Good morning, and welcome to the 2021 Second Quarter Earnings Conference Call hosted by BNY Mellon. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material.

You may not record or rebroadcast these materials without BNY Mellon’s consent. I will now turn the call over to Marius Merz, BNY Mellon Investor Relations. Please, go ahead..

Thank you, operator. Good morning, everyone. Welcome to the BNY Mellon's second quarter 2021 earnings conference call. Today, we will reference our financial highlights presentation available on the Investor Relations page of our website at bnymellon.com..

Thank you, Marius, and good morning, everyone. Now, I'm going to touch on a few of the highlights before I hand it over to Emily, and she'll review our second quarter financial results and the outlook for the second half of the year in more detail.

So if we refer to Slide 2 of the financial highlights presentation, we reported EPS of $1.13, that's on $4 billion of revenue, and we generated a return on tangible common equity of 19%. Fee revenue was up 4% year-over-year, and it was up 10%, excluding the impact of money market fee waivers. Average deposits were down 1% quarter-over-quarter.

This, together with strong capital generation, drove an approximately 20 basis point increase in our Tier 1 leverage ratio. And we are pleased with the results of this year's supervisory stress tests, which once again demonstrated the resilience of our business model and the strength of our balance sheet, even under severe stress.

And we also welcomed the Fed's decision to lift the recent restrictions on common stock dividends and share repurchases at the end of June. Now, taking a step back for a look at the broader operating environment. We continue to be impacted by the significant amount of excess cash in the system.

We welcomed the Fed's decision to raise the IOER and the overnight reverse repo rate by 5 basis points last month. That provided a bit of support to short-term rates, although they continue to be exceptionally low by historical standards.

Money market funds take up of the Fed's reverse repo facility increased from approximately $500 billion prior to the Fed's action to north of $750 billion, and they actually spiked to almost $1 trillion at quarter end. This means that somewhere between 15% and 20% of total U.S.

money market fund assets are being parked at the Fed, earning 5 basis points. Now given the significant amount of excess cash in the system and the expectation for further Fed balance sheet expansion, bank balance sheets will continue to be under pressure, but money market funds may provide some relief..

Thank you, Todd, and good morning, everyone. As I walk you through the details of our results for the quarter, all comparisons will be on a year-over-year basis, unless I specify otherwise. Beginning on Page 3. Total revenue was lower by 1% due to lower net interest revenue and higher money market fee waivers, partially offset by strong fee growth.

Fee revenue grew 4%, or 10% excluding the impact of fee waivers. This reflects the positive impact of higher market values, the favorable impact of a weaker U.S. dollar and higher client activity. Other revenue was $91 million and included approximately $30 million of investment disposal and other income gains. Net interest revenue was down 17%.

Expenses increased 3% with about two-thirds driven by the weaker U.S. dollar. Provision for credit losses was a benefit of $86 million, driven by an improvement in the macroeconomic forecast. EPS was $1.13, and pretax margin was 32%. Moving to page 4, which shows a trend analysis of the main drivers of our quarterly results.

Investment Services revenue was $3 billion, down 4% year-on-year, mainly driven by lower net interest revenue and higher fee waivers.

Excluding fee waivers, Investment Services fee and other revenue was up 5%, reflecting increased client activity and organic growth in assets from existing clients, higher liquidity balances and market levels and the benefit of the weaker U.S. dollar.

Investment and Wealth Management revenue of $1 million increased 13% as higher market values and the benefit of the weaker U.S. dollar more than offset the impact of fee waivers. Excluding fee waivers, fee and other revenue was up 21%.

Money market fee waivers, net of distribution and servicing expense were $252 million in the quarter, up $64 million from the prior quarter, which impacted pretax income by approximately $40 million, sequentially. Higher waivers were driven by lower key bill and repo rates as well as higher average balances. Turning to page 5.

Our capital and liquidity ratios remain strong and well above internal targets and regulatory minimums. Our CET1 ratio was 12.6%, flat to Q1 under the standardized approach.

And our Tier 1 leverage ratio, which is our binding capital constraint was 6%, up approximately 20 basis points sequentially due to net capital generation and a 2% quarter-over-quarter decrease in average assets.

