Bank of New York Mellon Earnings Call Nuggets: Early Signs of Re-Risking and the Expense Ratio

Bank of New York Mellon Corp (NYSE:BK) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Early Signs of Re-Risking

Howard Chen – Credit Suisse: Just throughout the commentary you spoke a lot about the fourth quarter environment being one of which you had low client activity and low volatility. Just curious, given we had a couple of idiosyncratic events like the U.S. election and the fiscal cliff and we’re into 2013 now. Have you seen any meaningful changes across the business or early signs of re-risking whether it’s kind of the custodial and servicing side of the business, or things like frictional deposits rolling off?

Gerald L. Hassell – Chairman, President and CEO: Interesting question, Howard. What we did see toward the end of the year just as we saw in August of 2011 was with the fiscal cliff looming, we saw that fairly significant increase in our deposits on our balance sheet, and so we saw a run-up of $20 billion to $30 billion in our deposits. Most of that has already moved back off the balance sheet, some of which has moved into traditional money market funds, some of which appears to be going into investments. I think we’re going to be facing someway a bit of number of cliffs, so I think the debt ceiling limit is going to put another potential concern in the eyes of investors. Hopefully, we’ll get through that. But we are seeing people trying to put some money to work, but still there is an enormous amount of cash sitting on the side lines waiting for better certainty and clarity. I think some of the investment management flows which I can maybe, I can ask Curtis to speak to, he is seeing some activity pick up there, showing up in some of our numbers. So, maybe Curtis you want to just touch upon that a little bit too.

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Curtis Y. Arledge – VC and CEO, Investment Management: Absolutely, I mean there has been a lot discussed in the media about the flows that have been into equity funds in the first part of this year and we have seen that and then some. I think at the end of 2012, clients broadly were waiting to see kind of how the fiscal cliff played out and obviously with debt ceiling and sequestering budget and other things still in front of us, and there still are some uncertainties, but I think as each uncertainty gets removed, we definitely see a reason to not act (fault) way and the flows that we’ve seen and the conversation that we are having would lead us to believe that investors and – when I say investors, I mean, everything from retail, mutual fund investors to some of the world’s largest sovereign wealth funds are absolutely looking at this as an environment to begin to put money back to work. Again, I think uncertainty has dampened peoples’ activity in terms of making a decision to investment and as we get pass each of these events we’ve seen people absolutely take action. Other parts of our company see close as well.

Gerald L. Hassell – Chairman, President and CEO: Yeah, Brian, maybe you want to talk about what you see an encouraging platform on the retail side, particularly?

Brian G. Rogan – Vice Chairman and Chief Risk Officer: Yeah, we’ve only had a couple of weeks of data to monitor, but so far this year this is significant shifts both an increase in net inflows into mutual funds on the platform and a big shifts from what was in 2012 primarily fixed income-oriented funds to more of a balance. So, you are seeing a big growth in equity mutual fund inflows at least for the first couple of weeks. So, hard to tell if that’s a long-term trend yet, but definitely a positive sign.

Howard Chen – Credit Suisse: Todd, you provided some near term outlook for spread revenues. Just putting aside that outsized deposit movement that we just spoke about for a minute. Can you discuss the reinvestment environment for the securities book as you see it, I mean, we’ve clearly seen some movement on the longer end of the curve, but not a lot on the shorter end where I think in my opinion historically is matter more for your guys?

Thomas P. (Todd) Gibbons – VC and CFO: I think that’s a good observation. The shorter end of the curve is more important at this point because the duration of our liabilities is more better matched there. When you look through the course of the year or even a quarter the decline that we’ve seen in the net interest margin is a reflection of two things; one is spreads and the other balance and it’s about 50-50. So, we don’t see the spread environment on the short end improving in fact we’ve pretty much gone through the repricing as you would have expected with the resets in the lower LIBOR rates. So, it’s a headwind and we expect more of the same as we had indicated. We’re not expecting a better environment in 2013, we’re expecting more of the same. We got a couple of pretty tough punches in 2012 when ECB eliminated the credit on excess reserves as well as QE3 which dragged down mortgages as well as some of the short end of the curve. So hopefully, we won’t see those kind of events again in 2013, but we don’t expect a lot of improvement.

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Howard Chen – Credit Suisse: The final one for me just on capital return. Todd, you mentioned the capital ratios continuing and just continuing to plug along in the buyback, but on the near-term in the fourth quarter. Did the buybacks slowed down due to timing of year or potentially the Meriten acquisition or something else, and then, do you have any more overall thoughts on CCAR in 2013 as you enter the year with really strong Basel I and Basel III ratios?

Thomas P. (Todd) Gibbons – VC and CFO: Yeah, at the end of 2012, as Gerald has mentioned, we saw a pretty sharp spike in our balances, and most of that spike has since whittled away, but when we saw that, we actually saw a little bit of – what could have been a little bit of pressure on our leverage ratio and we thought it was in our interest to hold back on about $100 million or so sort of buybacks that we probably could have done to make sure that we had a strong leverage ratio and a strong CCAR that we could present for 2013, so we didn’t wanted to interfere at all with our 2013 efforts.

