The Bank of New York Mellon Corporation (BNY) Earnings Call Transcript & Summary

Hi. This is Jason Goldberg, and I cover the U.S. large-cap bank stocks here at Barclays. Thanking, tuning in for another presentation of our Annual Americas Select Franchise Conference. Next up, very pleased to have BNY Mellon with us. Now I've been getting a lot of questions around its investment manager operations, given its new leadership, recent restructuring announcement, and as the industry landscape continues to evolve. I also got a lot of increase on its balance sheet, given what we're seeing on the deposit front with interest rates. As such, we're very pleased to have with us Hanneke Smits, who is the CEO of BNY Mellon Investment Management; and Scott Freidenrich, who's the Global Treasurer. Hanneke became CEO of Investment Management on October 1st of last year, after running BK's Newton Investment Management unit for several years. With, I think, $700 million in revenues in the first quarter and asset management contributes, I think, over -- almost 1/5 of BK's total. And with over $2 trillion -- $2.2 trillion in AUM, it's one among the top 10 largest asset managers in the world. Scott's been Treasurer for the past over 11-or-so years, and we knew him even before that, given his work at Citi. And with average earning assets in excess of $400 billion, one of the top ten balance sheets of any U.S.-based bank. So both, thank you so much for joining us.

Hanneke, we'll start with you, but you've been in your role for almost a year now. Maybe just share some of your initial impressions, what it was like taking on these expanded responsibilities in middle of a pandemic.

Yes. So first of all, Jason, Thanks for having me here. It's great to have the opportunity. So reflecting on taking this role during a pandemic, it's actually been quite interesting. I have not been jet lagged. So that's been a little bit of a bonus. I haven't had to travel which is what one often would expect taking on a role like this and becoming CEO of a global organization, meeting clients as well as colleagues, of course. But I would also say that we all got -- by the time I took it on, October, we were sort of half -- we were all much more comfortable working in this virtual environment. And I think it's actually given me the opportunity to meet many, many more people than I think I would have been able to meet physically in person by going on a roadshow. And that has actually been a really nice positive to this environment. I also think when I sort of take a step back, having already been part of the organization by -- as you mentioned, I've been CEO of Newton, which is one of our key investment management subsidiaries, for 4 years. Prior to assuming this role, I have been recruited by Mitchell Harris, my predecessor in this role in his Newton role. So there was some familiarity with the overall business, clearly of BNY Mellon Investment Management culture, the team as well as thinking about the strategic opportunities. So I think a great opportunity ahead of me, which I've started to embrace as also having joined the Executive Committee and really establishing, leveraging collaboration across the enterprise. And I'm sure we'll talk about that in sort of the next 20 minutes.

Helpful. I guess looking forward, what is your -- what do you view as the key themes that are going to shape the asset management industry over the next couple of years?

So I think some of the key themes are actually things that sort of have been in play for some time. The first one is clearly the low interest rate environment, which we've been in pretty much since the GFC and has really led to the great search for, not just for yields, but also for higher return and has been pushing investors into more active and indeed, more alts as well. I think you'd be aware, Jason, that revenues going to alts is around 45% of the industry revenues and growing. Not so much in AUM, but there are clearly higher fees. But the other end of spectrum, we've continued to see the trend, the pressure on fees and investors looking for value to money, and that's really been driving the flows into passive. Now the revenue opportunity in passive is clearly much smaller, but the flows are there. So it's obviously been cited as the barbelling of the industry. And I don't think that's really going away. So it's really important for us as being BNY Mellon Investment Management to make sure we have capabilities, which we do have and are increasing our exposure to sort of both sides of the barbell. And I would say another trend, it has -- I would say, all-rise retail, right? Retail is large. It's growing. It's not going away. It's important in the U.S. market, but also increasingly in APAC. And we'll talk about that a bit more in terms of what it means for us. And then I would say, it's hard to sit here and not talk about COVID. And I think COVID has really impacted 2 areas: one is technology; and in particular, the digital delivery of the client experience, which we all had to accelerate, right? Doing a conference like the one we're doing today, I don't think any of us would have contemplated the virtual -- the complete virtual delivery of settings like this or indeed, engaging with clients is what we are all doing. And I think we'll continue to do more digitally -- has become a very important component of the client delivery. And then it's also been important. It's put more emphasis on, in particular, the E and S in ESG. And that has really led to, I think, more -- and will continue to lead to more -- both more product innovation, but also an expectation on the part of investors, the investment managers that they entrust their assets to actually need to live the same values. So I would sort of say 3 sort of key things: the barbelling of the industry, retail, the importance of the retail investor. And then the impact that COVID really had on digital as well as on ESG, and we'll continue to have.

