BK Bank of New York Mellon Corporation

Large custody bank faces pressure as depositors chase higher interest rates

By Justin Baer 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (April 18, 2019).

Bank of New York Mellon Corp. delivered a grim reminder that shifting Federal Reserve policies and softening long-term interest rates are taking their toll on part of the finance industry.

Shares of BNY Mellon fell by nearly 10% Wednesday after the custody bank reported quarterly earnings and revenue that fell short of Wall Street's expectations.

BNY Mellon's disappointing results underline how sensitive financial firms can be to the ebb and flow of interest rates, particularly when increases in short-term rates aren't matched with rising longer-term rates. Federal Reserve officials hiked rates four times in 2018. Then, in January, they signaled they would leave rates unchanged for some time, citing increasing risks to economic growth. In March, the central bank indicated it was unlikely to raise rates at all in 2019.

The policy reversal caused the yield on the benchmark 10-year Treasury to drop to its lowest level in more than a year. Treasury yields decline when bond prices rise and investors' outlook for the economy darkens.

Last month, the 10-year yield fell below that of three-month Treasurys for the first time since 2007 -- a so-called inverted yield curve that may indicate a recession is lurking in the economy's future.

"We're not getting help from interest rates now, which we had for the last few years," said Jeffrey Harte, a bank analyst with Sandler O'Neill + Partners. "That puts banks in a position where interest income is now a function of volume. Can you grow loans?"

For banks and other financial firms that fund themselves with deposits and other short-term loans and put that money to work through loans and longer-term investments, a flattening yield curve can squeeze their interest margins and leave a mark on earnings. At BNY Mellon, net interest revenue fell 8% to $841 million from a year earlier.

"Rates across the entire yield curve declined versus our assumptions, deposit balances declined, and we saw changes to the mix between interest and noninterest-bearing deposits," Charles Scharf, BNY Mellon's chairman and chief executive, said Wednesday during a conference call with analysts. "We see significant competitive pressure for deposits."

While Goldman Sachs Group Inc., Bank of America Corp. and other big banks were able to sidestep the brunt of these effects, custodians like BNY Mellon tend to lose clients' deposits faster as rates go up. That is because commercial banks draw more of their short-term funding from retail customers who are slower to pull their money than big companies and institutions.

That is especially true for BNY Mellon, which tends to collect more deposits that don't pay interest. As rates rose, more of BNY Mellon's customers moved money out of the bank and into interest-bearing deposits with a higher yield. That shift left BNY Mellon with a bigger slice of their deposits drawing interest; meantime, the average deposit rate rose from a year ago.

BNY Mellon and other custody banks don't have big lending businesses, so a drop in deposits is usually with a decline in securities holdings that generate interest income. So their revenue from that interest was shrinking at the same time that their interest margins were narrowing.

BNY Mellon "is suffering more than other firms now, and certainly today is a stark reminder that there's an increasing demand for yield," said Brennan Hawken, an analyst with UBS Group AG. "You've got a double whammy on your hands."

BNY Mellon executives predicted in January that the bank's net-interest revenue would be little-changed or slightly higher in the first quarter from the last three months of 2018. Instead, interest revenue fell 5%

On the conference call, BNY Mellon finance chief Michael Santomassimo said the bank expected deposit rates would "inch up a little bit" in the second quarter.

BNY Mellon reported net income of $946 million, or 94 cents a share, in the first quarter, down 19% from a year earlier. Total revenue slipped 6.7% to $3.9 billion.

Analysts polled by S&P Global Market Intelligence had expected a profit of 96 cents a share, on revenue of $4 billion.

BNY Mellon said the fees it collects also fell, dropping 9% to $3.03 billion.

The bank's results were also hurt by changes to currency exchange rates and the flow of assets from its investment-management division. The sale of several asset-management businesses last year also affected the most-recent quarter.

Assets under management dropped 1% from a year ago, to $1.84 trillion.

On the call, BNY Mellon executives said they were continuing to look for ways to trim expenses even as they invest heavily in technology initiatives they expect will boost growth.

Noninterest expenses fell 1% to $2.7 billion in the first quarter from a year earlier.

Allison Prang contributed to this article.

Write to Justin Baer at justin.baer@wsj.com

(END) Dow Jones Newswires

April 18, 2019 02:47 ET (06:47 GMT)

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