Average deposit balances declined by 1% as we've been successful at curtailing deposit growth by working with our clients to move excess deposits to off balance sheet vehicles, namely money market funds, which were up roughly 9% sequentially, outpacing the industry. Finally, our LCR was 110% flat to the prior quarter..

Our first question comes from the line of Glenn Schorr with Evercore ISI..

And thanks for taking away like 17 of my questions with that outlook. That was helpful. Can I get a follow-up on the expense question? So if you look at year-on-year, it was up 3%, I heard your guide. It was - expenses were down 3% quarter-over-quarter.

Can we talk about the growth opportunity piece you mentioned? What growth opportunities are you investing in? And what kind of payback can we expect? How do you think about that given your huge excess capital? I'm just - my real question is why not invest more? So that's where I'm going with it..

It's a great question, Glenn. Thank you. So, as you have rightfully pointed out, we have been extraordinarily disciplined on expenses, and we've actually held them flat over the course of the last four years. Everything that we're talking about here are investments in growth and efficiency, and just to name a few.

So certainly, digital assets and all the things we've talked about around digital assets, data and analytics, advisory services in Pershing as well as the managed account space. I'd highlight also electronic payment and collection services and Treasury Services.

And then the remainder would be modernizing and automating our - both our risk management and our operations infrastructure. And really, as you alluded to, we had a very strong half. We have a very strong capital-generative model. There are interesting opportunities.

All of these have been properly vetted and truly will drive incremental growth and efficiency. So we feel now it's an important time to invest..

Glenn, you're still there? I think we lost you..

Yes. Sorry about that. I appreciate all that, Emily. Maybe just a quick follow-up on Pershing. So in past, you spoke about some - maybe some headwinds in the second half.

Are you able to quantify that? Just give us that heads up on what to expect in the second half? And maybe at the high level, talk about the competitive backdrop there, because it seems like some - yet another competitor is poking their nose in and trying to get involved on the high rate clear….

Sure. I can start and I'm sure Todd can add. Just in terms of the impact of the lost business that we had, talked about in the past, it's going to be about $20 million per quarter going forward. And that is, by the way, Glenn, baked into the forecast. So that is embedded in there. And yes, it is a competitive space.

And actually, that particular piece of business that we're talking about was really - were just on the wrong side of some M&A activity. So we do - although, we see a lot of growth and a lot of opportunity, there's certainly further consolidation as well..

Yes. And I would add the consolidation that we've seen is actually a positive for us. So we've got a very robust pipeline. We continue to add a significant number of accounts over the course of the quarter, and as well as seeing significant growth in funds. And we think there's opportunity to actually invest more.

So what we did this quarter is we actually separated the businesses into two. One is the institutional side, where we have some unique capabilities with some very large clients and we've got some pretty good leads there that we're excited about.

But also on the advisory and the broker-dealer side, we think we can invest there and garner some more of what's a very fast-growing industry. There is some competition there. But the consolidation has also provided some opportunity for us. So we do get - every now and then, you get a lumpy loss due to an M&A.

We've looked at over history that really - it hasn't changed. We probably won more than we've lost. But we have pointed out that will have an impact in the third quarter..

Our next question comes from Jim Mitchell with Seaport Research. Please go ahead..

Can you speak to your efforts on deposits? It seems like you had some success keeping deposits flat to down.

Is that deliberate efforts on your part, with less demand for your balance sheet? Maybe you could just speak to the deposit growth in the quarter and how you think about it going forward?.

Sure. I'll take that. So you're right, we have been proactively managing deposits and very successfully. We've been working with our clients, and you can see that in our trends. So despite the Fed and - continuing to pump access liquidity into the system, ultimately, we have managed our deposits, and they're down 1% sequentially.

This has been very much a coordinated effort with our salespeople and our clients and in terms of looking at what's excess on our balance sheet, we probably think we have about $25 billion to $50 billion that still excess.

But what we have been doing is looking at what is excess and actually working with our clients to move it to off balance sheet vehicles such as money market funds. That's partially why you see a 9% growth in our money market fund balances that were driving waivers. And we're fortunate, too, in that we have a very robust liquidity solutions business.

