Bank of New York Mellon Corporation — Second-quarter 2011 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2011; financial results are generally presented on a continuing-operations basis. BNY Mellon provides investment management and investment services, including custody, asset servicing, clearing and payments. In the first quarter, it reorganized reporting around Investment Management, Investment Services and Other; prior periods were reclassified without changing consolidated results.
Financial performance and position
| Metric | Q2 2011 | Comparison |
|---|---|---|
| Net income attributable to common shareholders | $735 million; diluted EPS $0.59 | Up from $658 million and $0.54 in Q2 2010; up from $625 million and $0.50 in Q1 2011 |
| Total revenue | $3.850 billion | Up from $3.342 billion in Q2 2010 |
| Fee and other revenue | $3.056 billion | Up 20% year over year |
| Net interest revenue; FTE net interest margin | $731 million; 1.41% | Revenue up from $722 million year over year; margin down from 1.74% |
| Noninterest expense | $2.816 billion | Up 22% year over year, including acquisition impacts and higher legal costs |
| Pre-tax operating margin | 27% reported; 29% adjusted, non-GAAP | 30% reported and 32% adjusted in Q2 2010 |
| Credit provision | None | $20 million provision in Q2 2010 |
| Six-month net income; diluted EPS | $1.360 billion; $1.08 | Compared with $1.217 billion and $1.00 in 2010 |
For the first half, revenue was $7.496 billion, up from $6.701 billion. Net interest revenue declined to $1.429 billion from $1.487 billion, and the FTE margin fell to 1.43% from 1.82%. Net cash from operating activities was $997 million, versus $142 million used in the first half of 2010; investing activities used $52.024 billion and financing activities provided $52.900 billion.
At June 30, assets were $304.7 billion, deposits $198.0 billion, loans $42.1 billion, investment securities $68.6 billion and long-term debt $17.0 billion. Available funds totaled $127.3 billion, including $65.3 billion of liquid funds; available funds were 42% of total assets. Basel I Tier 1 and total capital ratios were 14.1% and 16.7%; estimated Basel III Tier 1 common equity was 6.6%. Common equity was $33.9 billion, book value per share $27.46 and tangible book value per share $10.28 (non-GAAP).
Assets under custody and administration reached $26.3 trillion, up 21% year over year; assets under management reached $1.274 trillion, up 22%. The company reported $11.8 trillion of debt serviced and average daily global payments of $1.7 trillion. The quarterly dividend was $0.13 per share; BNY Mellon repurchased 9.8 million shares for $272 million during Q2.
Material changes and management commentary
- Investment Services fees increased 27% year over year, primarily reflecting the 2010 GIS and BAS acquisitions, net new business and higher market values. Investment Management fees rose 14%, supported by market values and net inflows.
- Expense growth outpaced revenue growth in Q2: noninterest expense increased 22% year over year, versus total revenue growth of about 15%. Management cited acquisitions, litigation and legal expense, merit increases, business growth and higher volume-related costs. It expects litigation costs to remain above historical levels.
- Net interest revenue improved modestly year over year as client deposits and securities holdings grew, but tighter spreads in the low-rate environment reduced the margin. Foreign exchange revenue fell 25% year over year, primarily due to lower volatility.
- Q2 included $48 million of net securities gains and $58 million of gains on loans held for sale from a previously divested bank subsidiary. The filing also reports $8 million of securities impairment charges. Such gains are not necessarily recurring.
- The allowance for credit losses was $535 million, down from $645 million a year earlier; nonperforming assets were $351 million, down from $399 million at year-end 2010. The company introduced a qualitative allowance framework during Q2. Certain older prime and Alt-A residential mortgages remained stressed, with approximately 30% of the identified $676 million pool at least 60 days delinquent.
Outlook, transactions and risks
- Management estimated the Basel III Tier 1 common equity ratio would exceed 7% by December 31, 2011, based on its then-current interpretation of the rules, and said it did not anticipate accelerating its timeline for meeting proposed Basel III requirements. This is an estimate, not a guaranteed outcome.
- The company agreed to sell Shareowner Services for $550 million, with closing anticipated in Q4 2011 subject to regulatory approval. It expected a pre-tax gain but a modest after-tax loss, largely from goodwill write-off; the sale was estimated to add about 20 basis points to the Basel III ratio.
- On July 1, 2011, BNY Mellon acquired Talon Asset Management’s wealth management operations, which managed more than $800 million. On July 20, it announced an agreement to sell most of its ConvergEx stake. The filing gives differing anticipated ConvergEx closing periods—Q3 in the overview and Q4 in the Other-segment discussion—so timing should be verified. The expected capital benefit was about 15 basis points.
- Management cited intense competition, low interest rates, market volatility, client deposit fluctuations and evolving Dodd-Frank and Basel regulations. Moody’s placed long-term ratings on negative outlook; the filing describes potential rating effects from reduced assumed government support.
- Legal matters include securities-lending, foreign-exchange, Madoff-related and other proceedings. For matters where a reasonably possible loss could be estimated, aggregate exposure was up to $800 million above related accruals, if any; for other matters, the company could not estimate a range. A separate tax dispute concerns approximately $900 million of tax benefits, including interest, with trial scheduled for April 2012.
- Potential close-out exposure on derivatives was $625 million at an A3/A- rating trigger, $814 million at Baa2/BBB and $1.567 billion at Ba1/BB+; an additional $659 million of collateral would have been required if the company had fallen below investment grade at quarter-end.
Most important facts for investors to verify
- Whether fee growth and reported earnings can continue without reliance on acquisition-related growth and Q2 gains, and whether expense growth moderates.
- Subsequent net interest margin, deposit levels and funding mix, given the continuing low-rate environment and the importance of client deposits.
- Actual closing dates, proceeds and capital effects of the Shareowner Services and ConvergEx transactions, including the conflicting ConvergEx timing in the filing.
- Capital progress against Basel III requirements and any effects of final U.S. rules, systemic-bank surcharges or rating changes.
- Developments in material litigation and the tax dispute, as well as changes in mortgage delinquencies, credit allowances and securities impairment assumptions.
- Liquidity resilience if client deposits or Investment Services activity decline; the filing notes that reduced activity could reduce access to deposits.