Until recently, the big US trust banks were Wall Street’s idea of a safe bet.
The likes of State Street and Bank of New York Mellon have long been the irreplaceable plumbing of the financial system, earning steady fee income by providing back-office services for investors. For years, they traded at wide premiums to their better-known and more risk-taking competitors in banking.
But times have changed for State Street and BNY Mellon. Their core business of global custody — executing, settling and clearing trades, custody of securities and so on — is coming under pressure as customers seek lower fees for services and higher yields on deposits, and the more diversified JPMorgan Chase gains market share.
In the first quarter, fee revenue from investor clients was down 8 per cent in aggregate at State Street and BNY Mellon. Over the past three months, shares in the two banks have underperformed bank indices by roughly 10 percentage points. In the 52 weeks to Thursday, State Street shares were off 35 per cent, while BNY Mellon stock had fallen 14 per cent.
“The revenue yield they earn on assets under administration keeps going down,” said Jeffrey Harte, an analyst at Sandler O’Neill, adding that he finds it hard to get excited about companies facing “continual pricing pressure in their core business”.
The underlying problem for the trust banks is that their customers are struggling to deal with the rise of low-fee passive investment strategies. Money managers pay the trusts a tiny fraction of a percentage point on the assets moved or held, but as the managers’ margins are squeezed, they have pressed the trusts for ever-lower fees.
In its first-quarter calls with analysts, State Street, which is the most exposed to the big asset managers that are suffering acute margin pressure, said it “continue[d] to see the ongoing impact of fee concessions”. BNY attributed soft fee income more to reduced client activity and a stronger dollar.
One longtime investor in BNY Mellon said the trust banks boast “wonderful returns on equity and offer an incredible service at a very low price — we’re talking 1 basis point — but the thing I get agitated by is why they can’t have more pricing discipline”.
JPMorgan has added to the pressure, drawing on its markets expertise to help clients with performance measurement and complex derivates portfolios. The bank won $1tn of custody assets from BlackRock, the world’s largest asset manager, in 2017, and it increased custody fees faster than State Street or BNY Mellon last year.
“We have had a multiyear investment programme in securities services technology,” said Teresa Heitsenrether, who leads the business for JPMorgan. “The combination of technology investments and operational knowhow has certainly contributed to our share growth.”
At the same time, the end of the Federal Reserve’s rate-raising cycle poses particular problems for the trust banks. The general problem is that yields on loans and bonds stop increasing while deposit rates, which tend to lag behind, continue to rise. The effect is pronounced at the trust banks as they have few if any sticky retail deposits. Their institutional clients care about the last basis point.
The situation is more acute still because the Fed is shrinking its balance sheet. When the Fed was buying Treasuries as part of its quantitative easing programme, it pushed cash into the hands of investors, and some of that cash ended up parked, interest-free, at trust banks. As the Fed has shrunk its balance sheet — quantitative tightening — the opposite has happened, draining the trusts’ balance sheets of cheap funding.
The net result: interest-free deposits at State Street, BNY and Northern Trust, a smaller trust bank, have fallen by a whopping 28 per cent, or $44bn, in the past 12 months.
“With QE you had a massive influx of liquidity and deposits into the system; with QT, you have seen the opposite of that,” said Steven Chubak, an analyst with Wolfe Research. As a result, “the trusts have seen a massive decline in non-interest bearing deposits”.
Since December, when the market started to anticipate a pause in rate rises at the Fed, and to reflect investor nerves about QT, the three big trust banks have all underperformed banks in general, and their price-to-book ratios have fallen.
The main strategy of the trusts in the face of the pressure on revenue has been to take out costs while offering more services to clients. But, as Mr Harte puts it: “You have to work pretty hard to win the arms race — providing more services for the same dollar.”