Bank of New York Mellon Corp. and State Street Corp. could show improvement on a key measure of capital strength because of a new accounting rule

By Sree Vidya Bhaktavatsalam and Christopher Condon April 20 (Bloomberg) -- Bank of New York Mellon Corp. and State Street Corp. could show improvement on a key measure of capital strength because of a new accounting rule, alleviating investors’ concerns the custody banks would have to sell more shares, analysts said. The tangible common equity ratio, which measures a company’s ability to absorb losses, will probably rise when BNY Mellon and State Street report first-quarter financial results tomorrow. The rule change could allow BNY Mellon to almost eliminate unrealized losses on hard-to-sell asset-backed debt, and State Street might cut similar losses by a quarter. BNY Mellon, based in New York, and Boston’s State Street likely earned less in the first quarter than they did a year earlier because of lower fees from administering and managing client assets, according to analysts surveyed by Bloomberg. Changes to mark-to-market rules by the Financial Accounting Standards Board may help them avoid having to raise capital, analysts said. Whether the companies match earnings estimates “doesn’t really matter,” Murali Gopal, an analyst in New York with Keefe, Bruyette & Woods Inc. said in an interview. “The market will be focused on capital and the balance sheets.” Custody banks such as BNY Mellon, State Street and Chicago- based Northern Trust Corp. keep records, track performance and lend securities to institutional investors including mutual, pension and hedge funds. The companies also manage mutual funds and investment accounts for institutions and wealthy individuals. BNY Mellon administered $20 trillion as of Dec. 31. State Street oversaw $12 trillion and Northern Trust, $3 trillion. Unrealized Losses BNY Mellon said unrealized mark-to-market losses rose to $4.1 billion as of Dec. 31. State Street said in January that unrealized losses on investments and commercial paper programs had doubled to $9.9 billion. Mark-to-market losses represent the difference between what an investor would get if it sells a security now and its value at maturity. The unrealized losses at BNY Mellon and State Street have increased concern among investors that the banks may have to raise equity capital, diluting the value of existing shares. BNY Mellon’s tangible common equity ratio was 3.8 percent as of Dec. 31, according to regulatory filings. Excluding certain items, such as deposits maintained by the Federal Reserve, that ratio drops to 1.6 percent, the lowest of 19 banks stress-tested by the U.S. government, said Mark Fitzgibbon, an analyst with Sandler O’Neill & Partners LP in New York. Greater Leeway State Street’s tangible common equity ratio stood at 4.6 percent as of Dec. 31, and 1.05 percent if the company’s commercial paper programs were consolidated onto its balance sheet. FASB’s decision on April 2 gives companies more leeway to ignore market prices when accounting for the value of some securities it intends to hold. The change could allow BNY Mellon to wipe away as much as $4 billion in unrealized mark-to-market losses, and as much as $2.5 billion for State Street, Gopal said. BNY Mellon’s securities portfolio held $39 billion as of Dec. 31, while State Street’s had $78.8 billion. State Street’s off-balance-sheet commercial paper programs held $23.9 billion in additional assets. None of the holdings has suffered a default, which would make the losses permanent. BNY Mellon is expected to report net income of $695 million in the first quarter, according to seven analysts surveyed by Bloomberg. That would be a decline of 7 percent from a year before. Excluding some costs and gains, the company is expected to earn 63 cents a share. Revenue State Street is expected to report net income of $466 million, a decrease of 12 percent from the prior year, according to a Bloomberg survey of six analysts. Revenue in several of the company’s main businesses, asset administration and money management, is likely to drop, Gopal said. He expects State Street to earn 97 cents a share, excluding some items, compared with the average $1.04 estimate by 13 analysts. Marty Mosby, an analyst for FTN Equity Capital Markets Corp. in Memphis, said State Street’s securities-lending business suffered in the quarter, as demand from borrowers such as hedge funds has fallen. The company has become more efficient by cutting costs. State Street announced in December it would cut 1,700 jobs, or 6 percent of staff. Mosby expects State Street to earn $1.18 in the quarter. Northern Trust Northern Trust continued to benefit from what a more- cautious approach to managing investments for clients compared with rivals, Fitzgibbon said. “Northern Trust is the most conservative of the custody banks, and that has helped them,” he said. “They have good revenue momentum.” The average estimate of seven analysts surveyed by Bloomberg expected Northern Trust to report net income of $225 million, down 42 percent from the prior year. Fitzgibbon expected Northern Trust to earn 97 cents a share, equal to the average estimate of 16 analysts surveyed by Bloomberg.