Ronald Logue's clients are merging, and he doesn't much care.
As chairman and chief executive of State Street Corp., Logue's business is asset-servicing and management. These clients are joining in a swell of consolidation expected to gain further momentum. But while appearances would suggest that such consolidation could threaten State Street's core lines, Logue contends the opposite is true.
"We have been the beneficiary of that kind of consolidation, and that has been the longtime trend for the past five to 10 years, where we have been on one side or the other," he said. "Recently, because we have been doing so much for the sellers, it has been easier for the buyers to pick us up, and I expect that will continue."
In recent quarters when large consolidations have occurred, State Street has gained asset-servicing business, Logue told analysts in a conference call Tuesday. For example, he said, when Wells Fargo bought Wachovia Corp., State Street was handling the "majority" of Wachovia's asset-servicing but did "nothing" for Wells — and State Street gained $230 billion of new assets under custody.
But looking forward, others contend, the consolidation wave could put new pressures on State Street and rivals like Bank of New York Mellon Corp. "Consolidation means somebody wins and somebody loses," said Geoffrey Bobroff of Bobroff Consulting in East Greenwich, R.I. "We don't know who the winners or losers will be, but we just know that there will be both. Pricing becomes very important. Anyone playing in that market knows that there aren't many players, so that means people will have to make concessions to add business."
In the longer term, State Street and Bank of New York Mellon — both of which reported quarter results Tuesday — will "square off against one another for share," he said. "To take business away, one will have to be highly competitive, and that means they have to be more efficient than the competition."
Custody banks keep records, track performance and lend securities to institutional investors, including mutual funds, pension funds and hedge funds, but these types of institutions are rapidly consolidating, according to Jefferies Financial Institutions Group.
In the third quarter, more than two-thirds of the global asset management merger-and-acquisitions activity reflected financial services firms' selling of subsidiaries — a record level for a three-month period, according to Jefferies. For example, Bank of America Corp. announced plans its Columbia Management unit to Ameriprise Financial Inc. for about $1 billion, and BlackRock said it would buy Barclays Global Investors, a unit of the British banking company Barclays PLC, for $13.5 billion.
These deals could prompt further consolidation, analysts say. On Monday, Invesco Ltd. announced it agreed to buy Morgan Stanley's retail investment management business, Van Kampen Investments, for $1.5 billion.
Marty Mosby of First Horizon National Corp.'s FTN Equity Capital Markets says such "consolidation creates disruption," which leads companies to reexamine their businesses. In most cases, he said, companies are being sold to save money, and they may be interested in outsourcing custody to save more money. "Companies are looking for every angle to gain more efficiencies in an acquisition," he said.
That's a silver lining for custody banks.
State Street added $626 billion of assets under custody from new business in the first nine months of this year, and Logue said he is confident it is well positioned to deal with the merger wave. Citing some of the recent deals, he said State Street does "most" of the asset servicing for Columbia but "nothing" for Ameriprise and "does everything" for Van Kampen and nothing for Invesco.
Bank of New York Mellon, which is the industry's largest custody bank, has gained $1.6 trillion of assets under custody in the past year, including $300 billion in the third quarter. Todd Gibbons, its chief financial officer, said in an interview that these gains resulted mostly from new business generated from existing clients.
"As they open new funds, they are keeping the business with us," he said.
Like Logue, he emphasized the upside of consolidation. "This is [a] huge scale business and a huge technology business. We are much better positioned than anyone to benefit from consolidation."
Burton Greenwald, an analyst at BJ Greenwald Associates in Philadelphia, said that State Street and Bank of New York Mellon have been fortunate in the most recent merger waves but that this is not guaranteed to continue. They could find themselves "outside looking in" if they aren't already providing custodial services to either the buyer or the seller.
Gibbons said that he does not expect Bank of New York Mellon to be on the outside. "This is a competitive business, so typically acquisitions lead to RFPs … and we will win our share," he said. "We think that there is a risk and an opportunity for us."
There has been a flight to quality on the asset-servicing side, Gibbons said, because "some of the problems" with Bernard Madoff "and others were caused because they were their own custodian and their own clearing firm. Asset managers are looking for the protection of a third-party custodian."
Gibbons said the pipeline is strong, and he expects strong organic growth from Bank of New York Mellon's asset-servicing business. He also hopes the company will be able take advantage of the consolidation by acquiring "subscale" custodians that will no longer be able to compete. He said he expects to expand into "new geographies" this way.
On Tuesday, Bank of New York Mellon reported a third-quarter net loss of $2.46 billion, or $2.05 a share, compared with a $303 million profit, or 26 cents, a year earlier. Excluding $4.8 billion to restructure debt securities, it posted a profit of 54 cents per share. Analysts polled by Thomson Reuters had expected a profit of 46 cents per share.
Bank of New York Mellon announced it sold $3.6 billion of its lowest-rated securities in an effort to increase net interest revenue by as much as $175 million next year and "significantly" reduce the risk of future writedowns.
Gibbons said Bank of New York Mellon used "a window" of increased prices on distressed investments to sell or restructure about $12 billion of risky securities, which led to its loss. Less than a year ago, he said, the market would probably have offered "heavily distressed fire-sale prices" for mortgage-backed securities. He said the company got better prices under its current plan.
Despite the loss, the company's stock rose 6.13%, to $28.90 a share, on Tuesday. Analysts said investors were glad it was able to sell the assets.
Robert Kelly, Bank of New York Mellon's CEO, said during its quarterly earnings call that in 12 to 24 months he expects the company will be seen as an "early mover" for "putting major balance sheet issues behind us."
State Street reported its third-quarter earnings rose 8.1% from a year earlier, to $516 million, or $1.04 per share, after it cut expenses. Excluding some items, earnings of $1.05 a share met the $1.04 forecast by analysts surveyed by Thomson Reuters.
Despite delivering stronger results than Bank of New York Mellon, State Street's stock slumped 8.44%, to $47.84. Unlike Bank of New York Mellon, Mosby said, State Street had shed the concerns in its investment portfolio in the second quarter, but in the third quarter, it did not generate the revenue gains analysts expected.
Kelly said during Bank of New York Mellon's earnings call that it will look to reinvest in its asset management businesses and higher-growth markets, including Asia, the Middle East and Brazil. In August, it announced it had bought Insight Investment Management Ltd. for $387 million from Lloyds Banking Group PLC.
Logue, who has spoken fairly aggressively in the past about looking to acquire, said State Street does not have anything in the pipeline right now. It will focus on cross-selling to some of its new customers, he said, including Wells Fargo. "After you acquire the core fundamental business, the rest follows," he said.