The Bank of New York Mellon (NYSE:BK) is struggling to improve investors' sentiments amid bleak market fundamentals. Its share price plunged sharply in the past couple of months; the future fundamentals suggest that this bank is likely to face further headwinds in the coming days. Declining interest rate, poor financial performance and lower-than-expected growth in dividends make it a poor play for investors.
Falling Interest Rates Are Hindering Growth Potential of BK
Financial and banking industry experienced strong gains in 2018 amid four rate hikes from the Fed. The Fed didn’t make any change in interest rate at the beginning of this year, while some people were expecting the Fed to raise interest rate one or two times this year.
The Fed, however, took a big U-turn due to strong criticism from the U.S. President Donald Trump. The U.S. President is eager to offer cheap money to people in order to give a boost to the economy. He is aggressively campaigning for rate cuts. He said,
"The Fed really slowed us down and cutting rates would allow the U.S. economy to grow further and take off like a "rocket ship."
Due to criticism from the U.S. president, the Fed has signaled that it is likely to make two rate cuts this year. The first rate cut is expected at its next meeting at the end of July. Trump already tweeted that he is likely to nominate Judy Shelton and Christopher Waller to the Federal Reserve Board of Governors. The president believes these two economic experts would help him in implementing his economic growth agenda.
How Lower Rate Will Impact Commercial Banks Like The Bank of New York Mellon?
Lower interest rates always give more confidence to borrowers and help in increasing the flow of money in markets. However, lower interest rates always have a negative impact on commercial banks such as The Bank of New York Mellon. This is because BK’s net interest margin is the difference between the interest it pays to depositors and the revenue earned from collecting loan payments. In the case the Fed raises interest rates, the bank can charge a higher interest rate for loans and boost its net interest margin. On the other hand, when interest rates decline - which is likely to come at the end of July - a bank’s margins decrease.
BK already started experiencing weakness in net interest income, which is one of the largest revenue generation sources. Increasing competition amid the arrival of high-yielding challenger banks, along with higher cost of deposits, had significantly impacted its revenues in the latest quarter. Its interest revenue declined close to a double-digit rate in the latest quarter.
The CEO said,
Rates across the entire yield curve declined versus our assumptions, deposit balances declined and we saw changes to the mix between interest and non-interest-bearing deposits. We see significant competitive pressure for deposits. I'll let Mike discuss that in more detail.”
The Bank of New York Mellon warned that a flattening yield curve is likely to hurt revenue for the following few quarters. This situation occurs when the spread between short- and long-term Treasury rates narrows, and typically indicates market sentiment turning cautious. With the expected 4 rate cuts through year-end 2020, BK is likely to face pressure on its financial numbers.
The Bank of New York Mellon's Financials are Declining
The Bank of New York Mellon has been experiencing a tough market environment over the last couple of quarters. The bank's revenue extended the declining trend in the first quarter of 2019, after reporting lower-than-expected revenue for the final quarter of 2018. Its first-quarter revenue plunged 7% year over year to $3.9 billion. Its fee revenue declined 9% while interest revenue dropped 8% Y/Y in Q1 of 2019.
Source: Earnings Release
Although the company is aggressively working on reducing its cost structure, the company still didn’t manage to make a big change in earnings. Its earnings per share declined 15% compared to the same period last year. The company blames the flattening yield curve and the changing mix and cost of its deposits for lower revenue and earnings.
The cost of interest-bearing deposits has been increasing over the past few quarters due to increasing competition while non-interest-bearing deposits are declining. The arrival of mobile banking and challenger banks has also been impacting non-interest-bearing deposits.
Poor Revenue and Earnings Performance Negatively Impact Cash Returns
The banks have declined their cash returns for this year. This is due to declining financial numbers and bleak fundamental outlook. The bank plans to raise the dividend by 11% for the following four quarters – down from the previous dividend increase of 16%. The prospect for next year's dividend growth depends on the government’s interest rate policy.
The Bank of New York Mellon's shares are likely to remain under pressure in the coming days. This is due to its struggling financial numbers and prospects for two interest rate cuts in 2019. The U.S. president is aggressively seeking to drop the interest rate in the following quarters to give a boost to economic growth – which will significantly impact margins of commercial banks. On the whole, it’s not a good time to buy BK stock ahead of financial and fundamentals headwinds.
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