Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

[ ü ] Quarterly Report Pursuant To Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2012

or

[     ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

Commission File No. 000-52710

THE BANK OF NEW YORK MELLON CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   13-2614959

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)

One Wall Street

New York, New York 10286

(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code — (212) 495-1784

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ü     No         

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ü     No         

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer   [ü ]      Accelerated filer    [    ]
  Non-accelerated filer   [     ]  (Do not check if a smaller reporting company)      Smaller reporting company    [    ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes          No ü

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class  

Outstanding as of

June 30, 2012

Common Stock, $0.01 par value   1,181,297,952


Table of Contents

THE BANK OF NEW YORK MELLON CORPORATION

Second Quarter 2012 Form 10-Q

Table of Contents

 

 

     Page  

Consolidated Financial Highlights (unaudited)

     2   

Part I – Financial Information

  

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and Results of Operations; Quantitative and Qualitative Disclosures About Market Risk:

  

General

     4   

Overview

     4   

Second quarter 2012 and subsequent events

     4   

Highlights of second quarter 2012 results

     5   

Fee and other revenue

     7   

Net interest revenue

     11   

Average balances and interest rates

     12   

Noninterest expense

     14   

Income taxes

     16   

Review of businesses

     16   

Critical accounting estimates

     27   

Consolidated balance sheet review

     27   

Liquidity and dividends

     40   

Capital

     43   

Trading activities and risk management

     47   

Foreign exchange and other trading

     48   

Asset/liability management

     49   

Off-balance sheet arrangements

     50   

Supplemental information – Explanation of Non-GAAP financial measures

     50   

Recent accounting and regulatory developments

     54   

Government monetary policies and competition

     62   

Website information

     62   

Item 1. Financial Statements:

  

Consolidated Income Statement (unaudited)

     63   

Consolidated Comprehensive Income Statement (unaudited)

     65   

Consolidated Balance Sheet (unaudited)

     66   

Consolidated Statement of Cash Flows (unaudited)

     67   

Consolidated Statement of Changes in Equity (unaudited)

     68   

Notes to Consolidated Financial Statements:

  

Note 1 – Basis of presentation

     69   

Note 2 – Accounting changes and new accounting guidance

     69   

Note 3 – Acquisitions and dispositions

     70   

Note 4 – Securities

     71   

Note 5 – Loans and asset quality

     74   

Note 6 – Goodwill and intangible assets

     81   

Note 7 – Other assets

     82   

Note 8 – Net interest revenue

     83   

Note 9 – Employee benefit plans

     84   

Note 10 – Restructuring charges

     84   

Note 11 – Income taxes

     85   

Note 12 – Securitizations and variable interest entities

     86   

Note 13 – Other comprehensive income

     88   

Note 14 – Fair value measurement

     90   

Note 15 – Fair value option

     104   

Note 16 – Derivative instruments

     104   

Note 17 – Commitments and contingent liabilities

     109   

Note 18 – Review of businesses

     114   

Note 19 – Supplemental information to the Consolidated Statement of Cash Flows

     117   

Item 4. Controls and Procedures

     118   

Forward-looking Statements

     119   

Part II – Other Information

  

Item 1. Legal Proceedings

     121   

Item 1A. Risk Factors

     121   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     122   

Item 6. Exhibits

     122   

Signature

     123   

Index to Exhibits

     124   


Table of Contents

The Bank of New York Mellon Corporation

Consolidated Financial Highlights (unaudited)

      Quarter ended     Year-to-date  

(dollar amounts in millions, except per common share

amounts and unless otherwise noted)

   June 30,
2012
    March 31,
2012
   

June 30,

2011

    June 30,
2012
   

June 30,

2011

 

Results applicable to common shareholders of

          

The Bank of New York Mellon Corporation:

          

Net income

   $ 466      $ 619      $ 735      $ 1,085      $ 1,360   

Basic EPS

     0.39        0.52        0.59        0.91        1.09   

Diluted EPS

     0.39        0.52        0.59        0.90        1.08   

Fee and other revenue

   $ 2,826      $ 2,838      $ 3,056      $ 5,664      $ 5,894   

Income from consolidated investment management funds

     57        43        63        100        173   

Net interest revenue

     734        765        731        1,499        1,429   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 3,617      $ 3,646      $ 3,850      $ 7,263      $ 7,496   

Return on common equity (annualized) (a)

     5.5     7.4     8.8     6.4     8.3

Non-GAAP adjusted (a)

     8.9     8.9     10.1     8.9     9.6

Return on tangible common equity (annualized) – Non-GAAP (a)

     15.7     21.0     26.3     18.3     25.3

Non-GAAP adjusted (a)

     22.4     23.0     27.6     22.7     26.6

Return on average assets (annualized)

     0.61     0.83     1.06     0.72     1.02

Fee revenue as a percentage of total revenue excluding net securities gains (losses)

     78     78     79     78     78

Annualized fee revenue per employee (based on average headcount)
(in thousands)

   $ 233      $ 233      $ 248      $ 233      $ 243   

Percentage of non-U.S. total revenue (b)

     37     37     37     37     37

Pre-tax operating margin (a)

     16     24     27     20     26

Non-GAAP adjusted (a)

     29     30     31     29     30

Net interest margin (FTE)

     1.25     1.32     1.41     1.28     1.43

Market value of assets under management at period end (in billions)

   $ 1,299      $ 1,308      $ 1,274      $ 1,299      $ 1,274   

Market value of assets under custody and administration at period end
(in trillions)

   $ 27.1      $ 26.6      $ 26.3      $ 27.1      $ 26.3   

Market value of cross-border assets at period end (in trillions)

   $ 9.9      $ 10.4      $ 10.1      $ 9.9      $ 10.1   

Market value of securities on loan at period end (in billions) (c)

   $ 275      $ 265      $ 273      $ 275      $ 273   

Average common shares and equivalents outstanding (in thousands):

          

Basic

     1,181,350        1,193,931        1,230,406        1,187,649        1,232,232   

Diluted

     1,182,985        1,195,558        1,233,710        1,189,264        1,236,016   

Capital ratios (d):

          

Estimated Basel III Tier 1 common equity ratio(a)(e)

     8.7     N/A        N/A        8.7     N/A   

Basel I Tier 1 common equity to risk-weighted assets ratio –

          

Non-GAAP (a)

     13.2     13.9     12.6     13.2     12.6

Basel I Tier 1 capital ratio

     14.7     15.6     14.1     14.7     14.1

Basel I Total (Tier 1 plus Tier 2) capital ratio

     16.4     17.5     16.7     16.4     16.7

Basel I leverage capital ratio

     5.5     5.6     5.8     5.5     5.8

BNY Mellon shareholders’ equity to total assets ratio (a)

     10.5     11.3     11.1     10.5     11.1

BNY Mellon common shareholders’ equity to total assets ratio (a)

     10.3     11.3     11.1     10.3     11.1

Tangible common shareholders’ equity to tangible assets of operations ratio – Non-GAAP (a)

     6.1     6.5     6.0     6.1     6.0

 

2    BNY Mellon


Table of Contents

The Bank of New York Mellon Corporation

Consolidated Financial Highlights (unaudited) continued

 

      Quarter ended     Year-to-date  

(dollar amounts in millions, except per common share

amounts and unless otherwise noted)

   June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Selected average balances:

          

Interest-earning assets

   $ 239,755      $ 236,331      $ 209,923      $ 238,042      $ 200,105   

Assets of operations

   $ 293,718      $ 289,900      $ 264,254      $ 291,808      $ 253,863   

Total assets

   $ 305,002      $ 301,344      $ 278,480      $ 303,172      $ 268,147   

Interest-bearing deposits

   $ 130,482      $ 125,438      $ 125,958      $ 127,959      $ 121,263   

Noninterest-bearing deposits

   $ 62,860      $ 66,613      $ 43,038      $ 64,737      $ 40,839   

Preferred stock

   $ 60      $ -      $ -      $ 30      $ -   

Total The Bank of New York Mellon Corporation common shareholders’ equity

   $ 34,123      $ 33,718      $ 33,464      $ 33,920      $ 33,147   

Other information at period end:

          

Cash dividends per common share

   $ 0.13      $ 0.13      $ 0.13      $ 0.26      $ 0.22   

Common dividend payout ratio

     33     25     22     29     20

Common dividend yield (annualized)

     2.4     2.2     2.0     2.4     1.7

Closing common stock price per common share

   $ 21.95      $ 24.13      $ 25.62      $ 21.95      $ 25.62   

Market capitalization

   $ 25,929      $ 28,780      $ 31,582      $ 25,929      $ 31,582   

Book value per common share – GAAP (a)

   $ 28.81      $ 28.51      $ 27.46      $ 28.81      $ 27.46   

Tangible book value per common share – Non-GAAP (a)

   $ 11.47      $ 11.17      $ 10.28      $ 11.47      $ 10.28   

Full-time employees

     48,200        47,800        48,900        48,200        48,900   

Common shares outstanding (in thousands)

     1,181,298        1,192,716        1,232,691        1,181,298        1,232,691   
(a) See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for a calculation of these ratios.
(b) Includes fee revenue, net interest revenue and income (loss) from consolidated investment management funds, net of net income (loss) attributable to noncontrolling interests.
(c) Represents the securities on loan managed by the Investment Services business.
(d) When in this Form 10-Q we refer to BNY Mellon’s or our bank subsidiary’s “Basel I” capital measures (e.g., Basel I Total capital or Basel I Tier 1 capital), we mean Total or Tier 1 capital, as applicable, as calculated under the Federal Reserve’s risk-based capital guidelines that are based on the 1988 Basel Accord, which is often referred to as “Basel I”.
(e) The estimated Basel III Tier 1 common equity ratio at June 30, 2012 is based on the Notices of Proposed Rulemaking (“NPRs”) and final market risk rule released on June 7, 2012. The estimated Basel III Tier 1 common equity ratios of 7.6% at March 31, 2012 and 6.5% at June 30, 2011 were based on prior Basel III guidance and the proposed market risk rule.

 

BNY Mellon    3


Table of Contents

Part I – Financial Information

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and Results of Operations; Quantitative and Qualitative Disclosures about Market Risk

 

 

General

In this Quarterly Report on Form 10-Q, references to “our,” “we,” “us,” “BNY Mellon,” the “Company” and similar terms refer to The Bank of New York Mellon Corporation and its consolidated subsidiaries. The term “Parent” refers to The Bank of New York Mellon Corporation but not its subsidiaries.

Certain business terms used in this document are defined in the Glossary included in our Annual Report on Form 10-K for the year ended Dec. 31, 2011 (“2011 Annual Report”).

The following should be read in conjunction with the Consolidated Financial Statements included in this report. Investors should also read the section titled “Forward-looking statements.”

How we reported results

Throughout this Form 10-Q, measures which are noted as “Non-GAAP” exclude certain items. BNY Mellon believes that these measures are useful to investors because they permit a focus on period-to-period comparisons, using measures that relate to our ability to enhance revenues and limit expenses in circumstances where such matters are within our control. We also present the net interest margin on a fully taxable equivalent (“FTE”) basis. We believe that this presentation allows for comparison of amounts arising from both taxable and tax-exempt sources and is consistent with industry practice. Certain immaterial reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for a reconciliation of financial measures presented in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) to adjusted Non-GAAP financial measures.

Overview

BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE symbol: BK). BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets.

BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, offering superior investment management and investment services through a worldwide client-focused team. At June 30, 2012, we had $27.1 trillion in assets under custody and administration and $1.3 trillion in assets under management, serviced $11.5 trillion in outstanding debt and processed global payments averaging $1.4 trillion per day.

Second quarter 2012 and subsequent events

Settlement of securities lending matter

On July 5, 2012, BNY Mellon, N.A. and The Bank of New York Mellon entered into a settlement agreement related to a previously disclosed class action lawsuit pending in federal court in Oklahoma and initiated by CompSource Oklahoma concerning losses in connection with the investment of securities lending collateral in Sigma Finance Inc. (“Sigma”). The settlement agreement is subject to final court approval.

The company recorded an after-tax charge of $212 million (approximately $350 million pre-tax) in the second quarter of 2012 primarily related to claims involving Sigma investments. This charge includes in part the expected payment of $280 million settling the Sigma-related class action.

Proposed risk-based capital rules

On June 7, 2012, the U.S. regulatory agencies released three Notices of Proposed Rulemaking (“NPRs”) and final market risk rule which provide guidance on the determination of regulatory capital ratios. At June 30, 2012, our estimated Basel III Tier 1 common equity ratio calculated under the new guidelines was 8.7%. Our estimated Basel III Tier 1 common equity ratio of 7.6% at March 31, 2012 and 6.5% at June 30, 2011 were based on prior Basel III guidance and the proposed market risk rule. The sequential increase was primarily due to the reduction in risk-weighted assets related to the treatment of sub-investment grade securities, partially offset by the treatment of investment-grade securitizations and financial institution exposure. The positive impact of the NPRs was partially offset by balance sheet growth in the second quarter of 2012.

 

 

4    BNY Mellon


Table of Contents

See the “Regulatory Developments” section for a discussion of the NPRs and final market risk rule and the “Capital” section for the calculation of our estimated Basel III Tier 1 common equity ratio.

European Central Bank interest rate cut

On July 5, 2012, the European Central Bank (“ECB”) cut its main refinancing rate to 0.75% and reduced its deposit rate, which acts as a floor for the money markets, to zero. The combination of the lower ECB deposit rate and the balances maintained at the ECB could negatively impact our net interest revenue by approximately $20-$25 million in the second half of 2012. We expect to substantially mitigate the adverse impact of the rate cut through investment strategies. Additionally, the rate cut could result in an increase to our balance sheet if deposit balances were to increase as fund managers exit money market funds. We expect any impact to fee revenue from the rate cut to be immaterial.

Highlights of second quarter 2012 results

We reported net income applicable to common shareholders of BNY Mellon of $466 million, or $0.39 per diluted common share including a litigation charge of $212 million (after-tax) or $0.18 per common share, in the second quarter of 2012 compared with $735 million, or $0.59 per diluted common share, in the second quarter of 2011 and $619 million, or $0.52 per diluted common share, in the first quarter of 2012.

