There is more than one way to run a bank. Most banks make their money by taking in low-cost deposits and loaning money out at higher interest rates. Some do this recklessly and, in my opinion, should be avoided.
Some banks make their money in an entirely different way. Trust banks like State Street Corp, (STT), Northern Trust Corp. (NTRS), and the Bank of New York Mellon Corp. (BK) do not focus on checking accounts or debit cards, and do not run catchy advertisements for home loans or auto loans. They do not have branches in your neighborhood. They make their money by charging fees for custodial, administrative, or trust services. I am going to take a closer look at a few of the country's largest trust banks to see whether any, from an investor's perceptive, appear to have quality prospects going forward.
Northern Trust Corp. (NTRS) is the nation's 23rd largest bank, with about $94 billion in assets. It has 15 branches in this country, and four overseas offices. It has $4.1 trillion in assets under custody, and about $645 billion of assets it actively manages. These branches are for the purpose of securing select private banking clients in high income areas.
Northern stock was trading recently at about $41 per share. Its 52 week range is from $56.18 to $33.20. It trades at a P/E of 16, has a market capitalization of $9.9 billion, and pays a quarterly dividend of $0.28, for a yield of 2.7%. The dividend payout has been stable for the past four years. In its third quarter of 2011, Northern posted profits of $170.4 million, or $0.70 per share. This was up 10% from the year ago quarter when it earned $155 million, or $0.64 per share. If Northern in the 4th quarter of 2011 meets projections of $0.68 per share, its return on assets for the year will have been 0.64%.
Like other trust/custodial banks, Northern has no real issue with credit quality or reserves. Its reserve for loan losses is roughly $60 million, a small fraction of what one would expect of a similarly sized commercial bank. But the bank is struggling both from revenue and an expense standpoint. For the first nine months of 2011, non interest expenses have actually exceeded non interest income, an absurd situation for a trust bank. And in this low interest rate environment, it is not easy for any bank to maintain interest income.
In October, a Goldman Sachs Group (GS) analyst listed Northern as a company having a 15% chance of being acquired during the 12 months through October of 2012. Northern has been in a downward trend in profitability since 2000, and barring a rumored or actual tender for the company, I see no other compelling reason to buy into it.
State Street Corp. (STT) traces its roots to 1792 in Boston. It has grown since that time to have been included in the Financial Stability Board's list of 29 global banks deemed too big to fail. It is the ninth largest bank in the United States, with some $209 billion in assets.
STT's stock was trading recently at about $42 per share. Its 52 week range is from $50.26 to $29.86. It has a P/E of 13.1, and a market capitalization of $20.5 billion. It raised its dividend early in 2011 from 1 cent per quarter, to $0.18 per quarter, for a current yield of 1.7%.
In the third quarter of 2011, STT reported profits of $1.10 per share, or 10% above the same period of 2010. STT attributed this to a combination of leverage (margin) improvement, expense control, and fewer shares outstanding. The company is expecting earnings of $1.00 per share in the fourth quarter, which if true will give STT full 2011 earnings of $4.03 per share, up from $3.09 in 2010. That would also give STT a return on assets of 1.0%, a nice return for a bank with relatively little credit risk.
As a trust bank, STT does not have things like billion-dollar charge-offs, and its reserve at this time is less than 0.2% of loans outstanding. But its margin is also far less than commercial banks. It makes its money charging modest fees on the $21.5 trillion it has under custody, and the $1.86 trillion it actively manages. STT is looking to Europe to grow its business, and its most recent acquisition in a string of 2011 activity was Swiss analytics firm Complementa Investment-Controlling, AG.
Activist investor Nathan Peltz of Triad Management took a position in STT late in 2011, and has made demands that the bank to more to increase its profitability. STT announced a $1 billion stock buyback, and with its exceptional capital strength, indicated a willingness to share this strength with its shareholders. Goldman Sachs likes STT more than other trust banks, and analysts in general have a moderately positive mean rating of 2.1. For the few years ahead, STT is clearly the trust bank of choice for investors.
Bank of New York Mellon Corp. (BK) is the nation's sixth largest bank, with banking assets of about $330 billion. It is also on the Financial Stability Board's list of banks too big to fail. The reason why BK and STT are on that list is not just a matter of their size; both are deeply entwined with other banks and institutions. BK is the custodian of some $26 trillion, and the active manager of $1.2 trillion. Its stock was trading recently at just over $20 per share, near the low end of its 52 week range of from $32.50 to $17.10. It trades with a P/E of 9.5, has a market capitalization of $24.8 billion, and pays a quarterly dividend of 13 cents, for an annual yield of 2.5%.
In the third quarter of 2011, BK reported earnings of $653 million, or $0.53 per share. This was up 4% from the $0.51 per share in the third quarter of 2010, but down nearly 10% from the $0.59 per share profit in the second quarter of 2011. The consensus analyst expectation for the 4th quarter of 2011 is $0.53 per share, which if true would make for a per share of $2.15 for the year, which would equal a return on assets for the year of about 0.80%.
Much of BK management’s attention in 2011 was on litigation concerning alleged currency manipulation. In late December, BK settled state claims for a total of $1.3 billion. More litigation remains, and is a drag on BK's stock price. BK's stock has traded in the same range for most of the last 10 years. During that time, the P/E has trended down steadily to its current level. By most measures, BK is undervalued now, with its price some 30% below its current book value. Yet I do not see much support even at this price, as the mean analyst rating is neutral 2.4. I believe many commercial banks make for better bets than BK. So does State Street.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.