The Bank of New York Mellon Corporation

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

The Bank of New York Mellon Corporation (BNY) is a global financial services company that operates as a custodian bank, investment manager, and wealth manager.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

BNY Mellon’s primary operations are conducted through three main business segments: Securities Services, Market and Wealth Services, and Investment and Wealth Management.

Business Overview

BNY Mellon operates in three primary segments: Securities Services, Market and Wealth Services, and Investment and Wealth Management.

Securities Services: This segment provides global custody and other services for asset owners, asset managers, and financial intermediaries. It is their largest division and includes activities related to asset servicing, global collateral management, securities lending, and issuer services, as well as their treasury service related to securities clearing and settlement.
Market and Wealth Services: This segment offers a variety of global clearing, collateral management, foreign exchange, securities lending, and liquidity services to banks and other clients. This includes services like treasury services and wealth management services.
Investment and Wealth Management: This division includes asset and wealth management solutions for institutions and ultra-high net-worth clients. The businesses offer investment management strategies across multiple asset classes and geographies, and comprehensive wealth management offerings, including financial planning, private banking, and family office services.

BNY Mellon operates in a highly regulated industry and is subject to extensive oversight from various regulatory bodies, including the Securities and Exchange Commission (SEC) and the Federal Reserve.

Industry Analysis

The financial services industry faces several challenges.

Increased Regulation: Financial institutions are subject to increasingly stringent regulations and compliance requirements, which increase operating costs.
Technological Disruption: Advancements in technology (FinTech) are changing the way financial services are delivered, forcing established players to adapt.
Interest Rate Sensitivity: BNY Mellon’s earnings are particularly sensitive to changes in interest rates, which could reduce earnings or increase credit costs.
Competitive Landscape: Competition in the banking sector is intense, with traditional banks facing rivalry from FinTech companies and other financial institutions.

Financials

BNY Mellon’s financial performance is influenced by various factors, including the market’s volatility and changes in interest rates, as it operates in the financial and banking sectors that are sensitive to these factors. Let’s take a look at its financials.

Income Statement

A look at BNY’s consolidated income statement for the first quarter of 2024 compared to the same period in the prior year shows:

Fee and Other Revenue: Decreased to $3.23 billion from $3.6 billion, primarily due to lower trading revenue.
Total Revenue: Decreased to $4.66 billion from $5.14 billion, reflecting a decline in both fee revenue and net interest income.
Noninterest Expense: Increased slightly to $3.35 billion from $3.31 billion, which is likely due to higher employee-related expenses and technology investments.
Net Income Applicable to Common Shareholders (GAAP): Decreased to $770 million, or $0.99 per diluted share, from $983 million, or $1.21 per diluted share, in the prior year, partially due to the decline in revenue.
Net Income (Non-GAAP): Adjusted net income was $1.03 billion, or $1.32 per diluted share, compared to $1.03 billion or $1.27, in the previous year. The change is primarily caused by higher revenues and the tax rate effects mentioned above.
Net interest income: The net interest income decreased from $1.5 billion to $1.4 billion, due to higher interest expense.

Here’s a further breakdown of segment performance for the first quarter of 2024:

Securities Services: Total revenues declined by 5% year-over-year to 2.4 Billion. Securities services revenues decreased, as an increase in investment services and revenue from net interest income was more than offset by decreases in securities lending and foreign exchange.
Market and Wealth Services: Total revenues increased by 1% year-over-year to 1.2 Billion. The increase was driven by higher investment and wealth management revenues, partially offset by lower trading and funding-related revenue.
Investment and Wealth Management: Total revenues increased by 6% year-over-year to $1.13 Billion. The growth was primarily driven by higher management fees.

Balance Sheet

In terms of balance sheet, here are some observations for Q1 of 2024.

Total Assets: BNY Mellon reported total assets of $422 billion, compared with $431 billion the prior year, due to a slight decline in securities available for sale, partially offset by other liquid assets.
Total Liabilities: A reduction of short term debt.
Total Equity: Increased to 44.6 billion, compared with 44.3 billion at Dec 31, 2023 due to changes in unrealized losses in securities and dividends to shareholders.
The balance sheet of BNY is primarily made up of securities, loans, derivatives, goodwill and other intangible assets with the majority portion being securities, a huge portion of this is held for trading. They have also large deposits, which they use to fund their loans.
Their loan book comprises: Commercial Real Estate: 49.5 billion, of this, most is in the USA. They also have loans in Brazil, and the United Kingdom. Leveraged lending: 13.4 Billion. Wealth management mortgages: 9.3 Billion
Their portfolio is of high credit quality, which has an A+ rating. They hold more A rated securities than BB.

