BNY Mellon — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. BNY Mellon provides investment services and investment management across 35 countries. At quarter-end, assets under custody and/or administration (AUC/A) were $31.1 trillion and assets under management (AUM) were $1.77 trillion.
Financial performance and position
| Metric | Q2 2017 | Comparison |
|---|---|---|
| Revenue | $3.956 billion | Up 5% year over year |
| Net income applicable to common shareholders | $926 million | Up from $825 million |
| Diluted EPS | $0.88 | Up from $0.75 |
| Net interest revenue | $826 million | Up 8% year over year; net interest margin 1.14% versus 0.97% |
| Noninterest expense | $2.655 billion | Up 1% year over year |
| Effective tax rate | 25.4% | 24.9% in Q2 2016 |
- For the first six months, revenue was $7.799 billion, net income applicable to common shareholders was $1.806 billion, and diluted EPS was $1.70, versus $7.506 billion, $1.629 billion, and $1.48, respectively, in the prior-year period.
- Q2 fee and other revenue was $3.120 billion, up 4% year over year. Investment services fees rose 4% and investment management and performance fees rose 6%; foreign exchange and other trading revenue fell 9%, mainly due to lower volatility.
- Pre-tax operating margin was 33%, compared with 31% a year earlier. Adjusted pre-tax operating margin, a non-GAAP measure, was 35% versus 33%.
- Q2 provision for credit losses was a $7 million credit. Nonperforming assets were $100 million, and the total allowance for credit losses was $270 million.
- Total assets were $354.8 billion at June 30, up from $333.5 billion at year-end 2016. Deposits were $235.7 billion, up from $221.5 billion; loans were $61.7 billion, down from $64.5 billion. Long-term debt was $27.7 billion, versus $24.5 billion.
- Available funds were $119.9 billion, up from $103.8 billion at year-end. Average Q2 liquidity coverage ratio (LCR) was 116%, above the 100% regulatory minimum. The filing states the Parent complied with its liquidity policy.
- Capital ratios at June 30: CET1 12.0% under the Standardized Approach and 10.8% under the Advanced Approach; supplementary leverage ratio (SLR) 6.2%. Estimated fully phased-in CET1 ratios were 11.5% and 10.4%, respectively, and estimated fully phased-in SLR was 6.0% (non-GAAP).
- For the first six months, operating cash flow was negative $1.9 billion, investing cash flow negative $13.4 billion, and financing cash flow positive $15.1 billion. Management notes that cash-flow movements can be affected by balance-sheet and accrual changes.
Material changes and notable events
- Versus Q2 2016, earnings and revenue increased, supported by higher interest rates, lower securities premium amortization, market values, clearing fees, and investment management fees. Expense growth was modest but included higher regulatory, compliance, software, and litigation costs.
- AUC/A increased 5% year over year, primarily from higher market values. AUM increased 6%, reflecting higher market values and net inflows, partly offset by currency translation. Q2 net inflows were $3 billion in long-term strategies and $11 billion in short-term strategies.
- The Advanced Approach CET1 ratio rose from 10.4% at March 31 to 10.8% at June 30, primarily due to capital generation; the Standardized CET1 ratio remained 12.0%.
- In July, Charles W. Scharf was appointed CEO, succeeding Gerald L. Hassell, who is to retire as chairman at year-end; Scharf is expected to become chairman on January 1, 2018.
- The Federal Reserve did not object to the 2017 capital plan. The board authorized up to $2.6 billion in common-share repurchases, plus up to $500 million contingent on issuing $500 million of preferred stock. The quarterly common dividend was increased 26%, from $0.19 to $0.24 per share, effective for the August 2017 payment.
Outlook, risks, and contingencies
- Management expected a 2017 effective tax rate of approximately 25%–26%. It also expected a modest decrease in the run rate of risk management and regulatory-compliance expenses in the second half of 2017 after filing the resolution plan.
- Management cited seasonally higher Depositary Receipts revenue in Q3, but at a reduced level versus historical patterns, and warned that volume-related fees could decline with reduced client activity. Staff expenses typically rise in Q3 due to annual merit increases.
- Results remain sensitive to financial-market levels, interest rates, client activity and FX volatility. Management estimated that a 5% change in global equity markets, spread evenly through the year, would affect fee revenue by less than 1% and diluted EPS by $0.02–$0.04.
- Key stated risks include market and interest-rate changes, lower market activity and fee pressure, currency movements, credit and counterparty losses, operational and cybersecurity events, regulatory costs or restrictions, and the execution and credibility of the resolution plan.
- Legal matters include mortgage-securitization trustee litigation, Stanford-related claims, Brazilian Postalis and Silverado litigation, Depositary Receipt FX-pricing claims, and an SEC inquiry into ADR pre-release practices. For matters where a reasonably possible loss could be estimated, the aggregate range was up to $920 million in excess of accrued liabilities; the company could not estimate a range for certain other matters. Management said outcomes could materially affect net income in a given period.
- The 2017 resolution plan uses a single-point-of-entry strategy and an intermediate holding company support agreement. In severe financial stress, the Parent’s committed line could terminate and the Parent may enter bankruptcy; Parent securities holders could face significant losses.
- The annual goodwill impairment test found no impairment. However, the Asset Management reporting unit’s fair value exceeded carrying value by 16%; changes in AUM or operating margins could lead to a non-cash impairment.
Investor verification priorities
- Reconcile reported GAAP earnings and margins with the company’s non-GAAP adjusted measures and their exclusions.
- Assess whether revenue growth and AUM/AUC/A gains are sustainable without continued market appreciation, higher rates, or favorable client flows.
- Track expense trends, especially regulatory, compliance, technology, litigation, and staff costs, against management’s second-half expectations.
- Review capital and liquidity after planned buybacks, the higher dividend, any preferred issuance, and transfers of Parent cash to the intermediate holding company.
- Monitor resolution-plan developments and legal proceedings, including the disclosed potential losses and matters with unestimable exposure.
- Evaluate credit quality and concentrations, including financial-institution exposures, real estate, Brazilian exposures, and the allowance’s sensitivity to rating assumptions.