The Bank of New York Mellon Corporation (NYSE:BK) Q3 2023 Earnings Call Transcript

The Bank of New York Mellon Corporation (NYSE:BK) Q3 2023 Earnings Call Transcript October 17, 2023

Operator: Good morning, and welcome to the 2023 Third Quarter Earnings Conference Call hosted by BNY Mellon. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material. You may not record or rebroadcast these materials without BNY Mellon’s consent. I will now turn the call over to Marius Merz, BNY Mellon, Head of Investor Relations. Please go ahead.

Marius Merz: Thank you, operator. Good morning and thank you all for joining our third quarter earnings call. As always, we will reference our financial highlights presentation, which can be found on the Investor Relations page of our website at bnymellon.com. I’m joined by Robin Vince, President and Chief Executive Officer; and Dermot McDonogh, our Chief Financial Officer. Robin will start with introductory remarks before Dermot take you through the earnings presentation. Following their remarks, there will be a Q&A session. Before we begin, please note that our remarks include forward-looking statements and non-GAAP measures. Information about these statements and non-GAAP measures are available in the earnings press release, financial supplement and financial highlights presentation, all available on the Investor Relations page of our website.

Adam Gregor/Shutterstock.com

Forward-looking statements made on this call speak only as of today, October 17, 2023, and will not be updated. With that, I will turn it over to Robin.

Robin Vince: Thanks, Marius. Good morning, everyone and thank you for joining us. Before we get to the earnings call I’d like to address the horrific terrorist attack on Israel and the ongoing conflict in the surrounding region. We’re heartbroken as we continue to witness a human tragedy unfold. And I’m immensely grateful and proud of our employees in Israel who despite everything that they have been going through continue to deliver uninterrupted service to our clients. Our hearts go out to colleagues, clients, and community members in the region. Now I’ll share some brief comments about our financial results for the third quarter and we’ll then give a quick overview of some of our strategic priorities. BNY Mellon delivered solid financial performance and continued progress on the steady transformation of our company.

As you can see on Slide 2 of the financial highlights presentation, we reported earnings per share of $1.22 versus $0.39 in the third quarter of last year. Excluding notable items, which primarily impacted last year’s results, EPS of $1.27 increased by 5% year-over-year. We generated a return on tangible common equity of 20% on $4.4 billion of revenue, up 2% year-over-year and a pre-tax margin of 29% in the third quarter. These results once again highlight the efficacy of our prudent and proactive asset and liability management amid a rapidly evolving operating environment. Net interest revenue was up 10% year-over-year, as we continued to maximize the positive aspects of rising interest rates. Our strong liquidity position allowed us to reduce our wholesale funding footprint.

And despite the significant steepening of the curve, unrealized losses in our investment securities portfolio remained well contained. Our 20% return on tangible common equity, together with all of these actions, allowed us to continue to deliver attractive capital returns to our shareholders, while further strengthening our capital and liquidity ratios to be prepared for a wide range of macroeconomic outcomes. As I’ve just rounded out the first 12 months in my seat. I’d like to take a step back for a moment and reflect on our work to date and where we’re headed. Through a series of strategic reviews, we have affirmed what we believe to be our key assets. Number one, our client reach and breadth of engagement. Our top tier clients from all regions of the world both trust and want to do more business with us.

Number two, our collection of market leading businesses. We’re a broad based financial services company with a balance and diversification that makes us stronger and our unique business mix sets us apart from our competitors. And number three, our culture of teamwork. Our people are naturally collegial and seek out opportunities to work together to serve our clients and communities. These assets are hard to replicate and it’s rare that they exist together. But as I have acknowledged before, the company’s long-term financial performance track record hasn’t lived up to the quality of this franchise. As a result, we’ve committed to drive higher underlying growth, consistently deliver positive operating leverage, and improve our pre-tax margin over time.

