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

[Audio Gap] Thanks for joining us this morning. I have a disclosure statement. For important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Well, this morning, I'm pleased to have with us today Emily Portney. Emily, thank you so much, CFO of BNY Mellon.

Great to be here.

And I think you've been CFO since when? A couple of years ago?

About 2 years.

Two years ago, but you've been with BNY Mellon since 2018. And before CFO, you were running Global Client Management, sales and service teams for the Asset Servicing business and also oversaw Americas region for Asset Servicing.

Correct.

All right. Thank you. Well, I do want to kick off a question on the whole theme of NII and the balance sheet. Maybe we could talk a little bit about QT. QT, I hear, got kicked off a few weeks ago. And I'm just wondering, is there any early readings for how that's been impacting you?

So it's, as you said, I mean, it's literally early days. So we haven't seen anything unusual yet or unexpected really in the balance sheet. And as you've been talking about and people on the stage have been talking about for the last couple of days, we have only one other experience with QT. We've never also seen anything that would be of this size or this pace. Even today, with the Fed meeting, we're not really sure is it going to be 50 basis points? Is it going to be 75 basis points? So it's very uncertain, but we haven't seen anything unusual yet. What I would say is Bank of New York Mellon is in a very unique position in that we manage in excess of $1 trillion of our clients' liquidity across asset owners and asset managers. That's both on-balance sheet and off-balance sheet alternatives, whether it's our own money market funds, other money market funds, third-party money market funds, FICC repo, other short-term investment opportunities. So we're also, as you know, the sole clearer of U.S. government securities. So we have a very unique vantage point. And literally, the way I kind of think about it is that we're at the end of every cul-de-sac irrespective of where does the cash is going to slosh around. But -- so we feel -- we're watching the space like everybody else.

Okay. Now if I look back at last QT, and I say this because as an analyst trying to estimate what will happen, I'm looking back at what happened last time. And when I look back at last QT, you only lost a few percentage points of deposits. Now this QT is expected to be running at a hotter speed, right, 3x the speed of last QT. So could you just give us a sense how much deposits in each of your businesses do you think are at risk when considering QT and its impact?

So I won't comment actually on individual businesses, but certainly, I'll talk a little bit about what we're anticipating now for the full year across our businesses and our complex. And again, as I said before, we're pretty uniquely positioned. So even if you see deposit runoff, we can -- definitely would expect to see perhaps some of that into money market funds, et cetera, so we could really benefit either way. But in -- I mean, just to give some color. In the first (sic) [ second ] quarter, deposits are down a bit, but they are higher than we had originally anticipated. And based upon what we've seen thus far, we're frankly more optimistic about where deposits will end at year-end or the runoff that we're going to see through year-end versus at least what we saw a few months ago when we last spoke to the market. So assuming Fed funds at 300 basis points, maybe 325 basis points, hard to tell, we would now expect our fourth quarter average deposits to be about 8% lower than they were in the first quarter. So that's down about $20 billion to $25 billion just for comparative purposes. That compares to guidance I gave that was about 10% last time I spoke to the market. So a little less runoff than anticipated. We're seeing risk-off based on the geopolitical uncertainty, also just in terms of the rate environment, certainly the clients holding more cash. So all of that is playing into it and plays into our more recent projection. And I just -- as we talk about runoff though, I also just want to give some color on the shape of our deposit base. And over the course from Q4 2019 to Q4 2021, our deposits grew by about $100 billion, and 50% of that was NIB. And NIBs by the way, we think, are much more sensitive to the absolute level of rates more so than actually the size of the Fed balance sheet. Also, the other thing I would mention is that since prepandemic, call it 2018, we've had significant organic growth in Asset Servicing as well as Treasury Services. So the endpoint for deposits through the entirety of the cycle we expect to be higher than where it was certainly prepandemic. And to put that kind of in context, we would think holistically as we step back that we'll probably retain about two-thirds of that $100 billion. And that NIBs will revert back to more of what we would call normalized levels. They'll probably be in the 20% to 25% range versus they're now in the 30% to 35% range.

