ASSET SERVICING: The see-saw effect

The credit crunch has seen the fortunes of asset managers fall, while custodians’ financial results have risen. Rather than be irked by this, Nick Fitzpatrick suggests investors should see the opportunities

08_02_see-saw.jpgThe market turbulence that resulted from the credit crunch has certainly put a smile on the face of the securities services industry – at least if BNY Mellon’s experience is anything to go by. In January, while their asset management clients were announcing, or preparing to announce, depressed results for the last half of 2007, Champagne corks were being popped by executives at custodian banks, which provide most of the back and middle office functions for asset managers.

Asset servicing fees at BNY Mellon, one of the world’s largest custody banks and asset service providers, totalled $809 million (e557.1m) at the end of Q4 2007, a pro forma increase of 36%. Clearing and execution fees for the same period totalled $314m – a 21% increase over the year-before quarter, and extending a good run from the equally volatile Q3 period in 2007 where fees were just 3% lower.

In its quarterly statement in January, BNY Mellon said that the increase in its clearing and execution fees “reflects increased activity resulting from market volatility along with continued growth in money market and mutual fund positions”. Market volatility also partly caused the increase in its asset servicing fees too.

There was a great deal of joy over at BNY Mellon’s great rival, State Street, as well, where asset servicing fees totalled $967m for Q4 2007, an increase of $269m, or 39%, from $698m in the year-ago quarter. State Street did not mention whether this increase was due to volatility among its client base, however. Instead, it said that the increase was attributable to business from customers added from the Investors Financial acquisition, along with business from new and existing clients and higher average equity valuations.

Nevertheless, the figures reflect a see-saw type of relationship between the fortunes of asset managers and their service providers. When investors do badly, the service providers do well.

Cause for optimism
State Street’s management is optimistic about the outlook for 2008 too. Ron Logue, CEO, said at an analysts’ conference call: “We expect earnings per share on an operating basis, excluding merger costs, to increase 10-15% compared to 2007…” Revenues, he said, were expected to grow faster than his competitors, between 14 and 17%. This compared to the 8-12% previously forecasted. These figures are for the overall business, which includes State Street Global Advisors, its asset management arm. State Street’s total assets under custody at quarter-end 2007 were $15.3 trillion, a record level, up 29% compared with $11.85 trillion at the end of the year-ago quarter.

Meanwhile, over at another large custody bank, Frederick H. Waddell, president and chief executive officer of Northern Trust, was also celebrating “great results” resulting from record operating earnings. Like State Street, he did not relate the success in his asset servicing division directly to sub-prime-related volatility, although he did highlight the growth in fees from the division. He said: “Record operating earnings for the quarter and full year were driven by strong growth in trust, investment and other servicing fees, foreign exchange trading income, and net interest income, while the quality of our loan portfolio continued to be exceptionally strong.”

Northern Trust’s success in the marketplace was evidenced by double-digit growth in client assets, with assets under custody increasing 17% to $4.1 trillion, and global custody assets growing 23% to $2.1 trillion. Like BNY Mellon and State Street, Northern Trust also runs an asset management business, where assets under management increased 9% to $757.2 billion, versus the previous year.

As Waddell points out, Northern Trust’s loan portfolio continued to be of strong quality. And in this he indicates another reason why custodian banks are enjoying a boom at present, at least in comparison to the wider banking sector: no, or little, exposure to low-quality mortgage loans.

It was not just the juggernaut players that reported strong results for the last quarter. BlackRock Solutions, which operates various operational services for asset managers, also finished the year strongly. In its quarterly statement, the firm, which is part of the BlackRock asset management business, said: “The liquidity crunch and associated market disruption has given rise to even greater demand for advisory services that marry our extensive capital markets and structuring expertise with our rigorous modeling and analytical capabilities. BlackRock Solutions closed the year on a very strong note, adding two new Aladdin [system outsourcing] mandates and twelve new short-term advisory assignments, nine of which were completed during the quarter.”

On a positive note
In Q4 2007 BlackRock Solutions revenue rose to $62 million compared to $48m in Q3, an increase of 30%. Revenue stood at $45m in Q4 2006, meaning Q4 2007’s revenue increased by 36%, and primarily reflects an increase in portfolio advisory services as well as additional Aladdin mandates, the company said.

The last great bear market at the beginning of the century helped custodians shift the marketing of their outsourced service solutions up a few gears, claiming that asset managers would benefit from operational and cost efficiencies by letting custodians take over their back and middle offices. The credit crunch may give custodians a fresh impetus.
But if asset managers should wince at the profits custodians have been making and which seem linked to their own hardship, then they should look on the bright side. Not only are their major service providers secure at a time of uncertainty, but they may also represent good investment opportunities too!

© fe February 2008