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

Thanks, everyone, for joining us. I would like to welcome Emily Portney, CFO of BNY Mellon; and Roman Regelman, CEO of Securities Services and Digital. BNY Mellon is the largest and most diversified bank among the custody bank peers. In addition to having $42 trillion in assets under custody and $1.8 trillion in assets under management, the firm also serves as one of the largest service providers to the wealth management industry through Pershing, runs a meaningful payments network and operates the largest clearance and collateral management business in the market. With Roman and Emily here, we'll zone in on how the firm is positioned to drive revenue and profitability in Asset Servicing, the firm's largest business, as well how the bank is navigating, obviously, there’s choppy macro factors. Thank you both for being here. Looking forward to this conversation as always.

So Roman, why don’t we start with you on the Asset Servicing side. When I look at BK's business, it's the largest part of the pie, $6 billion in total annual revenue run rate, probably most comparable to what investors consider the custody bank or a trust bank. So maybe we could start by focusing what differentiates BK in this business relative to other large providers, whether it's State Street, Northern Trust, JPMorgan, Citi, et cetera.

Yes, sure. Thanks, Alex. Thanks for having us here. And first, just a couple of things to get grounded. Obviously, Asset Servicing is a lot more than custody, and then Bank of New York is a lot more than Asset Servicing. But focusing on Asset Servicing, I think there are 3 areas of differentiation. One, I would say, it’s service quality and talent. Second is the breadth of our solution enabled by our operating model. And the third is really focused on broad and deep coverage of our clients. So let me just quickly walk through all to you. So on service quality, it's a foundation of our business. If service quality is great, you can grow the business, you can grow the wallet share, you can really expand your products. It's really a bedrock. We've been investing in service quality. We really feel that's a differentiation. And that's enabled by talent, which is critical, but it's also enabled by our data-driven approach to service. The second thing, when I talk about our operating model, that's a data-driven operating model. It's open architecture. It really allows us to connect our products and services to other products and services, to client's own operating model, and really solve complicated operating model issues for our clients, which has required a change in the way we cover clients. We really stepped out our coverage. We're covering C-suite, we are covering broad organization, and that allows us to really have a transformative dialogue, addressing our clients' changes, operating model, the way asset managers and asset owners look at their business.

Great. So when we think about growth priorities in your business, can you spend a couple of minutes on what those are? Again, from the outside looking in, it's a little harder to dissect all the numbers and kind of really zone in on pure organic growth, but at a high level, maybe you can go through some of the key focus areas?

Sure. The first one would be to optimize our core business. Fundamentally, the business that we have, it's about scale, and it's about speed. And a situation where scale and speed really need to come together. Obviously, at our size, we have scale, but deploying the scale at the right speed for the right solution with clients, that's optimization; obviously, the cost profile goes in that. Second one, there are high-growth areas that actually tend to be profitable as well, that's alternatives, ETFs and emerging markets. And what I mean by emerging markets, it's following our clients into emerging markets. Third one, and that's -- you mentioned, Alex, that's what differentiates us from many of our direct competitors. It’s really breadth of offerings. You have probably heard about the deal that we made with Aviva Investors recently. It's really working with the client end-to-end on the whole operating model. It's back office, it's middle office. It's helping them to connect front office, all of that. And it's really underpinned by data. It's not just a set of services and products that the client bought from the same company. It's really the model kind of working together. That would be the second one. The third one -- sorry, that will be the third one. And the last one is the data ecosystem. It's our connectivity to OMS providers, it's our connectivity to fintechs. When clients look, when an asset manager looks at the whole operating model they have, they want to have a partner that can help them in what we call a future proof of the operating model. So if our products and services work with the ecosystem, works with external providers, especially for more complex asset classes, that's a winning formula we feel really differentiates us.

Got you. So maybe if we could put some numbers around that. When we think about organic growth and really organic growth algorithm for your business, what does that look like? If you look back into 2022, obviously, it's been a pretty challenging year for the market. So maybe help us frame like what the level of organic growth was last year, or this year but a little bit lower? And more importantly, kind of how you think about next year and again, the building blocks of that on a forward basis.