As an important mark of clarity and focus to help tie together where we are heading and why, we recently communicated three strategic pillars to our employees around the world. One, be more for our clients. Two, run our company better. And three, power our culture. These three pillars are not fundamentally changing the businesses we’re in. Instead, they drive at how we operate and who we are day to day for our clients. As I’ve said before, strategy is important, but ultimately just a set of words. Actually doing it and how we do it matters a lot. While this was just one quarter in what will be a multi-year transformation, I’m optimistic about the steady improvements we are seeing inside of BNY Mellon, and I want to share with you some of this perspective that gives us confidence that we’re on the right track with the work that we are doing under each of these pillars.

First, I’m encouraged by the pace of progress toward making BNY Mellon a better run company. Our businesses have historically operated largely in silos. We’ve run somewhat like a corporate conglomerate with a holding company that owns a series of vertically self-sufficient subsidiaries. This has led to clunky client journeys, wasteful duplication, and a lack of joined-up thinking. We have many opportunities to run our company better and more efficiently, to reduce bureaucracy, and we need to be smart and disciplined with how we spend so our investments in the business go further. I’ve talked to you before about our efficiency initiative comprising about 1,500 ideas developed by those who often see items ripe for improvement most clearly and closely, our people.

This program, internally we call it project catalyst, is well underway, and we started to see some early benefits in our financial results. As you may recall, in January, we set out to essentially half our expense growth rate this year to roughly 4% growth excluding notable items compared to roughly 8% ex-currency in 2022. We have made good progress against this goal. With less than three months left in the year, we are confident that we will outperform our 4% expense growth target for 2023, all while self-funding over $0.5 billion of incremental investments this year. As we’ve started the budgeting process for 2024, we are determined to bend the cost curve further. We’re now working to adopt a platform’s operating model, which will help us to do things in one place, do them well, and elevate overall execution.

And we’re embracing new technologies so we can be more productive, more efficient, and focus on growth. Automation of processes and investment in operations digitization and AI across the firm will make it easier for our employees to do their jobs and subsequently channel their energies toward new innovations. Which brings me to our work toward being more for our clients. Our financial results in the quarter tell a tale of two cities. Against the backdrop of seasonally slower summer months, we once again saw outperformance in some of our differentiating businesses. Strengthening clearance and collateral management continued, and we saw healthy underlying growth in Pershing, as well as solid momentum in asset servicing. This was offset by continued softness in investment management fees and lower foreign exchange revenue given the subdued market backdrop.

Our path to higher underlying growth is clear. In addition to always being on the hunt for new clients, we have to deliver more to our existing clients, develop new products, and do a better job at connecting the adjacent ones. Our new Chief Commercial Officer has hit the ground running as we start operationalizing one BNY Mellon across the organization to sharpen our commercial focus and elevate the client experience across the firm. At the same time, we’re pushing forward with innovative new client solutions that leverage the adjacencies among our businesses. While still early days, initial client wins with our recently launched solutions as well as the quality of our pipelines are encouraging. PershingX’s new open architecture wealth management platform, Wove, is off to a promising start, including a couple of client agreements already signed, several prospective clients in active contracting, and a steadily growing pipeline.

As an example, Integrity, a nationwide insurance and financial services firm with a network of over half a million agents and advisors has selected our Wove platform to support their wealth management business. With Wove, we are also connecting solutions from across BNY Mellon. For example, Integrity will have access to third party models and institutional grade solutions from our specialist firms in investment management and broker dealer clearing and custody solutions through Pershing. In another example, Pershing expanded their long-standing relationship with Lincoln Investment as the company transitioned their self-clearing business onto Pershing’s custodial platform and selected Wove to provide a suite of technology solutions to its financial professionals.

As we onboard additional clients through the remainder of 2023. We are planning to start disclosing relevant financial information and leading indicators for you all to keep track of Wove’s growth trajectory at the beginning of next year. We also signed the first external client, a leading GSIB-owned European Asset Manager, for our recently launched buy-side trading solutions. Without a doubt, we expect our more prominent solutions, like Wove and buy-side trading, to move the needle on growth over time. But we are leaning into innovation to solve evolving client challenges across all of our businesses. For example, in Treasury Services, we were one of the first banks to go live on FedNow, the Federal Reserve’s new instant payment rail. This allows us to expand our capabilities for corporations, non-bank financial institutions, and fintechs, and as a service provider, we are helping our financial institutions clients access instant payments, remain competitive, and provide best-in-class service for their customers.

