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

Great. Good morning. I'm Jason Goldberg. I cover the U.S. large-cap bank stocks here at Barclays, and welcome to day 2 of our 20th Annual Global Financial Services Conference. Kicking off this morning's festivities, I'm very pleased to have Bank of New York Mellon, who will be the first company, I think, in a streak of 7 or 8 companies we have to get through before lunch. From the company, very pleased to have Emily Portney, the Chief Financial Officer; and Jim Crowley, the CEO of Pershing. Pershing is about 15% of Bank of New York's revenues, so a significant business with some unique growth opportunities, so we thought it was worthwhile to feature it this morning. And Jim, maybe let's start there. Perhaps maybe start with an overview of the business. It's not a business, the other trust banks operate in. And maybe not, at least when I talk to people, not as well understood as perhaps it should be. So maybe just start with an overview of the business, what services Pershing provides and just how it fits into the overall BNY Mellon franchise.

Sure. Happy to. Thank you, Jason, for having us. And you started off with an excellent point, actually, which makes us a bit unique amongst all the other trust banks, having a company like Pershing inside of it. It is the third largest business, as you just mentioned, with about 15% of the revenues that we drive through the organization. And just for context for everyone, because I won't say Pershing is misunderstood, but it's not well known. We really do provide a lot of the infrastructure and connectivity to a broad base of the financial services company. So maybe just some context of what that really means. At our very core, we are a clearing and custodial firm. We serve roughly 1,200 intermediaries around the globe, and those 1,200 intermediaries have roughly 7 million investors connected to their business. And on behalf of those 7 million investors, we are the custodian for about $2.2 trillion worth of assets. On any given day, we're doing in excess or processing in excess of 2.2 million trades. And I think the other thing, which is largely unknown about what we, Pershing as a platform, do inside of BNY Mellon, we act as a platform for many of the other BNY Mellon clients as well as our own Investment Management franchise as a distribution network, having connectivity to all these intermediaries and all these advisers. So on that platform, we hold on behalf of those clients roughly $1 trillion of assets. And that would be mutual funds, money market funds, ETFs, those sort of things. And then beyond all of the things that I just talked about in terms of record-keeping and trading, we do provide to all of our clients technology, and that's really important because the cost around building technology, maintaining technology, securing technology is only escalating. We provide an advisory platform for all of the advisers attached to those clients, and we provide an investor portal. And through that investor portal, for example, we have over 700,000 investors with active IDs, and they're hitting that portal over 3 million times a month, so looking at the activity that they're actually processing through the platform and connecting with what the adviser is doing with them. And then the last thing I would just say quickly is we are also very much focused on other services that we can connect to these advisers into their clients so they can compete more effectively.

Got you. And just maybe spend a minute talking just about what drives revenues in any given quarter over time, how much of fees are from asset levels, volumes, et cetera?

I'll start by saying that it's a high-margin business, largely recurring fee revenue. We've been blessed with a very strong organic business growth. We've talked about this, Emily has talked about this on multiple earnings calls now, where we see account growth growing roughly 5% year-over-year. We see net new asset growth in the high single digits year-over-year. So those things have been very powerful drivers to our financial results. Nothing good happens to us until our clients grow first, and so that's kind of how we're focused. And by doing that, obviously, our clients will drive more accounts, more balances, more assets to our platform. It is a well-diversified revenue base, Jason, largely fee-based and recurring, as I just mentioned. Just as an example, most recently in this environment, with the headwinds of the market, offset in our revenues with strong transaction balances, the abatement of fee waivers, higher interest income as a result of the higher rates. So those are good dynamics for us. And if you want to go a little bit deeper and you think about what our recurring fee revenue looks like, about 2/3 of that is split across 3 major parts. First is transactional revenue, which you would expect from a clearing firm. And we track pretty closely to the UX (sic) [ U.S. ] exchange transaction rates. Second is asset based. And so as equity markets rise, we're going to see the benefit of that. To a lesser degree, we're impacted by the fixed income marketplace. And the third is balance based, which is driven mostly by the money market fund balances that we maintain on our books on behalf of all of those investors. And then the remainder is the level of -- number of accounts that we have, mutual fund positions that we have, and importantly, the subscription fees that we get for our technology.