So we actually feel pretty positive about our growth. The sales momentum been positive for the last few years. Asset Servicing is actually growing faster than the rest of our company. And we feel, this year, we are really kind of keeping business momentum and our performance, we believe, is superior to our competition. What are the elements of that? One is the win/loss ratio. We're really winning good business, profitable business, but we're also kind of keeping this ratio pretty high, which is enabled by high retention. In this business, if you lose a client, it takes a lot to onboard other clients. And our retention ratio is very high, and it's a quality business, it's a good profitability business. So we outperformed the company and it's really driven by organic growth. But we also feel the way we put our products and services together -- custody, accounting, middle office, data, transfer agency, which is something unique that we have -- really puts us in a very strategic dialogue with our clients, and that helps us kind of fill these goals. But I want to be specific because I know you want to be specific. ETFs and Alts are growing middle-single digits. This is above median for the company, for the industry, and it allows us, especially in these markets to win some good deals. Also, data is a differentiator. And when you put data together with the rest of the services, it really helps you not only win the data deals and get that revenue, but really get the integrated revenue. Which leads us to 1 BNY Mellon, I'm sure many people heard of that. It's really focused on moving up and across the value chain. Up, as I mentioned, strategic dialogue across our clients, our clients are asset managers and asset owners, and across, it's not only the suite of services in Asset Servicing, but connecting to the rest of our company, to Pershing, to Treasury Services to Corporate Trust. Of course, external environment is challenging, but it's challenging for the whole industry. But what we see in this environment, that our asset management clients, specifically, but also our asset owner clients, really wanted to solve their complicated operating model challenges. They, obviously, need to have right cost and a good performance. And they're stepping back and they're saying, do I kind of stay with the decisions I made historically, or do I look at my whole operating model and do I have a transformative partner that will work with me on that? And I think, quite often, we are the partner for them. So that's all these things, I think layering together, and we are quite pleased with our growth this year and our prospects.

Got it. Let's talk about pricing for a second. One of the larger competitors in the space pretty recently announced the fact that they'll be conducting a more comprehensive pricing analysis across a number of their custody platform, frankly, to reflect higher costs and the --inflationary environment, higher cost in the business. Are you guys doing something similar? Does that present an opportunity either to win new business or just improve your own pricing in this business?

I can take that one. So look, we're definitely seeing opportunities to take market share across the franchise. So whether it is, what Roman just talked about, and the momentum that we have, the strong momentum in both ETFs and alternatives in Asset Servicing, whether it's in Pershing where we're actually seeing strong interest from RIAs and other breakaway advisers and certainly our investments in Pershing X we expect to only accelerate that further, or Treasury Services for that matter, where we’ve been leading the industry with innovative real-time payment and other digital solutions. So in all of those things, I would just highlight, we're winning on the breadth of our capabilities, not on pricing. But if -- at the heart of your question around Asset Servicing pricing, the first thing I would just remind folks that our Asset Servicing deals, they are 3-, 5-, 7-year deals. As contracts come up for renewal, we always take into account the cost to serve. And of course, some of those inputs have to do with inflation and/or complexity. And so we price accordingly. Likewise, we do have inflation escalators in some of our contracts. And if we don't, again, as they come up for renewal, we're embedding those in. And then I think most importantly is that also we take into account, even if it's an Asset Servicing RFP, the entirety of the relationship. So not just what they're doing in Asset Servicing, but what they're doing across the franchise. And we look at the entirety of the relationship, the profitability and the margins, and this -- to Roman's point earlier as well, we do have an advantage because we have a more diversified set of products than many of our peers. So very specifically, too, just in Asset Servicing, what I'll end with is that the average margin on the new deals is rising. And almost we are being more selective in just in terms of all of the RFPs that we're participating in.

Got it. That's helpful. Thanks. Roman, why don't we go back to you -- I was hoping you could spend a couple of minutes on Issuer Services. It's a business that kind of falls underneath your whole Securities Services umbrella. It's not a business that the market talks a lot about, but it is a $1.5 billion annual revenue business, it's quite sizable. There have been, obviously, some incremental headwinds this year related to Russia sanctions, et cetera. But as you think about the growth of this business over time, what does that look like? What's a good kind of growth algorithm to be thinking about?

