Eric Compton: The trust banks do not operate like your typical bank. For example, trust banks are not primarily focused on deposit gathering in order to fund loan growth. As a result, trust banks typically take on minimal credit risk and have low liquidity and duration risk.
Rather than viewing trust banks through the lens of your typical bank, we instead think of them more as a service provider. The trust banks provide the infrastructure and technology which allow everyone to connect to and use the financial markets. This includes items such as record-keeping, maintaining custody of assets, calculating NAV values for mutual funds, and much more. The trust banks then charge fees for providing these services, leading to roughly 80% of total revenues coming from fees for these banks. We currently view BNY Mellon and State Street as more or less fairly valued, with both trading at roughly 8% above our fair value estimates.
We view Northern Trust as overvalued at this point, trading at 30% above our fair value estimate, and this is even after factoring in a boost from tax reform, of which Northern Trust would be the largest beneficiary of the three given its higher concentration in the U.S. Northern Trust is arguably the most conservative of the trust banks, and the bank is loath to lever up or take on excessive risk simply to boost returns. We expect this culture of conservatism will continue, maintaining the bank's excellent reputation among its high net worth clients, and slow but steady cost cuts will help expand margins over time. Right now we think the market is simply expecting too much margin expansion, and we believe returns may be limited in the stock over the next several years.