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Morningstar | Difficult Quarter for BNY Mellon, as Fees and Net Interest Income Both Drop, Outlook Worsens

Wide-moat-rated Bank of New York Mellon reported first-quarter results that highlighted the difficult environment the trust banks are facing today. Revenue was down 7%, driven by declining fee revenue and net interest revenue. While expense control was good, with expenses declining 1%, it could not make up for the revenue headwinds the bank is facing, and earnings per share declined 15%. This should have been partially expected, given the flattening yield curve as well as the more difficult market environment we saw at the end of 2018, and the share price was indeed shooting past our fair value estimate prior to earnings. Overall it was a tough quarter for BNY Mellon, and while we had already been baking much of this into our projections, revenue growth in particular was even worse than we anticipated. After making some adjustments to our overall growth projection, we are our reducing our fair value estimate to $48 per share from $51.

Net interest income was down 5%, largely due to heightened deposit competition, which management highlighted throughout the call. BNY Mellon is now facing a perfect storm for its net interest income, as deposit competition is causing higher rates on interest-bearing deposits and a heightened shift toward interest-bearing deposits, all while a flattening yield curve is putting pressure on asset yields. These will decrease net interest margins while further deposit outflows in general could pressure funding for earning assets, putting even more pressure on overall net interest income. Because of these factors, management guided down even further on net interest income for the second quarter. These are certainly profitability headwinds, but we wouldn't be surprised, in a steady rate environment, if some of the pricing pressure eventually eases up a bit.

Fitting broadly in line with our existing thesis on the space, the investment services segment was more insulated than the investment management segment. Overall revenue for investment services was down 5%. Within this segment, asset-servicing revenue was down 7%, hit by multiple headwinds, while assets under custody were up 3%. Pershing revenue was down 5%, as we are still lapping quarters when Pershing lost some clients; however, underlying client growth has picked back up, and we would not be surprised to see this area return to growth. Issuer services revenue was down 5%, as net interest revenue hit this segment; however, the unit is seeing some growth within its corporate trust activities. Clearance and collateral management was the only area of growth, as the segment is still benefiting from getting the JPMorgan triparty repo business, although BNY Mellon is seeing underlying growth in addition to those business wins. With net interest income headwinds persisting, we wouldn’t be surprised to see limited growth here over the next quarter, but do recognize that there are still some positive growth areas underlying this to consider as well. The partnership with BlackRock on the Aladdin platform is another example of positive potential for the future that is only just beginning to play out.

Investment management revenue was down 14%, as assets under management were down 1%. A large percentage of this decrease was driven by previous divestitures as well as a stronger U.S. dollar, and net outflows were neutral in the quarter. The bank's LDI strategy continues to be a bright spot, and management expects investment management fees to pick up given current asset levels.