Cash Flows

A quick summary of cash flows in BNY’s 2024 10-Q reveals:

Operating activities: generated $2 billion in cash in three months compared to $1.3 billion in the first quarter of the previous year.
Investing activities: Net cash used for investing activities was 2.8 billion in the three months, compared to $1.4 Billion the previous year. The increase was related to purchases of available-for-sale securities and loan origination activity, partially offset by proceeds from sales and maturities of available-for-sale securities.
Financing activities: Cash inflow of $849 billion due to a large increase in deposits and decrease in short-term debt.

Capital

Common Equity Tier 1 capital ratio: 11.8%. Tier 1 leverage ratio is at 8.4%.

These ratios are still quite high, indicating that BNY is well capitalized, even under stress scenarios.

Moat Analysis

BNY Mellon’s moat is largely derived from switching costs and network effects, but also enjoys other forms of smaller competitive advantages.

Switching Costs: BNY Mellon’s services are deeply integrated into their clients’ operations, creating significant switching costs. It’s hard for clients to migrate away to competitors, as it’s time-consuming, costly and prone to errors. Services such as custody, fund administration and clearing are tightly embedded with their customers’ processes, requiring them to have high barriers of entry for any new competitor.
Network Effects: As a leading player in their segments, BNY Mellon benefits from a network effect where more customers attract more clients, enhancing their liquidity. For example, in securities lending and repo markets, a larger lender’s network means it can more easily source securities needed by the borrower.
Scale: BNY is one of the largest custody banks in the world, which provides it with advantages in terms of economies of scale that are difficult for competitors to match. These economies of scale manifest in a lower cost structure.
Reputation & Legacy: BNY has a long-standing reputation and a long record in the industry. A high brand value is very important in finance, which creates barriers to entry for new companies, as it takes time to build trust with the client.

Overall, they have multiple smaller moats, but none of those could be considered to be wide. They all seem to be narrow, at least for the moment. For that reason, they get a score of 2 out of 5 in terms of moat.

Risks to Moat and Resilience

There are several risks and concerns that can harm BNY’s moat and financial resilience.

Technological Disruption: While technology is an enabler for many business models of the banks, it is also a risk. New fintech companies, blockchain technologies and AI could disrupt traditional services, eroding BNY Mellon’s competitive advantages.
Increased Regulation: Changes in financial regulations, specifically around capital requirements and leverage, could impact BNY Mellon’s profitability and business structure. Furthermore, increased regulations to the fee structure can make some of their businesses unattractive.
Financial Crises: As a custodian bank that manages a huge amount of assets, BNY Mellon is exposed to financial crises that can reduce market prices and asset values, decreasing revenue and profits.
Operational Risk: Operational risk continues to be an area of concern, with BNY spending a considerable portion on compliance and internal controls. A security breach or bad operational control could significantly harm their revenue and reputation.
Cybersecurity: As a global financial institution, BNY Mellon faces growing threats from cyberattacks. A security breach could significantly harm the company’s credibility and cause regulatory fines.
Interest Rate Risk: BNY Mellon’s earnings are sensitive to changes in interest rates, both on the lending side and the investment side. Rising interest rates can harm the loan book and the bond portfolio while increased rates also increase the cost of lending.
Competition: Increasing competition in various segments can significantly affect revenue streams. As a big player in financial services, they face a lot of competition from other incumbents, and new players trying to capture the existing business.

From the latest 10-Q filings, there are concerns over certain legal disputes and other issues. BNY Mellon has been in conversations with regulators about whether it had sufficient controls around preventing money laundering and other illicit activity. The company is under a compliance order from the OCC, because of deficiencies in controls over risk management and regulatory compliance.

Further scrutiny may be coming on the bank’s compliance, given the recent scrutiny into the business from US authorities and the US Department of Justice.

Management’s View on Problems and How They Will Improve

The management has recently communicated their intent to continue working on the deficiencies in the existing controls and has made considerable investments in IT and other technologies that help with risk management and compliance. They also state that they have a clear understanding of the shortcomings and they are working towards a resolution.

Understandability

The bank is relatively easy to understand, as most people, at the very least have a good understanding of what a bank is. It also deals with financial instruments that most educated people are somewhat familiar with, like stocks, and bonds. Due to the complexities of financial instruments that they use, it is given a rating of 4, as it is hard for the average person to understand the business.

Balance Sheet Health

BNY Mellon’s balance sheet is very healthy with adequate liquidity and capital. The liabilities, while big, are mostly the customer’s money. Their risk weighted assets and trading assets are a bit more volatile, so management must ensure that they do not fall below regulatory mandates. The company also shows some concerns about a few of their holdings, such as the real estate market, which they have started to wind down and sell their holdings. Given these factors, their balance sheet has a rating of 4/5, as there’s nothing immediately concerning about it.