If Bank of New York Mellon Corp.'s chief executive is right, the worst of this credit cycle is yet to come for bankers, and dealing with that will soon involve efforts that go well beyond financial efforts to raise capital.
"We are a year into the credit crisis now," Robert P. Kelly said in an interview last week after his company's investor day presentation. "It feels like the worst of the securities writedowns may be behind us, but it still feels like we are in the early stages of the credit cycle in terms of loan losses, and they clearly appear to be accelerating at this point."
Revenue growth across the banking industry will "remain pretty low in the near term, because people don't want to lend and put more assets on their books," he said. "Consumers are going to be hesitant to buy more durable goods and to buy new houses until they feel that housing prices have gotten closer to the bottom. Banks are still going to be hindered from a growth perspective, because of increases in loan losses."
While capital-raising and dividend cuts will continue, Mr. Kelly said, ongoing pressures may force more fundamental business decisions; he believes more will have to look at selling assets and businesses as part of their strategic and capital optimization efforts. Bankers "will probably be looking at their mix of businesses and thinking, 'What are our long-term competitive advantages?' and will look at getting out of the businesses that were a hobby, rather than a core competitive strength."
Mr. Kelly does not expect a quick turnaround for the economy. "A lot will depend on whether banks can continue to generate enough capital to remain viable, and so far large banks have done a very good job at this."
Mr. Kelly spoke favorably of the Federal Reserve Board's efforts to spark growth and said he thought the central bank made a necessary move in facilitating a rescue of Bear Stearns Cos.
"I think the Fed has been quite creative and aggressive in the past year, and in spite of the critics, who have been fairly vocal sometimes, I think they didn't have any choice with Bear Stearns," he said. "The Fed has been encouraging banks to raise capital and cut dividends as necessary, and they have done a lot of good things, including reducing interest rates and lowering the discount rate and giving direct access to investment banks to high-quality securities. Those are huge seat changes and stimuli that the country has already provided to the financial system."
He said he thought the banking sector would benefit from some degree of domestic consolidation, but given the industry's strict accounting guidelines, "it is not conducive at this point for mergers to occur," Mr. Kelly said. "That needs to be solved if we are going to have greater consolidation in the market."
Bank of New York Mellon will continue to make its acquisitions abroad while continuing to divest some noncore domestic businesses, he said.
It is in an advantageous position, because it has relatively low exposure to the consumer market, Mr. Kelly said. "Our business mix is non-capital-intensive and not lending-intensive either."
Bank of New York Mellon, which has $23.1 trillion of assets under custody and $1.1 trillion in assets under management, does not underwrite mortgage-backed securities and does not have a huge loan portfolio, he said. "We are different than most banks in the system today, and as a result we have outperformed peers. We are an asset manager and a securities servicer."
Analysts said the New York company has not been immune to some of the woes that have hampered other financial institutions. In the fourth quarter it took charges related to collateralized debt obligations and a conduit it sponsors. In the first quarter it was forced to take writedowns related to subprime mortgage investments.
Mr. Kelly acknowledged that his company has had some issues, but he said they have been "relatively modest" compared with those at some other banking companies.
"We still have good revenue, and we have very good EPS growth," he said. "We are very liquid, and our capital position is quite strong compared to our peers. I would say that we don't need to raise capital. We can generate quite a bit of capital internally through regular earnings."
Mark Fitzgibbon, the head of research at Sandler O'Neill & Partners LP, said in an interview last week that Bank of New York Mellon has maintained a strong balance sheet, but one red flag that remains is a $22.5 billion money laundering case brought against the company by Russian officials.
Mr. Fitzgibbon said part of the reason he has maintained a "sell" rating on Bank of New York Mellon's stock is because the company has not set aside any reserves for this case. "The company has been very cavalier about this lawsuit and dismissed it as PR. I don't think the investment community is viewing it that way."
During an April 7 investor call, Mr. Kelly said a judgement or a settlement would have to be "likely and estimatable" to take a reserve for any litigation.
In the interview, he said: "We feel we are well protected" in the Russian case. "This case is about plaintiff lawyers in Miami trying to make some money, and we still believe that this is not in the best interest of Russia."
As for the United States, banks here, particularly big ones, "are hoarding capital and liquidity at the moment, because of the losses and uncertainty in the market," he said. "That means that there is not an awful lot of lending going on, and there is probably not a lot of demand for lending."
Until bankers become "more comfortable with the credit system and gets more comfortable with their capital bases, we are not going to see the right level of lending from banks for a while here."
The economic recovery will not begin until the housing recovery does, he said. "We are probably a year away. Hopefully, it won't take that long."
When banks emerge from the credit crisis, the banks themselves may look different, he said. "Longer term, when we look at balance sheets, they will be less levered. It will be a combination of slightly smaller balance sheets and more capital. There are probably a lot of banks who feel at this point that they had too much consumer real estate exposure, and they probably want to rebalance that over time."
