Bank Of New York Mellon Corp quarterly report, Q3 FY2012

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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, 2012. The global financial services company focuses on investment management and investment services; it reported operations in 36 countries. Amounts below are U.S. dollars unless noted.

Financial performance and condition

  • Quarterly results: Total revenue was $3.675 billion, compared with $3.694 billion in Q3 2011 and $3.617 billion in Q2 2012. Net income applicable to common shareholders was $720 million, or $0.61 diluted EPS, versus $651 million, or $0.53, a year earlier and $466 million, or $0.39, in Q2. Income before taxes was $975 million, versus $945 million in Q3 2011.
  • Nine-month results: Revenue was $10.938 billion versus $11.190 billion in 2011; net income applicable to common shareholders was $1.805 billion versus $2.011 billion. Reported pre-tax operating margin was 27% for Q3 and 22% for the first nine months; adjusted non-GAAP margins were 29% and 29%, respectively.
  • Revenue mix and trends: Q3 fee and other revenue was $2.879 billion, essentially unchanged year over year. Investment services fees fell 6% to $1.678 billion, chiefly reflecting lower issuer services revenue and the prior sale of Shareowner Services. Investment management and performance fees rose 7% to $779 million. Foreign exchange and other trading revenue was $182 million, down 9%; foreign exchange revenue fell 45% to $121 million. Net interest revenue was $749 million, down 3%, while fully taxable equivalent net interest margin declined to 1.20% from 1.30%.
  • Expenses and taxes: Noninterest expense was $2.705 billion, down 2% year over year, mainly due to lower litigation, merger and integration, and restructuring charges. The Q3 income tax provision was $225 million, a 23.1% effective rate, compared with 29.7% a year earlier. Preferred dividends were $5 million in Q3.
  • Cash flow: For the first nine months, operating activities provided $1.273 billion, compared with $683 million used in 2011; investing activities used $10.375 billion versus $69.132 billion; financing activities provided $9.906 billion versus $73.125 billion.
  • Balance sheet and liquidity: September 30 total assets were $339.9 billion, up from $325.3 billion at year-end 2011. Deposits were $222.9 billion versus $219.1 billion; long-term debt was $19.5 billion versus $19.9 billion. Available funds were $124.4 billion, or 37% of total assets, versus $135.2 billion and 42% at year-end. The company reported $46.3 billion of liquid funds and $73.1 billion in deposits at the Federal Reserve and other central banks.
  • Capital and credit: Estimated Basel III Tier 1 common equity was 9.3%, up from 8.7% at Q2; Basel I Tier 1 and total capital ratios were 15.3% and 16.9%. Loans were $45.9 billion; the allowance for credit losses was $456 million, and nonperforming assets were $274 million, down from $341 million at year-end.
  • Client assets and shareholder returns: Assets under custody and administration reached a record $27.9 trillion, up 8% year over year. Assets under management reached $1.359 trillion, up 13%. The quarterly common dividend was $0.13 per share; the company repurchased 13.4 million shares for $288 million in Q3.

Material changes versus comparable periods

  • Q3 common net income and diluted EPS improved year over year, despite slightly lower revenue; lower expenses and a lower tax rate helped. Sequentially, common net income rose from $466 million, with Q2 results affected by a roughly $350 million pre-tax litigation charge related primarily to Sigma securities-lending losses.
  • For the first nine months, common net income declined about 10% and revenue declined about 2% year over year. The company attributed fee-revenue pressure largely to Shareowner Services’ sale, weaker issuer services and foreign exchange revenue; litigation costs also weighed on expenses.
  • Investment Management pre-tax income increased year over year, while Investment Services pre-tax income declined to $709 million from $791 million. Investment Services cited weaker depositary receipts, foreign exchange and net interest revenue, and the sale of Shareowner Services, partly offset by lower litigation expense.
  • The investment securities portfolio’s fair value rose to $103.6 billion from $82.0 billion at year-end 2011. The reported pre-tax unrealized gain was $2.5 billion at September 30, versus $793 million at year-end, primarily reflecting lower interest rates and improved credit spreads.

Outlook, commentary, risks and unusual items

  • Management expected a Q4 2012 effective tax rate of approximately 27%–28% and said it anticipated no significant Q4 provision for credit losses. It projected $240–$260 million in annualized pre-tax net savings from operational excellence initiatives in 2012; $223 million of net savings had been achieved through Q3.
  • Management said Hurricane Sandy affected some northeastern facilities, but business continuity plans enabled client service to continue. Revenue losses and storm-related costs from market closures and reduced activity could not yet be estimated.
  • On October 1, 2012, BNY Mellon acquired Portigon’s remaining 50% interest in WestLB Mellon Asset Management, consolidating the German business, which had more than $29 billion in AUM. Subsequent to quarter-end, the company also issued senior notes and additional Series C preferred shares and announced redemption of $550 million of trust preferred securities.
  • Risks include continued low reinvestment yields and margin pressure; foreign exchange competition and lower market volatility; possible further decline in structured debt markets, which management said could reduce annual revenue by 0.5%–0.75%; market-sensitive fee revenue; and deposit behavior under changing rates and market conditions.
  • Legal and regulatory matters remain significant. Management estimated reasonably possible legal losses of up to $750 million in excess of related accruals for matters where it could estimate a range, excluding tax matters. A foreign tax-credit dispute involves approximately $900 million including interest; the filing said reserves could increase by up to $837 million within 12 months. The filing also discusses ongoing foreign exchange, securities-lending, Madoff-related and other proceedings.
  • Other exposures include $1.620 billion of net on- and off-balance-sheet exposure to Ireland, Italy, Spain and Greece at quarter-end, with no sovereign exposure reported to those countries. BNY Mellon also acts as tri-party repo agent for about 80% of the U.S. market and was working to reduce secured intraday credit; the filing identified credit, regulatory and reputational risks.

Most important facts for investors to verify

  1. Whether fee growth, particularly in asset servicing and Investment Management, can offset continued weakness in issuer services, foreign exchange and net interest margin.
  2. How much reported earnings depend on lower litigation charges, tax-audit benefits, seed-capital gains, securities gains and other unusual or market-sensitive items.
  3. Progress and costs in litigation and tax disputes, including the Sigma settlement, foreign exchange matters and the foreign tax-credit case.
  4. Liquidity and funding trends, including available funds, deposit composition, short-term borrowings, and the impact of lower central-bank balances and securities investment.
  5. Capital development and shareholder distributions against evolving Basel III and other regulatory requirements, including announced post-quarter-end debt and preferred-security actions.
  6. Subsequent-quarter effects of Hurricane Sandy, the WestLB consolidation, market movements and structured debt run-off; these outcomes were not fully quantifiable in the filing.