We offer both in-house as well as third-party solutions. And that has been certainly very attractive to our clients as we've endeavored to the balance sheet. And look, going forward, we will continue to do that. It's - we're comfortable where we are.

But certainly, we will continue to do that considering there still likely be more liquidity coming into the system..

Jim, it's a very disciplined process that Emily leads along with the salespeople, treasury function. And we look at it client by client. And the good news is we've been able to capture most of that in our money market funds or our liquidity direct offerings. So we are gaining market share there.

And we've got a little bit of benefit when the Fed did increase the interest rate on excess reserves and the reverse repo that have made that alternative. They provided a bit of an outlet. So, we think even though the Fed will probably continue to provide liquidity and build their balance sheet that we should be able to manage it..

Right. That's helpful.

And then just as a follow-up to that, if you think, you've had success on the leverage ratio, when we think about the buyback that you're targeting over the next 18 months, can you front-load that? How do we think about the cadence of buybacks?.

Sure, Emily?.

Sure. So certainly, the cadence of buybacks is going to be determined by lots of different factors. Our capital position, our forward outlook for earnings, et cetera.

But you can definitely assume that considering we have about $2 billion of excess capital now, and that's just against our binding constraint of Tier 1 leverage, frankly, we have more excess capital when you actually think about what the - a normalized balance sheet size probably is and when some of those excess deposits received.

So assuming - taking that into account, taking into account the fact that we've also committed to our shareholders that we will return 100% of earnings over time, it's safe to assume that we'll probably front-load that $6 billion of authorization that we received from the Board..

Next question comes from Alex Blostein with Goldman Sachs..

So maybe just starting with the NIR guide for the back half, it looks like the amount continues to kind of grind lower a little bit and maybe given what the forward curve has done relative to last quarter, not particularly surprising, but curious if you guys feel like the most of the pain is now in the run rate.

Is this the right sort of jumping off point to think about as we sort of start to pencil out into 2022?.

Sure. So I hesitate to call a trough because every time we do it, it's not accurate. But in terms of just our forward - our outlook, we just use the forward curve when we project NIR. We don't try to get cute. Short-term rates are a bit lower in the forward curve than they were a couple of months ago.

Likewise, as you all have seen, the long end has come down and the curve is flattening. And likewise, in terms of prepayment fees, they have been elevated. And although we do expect them to slow down by the end of the year, they're probably going to still be more elevated than we had originally anticipated.

So all of those things are just baked into the 14% down year-on-year..

Yes, a couple of things. I mean, one of the key drivers is short-term rates when you look at LIBOR’s and obviously, when you look at - if the Fed funds rate or the IOER. So the fact that that has stabilized, and it stabilized a bit in the forward curve, at least out the next six months or so.

So the downside drag to that from where we are is probably not likely to be much, unless something else were to change. And then we're going to have to look at the impact of term rates as we do re-price assets as they come out of the investment portfolio. But our best guess right now is we're pretty close to the trough.

And as we think through money market fee waivers, it does feel like the support in the reverse repo program has probably bottomed that out..

Yes..

I was hoping to dig through a couple of business line items as well. Maybe just focusing on Asset Servicing in for a second, it seems like the business is seeing pretty decent momentum here when I, sort of, back out money market fee waivers from the Asset Servicing line.

And it looks like it was up 2% quarter-on-quarter, 7% year-over-year, so despite obviously moderating industry volumes backdrop.

Can you help us bridge maybe what sort of the source of growth here are sequentially? And as we're thinking ahead over the next 12 to 18 months, what do you expect to be the bigger contributors to growth here? I know there's a bunch of things that go in there, right? There's a custody and admin business, but then there's also tri-party repo and a couple of other things..

Yes. So let me start with the more traditional custody business. I think we are having quite a bit of success there when we've got - we won a couple of very nice mandates this year. Our sales growth is ahead of where it's been. The ETF business is growing very nicely. We captured - it's up significantly on a year-over-year basis.

