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Morningstar | BNY Mellon's Investment Management Under Pressure in 4Q, as Expected; Servicing Fees OK

Wide-moat-rated Bank of New York Mellon reported OK fourth-quarter results. Adjusting for notable items, earnings per share were up 9% quarter over quarter to $0.99; however, this was exclusively due to net interest income growth and tax reform. Underlying fee revenue growth in the fourth quarter was down 1% on an adjusted basis, while it was 3% for the full year. As expected, a tougher market environment in the fourth quarter weighed on results.

We take some solace in the fact that the investment services business segment did relatively fine, while (as expected) the investment management segment was hit the hardest. This fits broadly within our thesis on the space: that the trust banks are still primarily asset servicers (these segments make up roughly 80% of the business), and the servicing business should be better insulated than the more exposed areas of the investment services landscape. The asset managers are more exposed, particularly those with concentrations in active equity strategies.

After incorporating these results, and largely due to more conservatism along the asset management side, we are lowering our fair value estimate to $51 per share. We see a challenging road ahead for fee growth in investment management and low-single-digit fee growth overall for the firm. This, combined with less of a headwind from rising rates, makes for a lower-growth environment going forward. The bank will be more dependent on cost control, which we do think it will make progress on.

Asset servicing revenue was up 5% year over year for the full year, while assets under custody were down roughly 1% for the year. The greater resiliency of assets under custody versus assets under management, as well as more resilient servicing fee income, supports our overall thesis for the trust banks and BNY Mellon in particular. Clearing services' fees were up only 2% for the year as the bank continues to lap certain lost costumers in Pershing; management expects this unit to return to greater growth in 2019. Issuer services had a good year, as activity in items such as corporate actions increased. Finally, treasury services fees were roughly flat for the year.

Investment management and performance fees were still up 3% for the full year; however, for the quarter they were down 7%. Assets under management were down 9% for the year. BNY Mellon experienced net outflows for equities and fixed-income strategies during the quarter but maintained strong inflows in its liability-driven investment strategies. Index-based AUM experienced net outflows as well, leading to total outflows of $8 billion for the quarter and $4 billion for the year. This was in contrast to 2017, which saw $33 billion in net inflows. The market impact was by far the largest factor hurting AUM in the quarter, causing AUM to fall $69 billion. Overall, we see a tough road ahead for all asset managers but do believe certain strategies, such as LDI, should be more insulated. Equity-based strategies now make up only 8% of BNY Mellon’s total AUM.