Bank Of New York Mellon Corp quarterly report, Q3 FY2009

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Business context and reporting period

The Bank of New York Mellon Corporation (BNY Mellon) filed this Form 10-Q for the quarter and nine months ended September 30, 2009. Its global businesses provide asset management, wealth management, custody, securities servicing, clearing and treasury services. At quarter-end, the company reported $22.1 trillion in assets under custody and administration (AUC) and $966 billion in assets under management (AUM). Financial results are presented on a continuing-operations basis unless noted.

Financial results and key metrics

  • Quarterly earnings: Net loss applicable to common shareholders was $2.458 billion, or $2.05 per diluted share, versus net income of $303 million, or $0.26 per diluted share, in 3Q08 and $176 million, or $0.15 per share, in 2Q09. The 3Q09 continuing-operations loss was $2.439 billion.
  • Revenue: Reported total revenue was negative $1.500 billion, principally due to $4.833 billion of net investment securities losses. Fee and other revenue excluding those losses was $2.617 billion; net interest revenue was $716 million. Total revenue excluding investment securities losses and SILO/LILO charges, a non-GAAP measure, was $3.333 billion, down from $3.881 billion in 3Q08.
  • Expenses and credit: Noninterest expense was $2.318 billion, down 30% year over year, largely reflecting lower support-agreement charges and staff costs. Provision for credit losses was $147 million, versus $23 million in 3Q08; management cited downgrades in insurance and media portfolios.
  • Margins and returns: Net interest margin was 1.85% (FTE), compared with 1.92% in 3Q08, which included a SILO/LILO charge; excluding that charge, 3Q08 margin was 2.24%. GAAP returns on common equity and average assets were not meaningful due to the loss. Adjusted non-GAAP return on common equity was 10.1%.
  • Nine-month results: Net loss applicable to common shareholders was $1.960 billion, or $1.67 per diluted share, versus net income of $1.358 billion, or $1.17 per diluted share, in the first nine months of 2008. Revenue was $4.368 billion versus $10.709 billion, heavily affected by $5.384 billion of securities losses. Operating cash flow was $2.518 billion, compared with $1.533 billion in the prior-year period.
  • Balance sheet and liquidity: Total assets were $212.0 billion and deposits were $133.9 billion at September 30, 2009, down from $237.5 billion and $159.7 billion, respectively, at December 31, 2008. Available funds were approximately $72 billion, including $54 billion of liquid funds and $18 billion of cash; liquid assets were 34% of total assets. Long-term debt was $17.5 billion.
  • Capital and credit quality: Tier 1 capital ratio was 11.4%, above the company’s 10% target minimum, but down from 12.5% at June 30, 2009. Tier 1 common to risk-weighted assets was 9.9%; tangible common equity to tangible assets was 5.2% (non-GAAP). Total allowance for credit losses was $596 million, or 1.84% of non-margin loans; nonperforming assets were $560 million, up from $378 million at June 30.
  • Business indicators: AUC increased 7% sequentially to $22.1 trillion but was 1% lower year over year. AUM rose 4% sequentially but fell 9% year over year. Securities lending revenue fell to $43 million from $155 million in 3Q08, while asset and wealth management fees fell to $650 million from $795 million.

Material changes versus comparable periods

  • The dominant change was the $4.8 billion pre-tax charge from restructuring and sales of watch-list investment securities. The charge drove the reported quarterly loss; the company said approximately 90% had already been reflected in tangible capital.
  • Reported net interest revenue rose 5% year over year, but the comparison includes a $112 million SILO/LILO charge in 3Q08. Excluding SILO/LILO, net interest revenue declined 10% year over year on an FTE basis.
  • Core fee businesses remained pressured by lower market values, securities-lending balances and spreads, reduced money-market fees, and lower fixed-income issuance. New business and improved markets supported sequential AUC and AUM increases.
  • Credit indicators weakened: the quarterly provision rose to $147 million, nonperforming assets increased, and the allowance-to-non-margin-loans ratio rose to 1.84% from 1.53% in 2Q09.

Outlook, commentary, risks and unusual items

  • Investment portfolio: Sales and restructuring affected approximately $12.1 billion of securities at pre-restructuring amortized cost. After quarter-end, about $2.1 billion fair value of securities was sold. The company expected restructuring to be completed in 4Q09 and estimated a positive $125 million to $175 million effect on 2010 net interest revenue. Further declines in underlying collateral could result in additional impairment charges.
  • Management outlook: Management expected an operating tax rate of approximately 32% in 4Q09 and anticipated the provision for credit losses would decline in that quarter. It described low interest rates as a headwind to net interest revenue and money-market-related fees.
  • Liquidity and capital constraints: Following the securities charge, The Bank of New York Mellon and BNY Mellon, N.A. required regulatory approval to pay dividends to the parent. Management believed parent liquidity would remain sufficient for quarterly dividends. The company had $725 million of parent debt due in 4Q09 and expected to call and refinance $384 million of subordinated debt if market conditions were favorable.
  • Contingencies and legal matters: A Russian Federal Customs Service lawsuit seeking $22.5 billion was settled after quarter-end; the bank agreed to pay $14 million in previously accrued costs, with mutual releases and no admission of liability. A separate IRS dispute involving foreign tax credits carried approximately $900 million of disputed assessments, including interest; BNY Mellon said it would contest the claim and considered its tax accruals adequate. The filing also describes securities-lending litigation, Sentinel-related claims and inquiries, Auction Rate Securities investigations and litigation, Madoff-related claims, and other proceedings. Management did not expect pending matters, after reserves and insurance, to materially affect consolidated financial position or liquidity, but said they could materially affect income in a period.
  • Other developments: The company repurchased its TARP-related warrant for $136 million. It agreed to sell Mellon United National Bank, with closing expected in 1Q10 subject to approvals. After quarter-end, it acquired Insight Investment Management for approximately $377 million and a 20% interest in Siguler Guff & Company.
  • Regulatory and accounting: New consolidation guidance for variable-interest entities was expected to take effect January 1, 2010. Depending on interpretation, it could add approximately $7 billion of assets to the balance sheet; the broader impact was uncertain. Management also identified proposed capital and liquidity reforms as potential future considerations.

Most important facts for investors to verify

  • Whether the securities portfolio restructuring was completed as expected, the remaining watch-list exposure and any additional impairment or fair-value losses.
  • Whether the projected $125 million to $175 million 2010 net interest revenue benefit materializes, and how low rates and deposit trends affect net interest margin.
  • Trends in nonperforming assets, charge-offs, reserves and the insurance and media exposures underlying the elevated credit provision.
  • Capital ratios and regulatory dividend restrictions after the portfolio charge, alongside liquidity availability and upcoming debt maturities.
  • Developments in the approximately $900 million IRS dispute and other legal, regulatory and securities-lending matters, including any effect on earnings or reserves.
  • The realized impact of the planned MUNB sale and post-quarter acquisitions, including purchase costs, integration and any effects on capital or reported results.