As the Federal Reserve continues to raise interest rates, investors are beginning to worry about a potential recession. During a recession, consumers cut back on spending, workers get laid off, businesses fail, and credit losses mount. This is usually a difficult time to be invested in bank stocks.
That said, many banks have different business models and some are more resilient to economic shocks than others. If we are heading into a recession, investors interested in bank stocks should take a look at Bank of New York Mellon (BK 0.89%), which earns most of its money from fee income.
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The market is flashing a recessionary signal
One of the classic signs of a recession is an inverted yield curve, which means that short-term interest rates are higher than longer-term interest rates. The difference between the two-year Treasury and the 10-year Treasury is a pretty powerful economic indicator. If you look at the current difference, it is 0.68%, which is the biggest difference in 40 years.
Prior times that the yield curve inverted include the Great Recession of 2008-09, the bursting of the stock market bubble in 2000, the crash of 1987, and the 1980-1982 recession. An inverted yield curve has long been associated with an economic dislocation.
10-2 Year Treasury Yield Spread data by YCharts
If the U.S. is entering into a recession, banks will struggle as credit losses begin to mount. Both consumers and businesses will be affected. In this environment, banks that rely on fee income will have less exposure to the recession.
Trust banks are less sensitive to the overall economy
Bank of New York Mellon is a trust bank, meaning it makes most of its money from services other than lending. Bank of New York Mellon's securities services business performs custody services, fund management, accounting, and other services. A mutual fund may employ Bank of New York Mellon to handle its fund management. It will process inflows and outflows, forward dividend income to the ultimate investors, keep the books for the fund, and handle security clearing duties. But the bank earns fees from these businesses, not interest.
Bank of New York Mellon also owns Pershing, which is the biggest fixed-income clearing firm in the U.S. When Bank of New York Mellon "clears" a trade, it ensures that a transaction in the fixed-income market gets consummated. The company will ensure that the buyer has the money to buy the securities and the seller actually has the securities to sell and will forward the money and securities after the trade clears. Bank of New York Mellon then earns a fee for clearing the trade.
Pershing is part of the market and wealth management business, which has the highest margins for the Bank. Finally, Bank of New York Mellon also has a wealth management business. This is another business that is largely fee-based.
If the U.S. is entering a recession, Bank of New York Mellon will be in better shape than the typical bank given its lack of credit exposure. The company is trading at 12.9 times expected 2022 earnings per share and has a dividend yield of 3.4%. In a recession, Bank of New York Mellon could be your port in the storm.
