Bank Of New York Mellon Corp quarterly report, Q3 FY2013

Business context and reporting period

The Bank of New York Mellon Corporation (BNY Mellon) filed this unaudited Form 10-Q for the quarter ended September 30, 2013. It is a global investments company whose principal businesses are Investment Management and Investment Services; at quarter-end it reported $27.4 trillion of assets under custody and/or administration (AUC/A) and $1.532 trillion of assets under management (AUM).

Financial results and key metrics

Metric	Q3 2013	Comparable period
Total revenue	$3.767 billion	$3.675 billion in Q3 2012
Net income applicable to common shareholders	$967 million; diluted EPS $0.82	$720 million; diluted EPS $0.61 in Q3 2012
Net interest revenue	$772 million	$749 million in Q3 2012
Noninterest expense	$2.779 billion	$2.705 billion in Q3 2012
Net interest margin (FTE)	1.16%	1.20% in Q3 2012
Pre-tax operating margin	26%; adjusted non-GAAP 29%	27%; adjusted non-GAAP 29% in Q3 2012

Q3 net income included a $261 million after-tax benefit, or $0.22 per diluted share, from a partial U.S. Tax Court reconsideration. Excluding that item, the company reported non-GAAP common net income of $706 million and diluted EPS of $0.60. Q3 2012 results did not include this benefit.

For the first nine months of 2013, revenue was $11.389 billion versus $10.938 billion a year earlier; common net income was $1.534 billion versus $1.805 billion, and diluted EPS was $1.30 versus $1.51. The filing attributes the decrease in reported year-to-date earnings in part to tax litigation effects. Net interest revenue was $2.248 billion in both nine-month periods; FTE net interest margin declined to 1.14% from 1.25%.

At September 30, total assets were $371.952 billion, deposits $255.560 billion, loans $50.138 billion, and long-term debt $18.889 billion. Available funds were $153.4 billion, or 41% of total assets. Shareholders’ equity was $36.959 billion; tangible common equity to tangible assets of operations was 6.4%. Estimated fully phased-in Basel III Tier 1 common equity ratios were 10.1% under the Standardized Approach and 11.1% under the Advanced Approach. The filing reports no clear consolidated cash-flow forecast; for the first nine months, operating activities used $55 million, investing activities used $8.537 billion, and financing activities provided $11.244 billion.

Material changes versus prior periods

• Q3 revenue rose 3% year over year. Investment services fees increased 4%, and investment management and performance fees increased 5%; foreign exchange and other trading revenue fell 12%, mainly because of weaker fixed-income trading.
• Q3 net interest revenue increased 3% year over year, while the FTE margin declined four basis points. Management cited higher average earning assets and lower premium amortization as revenue drivers, offset by lower yields.
• Noninterest expense increased 3% year over year, primarily due to staff costs; the company also cited rising investment in compliance, risk, control and technology functions. Year-to-date expense declined 1%, primarily reflecting lower litigation charges.
• AUC/A rose 4% year over year and AUM rose 13%, with management citing higher market values and net new business. Q3 long-term and short-term AUM inflows were $32 billion and $13 billion, respectively.
• Compared with December 31, 2012, deposits rose 4%, loans rose to $50.1 billion from $46.6 billion, and long-term debt rose to $18.9 billion from $18.5 billion. Available funds increased to $153.4 billion from $145.3 billion.
• Net unrealized pre-tax gains on the investment securities portfolio were $723 million, down from $2.4 billion at year-end 2012; management cited higher long-term interest rates. The company transferred $7.3 billion amortized cost of agency RMBS from available-for-sale to held-to-maturity in Q3.

Outlook, risks, contingencies and unusual items

• Management expected an approximately 26% effective tax rate in Q4 2013 and a $0–$15 million Q4 provision for credit losses. The filing provides no broad earnings or revenue guidance.
• The Tax Court had not entered a final decision on the foreign-tax-credit matter; further adjustments were possible, and BNY Mellon said it intended to appeal. Tax reserves were $840 million at September 30, with accrued interest of $198 million. The company said reserves could decrease by up to $72 million over the next 12 months.
• Newton sold its private client business on September 27 for $120 million; BNY Mellon recorded a $27 million pre-tax gain and a $5 million after-tax gain. Q2 2013 common earnings had included a separate $109 million after-tax gain on an equity investment.
• Legal matters include Sentinel litigation, securities-lending lawsuits, foreign-exchange standing-instruction inquiries and claims, mortgage-securitization proceedings, and Stanford-related claims. The company estimated aggregate reasonably possible losses of up to $650 million in excess of related accruals for matters where it could estimate a range; it could not estimate a range for certain other matters. It stated outcomes could materially affect income in a period.
• For certain offshore tax-exempt funds, the company disclosed approximately $100 million of reasonably possible additional exposure related to administrative errors, beyond amounts accrued. The appellate reversal in Sentinel litigation could also affect the previously repaid $312 million loan and BNY Mellon’s secured-creditor status.
• Regulatory uncertainty includes Basel III implementation, proposed stricter supplementary leverage requirements, and a proposed U.S. liquidity coverage ratio. Moody’s had placed the parent’s long-term ratings under review for downgrade; the filing noted that ratings changes could affect funding and derivative collateral requirements. If the largest bank subsidiary fell below investment grade, existing collateral arrangements would have required an additional $456 million posting at quarter-end.
• BNY Mellon reported that its liquidity measures exceeded internal minimum guidelines and stress tests indicated sufficient liquidity. It also noted that a material reduction in Investment Services could reduce access to deposits. Tri-party repo reform remains a focus; management anticipated practical elimination of intraday credit in that activity by the end of 2014.
• Q3 included $121 million of common-share repurchases. From October 1 through November 7, the company repurchased a further $318 million of shares. Management’s operational-efficiency program targeted $500–$520 million of annualized gross savings by year-end 2013, with $170 million of estimated program savings reported for Q3.

Important facts for investors to verify

• Confirm the final Tax Court decision, appeal status, and any resulting changes to the $261 million benefit, tax reserves, or future tax expense.
• Track underlying earnings and expense trends excluding tax litigation and other non-GAAP adjustments; compare reported and adjusted margins consistently.
• Review the status and potential exposure of Sentinel, foreign-exchange, securities-lending and other legal proceedings, including the disclosed possible losses beyond accruals.
• Assess deposit stability, liquidity coverage requirements, credit-rating actions, and the effect of proposed leverage rules on capital distributions and business capacity.
• Monitor investment-securities valuations and interest-rate sensitivity, including the rationale and accounting consequences of the agency RMBS transfer.
• Check whether targeted efficiency savings are realized net of implementation costs and whether expense growth in staff, compliance, risk and technology persists.