Okay. So deposit runoff, where it happens, most likely in NIB going to maybe MMF or...

MMF potentially or just chasing other higher-yielding alternatives.

And then your point on the decline in outflows that you're looking for is largely a function of risk-off environment. Is that right?

No. I mean it's a mixture. I think the cycle is obviously very different. We don't know really what to expect. But we are seeing higher balances and -- than we had originally at least anticipated. We do attribute some of that to risk-off. A lot of clients likewise are keeping money in cash just because of the pace of -- or the uncertainty around the rate environment and the short term change.

Sure. Okay. Last question here from me on this topic is just around depositor behavior changes. Have you seen anything so far as rates have started to move up? And then do you expect any different kind of behavior as we cross over the 1-percentage line and 2-percentage line as related to Fed funds?

So I think speaking about deposit betas specifically, we largely -- and we still think that betas will largely retrace what we saw in the last cycle. Of course, we're just going to get to the end state faster because rates in the Fed are moving so much faster. Remember, just we're largely institutional, our deposit base, so not -- really good to compare our betas to perhaps the others which -- other players which have a huge retail base. As expected, so far, since the rate hikes have kicked off, we've seen cumulative betas of about 40% and that is on average across our businesses. So some are higher, some are a bit lower. And we just continue to expect that betas will likely increase steadily. As the Fed increases or as the Fed hikes, probably we would expect betas to be about 70% to 80% when Fed funds get to 2% to 2.5%. When you get to Fed funds greater than 2.5%, or call it, 2.5% to 3%, you'd probably see -- we expect to see betas north of 90%. But again, this is in an incredibly unprecedented, uncertain environment, a lot of geopolitical risk. So we're also monitoring the situation.

And is -- are those deposit betas the denominator for that your entire deposit base? Or is that just against the interest bearing?

IBs.

It's against the interest-bearing piece, right? I just want to make sure of that.

Yes.

Okay. On AOCI and capital, on the earnings call, you mentioned several actions to reduce the AOCI rate sensitivity by about 25%. And just wanted to get an update how that's going.

So we were very early in our actions to protect against AOCI volatility just understanding where we thought the environment was going. And the intersection, frankly, of the pandemic, inflation, QT expectations, geopolitical risk has caused, as we all know, especially in the last couple of days, just sharp moves in rates and significant market volatility. So we are continuing to be cautious. Quarter-to-date, we have continued to reduce our interest rate sensitivity in the AFS portfolio. So DV01 is now down about 30% from the beginning of the year. We've continued to shorten the duration of the AFS portfolio. So duration is now slightly less than 1.5 years. In first quarter, I think I said it was a little bit over 1.5 years. And most of last year it was over 2 years. So that gives you an idea. Likewise, we're swapping fixed to floating. We're obviously rolling exposure to shorter-dated securities. And also as I think I talked about, about 40% of our overall portfolio now is designated as held to maturity. We feel like that's the right level. We obviously want -- we're favoring liquidity and flexibility in this environment. But all of that said, yes, we're managing our balance sheet and the portfolio very actively.

Okay. So given where rates are right now and the actions you've taken to reduce the impact of rates on your balance sheet, how much of an AOCI hit should we expect as we go into 2Q '22 earnings?

So the majority of our exposure and interest rate sensitivity in the asset portfolio is in the belly of the curve. And I mean just to put it all into context, as everyone knows in the first quarter, rates across those tenors moved about 130 basis points. And that did translate into about $1.5 billion of unrealized gain (sic) loss for the AFS portfolio in the first quarter. When you think about this quarter, year-to-date, I'd almost put it into -- I'd break it almost into 2 sections. One is pre-CPI print and post the CPI and PPI print. So even before that, we'd seen rates again in these tenors moved about 60 basis points. In literally, the last 3 days or so, we've seen another, call it, 50 to 60 basis points. So we're currently looking at in AOCI, a unrealized loss in excess of $1 billion so far for the quarter. What I would say is just, yes, that is painful very much in the short term, but it pulls to par, as we all know, over time.