As another example, this quarter the business announced the launch of [Bankify] (ph), an open banking payment solution that as an alternative to credit or debit cards and third-party payment platforms helps organizations receive consumer payments from bank accounts with a seamless user experience and guaranteed settlement. Let me conclude by saying that we are optimistic about the opportunity in front of us and our strategic objectives for the short, medium, and long term are clear. We are innovating and pushing forward on our multi-year growth investments, all the while remaining disciplined to deliver positive operating leverage and pre-tax margin expansion. As I’ve said all along, the path to transforming BNY Mellon into a consistently high-performing company will take some time, but for 2023, we are on track to deliver what we said we deliver at the beginning of the year, while making steady progress toward our strategic priorities.

I’m proud and appreciative of our people’s dedication to be more for our clients, run our company better, and power our culture, collectively to unlock BNY Mellon’s potential. With that, over to you, Dermot.

Dermot McDonogh: Thank you, Robin, and good morning, everyone. I will start on Page 3 of the presentation with our consolidated financial results for the third quarter. Total revenue of $4.4 billion was up 2% year-over-year. Net interest revenue was up 10% year-over-year, primarily driven by higher interest rates, partially offset by changes in balance sheet size and mix. Fee revenue was flat. Growth on the back of higher market values, net new business, and the favorable impact of a weaker dollar was offset by the Alcentra divestiture in the fourth quarter last year, lower foreign exchange revenue and the mix of AUM flows. Firm-wide assets under custody/administration of $45.7 trillion were up 8% year-over-year, reflecting higher market values, client inflows, the weaker dollar, and net new business.

Assets under management of $1.8 trillion were up 3% year-over-year, reflecting the weaker dollar and higher market values, partially offset by the Alcentra divestiture. Investment and other revenue was $113 million in the quarter, reflecting continued strength in fixed income trading. Expenses were down 16% year-over-year on a reported basis, primarily reflecting the goodwill impairment associated with our investment management reporting unit in the third quarter last year. Excluding notable items, expenses were up 3% year-over-year. Provision for credit losses remained low at $3 million in the quarter, as the impact of reserve bills to reflect continued uncertainty on the outlook for commercial real estate was largely offset by reserve releases related to financial institutions.

As Robin noted earlier, reported earnings per share were $1.22. Excluding notable items, earnings per share were $1.27, representing 5% growth year-over-year. We delivered positive operating leverage. Our pre-tax margin was 29% and we generated a return on tangible common equity of 20%. Turning to capital and liquidity on Page 4. Consistent with the prior quarter, we returned $450 million of capital to our shareholders through common share repurchases and we paid approximately $330 million of dividends to our common stockholders, reflecting our previously announced 14% dividend increase, which became effective in the third quarter. Taken together, we returned 82% of earnings to shareholders in the quarter, or 107% on a year-to-date basis. Our Tier 1 leverage ratio improved sequentially by approximately 40 basis points to 6.1% reflecting a decrease in average assets and an increase in Tier 1 capital driven by capital generated through earnings, net of capital returns through buybacks and dividends.

Unrealized losses related to available for sale securities remained roughly unchanged in the quarter. The CET1 ratio was 11.4%, representing an approximately 30 basis points improvement compared with the prior quarter, reflecting lower risk weighted assets and an increase in CET1 capital. Just like our regulatory capital ratios, our liquidity ratios further strengthened in the quarter. The consolidated liquidity coverage ratio was 121%, a 1 percentage point improvement compared with the prior quarter. And our consolidated net stable funding ratio was 136%, well in excess of the regulatory requirement. Next, on Page 5, net interest revenue and further details on the underlying balance sheet trends, which I will describe in sequential terms. Net interest revenue of $1 billion was down 8% quarter-over-quarter, driven by changes in balance sheet size and mix, partially offset by higher interest rates.