Highlights for the second quarter of 2012 include:

 

   

Assets under custody and administration (“AUC”) totaled a record $27.1 trillion at June 30, 2012 compared with $26.3 trillion at June 30, 2011 and $26.6 trillion at March 31, 2012. This represents an increase of 3% compared with the prior year and 2% sequentially. The increases were driven by net new business, partially offset by lower equity market values. (See the “Review of businesses – Investment Services business” beginning on page 23).

   

Assets under management (“AUM”), excluding securities lending assets, totaled $1.30 trillion at June 30, 2012, compared with $1.27 trillion at June 30, 2011 and $1.31 trillion at March 31, 2012. This represents an increase of 2% compared with the prior year and a decrease of 1% sequentially. Year-over-year, net inflows were partially offset by lower equity market values. On a sequential basis, the decrease

   

resulted from lower equity market values, partially offset by net inflows. (See the “Review of businesses – Investment Management business” beginning on page 20).

   

Investment services fees totaled $1.7 billion in the second quarter of 2012 compared with $1.8 billion in the second quarter of 2011. The decrease was primarily driven by the impact of the sale of the Shareowner Services business in the fourth quarter of 2011, lower Depositary Receipts revenue and higher money market fee waivers, partially offset by higher Clearing Services fees and net new business. (See the “Review of businesses – Investment Services business” beginning on page 23).

   

Investment management and performance fees totaled $797 million in the second quarter of 2012 compared with $779 million in the second quarter of 2011. The increase was primarily driven by higher performance fees and net new business, partially offset by lower equity market values. (See the “Review of businesses – Investment Management business” beginning on page 20).

   

Foreign exchange and other trading revenue totaled $180 million in the second quarter of 2012 compared with $222 million in the second quarter of 2011. In the second quarter of 2012, foreign exchange revenue totaled $157 million, a decrease of 15%, reflecting lower volatility and volumes. Other trading revenue was $23 million in the second quarter of 2012 compared with $38 million in the second quarter of 2011. The decrease was primarily driven by lower fixed income trading revenue. (See “Fee and other revenue” beginning on page 7).

   

Investment and other income totaled $48 million in the second quarter of 2012 compared with $145 million in the second quarter of 2011. The decrease primarily resulted from lower asset-related gains and equity investment revenue. (See “Fee and other revenue” beginning on page 7).

   

Net interest revenue totaled $734 million in the second quarter of 2012 compared with $731 million in the second quarter of 2011. The increase was primarily driven by higher average client deposits, increased investment in high- quality investment securities and higher loan levels, partially offset by narrower spreads and lower accretion. The net interest margin (FTE) for the second quarter of 2012 was 1.25% compared with 1.41% in the second quarter of 2011. The decrease reflects increased client

 

 

BNY Mellon    5


Table of Contents
 

deposits which were invested in lower-yielding assets reflecting the current market environment. (See “Net interest revenue” on page 11).

   

The provision for credit losses was a credit of $19 million in the second quarter of 2012 primarily resulting from a decline in the expected loss related to a broker-dealer customer that previously filed for bankruptcy, as well as improvements in the mortgage portfolio. There was no provision in the second quarter of 2011. (See “Consolidated balance sheet review – Asset quality and allowance for credit losses” beginning on page 36).

   

Noninterest expense totaled $3.0 billion in the second quarter of 2012 compared with $2.8 billion in the second quarter of 2011. The increase primarily reflects a litigation charge of approximately $350 million (pre-tax), partially offset by the impact of our operational excellence initiatives. (See “Noninterest expense” beginning on page 14).

   

BNY Mellon recorded an income tax provision of $93 million (15.8% effective tax rate) in the second quarter of 2012, which includes a reduction in the tax rate of approximately 9% related to the litigation charge. The operating tax rate – Non-GAAP in the second quarter of 2012 was 26.1% and included an increased benefit of certain tax credits. This compared with an income tax provision of $277 million (26.9% effective tax rate) in the second quarter of 2011. (See “Income taxes” on page 16).

   

The unrealized pre-tax gain on our total investment securities portfolio was $1.4 billion at June 30, 2012 compared with $1.2 billion at March 31, 2012. The increase in the valuation of the investment securities portfolio primarily reflects a decline in market interest rates. (See “Consolidated balance sheet review – Investment securities” beginning on page 30).

   

At June 30, 2012, our estimated Basel III Tier 1 common equity ratio was 8.7% based on the NPRs and final market risk rule. The increase in the ratio from 7.6% at March 31, 2012, which was calculated under prior Basel III guidance and the proposed market risk rule, was primarily due to the reduction in risk-weighted assets related to the treatment of sub-investment grade securities, partially offset by the treatment of investment grade securitizations and financial institution exposure. The positive impact of the NPRs was partially offset by balance sheet growth in the second quarter of 2012. (See “Capital” beginning on page 43).

   

We generated $527 million of gross Basel I Tier 1 common equity in the second quarter of 2012, primarily driven by earnings. Our Basel I Tier 1 capital ratio was 14.7% at June 30, 2012 compared with 14.1% at June 30, 2011. (See “Capital” beginning on page 43).

   

In the second quarter of 2012, we repurchased 12.2 million common shares in the open market at an average price of $23.38 per share for a total of $286 million.

 

 

6    BNY Mellon


Table of Contents

Fee and other revenue

 

Fee and other revenue (a)

 

                                                    YTD12
vs.
YTD11
 
                       2Q12 vs.     Year-to-date    
(dollars in millions, unless otherwise noted)    2Q12     1Q12     2Q11     2Q11     1Q12     2012     2011    

Investment services fees:

                

Asset servicing (b)

   $ 950      $ 943      $ 973        (2 )%      1   $ 1,893      $ 1,890       

Issuer services

     275        251        365        (25     10        526        716        (27

Memo: Issuer services excluding

                

Shareowner Services

     275        251        314        (12     10        526        606        (13

Clearing services

     309        303        292        6        2        612        584        5   

Treasury services

     134        136        134               (1     270        268        1   

Total investment services fees

     1,668        1,633        1,764        (5     2        3,301        3,458        (5

Investment management and performance fees

     797        745        779        2        7        1,542        1,543          

Foreign exchange and other trading revenue

     180        191        222        (19     (6     371        420        (12

Distribution and servicing

     46        46        49        (6            92        102        (10

Financing-related fees

     37        44        49        (24     (16     81        92        (12

Investment and other income

     48        139        145        (67     (65     187        226        (17

Total fee revenue

     2,776        2,798        3,008        (8     (1     5,574        5,841        (5

Net securities gains (losses)

     50        40        48        4        25        90        53        70   

Total fee and other revenue – GAAP

     2,826        2,838      $ 3,056        (8            5,664        5,894        (4

Less: Fee and other revenue related to Shareowner Services (c)

     (3            54        N/M        N/M        (3     116        N/M   

Total fee and other revenue excluding Shareowner Services – Non-GAAP

   $ 2,829      $ 2,838      $ 3,002        (6 )%        $ 5,667      $ 5,778        (2 )% 

Fee revenue as a percent of total revenue excluding net securities gains (losses)

     78     78     79         78     78  

Market value of AUM at period end (in billions)

   $ 1,299      $ 1,308      $ 1,274        2     (1 )%    $ 1,299      $ 1,274        2

Market value of AUC and administration at period end (in trillions)

   $ 27.1      $ 26.6      $ 26.3        3     2   $ 27.1      $ 26.3        3

 

(a) See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for fee and other revenue excluding Shareowner Services – Non-GAAP.
(b) Asset servicing fees include securities lending revenue of $59 million in the second quarter of 2012, $49 million in the first quarter of 2012, $62 million in the second quarter of 2011, $108 million in the first six months of 2012 and $99 million in the first six months of 2011.
(c) The Shareowner Services business was sold on Dec. 31, 2011.
N/M – Not meaningful.

 

Fee and other revenue

Fee and other revenue was $2.8 billion in the second quarter of 2012, a decrease of 8% year-over-year and was unchanged sequentially. Excluding the impact of the Shareowner Services business, fee and other revenue decreased 6% year-over-year primarily reflecting gains on loans held-for-sale retained from a previously divested bank subsidiary recorded in the second quarter of 2011, lower investment services fees, lower foreign exchange and other trading revenue and lower equity investment revenue, partially offset by higher investment management and performance fees and Clearing Services fees. Sequentially, fee and other revenue was virtually unchanged as lower investment and other income and lower foreign exchange and other revenue was offset by higher investment management and performance fees and investment services fees.

Investment services fees

Investment services fees were impacted by the following, compared with the second quarter of 2011 and the first quarter of 2012:

 

   

Asset servicing fees were $950 million, a decrease of 2% year-over-year and an increase of 1% (unannualized) sequentially. The year-over-year decrease primarily reflects lower equity market values and securities lending revenue, partially offset by net new business. The sequential increase was primarily driven by net new business and seasonally higher securities lending revenue, partially offset by lower equity market values.

 

 

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Issuer services fees were $275 million, a decrease of 25% year-over-year and an increase of 10% (unannualized) sequentially. Excluding Shareowner Services, Issuer services decreased 12% year-over-year. The year-over-year decrease primarily resulted from lower Depositary Receipts revenue, lower money market related fees and lower trust fees related to the weakness in structured products in Corporate Trust. The increase sequentially resulted from higher Depositary Receipts revenue as well as higher money market related fees in Corporate Trust.

   

Clearing services fees were $309 million, an increase of 6% year-over-year and 2% (unannualized) sequentially. The year-over-year increase was driven by higher mutual fund fees, partially offset by the impact of lower DARTS volume and higher money market fee waivers. The sequential increase primarily reflects higher mutual fund fees and lower money market fee waivers, partially offset by the impact of lower DARTS volume.

   

Treasury services fees were $134 million, unchanged compared with the second quarter of 2011 and a decrease of 1% (unannualized) sequentially. The sequential decrease reflects lower global payment fees.

See the “Investment Services business” in “Review of businesses” for additional details.

Investment management and performance fees

Investment management and performance fees were $797 million, an increase of 2% year-over-year and 7% (unannualized) sequentially. Both increases reflect higher performance fees. Performance fees were $54 million in the second quarter of 2012, $18 million in the second quarter of 2011 and $16 million in the first quarter of 2012. Excluding performance fees, investment management fees decreased 2% year-over-year and increased 2% (unannualized) sequentially. The decrease year-over-year was primarily due to lower equity market values, partially offset by net new business. Sequentially, the increase was primarily due to net new business and higher money market fees, partially offset by lower equity market values.

Total AUM for the Investment Management business was $1.30 trillion at June 30, 2012 compared with $1.27 trillion at June 30, 2011 and $1.31 trillion at March 31, 2012. The 2% year-over-year increase primarily reflects net inflows, partially

offset by lower equity market values. On a sequential basis, the 1% decrease primarily resulted from lower equity market values, partially offset by net inflows.

See the “Investment Management business” in “Review of businesses” for additional details regarding the drivers of investment management and performance fees.

Foreign exchange and other trading revenue

 

Foreign exchange and other trading revenue

  

               
                        Year-to-date  
(in millions)    2Q12      1Q12     2Q11     2012     2011  

Foreign exchange

   $ 157       $ 136      $ 184      $ 293      $ 357   

Fixed income

     16         47        28        63        45   

Credit derivatives (a)

     1         (2     (1     (1     (2

Other

     6         10        11        16        20   

Total

   $ 180       $ 191      $ 222      $ 371      $ 420   

 

(a) Used as economic hedges of loans.

Foreign exchange and other trading revenue totaled $180 million in the second quarter of 2012, $222 million in the second quarter of 2011 and $191 million in the first quarter of 2012. In the second quarter of 2012, foreign exchange revenue totaled $157 million, a decrease of 15% year-over-year and an increase of 15% (unannualized) sequentially. The year-over-year decrease reflects lower volatility and volumes, while the sequential increase primarily resulted from higher volumes. Additionally, foreign exchange revenue continues to be impacted by increasingly competitive market pressures. Other trading revenue was $23 million in the second quarter of 2012 compared with $38 million in the second quarter of 2011 and $55 million in the first quarter of 2012. Both decreases were primarily driven by lower fixed income trading. Foreign exchange revenue is primarily reported in the Investment Services business. Other trading revenue is primarily reported in the Other segment.

The foreign exchange trading engaged in by the Company generates revenues, which are influenced by the volume of client transactions and the spread realized on these transactions. The level of volume and spreads is affected by market volatility, the level of cross-border assets held in custody for clients, the level and nature of underlying cross-border investments and other transactions undertaken by corporate and institutional clients. These revenues also depend on our ability to manage the risk associated with the currency transactions we execute. A substantial majority of our foreign

 

 

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exchange trades is undertaken for our custody clients in transactions where BNY Mellon acts as principal, and not as an agent or broker. As a principal, we earn a profit, if any, based on our ability to risk manage the aggregate foreign currency positions that we buy and sell on a daily basis. Generally speaking, custody clients enter into foreign exchange transactions in one of three ways: negotiated trading with BNY Mellon, BNY Mellon’s standing instruction program, or transactions with third-party foreign exchange providers. Negotiated trading generally refers to orders entered by the client or the client’s investment manager, with all decisions related to the transaction, usually on a transaction-specific basis, made by the client or its investment manager. Such transactions may be initiated by (i) contacting one of our sales desks to negotiate the rate for specific transactions, (ii) using electronic trading platforms, or (iii) electing other methods such as those pursuant to a benchmarking arrangement, in which pricing is determined by an objective market rate plus a pre-negotiated spread. The preponderance of the notional value of our trading volume with clients is in negotiated trading. Our standing instruction program, including a new standing instruction program option called the Defined Spread Offering, which the Company introduced to clients in the first quarter of 2012, provides custody clients and their investment managers with an end-to-end solution that allows them to shift to BNY Mellon the cost, management and execution risk, often in small transactions not otherwise eligible for a more favorable rate or transactions in restricted and difficult to trade currencies. We incur substantial costs in supporting the global operational infrastructure required to administer the standing instruction program; on a per-transaction basis, the costs associated with the standing instruction program exceed the costs associated with negotiated trading. In response to competitive market pressures and client requests, we are continuing to develop standing instruction program products and services and making these new products and services available to our clients. Our custody clients may also choose to use third-party foreign exchange providers other than BNY Mellon for a substantial majority of their U.S. dollar-equivalent volume foreign exchange transactions.