I guess when you think about those trends, maybe talk to which ones you're particularly leaning into, and just how the strategy is evolving around those trends?

Yes. So taking a step back for a moment, I think you talk for a moment, perhaps in terms of -- a little bit more in terms of who we are. I think you summarized the headlines nicely earlier. We are -- as of the end of 2020, $2.2 trillion of AUM and growing, $2.6 billion of revenues over the course of 2020 and growing. Our clients are split 2/3 institutional, 1/3 retail, just under 50% U.S. with the balance international, a big component of that is actually in the U.K. So our -- we're a little different to our competitors from a geographic perspective, but we really offer our investment solutions today through 8 specialist firms, 6 of which really deliver specialty at scale. So to answer your question in terms of what we're leaning into is having indexing with Mellon as a pioneer in indexing on the one hand, partnering across the enterprise to deliver also new solutions to clients, including ETFs. I hope you've seen us launch 8 passive ETFs last year. We've just also filed 3 sustainable, active ETFs with Newton, which we'll hopefully launch later in the year. So that is -- that's leaning into both the trend in terms of wrap product wrapper as well as sustainable. And then we're leaning into explore -- increasing our scale in U.S. retail as well as increasing scale in APAC, and I can talk more about that later. And then the third component is clearly technology. We are investing in the client experience through our centralized distribution team, but we're also continuing to invest in technology in the infrastructure of the firms to make sure that we have an operating platform that is not only efficient, but is also scalable and resilient.

Helpful. I guess, in February, you announced plans to realign over $200 billion of Mellon investment in AUM and some of the other affiliates. Maybe just talk to what you were trying to accomplish with that realignment? How it positions you going forward? Was it more of a cost saving thing? Is it to better leverage of sales forces or potentially both? And any changes to that multi-boutique model that we've heard a lot about going forward?

Yes. So first of all, we remain very committed to our multi-boutique model. I know it's increasingly unique for organizations our size, but we very much believe in the unique -- and I would say, this coming from one of the investment firms you might argue. But I think there's something unique about what each of the investment firms has to offer, not just in terms of investment strategy, but also in terms of culture and processes and the people that they attract. They all have their own DNA, which is really important to preserve to deliver great investment performance to our clients. It's increasingly also important to deliver what we now say is specialization at scale to our clients. So there is a better depth and breadth to our offerings. And so look, when I started in October, one of the things you obviously always do is to do a review of the different capabilities. And it seemed to me, you were talking about, what is about savings or growth, It seemed to me that by realigning the different component capabilities, so the fixed income book business of Mellon into inside equity -- active equity and multi asset, which also have a thematic component, which they have in common with Newton, into Newton and combining the cash with drivers would be really giving those investment teams really the opportunity to enhance their offering. It's strengthening the research platforms that I think, ultimately, will lead to better outcomes for the clients and will, therefore, also lead to growth opportunities for us. Now there may be some cost benefits that will come out of this exercise, but that was actually not the key driver. And I just can't emphasize this enough because I think you will probably agree with this, if you just focus on the cost, you sort of get a one-off benefit, but you really need to figure out that a realignment or an integration or a different way of combining teams will lead to growth because cost benefits alone will not help the business move forward.

No, that makes sense. I guess as you look at BNY Mellon Investment Management, where do you see yourself being differentiated? And, maybe, where areas that you think you need to either add to capabilities or increase scale or expand distribution?

So first of all, I do think we have what we -- what I've often described, also when I was at Newton, the best of both worlds. We have the unique cultures and investment capabilities of our respective firms to help address clients' needs, but we also have the scale, the resources and in particular, the distribution capabilities of BNY Mellon. When I look at where we expect to those trends and what we'd like to lean into, you look at the markets, we would like to grow in alternatives. We're doing that first through Alcentra. I think the appointment of Jonathan DeSimone, who joined in September of last year as CEO of Alcentra, with his credentials both in the credit markets as well as in the U.S. market, that's an opportunity for Alcentra to leverage strengths in Europe into the U.S. market and grow there. But we also really want to leverage the opportunities that the Newton and Mellon combo can provide clients in thematic strategies as well as outcome-oriented solutions that Insight can offer as well. In terms of thinking about the clients, we're doing quite a bit of work in the retail channel. So for example, we are building retirement solutions to tap into the 401(k) market by applying some of our leading LDI capabilities, which we have through Insight, to develop the accumulation solutions for U.S. and U.K. retirement market. We've announced some partnerships that you may have seen with AFL-CIO, for example, where we launched a number of collected investment funds to serve their clients better. They've actually garnered already about $8 billion in assets. So through a number of angles, partnerships, adding capabilities leaning into alts, we're hoping to drive growth as well as attracting talent into the organization.