Got it. And then maybe just from a business strategy perspective, how did Pershing compare today versus 3 to 5 years ago? Maybe you just kind of highlight some of the meaningful -- the most meaningful growth opportunities you're seeing today and how you intend to capitalize on those?

Yes, night and day 5 years ago, the market's trends that we've seen really have changed the complexion of the marketplace. If you're asking me 5 years ago kind of where was our sweet spot, I would say our sweet spot really was serving wealth managers in the broker-dealer business. We had in excess of 30% market share, and that really was kind of our sweet spot. I would also have said that we're just sort of an emerging player in the RIA custody business. Fast forward to today, we've seen this massive change in the complexion of the marketplace in terms of the number of providers out there with mass consolidation following the financial crisis and kind of what has happened over the last couple of years, the need for scale, the need for more investment dollars, the limited number of resources, the scarcity of talent. All those things have sort of fueled this consolidation. The second thing I would say is that the behavioral shift and change from the adviser perspective shifting their book away from transactional based to more advisory based has really influenced our thinking. And then the third thing is the way that investors think, the way the consumers think. They want a different experience. They want more digital experience. And so those 3 things really have made us think about how we need to accelerate our investments in things that are supporting those trends. So doubling down on the RIA space, how can we serve advisers better, create more tools for them specifically, and I know we may get to this later in the conversation in areas such as managed accounts, which we just rebranded as Pershing X and in supporting our clients in their digital efforts so they can reach the next generation of investors.

Got you. And I guess, recognizing your leadership position with broker-dealer clients as well as your success with managing larger RIAs, do you still think there's significant opportunity to gain further market share? And just how are you differentiating yourself from your competitors?

I have to say yes. I have to yes to that question. First of all, just to sort of level set, the barriers to entry to become a clearing and custodian firm are pretty darn high. It takes capital, running into the face of the change that's happening in the marketplace with regulations, running into the face of all the technology needs. It's a pretty daunting task. And so I'm not saying the moat is deep and wide, but I am saying that we believe that we're pretty well positioned because we do believe that having the scale, the expertise, the talent that we have in the organization has us pretty well positioned going forward. We do think that, again, some of the trends in the wealth marketplace are going to sort of help us continue to penetrate into the RIA marketplace. We've all been sort of hearing and reading about the breakaway marketplace in terms of RIAs breaking away from the wirehouses. We believe Pershing X is going to be a big accelerator and differentiator for us, and we also think that there are some blue oceans out there in terms of new markets for us to pursue. We think that, for instance, trust companies, private banks have been largely underserved in terms of the innovation and the experience that they're giving to investors. And as these financial institutions, and particularly the larger ones, think about how they connect the client experience across the different market segments that they serve, we think that we're kind of in a really cool position to figure that -- help them figure that out and connect all those experiences.

And maybe discuss maybe some of the risks inherent in the business. One thing that comes to my mind is there's been obviously a fair amount of M&A among your clients over the last couple of years. Continuous consolidation may make self-clearing for some of them more viable as they grow larger. How do you manage that risk? And are there other risks that keep you up at night?

Well, I think -- I don't know if anything keeps me up at night. I get a good hour or 2 of sleep every night. But if you think about what keeps me up at night, it would be probably the same thing that keeps all of us up at night. Is there going to be any kind of cyber risk that we might be facing tomorrow morning when we get out of bed? When I think about M&A and I think about kind of our history, because I've been with the firm for many, many years, we've largely been on the winning side, for instance, of the M&A threat. We are in a position where we have lost some clients as a result of people making decisions to change their business model. It happens. But more often than not, we have been in a position where our clients, who are the larger, more complex, sophisticated organizations, more well-capitalized organizations, are the acquirers. Just for the first, whatever it is now, 8 full months of 2022, 30 of our clients have been involved in inorganic M&A activity, bringing assets to the platform or retaining assets on the platform. So that has sort of been a very good trend for us to make certain that we succeed there.