Okay. So just to make sure, the first quarter was a $1.5 billion hit unrealized loss right? Okay. And now based on last night, it's $1 billion.

In excess of $1 billion.

In excess of $1 billion. Okay, got it. And you mentioned being cautious on buybacks in the near term. I'm just wondering what you would need to see to be more comfortable to turn them back on or accelerate them? Is it the pace of rate hikes slowing down? Or is there something else?

Again, with all of the uncertainty in the rapidly evolving environment, the outcomes are very wide. So we're going to be cautious. I think our shareholders would want us also to be cautious. As I said in the first quarter, both the size, the pace of buybacks are completely dependent upon AOCI and the trajectory of deposits. As I just said, there is a deterioration in AOCI. Deposits are trending a bit higher than we had originally anticipated and we think through year-end. So we're going to continue to be cautious. And what I would say, though, is that our overall framework for capital distribution hasn't changed. And we do -- we are committed to returning 100% of our excess capital to our shareholders over time.

Okay. Let's shift to the business, Pershing. Let's start with Pershing.

Okay.

So BNY Mellon announced a multiyear investment in Pershing X, and my understanding this is really to modernize your wealth servicing platform. Could you give us a sense of what the end state is that you're looking for here?

Sure. So first and foremost, I just -- I do want to stress that Pershing X is far beyond modernization. And so just to explain what it is, we are obviously the world's leading custodian. We also have a leading position specifically offering custodial services for investment advisors. And what we're going to do and what Pershing X is really all about is to take that leading position and to build an end-to-end platform for wealth advisors and in the wealth space. And if you think about it, first of all, the wealth space is growing at a faster pace than most other areas of financial services. It's also so incredibly complex. So if you are an RIA and you're trying to service your end client, you basically -- if you can just imagine, you have a CRM tool, you have an investment modeling tool, you have an investment selection tool, an order management system. You have rebalancing tools, maybe now direct indexing tools, reporting tools, data analytics. And all of those are not connected to one another. And we recognize that. And what we are aiming to do with Pershing X is to simplify the life of our -- of advisors -- of wealth advisors and offer an end-to-end platform that also leverages best-in-class technology, and we're doing it from a position of strength. And we think this will really deepen our relationships with our existing clients, open up new opportunities with breakaway advisers, et cetera, that are looking for turnkey solutions and also strengthen our relationships with our existing and new -- and broker-dealers who are our existing clients, broker-dealers and other new -- and broker-dealers who are now considering also outsourcing some of their own tech solutions and tech stacks.

Got it. Okay. That's very comprehensive. Can you give us a sense on the kind of timing or size of the investment spend here or the ROI that you're expecting?

Sure. So it's very early days, Betsy. So I mean, we literally kicked off Pershing X less than a year ago. And what I would say is we're making great progress. So just within the last couple of months, we have hired a Head of Pershing X, a CTO, a Head of Operations, a Head of Client Experience. We've closed a direct indexing acquisition. We've integrated a data platform and an SMA platform. So we're making a lot of progress. And we feel very strongly that this is an engine of growth for the firm in the future. We'll keep everyone updated as we go, but it's -- I wouldn't put a time frame right this minute on or the ROI on it at the moment. But we're making great progress.

Got it. So it's a multiyear journey.

It's a multiyear journey, for sure.

And is there a sleeve of clients that you're looking to expand into, particularly like smaller RIAs or the broker-dealers you mentioned earlier? Or it's more about adding the functionality to existing clients or it's both?

No. It's both, it's absolutely both. As I said before, it's for -- it's both expanding our relationship with existing RIAs. It's, again, opening opportunities and doors with the growing RIA segment as well as breakaway RIAs, et cetera. So it's opening those doors because more and more they want turnkey solutions. And it's both new and existing broker-dealer clients.

Got it. All right. So I'm going to turn to Servicing.