And then you touched on it how your boutique model is becoming even more differentiated. Can you maybe talk to kind of why you stick with in kind of the synergies between your boutiques? And then just maybe talk about how synergistic and how you interact with kind of the broader BNY Mellon as a whole?

Yes. So look, some of the synergies for the boutiques are around our central distribution model, right? So anything when you sort of look at how we go to market and engage with clients from a retail perspective that is very much delivered through central -- through centralized distribution team and investment management. And I think that's an important leverage point, which we want to continue to leverage and grow for the investment firms. Secondly, we are -- we have invested in the operating model. So a number of our firms are moving into more efficient platforms, Aladdin being one of them with Newton, Mellon, the cash businesses and indexing as well moving on -- in process of moving on to that, which I think will help with scale. And it will also help with sort of the solutions outside of the business. From a partnering across the enterprise, there are a number of ways to do that, and there are a number of ways to continue to grow. Clearly, we have wealth. Wealth Management is a client of Investment Management. And also when we look at Pershing, we've worked on varying market opportunities with Pershing, including the launch of the 8 passive ETFs last year, and we're now partnering with them on the launch of the active ETF. We have an integrated cash offer by aligning different capabilities across the bank. We're partnering on digital assets in that. We have working groups, exploring what the opportunities can be from an investment management perspective based on the work that asset servicing has been doing in that space. So they're just -- in a number of different ways, I think there are opportunities across BNY Mellon that can leverage investment management.

Got it. And then long-term flows we've seen, 4 straight quarters of increases, which is good. Maybe just help us discern how much of that is due to improved investment performance. And then it's a question I get a lot, what are you trying to do to kind of stabilize annualized revenue and margins?

Yes, that's why, that's always a little bit tricky. One, I do think the diversification we have in the business does help, right? So we've seen -- like if you sort of take a step back and look at 2020, our experience wasn't hugely different for the market where in the beginning, there was a strong pull into cash into fixed. And we've also had good wins into LDI more recently. We've seen again more demand, good momentum into sort of the equity strategies as well as multi-asset, which are obviously the higher fee-earning strategy. It's really important that in your cash and fixed and LDI, you attract big flows, but I think you also continue to have good momentum in the higher fee-earning strategies. With that it's really important to focus on investment performance. We are an investment management organization, delivering investment performance. Excellent investments performance to our clients is really what is a big driver of flows. And to get a sense, I'm actually very proud that our investment performance -- in fact, we didn't mean to beat, during 2020, our performance improved over the course of 2020. If we look at our top 30 strategies by revenue, and this gets a little bit complicated, but it's top 30 strategies by revenue, 80% of those with or over 80% of those that have peer rankings, we're in the top 2 quartiles, and that compares to 73% a year ago. So the investment performance improved into that over 80%. And I think that's something to be proud of and is clearly helping with not only client retention but is also driving flows. Walter Scott, one of our investment firms, very focused on equities, posted great performance, both short-term and long-term through 2020 and saw some nice momentum in their flows is one example of that.

Okay. And I guess when we're going through kind of the key industry themes, you mentioned ESG, and it's obviously been a very hot topic of late. Maybe just talk about what you're doing in this segment?

So first of all, ESG, as you say, has been a hot topic. It's actually an important topic for BNY Mellon as a whole. We actually had our -- I think you're aware, we had our first dedicated ESG conference last week on which we've had hugely positive feedback. And so for BNY Mellon as a whole, it sort of cuts across everything from how we manage our resources, how we think about the S and how we sort of live according to our own values, but then it also is about solutions for our clients. From an investment management perspective, I think we're doing well. We have $330 billion of AUM that are already classified as responsible investment assets. We have 6 of our firms that have been integrating ESG for quite some time. Insight was a founder signatory of UNPRI and Newton followed very, very shortly. We've launched a suite of sustainable strategies with Newton, which is just grown to $4.5 billion. So that's pleasing to see. So across investment management bank, we've partnered actually with asset servicing on the development of the ESG app. So there are a number of initiatives that I think will be attractive to clients but are also really important to BNY Mellon's broader stakeholders when it comes to ESG. And I see real opportunities for investment management to grow our assets in responsible investment based on the strength of our investment firms.