Our capabilities there are quite good. In our venture with CIBC Mellon, we've actually won 11 of the 16 ETFs that have been listed on the TSE. And so we're seeing healthy growth there. We've got about 100 opportunities in our digital asset space. So that is getting some traction.

And we've got really good flows across a number of our existing organic flows with our existing clients. So it's a combination of all of that, Alex..

Our next question comes from Brennan Hawken with UBS..

Thanks for taking my questions. I'd like to start with the balance sheet. You touched on the estimate of excess deposits that was really helpful. Thanks for that, Emily. Curious about what drove though on the funding cost side, the improvement quarter-over-quarter.

Was there any noise in that? Or do you think that's sustainable? And then when we think about squaring the guide for balances, what are you assuming for deposit growth from here for the rest of the year? Thanks..

Sure. So just on the funding side, really, there was a benefit of also lower rates there. So that was what was driving it, nothing else really notable..

Yes, a lot of our debt is swapped to floating. So as we saw lower LIBOR, we saw through that as well..

Exactly.

And then I think the other question was the - what was the second part of the question?.

Balance sheet growth..

Oh, balance sheet, yes. We - as similar to what I had alluded to before, we will continue to monitor and proactively manage the balance sheet. We do have room should deposits go up further. But of course, like I said, based on the excess that we have, we'd like to kind of stay where we are and frankly, manage it down further..

And then when we think about servicing - the servicing revenue, and Alex touched on this a little, what was the contribution of activity this quarter? What was the benefit of new business? Was there some - did that come in late in the quarter from a - I know we - it's an imperfect way to model, but the way we all model this, it looks that the fee rate got hit this quarter.

So, what were some of the dynamics there? And how should we be thinking about that going forward?.

I mean, if you're talking about like Asset Servicing versus AUCA, which I think is kind of what you're alluding to, AUCA was up 8% sequentially. It's about - one-third of that was market and currency driven, and the remainder was really organic growth. So some really good signs of organic growth.

When you look at that, though, against Asset Servicing fees and revenues, like when we think about it, it's generally helpful rather than look at the 8% to probably look at the thought - sorry, rather than look at the spot to look at the average growth in AUCA, which was about 5%.

And then when you look at the Asset Servicing fee line, it was flat, but ex-waivers was up 2%. And actually, as we've kind of reminded folks in the past, when we look Asset Servicing fees, only 50% or so are truly driven by asset levels. The remainder are driven by account-based fees and transaction fees. So hopefully, that helps..

Yes.

When you get under it all, if you look at really what is the organic growth rate underneath - across the businesses, especially in the Investment Services business, when we look at fees only, if you exclude market appreciation or depreciation and the currency impact, waivers and some of the extraordinary volumes that we had in the second quarter of last year due to the COVID, that's - if you net that out and net the fee waivers out, we're seeing probably something like 2% or slightly better than 2% in the core organic growth..

Our next question comes from Ken Usdin with Jefferies..

Emily, on the fee side, ex-waivers, you talked about the improvement on your outlook to plus seven, eight, plus three.

And I'm just wondering how much of that was just a pull-through of the first half, as you mentioned? And - or if you are actually more confident in what you're seeing in some of the core businesses following on the last few questions about the underlying growth that you are seeing in other fee areas?.

Sure. So ultimately, the 78% is fees, ex-waiver growth over the course of will be year-on-year. So, if you have some of the numbers to do the math. In the first half, we had about 8% growth. In the second half, it will still be very, very healthy, but probably closer to 7%..

So it was more of just how good it's been and then stays is the way to think about it?.

Exactly..

And just coming back to - you laid out a lot of new product insurers you've been talking about this for a while. I guess, the challenge for us is to understand how these product intros turn into revenues and the time frame by which they do convert.

And you've talked about the organic growth improving directionally over time, but how do - how quickly can we start to see some of these improvements and new intros really starting to roll into the income statement? And are there other ones that you can give examples of, which - where they're live and now starting to be meaningful contributors? Thanks..

Sure, Ken. So as we described in the past, if you looked at our organic growth over the past few years before last year, it was basically flat.

