Business context and reporting period
The Bank of New York Mellon Corporation (BNY Mellon) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. Its principal businesses are Investment Management and Investment Services, alongside an Other segment. At quarter-end, it reported $26.2 trillion of assets under custody and/or administration (AUC/A) and $1.43 trillion of assets under management (AUM).
Financial results and key metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $4.009 billion | $3.617 billion | $7.622 billion | $7.263 billion |
| Net income applicable to common shareholders | $833 million | $466 million | $567 million | $1.085 billion |
| Diluted EPS | $0.71 | $0.39 | $0.48 | $0.90 |
| Net interest revenue | $757 million | $734 million | $1.476 billion | $1.499 billion |
| Noninterest expense | $2.822 billion | $3.047 billion | $5.650 billion | $5.803 billion |
| Net interest margin (FTE) | 1.15% | 1.25% | 1.13% | 1.28% |
- Q2 pretax income was $1.206 billion; income tax provision was $321 million, for a 26.6% effective tax rate. The reported Q2 2012 tax rate was 15.8% and included a tax-rate reduction associated with a litigation charge.
- Q2 GAAP pre-tax operating margin was 30%, versus 16% a year earlier; the company’s adjusted non-GAAP measure was 32%, versus 29%. These measures exclude specified items and should be read with the filing’s reconciliations.
- Q2 provision for credit losses was a $19 million credit. Six-month operating cash flow was negative $959 million, versus positive $374 million in the prior-year period; investing cash flow was negative $632 million and financing cash flow positive $3.931 billion.
- At June 30, total assets were $360.5 billion; deposits $244.9 billion; long-term debt $18.5 billion; and shareholders’ equity $35.9 billion. Available funds were $136.2 billion, or 38% of total assets, down from $145.3 billion and 40% at year-end 2012.
- Estimated Basel III Tier 1 common equity ratio was 9.3% under the Standardized Approach (9.8% under the Advanced Approach); Basel I Tier 1 and total capital ratios were 14.8% and 15.8%. The Basel III estimate was preliminary and based on the recently finalized rules.
Material changes versus comparable periods
- Q2 revenue rose 11% year over year, led by fee and other revenue, up 13% to $3.187 billion. The increase included a $200 million equity-investment revenue contribution, principally reflecting a $109 million after-tax gain on BNY Mellon’s ConvergEx investment.
- Q2 net income increased from $466 million to $833 million. The comparison benefited from the ConvergEx gain and lower litigation charges; Q2 2012 included a $212 million after-tax litigation charge.
- Q2 noninterest expense fell 7% year over year, primarily because litigation charges declined. Excluding amortization and merger, litigation and restructuring charges, expenses instead increased 6%, reflecting higher staff, software and business-development costs.
- Net interest revenue rose 3% in Q2 year over year, but fell 2% for the first six months. The year-to-date decline reflected lower securities reinvestment yields and the elimination of interest on European Central Bank deposits. Net interest margin remained under pressure.
- AUC/A increased 4% and AUM 10% year over year, primarily due to higher market values and net new business. Q2 long-term AUM inflows were $21 billion; short-term outflows were $1 billion.
- The prior-quarter comparison is affected by an $854 million charge in Q1 2013 following the U.S. Tax Court’s disallowance of certain foreign tax credits; Q1 reported a $266 million common-shareholder net loss.
Outlook, commentary, risks and unusual items
- Management expected an effective tax rate of approximately 26% in Q3 2013 and a Q3 provision for credit losses of up to $15 million.
- The company targeted $500 million to $520 million in annualized gross operating-excellence savings by the end of 2013; this was a target, not a reported guarantee of net expense reduction.
- Management said legal and litigation costs were expected to remain elevated. For certain matters where a reasonably possible loss could be estimated, the aggregate range was up to $715 million in excess of related accruals, if any. The filing also noted it could not estimate losses for some matters.
- BNY Mellon continued to dispute the foreign-tax-credit ruling and planned to appeal; the $854 million charge was recorded in Q1. Total tax reserves were $1.060 billion at June 30, including accrued tax interest of $289 million.
- Other disclosed contingencies include approximately $100 million of potential additional exposure related to administrative errors involving certain offshore tax-exempt funds. The filing describes ongoing foreign-exchange-related inquiries and litigation, securities-lending claims, and other proceedings.
- Interest-rate increases could affect securities valuations and client behavior. The portfolio’s net unrealized pretax gain fell to $656 million from $2.2 billion at March 31, primarily as long-term rates rose. The company also cited risks from low or volatile rates, deposit outflows, money-market-fund reform, competition, regulatory change and reliance on fee-based revenue.
- Regulatory capital rules were finalized after quarter-end and are scheduled to phase in principally through 2019. Proposals could make supplementary leverage requirements more restrictive. The company said all liquidity ratios it monitored exceeded minimum guidelines and stress tests indicated sufficient liquidity.
- BNY Mellon increased its quarterly common dividend 15%, to $0.15 per share, and repurchased 11.9 million shares for $330 million in Q2. It issued $500 million of Series D preferred stock; subsequent to quarter-end, it issued $1.1 billion of senior notes.
Most important facts for investors to verify
- How much of the earnings improvement is repeatable, given the ConvergEx gain, prior-year litigation charge and Q1 tax charge?
- Whether fee growth and expense discipline can offset continued net-interest-margin pressure, fee waivers, competitive pricing and structured-securitization runoff.
- Developments in the foreign-tax-credit appeal, legal and regulatory proceedings, and potential losses beyond recorded accruals.
- Capital and liquidity effects of final Basel III requirements and proposed supplementary leverage changes; confirm the assumptions underlying the 9.3% estimated Basel III ratio.
- Whether available-funds levels, deposits and operating cash flow remain adequate as the company redeploys funds into securities and loans.
- Credit quality and allowance adequacy, including the delinquent legacy mortgage subset and concentrations in financial-institution and commercial lending.