We typically price negotiated trades for our custody clients at a spread over our estimation of the current market rate for a particular currency or based on an agreed upon third-party benchmark. With respect to our standing instruction program, we typically

assign a price derived from the daily pricing range for marketable-size foreign exchange transactions (generally more than $1 million) executed between global financial institutions, known as the “interbank range.” Using the interbank range for the given day, we typically price purchases of currencies at or near the low end of this range and sales of currencies at or near the high end of this range. The standing instruction program Defined Spread Offering prices transactions in each pricing cycle (several times a day in the case of developed market currencies) by adding a predetermined spread to an objective market source for developed and certain emerging market currencies or to a reference rate computed by BNY Mellon for restricted and other currencies. A shift by custody clients from the standing instruction program to other trading options combined with the increasing competitive market pressures on the foreign exchange business may negatively impact our foreign exchange revenue. For the quarter ended June 30, 2012, our total revenue for all types of foreign exchange trading transactions was $157 million, which is approximately 4% of our total revenue. Approximately 48% of our foreign exchange revenue resulted from foreign exchange transactions undertaken through our standing instruction program.

Distribution and servicing fees

Distribution and servicing fee revenue was $46 million in the second quarter of 2012 compared with $49 million in the second quarter of 2011 and $46 million in the first quarter of 2012. The year-over-year decrease primarily reflects higher money market fee waivers. Sequentially, distribution and servicing fees were unchanged reflecting lower money market fee waivers offset by lower equity market values.

Financing-related fees

Financing-related fees, which are primarily reported in the Other segment, include capital markets fees, loan commitment fees and credit-related fees. Financing-related fees were $37 million in the second quarter of 2012, $49 million in the second quarter of 2011 and $44 million in the first quarter of 2012. Both decreases were primarily driven by lower capital markets fees and credit-related fees.

 

 

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Investment and other income

 

Investment and other income                         Year-to-date  
(in millions)    2Q12     1Q12     2Q11     2012     2011  

Corporate/bank-owned life insurance

   $ 32      $ 34      $ 42      $ 66      $ 79   

Lease residual gains (losses)

     3        34        (5     37        8   

Seed capital gains

            24        3        24        5   

Expense reimbursements from joint ventures

     9        10        8        19        17   

Equity investment revenue (loss)

     (5     6        19        1        24   

Private equity gains (losses)

     1        4        12        5        22   

Asset-related gains (losses)

            (2     66        (2     80   

Other income (loss)

     8        29               37        (9

Total

   $ 48      $ 139      $ 145      $ 187      $ 226   

Investment and other income, which is primarily reported in the Other segment and Investment Management business, includes income from insurance contracts, lease residual gains and losses, gains and losses on seed capital investments, equity investment income, gains and losses on private equity investments, asset-related gains (losses), expense reimbursements from joint ventures and other income (loss). Asset-related gains (losses) include loan, real estate and other asset dispositions. Expense reimbursements from joint ventures relate to expenses incurred by BNY Mellon on behalf of joint ventures. Other income (loss) primarily includes fees from transitional service agreements, foreign currency remeasurement gain (loss), other investments and various miscellaneous revenues. Investment and other income decreased $97 million compared with the second quarter of 2011 and $91 million compared with the first quarter of 2012. The year-over-year decrease primarily resulted from lower asset-related gains and equity investment revenue. Sequentially, the decrease was primarily driven by lower leasing gains, seed capital gains and equity investment revenue.

Net securities gains (losses)

Net securities gains totaled $50 million in the second quarter of 2012 compared with $48 million in the second quarter of 2011 and $40 million in the first quarter of 2012.

Year-to-date 2012 compared with year-to-date 2011

Fee and other revenue for the first six months of 2012 totaled $5.7 billion compared with $5.9 billion in the first six months of 2011. The decrease primarily reflects the impact of the sale of the Shareowner Services business. Excluding the impact of the Shareowner Services business, fee and other revenue decreased 2% primarily reflecting lower issuer services fees, investment and other income and foreign exchange and other trading revenue, offset in part by higher net securities gains.

The decrease in issuer services fees primarily reflects lower Depositary Receipts revenue and higher money market fee waivers. The decrease in foreign exchange and other trading revenue was primarily driven by lower foreign exchange revenue resulting from lower volumes and volatility. The decrease in investment and other income in the first six months of 2012 reflects lower gains on asset sales and lower equity investment revenue, partially offset by higher lease residual gains. Net securities gains (losses) increased $37 million in the first six months of 2012 compared with the first six months of 2011.

 

 

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Net interest revenue

 

 

 

Net interest revenue                                              YTD12  
                       2Q12 vs.     Year-to-date     vs.  
(dollars in millions)    2Q12     1Q12     2Q11     2Q11     1Q12     2012     2011     YTD11  

Net interest revenue (non-FTE)

   $ 734      $ 765      $ 731            (4 )%    $ 1,499      $ 1,429        5

Tax equivalent adjustment

     13        11        6        N/M        N/M        24        10        N/M   

Net interest revenue (FTE) – Non-GAAP

   $ 747      $ 776      $ 737        1     (4 )%    $ 1,523      $ 1,439        6

Average interest-earning assets

   $ 239,755      $ 236,331      $ 209,923        14     1% $ 238,042      $ 200,105        19

Net interest margin (FTE)

     1.25     1.32     1.41     (16 ) bps      (7 ) bps      1.28     1.43     (15 ) bps 

bps—basis points.

FTE - fully taxable equivalent.

 

Net interest revenue totaled $734 million in the second quarter of 2012, an increase of $3 million compared with the second quarter of 2011 and a decrease of $31 million sequentially. The year-over-year increase in net interest revenue was primarily driven by higher average client deposits, increased investment in high-quality investment securities and higher loan levels, partially offset by narrower spreads and lower accretion. Compared with the first quarter of 2012, net interest revenue was adversely impacted by narrower spreads and lower accretion.

The net interest margin (FTE) was 1.25% in the second quarter of 2012 compared with 1.41% in the second quarter of 2011 and 1.32% in the first quarter of 2012. The year-over-year decrease in the net interest margin (FTE) was primarily driven by increased client deposits which were invested in

lower-yielding assets reflecting the current market environment. The sequential decrease in the net interest margin (FTE) reflects the impact of narrower spreads and lower accretion.

Year-to-date 2012 compared with year-to-date 2011

Net interest revenue totaled $1.5 billion in the first six months of 2012 and $1.4 billion in the first six months of 2011. The increase primarily reflects higher average client deposits, increased investment in high-quality investment securities and higher loan levels, partially offset by narrower spreads and lower accretion. The net interest margin (FTE) was 1.28% in the first six months of 2012, compared with 1.43% in the first six months of 2011. The decline was primarily driven by increased client deposits which were invested in lower-yielding assets.

 

 

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Average balances and interest rates

 

Average balances and interest rates    Quarter ended  
     June 30, 2012     March 31, 2012     June 30, 2011  
(dollar amounts in millions)    Average
balance
    Average
rates
    Average
balance
    Average
rates
    Average
balance
    Average
rates
 

Assets

            

Interest-earning assets:

            

Interest-bearing deposits with banks

            

(primarily foreign banks)

   $ 38,474        0.98   $ 35,095        1.30   $ 59,291        0.98

Interest-bearing deposits held at the Federal Reserve and other central banks

     57,904        0.27        63,526        0.27        34,068        0.32   

Federal funds sold and securities purchased under resale agreements

     5,493        0.62        5,174        0.73        4,577        0.46   

Margin loans

     13,331        1.27        12,901        1.29        9,508        1.34   

Non-margin loans:

            

Domestic offices

     19,663        2.52        20,128        2.46        21,093        2.54   

Foreign offices

     9,998        1.86        10,180        1.77        9,727        1.53   
  

 

 

     

 

 

     

 

 

   

Total non-margin loans

     29,661        2.30        30,308        2.23        30,820        2.23   

Securities:

            

U.S. government obligations

     15,387        1.65        17,268        1.56        14,337        1.63   

U.S. government agency obligations

     39,070        2.23        32,347        2.44        20,466        3.09   

State and political subdivisions – tax exempt

     4,777        2.65        3,354        2.97        934        5.32   

Other securities

     32,625        2.51        33,839        2.84        33,045        3.25   

Trading securities

     3,033        2.57        2,519        2.78        2,877        2.44   
  

 

 

     

 

 

     

 

 

   

Total securities

     94,892        2.26        89,327        2.44        71,659        2.87   
  

 

 

     

 

 

     

 

 

   

Total interest-earning assets

   $ 239,755        1.48   $ 236,331        1.56   $ 209,923        1.70

Allowance for loan losses

     (382       (392       (463  

Cash and due from banks

     4,412          4,271          4,335     

Other assets

     49,933          49,690          50,459     

Assets of consolidated investment management funds

     11,284                11,444                14,226           

Total assets

   $ 305,002              $ 301,344              $ 278,480           

Liabilities

            

Interest-bearing liabilities:

            

Interest-bearing deposits:

            

Money market rate accounts

   $ 8,236        0.24   $ 4,299        0.27   $ 4,029        0.41

Savings

     702        0.13        704        0.10        1,561        0.12   

Time deposits

     33,180        0.11        33,618        0.08        34,853        0.09   

Demand deposits

     185        0.32        147        0.36        85        0.91   

Foreign offices

     88,179        0.13        86,670        0.15        85,430        0.26   
  

 

 

     

 

 

     

 

 

   

Total interest-bearing deposits

     130,482        0.13        125,438        0.14        125,958        0.22   

Federal funds purchased and securities sold under repurchase agreements

     11,254        0.01        8,584        (0.02     10,894        0.06   

Trading liabilities

     1,256        1.87        1,153        1.55        1,524        2.35   

Other borrowed funds

     2,550        0.99        2,579        0.79        1,877        0.99   

Payables to customers and broker-dealers

     7,895        0.10        7,555        0.11        6,843        0.09   

Long-term debt

     20,084        1.67        20,538        1.79        17,380        1.63   
  

 

 

     

 

 

     

 

 

   

Total interest-bearing liabilities

   $ 173,521        0.32   $ 165,847        0.34   $ 164,476        0.38

Total noninterest-bearing deposits

     62,860          66,613          43,038     

Other liabilities

     23,588          24,248          23,694     

Liabilities and obligations of consolidated investment management funds

     10,072                10,159                12,966           

Total liabilities

     270,041          266,867          244,174     

Temporary equity

            

Redeemable noncontrolling interests

     78          72          65     

Permanent equity

            

Total BNY Mellon shareholders’ equity

     34,183          33,718          33,464     

Noncontrolling interests

     700                687                777           

Total permanent equity

     34,883                34,405                34,241           

Total liabilities, temporary equity and permanent equity

   $ 305,002              $ 301,344              $ 278,480           

Net interest margin (FTE)

             1.25             1.32             1.41
Note: Interest and average rates were calculated on a taxable equivalent basis, at tax rates approximating 35%, using dollar amounts in thousands and actual number of days in the year.

 

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Average balances and interest rates    Year-to-date  
     June 30, 2012        June 30, 2011   
(dollar amounts in millions)     
 
Average
balance
  
  
   
 
Average
rates
  
  
   
 
Average
balance
  
  
   
 
Average
rates
  
  

Assets

        

Interest-earning assets:

        

Interest-bearing deposits with banks (primarily foreign banks)

   $ 36,784        1.14   $ 58,468        0.94

Interest-bearing deposits held at the Federal Reserve and other central banks

     60,715        0.27        27,255        0.32   

Federal funds sold and securities purchased under resale agreements

     5,333        0.67        4,546        0.47   

Margin loans

     13,116        1.28        8,502        1.40   

Non-margin loans:

        

Domestic offices

     19,895        2.49        21,472        2.55   

Foreign offices

     10,089        1.81        9,478        1.49   
  

 

 

     

 

 

   

Total non-margin loans

     29,984        2.26        30,950        2.22   

Securities:

        

U.S. government obligations

     16,328        1.61        13,597        1.61   

U.S. government agency obligations

     35,709        2.33        20,344        3.02   

State and political subdivisions – tax exempt

     4,066        2.78        747        5.66   

Other securities

     33,231        2.67        32,411        3.31   

Trading securities

     2,776        2.67        3,285        2.44   
  

 

 

     

 

 

   

Total securities

     92,110        2.36        70,384        2.89   
  

 

 

     

 

 

   

Total interest-earning assets

   $  238,042        1.53   $  200,105        1.75

Allowance for loan losses

     (387       (479  

Cash and due from banks

     4,341          4,215     

Other assets

     49,812          50,022     

Assets of consolidated investment management funds

     11,364                14,284           

Total assets

   $ 303,172              $ 268,147           

Liabilities

        

Interest-bearing liabilities:

        

Interest-bearing deposits:

        

Money market rate accounts

   $ 6,267        0.25   $ 4,719        0.38

Savings

     703        0.12        1,539        0.12   

Time deposits

     33,399        0.10        33,494        0.09   

Demand deposits

     166        0.33        84        0.89   

Foreign offices

     87,424        0.14        81,427        0.22   
  

 

 

     

 

 

   

Total interest-bearing deposits

     127,959        0.14        121,263        0.19   

Federal funds purchased and securities sold under repurchase agreements

     9,919        —          8,049        0.06   

Trading liabilities

     1,205        1.72        2,141        2.04   

Other borrowed funds

     2,564        0.89        1,849        1.30   

Payables to customers and broker-dealers

     7,725        0.11        6,772        0.09   

Long-term debt

     20,311        1.73        17,198        1.75   
  

 

 

     

 

 

   

Total interest-bearing liabilities

   $ 169,683        0.34   $ 157,272        0.39

Total noninterest-bearing deposits

     64,737          40,839     

Other liabilities

     23,919          23,026     

Liabilities and obligations of consolidated investment management funds

     10,115                13,040           

Total liabilities

     268,454          234,177     

Temporary equity

        

Redeemable noncontrolling interests

     75          70     

Permanent equity

        

Total BNY Mellon shareholders’ equity

     33,950          33,147     

Noncontrolling interests

     693                753           

Total permanent equity

     34,643                33,900           

Total liabilities, temporary equity and permanent equity

   $ 303,172              $ 268,147           

Net interest margin (FTE)

             1.28             1.43
Note: Interest and average rates were calculated on a taxable equivalent basis, at tax rates approximating 35%, using dollar amounts in thousands and actual number of days in the year.