You mentioned Pershing X a couple of times. I want to delve into that, but want to get Emily involved as well. Before we get there, maybe just put up the first ARS question. For those of you here yesterday know this, for those that are new to this room, in front of you, there are clickers. If you could -- the first question we've asked in all the meetings on ranking at the end of the conference. What is your current position in the shares of the BK? Okay. So opportunity. Maybe put up the next question. What is the most compelling bull case for the BK shares? Equity markets, organic revenue growth and minimal credit risk. We'll make sure we touch on all those. Emily, so this is probably the last time I get you up on stage as CFO. So why don't we just jump right in? Third quarter, 2 weeks left. Any update you could provide?

So first of all, thanks. It's great to be here. So it's certainly been another pretty volatile quarter, both across, obviously, equity and fixed income markets, and the rate environment continues to evolve very rapidly. Against the backdrop, we are very pleased with the underlying performance of our businesses, and we do just continue to manage the balance sheet to retain full flexibility. As we sit here today with just about 2 weeks left in the quarter, and if you assume market levels pretty much stay where they are, we would expect our fee revenue for the third quarter to be slightly down year-on-year. The positive impact of waivers abating is being offset largely by the stronger U.S. dollar as well as lower market levels. In terms of when you think about it by business, we are seeing nice organic growth across Securities Services as well as Market and Wealth Services, but Investment and Wealth Management is finding it more challenging, based upon the economic backdrop. All of this, basically, is in line, Jason, with what I had talked about when I gave full year guidance in July. In terms of NIR, it continues to be better than we had originally anticipated. So for the third quarter, we now expect NIR to be up about 8% to 9% sequentially, and that would mean or translate into about 40% up year-on-year. And accordingly, when you then think about the full year, we would now expect NIR to be up about 25-plus percent, and that is versus the guide I gave back in July, which was in the low 20% range. And finally, on expenses, excluding notable items, we would expect expenses to be down about 1% to 2% sequentially. That's a pretty fulsome view, I hope.

It is. But as always, there's certainly some stuff to unpack within that. Maybe we could just maybe start with deposits just because that's been a big topic of event. You gave the NII guide, and maybe just unpack that a bit in terms of deposit balances, mix, pricing behavior, et cetera.

Sure. So a lot in that. So overall, deposit balances are behaving largely as we anticipated. If you remember, in July, I did give the guide that by the fourth quarter, we thought our fourth quarter average would be down about 5% to 10% from where we were in the second quarter. And if you remember, that was about $311 billion. We still believe that's largely going to be the case. So we're on track. Just a reminder that the third quarter generally is seasonally lower. So we're seeing that also play out. And there is an impact of a stronger U.S. dollar to the tune of about 1%, which is a negative impact in terms of growth. When we think about the mix, actually, noninterest-bearing deposits are holding up better than we had anticipated. So as we expected in the second half NIBs to be about 20% to 25% of total deposits, and they're running higher. That's, of course, helpful when it comes to NIR and NIR projections. And finally, as it relates to betas, they are running slightly better than we had also anticipated. So again, a bit helpful.

Interesting. Maybe put up the next ARS question. What do you expect for deposit growth in 2023? Down 1 to 5, so less than this year. What's your prediction, Emily?

I think that's probably not outside the realm of possibilities, but we think it's going to be roughly kind of where we end year-end.

Interesting. I guess maybe shifting to the fee income side, you gave us guidance for Q3. We have kind of full year guidance. So can you talk to us just how many you had to think about the rest of the year, remind us just how extensive you are to the equity in the fixed income markets and just how much of the fees are tied to market levels?

So when you think about our fee revenues across the entire enterprise, about 50% are balance based. And obviously, Jim talked a little bit about it within the Pershing context. And about the remainder, obviously, are transaction-based or basically account-based. And when we -- this is nothing that we haven't disclosed in the Q or the K. So a 5% change in global equity markets and if you think about that gradually over the course of the year, so not a shock, would impact fee revenue by about $70 million to $80 million. And the same 5% change in fixed income markets, again, gradually over the year would be closer to $40 million or $50 million.

Got you. And then on expenses, you've had this kind of full year guide of 5% to 5.5% year-over-year. Year-to-date growth has probably been a bit above that. Is that 5% to 5.5% still good? Should we expect expense growth to moderate in the back half of the year? And just have you been taking any actions as it relates to investment spend or otherwise to manage to that number?

