Last week, BNY Mellon’s (NYSE:BK) CEO Gerald Hassell and CFO Todd Gibbons presented at the Goldman Sachs (NYSE:GS) Financial Services Conference 2012.  And as they outlined the banking group’s performance over recent years and the outlook for their business model which cover all aspects of the investment life cycle, the proposed “operational excellence initiatives” aimed at cutting down recurring costs grabbed our attention.
While cost cutting is a top priority for all major banking groups around the globe due to the weak economic conditions prevalent, we concluded that such measures are much more important for the world’s largest custody bank because of the marked impact that costs have on its bottom-line and therefore its stock value.
In this article, we highlight how sensitive our $27 price estimate for BNY Mellon’s stock is to its non-interest expenses. Our price estimate is at a premium of about 10% to the current market price.
BNY Mellon’s top brass intends to cut down on annual costs by about $650-$700 million within three years by streamlining operations, investing in technology and consolidating corporate services. That is a reduction of 6%-7% in $11.1 billion in total non-interest expenses BNY Mellon reported for 2011.
We capture BNY Mellon’s non-interest expenses in our analysis of the bank through our forecast for these expenses as a percentage of total revenues as shown in the chart above. The figures for 2008 and 2009 were inflated as losses dragged down total revenues while costs remained at nearly the same level before 2008. In 2011, the figure was slightly above 75%, and we forecast it to gradually improve to 72% by the end of our forecast horizon. Note that we actually forecast an increase in non-interest expenses in dollar terms from $11.1 billion in 2011 to $14.3 billion over the forecast period – and the reduction as a percentage of revenues is because of faster estimated growth in BNY Mellon’s total revenues.
Now here’s the important thing – how much of BNY Mellon’s value depends on these expenses? For that, let us assume an extremely optimistic scenario where BNY Mellon is not only successful in implementing its current cost cutting plan, but also chips in more because of which non-interest expenses only increase marginally to reach $12.5 billion by the end of the forecast period.
As a percentage of revenues, expenses fall to about 65% over the period in this case. Making this change in the chart above lifts the price estimate to $32 from the current $27 value – an almost 20% jump.
The key takeaway here is that BNY Mellon will naturally incur additional costs as it focuses on expanding its business, but it is extremely important for the bank to keep a close eye on its bills to make sure it is returning maximum value to its shareholders along the way.
- BNY Mellon Presentation, Dec 5 2012