Fitch: BNY Mellon's 3Q16 Earnings Benefit from Fee Growth

The Bank of New York Mellon Corporation (BK) benefitted from solid fee income growth in the third quarter of 2016 (3Q16) and reported net income of $974 million on revenue of $3.94 billion. Revenues were up 4% year-over-year and sequentially due to stronger depositary receipts and investment management fees. BK also continues to focus on holding down its expenses, which remains a key driver for producing positive operating leverage, according to Fitch Ratings.

BK's 3Q16 net income equated to a 1.11% annualized return on average assets (ROAA) up from 0.88% both in the sequential quarter and a year ago. ROAA in 3Q16 benefitted from fee growth and a smaller average balance sheet. The company's adjusted 3Q16 annualized return on average common equity (ROACE) was 11.3%, up from the 9.7% it generated in 2Q16 and in 3Q15.

BK's returns this quarter were stronger than most of the other U.S. Globally Systemic Important Banks (G-SIBs), reporting to date, which averaged ROACE of 9.3%. This outperformance comes despite the other G-SIBs benefitting from a strong fixed income trading environment, a business which BK lacks. BK's returns benefitted from seasonally higher revenue in depositary receipts, higher investment management fees, good cost control, and a modest reserve release due to a loan recovery.

Total fee revenues were up 5% on a linked-quarter and up 3% on a year-over-year basis. Results mainly reflect higher fees in depositary receipts due to seasonality in this business and higher corporate actions, higher market values in investment management, and higher seed capital and other asset sale gains. Management indicated that roughly half of money market fee waivers have been recovered to date with a further 20% anticipated should the Fed raise rates another 25 basis points (bps). Fitch regards BK's overall business performance to be solid and in line with expectations.

Net interest revenue (NIR) was up 1% on a sequential basis and was up 2% year-over-year due to an 8bps improvement in the net interest margin (NIM) to 106bps. NIM expansion was mainly driven by higher short-term rates, higher loans, and management actions to reduce certain higher cost deposits. Fitch continues to believe BK's NIR is quite sensitive to further movements in short-term interest rates.

Management noted it expects to issue approximately $2 to $4 billion of incremental unsecured long-term debt above its normal funding requirements by July 2017, which will have a modest negative impact on NIR and NIM moving forward. This expected issuance is associated with its resolution plan strategy.

Expenses, excluding one-off items, were flat sequentially and down 1% year-over-year, as BK remained focused on driving incremental improvements across the company. BK continues to approach expense management as an ongoing process. Results this quarter reflect progress on renegotiating vendor contracts and reducing its real estate footprint relative to previous quarters, somewhat offset by higher staff costs from annual merit increases. Fitch believes that in a stronger rate and economic environment much of the work BK has done on the expense front will become more evident through further increases in operating leverage.

BK's assets under management (AUM) through 3Q16 were $1.72 trillion, which is up 3% from 2Q16 and up 6% from 3Q15. The result was driven by higher market values, offset somewhat by currency movements and small year-over-year outflows. Assets under custody and administration (AUC/A) were up 3% sequentially due to net new business and higher markets. AUC/A totaled $30.5 trillion at the end of 3Q16.

BK's fully phased-in Basel III CET1 of 9.8% (advanced approach) reported at the end of 3Q16 improved by 30bps sequentially. The increase in CET1 was primarily attributed to organic capital generation and a modest reduction in risk-weighted assets. Tier 1 and Total capital ratios improved during the quarter due to the issuance of $1 billion of preferred stock. BK also continues to exceed the fully phased-in liquidity coverage ratio (LCR) requirement.

The company continues to make progress toward achieving full compliance with the U.S. supplementary leverage ratio (SLR), BK's binding constraint capital ratio, having reached the required ratio at the consolidated level. On a fully phased-in basis, BK reported a consolidated 5.7% SLR, which is up 70bps from the prior quarter. BK also reported that its main bank subsidiary, The Bank of New York Mellon, had an estimated 5.9% SLR, which improved 60bps during the quarter. The main bank subsidiary is now 10bps away from fully phased-in compliance. Improvements were driven by capital generation from the preferred stock issuance and earnings, along with a reduction in average deposits and repo funding during the quarter due to management actions, though period-end balances were similar to last quarter.

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