The fourth-quarter earnings announcement that Mellon Financial (NYSE:MEL) released last week trumpets a 50% increase in EPS from continuing operations. A close look at the numbers reveals that the performance of this investment manager and securities processor was solid, but less dazzling than the headline would suggest.
The bank's revenue, which is mainly noninterest income, was $1.5 billion in the quarter, an increase of 27% from the previous year. Mellon's net income rose to $237 million from $208 million, an increase of 14%. The decision to sell the venture capital business caused the bank to recognize a loss of $61 million in the fourth quarter, and that charge for discontinued operations largely accounts for an earnings growth rate that is modest when compared with the sizzling earnings increase attributed to continuing operations. For the full year, revenue rose to $5.3 billion from $4.7 billion, or 14%, and net income increased to $898 million from $782 million, a 15% improvement.
The triumphant tone in the headline obscures a number of other items that might lead investors to a more sober view of the bank's prospects. In particular, Mellon's $0.72 of EPS from continuing operations in the fourth quarter was boosted by a tax benefit of about $0.18 per share. In addition, about one-third of Mellon's revenue growth came from the increase in performance fees earned by its investment management unit. Unlike investment management fees, which are generally steady throughout the year, performance fee income is more seasonal. As the name implies, that income also depends on an adviser's ability to deliver returns in excess of certain benchmarks. Investors should therefore be careful about spotting a trend in Mellon's stunning 154% year-over-year increase in performance fee income.
There were a number of one-time items included in Mellon's results from continuing operations that hurt performance. Had severance payments, impairment charges, and merger-related expenses been omitted, Mellon's net income would have been higher by $41 million, or $0.10 per share. Nevertheless, a quick read of Mellon's earnings announcement was much more likely to leave an impression of the bank's performance that is too exuberant rather than too restrained.
On balance, however, Mellon shareholders should feel very positive about both the recent performance and the outlook for Mellon's pending merger with Bank of New York (NYSE:BK). Mellon's core businesses are attractive for their stability and long-term earnings growth potential. Mellon is one of the world's largest asset managers, with $995 million under management, which represents a 27% increase over the previous year. Overall, investment management fees increased by 52% to $797 million, and excluding the effect of acquisitions and performance fees, investment management income grew by a still impressive 26%. Mellon's large custody business also showed strong growth. Assets under custody or administration reached a record level of nearly $4.5 trillion, a 15% increase over the previous year's total. Trust and custody fees increased by 14%, but earnings fell by 15% because of certain one-time items.
The combination of Mellon and Bank of New York's custody businesses will create a giant with more assets under custody than JPMorgan Chase (NYSE:JPM), the industry leader. Such market dominance is important in determining the profitability of both asset managers and securities processing firms. Accordingly, it's expected that the merger of Mellon and Bank of New York will result in significant cost savings from their scale businesses -- the ones that get more profitable as they grow. The complementary nature of asset management and securities processing also promises to create opportunities for revenue growth.
Investors who are considering buying shares of Mellon might view the recent share price of $44 to be a good value when compared with the stock of industry rival State Street (NYSE:STT), which trades at a higher price-to-earnings multiple than Mellon. Mellon is an attractive investment for its steady, low-risk asset management and securities processing franchises, as well as the enhanced potential for earnings growth that will follow its merger with Bank of New York. The bank's dramatic improvement in earnings from continuing operations, however, does not appear relevant to the compelling rationale for making a long-term investment in Mellon's stock.
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Fool contributor Michael Leibert welcomes your feedback. He owns shares of Bank of New York. The Fool has a disclosure policy.
