Custody banks hurt by absence of commercial lending

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Bank of New York Mellon and State Street in Boston have been struggling with their balance sheets.

While core fee-generating businesses helped the custody banks' second-quarter profits, their traditional banking operations have been hampered by fallout from the coronavirus outbreak.

Net interest income at the $280 billion-asset State Street fell by 16% from the first quarter to $559 million. Chief Financial Officer Eric Aboaf warned on Friday that another 9% to 11% decline is likely in the third quarter.

The $442 billion-asset Bank of New York Mellon reported earlier in the week that its net interest income fell 4% in the second quarter, with an expectation of an 8% to 11% decline in the current quarter.

State Street is focused on expense management as lending conditions worsen, says CEO Ronald O'Hanley.
State Street is focused on expense management as lending conditions worsen, says CEO Ronald O'Hanley.

Low interest rates in the wake of emergency cuts by the Federal Reserve were largely to blame, executives at the companies said.

“When you look at the third quarter, it's really all about rates coming down and getting the full impact of that for the full quarter, that's really the primary driver,” Michael Santomassimo, Bank of New York Mellon's CFO, said during a conference call Wednesday.

Unlike other large banks, State Street and Bank of New York Mellon did not participate in the Paycheck Protection Program. Many other banks were able to bring in millions of dollars in PPP loans, along with low-cost deposits, and they will eventually collect fees that will be included in net interest income.

At the same time, neither bank is a major player in commercial and industrial lending or commercial real estate.

Total loans at State Street fell by 17% from the first quarter to $26.9 billion, while deposits decreased by 92% to $200.5 billion. Bank of New York Mellon's loan portfolio shrank by 11% to $55.4 billion, and deposits declined by 9% to $305.5 billion.

Those declines highlight the importance of the companies' fee businesses and expense management.

Overall, State Street's earnings rose by 9.5% from a quarter earlier to $694 million. Bank of New York Mellon's profit was flat from the first quarter, at $965 million.

State Street was able to reduce expenses for the first six months of 2020 by 2% from a year earlier, CEO Ronald O'Hanley said during the company's earnings call. "We cannot control the economic environment, but we can control our expenses," he said.

Several extraordinary steps factored into each company's quarterly results.

Low rates forced Bank of New York Mellon to waive about $80 million in money market advisory fees in the second quarter. Executives said they expect the waivers to continue through the rest of 2020.

State Street reported $14 million in net charge-offs for the second quarter tied to a decision to de-risk its $4 billion leveraged loan portfolio. The company sold about $160 million of loans at a discount.

“It effectively cost us $6 million given the necessary reserve build, so a good trade,” Aboaf said.

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