As we expected, temporary deposits related to the debt ceiling impasse in the second quarter left in July and along with seasonally low balances in August, average deposits for the quarter decreased by 5% sequentially. In line with our expectations interest-bearing deposits were down 3% and non-interest bearing deposits were down 16%. You will remember from prior earnings calls that we expected non-interest bearing deposits to moderate to approximately 20% of total deposits in the second half of this year, which is consistent with our deposit mix in the third quarter. Following seasonal troughs in August, we saw the anticipated pickup in monthly average balances in September, and again, some modest growth in the first two weeks of October. Average interest earning assets were down by 6% quarter-over-quarter.

This reflects a reduction in cash and reverse repo by 11%, while we actively reduced wholesale funding. Our investment securities portfolio was down 4% and loan balances were up 1%. Moving to expenses on Page 6. Expenses for the quarter were down 16% year-over-year on a reported basis and up 3% excluding notable items. This year-over-year increase was driven by higher investment and revenue related expenses, the unfavourable impact of the weaker dollar as well as inflation, partially offset by efficiency savings and the Alcentra divestiture. I’ll talk more about our outlook for expenses in a moment, but as Robin mentioned earlier, it is worth highlighting that for 2023, we are expecting to fully self-fund over $0.5 billion of incremental investments through efficiency savings.

Turning to our business segments, starting with security services on Page 7. As I discuss the performance of our Security Services and Market and Wealth Service segments, I will comment on the investment services fees for each line of business described in our earnings press release and the financial supplement. Security services reported total revenue of $2.1 billion, up 1% year-over-year. Fee revenue was flat. 2% growth in investment services fees was offset by a 19% decline in foreign exchange revenue on the back of lower volatility and volumes. Net interest revenue was up 12%. In asset servicing, investment services fees were up 3%, driven by higher market values, healthy net new business, and a weaker dollar, partially offset by lower client transaction activity.

The strength of our balance sheet, as well as the stability, breadth, and depth of our solutions remain clear differentiators that position us well with clients, confronted with a persistently challenging market environment and an evolving competitive landscape. For example, ETFs, Assets Under Custody/Administration, were up over 20% year-over-year and the number of funds serviced on our platform continued to grow at a healthy clip. In all, assets under custody/administration and related investment services fees, both grew in the mid-single digit percentage range despite the number of fund launches having slowed significantly over the past year. With Issuer Services, investment services fees were down 2%. Growth from net new business and corporate trust was more than offset by the absence of fees from elevated depository receipt cancellation activity in the third quarter of last year.

Next, Market and Wealth Services on Page 8. Market and Wealth Services reported total revenue of $1.4 billion, up 6% year-over-year. Fee revenue was up 5%, and net interest revenue increased by 6%. In Pershing, investment services fees were up 2%, reflecting higher fees on sweep balances, partially upset by the impact of lost business and lower transaction volumes consistent with the decline in US equity exchange volumes. Despite the continued headwind from the ongoing deconversion of the regional bank client highlighted in the second quarter, Pershing saw $23 billion of net new assets on the platform this quarter, reflecting positive momentum in the underlying business. As Robin mentioned earlier, the momentum around Wove is building with both new and existing clients.

While at the same time, ongoing investments in the core Pershing platform to enhance advisor experience and lead with innovative solutions have positioned us well to capitalize on the heightened pace of change in the RIA community. In Treasury services, investment services fees decreased by 1% as growth from higher client activity was offset by higher earnings credits for non-interest bearing deposit balances. In clearance and collateral management, investment services fees were up 16%, reflecting broad base growth across US and international clearance and collateral management. In particular, we saw strength in domestic clearance volumes reflecting elevated volatility and US treasury issuance activity and continued migration from the Fed’s reverse repo facility to traditional tri-party collateral management balances.

