Opinion

Felix Salmon

BNY Mellon’s interest-rate problem

By Felix Salmon
September 5, 2011

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.

Comments
11 comments so far | RSS Comments RSS

So repo rates on all products are the same as the discount rate? If I ever need a locate I am coming to you!!!

Posted by Danny_Black | Report as abusive
 

Amazing piece of nonsense.
Actually, BNY has $1.3 trillion of assets under management and $26.3 trillion under custody (custody means: settlement, safekeeping, and reporting of customers’ marketable securities and cash). If some of the assets under custody are available for lending, it is a choice by and for the benefit of the customer/owner, and BNY gets a servicing fee, not the “interest rate”.

Posted by alea | Report as abusive
 

alea, I didn’t even get that far just saw securities lending and interest rate.

It is extraordinary that some 3 years at least of writing about finance, Mr Salmon cannot get the very elementary basics correct. Custody has nothing to do with asset management. It is not “incredibly difficult and expensive”, it is merely a scale business that requires a big upfront investment in systems and people but once you have the scale it is usually money for old rope. You charge a few basis points on the assets under management.

Off the top of my head, recently you have got wrong what sub debt is, what duration is, what custody is, how securitisation works – repeatedly – the difference between market making and clearing – admittedly you were cutting and pasting from some other incompetent – how second liens work and what in fact the Fed does.

You wrote about economists a little while back. Is it not time for journalists to have to pass some sort of basic competency test for the field they are reporting in? Especially in finance, where they seems to be an even stronger tendency to cut and paste and where they can have a direct market impact. Analysts are required to at least have some elementary grasp of the words they use, why not journalists?

Posted by Danny_Black | Report as abusive
 

“Is it not time for journalists to have to pass some sort of basic competency test for the field they are reporting in?”

Hasn’t ever been that way, has it?

Felix does bring up interesting topics, and generates interesting responses. Valuable, even if occasionally his articles are off-base.

Posted by TFF | Report as abusive
 

I don’t know… Maybe it is nostalgia but it does seem over the last decade that basic fact checking went out the window.

Posted by Danny_Black | Report as abusive
 

“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.”

Hm. The $270 billion of liabilities on its balance sheet may also have something to do with this.

Posted by right | Report as abusive
 

The amazing thing here is the $38 million payout for failing. That’s obscene. But then executive pay has mushroomed by 187% since 2002 while stock prices have only gone up by 21% in the same period. The day when managers cared about shareholders has long gone.
http://www.bbc.co.uk/news/business-14781 254

Posted by FifthDecade | Report as abusive
 

If you are talking about the custodian then it is usually a percentage of assets under management. You could argue that in a low-interest rate environment that asset prices are inflated and so they make MORE fees. You could also argue that there is only a low-interest environment when prices are depressed so they make LESS fees. Point is that it has nothing to do with interest rates.

Posted by Danny_Black | Report as abusive
 

FifthDecade, actually he got a 2 million payout. The rest is stock he built up over time, pension and 4 million stock related bonus.

No idea if he is worth 2 million but as usual the headline is inaccurate.

Posted by Danny_Black | Report as abusive
 

“No idea if he is worth 2 million but as usual the headline is inaccurate.”

I’m not sure how inaccurate that headline is. The guy is walking with 80 million bucks and the stock at a multi-year low. I’m a capitalist. I love the idea of earning powerball money instead of just winning powerball… and make no mistake it can be done. Whatever Steve Jobs is worth he was massively underpaid. Mark Hurd was worth of every penny he ever got out of HP… but this guy is retiring with a level of compensation which simply does not reflect the contributions he made to the company. That is a EPIC FAIL of the board of directors fidicuary responsibility to their shareholders and the reason I hope Karl Ichan lives to be 200 years old.

Felix… you are absolutely right that custody is tricky. Just ask Fifth Third or Key bank if custody is easy… they have both had to invest millions upon millions in systems and technology and make virtually nothing custodying hundreds of billions of dollars. Custody is a go big or go home business!

Posted by y2kurtus | Report as abusive
 

y2kurtus, according to report – which admittedly may not be accurate – the total amount he is getting is 33.8million not 80mn. He sold Mellon to BNY at the top of the market and I suspect a large portion of his compensation derives from that fact. The only bit that makes no immediate sense is how he gets 4million bonus for dragging the stock down but i suspect he is compensated based on outperforming certain peers and the index he is being measured against is massively down.

Posted by Danny_Black | Report as abusive
 

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