So thank you, Alex. We actually feel very good about this business. So let me talk about Issuer Services. Two distinct businesses, Corporate Trust and Depositary Receipts. Both actually have market leading positions. They're both highly scalable and high-margin businesses for us. So Corporate Trust is really the enterprise franchise business. 90% of Corporate Trust clients cross over into the rest of the company, so great synergies, unique position. Depositary Receipts allows us exposure to global equity markets, which is -- global equity capital markets, which is a nice thing to do. So I really believe that, organic growth in these businesses is good. It's been good this year. We expect that to continue. So let me maybe talk specifically about each of them. So Corporate Trust, ultimately, is driven by the issuance, the issuance in debt, which obviously itself correlated to some GDP growth. But complexity in markets, that’s what helps because clients look at stable providers to work with them. Of course, the issuances is down this year, so that's a headwind. But NIR, high interest rates, obviously help this business. So we feel very good. We're also optimistic for the future. Specifically, we are optimistic in tokenization and digitization of this whole business because that will unlock other opportunities, will bring new issuers to the market and will focus us on being not just a traditional provider but a digital asset provider in this market. Things like private credit, that's where we can really focus on. Other things like loan fund administration, that’s where we've been investing. That's a good growth area, and we feel quite bullish about the prospects there. There are adjacencies like similar to Asset Servicing, where it was a back-office business and now is becoming increasingly end-to-end business. So there are adjacencies in Corporate Trust for middle office and the front office, which we're looking to see as well. And again, NIR growth really falls to the bottom line here. So that's Corporate Trust. Now DRs, obviously, that's a very global business. The growth is driven by capital market activity globally, IPOs, corporate actions. And it's impacted by geopolitics, of course, as you mentioned. There are many bad things about Russia situation, but the good thing we have a playbook. And if we need to apply that to any other markets, we can. It's tested. We do not, obviously, hope and expect that to apply anywhere, but this is very tested. But there is a lot of growth. There is growth in Southeast Asia. There is growth in Middle East. And it's also growth in different asset classes. So the Depositary Receipts as an equity instrument. We see very much an adjacent market in depositary notes, which follow the same paradigm. And doing that globally as we do today, especially in a more digital way, it presents really good opportunity for us and for the industry. I mean, we are the market leader in this industry. So Alex, yes, it's a nice business. We're very happy to have it in our portfolio.

Great. Let's talk about profitability a little bit. When Bank of New York resegmented the business actually exactly a year ago at our conference here last December, you talked about targeting 30-plus percent pretax margin in Securities Services. I think term you sort of described is under the normalized rate environment. I think we got to the normalized rate environment a little bit faster than anybody would have thought a year ago. So with rates now close to that level, pretax margin is still in the mid-20s, what's been the disconnect? And what are you kind of doing to get you guys over that 30-plus percent range? How long is it going to take?

I mean so we're extremely committed to 30-plus percent. We always said it's in medium term, and it's achievable. It's fully achievable, and we are very committed. So 3 things on how we get there. First is NIR. And while we got to a pretty good environment now, we still believe there is some room to grow and the client balances are something to be focused on. And obviously, we expect to benefit in '23 and maybe '24. So that's one. Second is profitable growth. I mean Emily mentioned some of these things, but I want to just maybe to punctuate that. It's high-growth products and services. It's discipline around pricing, but that's new deals and its existing deals. And again, Emily talked about that a lot, but fundamentally, clients really value what we do, and clients are willing to pay for that. And the last thing is distinct digital capabilities. We don't need to be digital, but often they are. Digital assets, advanced analytics, these are the things that help us sell new products, but also extend the overall value proposition. So that's on the revenue growth. And the last one, obviously, is the cost transformation. So we're consolidating platforms in places like fund accounting. We're really focusing on more of a high-margin business. So that's obviously part of the cost transformation. Our middle office offering and our data offerings became much more standardized. So the cost of delivery and the cost of onboarding, obviously, under control. And fundamentally, working with clients in a more digital way, it's great for cost. Frankly, it's great for experience. You onboard business quicker, which means you get revenue. You get profitable revenue quicker. So we're really digitizing the whole experience, automating client onboarding. So between these 3 things: NIR first; growth, organic growth; and the cost transformation, we're very committed to what we said a year ago.

