BNY Mellon — Second-quarter 2010 Form 10-Q
Business context and reporting period
The Bank of New York Mellon Corporation is a global asset-servicing, asset-management and wealth-management company. This unaudited filing covers the quarter and six months ended June 30, 2010; results are generally presented for continuing operations. At quarter-end, it reported $21.8 trillion of assets under custody and administration and $1.047 trillion of assets under management.
Financial performance and condition
- Earnings: Q2 net income applicable to common shareholders was $658 million, or $0.54 per diluted share; continuing-operations income applicable to common shareholders was $668 million, or $0.55 per diluted share. For the first half, those figures were $1.217 billion ($1.00 per diluted share) and $1.269 billion, respectively.
- Revenue and expenses: Q2 total revenue was $3.358 billion, versus $2.957 billion a year earlier and $3.379 billion in Q1. Fee and other revenue was $2.571 billion, net interest revenue $722 million, and noninterest expense $2.332 billion. Q2 pretax margin was 30% (32% adjusted, a non-GAAP measure).
- Revenue drivers: Compared with Q2 2009, asset and wealth management fees rose 6% to $676 million; securities servicing fees declined 2% to $1.267 billion; securities-lending revenue fell 53% to $46 million; and foreign exchange and other trading revenue declined 7% to $220 million. Net securities gains were $13 million, versus a $256 million loss a year earlier.
- Interest and credit: Net interest margin (FTE) was 1.74%, down from 1.80% a year earlier and 1.89% in Q1. The credit-loss provision was $20 million, versus $61 million a year earlier. Nonperforming assets were $406 million, down from $459 million at March 31; the total allowance for credit losses was $645 million.
- Balance sheet and capital: Total assets were $235.7 billion and deposits $143.7 billion at June 30. Long-term debt was $16.754 billion; common shareholders’ equity was $30.4 billion. The Tier 1 capital ratio was 13.5%, Tier 1 common ratio 11.9%, and total capital ratio 17.2%. Reported tangible common equity to tangible operating assets was 6.3% (non-GAAP).
- Liquidity and cash flow: The company reported approximately $83.0 billion of available funds, including $57.9 billion of liquid funds and $25.1 billion of cash; liquid assets were 35% of total assets. For the first half, operating cash flow was negative $142 million, investing cash flow negative $14.345 billion and financing cash flow positive $14.345 billion.
Material changes versus comparable periods
- Q2 common net income rose from $176 million and diluted EPS from $0.15 in Q2 2009; continuing-operations common income rose from $267 million and diluted EPS from $0.23. The comparison reflects, among other items, the prior-year securities loss and preferred-stock redemption charge, so the improvement should not be read as solely recurring operating growth.
- First-half fee and other revenue increased to $5.120 billion from $4.393 billion, and net income applicable to common shareholders increased to $1.217 billion from $498 million. First-half net securities results improved to a $20 million gain from a $551 million loss in 2009.
- AUM increased year over year, primarily reflecting the 2009 Insight acquisition, but fell from $1.105 trillion at March 31 as markets declined. Q2 net AUM outflows were $5 billion: $17 billion of money-market outflows partly offset by $12 billion of long-term inflows. AUC likewise declined sequentially, mainly on lower market values, while remaining above the prior-year level.
- Adoption of consolidation accounting guidance added $13.4 billion to reported assets at June 30, principally from consolidated asset-management funds; this changed presentation and did not itself represent equivalent growth in the company’s operating assets.
Outlook, commentary, risks and unusual items
- Management expected a Q3 2010 effective tax rate of approximately 30%–31%. It said GIS and BHF Asset Servicing acquisitions were expected to be accretive to 2010 earnings; these are forward-looking expectations, not reported results.
- After quarter-end, BNY Mellon acquired Global Investment Servicing for $2.31 billion cash on July 1 and BHF Asset Servicing for €253 million (about $330 million) on August 2. The GIS transaction included an expected transition of about $3.9 billion of deposits over 18 months.
- In June, the company priced a $700 million common-stock offering through a forward-sale arrangement. It had not received proceeds at June 30; settlement was expected in Q3, with proceeds intended for GIS or general corporate purposes. The common dividend remained $0.09 per share per quarter. Regulatory consent was still required for dividends from two bank subsidiaries, and management expected that restriction to be lifted in Q4 2010.
- Management cited a challenging operating environment, continued money-market fee waivers, low global debt issuance, market-value sensitivity and narrower securities-lending spreads. It anticipated litigation costs for the remainder of 2010 would exceed historical trends.
- Key risks include credit and valuation sensitivity in mortgage-related securities, legal and regulatory proceedings, and support agreements. Maximum potential exposure under support agreements was about $116 million. The filing describes multiple significant matters, including securities-lending claims, investigations and a tax dispute with approximately $900 million of exposure including interest; the ultimate outcomes and timing were uncertain.
- The Dodd-Frank Act was signed after quarter-end. Management said its effects, including potentially higher capital, liquidity, regulatory and deposit-insurance costs, remained subject to rulemaking. The filing estimated a proposed Financial Crisis Responsibility Fee could cost about $200 million annually if enacted as proposed; this was a proposal, not an incurred charge.
Important facts for investors to verify
- How much of earnings growth is recurring after accounting for prior-year securities losses, tax effects, preferred-stock charges and other unusual items; reconcile GAAP and non-GAAP measures.
- Whether fee growth, long-term inflows and integration of Insight and GIS offset money-market outflows, market declines and weaker securities-lending revenue.
- Credit quality and valuation assumptions for mortgage-related securities, loan-loss reserves, nonperforming assets and support-agreement exposures.
- Actual GIS and BHF integration costs, deposit transitions, acquisition accretion and settlement proceeds from the forward-sale agreement.
- Developments in the cited litigation, investigations and tax dispute, and the eventual costs of Dodd-Frank and related regulatory changes.