So we do continue to see or expect our expenses ex notable, full year to be up between 5% and 5.5%. So that still is what we expect. Just as a reminder, any tailwind that we, and I spoke about this in July, any tailwind that we have been getting from a stronger U.S. dollar has been pretty much completely offset by higher inflationary pressures. So then when you look at that 5% and break it down, it's about 2% revenue related and think things like distribution fees associated with the money market funds that we distribute and think about it in Jim's world, as he just talked about, as well as clearing fees, expenses associated with our on-boarding, our strong pipeline. And then the remainder relates to investments net of efficiencies as well as just the normalization of many costs associated with the return to the office, whether it's travel, whether it's occupancy and building expense, et cetera. But in answer to the second part of your question, yes, we do expect and are seeing that expenses -- expense growth in the second half is moderating. And some of that is just the fact that in the second half of last year, we decided to make some incremental and we accelerated some incremental investments along many of the things that we've talked about, whether it's the Future of Custody, digital assets, Pershing X, data analytics, all of those themes that we have been talking about. So that was in the second half of last year. So by default, the year-on-year comparison will be more favorable. But also, very importantly, as you rightfully point out, given the macroeconomic backdrop, we are incredibly laser-focused on discretionary spend and looking in at all possible areas and ensuring that we are delivering efficiencies.

Let me put up the last ARS question. On the topic of expenses. Looking at 2023, what do you expect BK's expense growth to be next year? Good thing you're still guiding to up 5% to 5.5% for this year, otherwise we would have changed that. So up 1 to 5. Reasonable. Jim, maybe back to you. You started out -- you mentioned Pershing X a couple of times when you were speaking. I know Todd, Emily, Robin have all talked about it on the last few earnings calls since you launched this initiative last year, but maybe you can just refresh for those who maybe not be familiar with it in terms of what it is, why it's important, why you think you can compete with it.

Yes. Thanks, Jason. So let me first start by saying Pershing X is a big and bold initiative business actually for us that we've launched. And before I say exactly what it is or remind everyone what it is, I think it's important so everyone understands, like why we have so much confidence in the story for Pershing X. We have got this massive installed client base of 1,200 clients and 80,000 advisers attached to those advisers who really are very much connected to us, and they've got a great deal of confidence in what we do. We are their trusted custodian, their trusted partner in technology. So it puts us in this very, very unique position to support them with new business ideas and things like Pershing X. So Pershing X is going to be the next generation of adviser workstation that supports an adviser's practice. And if you were an adviser and out there practicing, working with clients, you would have this collection of software tools that may be homegrown, they may be third-party, that you are trying to figure out how you're going to make them all connect, how you're going to make the data work across all those different data sets. And we see this, and it's not just us. Actually, advisers have said that 60% of their time is spent on working out issues connected to the technology and the connectivity of the technology and data. We see this massive opportunity to create a platform that is truly interoperable and flexible and multi-custodian. So that will include things that begin with, for instance, CRM and follow right through to proposal, or I should say, financial planning, proposal generation, trading, rebalancing, billing, reporting, all aspects of what a financial adviser does and spends a good part of their day on. And we don't believe that there's any other solution out there. We know that there's no other custodian out there that has built such a platform. The other competitor platforms out there are third-party tools, which as I just mentioned, I think are a collection of things that they have pulled together in order to bring to the marketplace. We're thinking about building something together with our clients rather than sort of bringing a bunch of different pieces together and trying to deliver the pieces. So that is what we're trying to do with Pershing X. We've hired Ainslie Simmonds. She's a proven individual in the wealth marketplace. She's a proven entrepreneur. She has filled out her entire management team now. We've integrated our data reporting business, which was formerly known as Albridge in under Pershing X. And importantly, what that brings along with all of the data, brings 150 engineers, it brings 50,000 advisers and a whole bunch of new assets that we have now the opportunity to support these advisers within this holistic Pershing X environment.

That makes sense.

Jim, you might just want to mention also the unconflicted nature of your business.

Yes. So when we think about -- kind of like you asked a question earlier about how we differentiate in the marketplace. The idea that we're not out there competing with our clients, the idea that we're connected to a globally systematic important financial institution, that puts us in such a unique position like, for instance, within X, to not only provide the platform, but to provide products that are also sort of, for the most part, provided by third-party providers. For instance, whether it's mortgage lending or security-based lending. As BNY Mellon, as a franchise, we are this sort of uniquely positioned institution in the marketplace, not only to provide cool technology and custody and execution services, but all these other additional products in an unconflicted way.