Recent macro trends, including heightened volatility, uncertainty associated with monetary policy and banks regulatory capsule requirements, as well as the recent consolidation in the banking sector, further reinforce the value of our tri-party collateral management service. In addition to expanding our platform both in the U.S. and internationally, we continue to innovate new solutions for our clients to better utilize their collateral. Turning to investment and wealth management on Page 9. Investment and wealth management reported total revenue of $827 million, down 4% year-over-year. Fee revenue was down 2%, and net interest revenue declined 33% year-over-year. Assets under management of $1.8 trillion increased by 3% year-over-year. As I mentioned earlier, this increase reflects the weaker dollar and higher market values, partially offset by the Alcentra divestiture.

In the quarter, we saw $15 billion of net outflows from long-term strategies driven by client de-risking and rebalancing, and $7 billion of net inflows into short-term strategies led by our [DRIFAS] (ph) money market fund complex. In investment management, revenue was down 4% year-over-year, primarily reflecting the Alcentra divestiture and the mix of AUM flows, partially offset by higher performance fees, as well as the impact of higher market values and the weaker dollar. In our wealth management business, revenue decreased by 5%, driven by lower net interest revenue and changes in product mix, partially offset by higher market values. Client assets of $292 billion increased by 14% year-over-year, reflecting higher equity market values and cumulative net inflows.

Page 10 shows the results of the other segments. I will close with our current outlook for the rest of the year. Based on market implied forward interest rates at the end of last month, our net interest revenue outlook for the full year 2023 remains unchanged for 20% growth year-over-year. Moving to expenses. We are making good progress on bending the cost curve by protecting our important investments to accelerate growth and deliver superior client experiences. Where we sit today, I am confident that we will outperform the target of 4% expense growth, excluding notable items that we communicated in January, and we remain determined to drive that growth rate down to 3% for the full year 2023. This reflects our expectation for a sequential step up in expenses, excluding notable items in the fourth quarter, with seasonally higher business development expenses, as well as discrete increases for professional services and occupancy.

And finally, we expect continued stock buybacks at a pace consistent with the second and third quarter. This is inline with our full year outlook to return 100% of earnings or more to shareholders over the course of 2023, while maintaining our strong capital ratios, mindful of the significant uncertainties relating to the operating environment. In conclusion, our financial results this quarter highlight the effectiveness of our balance sheet management and tangible progress on our journey towards higher operational efficiency and scalability. While we have more work to do, our teams around the world are embracing change and our pace of bringing innovative new client solutions to the market gives us confidence that revenue growth will follow over time.

With that, operator, can you please open the line for Q&A.

See also 20 High Demand Products With Low Competition and 11 Best Green Stocks To Invest In 2023.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Steven Chubak with Wolf Research. Please go ahead.

Steven Chubak: Hey, good morning.

Robin Vince: Good morning, Steven.

Steven Chubak: I wanted to start off with a question on the NII outlook. I was hoping you could just give some thoughts on the deposit trajectory if rates are higher for longer and the Fed continues to engage in QT? And given we’re at that 20% lower bound for NIBs, where do you expect that to ultimately settle out as a percentage of deposits?

Dermot McDonogh: Sure, Steven, I’ll take that, and good morning. So I guess the way I’d like to answer the question is just to kind of start with January, where we kind of gave the guidance to the market of 20% NII growth for the year and we’ve been consistent with that on the call since then. And we reconfirmed that guidance today for 20% for the full year. Now, the world has kind of played a different hand to us over the course of the year since January. We had the bank turmoil in March and we had the debt ceiling impasse over the summer. And clients used us as the porch in a storm during that time and we kind of saw surges in deposits and so that benefited us. Now over the course of the summer we see those deposits leave and we feel we’ve reached an inflection point of puts and takes between the natural organic flow versus our kind of surge deposits leaving.

So we feel the pace of decline has slowed. We feel like we hit the trough in August and we’ve seen modest pickup in deposits in September and into October. So overall, that and when you take the asset side of the balance sheet and how liquid we are on the asset side and how that’s rolling down, you might want to know that as the balance sheet continues to roll down, we have a yield pickup of 200 basis points to 300 basis points, which kind of gives us a lot of confidence in our estimate for the year and outlook into 2024. As it relates to NIBs, we always said that it was going to be 25% to 20% through the cycle. The trough happened during the summer months and has stayed in the 20% zip code. So we feel overall pretty good about NIBs as a percentage of total deposits being in the 20% range.

