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Bank of New York fails to make acquisitions pay

It is more than a year since the Bank of New York began a restructuring programme that its management hoped would keep it at the forefront of the securities processing business.

In its 2006 first-quarter earnings release, the bank was bullish about its prospects and the impact of one of the elements of the restructuring - an asset exchange with JP Morgan in which it exchanged its retail banking and middle-market business in return for JP Morgan's corporate trust operation.

Tom Renyi, chairman and chief executive of the Bank of New York, said: "We are unlocking the value of our retail franchise to invest in strengthening our leadership position in corporate trust. In doing so, we are concentrating our capital and resources on the higher-growth, higher-margin businesses where we have scale, skill and competitive advantage."

The asset swap was one of several moves that Renyi and his team made to move the share price in the right direction and, just as crucially, cap the enormous investments the bank had been making in businesses that did not generate an adequate return. Analysts appeared to welcome the strategy, no doubt as much for the fact that the Bank of New York finally had a plan as for what it contained. Action had been needed for years and Renyi had delivered what appeared to be a pragmatic way out of the bank's problems.

Even though the bank subsequently decided to abandon this plan in favour of a merger with Mellon, the ramifications of its consolidation programme are starting to filter through to its results. In the first quarter, the Bank of New York reported total non-interest income of $1,475m, up 17% on the same period last year.

Asset servicing fees were also up by 17% over the period, and up 11% compared with the fourth quarter of last year. That part of the equation looks good, particularly when viewed against a drop of 1% in non-interest expenses between the fourth quarter last year and the first quarter this year. But go back to Renyi's statement a year ago about the bank's focus on higher-margin businesses and the numbers are not so impressive.

In the first quarter last year, pre-tax operating margin was 33%. This has crept up to 34%. Over the same period, staff numbers grew by 15% to more than 23,000, contributing to an increase in quarterly employee costs of 19%.

Not for the first time, someone has got their sums wrong. After a long period when the bank has been struggling to deal with staff numbers and employee costs, adding more than 3,000 people to the payroll makes little sense when they appear to be making no impact on the group's operating margin.

One of the main drivers behind the merger with Mellon was the Bank of New York's admission it had made a mistake by not developing a stronger asset management brand. Yet, just months before it publicly accepted this and turned to Mellon as the solution, it was taking on a corporate trust operation that had none of the characteristics required to transform its image as a low-cost securities processor.

But the bank has been making progress this year with its value-added services. It was recently appointed by Global Capital Partners to provide private equity administration for its global buyout fund, which will target opportunities in the Middle East and North Africa, Turkey, China, India and Pakistan.

The bank has also scored wins for its collateral management service, including with Lehman Brothers in Asia and a tri-party repo agreement with Riyad Bank in Saudi Arabia. It has also expanded its exchange-traded funds relationship with fund manager WisdomTree, building on its strength in the sector, where it enjoyed a 60% rise in business last year.

This has not been enough to address the fundamental issues with the asset servicing business. Its asset growth rate is comfortably ahead of its asset servicing revenue growth rate: assets under custody rose by 19% last year but investor services revenue only rose 8%.

The custody asset mix is part of the problem, with fixed income holdings making up two thirds of the bank's total book, a proportion that has not changed since 2003. Bank of New York is paying the price for its inability or unwillingness to put serious money into high-margin, high-growth sectors.

Having failed to make an impact with its asset management business and lost out in the race to become a global service provider to alternative investment managers, it has been unable to make significant headway in widening the gap between revenue and cost growth. The corporate trust acquisition only serves to highlight the problem.

This should be one of the top priorities for Bob Kelly, the proposed chairman and chief executive of Bank of New York Mellon. He will need to look carefully at the synergies between the business lines and decide whether some parts of the new group should be offloaded.

This is precisely the process that Mellon went through as it was trying to reinvent itself under former chairman Marty McGuinn. He was bold enough to take a bet on asset management and administration, viewing almost everything else as surplus to requirements.

History has a habit of repeating itself and Kelly will have to go through a similar review to ensure the group hits its targets of higher margins and stronger growth.

Source: Scrip
Date: 12.05.2007 [27]
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