Custody banks like Bank of New York Mellon (NYSE: BK) do not generally get all that much attention. These "banks' banks" operate huge businesses involving trillions of dollars, but they take only tiny percentages of these awesome amounts and generally run themselves quite conservatively. As a result, the average investors' default response is to scrunch up their faces at the blizzard of numbers they report, sigh at the generally modest growth and move on to other ideas.
That could be a mistake, however. While custody banks are not operating the most exciting businesses in the world, they are gatekeepers and toll collectors in the massive financial services industry and an integral part of an industry that seems poised for worldwide growth. So, while regular banks like Wells Fargo (NYSE: WFC) and TCF Financial (NYSE: TCB) worry about loans and deposit share in their home markets, and Morgan Stanley (NYSE: MS) battles for hegemony in trading and asset management, BNY quietly services hundreds of banks and asset managers across the world.
The Quarter That Was
BNY (as the company is still often abbreviated) reported that operating revenue in the second quarter rose 2% on an annual basis but slipped 1% from the Q1. Fee income rose 2% over last year, and net interest income rose 3%, but those metrics were flat and down 6% on a sequential basis, respectively.
I think the "how and why" will sound pretty familiar. Assets under custody and assets under management were both hurt by declines in market value. Custody fees are based on the assets under custody, and when the market value of those assets declines, so does the fee revenue. On the net interest income line, the answer is likewise straightforward - it is difficult to make money lending cash and securities when the Fed has a virtually zero rate policy in effect.
While revenue was up a bit, cash operating expenses were up more. Some of this is likely due to the real costs of integrating some large acquisitions, but BNY has also been actively adding to its employee headcount, and those new positions cost money.
On the credit side, news was largely positive. BNY reported lower loan loss provisions, and although non-performing assets did rise from last year, they dropped sequentially by 12%.
All in all, the company did more or less as Wall Street expected, and this is a pretty widely recommended stock right now (15 buy/strong buy recommendations, six holds and nothing lower).
Where To From Here?
(NYSE: STT) looks cheaper relative to its historical valuation range, BNY is my favorite custody bank stock. Northern Trust (Nasdaq: NTRS) is the other major name. BNY has a more conservative-looking bias toward fixed income in its assets under custody and assets under management.
Moreover, my analysis suggests that BNY is the most sensitive to higher rates; if rates go up, BNY profits. Likewise, I like BNY's diverse revenue base, including pieces like ADR services and equity clearing. Northern Trust gets a big chunk of revenue from asset management, so a strong bull market would probably help it most, and both Northern Trust and
depend more heavily on asset servicing than BNY.
Broad Geographical Base Should Work In BNY's Favor
BNY has been very active of late buying up custody and servicing businesses around the world. Given the inevitability of ongoing globalization of financial services, that broad geographical base should work in BNY's favor in the coming years. Couple that leverage to global financial services growth with a diversified business that has upside to higher interest rates, and I think there is a reasonable case for investigating BNY as an addition to value-oriented portfolios. (For related reading, see The Evolution Of Banking.)
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