Makes sense. One of the things, I had a question on on the last earnings call. Robin mentioned minimum variable product to be rolled out with a set group of clients by year-end. Maybe just elaborate what that is and when will that be kind of available more broadly?

Yes, our MVP, our minimum viable product, is on schedule to happen this year, so we're super excited to have that out there. And one of the first things that Ainslie did when she joined the organization is she closed on a transaction of a company called Optimal Asset Management, which brought to the Pershing X team a core capability called direct indexing. Everyone will be familiar with what that is, given its popularity, and tax optimization. And as part of our MVP that we plan to roll out at the end of this year, there'll be a couple of component parts to Pershing X. The direct indexing will be a part of it. The platform part where I talked about some of the different applications a second ago will be part of that, and we will also build in some of our own models into the Pershing X platform. So the MVP, on schedule for November, December. We have several clients who are going to take advantage of it from a platform perspective, some who are going to take advantage of it from a direct indexing perspective. We have one that will be using the multi-custodial aspect of it. So we're making certain that we're keeping the promises that we've made to the marketplace and to our clients by delivering this functionality. And then throughout 2023, we'll have a couple more major releases and a couple of iterative things along the way. X is operating in a totally agile like environment, so it's fun to watch them, hands on keyboards every day.

I guess maybe touch a bit just on the economics of the business. Sounds like you spent some money to put this together, hire people. At what point do you think it could be maybe accretive? How does it impact Bank of New York's pretax margin? How long will it take to revenue to overtake expenses? Just color you can provide on that.

As I said, it's big and bold. It's probably one of the most ambitious things that we're doing across the franchise. And so we're incredibly excited, as I said, about the opportunity in the marketplace and our position. Revenue growth, obviously, is top of mind as well as improved margins, as you mentioned. So when we think about X, we think about the revenue opportunity through a couple of frames. One, we think about it on a subscription basis for this platform that I mentioned. Secondly, we think about Pershing X as a significant asset gatherer. And I talked earlier about the value of assets, adding new assets to our platform. So that would be the second lens that we look at, revenue generation. The third lens would be product. We have the opportunity to introduce models. We have the opportunity to introduce our own proprietary, for instance, ETFs through that platform. So we think about it through those lenses. There may be a new lens, which the marketplace sort of leads us to, to be determined, Jason. We'll see where that goes. But as we roll out these different products and capabilities of Pershing X, you will start to sort of see the revenues arrive. I think as Emily and Robin have guided, it's going to be a couple 3 years, 2 or 3 years before we start to see those revenues in any meaningful way start to hit the income statement. And then on the expense side, which you also asked about, we're in an investment phase right now. So I suspect what we're going to experience is that for the next -- again, 2 to 3 years, sort of the inverse of what I said about the revenues, we're going to sort of see a ramp-up of some of the investment related to building out some of this functionality, maybe some partnership investments that we make. So that too will sort of be kind of an inverse relationship to revenues over the next couple 3 years.

Got it. And then I guess from an outsider's perspective, it appears that Pershing has become more closely connected to the rest of the company than maybe it was in the past. Just your thoughts around that? What drove that? What's driving that, if it's true? And just where do you see runway to better connect the dots for your clients across your organization?

