Driven by Wall Street demands for higher profits and returns to shareholders, Bank of New York's proposed $16.5 billion acquisition of Mellon Financial is the latest in a string of blockbuster mergers transforming the financial services industry.
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Headquarters: New York City
Annual revenues: $12.5 billion
Employees: 40,500 worldwide; 32,000 in U.S.
Asset servicing: $16 trillion in assets under custody
Asset management: $1.1 trillion under management
Wall Street's response yesterday: Mellon up $2.73, or 6.8%, to $42.78; Bank of New York up $4.27, or 12%, to $39.75
Whether the partners are large, medium or small, whether their business is banking, investment management or something else, the objectives are the same: fatten profit margins by spreading costs over a larger asset base; expand product or service offerings; and extend market horizons.
The payoff, it is hoped, will benefit shareholders by creating ever bigger banks and financial service firms capable of making more money and thus, creating more value in the marketplace. Shares in both the Bank of New York and Mellon, for example, rose a respective 12 percent and 6.8 percent yesterday, as investors viewed the combination as the best of both worlds -- two institutions getting bigger and better by merging complementary services.
The Bank of New York-Mellon combination joins two former banks that shed their retail branches to focus on fee-based businesses where, in many cases, size increases the likelihood of success. Bank of New York Mellon will be the world's fifth-largest asset servicing manager and the 11th-largest asset manager by handling money for others, be it companies, institutions, other banks and financial services firms, wealthy individuals or investors.
Yesterday's announcement comes on the heels of Merrill Lynch combining its investment management business with PNC Financial Services Group's BlackRock unit, creating a $1 trillion money manager. But even as it relinquished majority control of BlackRock, PNC continued beefing up its core banking business, striking a $6 billion deal it expects to close early next year for Baltimore-based Mercantile Bankshares Corp. That acquisition will complement its $652 million acquisition of Washington, D.C.'s Riggs Bank last year and make PNC the nation's 11th largest bank -- at least for the time being. "There's more consolidation to come," said Morningstar analyst Jeffrey Ptak.
The sharp rise in Mellon and Bank of New York shares yesterday -- Mellon closed at $42.78, a new 52-week high and Bank of New York closed at $39.75, also a new 52-week high -- signals Wall Street's faith that the merger will play out as advertised. The companies expect to reduce costs by $700 million annually, savings that will be crucial to the success of the asset servicing business of the combined company. Asset servicing includes securities lending, cash management, foreign exchange, administering hedge funds and a host of other services that rely heavily on people and computers.
"It's a scale business," Mr. Ptak said, meaning the best way to make money on it is to do a lot of it so that the costs of all those large investments necessary to build the business can be offset by volume. "There are huge personnel and technology outlays to go hand in glove with providing that kind of business."
The same is not true with asset management, where Mellon is providing most of the muscle through its Dreyfus funds and other investment offerings. It manages $856 billion for clients while Bank of New York oversees $155 billion.
Although size can help asset managers, it isn't as crucial to success as it is in asset servicing, Mr. Ptak said. Small firms can be better investors than large firms, which sometimes results in large managers acquiring their smaller competitors.
But in asset servicing, "It's more difficult not to be big and still be successful," Mr. Ptak said. "It's not really a 'high five' type of business [like investment management] where you get it right and you whoop it up. You either get it right or you don't. What it boils down to for many clients is price."
Mr. Ptak said the Bank of New York-Mellon combination also offered plenty of opportunities for Mellon to sell services to Bank of New York customers that their banker couldn't provide and vice versa. Consolidation in the financial services industry has enabled the survivors to offer clients far more products and services than they have in the past, said Morningstar analyst Craig Woker.
Such cross-selling, such as eliminating unnecessary workers, is an underlying rationale for consolidation. Whether textbook theory becomes reality depends on how the merger is implemented. Mellon and Bank of New York plan to combine operations over three years, which Mr. Ptak believes reduces chances of aggravating clients with a disruptive transition.
Still, there are risks. "There are a lot of moving parts, so it's only natural you have some attrition in your client base," he said.
The announcements heralding mergers and acquisitions always make the road to consolidation sound like a wide-open, well-paved, well-marked straightaway. It isn't, says John Frankola of Vista Asset Management of Pittsburgh.
Just ask Citigroup, Bank of America and JP Morgan Chase, three of the largest consolidators in the financial services industry whose stock performance hasn't held up to the hype that accompanied all their takeovers. "There has been a lot of underperformance among the serial acquirers," he said.
Len Boselovic can be reached at firstname.lastname@example.org or 412-263-1941.