Okay? We'll keep track of that again.

Please do.

So, Emily, why don't we pivot to you for a couple of minutes. We're, obviously, towards the end of the quarter, so I want to give you an opportunity to go through any updated guidance thoughts for Q4, run through your list and we can sort of follow up.

Always feel like there should be a drum roll. So as we think about the fourth quarter and just taking a step back and certainly others this year at the conference are talking about it. Markets generally up on a spot basis quarter-to-date, but still, if you look at most indices are flat to down on an average basis. But our transaction activity is very healthy, and obviously, short-term interest rates continue to rise. So with 3 weeks left in the quarter and assuming that markets more or less hold steady where they are, we'd expect fee revenue for the fourth quarter to be flat to slightly down year-on-year, which -- that would now imply that fee revenue, overall, for the year will be roughly flat to last year. In terms of NIR, NIR continues to be stronger than we had anticipated and really because of 3 factors. We've seen first, the deceleration of deposit runoff even more so than we had anticipated in the fourth quarter. Favorable funding mix, of course, I've talked kind of all year about the fact that NIBs are actually running higher than we had anticipated and still are. And also betas continue to lag what we had expected. So for the fourth quarter, we now expect NIR to be up about 12% sequentially. And what that would imply for the year would be NIR north of 30% year-on-year. As far as expenses, excluding notable items, we intend, or we expect expenses to be up about 1% sequentially. And that would imply that we are going to land the plane very much as we had suggested in the last earnings call at the lower end of the 5% to 5.5% range year-on-year that we are driving towards. And Alex, before I end on fourth quarter guidance, just one thing I do want to mention. So as you’ve heard me talk about all year, we've been very proactively managing our securities portfolio really to retain flexibility and optionality. So we took the opportunity last week to sell roughly $3 billion of longer-dated, lower-yielding muni and corporate bonds that were in our portfolio. We started to replace those with significantly higher-yielding and lower-credit-risk securities. So what that will also mean, though, for the fourth quarter is that we're going to realize an approximately $450 million pretax loss that will be a notable item. Of course, there’s really no impact to reg capital because the loss was already recognized in AOCI. We're also freeing up about $150 million of CET1. And it goes without saying that because we are reinvesting in securities that are yielding roughly 5%, which is more than double than what we were earning on the securities that we actually sold, this will be significantly beneficial to NIR in the next couple of years, which is obviously a big driver.

Great. You just saved me like 5 questions.

There you go.

So maybe just to unpack this a little bit more. So $3 billion is what you're doing in the quarter. As you look at the rest of the securities portfolio, are there additional opportunities to do that? And it feels like you're pivoting sort of towards this favorable trade-off between kind of crystallizing the losses given the fact that they have been recognized through capital but picking up NII. So is there more of that to do?

We're going to continue to be very opportunistic and also just very nimble in terms of how we manage the portfolio.

And roughly the yield on the securities that you guys have sold, what was that roughly? I know you said the new was coming in at 5...

It was, call it, 2%.

2%, great. Okay. So I guess on deposits, great to see the deposits fairly stable to what you talked about on the last call. I think in some of your prior comments, you mentioned that you expect the exit level of deposits to relatively hold through 2023. So a, curious if that's still your expectation; and b, what sort of gives you that confidence that deposits could ultimately be at that level. There seems to be still quite a bit of uncertainty in the market.