All right. Before we transition to Scott, Hanneke, I have one final prepared question for you, but I think it's a good segue, and I'm sure Scott is going to talk to it, too. But clearly, we've heard a lot in the industry about exceptionally strong deposit growth. And for banks, the leverage ratio is becoming increasingly a constraint. And you've heard banks kind of talk to managing deposit inflows maybe a bit more aggressively, trying to divert them into off-balance sheet alternatives. You have one of the leading money market businesses under your umbrella. Maybe talk to what you're seeing, what you're doing in terms of helping manage this phenomenon?

Yes. So it's actually been interesting. First of all, we have seen good flows. We've actually increased share at Dreyfus. I think part of that is because of a number of the actions that we've taken under Stephanie Pierce's leadership. We've optimized the money market fund lineup, which you may have seen. We simplified and basically simplified the platform. We reduced the number of funds. We reduced the number of share classes. We implemented a more uniform pricing structure. But again, we're also working on performance. We're absolutely thrilled to have attracted John Tobin as CIO of the cash business. We start at the beginning of this year, and that is also helping to not only keep clients but to attract new ones. So from -- again, taking a step back, it's also about optimizing that business from a talent perspective and making sure that we have the funds on the platform that are attractive to clients, and I believe we're well on the way there. And when I look at our market share, as I mentioned at the beginning, that has to increase, the numbers suggest the clients are following.

Got you. Scott, we did not forget about you. Before I ask you my first question, just for those in the audience listening in feel free to e-mail in questions to [email protected]. Please put BK in the ticker and we'll try to get to them in the end, time permitting. But Scott, maybe the best place to you is kind of a follow-up on that. But maybe share your kind of broader perspective on how BK has been managing deposit inflows, have been investing the cash coming in, how you're working with clients to find alternatives to deposits, considering tier 1 leverage is BK's binding capital constraint?

Right. Well, Thanks, Jason. And you are right, the topic segues nicely from Hanneke's comments on money market fund dynamics and it often correlates very highly to deposit dynamics and behavior. So if you look back to pre-COVID, starting at the end of 2019, our average deposits have grown nearly $100 billion. A lot of the growth was very strategic as we developed and enhanced client relationships, but deposit growth comes naturally with transactional activities. More recently, especially over the past 2 quarters, we attribute most of the deposit growth to the effect of expansionary monetary policy or quantitative easing. So for most of that deposit growth, about -- call it, $25 billion to $50 billion is excess or nonoperational in nature. And now that we're resuming buybacks, we're winding the returns we earn from placing these excess deposits at the Fed at 10 basis points or other short-term investments against the returns we can realize using our excess capital to repurchase shares. So we're monitoring our deposits very closely, especially our nonoperational deposits and proactively working with our businesses and clients to find alternatives to these excess balances. Conversations happen on a client-by-client basis and are holistic in nature and consider total revenues, margin and overall relationships. We do have experience in balance sheet management during periods of reserve expansion, if you recall. We are proactively working with clients to move nonoperational deposits into our off-balance sheet vehicles. We've been successful and that is evidenced by increases in money market fund balances. And fortunately, we have several opportunities to offer to our clients through our platforms, including LiquidityDirect that provides access to our funds and is also an open architecture for other products. So it's an ongoing process, and it's a work in progress, but we feel good about the conversations we're having and the progress we're making.

Okay. And maybe can you give us an update maybe on some of the more recent deposit trends and maybe your just expectation for deposit growth growing forward? And when do you expect an inflection point? And how quickly do you think the deposits may come down when the Fed stops QE?

Sure. So firstly, we have and we will continue to support our clients with our balance sheet. So that's working well. But more broadly, keep in mind that U.S. bank deposits are off about $3.2 trillion since the end of 2019. The market expects about another $1.5 trillion of reserve growth from here, depending on the forecast you look at. So pretty far along in the monetary base expansion cycle, but there is more to come. And with that said, tier 1 leverage is our bonding constraint, as you mentioned. And as I mentioned, we estimate a large portion of recent deposit growth is excess. So these deposits are worth little in terms of marginal NIR. So we are managing the size of our balance sheet to optimize our capital ratios and to manage our shareholder returns. Now as we move through the course of 2021, we would expect that the first quarter was likely the peak of our deposit balances. But based on the strategies I just described, we continue to work with clients to reduce excess deposit balances. There are circumstances where deposits could grow based on macro considerations, but we do have a concerted strategy.

I guess, given what you said about the deposit or about the -- just the balance sheet outlook, how does that play into your thoughts around dividends and buybacks going forward?