Steven Chubak: Very helpful. And just for my follow-up on the expense outlook, you’ve spoken about the commitment to improve operating margins. You’ve cited a number of efforts, Robin, to deliver efficiencies across the platform. As we look out to next year, given a lower NII exit rate relative to the first half for you and for some of your industry peers, I want to get a sense of how much flexibility is embedded in your expense plans and your ability to drive expenses lower potentially in a more challenging revenue backdrop.

Dermot McDonogh: Steven, I’ll start. So, look, we’ve said on every call this year that bending the cost curve is a very important strategic objective for the firm. And we’re attacking structural expenses in a number of different ways. And that’s just continuous execution, day in, day out, blocking and tackling. The result of all that blocking and tackling has caused us to outperform the 4% guidance that we gave in January. And we’re determined to push that number closer to 3%. But we don’t believe the work is over this year and we’re now in the middle of budget season and we are determined to bend the cost curve into next year and to continue to deliver that positive operating leverage. And we kind of go at it in a number of different ways, rationalizing vendors, rationalizing locations, remixing our kind of headcount on how we hire.

This year was our biggest campus class ever, double last year, and we continue to build on that. So there are a lot of things happening underneath the hood that give us a high degree of confidence that we’ll be able to continue to bend the cost curve into 2024 and beyond.

Steven Chubak: Very helpful, Dermot. Thanks so much for taking my questions.

Operator: Our next question comes from the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala: Good morning. Just maybe following up on the discussion around deposits. I think Dermot, you used the word trough multiple times. Just give us a sense of it. Obviously, you called it right this year in terms of how things have played out. But just give us a sense of, is it about the mix or the granularity of your deposits or the client behavior that you’ve seen that gives you confidence that this 20% of what you saw in August was a trough? And if we are in a period through next year where there are no rate cuts, it’s higher for longer, like, where does the negative surprise come from, if any?

Dermot McDonogh: Thanks for the question. So, look, this has been a journey for the last 15 months. We took a view at the beginning of last year that the Fed was going to hike quite significantly and we positioned the balance sheet in a way to do that. And so, when we kind of talk about deposit, I think it’s very important to look at both sides of the balance sheet at the same time in terms of how we’re positioned on the asset side. We have a lot of the balance sheet in cash which benefits from the higher interest rates. Our fixed rate securities are going to roll down over the next, a decent amount of the fixed securities, I think it’s a quarter a year rolled down over the next couple of years. And that gets us a pick-up of 200 basis points to 300 basis points.

And at the beginning of the year, we did forecast a kind of mid-single digit decline in deposits. And that kind of bottoms up analysis. And also, it’s important to remember that clients of BNY Mellon are not just with us for deposits. They come into our ecosystem. And just remember, it’s a $1.3 trillion cash ecosystem that we have and they come in for a variety of different reasons. It’s a portfolio of businesses that give us our deposit makeup. So when we look at it at a portfolio level we get a lot of confidence around the stability of the deposit base. And look, there were a lot of gives and takes this year through the bank turmoil in March and the debt ceiling impasse which benefited us and that’s kind of moderated and those deposits have left for higher yielding opportunities.

But we feel like the summer slowdown, the seasonal slowdown that we experienced in August and the conversations that we have and talking to our deposit team, we feel very good about where we are on the deposit balance now and the pickup that’s happened in September and October. And that kind of gives us the confidence to say here today that 20% NII is a good number, which I think should be good for you guys to know that we’ve been consistent in our approach over the whole year.

Ebrahim Poonawala: That’s helpful. Thank you. And I guess maybe if I heard you correctly, I think you mentioned $0.5 billion of investments are self-funded. That’s about 4% of your expense base. Is that $0.5 billion — I’m just wondering the relevance of that number, is that something that we should think about as a go forward sort of incremental investment spend that you need to self-fund to efficiencies as we from the outside try to figure out what expense growth could look like next year? Just if you could contextualize that $0.5 billion in investments and what that means going forward?