BNY Mellon’s interest-rate problem

By Felix Salmon
September 5, 2011
$33.8 million in severance and benefits in the wake of resigning his position?

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Why is BNY Mellon’s ex-chief, Bob Kelly, getting $33.8 million in severance and benefits in the wake of resigning his position? As Theo Francis explains, it’s because, in the words of the official 8-K, “Mr. Kelly will receive the benefits to which he is contractually entitled on a termination other than for cause”. If this was actually a resignation, Kelly would have got much less. But in reality — and this will come as a surprise to absolutely no one — he had no choice in the matter: he was fired by the board.

The board is spinning this as a question of management style: they’re kicking out the hotshot CEO, and replacing him with the company man. That’s fine, and their prerogative. But the real problem at BNY Mellon is not one of management. And although it can look pretty bad in the press, massaging its earnings and neglecting its duties as RMBS trustee and ripping off its customers on FX fees, ultimately such things are symptoms of a much deeper malaise.

BNY Mellon makes its money by managing $26.3 trillion in assets under custody. That’s a bigger number, I think, than is humanly possible to comprehend, but here’s a start: it’s about $4,000 per human being on the planet, or $85,000 per American, or $235,000 per US household, or five times the market capitalization of the S&P 500. It’s a truly insane amount of money. These aren’t BNY’s assets, of course — they all belong to someone else. But BNY looks after them, and reliably looking after that quantity of assets is an incredibly important and stressful and difficult and expensive thing to do.

Now if you have $26 trillion in assets under custody, and you can lend them out at a very modest interest rate, you can make a lot of money. But interest rates have been at zero for three years now, and show no sign of rising any time soon — BNY Mellon, and its custodial rival State Street, are among the biggest losers when it comes to the Fed’s zero interest rate policy.

So BNY Mellon is facing a much bigger problem than the question of whose name is going to be on the CEO’s desk. It can try to squeeze profits out of areas where they shouldn’t really be squeezed — by dodgy accounting, or by being less than fully transparent in its FX dealings, or by failing to live up to its duty as a trustee. But the big problem, of zero interest rates, isn’t going away any time soon. Which is why BNY Mellon is trading at a market capitalization of less than $25 billion, despite having roughly six times that sum in cash on its balance sheet.

The board, I think, should not be trying to maximize quarterly profits in this interest-environment. The right thing to do, in terms of preserving the long-term value of the franchise, is to treat clients as well as you possibly can, understand that profits are hard to come by when rates are at zero, and wait patiently for better days to arrive. BNY is a public company, so it finds it hard to do that — you can be sure that Kelly would never have been fired if the stock had been going up rather than down. The board’s duty is to represent shareholders, and the shares have been falling, so the board fired the CEO. It’s unlikely to make much of a difference. It just isn’t Bob Kelly’s problem any more.

Update: The part about lending out assets was silly and lazy, sorry. BNY does have an asset-management business with something over a trillion dollars under management; those assets can be lent out. Are repo rates directly related to the overnight Fed funds rate? No, but they’re not unrelated, either. More importantly for BNY, there’s the question of how custodian banks make money from the assets they’re looking after. I haven’t seen a breakdown, but my guess is that most of those assets are fixed income of some description; even if they’re not, their owners tend to be hyperconscious of every basis point when they’re living in a zero-interest-rate environment. Custodian banks make money by effectively reducing the income that the owner gets from her securities by a certain number of basis points. That number looms much larger in a zero-interest-rate environment than it does when rates are higher.

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