As the country’s two largest custody banks wait for interest rates to improve to spur organic growth, both continue to jockey for position as the industry consolidates.

Bank of New York Mellon Corp. [BK] gathered significant scale with a pair of deals in the past four months, but State Street Corp. [STT] is looking for more deals this year.

In the first quarter, BNY Mellon edged ahead when it announced a deal to buy PNC Financial Services Group Inc.’s [PNC] Global Investment Servicing Inc. business unit, which would make BNY Mellon the second largest provider of fund accounting, administration and transfer agency and the third largest provider of alternative-fund assets under administration when that deal closes.

Joseph L. Hooley, State Street’s chief executive officer, expects more deals.

“Unless you are at a certain scale, it is hard to drive growth and reinvest in the business,” he said in an interview Tuesday. “Scale is going to be increasingly important. I think subscale providers will decide over time to consolidate.”

Todd Gibbons, BNY Mellon’s chief financial officer, said in an interview Tuesday that he doesn’t see any other major deals on the horizon for the large custody banks. He said BNY Mellon would consider “geographic or product capability fill-ins,” but “there is nothing else out there, frankly. I mean, there could be something in the asset management space, but I just don’t see anything else substantial, right now.”

Despite this skepticism, Robert Kelly, BNY Mellon’s chairman and chief executive officer, said during the company’s quarterly earnings conference call on Tueday that it plans to raise $700 million in equity that will be used to “fund purchases and give us additional capital.”

“Clearly, our capital ratios are stronger than we’d have expected a quarter ago, but to maintain a strong balance sheet” we need to raise more, he said. BNY Mellon plans to use the capital to grow organically and to fund smaller deals, he said.

Kelly admitted, “I would think we are more or less done for the year except perhaps something small outside of the U.S.”

Hooley, who assumed the top post at State Street on March 1 after Ronald E. Logue retired, said it plans to continue to target “high-growth” segments, including alternative asset management, and deals outside of the United States.

“We are not necessarily looking for large deals or smalls, but at clearly defined strategies,” he said. “We are offering a broad range of services across the globe. When there are opportunities to make an acquisition, we plan to be aggressive.”

Analysts said both companies have spent the past year trolling for bargains, but BNY Mellon has been more successful thus far because of the deal with PNC. While it announced deals for PNC’s Global Investment Servicing in February and BHF Asset Servicing GmbH from BHF-Bank Aktiengesellschaft in March to become the second largest asset servicer in Germany, State Street announced two overseas in December to buy Intesa Sanpaolo securities services business for $1.87 billion and a European fund administrator, Mourant International Finance Administration that is based in Jersey in the Channel Islands to expand its alternative servicing capabilities.

Both of BNY Mellon’s deals are expected to close in the third quarter. For State Street, the Mourant deal closed April 1 and Hooley said he expects the Intesa deal to close in the third quarter.  “All of these deals, and any future ones, are going to enhance our capabilities over time,” Hooley said. “You are not going to immediately see an impact on quarterly results, but over time they are going to give us opportunities to cross sell and add scale.”

Nancy Bush of NAB Research LLC said that BNY Mellon’s deal with PNC is “clearly a defensive move.” She said other custody banks, specifically Northern Trust [NTRS], “would like to have scale in fund accounting and” Global Investment Servicing “was the only vehicle of any size let to them.”

Gerard Cassidy an analyst at Royal Bank of Canada’s RBC Capital Markets said that BNY Mellon “didn’t pay a Filene’s Basement Price” for Global Investment Servicing “but they didn’t pay a Nieman Marcus price either.” He said BNY Mellon got a better deal than State Street did when it bought the securities servicing business from Intesa.

BNY Mellon’s first-quarter earnings rose 74% to $559 million, or 46 cents a share. After a 10 cent charge for increased litigation reserves, analysts expected the company to report a profit of 43 cents, according to Thomson Reuters.

Gibbons said the surge in assets is a result of securities losses in the first quarter of last year. He said that BNY Mellon had moderate securities gains this quarter and “asset management continues to gain nicely.”

“It feels like the credit environment is improving,” he said. “Credit quality continues to improve.”

Robert Kelly, the company’s chairman and chief executive officer, said during the company’s earnings conference call that it was an “encouraging quarter.”

State Street’s first-quarter profit increased 4% to $495 million, or 99 cents a share, from a year earlier as revenue rose 15% to $2.3 billion. Analysts surveyed by Thomson Reuters expect a profit of 75 cents on revenue of $2.18 billion.

Both companies said that the low-interest-rate environment remains a challenging hurdle as they look to generate fee revenue. BNY Mellon’s fee revenue increased 5% to $2.56 billion from a year earlier. Net interest revenue declined 1% from a year earlier to $765 million, but rose 6% from the previous quarter.

“Our business model is levered to rates levering up,” Kelly said. “We haven’t seen that yet.”

Hooley called 2010 a “transition year.”

“As the economy recovers and unemployment rates improve and consumer confidence improves, we expect interest rates to tighten and that will be good news for us,” he said. “In 2010, we are trying to drive growth and share gain in our core business. When this cycle passes, we expect market driven revenues to return to more normal volumes and levels. This environment is not unexpected given the trauma of the last few years.”

“A move toward more normal market conditions is going to help all of our businesses,” he said.



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