The Expense Ratio

Betsy Graseck – Morgan Stanley: Two questions. One on the expense ratio, Todd, you mentioned that the expenses reflect the revenue profile that you have right now. Should I take that to mean that we should anticipate a higher expense ratio going forward, until we see some rate hikes or that there’s going to be another round of effort on trying to lower the expense ratio or is this about as low as it can go?

Thomas P. (Todd) Gibbons – VC and CFO: I think mix will have been key to it Betsy, and the fourth quarter was particularly soft for DRs. So, if you just imagine $100 million was very little variable expense from quarter-to-quarter. So, it’s going to be the revenue mix and DRs, was the noisiest component of that revenue mix. We had expected it to improve a little bit as the revenue mix gets more normal and adjusted some of the seasonal impact. So, I think in your model, you’ll have to average that out a little bit bitter. We probably should have given you a little clearer guidance on that.

Betsy Graseck – Morgan Stanley: Okay, and you are running ahead of your expense programs in terms of targeted improvement in the expenses?

Thomas P. (Todd) Gibbons – VC and CFO: Yeah, we’re slightly ahead of where we would have expected to be. The costs are slightly less to get there and the reason for that largely is because we allocated a lot of those costs in a restructuring charge against a gain that we took on the sale of a property.

Betsy Graseck – Morgan Stanley: Okay, and then from here, how should we be thinking about the benefit of the program on earnings?

Thomas P. (Todd) Gibbons – VC and CFO: I think it’s going to be consistent with what we had indicated in the past. Effectively what the operational expense initiatives are doing for us, is they’re offsetting some of the growth related to pension, related to other benefits expenses, related to merit increases and some slight inflations on other operating expenses. So, those are matching themselves off. So, in order to generate operating leverage, it’s pretty hard if we don’t show a little bit of growth outside of that to generate a whole lot of operating leverage. If we can generate 2% or 3% or 4% of revenue growth, then can see some operating leverage. But again we want you to be mindful of the revenue mix in that. So if NIR is flat and FX is flat and we are seeing in the lower margin business the revenue growth and you are going to – then the operating leverage is going to be more challenging.

Betsy Graseck – Morgan Stanley: Then the second question is on the capital ratio and you mentioned that part of the reason for the improvement this quarter was the lower RWA. Could you describe what’s backing them, I guess just the follow-up on that is are you as able to payout against lower RWAs as you are against earnings accreted improvements in the capital ratio?

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Thomas P. (Todd) Gibbons – VC and CFO: Yeah, I mean couple of questions there. The reason for the lower improvement in the Basel III Tier 1 common ratio the numerator accounted for about 10 basis points as we did see about $150 million or 10 basis point increase in the cap and that’s pretty consistent with what we would expect to retain in a quarter — in a normal quarter. The denominator we’d expect to get some benefit as we see some runoff typical in some of the higher weighted, risk weighted assets. This quarter for the same reason that we got some improvement on the reserve, we got some improvement using the similar models. We got some improvement on the risk weighted assets as our historical data against a lot of our retail analysis and commercial analysis improved dramatically. So as we’d improved the quality of our portfolio which reflected in our risk weights and we addressed those risk weights in the quarter so we picked up some of the benefit of that. So that is a little bit more, the 40 basis points and the denominator is probably heavy by about 20 to 25.

Betsy Graseck – Morgan Stanley: Then just thinking on the payout ratio. We hear that sustainable earnings is obviously very critical for payout ratio and I’m just trying to understand do you think that the improvement in the capital ratio you got this quarter feeds into that much higher of ability to do the payouts in 2013, or should we really be looking at what the earnings generation is driving in terms of improvement in the capital ratio?

Thomas P. (Todd) Gibbons – VC and CFO: Let me make a couple of comments and then Gerard probably will make a comment or two. The CCAR looks at things under normal and also under stress. As we’ve indicated in the past, we tend to do pretty well, because we got really two things going for us, one is, we don’t rely on a lot of risky assets in order to generate our revenues, and the other thing is the mix of our businesses is a little less equity intensive, so a steep drop in the equity markets has a little less impact to us. So, as a result we can continue to generate even through a pretty ugly environment like the ones that we’ve gone through for us. So, it’s really based on – the payouts will be based on where we see our performance and what we see as being prudent given where our capital ratios are, but certainly it puts us in a position with stronger capital ratios than we would have expected at this point of the year to do little better. Gerald…

Gerald L. Hassell – Chairman, President and CEO: Maybe I can add-on to that a little bit. I think we’re quite pleased with that 9.8% Basel III Tier 1 common ratio. I think it gives us increased flexibility to consider capital actions. We generally say that dividend payout ratio in the 25% to 30% is probably something for all of us to think about and our total payout ratio last year we guided you to about the 65% range, I think we have the flexibility to see that north of that 65%.

A Closer Look: Bank of New York Mellon Earnings Cheat Sheet>>