Q4 2014 results from the top five U.S. headquartered securities services firms indicate that revenue growth for securities and custody services is slowing down. The two largest global custodians, BNY Mellon and State Street, along with Citibank, reported revenue decline in calendar year Q4 2014.

The figures below show change in securities services revenue versus the prior quarter (q/q) and versus the same quarter the previous year (y/y) for the top five:

• BNY Mellon: -6.0% q/q (+1% y/y)
• State Street: -0.1% q/q (+5.6% y/y)
• Northern Trust: +1.0% q/q (+8.0% y/y)
• JP Morgan: +0.05% q/q (+5.8% y/y)
• Citi Securities: -4.0% q/q (+4.0% y/y)

Securities services revenues are based on securities valuations (stock market values), but the market went up in Q4 2014, as well as for the year. In fact, the S&P 500 was up 4.93% in Q4 2014 over the prior quarter and that was the lowest advance of the major U.S. markets. For the year 2014, the S&P 500 was up 13.69%, the highest advance of the major U.S. markets. Securities services revenue growth in 2014 underperformed both the annual and quarterly growth in market valuations and the trend to underperform accelerated during the year.

What happened? Below we take a closer look at the BNY Mellon and State Street results and at the market conditions that are causing such strong headwinds.

BNY Mellon announced Q4 2014 revenues of $3,689m, up 2.2% y/y. Q4 2014 revenues (and y/y change) by activity were:

• Investment servicing fees: $1,704m (+1.0%)
• Investment management fees: $885m (-2.0%)
• Trading services: $151m (+3.4%)
• Securities finance: $43m (+0.0%)
• Distribution fees: $43m (+0.0%)
• Investment gains: $78m (+n.m.%))
• Net interest revenues: $712 m (-6.1%).

Assets under management were $1.71 trillion, +8.0% y/y, while assets under custody/administration were $28.5 trillion, +3.0% y/y.

State Street announced Q4 2014 revenues of $2,724m, up 1.7% y/y. Q4 2014 revenues (and y/y change) by activity were:

• Servicing fees: $1,301m (-0.1%)
• Investment management fees: $299m (-5.4%)
• Trading services: $293m (+5.4%)
• Securities finance: $106m (+7.1%)
• Processing fees: $138m (+34.0%)
• Net interest revenues: $587m (+1.2%)
• Investment gains: $0.0m (n.m.).

Assets under management were $2,448bn (+1.1%), while assets under custody and administration were $28,188bn (-1.0%).

Both BNY Mellon and State Street securities services revenue underperformed growth in assets under custody, which in turn underperformed growth in U.S. market valuations.

All securities services vendors faced the same headwinds in Q4. While they reported that securities services revenues were driven by increases in security markets valuation and by modest increases in new customers, they also reported that revenue growth was held back by declining pricing for securities services and the stronger dollar negatively affecting revenues from overseas markets.

JP Morgan provided additional insight that revenue growth was driven in part by increases in net interest income (NII), which means cash on deposit from securities trading/liquidation which was not reinvested.

Vendors reported that ancillary services such as securities financing, trading services, and processing fees, grew handsomely (boosting overall revenue growth into mid-single digits). However, all vendors have been aggressively focused on cost control, and will continue to do so for the foreseeable future.

What does it all mean?

As the market slows and perhaps corrects in 2015, vendors will face more of the same market conditions. Q1 2015 so far seems to point to an accelerating slowdown in markets valuation. More specifically:

• Emerging markets, the primary source of revenue growth over the past few years, will not be generating increasing revenues as the dollar continues to strengthen
• Market corrections will accentuate the revenue slide
• New customers will become harder to find at scale (mature clients have larger portfolios, but are already clients, and their portfolios are growing at a slower rate).

Under these conditions, cost reduction, specifically lowering of break-even levels, will determine winners over the next year and beyond. To continue to achieve these cost reductions, global custodians will increasingly turn to third party sub-processors to further drive down costs. Specific areas for increased outsourcing include:

• Compliance initiatives
• Moving emerging market processing to in-market delivery
• Restructuring offshore captives to increase the footprint of outsourced work
• Scaling growth in ancillary services (e.g. securities financing, trading services, and processing fees) as much as possible from third party vendors.

In short, downward revenue pressure is set to accelerate strongly in 2015. Custodians will need to aggressively reduce costs and outsource more work to increase operational flexibility. Successful execution will determine the winners.

Later this Spring, NelsonHall will be writing a market assessment of how the capital markets vendors are faring as they strive to meet the challenge.