 

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Noninterest expense

 

Noninterest expense                         2Q12 vs.     Year-to-date     YTD12 vs.  
(dollars in millions)    2Q12     1Q12     2Q11     2Q11     1Q12     2012     2011     YTD11  

Staff:

                

Compensation

   $ 866      $ 861      $ 903        (4 )%      1   $ 1,727      $ 1,779        (3 )% 

Incentives

     311        352        328        (5     (12     663        653        2   

Employee benefits

     238        240        232        3        (1     478        455        5   

Total staff

     1,415        1,453        1,463        (3     (3     2,868        2,887        (1

Professional, legal and other purchased services

     309        299        301        3        3        608        584        4   

Net occupancy

     141        147        161        (12     (4     288        314        (8

Software

     127        119        121        5        7        246        243        1   

Distribution and servicing

     103        101        109        (6     2        204        220        (7

Furniture and equipment

     82        86        82        —          (5     168        166        1   

Sub-custodian

     70        70        88        (20     —          140        156        (10

Business development

     71        56        73        (3     27        127        129        (2

Other

     254        220        247        3        15        474        476        —     

Amortization of intangible assets

     97        96        108        (10     1        193        216        (11

M&I, litigation and restructuring charges

     378        109        63        N/M        N/M        487        122        N/M   

Total noninterest expense – GAAP

   $ 3,047      $ 2,756      $ 2,816        8     11   $ 5,803      $ 5,513        5

Total staff expense as a percent of total revenue

     39     40     38         39     39  

Full-time employees at period end

     48,200        47,800        48,900        (1 )%      1     48,200        48,900        (1 )% 

N/M—Not meaningful.

 

                
Noninterest expense excluding Shareowner Services                         2Q12 vs.     Year-to-date     YTD12 vs.  
(dollars in millions)    2Q12     1Q12     2Q11     2Q11     1Q12     2012     2011     YTD11  

Staff:

                

Compensation

   $ 866      $ 861      $ 888        (2 )%      1   $ 1,727      $ 1,750        (1 )% 

Incentives

     311        352        327        (5     (12     663        650        2   

Employee benefits

     238        240        229        4        (1     478        448        7   

Total staff

     1,415        1,453        1,444        (2     (3     2,868        2,848        1   

Professional, legal and other purchased services

     309        299        289        7        3        608        561        8   

Net occupancy

     141        147        158        (11     (4     288        308        (6

Software

     127        119        119        7        7        246        238        3   

Distribution and servicing

     103        101        109        (6     2        204        220        (7

Furniture and equipment

     82        86        82        —          (5     168        165        2   

Sub-custodian

     70        70        88        (20     —          140        156        (10

Business development

     71        56        72        (1     27        127        128        (1

Other

     254        220        237        7        15        474        458        3   

Subtotal

     2,572        2,551        2,598        (1     1        5,123        5,082        1   

Amortization of intangible assets

     97        96        104        (7     1        193        209        (8

M&I, litigation and restructuring charges

     378        109        63        N/M        N/M        487        122        N/M   

Total noninterest expense – Non-GAAP

   $ 3,047      $ 2,756      $ 2,765        10     11   $ 5,803      $ 5,413        7

Total staff expense as a percent of total revenue

     39     40     38         39     38  

Full-time employees at period end

     48,200        47,800        48,000        —       1     48,200        48,000        —  

N/M—Not meaningful.

 

Total noninterest expense increased 8% compared with the second quarter of 2011 and 11% (unannualized) compared with the first quarter of 2012. Both increases were driven by the litigation charge recorded in the second quarter of 2012. Excluding amortization of intangible assets, merger and integration expenses (“M&I”), litigation and restructuring charges and the direct expenses related to Shareowner Services, noninterest expense decreased 1% year-over-year, reflecting the impact

of our operational excellence initiatives, and increased 1% (unannualized) sequentially. Sequentially, noninterest expenses increased slightly primarily due to the costs of certain tax credits, higher business development expenses and a deposit levy imposed on Belgian banks, including our Belgian bank subsidiary, largely offset by lower staff expense.

 

 

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The following staff and non-staff expense discussions exclude the impact of the Shareowner Services business.

Staff expense

Given our mix of fee-based businesses, which are staffed with high-quality professionals, staff expense comprised 55% of total noninterest expense in the second quarter of 2012, 56% in the second quarter of 2011 and 57% in the first quarter of 2012, excluding amortization of intangible assets, M&I, litigation and restructuring charges.

Staff expense totaled $1.4 billion in the second quarter of 2012, a decrease of 2% compared with the second quarter of 2011 and 3% (unannualized) compared with the first quarter of 2012. The year-over-year decrease in staff expense primarily reflects lower compensation and incentive expenses. The sequential decrease was driven by lower incentive expense.

Non-staff expense

Non-staff expense, excluding amortization of intangible assets, M&I, litigation and restructuring charges totaled $1.2 billion in the second quarter of 2012, unchanged compared with the second quarter of 2011 and an increase of 5% (unannualized) compared with the first quarter of 2012. Non-staff expense year-over-year primarily reflects the impact of our operational excellence initiatives, partially offset by higher professional, legal and other purchased services. The sequential increase was driven by the costs of certain tax credits, higher

business development expenses and a deposit levy imposed on Belgian banks, including our Belgian bank subsidiary, primarily offset by our operational excellence initiatives.

On July 5, 2012, BNY Mellon, N.A. and The Bank of New York Mellon entered into a settlement agreement related to a previously disclosed class action lawsuit pending in federal court in Oklahoma and initiated by CompSource Oklahoma concerning losses in connection with the investment of securities lending collateral in Sigma. The settlement agreement is subject to final court approval. The company recorded a pre-tax charge in the second quarter of 2012 of approximately $350 million primarily related to claims involving Sigma investments.

The financial services industry has seen a continuing increase in the level of litigation activity. As a result, we anticipate our legal and litigation costs to continue at elevated levels. For additional information on litigation matters, see Note 17 of the Notes to Consolidated Financial Statements.

Year-to-date 2012 compared with year-to-date 2011

Noninterest expense in the first six months of 2012 increased $290 million, or 5% compared with the first six months of 2011. The increase primarily reflects the litigation charge recorded in the second quarter of 2012, higher professional, legal and other purchased services, pension expense and the cost of certain tax credits, partially offset by lower compensation expense and the impact of our operational excellence initiatives.

 

 

Operational excellence initiatives update

 

Expense initiatives (pre-tax)    Program savings     

Annualized

targeted savings

by the end of 2012

 
(dollar amounts in millions)    1Q12      2Q12      through 2Q12     

Business operations

   $ 45       $ 55       $ 100       $  225 - 240   

Technology

     16         21         37       $ 75 - 85   

Corporate services

     14         18         32       $ 60 - 65   

Gross savings (a)

     75         94         169       $ 360 - 390   

Less: Incremental program costs (b)

     5         23         28       $ 120 - 130   

Net savings (c)

   $ 70       $ 71       $ 141       $ 240 - 260   
(a) Represents the estimated pre-tax run rate expense savings since program inception in 2011. Total Company actual operating expense may increase or decrease due to other factors.
(b) Represents incremental program costs incurred to implement the operational excellence initiatives. These costs will fluctuate by quarter.
(c) Net savings cannot be annualized due to the variability of program costs.

 

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As a result of our operational excellence initiatives, we are currently on track to achieve our anticipated pre-tax savings of $240-$260 million in 2012 on an annualized pre-tax basis.

Through June 30, 2012, we accomplished the following operational excellence initiatives:

Business Operations

 

   

Consolidated Treasury Services functions from New York, Philadelphia and Boston to Pittsburgh.

   

Continued global footprint position migrations.

   

Reengineered Dreyfus and Global Fund Accounting operations to reduce headcount.

   

Realized synergies in custody operations and clearing related to the Global Investment Servicing (“GIS”) acquisition.

Technology

 

   

Migrated GIS systems to BNY Mellon platforms—over 90% of the production applications have been successfully migrated as of June 30, 2012.

   

Insourced software engineers to Global Delivery Centers.

   

Standardized infrastructure through server elimination and software rationalization.

Corporate Services

 

   

Consolidated real estate in Los Angeles and New York.

   

Benefited from the new global procurement program.

Income taxes

The effective tax rate was 15.8% in the second quarter of 2012 and includes a reduction in the tax rate of approximately 9% related to the litigation charge. The operating tax rate – Non-GAAP in the second quarter of 2012 was 26.1% and includes an increased benefit of certain tax credits. The effective tax rate was 26.9% in the second quarter of 2011 and 28.7% in the first quarter of 2012. See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for additional information.

We expect the effective tax rate to be approximately 27%-28% in the third quarter of 2012.

Under U.S. tax law, income from certain non-U.S. subsidiaries has not been subject to U.S. income tax as result of a deferral provision applicable to income that is derived in active conduct of a banking and

financing business. This active financing deferral provision for these foreign subsidiaries expired for tax years beginning on Jan. 1, 2012. We do not anticipate a material impact to our 2012 financial statements if the law is not extended and will monitor the financial statement impact for subsequent years.

Review of businesses

We have an internal information system that produces performance data along product and service lines for our two principal businesses and the Other segment.

Organization of our business

On Dec. 31, 2011, BNY Mellon sold its Shareowner Services business. In the first quarter of 2012, we reclassified the results of the Shareowner Services business from the Investment Services business to the Other segment. The reclassification did not impact the consolidated results. All prior periods have been restated.

Business accounting principles

Our business data has been determined on an internal management basis of accounting, rather than the generally accepted accounting principles used for consolidated financial reporting. These measurement principles are designed so that reported results of the businesses will track their economic performance.

For additional information on the accounting principles of our businesses, the primary types of revenue by business and how our businesses are presented and analyzed, see Note 18 of the Notes to Consolidated Financial Statements.

The results of our businesses may be influenced by client activities that vary by quarter. In the second quarter, we typically experience an increase in securities lending fees due to an increase in demand to borrow securities outside of the United States. In the third quarter, depositary receipts revenue is typically higher due to an increased level of client dividend payments paid in the quarter. Also in the third quarter, volume-related fees may decline due to reduced client activity. In our Investment Management business, performance fees are typically higher in the fourth quarter, as the fourth quarter represents the end of the measurement period for many of the performance fee-eligible relationships.

 

 

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The following table presents the value of certain market indices at period end and on an average basis.

 

Market indices                                            2Q12 vs.     Year-to-date      YTD12 vs.
YTD11
 
      2Q11      3Q11      4Q11      1Q12      2Q12      2Q11     1Q12     2012      2011     

S&P 500 Index (a)

     1321         1131         1258         1408         1362         3     (3 )%      1362         1321         3

S&P 500 Index – daily average

     1318         1227         1224         1347         1351         3        —          1349         1310         3   

FTSE 100 Index (a)

     5946         5128         5572         5768         5571         (6     (3     5571         5946         (6

FTSE 100 Index – daily average

     5906         5470         5424         5818         5555         (6     (5     5690         5926         (4

MSCI World Index (a)

     1331         1104         1183         1312         1236         (7     (6     1236         1331         (7

MSCI World Index – daily average

     1332         1217         1169         1268         1235         (7     (3     1250         1326         (6

Barclays Capital Aggregate BondSM Index (a)

     341         346         347         351         353         4        1        353         341         4   

NYSE and NASDAQ share volume (in billions)

     213         250         206         186         192         (10     3        378         434         (13

JPMorgan G7 Volatility Index – daily average (b)

     11.21         12.60         12.95         10.39         10.30         (8     (1     10.35         11.14         (7
(a) Period end.
(b) The JPMorgan G7 Volatility Index is based on the implied volatility in 3-month currency options.

 

Fee revenue in Investment Management, and to a lesser extent Investment Services, is impacted by the value of market indices. At June 30, 2012, using the S&P 500 Index as a proxy for the global equity markets, we estimate that a 100-point change in the value of the S&P 500 Index, sustained for one year,

would impact fee revenue by approximately 1% and diluted earnings per common share by $0.03 to $0.05. If global equity markets over- or under-perform the S&P 500 Index, the impact to fee revenue and earnings per share could be different.

 

 

The following consolidating schedules show the contribution of our businesses to our overall profitability.

 

For the quarter ended June 30, 2012

(dollar amounts
in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  
                               

Fee and other revenue

   $  861 (a)    $ 1,881      $ 112      $  2,854 (a) 

Net interest revenue

     52        607        75        734   

Total revenue

     913        2,488        187        3,588   

Provision for credit losses

     —          (14     (5     (19

Noninterest expense

     690        2,146        211        3,047   

Income (loss) before taxes

   $  223  (a)    $ 356      $ (19   $ 560 (a) 

Pre-tax operating margin (b)

     24     14     N/M        16

Average assets

   $ 35,970      $ 209,454      $ 59,578      $ 305,002   

Excluding amortization of intangible assets:

        

Noninterest expense

   $ 642      $ 2,097      $ 211      $ 2,950   

Income (loss) before taxes

     271 (a)      405        (19     657 (a) 

Pre-tax operating margin (b)

     30     16     N/M        18
(a) Total fee and other revenue includes income from consolidated investment management funds of $57 million, net of noncontrolling interests of $29 million, for a net impact of $28 million. Income before taxes includes noncontrolling interests of $29 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

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For the quarter ended March 31, 2012

 

        

(dollar amounts

in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $  852 (a)    $ 1,852      $ 166      $  2,870 (a) 

Net interest revenue

     55        642        68        765   

Total revenue

     907        2,494        234        3,635   

Provision for credit losses

     -        16        (11     5   

Noninterest expense

     667        1,827        262        2,756   

Income (loss) before taxes

   $  240 (a)    $ 651      $ (17   $ 874 (a) 

Pre-tax operating margin (b)

     26     26     N/M        24

Average assets

   $ 36,475      $ 214,135      $ 50,734      $ 301,344   

Excluding amortization of intangible assets:

        

Noninterest expense

   $ 619      $ 1,779      $ 262      $ 2,660   

Income (loss) before taxes

     288 (a)      699        (17     970 (a) 

Pre-tax operating margin (b)

     32     28     N/M        27
(a) Total fee and other revenue includes income from consolidated investment management funds of $43 million, net of noncontrolling interests of $11 million, for a net impact of $32 million. Income before taxes includes noncontrolling interests of $11 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

For the quarter ended June 30, 2011

 

                            
(dollar amounts
in millions)
  

Investment

Management

   

Investment

Services

    Other     Consolidated  

Fee and other revenue

   $  862 (a)    $ 1,967      $ 269      $  3,098 (a) 

Net interest revenue

     48        649        34        731   

Total revenue

     910        2,616        303        3,829   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     694        1,827        295        2,816   