Yes. So I think Todd started and Robin has been beating the drum of connecting the dots, One BNY Mellon. It clearly is something that across the franchise, rolls right off the lips for all of us right now. When we think about the business just within Pershing, there are multiple ways in which we're connected with the franchise. And I think, again, uniquely positioned from some of our competitors, trust bank competitors. As an example, many RIAs do business with investors who might require more sophisticated custody solutions than what a brokerage platform would offer. We have the option to offer bank custody as well as brokerage custody all through the same front end. So that is one way where we're working with our Asset Servicing team to provide us with custody solutions that -- for the more sophisticated investors. A second way is as we talked about money market funds and our balanced revenues, we have the opportunity to drive not only money market fund deposits to Dreyfus, example, but we also have the opportunity through a multibank and a single bank FDIC program to drive deposits to our own bank. So that is another way in which we're thinking about One BNY Mellon. And then the third thing that I would say is, Emily prompted me before, if you think about investors and advisers today, they're always seeking out more sophisticated lending solutions. And so being part of BNY Mellon again allows us to offer nonpurpose loans, it allows us to offer mortgage loans, it allows us to offer more sophisticated insurance premium loans, things that aren't necessarily sort of right there on the shelf, but really, really important for an adviser that might be with a wire, thinking about breaking away with a complex lending need in their book to find a home, to find a custodian that can support them. So that's one of the ways that we're thinking about it. And we've got recent sort of proof points. I know -- I think Robin talked about the government agency thing that we recently did. So this is kind of a cool arrangement that we worked out. A client of ours was contracting with a government agency to provide record keeping and investment choices for a retirement plan. And there were some unique conditions around that business model, which I can't talk about, but it really required for us to think out of the box as BNY Mellon to figure out how we were going to operationalize that for the client. And so for this government agency, I partnered with Roman. And so Roman is on our Asset Servicing side, providing all of the record keeping, if you will, for the 5,000 mutual funds that they're offering to the program participants, and there are millions in excess of 6 million participants in this program. And Pershing is creating the connectivity to the client. So that is a great example where BNY Mellon came together, connected the dots and brought a solution to this government agency that no other -- I believe no other institution could have done. And then another quick example I will give you with a major advisory firm down in Texas. They came to us asking us could we bring the Wealth Management portfolio models together with our Investment Management product and deliver to them models with product to their clients that would be more efficient for them to operate their business and more efficient for the investor, and we were able to do that. So that's just a couple of ways in which we're connecting the dots.

Good stuff. Emily, still not going to let you off the hook. We didn't talk about capital earlier, so that maybe we can pivot back to that. Obviously, another topic among investors. On the earnings call, you talked about getting back at or above a 5.5% Tier 1 leverage ratio by the end of the third quarter. I think you were 5.2% in the second. Is that still possible? And maybe more importantly, what's your latest thinking around share buyback?

Sure. So well, with the caveat that there's 2 weeks left in the quarter, we do still expect above our internal targets for both Tier 1 leverage as well as CET1. And as you pointed out, our internal target for Tier 1 leverage is around 5.5%. Likewise, for CET1, we want to be north of 10%, and have been. And when we think about buybacks in general, ultimately, we consider 3 factors: earnings generation, which, of course, has been very healthy; the trajectory of deposit balances, which are, as I said earlier, behaving as anticipated and ultimately declining, so that is obviously helpful for Tier 1 leverage; and then AOCI. And so far, this quarter, it's -- AOCI has been a substantially lower headwind than we had seen in both the first and the second quarter of this year. So in the fourth quarter, we will consider resuming buybacks, and we'll evaluate our plans based upon the framework I just described as well as market conditions at that time. Having said that, I just would remind folks that there is incremental upside in the -- if you look a little bit beyond the near term in terms of when we close the Alcentra deal. Likewise, also when you look beyond the near term, obviously, as we all expect the AFS portfolio to basically pull back to par over time. And finally, I'll just say as we've said all the time, and I think this is something that the strength of our business model is, that we do generate enough to be able to continue to invest and grow in the areas that we've talked about, and Pershing X, we've obviously showcased today, but also return a meaningful amount of our capital to our shareholders.

Jim, we've got a minute left, so we could do this quick, but Emily talked about balance sheet management and capital in this environment. You talked about accessing the bank's balance sheet. Just maybe touch on the product reference to clients and just what you're seeing in terms of loan demand, cash balances and the like.

Sure. So loan demand, I would say, is still healthy. Not at the levels that we saw for the prior couple of years, but still healthy. And we're going to -- we believe that because we're just sort of the success that we're having with breakaways and with other sort of enterprise new relationships that we're creating, that, that demand is going to continue on going forward for, as I said, those different products around loan demand. Cash balances, it's been phenomenal the last number of years, the growth in cash balances, particularly in the off-balance sheet money market fund sweep programs. We continue to see good growth there. We continue to see significant growth in the FDIC deposit programs, and I do believe that we'll probably be thinking about how we can utilize our own bank more efficiently in that program going forward. Those would be the couple 3 things I would say in my last second.

Perfect. Please join me in thanking Emily and Jim for their time today.

Thank you.