Business context and reporting period
The Bank of New York Mellon Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2009. Its principal businesses are asset and wealth management, securities servicing, clearing and treasury services. Results are presented on a continuing-operations basis unless noted; Mellon United National Bank (MUNB) was classified as discontinued operations after the company agreed in July 2009 to sell it.
Financial and operating performance
| Metric | Q2 2009 | Comparable period |
|---|---|---|
| Continuing revenue | $2.957 billion | $3.377 billion in Q2 2008; down 12% |
| Fee and other revenue | $2.257 billion | $2.989 billion in Q2 2008; down 24% |
| Net interest revenue | $700 million | $388 million in Q2 2008, which included a $377 million SILO charge; excluding SILO, Q2 2008 revenue was $769 million |
| Provision for credit losses | $61 million | $13 million in Q2 2008 |
| Noninterest expense | $2.383 billion | $2.743 billion in Q2 2008; down 13% |
| Income before taxes from continuing operations | $513 million | $621 million in Q2 2008 |
| Continuing income attributable to common shareholders; diluted EPS | $267 million; $0.23 | $303 million; $0.26 in Q2 2008 |
| Net income attributable to common shareholders, including discontinued operations; diluted EPS | $176 million; $0.15 | $309 million; $0.27 in Q2 2008 |
For the first six months, revenue was $5.868 billion versus $7.102 billion in 2008; continuing income attributable to common shareholders was $630 million versus $1.045 billion. Net income attributable to common shareholders was $498 million versus $1.055 billion. First-half net interest revenue rose 30%, but was down 2% excluding the prior-year SILO charge.
Q2 net interest margin was 1.80% on an FTE basis, down 37 basis points year over year excluding SILO and down 7 basis points sequentially. The reported 69-basis-point year-over-year increase reflects the prior-year charge. Q2 pre-tax operating margin was 18% FTE, or 31% excluding specified items; these adjusted measures are non-GAAP.
Balance sheet, liquidity, cash flow and capital
- At June 30, total assets were $203.0 billion, down from $237.5 billion at December 31, 2008. Deposits were $130.6 billion, down from $159.7 billion, principally as crisis-related client cash ran off. Loans were $38.2 billion, down from $43.4 billion.
- Available funds were approximately $67 billion, including $47 billion of liquid funds and $20 billion of cash. Liquid assets were 33% of total assets, versus 44% at year-end 2008.
- First-half cash from operating activities was $313 million, compared with $1.851 billion in 2008. Investing activities provided $30.889 billion; financing activities used $32.195 billion.
- Long-term debt was $17.363 billion at June 30, versus $15.865 billion at year-end. The company issued $1.5 billion of senior notes during Q2: $1.0 billion of five-year notes at 4.3% and $500 million of ten-year notes at 5.45%.
- Regulatory Tier 1 capital ratio was 12.5%, above the company’s 10% target, and Tier 1 common to risk-weighted assets was 11.1%. The quarter-end Tier 1 ratio fell from 13.8% at March 31, mainly due to repurchase of TARP preferred stock. The company also issued 48 million common shares for approximately $1.4 billion.
Material changes and unusual items
- Q2 included $256 million of pre-tax securities losses, mainly related to credit deterioration in mortgage-backed securities; first-half losses were $551 million. The available-for-sale portfolio’s net-of-tax unrealized loss was $4.4 billion at quarter-end.
- The company repurchased its $3.0 billion TARP Series B preferred stock in June. The redemption charge and final dividend/accretion reduced Q2 EPS by $0.23. It repurchased the related Treasury warrant for $136 million on August 5, after quarter-end.
- A $61 million pre-tax special FDIC assessment and $59 million of merger and integration expense were recorded in Q2. A $134 million tax benefit, primarily from final resolution of the LILO/SILO tax settlement below the previously recorded amount, benefited Q2 EPS by $0.11.
- MUNB’s Q2 discontinued operations included an $85 million pre-tax loss on sale and a $91 million after-tax loss. The sale, subject to regulatory approval, was expected to close by Q1 2010.
- Asset and wealth management fees, securities servicing fees and foreign exchange and trading revenue declined year over year, reflecting lower market values, securities-lending volumes and spreads, reduced fixed-income issuance and lower trading volumes. Securities-lending revenue fell to $97 million from $202 million; assets on loan were $290 billion versus $588 billion a year earlier. AUM was $926 billion and custody and administration assets were $20.7 trillion.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management cited continued pressure from low interest rates, market levels, securities-lending activity and declining crisis-era deposits, while noting new opportunities in asset servicing and corporate trust. Management expected nonperforming assets to increase in the third and fourth quarters of 2009.
Credit and valuation risks include further impairment if mortgage collateral defaults or loss severities worsen. A monoline insurer’s subsequent credit deterioration could result in additional HELOC impairment. The company also reported $449 million of loans past due 90 days or more, and noted that actual credit conditions could be worse than estimates. New consolidation rules for variable-interest entities were expected to increase the balance sheet; the impact on regulatory capital remained uncertain.
Contingencies include a Russian Customs Service claim seeking $22.5 billion, litigation and regulatory inquiries involving securities lending, auction-rate securities, Madoff-related funds and other matters, and an IRS dispute over foreign tax credits. The company deposited approximately $800 million with the IRS during Q2 to mitigate interest costs. Management stated pending matters were not expected to materially affect consolidated financial position or liquidity, though they could materially affect income in a period. Potential maximum exposure under client support agreements was approximately $266 million.
Most important facts for investors to verify
- How much of reported earnings reflects recurring operating performance versus securities impairments, the tax benefit, TARP redemption costs and discontinued operations.
- Whether mortgage-backed securities valuations, projected credit losses and the $4.4 billion unrealized portfolio loss improve or deteriorate; review the watch-list exposures and sensitivity assumptions.
- Whether client deposit runoff, the decline in net interest margin and securities-lending revenue continue, and whether AUM and custody assets recover.
- Capital and liquidity after the TARP preferred and warrant repurchases, share issuance, debt maturities and the reduction in available funds; assess the effect of dilution and the reduced common dividend of $0.09 per share.
- Developments in MUNB’s sale, nonperforming assets, the IRS dispute, major litigation and regulatory matters, and the forthcoming variable-interest-entity accounting changes.