Income (loss) before taxes

   $  215 (a)    $ 789      $ 9      $  1,013 (a) 

Pre-tax operating margin (b)

     24     30     N/M        26

Average assets

   $ 36,741      $ 191,756      $ 49,983      $ 278,480   

Excluding amortization of intangible assets:

        

Noninterest expense

   $ 641      $ 1,777      $ 290      $ 2,708   

Income (loss) before taxes

     268 (a)      839        14        1,121 (a) 

Pre-tax operating margin (b)

     29     32     N/M        29
(a) Total fee and other revenue includes income from consolidated investment management funds of $63 million, net of noncontrolling interests of $21 million, for a net impact of $42 million. Income before taxes includes noncontrolling interests of $21 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

For the six months ended June 30, 2012

 

                            
(dollar amounts
in millions)
  

Investment

Management

   

Investment

Services

    Other     Consolidated  

Fee and other revenue

   $  1,713 (a)    $ 3,733      $ 278      $  5,724 (a) 

Net interest revenue

     107        1,249        143        1,499   

Total revenue

     1,820        4,982        421        7,223   

Provision for credit losses

     -        2        (16     (14

Noninterest expense

     1,357        3,973        473        5,803   

Income (loss) before taxes

   $  463 (a)    $ 1,007      $ (36   $  1,434 (a) 

Pre-tax operating margin (b)

     25     20     N/M        20

Average assets

   $ 36,222      $ 211,795      $ 55,155      $ 303,172   

Excluding amortization of intangible assets:

        

Noninterest expense

   $ 1,261      $ 3,876      $ 473      $ 5,610   

Income (loss) before taxes

     559 (a)      1,104        (36     1,627 (a) 

Pre-tax operating margin (b)

     31     22     N/M        23
(a) Total fee and other revenue includes income from consolidated investment management funds of $100 million, net of noncontrolling interests of $40 million, for a net impact of $60 million. Income before taxes includes noncontrolling interests of $40 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

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For the six months ended June 30, 2011

 

(dollar amounts

in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $  1,730 (a)    $ 3,856      $ 416      $  6,002 (a) 

Net interest revenue

     100        1,270        59        1,429   

Total revenue

     1,830        5,126        475        7,431   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     1,376        3,579        558        5,513   

Income (loss) before taxes

   $  453 (a)    $ 1,547      $ (82   $  1,918 (a) 

Pre-tax operating margin (b)

     25     30     N/M        26

Average assets

   $ 37,027      $ 184,002      $ 47,118      $ 268,147   

Excluding amortization of intangible assets:

        

Noninterest expense

   $ 1,268      $ 3,479      $ 550      $ 5,297   

Income (loss) before taxes

     561 (a)      1,647        (74     2,134 (a) 

Pre-tax operating margin (b)

     31     32     N/M        29
(a) Total fee and other revenue includes income from consolidated investment management funds of $173 million, net of noncontrolling interests of $65 million, for a net impact of $108 million. Income before taxes includes noncontrolling interests of $65 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

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Investment Management business

 

                                                                         
                                   2Q12 vs.     Year-to-date    

YTD12

vs.

YTD11

 

(dollar amounts in millions,

unless otherwise noted)

   2Q11     3Q11     4Q11     1Q12     2Q12     2Q11     1Q12     2012     2011    

Revenue:

                    

Investment management fees:

                    

Mutual funds

   $ 290      $ 263      $ 237      $ 260      $ 270        (7 )%      4   $ 530      $ 573        (8 )% 

Institutional clients

     319        311        299        322        321        1        -        643        638        1   

Wealth management

     163        157        154        157        158        (3     1        315        327        (4

Investment management fees

     772        731        690        739        749        (3     1        1,488        1,538        (3

Performance fees

     18        11        47        16        54        N/M        N/M        70        35        N/M   

Distribution and servicing

     48        41        41        45        45        (6     -        90        99        (9

Other (a)

     24        (26     (11     52        13        N/M        N/M        65        58        N/M   

Total fee and other revenue (a)

     862        757        767        852        861        -        1        1,713        1,730        (1

Net interest revenue

     48        51        55        55        52        8        (5     107        100        7   

Total revenue

     910        808        822        907        913        -        1        1,820        1,830        (1

Provision for credit losses

     1        -        -        -        -        N/M        N/M        -        1        N/M   

Noninterest expense (ex. amortization of intangible assets)

     641        622        632        619        642        -        4        1,261        1,268        (1

Income before taxes (ex. amortization of intangible assets)

     268        186        190        288        271        1        (6     559        561        -   

Amortization of intangible assets

     53        53        53        48        48        (9     -        96        108        (11

Income before taxes

   $ 215      $ 133      $ 137      $ 240      $ 223        4     (7 )%    $ 463      $ 453        2

Pre-tax operating margin

     24     16     17     26     24         25     25  

Pre-tax operating margin (ex. amortization of intangible assets and net of distribution and servicing expense) (b)

     33     26     26     36     34         35     35  

Wealth management:

                    

Average loans

   $ 6,884      $ 6,958      $ 7,209      $ 7,430      $ 7,763        13     4   $  7,597      $ 6,855        11

Average deposits

   $ 8,996      $ 10,392      $ 11,761      $ 11,491      $ 11,259        25     (2 )%    $ 11,375      $ 9,133        25
(a) Total fee and other revenue includes the impact of the consolidated investment management funds. See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50. Additionally, other revenue includes asset servicing and treasury services revenue.
(b) Distribution and servicing expense is netted with the distribution and servicing revenue for the purpose of this calculation of pre-tax operating margin. Distribution and servicing expense totaled $108 million, $99 million, $95 million, $100 million, $102 million, $202 million and $218 million, respectively.
N/M – Not meaningful.

 

AUM trends (a)                                        2Q12 vs.  
(dollar amounts in billions)    2Q11     3Q11     4Q11      1Q12     2Q12     2Q11     1Q12  

AUM at period end, by product type:

               

Equity securities

   $ 428      $ 354      $ 390       $ 429      $ 417        (3 )%      (3 )% 

Fixed income securities

     398        419        437         451        480        21        6   

Money market

     337        321        328         319        299        (11     (6

Alternative investments and overlay

     111        104        105         109        103        (7     (6

Total AUM

   $ 1,274      $ 1,198      $ 1,260       $ 1,308      $ 1,299        2     (1 )% 

AUM at period end, by client type:

               

Institutional

   $ 733      $ 719      $ 757       $ 829      $ 835        14     1

Mutual funds

     462        406        427         404        388        (16     (4

Private client

     79        73        76         75        76        (4     1   

Total AUM

   $ 1,274      $ 1,198      $ 1,260       $ 1,308      $ 1,299        2     (1 )% 

Changes in market value of AUM:

               

Beginning balance

   $ 1,229      $ 1,274      $ 1,198       $ 1,260      $ 1,308       

Net inflows (outflows):

               

Long-term

     32        4        16         7        26       

Money market

     (1     (15     7         (9     (14                

Total net inflows (outflows)

     31        (11     23         (2     12       

Net market/currency impact

     14        (65     39         50        (21                

Ending balance

   $ 1,274      $ 1,198      $ 1,260       $ 1,308      $ 1,299        2     (1 )% 
(a) Excludes securities lending cash management assets.

 

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Business description

Our Investment Management business is comprised of our affiliated investment management boutiques and wealth management business. See page 19 of the 2011 Annual Report for additional information on our Investment Management business.

Review of financial results

Investment management and performance fees are dependent on the overall level and mix of AUM and the management fees expressed in basis points (one-hundredth of one percent) charged for managing those assets. Assets under management were $1.30 trillion at June 30, 2012 compared with $1.27 trillion at June 30, 2011 and $1.31 trillion at March 31, 2012. Year-over-year, net inflows were partially offset by lower equity market values. On a sequential basis, the decrease resulted from lower equity market values, partially offset by net inflows.

Long-term inflows in the second quarter of 2012 totaled $26 billion and short-term outflows totaled $14 billion. Long-term inflows benefited from fixed income and equity indexed products.

Revenue generated in the Investment Management business includes 44% from non-U.S. sources in the second quarter of 2012 compared with 41% in the second quarter of 2011 and 45% in the first quarter of 2012.

In the second quarter of 2012, the Investment Management business had pre-tax income of $223 million compared with $215 million in the second quarter of 2011 and $240 million in the first quarter of 2012. Excluding amortization of intangible assets, pre-tax income was $271 million in the second quarter of 2012 compared with $268 million in the second quarter of 2011 and $288 million in the first quarter of 2012. Investment Management results improved compared with the prior year period reflecting higher performance fees and net new business, partially offset by lower equity market values. On a sequential basis, Investment Management results declined reflecting lower equity market values and higher incentive expense, partially offset by higher performance fees and net new business.

Investment management fees in the Investment Management business were $749 million in the second quarter of 2012 compared with $772 million in the second quarter of 2011 and $739 million in

the first quarter of 2012. The year-over-year decrease was primarily due to lower equity market values, partially offset by net new business. Sequentially, the increase was primarily due to net new business and higher money market fees, partially offset by lower equity market values.

Performance fees were $54 million in the second quarter of 2012 compared with $18 million in the second quarter of 2011 and $16 million in the first quarter of 2012. Both increases primarily reflect investment strategies which exceeded their benchmarks for measurement periods ending in the second quarter of 2012.

In the second quarter of 2012, 36% of investment management fees in the Investment Management business were generated from managed mutual fund fees. These fees are based on the daily average net assets of each fund and the management fee paid by that fund. Managed mutual fund fee revenue was $270 million in the second quarter of 2012 compared with $290 million in the second quarter of 2011 and $260 million in the first quarter of 2012. The year-over-year decrease primarily reflects higher money market fee waivers and lower equity market values. The sequential increase primarily resulted from lower money market fee waivers, partially offset by lower equity market values.

Distribution and servicing fees were $45 million in the second quarter of 2012 compared with $48 million in the second quarter of 2011 and $45 million in the first quarter of 2012. The year-over-year decrease primarily reflects higher money market fee waivers.

Other fee revenue was $13 million in the second quarter of 2012 compared with $24 million in the second quarter of 2011 and $52 million in the first quarter of 2012. Both decreases primarily reflect lower seed capital gains.

Net interest revenue was $52 million in the second quarter of 2012 compared with $48 million in the second quarter of 2011 and $55 million in the first quarter of 2012. The year-over-year increase primarily resulted from higher average loans and deposits partially offset by tighter spreads. The sequential decrease reflects tighter spreads and lower deposit balances, partially offset by higher average loans. Average loans increased 13% year-over-year and 4% sequentially; average deposits increased 25% year-over-year and decreased 2% sequentially.

 

 

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Noninterest expense (excluding amortization of intangible assets) was $642 million in the second quarter of 2012 compared with $641 million in the second quarter of 2011 and $619 million in the first quarter of 2012. Year-over-year, noninterest expense was unchanged. The sequential increase primarily resulted from higher incentive expense driven by an increase in performance fees, as well as higher business development and distribution and servicing expenses.

Year-to-date 2012 compared with year-to-date 2011

Income before taxes totaled $463 million in the first six months of 2012 compared with $453 million in the first six months of 2011. Income before taxes (excluding intangible amortization) was $559 million in the first six months of 2012 compared with $561 million in the first six months of 2011. Fee and other revenue decreased $17 million compared to the first six months of 2011, primarily due to higher money market fee waivers and lower equity market values, partially offset by higher performance fees and net new business. Net interest revenue increased $7 million compared to the first six months of 2011 primarily as a result of higher average loans and deposits, partially offset by narrower spreads. Noninterest expense (excluding intangible amortization) decreased $7 million compared to first six months of 2011, primarily due to lower distribution and servicing expenses driven by higher money market fee waivers.

 

 

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Investment Services business

 

 

                                                           YTD12  
                                   2Q12 vs.     Year-to-date     vs.  
(dollar amounts in millions, unless otherwise noted)    2Q11     3Q11     4Q11     1Q12     2Q12     2Q11     1Q12     2012     2011     YTD11  

Revenue:

                    

Investment services fees:

                    

Asset servicing

   $ 943      $ 894      $ 858      $ 915      $ 920        (2 )%      1   $ 1,835      $ 1,833        -

Issuer services

     314        401        245        251        275        (12     10        526        606        (13

Clearing services

     292        297        278        303        309        6        2        612        584        5   

Treasury services

     134        132        133        136        132        (1     (3     268        267        -   

Total investment services fees

     1,683        1,724        1,514        1,605        1,636        (3     2        3,241        3,290        (1

Foreign exchange and other trading revenue

     203        236        196        176        179        (12     2        355        412        (14

Other (a)

     81        68        71        71        66        (19     (7     137        154        (11

Total fee and other revenue (a)

     1,967        2,028        1,781        1,852        1,881        (4     2        3,733        3,856        (3

Net interest revenue

     649        661        634        642        607        (6     (5     1,249        1,270        (2

Total revenue

     2,616        2,689        2,415        2,494        2,488        (5     -        4,982        5,126        (3

Provision for credit losses

     -        -        -        16        (14     N/M        N/M        2        -        N/M   

Noninterest expense (ex. amortization of intangible assets)

     1,777        1,849        1,706        1,779        2,097        18        18        3,876        3,479        11   

Income before taxes (ex. amortization of intangible assets)

     839        840        709        699        405        (52     (42     1,104        1,647        (33

Amortization of intangible assets

     50        49        50        48        49        (2     2        97        100        (3

Income before taxes

   $ 789      $ 791      $ 659      $ 651      $ 356        (55 )%      (45 )%    $ 1,007      $ 1,547        (35 )% 

Pre-tax operating margin

     30     29     27     26     14         20     30  

Pre-tax operating margin (ex. amortization of intangible assets)

     32     31     29     28     16         22     32  

Investment services fees as a percentage of noninterest expense (b)

     96     98     90     94     94         94     96  

Securities lending revenue

   $ 52      $ 32      $ 35      $ 39      $ 48        (8 )%      23   $ 87      $ 79        10

Metrics:

                    

Market value of assets under custody and administration at period-end (in trillions) (c)

   $ 26.3      $ 25.9      $ 25.8      $ 26.6      $ 27.1        3     2      

Market value of securities on loan at period-end (in billions) (d)

   $ 273      $ 250      $ 269      $ 265      $ 275        1     4      

Average loans

   $ 22,891      $ 22,879      $ 26,804      $ 25,902      $ 24,981        9     (4 )%    $ 25,441      $ 21,729        17

