Unless they boost profitability, the four largest trust and processing banks will come under increasing pressure to merge, according to Citigroup Inc. analysts Ruchi Madan and Keith Horowitz.
“Investors are beginning to understand that there are very large efficiencies in merging these operations; we believe the pressure will grow to produce higher operating leverage and margins,” the analysts wrote in an Oct. 7 report. One deal, they said, may “set off a domino effect within the sector.”
The note did not predict any specific combinations.
Over the past few years the trust banks have faced a number of problems, including poor expense management, pressures on net interest income, option and pension expenses, and building post-9/11 remote data centers, the note said.
Jacqueline Reeves, an analyst at BankAtlantic Bancorp’s Ryan Beck & Co., agreed that some consolidation is likely to occur as the trust and processing banks face “a more challenging revenue growth environment.
“In order to continue to have positive operating leverage it could make some significant sense” to consolidate and save costs, she said in an interview.
Ms. Madan and Mr. Horowitz have “buy” ratings on Bank of New York Co. Inc., State Street Corp., Mellon Financial Corp., and JPMorgan Chase & Co. (The analysts do not cover Northern Trust Corp.)
“These are inherently very attractive businesses with relatively high revenue growth rates and low capital requirements, with the potential to improve profit margins,” their note said. “We have already passed the inflection point of some of the headwinds. In 2006 this will become even more evident.”
Brian Bedell, an analyst at Merrill Lynch & Co., said Tuesday that he is most optimistic about the earnings at State Street. With $9.6 trillion of assets under custody, the Boston company has become “more profit driven,” as opposed to “revenue driven,” since it began an expense management campaign a year ago.
Mr. Bedell said the repositioning of its balance sheet to invest in higher-yielding securities and the lack of a loan-loss provision (since it does not have a retail presence) add to his optimism about State Street.
But Mr. Bedell, who published a note Friday on the trust banks, is more cautious about earnings growth at Bank of New York. He expects the company, which has $10.3 billion of assets under custody, to ramp up its loan-loss provisioning next year. “For them it’s a significant enough headwind to slow down their 2006 growth rate,” he said.
Mr. Bedell disagreed with the Citi analysts on the topic of consolidation. The theory sounds good, he said, but “practically, it’s very difficult to execute, and I don’t see it happening anytime soon.”
All of the banks mentioned declined to comment on the research notes.
Shares of Bank of New York rose 0.2%, while State Street fell 0.4% and Mellon fell 1%.