Sure. No, great question. So look, certainly, we would expect and everyone else expects that central banks around the world are going to continue to tighten, certainly for a large part of next year, whether that's through continuing to increase rates or, for that matter QT. With that, inevitably, reserves will start to drain -- or not start, will continue, I should say, to drain from the system. But when I think about our deposit base, a couple of things just to keep in mind. First of all, in 2022, deposits have behaved very much as anticipated. In fact, as I just suggested before, better given deposit mix and repricing. Also, when you think about our deposit base different from other peers, it's largely institutional. It's very sophisticated investors. So they acted very swiftly when rates started to rise. And so we saw a lot of the deposit migration very early in the hiking cycle, very much as we expected and as we saw last time around. And by the way, we captured -- a lot of migration we actually captured in our liquidity platform in our money market fund alternatives. Also another thing, which is just playing a part in this, is that we've gotten a lot more sophisticated actually in how we manage deposits. So whether it's just the data or the insights that we have in terms of deposit quality, literally at the client level or enhanced and differentiated pricing capabilities that we now have that we just actually didn't have several years ago. So all of that is really helping us in terms of predicting and managing deposits, both in the past and going forward -- this year and going forward. But if you're really asking what do you think about for 2023, I mean, ultimately, we do expect some, albeit lower runoff than we saw in 2022, certainly from QT. Some of that is going to be offset with continued underlying growth across our businesses. So in our businesses deposits are naturally a part of that, and whether that's the growth we're going to see in Asset Servicing, Pershing, Treasury Services, et cetera. So net-net, when you put it all together, I would project a modest decline from what will be our fourth quarter average.

Would that apply to the mix as well?

The mix actually we still expect for NIBs to kind of revert back to anywhere from 20% to 25% of the total deposit base, and they're running higher at the moment.

Got it. All right. Why don't we pivot a little bit and talk about expenses, everyone’s favorite topic. So clearly, 2022, even though you guys are coming in at the lower end of the guidance, 5% to 5.5%, is a fairly elevated level relative from what we have seen from the bank in the past. Can you spend maybe a couple of minutes on where are you incrementally adding versus the areas where you can see still some savings in, but also through the cycle, how do you think about a reasonable expense base growth for the firm?

So you're going to hear a lot more about our 2023 expense trajectory in January. But needless...

I had a feeling you would say that.

I knew you would try. Needless to say, myself, Robin and the entire executive committee are intensely focused on bending the cost curve. As we finalize next year's budget, and I think I even spoke about this on our third quarter call, we're actually applying a lot of rigor to our expense base. So we're stratifying all of our expenses, not just technology. We used to use this paradigm, but mostly for technology, and now we're using it for the entire cost base, and so we're stratifying expenses into 3 buckets. So first is structural or run the bank. And yes, they are higher as a percentage of the total cost base than we'd like. Second is change the bank. And there, we actually double click and look at what's actually investments for growth, investments to actually transform the business, or investments required to meet ongoing regulatory obligations. And then, finally, you've got, of course, revenue-related expenses, which we think of as good expenses because they're growing with topline revenue growth. We're looking at each and every bucket with a lot of intensity, looking at the CAGR, the exit rate, the ROI. And as we said and as also Roman alluded to, we are committed to reducing structural expenses and delivering on positive operating leverage. And the last thing I'd say is that when you think about just investments and investments we make on any given year. I mean, ultimately, it's driven really by a number of factors, I should say, but the 2 most important is really the opportunity set and the bandwidth or likelihood of success, meaning can we execute this well? In 2021, we started talking about very specific and compelling opportunities that we thought were time sensitive, whether it was Pershing X, digital assets, RTP, those sorts of things. In 2022, we've been just uber, uber focused on that body of work. It's not like you've heard us talk about a whole bunch of other things. So we've been very consistent and uber-focused. And so we are also committed to investing through the cycle. But again, we will not lose sight, and we know we have to and we are doubling down on structural expenses.

Great. Perfect. Roman, let's turn it back to you for a second. In your -- in the introduction, in addition to being CEO of Securities Services, you are also Head of Digital. What exactly does that mean when it comes to BK?