Average deposits

   $ 153,863      $ 181,848      $ 188,539      $ 175,055      $ 172,435        12     (1 )%    $ 173,745      $ 146,643        18

Asset servicing:

                    

New business wins (AUC) (in billions)

   $ 196      $ 96      $ 431      $ 453      $ 314             

Corporate Trust:

                    

Total debt serviced (in trillions)

   $ 11.8      $ 11.9      $ 11.8      $ 11.9      $ 11.5        (3 )%      (3 )%       

Number of deals administered

     133,262        134,843        133,850        133,319        133,301        -     -      

Depositary Receipts:

                    

Number of sponsored programs

     1,386        1,384        1,389        1,391        1,393        1     -      

Clearing services:

                    

DARTS volume (in thousands)

     196.5        207.7        178.7        196.6        189.8        (3 )%      (3 )%       

Average active clearing accounts U.S. (in thousands)

     5,486        5,503        5,429        5,413        5,427        (1 )%      -      

Average long-term mutual fund assets (U.S. platform)

   $ 306,193      $ 287,573      $ 287,562      $ 306,212      $ 306,973        -     -      

Average margin loans

   $ 7,506      $ 7,351      $ 7,548      $ 7,900      $ 8,231        10     4      

Broker-Dealer:

                    

Average collateral management balances (in billions)

   $ 1,845      $ 1,872      $ 1,866      $ 1,929      $ 1,997        8     4      

Treasury services:

                    

Global payments transaction volume (in thousands)

     10,944        11,088        10,856        10,838        11,117        2     3                        

 

(a) Total fee and other revenue includes investment management fees and distribution and servicing revenue.
(b) Noninterest expense excludes amortization of intangible assets, support agreement charges and litigation expense.
(c) Includes the assets under custody or administration of CIBC Mellon Global Securities Services Company, a joint venture with the Canadian Imperial Bank of Commerce, of $1.1 trillion at June 30, 2011, $1.0 trillion at Sept. 30, 2011, $1.1 trillion at Dec. 31, 2011, $1.2 trillion at both March 31, 2012 and June 30, 2012.
(d) Represents the total amount of securities on loan managed by the Investment Services business.

 

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Business description

Our Investment Services business provides global custody and related services, broker-dealer services, alternative investment services, corporate trust and depositary receipt, as well as clearing services and global payment/working capital solutions to institutional clients. See page 22 of the 2011 Annual Report for additional information on our Investment Services business.

We are one of the leading global securities servicing providers with a record level of $27.1 trillion of assets under custody and administration at June 30, 2012. We are the largest custodian for U.S. corporate and public pension plans, and we service 44% of the top 50 endowments. We are a leading custodian in the UK and service 20% of UK pensions. European asset servicing continues to grow across all products, reflecting significant cross-border investment and capital flows.

We are one of the largest providers of fund services in the world, servicing over $6.5 trillion in assets. We are the third largest fund administrator in the alternative investment services industry and service 42% of the funds in the U.S. exchange-traded funds marketplace.

BNY Mellon is a leader in both global securities and U.S. Government securities clearance. We clear and settle equity and fixed income transactions in over 100 markets and handle most of the transactions cleared through the Federal Reserve Bank of New York for 17 of the 21 primary dealers. We are an industry leader in collateral management, servicing on average $2.0 trillion in global collateral. We currently service approximately $1.4 trillion of the $1.8 trillion tri-party repo market in the U.S.

In connection with our role as a clearing and custody bank for the tri-party repurchase (“repo”) transaction market, we work with dealers who use repos to finance their securities by selling them to counterparties, agreeing to buy them back at a later date. In tri-party repos, a clearing and custody bank such as BNY Mellon acts as the intermediary between a dealer and its counterparty in settling the transaction providing valuation and other services as well as extending secured intra-day credit to the dealers. BNY Mellon currently has approximately 80% of the market share and is working to implement recommendations by the U.S. Tri-Party Repo Infrastructure Reform Task Force to achieve the practical elimination of secured intra-day credit.

BNY Mellon has taken several steps in that regard, including the reduction of the length of time for the majority of the intra-day credit exposure, the implementation of auto substitution of collateral and the introduction of three-way trade confirmations.

On June 27, 2012, we announced the formation of Global Collateral Services, which serves broker-dealers and institutional investors facing rapidly expanding collateral management needs as a result of current and emerging regulatory and market requirements. Global Collateral Services brings together BNY Mellon’s global capabilities in segregating, optimizing, financing and transforming collateral on behalf of clients, including its market leading broker-dealer collateral management, securities lending, collateral financing, liquidity and derivatives services teams.

In securities lending, we are one of the largest lenders of U.S. Treasury securities and depositary receipts and service a lending pool of approximately $3 trillion in 28 markets. We are one of the largest global providers of performance and risk analytics reporting, with $9.6 trillion in assets under measurement.

BNY Mellon is the leading provider of corporate trust services for all major conventional and structured finance debt categories, and a leading provider of specialty services. We service $11.5 trillion in outstanding debt from 61 locations in 20 countries.

We serve as depositary for 1,393 sponsored American and global depositary receipt programs at June 30, 2012, acting in partnership with leading companies from more than 65 countries – a 61% global market share.

With a network of more than 2,000 correspondent financial institutions, we help clients in their efforts to optimize cash flow, manage liquidity and make payments more efficiently around the world in more than 100 currencies. We are the fifth largest Fedwire and fourth largest CHIPS payment processor, processing about 170,000 global payments daily totaling an average of $1.4 trillion.

Pershing LLC (“Pershing”), our clearing service, takes a consultative approach, working with more than 1,500 financial organizations and 100,000 investment professionals who collectively represent approximately 5.5 million individual and institutional investors by delivering dependable

 

 

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operational support; robust trading services; flexible technology; an expansive array of investment solutions, including managed accounts, mutual funds and cash management; practice management support; and service excellence.

Role of BNY Mellon, as a trustee, for mortgage-backed securitizations

BNY Mellon acts as trustee and document custodian for certain mortgage-backed security (“MBS”) securitization trusts. The role of trustee for MBS securitizations is limited; our primary role as trustee is to calculate and distribute monthly bond payments to bondholders. As a document custodian, we hold the mortgage, note, and related documents provided to us by the loan originator or seller and provide periodic reporting to these parties. BNY Mellon, either as document custodian or trustee, does not receive mortgage underwriting files (the files that contain information related to the creditworthiness of the borrower). As trustee or custodian, we have no responsibility or liability for the quality of the portfolio; we are liable only for performance of our limited duties as described above and in the trust document. BNY Mellon is indemnified by the servicers or directly from trust assets under the governing agreements. BNY Mellon may appear as the named plaintiff in legal actions brought by servicers in foreclosure and other related proceedings because the trustee is the nominee owner of the mortgage loans within the trusts.

Review of financial results

Assets under custody and administration at June 30, 2012 were a record $27.1 trillion, an increase of 3% from $26.3 trillion at June 30, 2011 and 2% from $26.6 trillion at March 31, 2012. Both increases were driven by net new business, partially offset by lower equity market values. Assets under custody and administration were comprised of 31% equity securities and 69% fixed income securities at June 30, 2012 and June 30, 2011 and 32% equity securities and 68% fixed income securities at March 31, 2012. Assets under custody and administration at June 30, 2012 consisted of assets related to custody, mutual funds and corporate trust businesses of $21.5 trillion, broker-dealer service assets of $3.6 trillion, and all other assets of $2.0 trillion.

Income before taxes was $356 million in the second quarter of 2012 compared with $789 million in the second quarter of 2011 and $651 million in the first quarter of 2012. Income before taxes, excluding

amortization of intangible assets, was $405 million in the second quarter of 2012 compared with $839 million in the second quarter of 2011 and $699 million in the first quarter of 2012. The decreases from both prior periods primarily reflect higher litigation expense and lower equity market values, partially offset by higher Clearing Services revenue and net new business.

Revenue generated in the Investment Services businesses includes 36% from non-U.S. sources in the second quarter of 2012, 39% in the second quarter of 2011 and 36% in the first quarter of 2012.

Investment services fees decreased $47 million, or 3%, compared with the second quarter of 2011 and increased $31 million, or 2% (unannualized), sequentially. The fluctuations were driven by the following:

 

   

Asset servicing revenue (global custody, broker-dealer services and alternative investment services) was $920 million in the second quarter of 2012 compared with $943 million in the second quarter of 2011 and $915 million in the first quarter of 2012. The year-over year decrease primarily reflects lower equity market values and securities lending revenue, partially offset by net new business. The sequential increase was primarily driven by net new business and seasonally higher securities lending revenue, partially offset by lower equity market values.

   

Issuer services fees (Corporate Trust and Depositary Receipts) were $275 million in the second quarter of 2012 compared with $314 million in the second quarter of 2011 and $251 million in the first quarter of 2012. The year-over-year decrease primarily resulted from lower Depositary Receipts revenue, lower money market related fees and lower trust fees related to the weakness in structured products in Corporate Trust. The increase sequentially resulted from higher Depositary Receipts revenue as well as money market related fees in Corporate Trust.

   

Clearing services fees (Pershing) were $309 million in the second quarter of 2012 compared with $292 million in the second quarter of 2011 and $303 million in the first quarter of 2012. The year-over-year increase was driven by higher mutual fund fees, partially offset by the impact of lower DARTS volume and higher money market fee waivers. The sequential increase primarily reflects higher mutual fund

 

 

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fees and lower money market fee waivers, partially offset by the impact of lower DARTS volume.

Foreign exchange and other trading revenue was $179 million in the second quarter of 2012 compared with $203 million in the second quarter of 2011 and $176 million in the first quarter of 2012. The year-over-year decrease reflects lower volatility and volumes, while the sequential increase primarily resulted from higher volumes.

Net interest revenue was $607 million in the second quarter of 2012 compared with $649 million in the second quarter of 2011 and $642 million in the first quarter of 2012. The year-over-year decrease reflects lower spreads and accretion, partially offset by higher average deposits. The sequential decrease reflects lower spreads, average interest-earning deposits and accretion.

The provision for credit losses was a credit of $14 million in the second quarter of 2012 primarily resulting from a decline in the expected loss related to a broker-dealer customer that previously filed for bankruptcy.

Noninterest expense (excluding amortization of intangible assets) was $2.1 billion in the second quarter of 2012 compared with $1.8 billion in both the second quarter of 2011 and first quarter of 2012. Both increases primarily reflect higher litigation expense and a deposit levy imposed on Belgian banks, including our Belgian bank subsidiary.

Year-to-date 2012 compared with year-to-date 2011

Income before taxes totaled $1.0 billion in the first six months of 2012 compared with $1.5 billion in the first six months of 2011. Excluding intangible amortization, income before taxes decreased $543 million. Fee and other revenue decreased $123 million reflecting lower Depositary Receipts revenue and Corporate Trust fees and lower foreign exchange revenue due primarily to a decline in volatility and volumes, partially offset by higher Clearing Services revenue and net new business. The $21 million decrease in net interest revenue was primarily due to lower spreads and accretion, partially offset by higher average deposits and loans. Noninterest expense (excluding intangible amortization) increased $397 million primarily due to higher litigation expenses.

 

 

Other segment

 

                                         Year-to-date  
(dollars in millions)    2Q11     3Q11     4Q11     1Q12     2Q12     2012     2011  

Revenue:

              

Fee and other revenue

   $ 269      $ 121      $ 240      $ 166      $ 112      $ 278      $ 416   

Net interest revenue

     34        63        91        68        75        143        59   

Total revenue

     303        184        331        234        187        421        475   

Provision for credit losses

     (1     (22     23        (11     (5     (16     (1

Noninterest expense (ex. amortization of intangible assets, M&I and restructuring charges)

     272        182        245        253        189        442        521   

Income (loss) before taxes (ex. amortization of intangible assets, M&I and restructuring charges)

     32        24        63        (8     3        (5     (45

Amortization of intangible assets

     5        4        3        -        -        -        8   

M&I and restructuring charges

     18        12        139        9        22        31        29   

Income (loss) before taxes

   $ 9      $ 8      $ (79   $ (17   $ (19   $ (36   $ (82

Average loans and leases

   $ 10,553      $ 10,652      $ 10,223      $ 9,877      $ 10,248      $ 10,062      $ 10,868   

 

See page 24 of the 2011 Annual Report for a description of the Other segment. On Dec. 31, 2011, BNY Mellon sold its Shareowner Services business. In the first quarter of 2012, we reclassified the results of the Shareowner Services business to the Other segment from the Investment Services business.

Review of financial results

Income before taxes was a loss of $19 million in the second quarter of 2012 compared with income of $9 million in the second quarter of 2011 and a loss of $17 million in the first quarter of 2012.

Total fee and other revenue decreased $157 million compared with the second quarter of 2011 and $54 million compared with the first quarter of 2012. The

 

 

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year-over-year decrease reflects lower asset-related gains, the impact of the sale of the Shareowner Services business and lower equity investment revenue. The sequential decrease was driven by lower leasing gains and equity investment revenue and a lower credit valuation adjustment.

Noninterest expense (excluding amortization of intangible assets and M&I and restructuring charges) decreased $83 million compared with the second quarter of 2011 and $64 million compared with the first quarter of 2012. The decrease compared with the second quarter of 2011 resulted from the impact of the sale of the Shareowner Services business and lower incentive expense. The decrease compared with the first quarter of 2012 reflects lower incentives and benefits expense.

Year-to-date 2012 compared with year-to-date 2011

Income before taxes in the Other segment was a loss of $36 million in the first six months of 2012 compared with a loss of $82 million in the first six months of 2011. Total revenue decreased $54 million primarily reflecting the impact of the sale of the Shareowner Services business and lower equity investment revenue. Noninterest expenses (excluding amortization of intangible assets and M&I and restructuring charges) decreased $79 million, reflecting the impact of the sale of the Shareowner Services business, partially offset by higher benefits, professional, legal and other purchased services expenses and the costs of certain tax credits.

Critical accounting estimates

Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements contained in the 2011 Annual Report. Our more critical accounting estimates are those related to the allowance for loan losses and allowance for lending-related commitments, fair value of financial instruments, other-than-temporary impairment (“OTTI”), goodwill and other intangibles and pension accounting, as referenced below.