Sure.

You mentioned earlier, and it's pretty apparent to many people the period of high volatility that we're in. Is that a positive or a drag on the Asset Servicing pipeline?

I mean, remember, our clients are the most sophisticated asset managers and asset owners in the world. So they definitely have weathered many, many bouts of market volatility. Also Asset Servicing, we have very long sales cycles in Asset Servicing and long contracts -- well, contract terms. So we have a very good line of sight on the pipeline. We have not seen anyone pulling back from RFPs. We haven't seen any trepidation in terms of launching new funds as of yet. And frankly, in periods of such market volatility and uncertainty, frankly, it can be an opportunity for us. So clients are looking more and more during these kind of periods at outsourcing and not just the back-office stuff they did, but the mid-office and front-office capabilities and things looking for those solutions from service providers like ourselves. They're also looking for help with managing data and to simplify their lives, again, and analytics, especially trying to get and look at the signals in the market. And finally, they want to often now would be a great opportunity to explore migrating fixed to variable costs. So if anything, I would say is there's potentially enough -- more of an opportunity here.

Right. Okay. And just a question on digital assets because I know earlier this year or maybe it was last year, you mentioned that -- or BNY Mellon mentioned that you're going to be starting to deliver custodian services for the digital asset community, crypto community. Does the recent pullback in crypto valuations change your -- or affect your approach there?

No, no. Not at all. I mean, ultimately, we feel strongly that digital assets are here to stay. Both new and existing clients are talking to us about it as its own asset class, if you will. They're leveraging digital assets to diversify exposure. Obviously, it's been painful in the last couple of weeks and certainly in the last couple of days. But again, it's just another area of exposure that our clients are -- certainly feel they must be invested in. And frankly, what they're asking us to do is service those digital assets just like we do fiat currencies, just like we do traditional securities but all in one place. So the expectation or the ask, if you will, and this is very -- from both new and existing clients, frankly, on pitches, when I go on pitches, this is a topic in every single conversation. They want us to do all of the things that we do for traditional assets: so safekeeping and custody; fund administration and valuation; settlement, instantaneous settlement; trade execution; and also we're talking about issuance and tokenization. And why are they looking towards us? Well, I mean, frankly, they're turning to us because we are trusted. So -- we are regulated. They actually like that. We have proven risk management capabilities, focused on controls. We are resilient. As you know, we've spent billions of dollars in resiliency as a major G-SIFI. We offer scale. We offer multi-jurisdictional support. And as I was saying before, we can do it all one-stop shop, traditional and digital assets. So we think that financial services in general, and Bank of New York Mellon specifically, really has a significant role to play here. And if anything, certainly, that would help to reduce risk perhaps in the system.

Got it. I just wanted to ask as well, you mentioned on the earnings call that you were selected by Circle as their primary custodian for USD coin reserves. What differentiated you there?

A lot of the things that I just talked about.

Okay.

So really, they like -- they see us as an innovator, a thought leader and committed to the space and want to grow with us in the space.

Okay. All right. Turning to Investment and Wealth Management. You're one of the investment management boutiques -- one of the leading investment management boutiques globally. But you did recently sell one of the boutiques, right, Alcentra. And the question here is why reposition? And are there any sleeves within that you would really like to accelerate growth?

Sure. So just as a reminder, I mean, we owned Alcentra for -- and still own Alcentra. We've owned Alcentra for 15 years.

Right.

