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Morningstar | Another Slow-Growth Quarter for BNY Mellon; Lowering Our FVE to $55

Wide-moat-rated Bank of New York Mellon again reported slightly disappointing results. During the third quarter, fee revenue was up only 1% year over year, while expenses were up 3%. This led to negative operating leverage, with pretax income down 2% year over year. Year-to-date results look a little better, with fee revenue up 5% versus last year and 83 basis points of positive operating leverage. However, this quarter showed that the long road ahead may not be a straight one as CEO Charles Scharf attempts to significantly alter BNY Mellon from within. On the positive side, one-time litigation charges caused expenses to look abnormally high. Excluding these and expenses were almost flat year over year. This would have led to relatively stable margins. While these results weren’t the best, we only need a compounded annual growth rate of just over 2% for noninterest income to meet our current fair value estimate, with expenses growing just under that. After updating our model for these results, we are reducing our fair value estimate to $55 from $57.

While the overall numbers weren’t great, one-time items made them look worse, and there were still some positive underlying trends. Assets under custody and administration were still up 7% year over year on net new business. Average long-term mutual fund assets on the Pershing platform were up 5% year over year, and triparty collateral management balances also saw strong growth with the onboarding of the final JPMorgan clients. Total revenue for each line of business for the investment servicing segment was up 2%-3% year over year, except for the clearance and collateral management line of business, which was up 8% due to the final boost from the additional triparty repo clients. On the investment management side, net flows generally improved, although equity and index net flows were still negative. Management emphasized that the internal retooling will take time, and the sales and onboarding process for these businesses is longer in nature. Further, as a client is onboarded, BNY Mellon would incur initial expenses before any revenue flows through. With this in mind, we view this story as a slow steady grind toward better organic growth and holding on to margins in the face of pricing pressures. There will be unpredictable variability from quarter to quarter, but so far, signs of the underlying business still appear OK, expenses remain well controlled even as technology investment is ramping up, and the bank continues to repurchase shares. We would give the current initiatives more time to play out.