other matters it could not estimate a range. Separately, a tax dispute concerning 2001–2002 foreign tax credits involves approximately $900 million including interest; the filing notes a possible reserve increase of up to $830 million within 12 months if reassessment becomes necessary.
- Moody’s outlook was negative; S&P, Fitch and DBRS outlooks were stable. Management emphasized that Basel III estimates may change with regulatory implementation and business developments.
Important facts for investors to verify
- Whether the reported earnings improvement is sustainable given lower sequential asset values, margin compression and higher litigation and operating costs.
- Progress on the 1,500-position expense initiative, its Q4 restructuring charge and realized savings.
- Execution, closing dates and actual capital and earnings effects of the Shareowner Services and ConvergEx sales.
- Deposit stability, balance-sheet growth, liquidity composition and the effect of client flows on bank leverage and capital ratios.
- Credit quality trends, especially residential mortgages, financial-institution exposures, securities-lending indemnifications and the expected broker-dealer bankruptcy loss.
- Changes in European securities valuations, the foreign-exchange investigations, other litigation exposures and the foreign-tax-credit dispute.
- Actual Basel III capital requirements and the company’s progress toward applicable thresholds; the reported 6.5% ratio is an estimate based on management’s interpretation of the rules.