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Three custodian banks face ratings review
03 July 2013 New York
Reporter: Mark Dugdale

Image: Shutterstock
BNY Mellon, State Street and Northern Trust are facing reviews of their long-term ratings because of narrow margins in core custody services and an over reliance on ancillary services such as securities lending, according to Moody’s.

The rating agency placed the long-term ratings of the banks, including their bank financial strength ratings, all long-term senior debt, subordinated debt, and preferred stock ratings, on review for downgrade on 2 July.

The ratings review will focus on the long-term profitability challenges facing BNY Mellon, State Street and Northern Trust.

“These profitability challenges are driven by the aggressive pricing of all three banks' core custody products and services, such that their overall fee revenue is roughly similar to their total expenses. The review will also examine the banks' ability to generate more revenue from custody-related services and cut costs,” said Moody’s in a statement.

All three banks have “a strong, sustainable franchise in that their core custody businesses benefit from significant barriers to entry as well as favourable secular trends,” said Moody’s.

On top of this, they have significant asset management franchises. “These durable businesses, as well as the banks' liquid balance sheets and good capitalisation, underpin their very high ratings.”

As a result, any downgrades “are likely to be limited to one notch”.

Despite each bank’s significant market share, “pricing in the core custody business is very competitive, resulting in narrow margins”, said Moody’s.

“This makes the banks reliant on revenue from ancillary services to add to profitability, but these revenue sources have come under pressure. Specifically, net interest income has been constrained by low interest rates, foreign exchange revenue has been hurt by lower volatility and increased scrutiny of pricing, and securities lending revenue has declined due to lower demand.”

“The review will consider if the banks are overly dependent on ancillary services to generate a healthy level of profitability.”

Moody’s added that as interest rates rise, the banks’ earnings pressures will recede, but “the demonstrated vulnerability of their business models to protracted low interest rates constitutes a concentration risk”.

“This concentration risk may not be consistent with the business model resilience expected for a very high ‘aa3’ standalone credit assessment.”

The changing asset mixes of BNY Mellon, State Street and Northern Trust will also be a factor in the review, because each has large securities holdings that could be affected by Basel III capital requirements.

BNY Mellon and State Street declined to comment. Northern Trust is yet to respond to a request.
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