The COVID-19 pandemic has been tough on the financial sector. Banks have had to take massive provisions for future credit losses, while real estate investment trusts must deal with struggling tenants who can't make rent. In this environment, financial stocks with more limited levels of credit risk have proven resilient -- but that doesn't necessarily mean they've been immune to the crisis. Bank of New York Mellon (NYSE:BK) can attest to that: The Federal Reserve's dramatic actions to support the economy have had some negative effects on its earnings.
The fee model is different
BNY Mellon's business model is a bit different than that typically used by commercial banks, which take deposits and then use those funds to make loans or investments. As more of a trust bank, BNY Mellon earns its income from fees. It's the custodian bank for many mutual funds and major corporations, handling many of their day-to-day activities, such as making distributions and taking in new funds. Its Pershing unit -- a global financial solutions provider that handles the clearing of trades, among many other things -- is another big part of the institution.
Because BNY Mellon's business is largely fee-driven, its credit risk is much lower. Admittedly, it does take on some credit risk -- but not in the way a Citigroup or JP Morgan Chase does.
Total revenue for the third quarter came in at $3.1 billion, which was more or less flat on a year-over-year basis but down by about 2% from the second quarter. Earnings per share (EPS) were $0.98, compared to $1.01 in Q2 and $1.07 in Q3 2019. Asset servicing revenue fell 7% sequentially and 4% on a year-over-year basis, while Pershing revenue fell by 7% sequentially and 6% year over year.
Low interest rates take a bite out of fee income
Money market fee waivers drove the drop in revenue: Extremely low interest rates made it difficult for the bank's money market offerings to earn enough to cover the usual fees it charges for them. The waivers are put in place to ensure that such funds don't wind up with a negative rate of return. Note that this scenario is different from the financial crisis, when investors worried about money market funds "breaking the buck" -- in other words, that funds' net asset values would fall below par. Today, the concern relates to the interest being paid by the assets the funds hold, not those assets' underlying values.
BNY Mellon's CEO Todd Gibbons had this to say about the quarter:
"Our third-quarter results reflect the resilience of our business model despite the significant impact of lower rates and associated money market fee waivers, as we reported EPS of $0.98, down 8% year on year. Our operating margin was 30% as we controlled costs, and our return on tangible common equity was solid at 17%. ... While uncertainty lies ahead in terms of how the pandemic evolves and its impact on the global economy, I believe the underlying strength of our franchise will become more apparent next year, as we expect to have most of the run-rate impact of lower rates and associated money market fee waivers in our earnings."
Despite the issues with low interest rates, this business model continues to generate excess capital. On the earnings conference call, Gibbons that he hopes to reinstitute share buybacks as soon as regulators and market conditions allow. He also said he believes buybacks will be "meaningfully accretive to EPS." Investors looking for a more defensive bank stock to hold as the market moves into the next phase of the COVID-19 crisis should take a look at BNY Mellon.