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Bank of New York Mellon, a Long-Term Opportunity

December 14, 2011 | About:
Mara Kohn

Mara Kohn

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Bank of New York Mellon (BK) is the largest financial services company across the world. It was created in 2007 after the merger between Mellon Financial and Bank of New York.

BNY Mellon is a leader in providing back-office services to other financial firms. The bank's asset-management and private banking operations serve institutional and high-net-worth individuals globally.

In terms of global custody, BNY Mellon is the largest of the six firms that manage this business. Indeed, BNY Mellon administrates more than 75% of all the financial assets.

BNY Mellon operates in three main segments, namely:

  • The asset servicing business segment, where the bank essentially provides back office services for other financial institutions, including custody, administration, money transfers, forex, etc.

  • The wealth management segment, where the bank simply receives funds from other private or institutional entities and invests them in various vehicles, receiving a fee based on overall asset size.

  • The issuer services segment, where BNY assists clients in new securities issues.


BNY Mellon also earns from interest payments received on assets from its funding sources.

Finally, the bank engages in clearing and treasury services.

Positives and Risks

BNY Mellon is in excellent financial condition. It is the highest-rated U.S. bank and one of the highest rated financial institutions in the world with an AA- rating from S&P.

This condition is mostly a result of its business model which generates recurrent fee-income from services rather than interests from loans and trading activity.

BNY Mellon has certain competitive advantages. First, the bank enjoys a significant cost advantage thanks to its economies of scale. This is quite important, particularly because manpower, IT and marketing expenses do not increase proportionally with the amounts of assets under management. Second, a collection of clients find it more convenient to use BNY Mellon as a one-stop shop for most services. Clients generally look for companies that can operate in multiple countries. This is beneficial for an international player like BNY. Third, customer relationships tend to last for decades as powerful forces do not make clients switch providers very frequently.

Despite the competitive advantages, there are also certain risks that BNY Mellon may face.

Despite its relatively good credit standing, BNY Mellon is still exposed to the health of the financial sector as a whole. The major negative market swings can significantly affect the bank’s profitability.

Also, the bank's income partially depends on interest rates levels and spreads. Headwinds can affect the bottom line.

Last quarter results

EPS were $0.53 or $651 million. That´s a 4% improvement y/y.

Revenue was up 8% year-over-year and fees were up 9%, as they benefited from new business, net long-term asset flows and increased foreign exchange revenues.

Net interest income has also been in an upward trend driven primarily by higher client deposits.

Its loan loss provision was actually a credit of $22 million, and they remain much focused on containing expense growth and bringing down their run rate.

Valuation

The fair estimate is $35 per share. Assets under custody and under management are expected to grow 7% in the long run, while net interest margin is expected to remain around 2%.

Unfortunately, the net interest margin has dropped to 1.8% lately due to the low interest-rate environment.

It is assumed that the total revenue growth will be around 8% and it is expected that the bank will continue leading in terms of costs. The efficiency ratio will surely stay around 65%.

A look at BNY Mellon’s balance sheet suggests the company is significantly undervalued: The company’s market capitalization is 73% of its book value. However, this not justified. The balance sheet is high quality and this kind of discounts are usually found in companies with potentially toxic assets and over-leveraged. This is not BNY Mellon's case.

Management & Stewardship

The company has recently changed CEOs. Mr. Gerald Hassel has taken the position.

The former CEO has been blamed for taking excessive risks and reducing the bank’s financial solidity prior to the financial crisis.

The latest leadership change is a further step in the right direction. Indeed, in terms of shareholders, the company has been returning 25% of cash flow to them and 40% to new investments such as acquisition.

The Return on Invested Capital over ten years has averaged about 20%, which is excellent for an institution of this kind and confirms the management’s decent stewardship.

The chairman, president and CEO, Gerald L. Hassell, uses the correct explanation:

“We're undertaking a number of actions to achieve what I call operational excellence, a term that brings together the concepts of improving efficiency, reducing risk and delivering the highest quality of service to our clients.”

Rating: 4.0/5 (12 votes)

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