We are maintaining our Neutral recommendation on The Bank of New York Mellon Corporation (BK - Analyst Report) since we believe that the risk-reward profile of the company is currently balanced. Our decision is based on the company’s better-than-expected second quarter 2012 results. However, we remain wary of the persistent low interest rate environment, stringent regulatory landscape and rising operating expenses.
BNY Mellon is expected to announce its third-quarter results on October 17, 2012. The Zacks Consensus Estimate for the quarter is 54 cents on revenue expectation of $3.6 billion. BNY Mellon’s second quarter 2012 earnings were significantly ahead of the Zacks Consensus Estimate.
Despite the decreases in net interest revenue and fee income, BNY Mellon’s results benefited from lower operating expenses. Moreover, asset quality continued to show improvements and capital ratios remained healthy.
BNY Mellon launched an expense saving program that will enable it to improve its efficiency and consolidate organic growth. The initiative includes shedding expensive real estate, consolidating some facilities, outsourcing some technology functions and taking advantage of cloud computing.
The company is planning to save, on a pre-tax basis, $240–$260 million in 2012, $400–$430 million in 2013, $535–$575 million in 2014 and about $650–$700 million in 2015 through this initiative. For the first six months of the current year, the company recorded net saving of $141 million through its restructuring initiative and remains on track to achieve its targeted savings by the end of this year.
Further, BNY Mellon remains an attractive pick for yield-seeking investors. In March 2012, after receiving the Federal Reserve’s consent for its capital plan, the company announced a new share repurchase program and maintained its quarterly dividend at 13 cents per share. In the first six months of 2012, it bought back approximately 30.7 million shares worth $684 million. These capital deployment activities are expected to significantly boost investors’ confidence in the stock.
Capital deployment activities through dividend payment and share buybacks reflect BNY Mellon’s sound capital position. As of June 30, 2012, the company remained well capitalized with its capital ratios – tier 1 capital of 14.7%, total capital of 16.4% and leverage of 5.5% – well above the regulatory requirements. We expect the company to continuously focus on building capital over the next couple of years, resulting in a better financial position to withstand severe financial crisis in the future.
We believe such efforts will help the company to enhance its profitability in the long run. Yet, we are concerned about the pressure on net interest margin stemming from low interest rate environment.
NIM has been steadily declining over the last several years. Though the improvement in average interest-earning assets (up 28% in 2011 compared with the prior year) is expected to support NIM to some extent, lower spreads will be a headwind. Moreover, BNY Mellon’s interest-bearing deposit costs are expected to rise at a faster rate than asset yields due to the competitive pressure, leading to further strain on NIM in the near to medium term.
Though BNY Mellon has been experiencing stable top-line growth, escalating expenses remain a concern. The company intends to reduce expenses through several actions including nearly 1,500 job cuts. Nearly 55% of the non-interest expenses in 2011 were related to staff compensation.
Further, operating expenses have been rising continuously over the last few years and we do not anticipate cost-trimming initiatives to fully control the rising costs as the company continues to expand globally and might incur numerous regulatory and legal expenses.
Moreover, fee-based revenue is the largest revenue source for BNY Mellon, constituting about 78% of total revenue in 2011. The concentration risk emanating from the dependence on fee-based revenue could significantly alter the company’s financial position if there is any change in individual investment preferences, regulatory changes or a slowdown in capital market activities.
BNY Mellon shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. One of its peers U.S. Bancorp (USB - Analyst Report) retains a Zacks #2 Rank, which translates into a short-term Buy rating.