And so now we are starting to see - we're starting to get some traction as we've improved a number of our services, invested in our data and analytics capabilities, and we've talked about our digital assets capability. So we're already starting to see some benefit in these numbers, not that we’re seeing an underlying growth rate more like 2%.

We're already starting to see some benefit, to things like our custody and ETF servicing business around some of the digital assets. Our investments in the ETF business is starting to come through and show up in the numbers a bit.

Some of the longer-term investments that we're looking to make, like Pershing, where we're really investing in the platform, we don't expect that to really turn into revenues for as long as two years. So it's - some of these are very - are longer-term and some of them are coming through as we talk about them.

On the Treasury Services side, where you see us gaining some market share, and we've had pretty healthy organic growth there, the multi-currency sweeps, it's caught a lot of attention when we announced that. We have clients in it today, and we think that will gain some traction over the next year or so.

And I would say the same thing with what we're doing with real-time payments and collections. So we've mapped it out. It's kind of all over the board. Some of them are as far as two or three years out. Some of the investments that we're making in custody, we would expect to have a return maybe a year out.

And some of them are starting to bump into and help us generate a positive organic growth rate of the 2% that we're seeing today..

And we'll take our next question from Brian Bedell with Deutsche Bank..

Just want to come back to the AUCA, up to $45 trillion from the $41.7 trillion. You mentioned about two-thirds of that was organic. Can you parse that out a bit between organic from the client base in terms of net inflows at your clients? It seems like $2 trillion is a large number.

So I just wanted to sort of understand new business won by BNY Mellon versus the underlying client growth. And then if you can also comment on the demand for cryptocurrency servicing. Obviously, the Grayscale mandate, which is great.

Are you seeing an increase in that demand in the second quarter versus what - I know that began to spike up in the first quarter?.

Okay. So Brian, when you look at our flows and the growth on a year-over-year basis, about half of it is flows that would include net new, new business, and it would also include any lost business and any organic flows from existing clients. So hooking on some winners they do - as they generate new funds that would be a new business for us.

And then the combination - it's a little more than half is market and currency and the rest of it is coming from the client flows..

I'm sorry, I mean, on a sequential basis from $41.7 trillion to the $45 trillion..

On a….

Okay. On a sequential basis, that number is - it's pretty similar. It's probably….

Actually, a bit more. On the sequential basis, it's about - more of it is based on net new business and currency and markets than it was a year-on-year..

Yes, it's about 50-50. Not….

Okay..

And then you asked a question around demand for Bitcoin Services. And what we have mentioned earlier, we have initiated quite a few ETFs in Canada where they can be traded on the TFC. So we've got 11 of the 16 ETFs that exist there and there is activity there.

And Grayscale, which is the largest asset manager of digital currencies, we've teamed up and partnered with them, both to help them with the existing trust and when and if they get approval from the SEC to list the ETFs, they'll take down our TA and other capabilities there as well. So we are seeing some interest.

And then we're also seeing some interest in - on the - what I'd say, the high net worth side. So there is some retail interest that we're hearing through, some of the Pershing clients as well as other Wealth Management players..

And so just adding to that - that we have - we have been mandated on the 6 of the 13 filings for the….

For the U.S..

Yes, in the U.S. and in kind of the SEC..

And then just a quick follow-up on the assumptions for NIR and the money market fund fee waivers just you mentioned trying to move more of those excess deposits into money market funds.

Just in the assumptions of the guidance that you gave, are you assuming some of that transfer from those excess deposits in terms of both the fee waivers moving down, which would be good, if you were expecting an increase in money microphone balances? And then same with the balance sheet side as we move into year-end, given that guidance, is there an assumption of conversion of deposits to market fund balances within that guidance?.

Sure. I'll take both, and I'm sure Todd will chime in. On the waiver side, really, we're just using the forward curve, and we're just assuming balances stay flat.

As we just - as we talked about earlier before, the Fed actually taking some action with technical rates and raising the repo rate by - reverse repo rate by five basis points has been extraordinarily helpful and that has put a bit of a floor in terms of gross fund yield.

And so that is largely what's driving the improvement that we expect in the second quarter from a run rate of about 200 - what was $250 million this quarter to about $225 million.

