June 30 saw a $1.05 billion mystery solved: That day Nelson Peltz’s Trian Partners revealed that it owned 2.5 percent of all outstanding shares in Bank of New York Mellon Corp. The activist hedge fund firm had disclosed this stake in its April client letter without naming the target.
True to form, $8.7 billion, New York–based Trian has yet to announce its plans for change at BNY Mellon, which tops Institutional Investor’s 2014 ranking of the World’s Largest Global Custodians for the sixth consecutive year, with $28.5 trillion in assets under custody and administration. Trian prefers to meet with the management and board of a target first, CEO Peltz explained during a New York appearance at II’s Delivering Alpha conference in July.
He did concede his unhappiness with BNY Mellon’s performance, though, despite the fact that assets under custody have kept rising since Bank of New York merged with Pittsburgh-based Mellon Financial Corp. in 2007. Peltz noted that in 2010 the bank’s pretax profit margin was very close to that of State Street Corp., which climbs to No. 2 in the ranking for the first time, with $21.69 trillion under custody. “From 2010 to today, State Street’s margin has increased by around 250 basis points, and BNY Mellon decreased by 400 basis points,” Peltz said, calling that difference an opportunity. In four of the past five financial years, BNY Mellon has posted smaller pretax profits than State Street and Northern Trust Corp., whose $6 trillion in assets under custody earn it the No. 7 spot.
Peltz’s campaign reveals why activist investors have developed a taste for custodian banks: Costs are arguably too high, and lagging performance hurts shareholder value. In the wake of Trian’s April letter, BNY Mellon stock has gained some 18 percent, closing at $39.47 on August 25, its highest level since before the 2008 financial crisis. Trian knows how to squeeze profits from financial services firms. It also campaigned against Lazard in 2012 and State Street in 2011; since 2009 it’s worked with Legg Mason, the Baltimore-based asset manager. “Every one of those stocks has doubled,” Peltz boasted at Delivering Alpha.
Custodians have been cutting costs since the crisis shrank their lending revenue by pushing down interest rates and triggered compliance and other unavoidable expenses. For example, BNY Mellon has announced plans to consolidate operations and move its Manhattan headquarters from Wall Street to less-pricey Liberty Street this year. Boston-based State Street has slashed roughly 3,000 jobs since 2011 and plans to cut an additional 400 by year-end.
Complementing these cutbacks are new revenue streams, such as services that meet demand for data analysis and risk management. “Clients are focused on the safety of their assets and the strength of their service providers,” says Nick Rudenstine, global head of custody and fund services at J.P. Morgan, whose $21.66 trillion in assets under custody put it third in this year’s ranking. “As a result, custodians are becoming data providers as much as they are custodians.”
Samir Pandiri, global CEO of asset servicing at BNY Mellon, agrees: “Asset servicing providers can never stop reinventing themselves.” The New York–based custodian, which spends some $750 million on technology each year, has introduced a swath of new products to boost operational efficiency. In 2011, for instance, it rolled out BNY Mellon OnCore, which supports services such as trade processing, data warehousing, risk management and performance measurement for asset managers looking to outsource mid- and back-office functions.
Technology is also a priority at State Street, which, unlike many of its competitors, develops its own software. John (Jack) Klinck Jr., global head of global strategy and new ventures, says the bank has hired people with analytical skills “you wouldn’t necessarily relate with finance” — engineers, mathematicians and computer scientists — to build out its proprietary technology platform.
Although their streamlining efforts have helped, custodians still aren’t close to maximizing shareholder value, argues Mike Mayo, a New York–based banking analyst at investment bank CLSA. In a February research report to investors the outspoken Mayo suggested spinning off the asset management arm of BNY Mellon, in which CLSA holds a share, to cut compliance costs.
“I’m interested in seeing the [bank’s] stock price reflect more of its franchise potential,” he tells II. “They need to provide the right formula — whether it’s changes in expense allocation, management or the business mix — to generate returns above their cost of capital.”
Whatever happens, there’s a lot riding on Trian’s $1.05 billion stake in BNY Mellon. “Don’t underestimate Trian Partners,” Mayo warns. “Nobody should take them lightly.” • •