The Most Interesting Bank in America

The Bank of New York Mellon (BK 0.75%) is an atypical bank. It doesn't have an expansive branch network. It doesn't advertise widely. And it tends to steer away from doing business with normal folk like you and me.

It specializes instead in acting as a custodian or administrator for assets owned by institutional investors, serving as a clearinghouse in credit markets, and managing wealthy people's money, among an assortment of other activities.

For instance, you've probably heard of mortgage-backed securities at some point over the last decade -- I presume this only because they played a central role in the financial crisis. These represent ownership interests in trusts that hold thousands of mortgages, giving the securities' owners a share of the income generated from the home loans.

But while mortgage originators generally create these trusts, someone needs to administer them -- to act as their legal representative, pay their taxes if necessary, and make sure their beneficiaries (the securities' owners) get what they're contractually entitled to.

This is what custodian banks like The Bank of New York Mellon and State Street (STT 0.32%) do.

That the 230-year-old bank largely eschews the trappings of traditional banking -- writing loans and collecting deposits -- reveals itself in interesting ways in its financial statements.

While most banks generate half or more of their revenue from interest income, The Bank of New York Mellon got 79.5% of its net revenue from fee-based activities (noninterest income) in the third quarter, such as private banking and acting as a securities custodian.

Also interesting is its outwardly understated nature -- the same holds true for State Street, its Boston-based competitor. If you look at The Bank of New York Mellon's balance sheet, it holds $377 billion in assets. That's a lot, placing it just below U.S. Bancorp (USB 0.18%) in terms of size, but it's nowhere near JPMorgan Chase (JPM 1.15%) or Bank of America (BAC 1.74%), as you can see in the table below:

Data source: Quarterly financial filings.

Yet, interestingly, like JPMorgan Chase and Bank of America but unlike U.S. Bancorp, both The Bank of New York Mellon and State Street are classified as global systematically important banks, or G-SIBs, for regulatory purposes. This means that they, along with JPMorgan Chase, Bank of America, and 25 other global megabanks, must hold more capital as a percent of assets than, say, a U.S. Bancorp does.

Furthermore, as students of the financial crisis might recall, its CEO at the time, Robert Kelly, was among the dozen or so bankers present in meetings with government officials at the most acute stages of the financial crisis.

The point is that The Bank of New York Mellon's financial statements belie the central role it plays in the financial system. This doesn't mean there isn't quantitative evidence of its outsized role, because there is. But instead of being on the bank's balance sheet, the evidence is its "assets under custody or administration."

These assets are made up of the trusts (and similar devices) noted earlier, which are owned not by The Bank of New York Mellon, but rather by hedge funds, university endowments, insurance companies, sovereign wealth funds, and other types of institutional investors. The Bank of New York Mellon had $28.5 trillion worth of assets under custody or administration at the end of the third quarter -- that's trillion, not billion.

This is almost twice the size of the U.S. gross domestic product, which is the combined annual income of all people and corporations in the United States, the largest economy on earth. The only thing The Bank of New York Mellon compares to in this regard is State Street, which has $27.7 trillion in assets under custody or administration and a further $2.2 trillion in assets under management.

It's here, in turn, where you can see the fundamental difference between The Bank of New York Mellon's business model and the business model of, say, JPMorgan Chase, Bank of America, or U.S. Bancorp. That is, despite the fact that The Bank of New York Mellon oversees more assets than any other bank in the United States, narrowly edging out State Street, it requires much less capital to do so.

Data source: YCharts.com. Chart by author.

It had only $38.2 billion worth of shareholders' equity at the end of the third quarter. By comparison, JPMorgan Chase had $246 billion worth, Bank of America had $256 billion, and even U.S. Bancorp had $45 billion.

The point is that, because The Bank of New York Mellon doesn't hold its $28.8 trillion worth of assets under custody or administration on its balance sheet, it can scale up seemingly infinitely without running into regulatory limits on leverage. This goes a long way toward explaining why the enigmatic bank's shares have outperformed the S&P 500 over the past three decades by nearly 700 percentage points.