Sure. So as you know, the regulatory minimum for the tier 1 leverage ratio is 4%. And we -- internally, we established a buffer of about 150 basis points, primarily to protect against capital and balance sheet volatility, which for us is primarily driven by deposit growth. And on the margin, that drives GAAP asset growth rather than RWA growth. So the buffer is there for the exact circumstances we've been experiencing. In the current environment, we are comfortable utilizing our buffers, if necessary, for a period of time. And that's what they're there for, but still, we'll continue to stay well above regulatory minimums. If necessary, trend towards 5%. And this gives us flexibility based on daily stress and drawdown scenarios that we're continually considering. So as for the near-term capital management beginning in the third quarter, assuming the Federal Reserve fully implements the stress capital buffer framework in the third quarter, and distribution limitations are limited or I should say, are lifted. Well -- we do intend to return in excess of 100% of earnings to shareholders over time, given our excess capital levels. Now as a reminder, the 4.4 repurchase authority that we disclosed was approved by the Board in the fourth quarter of last year and related to the buybacks through the third quarter of this year. Given the regulatory buyback restrictions in the first and second quarters and daily repurchase volume limitations from a practical standpoint, it's unlikely we actually execute $4.4 billion through the third quarter. And of course, we're paying close attention to the regulatory limitations on payouts. But while we don't execute in the third quarter, we'll try to absorb in the fourth quarter and going forward.

Got you. We have about 10 or so minutes left. [Operator Instructions] We have had some come in. So I'll read the first. And it looks like it's for Hanneke. You've talked about your scale diversification of boutique model as strength and differentiators, but we've also seen a number of M&A transactions in the asset management space lately. Would you consider being an active participant in industry consolidation or adding any particular capabilities via M&A?

Yes. There is -- I'm not surprised that these questions come up because there's been a lot of activity for sure. I would say, for us, being the $2.2 trillion player, we're already moving in the scale direction and our strategic priorities, one of, organic growth. And secondly, also, we're very focused on execution of the recently announcement of the realignment of the Mellon capabilities, which, of course, we need to get to a good conclusion this year. Notwithstanding that, I think you should say never say never, and we'll look at it opportunistically. But for now, it's really not the area of focus. I would finally also say, because we're so aware through our specialist investment firms how important it is to really preserve the human capital and the cultures of firms, I personally think there is this high execution risk in M&A as well. So again, never say never, but be very clear as to what it is that you would be adding as a capability.

Got you. And another question come in. Can you expand a little bit on what you are doing in index, and how you're looking to accelerate growth in the business?

Yes, Thank you. It's obviously an important part of our lineup as well. Today, Mellon index is actually seventh largest index manager globally, having been a pioneer for 4, 5 decades ago, it's actually buy rated by all the major consultants. And I have sound very -- I'm thrilled with that. We did have some outflows in the '17 to '19 period. We started to see that turn. I think some of it is to do with now having a dedicated CEO and leadership team, which decision was made at the end of 2019, but also by driving some innovation. So I talked earlier about the signature AFL-CIO suite of retirement solutions. I think it's a very interesting opportunity that the team has developed, and those funds are now -- have already garnered $8 billion in assets and have a robust pipeline. I also think the innovation, the work that Stephanie and the team have been doing with Pershing on the inaugural ETF suite, which we actually include at the industry's first true zero-fee ETF, which were offered without fee waivers or other restrictions are also gaining traction and attention in the marketplace. They're standing at $0.7 billion in assets and growing and have been approved by some of the leading intermediary platform. So I think I think there is fresh leadership, there is innovation to leverage on the credibility we have in the indexing business, and I think there is more to come and more to go for.

Got you. Time for one final question. We'll go with this one. What about potential growth opportunities in APAC and more specifically, China?

I'm glad I got that question because you sort of touched on that in the very beginning when I was talking about some of the key themes. And clearly, I think you can't go to a conference in asset management without talking about China, right? As the regulatory environment is opening up to foreign managers, we're actively reviewing what we should or shouldn't be doing there. And as a reminder, we have an APAC footprint. We have -- currently, from a China perspective, we're at -- we're serving that outbound. We have $26 billion in AUM in China. We've also established an onshore presence in Taiwan. And the team there is actively exploring opportunities, but there is not a lot more I can say at this point, but it's an important strategic priority.

Helpful. I'm showing we're out of time. So Hanneke, Scott, thank you so much for joining us this year, and look forward to doing this next year in-person.

Thanks, Jason.

That's my real pleasure, and thank you Jason.

Thank you.