Critical policy   

Reference

Allowance for loan losses and allowance for lending-related commitments    2011 Annual Report, pages 29 and 30.

Fair value of financial instruments

   2011 Annual Report, pages 30 through 32.

OTTI

   2011 Annual Report, page 32. See page 32 of this Form 10-Q for the impact of market assumptions on portions of our securities portfolio.

Goodwill and other intangibles

   2011 Annual Report, pages 32 through 34. Also, see below.

Pension accounting

   2011 Annual Report, pages 34 and 35.

Goodwill and other intangibles

BNY Mellon’s three business segments include seven reporting units for which goodwill impairment testing is performed on an annual basis, in the second quarter. In the second quarter of 2012, we performed our annual goodwill test on all seven reporting units using an income approach to estimate fair values. Estimated cash flows used in the income approach were based on management’s projections as of April 1, 2012. The discount rate applied to these cash flows ranged from 10% to 12.25% and incorporated a 7% market equity risk premium. Estimated cash flows extend far into the future, and, by their nature, are difficult to estimate over such an extended time frame.

As of the date of the annual test, the fair values of six of the Company’s reporting units were substantially in excess of the respective reporting units’ carrying value. The Asset Management reporting unit, with $7.7 billion of allocated goodwill, which is one of the two reporting units in the Investment Management segment, exceeded its carrying value by approximately 15%. For the Asset Management reporting unit, in the future, small changes in the assumptions could produce a non-cash goodwill impairment, which would have no effect on our regulatory capital ratios. In addition to the other factors and assumptions discussed beginning on page 33 of our 2011 Annual Report, certain money market fee waiver practices and changes in the level of assets under management could have an effect on Asset Management broadly, as well as the fair value of this reporting unit. See “Critical accounting estimates” in the 2011 Annual Report for additional information on the annual and fourth quarter 2011 interim goodwill impairment tests. See “Critical accounting estimates” in the

 

 

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Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 for additional information on the first quarter 2012 interim goodwill impairment test of the Asset Management business.

Consolidated balance sheet review

At June 30, 2012, total assets were $330 billion compared with $325 billion at Dec. 31, 2011. The increase in consolidated total assets resulted from an increase in client deposits. Deposits totaled $221 billion at June 30, 2012 and $219 billion at Dec. 31, 2011. At June 30, 2012, total interest-bearing deposits were 54% of total interest-earning assets. Total assets averaged $305 billion in the second quarter of 2012 compared with $278 billion in the second quarter of 2011 and $301 billion in the first quarter of 2012. The fluctuations compared with both prior periods primarily reflect an increase in the levels of client deposits. Total deposits averaged $193 billion in the second quarter of 2012, $169 billion in the second quarter of 2011 and $192 billion in the first quarter of 2012.

At June 30, 2012, we had approximately $48 billion of liquid funds and $81 billion of cash (including approximately $76 billion of overnight deposits with the Federal Reserve and other central banks) for a total of approximately $129 billion of available funds. This compares with available funds of $135 billion at Dec. 31, 2011. Our percentage of liquid assets to total assets was 39% at June 30, 2012 compared with 42% at Dec. 31, 2011. The decreases in available funds and liquid assets to total assets were due to increased investment in securities and higher loan levels. At June 30, 2012, of our $48 billion in liquid funds, $40 billion are placed in interest-bearing deposits with large, highly rated global financial institutions with a weighted-average life to maturity of 47 days. Of the $40 billion, $7.8 billion was placed with banks in the Eurozone.

Investment securities were $93 billion, or 28% of total assets, at June 30, 2012 compared with $82 billion, or 25% of total assets, at Dec. 31, 2011. The increase primarily reflects larger investments in agency RMBS and state and political subdivision securities, as well as an improvement in the unrealized gain of our investment securities portfolio.

Loans were $45 billion, or 14% of total assets, at June 30, 2012 compared with $44 billion, or 14% of total assets, at Dec. 31, 2011. The increase in loan

levels primarily reflects higher overdrafts and margin loans.

Long-term debt decreased to $19.5 billion at June 30, 2012 from $19.9 billion at Dec. 31, 2011, primarily due to the maturity of $1.4 billion of senior debt and $300 million of subordinated debt as well as the redemption of $500 million of junior subordinated debentures, partially offset by the issuance of $1.75 billion of senior debt in the first six months of 2012.

Total shareholders’ equity applicable to BNY Mellon was $34.5 billion at June 30, 2012 and $33.4 billion at Dec. 31, 2011. The increase in total shareholders’ equity primarily reflects earnings retention and an increase in the valuation of our investment securities portfolio, partially offset by share repurchases. Additionally, in the second quarter of 2012, we issued $500 million of non-cumulative perpetual preferred stock which qualifies as Tier 1 capital under the recently released NPRs.

BNY Mellon, through its involvement in the Fixed Income Clearing Corporation, settles government securities transactions on a net basis for payment and delivery through the Fedwire system. As a result, at June 30, 2012, the assets and liabilities of BNY Mellon were reduced by $17 million for the netting of repurchase agreements and reverse repurchase agreement transactions executed with the same counterparty under standardized Master Repurchase Agreements.

Exposure in Ireland, Italy, Spain and Portugal

The following tables present our on- and off-balance sheet exposure in Ireland, Italy, Spain, and Portugal at June 30, 2012 and Dec. 31, 2011. We have provided expanded disclosure on these countries as they have experienced particular market focus on credit quality and are countries experiencing economic concerns. Where appropriate, we are offsetting the risk associated with the gross exposure in these countries with collateral that has been pledged, which primarily consists of cash or marketable securities, or by transferring the risk to a third-party guarantor in another country.

BNY Mellon has a limited economic interest in the performance of assets of consolidated investment management funds, and therefore they are excluded from this presentation. The liabilities of consolidated investment management funds represent the interest of the noteholders of the funds

 

 

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and are solely dependent on the value of the assets. Any loss in the value of assets of consolidated investment management funds would be incurred by the fund’s noteholders.

At June 30, 2012 and Dec. 31, 2011, BNY Mellon had no exposure to Greece and no sovereign exposure to the countries disclosed below.

Our exposure to Ireland is principally related to Irish-domiciled investment funds. Servicing provided to these funds and fund families may result in overdraft exposure.

See “Risk management” in the 2011 Annual Report for additional information on how our exposures are managed.

 

 

Exposure in the tables below reflects the country of operations and risk of the immediate counterparty.

 

On- and off-balance sheet exposure at June 30, 2012                                        

 

(in millions)

   Ireland      Italy      Spain      Portugal      Total  

On-balance sheet exposure

              

Gross:

              

Interest-bearing deposits with banks (a)

   $ 96       $ 192       $ 2       $ -       $ 290   

Investment securities (primarily European

              

Floating Rate Notes) (b)

     189         137         25         -         351   

Loans and leases (c)

     324         3         5         -         332   

Trading assets (d)

     44         39         16         1         100   

Total gross on-balance sheet exposure

     653         371         48         1         1,073   

Less:

              

Collateral

     77         35         7         1         120   

Guarantees

     -         2         1         -         3   

Total collateral and guarantees

     77         37         8         1         123   

Total net on-balance sheet exposure

   $ 576       $ 334       $ 40       $       $ 950   

Off-balance sheet exposure

              

Gross:

              

Lending-related commitments (e)

   $ 98       $ -       $ -       $ -       $ 98   

Letters of credit (f)

     74         4         14         -         92   

Total gross off-balance sheet exposure

     172         4         14         -         190   

Less:

              

Collateral

     90         -         14         -         104   

Total net off-balance sheet exposure

   $ 82       $ 4       $ -       $ -       $ 86   

Total exposure:

              

Total gross on- and off-balance sheet exposure

   $ 825       $ 375       $ 62       $ 1       $ 1,263   

Less: Total collateral and guarantees

     167         37         22         1         227   

Total net on- and off-balance sheet exposure

   $ 658       $ 338       $ 40       $ -       $ 1,036   

 

(a) Interest-bearing deposits with banks represent a $130 million placement with a financial institution in Italy, a $96 million placement with an Irish subsidiary of a UK holding company and $64 million of nostro accounts related to our custody business.
(b) Represents $326 million, fair value, of residential mortgage-backed securities located in Ireland, Italy and Spain, of which 62% were investment grade, $22 million, fair value, of investment grade asset-backed CLOs located in Ireland, and $3 million, fair value, of money market fund investments located in Ireland.
(c) Loans and leases include $263 million of overdrafts primarily to Irish-domiciled investment funds resulting from our custody business, a $66 million commercial lease to an Irish company, which was fully collateralized by U.S. Treasuries and $3 million of leases to airline manufacturing companies which are under joint and several guarantee arrangements, with guarantors outside of the Eurozone. There is no impairment associated with these loans and leases.
(d) Trading assets represent over-the-counter mark-to-market on foreign exchange and interest rate receivables, net of master netting agreements. Trading assets include $44 million of receivables primarily due from Irish-domiciled investment funds and $56 million of receivables due from financial institutions in Italy, Spain and Portugal. Cash collateral on the trading assets totaled $11 million in Ireland, $35 million in Italy, $7 million in Spain and $1 million in Portugal.
(e) Lending-related commitments represent $98 million to an insurance company, collateralized by $23 million of marketable securities.
(f) Represents $74 million of letters of credit extended to an insurance company in Ireland, collateralized by $67 million of marketable securities, a $4 million letter of credit extended to a financial institution in Italy and a $14 million letter of credit extended to an insurance company in Spain, fully collateralized by marketable securities.

 

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On- and off-balance sheet exposure at Dec. 31, 2011                                        
(in millions)    Ireland      Italy      Spain      Portugal      Total  

On-balance sheet exposure

              

Gross:

              

Interest-bearing deposits with banks (a)

   $ 97       $ 24       $ 4       $ -       $ 125   

Investment securities (primarily European

              

Floating Rate Notes) (b)

     208         155         27         -         390   

Loans and leases (c)

     411         3         4         -         418   

Trading assets (d)

     117         53         16         3         189   

Total gross on-balance sheet exposure

     833         235         51         3         1,122   

Less:

              

Collateral

     102         39         7         3         151   

Guarantees

     -         3         1         -         4   

Total collateral and guarantees

     102         42         8         3         155   

Total net on-balance sheet exposure

   $ 731       $ 193       $ 43       $ -       $ 967   

Off-balance sheet exposure

              

Gross:

              

Lending-related commitments (e)

   $ 273       $ -       $ -       $ -       $ 273   

Letters of credit (f)

     -         2         14         -         16   

Total gross off-balance sheet exposure

     273         2         14         -         289   

Less:

              

Collateral

     190         -         14         -         204   

Total net off-balance sheet exposure

   $ 83       $ 2       $ -       $ -       $ 85   

Total exposure:

              

Total gross on- and off-balance sheet exposure

   $ 1,106       $ 237       $ 65       $ 3       $ 1,411   

Less: Total collateral and guarantees

     292         42         22         3         359   

Total net on- and off-balance sheet exposure

   $ 814       $ 195       $ 43       $ -       $ 1,052   

 

(a) Interest-bearing deposits with banks represent a $96 million placement with an Irish subsidiary of a UK holding company and $29 million of nostro accounts related to our custody business.
(b) Represents $364 million, fair value, of residential mortgage-backed securities, of which 97% were investment grade, $23 million, fair value, of investment grade asset-backed CLOs, and $3 million, fair value, of money market fund investments located in Ireland.
(c) Loans and leases include $335 million of overdrafts primarily to Irish domiciled investment funds resulting from our custody business, a $65 million commercial lease fully collateralized by U.S. Treasuries, $15 million of financial institution loans, which were collateralized by marketable securities and $4 million of leases to airline manufacturing companies which are under joint and several guarantee arrangements, with guarantors outside of the Eurozone. There is no impairment associated with these loans and leases.
(d) Trading assets represent over-the-counter mark-to-market on foreign exchange and interest rate receivables, net of master netting agreements. Trading assets include $117 million of receivables due from Irish domiciled investment funds and $72 million due from financial institutions in Italy, Spain and Portugal. Cash collateral on the trading assets totaled $22 million in Ireland, $39 million in Italy, $7 million in Spain and $3 million in Portugal.
(e) Lending-related commitments represent $100 million to an asset manager fully collateralized by marketable securities, and $173 million to an insurance company, collateralized by $90 million of marketable securities.
(f) Represents a $14 million letter of credit extended to an insurance company in Spain fully collateralized by marketable securities. Exposure in Italy represents a $2 million letter of credit extended to a financial institution.

 

Investment securities

In the discussion of our investment securities portfolio, we have included certain credit ratings information because the information indicates the degree of credit risk to which we are exposed, and

significant changes in ratings classifications for our investment portfolio could indicate increased credit risk for us and could be accompanied by a reduction in the fair value of our investment securities portfolio.

 

 

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The following table shows the distribution of our total investment securities portfolio:

 

Investment securities portfolio

  

 

 

 

 

 

2Q12

change in

unrealized

gain/(loss)

  

  

  

  

                    
 
 
 
Fair value
as a % of
amortized
cost(a)
  
  
  
  
 

 

 

Unrealized

gain/(loss)

  

  

                                       
       

 

March 31,

2012

  

  

      June 30, 2012            Ratings   
        

 

Amortized

cost

  

  

    

 

Fair

value

  

  

        AAA/        A+/        BBB+/        BB+ and        Not   

(dollars in millions)

     Fair value                   AA-        A-        BBB-        lower        rated   

Agency RMBS

   $ 34,538      $ 187      $ 38,598       $ 39,441        102   $ 843        100     -     -     -     -

U.S. Treasury securities

     15,173        43        14,777         15,073        102        296        100        -        -        -        -   

Sovereign debt/sovereign guaranteed (b)

     12,171        (57     8,782         8,935        102        153        100        -        -        -        -   

Non-agency RMBS (c)

     3,232        (72     2,745         3,037        67        292        1        1        2        96        -   

Non-agency RMBS

     1,787        41        1,900         1,692        81        (208     17        15        11        57        -   

European floating rate notes (d)

     3,405        37        4,337         4,053        92        (284     79        15        3        3        -   

Commercial MBS

     3,161        (2     2,905         3,012        104        107        82        16        2        -        -   

State and political subdivisions

     4,067        32        5,640         5,684        101        44        84        14        1        1        -   

Foreign covered bonds (e)

     3,207        22        3,870         3,928        101        58        99        1        -        -        -   

Corporate bonds

     1,696        3        1,571         1,628        104        57        17        73        9        1        -   

CLO

     1,118        (1     1,025         1,013        99        (12     100        -        -        -        -   

U.S. Government agency debt

     1,108        2        1,066         1,097        103        31        100        -        -        -        -   

Consumer ABS

     447        5        1,051         1,060        101        9        77        22        -        1        -   

Other (f)

     3,093        18        3,285         3,339        102        54        31        60        2        1        6   

Total investment securities

   $ 88,203 (g)    $ 258      $ 91,552       $ 92,992 (g)      99   $ 1,440        89     6     1     4     -

 

(a) Amortized cost before impairments.
(b) Primarily comprised of exposure to UK, France, Germany and Netherlands.
(c) These RMBS were included in the former Grantor Trust and were marked-to-market in 2009. We believe these RMBS would receive higher credit ratings if these ratings incorporated, as additional credit enhancement, the difference between the written-down amortized cost and the current face amount of each of these securities.
(d) Includes RMBS, commercial MBS and other securities. Primarily comprised of exposure to UK and Netherlands.
(e) Primarily comprised of exposure to Germany, Canada and UK.
(f) Includes commercial paper of $2.0 billion, fair value, and money market funds of $918 million, fair value, at June 30, 2012.
(g) Includes net unrealized losses on derivatives hedging securities available-for-sale of $20 million at March 31, 2012 and $417 million at June 30, 2012.