And we're really proud of what that team has done. They had -- they built Alcentra into a leading credit manager in Europe with just about $40 billion in assets under management, so a formidable investment firm. But given capital and investment, when we started thinking about this and given the capital and investment that would be required to really take Alcentra to the next level, we decided it was really better to combine it with another more, frankly, formidable global alternative asset manager. And so the sale to Franklin Templeton really allows Alcentra to build on their leading position as part of a global alternatives platform. Benefit Street Partners is -- it's a very complementary business. The transaction also allows us to build on our strategic partnership with FT. So we'll continue to offer Alcentra's capabilities on a sub-advisory basis. We are going to continue to service Alcentra in all of its asset servicing needs. So it does build on that partnership as well. And I guess the last thing I'd highlight as it relates to the sale is that, upon closing, I look at this also as a very disciplined -- example and illustration of very disciplined capital management. So upon close, it will free up about $0.5 billion of CET1. It also frees up seed capital and management bandwidth to focus on some of the other areas and investment firms that we have. We will continue to invest in fixed income, equities, multi-asset class or index capabilities, our cash capabilities, and yes, also alternatives. We're not exiting alternatives. We do have strong alternative capabilities whether it's efficient beta, whether it's private structured credit, whether it's real estate, whether it's private equity, et cetera.

Okay. And what about Wealth Management, any plans on leaning in more?

We are a top 10 private bank in the U.S. already. So I feel like we have definitely leaned in. We've been doing this for well in excess of 230 years, and something Catherine Keating would want me to say, she runs Wealth Management would say that, remember, Eliza Hamilton was our first client, and so that's a pretty strong legacy. And we are continuing to seize on opportunities for growth. Catherine, about 3 or 4 years ago, outlined a very, very clear growth strategy for the business. So the 3 prongs are really client acquisition, so developing more and larger client relationships, and we're doing just that. Expanding on our banking capabilities, so now about 60% of our Wealth Management clients are using banking services as well. That's up significantly from a couple of years ago. We've been investing in our technology. In fact, last year, our proprietary goals planning tool that we call AdvicePath won an award from the FT. So again, really seeing that where -- the investments are truly paying off. And I would also just say when you think about wealth and Wealth Management, and again, I'm going to kind of go back to some of the comments I made on Pershing X, Bank of New York Mellon has a very extraordinary position across the wealth ecosystem when you think about both Wealth Management and Pershing. And so that -- when you think about all the investments holistically, we are really leaning in.

Got it. Moving to 2Q. 2Q is only a couple of weeks left in the quarter here. So wondering if you could give us any updates on what you're seeing quarter to date.

This is what everyone's been waiting for, right?

I think so. A few of us.

Yes. So gosh, I guess what I would say is, look, the overall volatility and the sharp moves that we're seeing in equity markets, bond markets, rate expectations, et cetera, is making anything other than literally really near-term projections virtually impossible. And if you had to be here on Wednesday of last week, it would be kind of different perspectives. So in any event, with 2 weeks left in the quarter, the color I'll give is that we would expect fee revenue to be up approximately 3% or so year-on-year. In terms of NIR, as I mentioned, deposits in the second quarter are a bit lower than they were in the first quarter but running higher than we had originally anticipated. That means NIR is going to be better than we had also originally anticipated. So think NIR up year-on-year about 25%, quarter-on-quarter up about 15%. Also, I'm sure you're interested in full year NIR projections. And again, everything is moving so rapidly. But considering we expect deposits to land a bit higher than we had originally anticipated and considering reinvestment yields, et cetera, that are now anticipated, we would expect NIR for the full year to be up about 18% plus or minus from last year. And the last thing I'll comment on is just expenses. And the reason I'm going to comment on it because I want to call everyone's attention to just a shift that we pulled forward our merit program into the second quarter from the third quarter. We had this planned for quite some time. And we wanted the timing to be more competitive. So that's going to make year-on-year and sequential comparisons a bit wonky. So just from an expense perspective to make it easy, we expect the expenses to be flat quarter-on-quarter.

Okay. Got it. And does that NII outlook include ECB rate turning positive?

It does, it does. But of course, as we all know, there's an emergency meeting this morning. So there's upside to that to the extent they move faster.

All right. And is that a big benefit to you moving faster on the ECB?

About 10% or so of our deposits are euro-denominated. And a good portion of that is held cash at the Central Bank as well as in floating rate assets that are going to reprice as the ECB hikes. Well, originally, we expected them to go positive probably by the third quarter. Maybe it will be a little bit earlier. If it was the third quarter, that would be about a $5 million to $10 million benefit in NIR for the quarter -- for each quarter once they do that. But again, that is baked in. So if they do more, that's upside.