That actually was my original job in the bank, and it's very important. But for clarity, what's digital for us? It's 2 things. One is digital assets and second is digitization of the bank. Let me start with the digitization of the bank. The ultimate vision is to digitize our processes, digitize client experience, and, as I said, it really delivers better cost profile, better client experience and better risk management. What's an example of that? Transfer agency. That's a business that we have. It really differentiates us from competition. Offering the digital investor portal. It's a great capability. It's something that clients really want. It's something that end client really wants. And as you can imagine, if an end investor wins, the whole value chain wins, right? Adoption of that leads to reduced reliance on call centers, you take out cost. That's just one example of that. We're deploying client relationship management software, eCRM, across the company, from sales to service. So this way, your salespeople, you can see what's happening with your service, and we really believe in client service superiority. Your service people can see what's being sold. It's digital, better for the client, kind of better for ourselves as well. We’ve obviously been making investments and Emily talked about that, to modernize our overall infrastructure. Modernize in this day and age, that's digital. So we really believe it's a set of capabilities that help us to have much more scalable, cost-effective and better for clients, client experience. And it's the top line as well because we're leveraging our data capabilities. So I talked about the data business that we have. That's the digital capabilities. We're leveraging AI. And again, AI could be sold as a part of something else, forecasting as a part of our custody product, investment analytics with the cash balances, which is something that our clients really need, especially in the market that we’re in today. Fail management capability. So those are the digital capabilities that are run on top of our existing franchise and really serve as the differentiation and kind of cost management measure. And establishing not just in Asset Servicing, in Pershing, you heard a lot about Pershing X. That's a very digital business. But we're also winning important digital-first clients. Arta Finance, that's really a forward-looking, digital-first family office, which was a very important win for Pershing.

Great.

And then on digital assets, we also are kind of proud of building the business. and I can talk about that if you like, for us.

Yes. Now I would love to get your thoughts on that. Yes.

So first of all, digital assets are a lot more -- I know you didn't say the word crypto because it's a lot more than crypto, we're not really focusing on that. I know some people might have seen Robin's article in FT on Friday. We really believe in digital assets in 2 ways. One, it’s an asset class by itself, it's digitized, tokenized securities. One could say this is the next wave of securitization, allowing much faster access to instruments, allowing creation of new instruments, allowing new asset classes, new use cases. So that's a big growth opportunity and a cost opportunity as well. And the second is technology itself. So the technology can make our whole infrastructure to be cheaper, be more scalable, and, frankly, more reliable. Now to do all of that, of course, we need to do it in the right regulatory frameworks. It needs to be done with the right risk management. And that's what we really believe, that digital assets need to be done in the same way, we look at all other financial services instruments, need to be done by regulated institutions. That's why our mission of trust is critical here, and we're putting innovation on top of that. So whether that's an asset class or underlying technology, we're quite bullish in both. And we really believe that institutional adoption of tokenization is here. We've done a recent survey, 90% of institutional investors are interested in digital assets, and they expect to have a reliable partner to do that. And we want to be that partner, and we are working with the regulators around the world to really advance the regulatory frameworks to ensure digital assets, like everything else, it's safe, secure and everything that you expect to come with services of Bank of New York.

Great. We have less in a minute left. So maybe I'll sneak one more question, just for Emily real quick on capital returns. Bank of New York Mellon’s been largely on the sidelines this year when it comes to buybacks. You guys are in a much better position now. You have $500 million of proceeds from Alcentra sale to Franklin earlier this year. AOCI should be much less of a headwind, hopefully actually a bit of a tailwind now. Any thoughts on 2023 buyback activity?

So basically, exactly as you suggested we've been accreting capital this quarter. It's obviously been helped by the sale of Alcentra, which freed up about $0.5 billion, as you suggested, that closed last month. We do expect in the fourth quarter to be comfortably above both our CET1 as well as our Tier 1 leverage ratios. We have been conservative. We think that during the period of volatility that we saw this year, that was correct. But certainly, as we look to 2023, we are expecting to resume buybacks in the first quarter. Again, as you suggested, we're starting the year with excess capital. We have a capital -- certainly generative business model and we're likely to see, again, based on the forward curve, some AOCI pull to par. So what I would end with is that we're very well positioned to return north of 100% of our earnings to our shareholders next year.

Great. Also great note to end on. Before we wrap up, this is Emily’s last time presenting at least in her CFO capacity in our conference. So I really just want to thank you for your insights, the time you spent with the investor community, the analyst community, and a lot of it was over Zoom. So you started at a tricky time for the ecosystem. But thank you so much, and we look forward to seeing what's next.

My pleasure.