So in terms of going forward, of course, as we start to recoup some of that, it's very dependent upon, obviously, it will be very dependent upon balance levels, but that's going to be some time in the future.

From a deposit perspective, where, as I mentioned before, we have a material amount of excess still on the balance sheet, we're fine in terms of where we are. But yes, we'd like to manage that down a bit..

So Brian, what I would add to that is - so yes, we're projecting that those balances are going to come down a little bit in the number for NIR. And you got to remember, when we had all this excess capital and there was nothing we can do about it.

It wasn't particularly in our interest to - to push those balances away, because they did make up - even though it was modest, they did make a little bit of an incremental income, but the return on capital was very poor.

So now that we have the flexibility to manage our capital base through the - through the new regime, we very much want to be much more efficient with the use of - with the usage of the balance sheet. Now, we didn't try to marry that with how much of the balance sheet comes down, how much of that is going to pour - is going to come into fee waivers.

And if - remember, if we are growing the money market funds, we're waiving a pile of the fees as well. So a fee waivers go up a little bit, even though there is some net benefit to us from that. We didn't try to solve that in the guidance that we gave you. We just made it simple, but it's not going to be material in - a material number..

Our next question comes from Rob Wildhack with Autonomous Research..

Just wanted to follow up on a couple of the business lines you called out, particularly noticed that Issuer Services and Treasury Services performed well. You mentioned some of the drivers, particularly the new product in Treasury Services.

But wondering how sustainable you think the growth rate seen in this quarter are going forward?.

Yes. I think we continue to see, as we continue to invest in our payments platform and volumes are moving nicely and we're capturing a little bit of market share, as we look out, we think it's sustainable that we can see some decent growth, and we're introducing some new products that are getting some take-up.

So our - the real-time payments for collections is going to be a very interesting product, and we've got a pretty robust pipeline for that, and we look forward to announcing something in the not-too-distant future around opportunities there. And so, I think, the team has done a good job of capturing that high-margin business.

I think the sales effort globally has been strong. And I think we're well positioned to be a provider of services around the globe. We've got great relationships, and I think we're benefiting from that. So I think there's a little bit of room for continued growth there.

When you look at issuer - when we look at Issuer Services, that includes corporate trust as well as the DR business. Corporate Trust, we've made good inroads in the CLO business. Frankly, a few years ago, we lost a little market share. We're capturing that. We've rebuilt our platform there.

And then, very good growth in kind of the conventional debt servicing. And DRs, they were very much impacted by COVID. And so now that we're seeing some of these global companies paying dividends, again, we're seeing a little more activity there. And so I think there's room to sustain where we are and grow a bit off of it..

And just two quick things I'd add on the Treasury Services space, it's a very fragmented market. So it's ultimately - even a little bit of share gain actually moves the needle considerably. And in DR, as Todd alluded to, just the third quarter tends to be seasonally our best quarter.

We had a very strong second quarter as again, as alluded to, with the resumption of dividends and certainly issuance activity. So the step up will probably be a little bit less in the third quarter..

And our final question comes from the line of Rajiv Bhatia with Morningstar..

Just a quick question on your margins. So your Investment Servicing margin was 34%. Curious if you can provide any color on the pre-tax margins of your - of the various LOBs within there? So, for example, I think several years ago, you spoke about Issuer Services and Treasury Services being higher margin..

Okay. Rajiv, we don't disclose the operating margins across the various businesses. And we did benefit in that margin, obviously, from the reserve release because a lot of that is related to it, but we did see a little bit of underlying margin improvement.

But the operating margins of the various businesses, most of them are similar to what we see across the total that - for example, clearance and collateral a bit higher..

And with that, that does conclude our question-and-answer session for today. I would now like to hand the call back over to Todd with any additional or closing remarks..

Thank you, operator, and thanks, everybody, for joining us today. I know it's a very busy day, so we appreciate the engagement and look forward to talking to you soon. Thank you very much..

Thank you. This does conclude today's conference and webcast. A replay of this conference call and webcast will be available on the BNY Mellon Investor Relations website at 2:00 p.m. Eastern Standard Time today. Have a great day..