Right. Or do it sooner.

Right. Sooner, sorry. Or if they do it sooner.

Fee waivers, how should we think about the impact on how much fee waivers you can recoup here?

So fee waivers, as everyone knows, because we've disclosed and tried to be very transparent, were a drag on revenues to the tune of $1 billion in 2021, $900 million if you want to do it net of distribution expense. We always said that we would recoup close to 100% of the waivers when Fed funds exceeds 100 basis points. I think we're certainly going to get that today. So what that means is that by next quarter, in the third quarter, we'll be clearly out of waiver territory. If you want to translate that into financial terms, what that means is for the full year, we would expect waivers to be about $300 million. And so obviously, you can do the math. That would mean a positive impact to PTI of about $600 million or so this year versus last year.

Got it. And what about money market fund flows? We've been seeing outflows Q-to-date at least about $70 billion, I guess it was last week's number. You had outflows last quarter. What are you seeing this quarter?

So again, I'll remind you about the central role that we play across liquidity and the financial ecosystem in terms of how cash moves around the system. And again, we -- like I said, we manage in excess of $1 trillion on behalf of our customers. And when we think about -- part of that is what we call our money market fund platform that includes money markets that we manage under the name of Dreyfus. That includes third-party money market funds that we offer through our platforms like Pershing, et cetera. And I'd also just remind folks that in the first quarter, although the industry saw outflows, we actually -- our money market balances were up. Our money market fund balances across the complex were actually up. So far, this quarter, we're pretty much in line with the industry. So I think they're seeing runoff of about 2%.

Okay. What about on the expense side? Is there anything you can do to be more nimble?

So the way we think about our expenses, really, there are 3 buckets. There's revenue-related expenses, which very much are dictated by client activity and flows. There's structural or run the bank expenses, which are more difficult to move in the short term. And then there is the change the bank expenses, which are investments, and they can be in growth, or for that matter, in efficiency. As you also may recall, we -- in over the course of the last 5 years, in each year, we've delivered anywhere from $300 million to $400 million of efficiency saves. We're on target to do the same this year. We generally use that to kind of plow back into the investment agenda that we have. By the way, we have a lot of very detailed granular reporting on these expense buckets and especially on our investments. We review progress against goals, both financial goals as well as milestones in terms of the programs we're investing in at monthly business reviews. And we reprioritize as we review. And what I would say is we -- and we have been talking about for the better part of the year, there are some very compelling opportunities out there whether it is Pershing X, which we talked about; whether it is digital assets; data and analytics; the future of custody; the future of collateral. And we will continue to invest in those things through the cycle because they are future growth engines for the firm. We will have -- there are other areas that are not critical that we could ultimately pull back on if required. But we will continue to invest in the cycle.

Okay. Two more questions here. One is on currency. We've had a very strong dollar this quarter. How should we think about how that impacts you and how much you're hedging?

We're naturally hedged when it comes to currency exposure. So basically, at least from a P&L perspective, so we generate roughly an equal amount of both our revenues and our expenses in foreign currencies. Of course, with a stronger U.S. dollar, it's a negative to revenue. It's a positive to expenses, but again, kind of equal and offsetting. And the FX impact is part of all the guidance I gave.

Okay. And then lastly, RRP. We know it's a $2 trillion-plus with 100% deposit beta. How does that impact your institutional deposit rates? I mean, do you feel the need to compete with RRP at all or not?

No. I wouldn't say that. I think -- look, it is -- our deposit betas and how we think about what happens from here is very dependent upon the deposit trajectory, as I said. Beta is a lever. The deposit beta or pricing is a lever that we can always pull and play with. Of course, we are -- we want and like good operational deposits but at the right rate. So certainly, that's the lever we can pull, but we're not going to compete directly, if you will.

Right. Great. Emily, thanks so much for your time this morning.

Thank you.