 

The fair value of our investment securities portfolio was $93.0 billion at June 30, 2012 compared with $81.7 billion at Dec. 31, 2011. The increase in the fair value of the investment securities portfolio primarily reflects larger investments in agency RMBS and state and political subdivision securities, as well as an improvement in the unrealized gain of our investment securities. In the second quarter of 2012, we received $246 million of paydowns and sold $24 million of sub-investment grade securities.

In the second quarter of 2012, we reassessed the classification of certain Agency RMBS and reclassified $2.8 billion at fair value of our available-for-sale securities to held-to-maturity. The related unrealized pre-tax gain on these securities was $117 million at June 30, 2012.

At June 30, 2012, the total investment securities portfolio had an unrealized pre-tax gain of $1.4 billion compared with $1.2 billion at March 31, 2012. The improvement in the valuation of the investment securities portfolio was primarily

driven by a decline in market interest rates. The unrealized net of tax gain on our investment securities available-for-sale portfolio included in accumulated other comprehensive income was $784 million at June 30, 2012 compared with $654 million at March 31, 2012.

At June 30, 2012, 89% of the securities in our portfolio were rated AAA/AA- compared with 88% at March 31, 2012.

We routinely test our investment securities for OTTI. (See “Critical accounting estimates” for additional disclosure regarding OTTI.)

At June 30, 2012, we had $1.0 billion of accretable discount related to the restructuring of the investment securities portfolio. The discount related to these securities had a remaining average life of approximately 4.4 years. The accretion of discount related to these securities increased net interest revenue and was recorded on a level yield basis. The discount accretion totaled $74 million in the

 

 

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second quarter of 2012, $98 million in the second quarter of 2011 and $81 million in the first quarter of 2012.

Also, at June 30, 2012, we had $2.3 billion of net amortizable purchase premium relating to investment securities with a remaining average life of approximately 4.3 years. For these securities, the amortization of net premium decreased net interest revenue and was recorded on a level yield basis. We recorded net premium amortization of $118 million in the second quarter of 2012, $60 million in the second quarter of 2011 and $109 million in the first quarter of 2012.

The following table provides pre-tax securities gains (losses) by type.

 

Net securities gains                         Year-to-date  
(in millions)    2Q12     1Q12     2Q11     2012     2011  

U.S. Treasury

   $ 44      $ 38      $ 41      $ 82      $ 41   

Sovereign debt

     61        7        -        68        -   

FDIC-insured debt

     -        10        -        10        -   

Corporate bonds

     7        2        -        9        -   

Prime RMBS

     (1     (1     -        (2     9   

Alt-A RMBS

     (3     (10     (1     (13     4   

Trust preferred

     (18     -        -        (18     -   

European floating rate notes

     (22     (1     (12     (23     (15

Subprime RMBS

     (23     (3     (6     (26     (12

Agency RMBS

     -        -        8        -        8   

Other

     5        (2     18        3        18   

Net securities gains (losses)

   $ 50      $ 40      $ 48      $ 90      $ 53   

On a quarterly basis, we perform our impairment analysis using several factors, including projected loss severities and default rates. In the second quarter of 2012, this analysis resulted in approximately $67 million of credit losses primarily on subprime RMBS, European floating rate notes and trust preferred securities. If we were to increase

or decrease each of our projected loss severities and default rates by 100 basis points on each of the positions in our Alt-A, subprime and prime RMBS portfolios, including the securities previously held by the Grantor Trust we established in connection with the restructuring of our investment securities portfolio in 2009, credit-related impairment charges on these securities would have increased $13 million (pre-tax) or decreased $1 million (pre-tax) in the second quarter of 2012. See Note 4 of the Notes to Consolidated Financial Statements for the projected weighted-average default rates and loss severities.

At June 30, 2012, the investment securities portfolio includes $83 million of assets not accruing interest. These securities are held at market value.

The following table shows the fair value of the European floating rate notes by geographical location at June 30, 2012. The unrealized loss on these securities was $284 million at June 30, 2012, an improvement of 18% compared with $347 million at Dec. 31, 2011.

 

 

European floating rate notes at June 30, 2012 (a)

 
                   Total fair  
(in millions)    RMBS      Other      value  

United Kingdom

   $ 1,758       $ 259       $ 2,017   

Netherlands

     1,476         46         1,522   

Ireland

     164         21         185   

Italy

     137         -         137   

Australia

     85         -         85   

Germany

     1         68         69   

Spain

     25         -         25   

France

     4         9         13   

Total

   $ 3,650       $ 403       $ 4,053   

 

(a) 79% of these securities are in the AAA to AA- ratings category.

See Note 14 of the Notes to Consolidated Financial Statements for the detail of securities by level in the fair value hierarchy.

 

 

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Loans

 

Total exposure — consolidated    June 30, 2012      Dec. 31, 2011  
            Unfunded      Total             Unfunded      Total  
(in billions)    Loans      commitments      exposure      Loans      commitments      exposure  

Non-margin loans:

                 

Financial institutions

   $ 10.5       $ 14.6       $ 25.1       $ 11.1       $ 15.5       $ 26.6   

Commercial

     1.4         17.3         18.7         1.3         16.3         17.6   

Subtotal institutional

     11.9         31.9         43.8         12.4         31.8         44.2   

Wealth management loans and mortgages

     7.9         1.6         9.5         7.3         1.5         8.8   

Commercial real estate

     1.6         1.9         3.5         1.5         1.5         3.0   

Lease financing

     2.5         -         2.5         2.6         -         2.6   

Other residential mortgages

     1.8         -         1.8         1.9         -         1.9   

Overdrafts

     5.7         -         5.7         4.8         -         4.8   

Other

     0.5         -         0.5         0.7         -         0.7   

Subtotal non-margin loans

     31.9         35.4         67.3         31.2         34.8         66.0   

Margin loans

     13.5         0.7         14.2         12.8         0.7         13.5   

Total

   $ 45.4       $ 36.1       $ 81.5       $ 44.0       $ 35.5       $ 79.5   

 

At June 30, 2012, total exposures were $81.5 billion, an increase of 3% from $79.5 billion at Dec. 31, 2011, primarily reflecting higher commercial exposure, overdrafts, wealth management loans and mortgages and commercial real estate exposure, partially offset by lower exposure in the financial institutions portfolio.

 

Our financial institutions and commercial portfolios comprise our largest concentrated risk. These portfolios make up 54% of our total lending exposure. Additionally, a substantial portion of our overdrafts relate to financial institutions and commercial customers.

 

Financial institutions

The diversity of the financial institutions portfolio is shown in the following table:

 

Financial institutions    June 30, 2012     Dec. 31, 2011  

portfolio exposure

(dollar amounts in billions)

   Loans      Unfunded
commitments
    

Total

exposure

     % Inv
grade
    % due
<1 yr
    Loans      Unfunded
commitments
    

Total

exposure

 

Banks

   $ 5.5       $ 1.7       $ 7.2         81     95   $ 6.3       $ 1.9       $ 8.2   

Securities industry

     3.5         2.0         5.5         92        95        3.8         2.6         6.4   

Insurance

     0.2         4.4         4.6         98        30        0.1         4.6         4.7   

Asset managers

     1.1         3.5         4.6         99        76        0.8         3.2         4.0   

Government

     -         1.7         1.7         95        20        -         1.6         1.6   

Other

     0.2         1.3         1.5         96        57        0.1         1.6         1.7   

Total

   $ 10.5       $ 14.6       $ 25.1         92     72   $ 11.1       $ 15.5       $ 26.6   

 

The financial institutions portfolio exposure was $25.1 billion at June 30, 2012 compared with $26.6 billion at Dec. 31, 2011. The decrease primarily reflects lower exposure to banks and broker-dealers, partially offset by increased exposure to asset managers.

Financial institution exposures are high-quality, with 92% meeting the investment grade equivalent criteria of our rating system at June 30, 2012. These exposures are generally short-term. Of these exposures, 72% expire within one year, and 34% expire within 90 days. In addition, 42% of the financial institution exposure is secured. For example, securities industry

and asset managers often borrow against marketable securities held in custody.

For ratings of non-U.S. counterparties, as a conservative measure, our internal credit rating classification generally caps the rating based upon the sovereign rating of the country where the counterparty resides regardless of the credit rating of the counterparty or the underlying collateral.

Our exposure to banks is predominantly to investment grade counterparties in developed countries. Noninvestment grade bank exposures are

 

 

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short term in nature supporting our global trade finance and U.S. dollar-clearing businesses in developing countries.

The asset manager portfolio exposures are high- quality, with 99% meeting our investment grade equivalent ratings criteria as of June 30, 2012.

These exposures are generally short-term liquidity facilities, with the vast majority to regulated mutual funds.

 

 

Commercial

The diversity of the commercial portfolio is shown in the following table:

 

Commercial portfolio exposure    June 30, 2012     Dec. 31, 2011  
(dollar amounts in billions)    Loans      Unfunded
commitments
    

Total

exposure

     % Inv
grade
    % due
<1 yr
    Loans      Unfunded
commitments
    

Total

exposure

 

Services and other

   $ 0.7       $ 5.4       $ 6.1         92     21   $ 0.5       $ 4.5       $ 5.0   

Manufacturing

     0.3         5.4         5.7         90        10        0.3         5.7         6.0   

Energy and utilities

     0.3         4.9         5.2         97        6        0.3         4.8         5.1   

Media and telecom

     0.1         1.6         1.7         90        4        0.2         1.3         1.5   

Total

   $ 1.4       $ 17.3       $ 18.7         93     12   $ 1.3       $ 16.3       $ 17.6   

 

The commercial portfolio exposure increased 6% to $18.7 billion at June 30, 2012 from $17.6 billion at Dec. 31, 2011, primarily reflecting an increase in exposure in the services and other portfolio.

Our goal is to maintain a predominantly investment grade portfolio. The table below summarizes the percent of the financial institutions and commercial exposures that are investment grade.

 

 

Percentage of the portfolios that are investment grade    June 30,
2011
    Sept. 30,
2011
    Dec. 31,
2011
    March 31,
2012
    June 30,
2012
 

Financial institutions

     91     92     93     92     92

Commercial

     91     91     91     92     93

 

Our credit strategy is to focus on investment grade names to support cross-selling opportunities, avoid single name/industry concentrations and exit high-risk portfolios. Each customer is assigned an internal rating grade, which is mapped to an external rating agency grade equivalent based upon a number of dimensions which are continually evaluated and may change over time. The execution of our strategy has resulted in 92% of our financial institutions portfolio and 93% of our commercial portfolio rated as investment grade at June 30, 2012.

Wealth management loans and mortgages

Wealth management loans and mortgages are primarily composed of loans to high-net-worth individuals, which are secured by marketable securities and/or residential property. Wealth management mortgages are primarily interest-only adjustable rate mortgages with an average loan to value ratio of 63% at origination. In the wealth management portfolio, 1% of the mortgages were past due at June 30, 2012.

At June 30, 2012, the private wealth mortgage portfolio was comprised of the following geographic concentrations: New York – 23%; California –18%; Massachusetts – 17%; Florida – 8%; and other – 34%.

Commercial real estate

Our commercial real estate facilities are focused on experienced owners and are structured with moderate leverage based on existing cash flows. Our commercial real estate lending activities include both construction facilities and medium-term loans. Our client base consists of experienced developers and long-term holders of real estate assets. Loans are approved on the basis of existing or projected cash flow, and supported by appraisals and knowledge of local market conditions. Development loans are structured with moderate leverage, and in most instances, involve some level of recourse to the developer. Our commercial real estate exposure totaled $3.5 billion at June 30, 2012 and $3.0 billion at Dec. 31, 2011.

 

 

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At June 30, 2012, 58% of our commercial real estate portfolio was secured. The secured portfolio is diverse by project type, with 60% secured by residential buildings, 19% secured by office buildings, 11% secured by retail properties and 10% secured by other categories. Approximately 97% of the unsecured portfolio is allocated to investment grade real estate investment trusts (“REITs”) under revolving credit agreements.

At June 30, 2012, our commercial real estate portfolio was comprised of the following geographic concentrations: New York metro – 44%; investment grade REITs – 41%; and other – 15%.

Lease financings

The leasing portfolio exposure totaled $2.5 billion and includes $188 million of airline exposures at June 30, 2012 compared with $2.6 billion of leasing exposures, including $197 million of airline exposures, at Dec. 31, 2011. At June 30, 2012, approximately 88% of the leasing exposure was investment grade.

At June 30, 2012, the $2.3 billion non-airline lease financing portfolio consisted of exposures backed by well-diversified assets, primarily large-ticket transportation equipment.

At June 30, 2012, our exposure to the airline industry consisted of $68 million to major U.S. carriers, $105 million to foreign airlines and $15 million to U.S. regional airlines.

Despite the significant improvement in revenues and yields that the U.S domestic airline industry achieved in the past year, high fuel prices pose a significant challenge for these carriers. Combined with their high fixed cost operating models and extremely high debt levels, the domestic airlines remain vulnerable. As such, we continue to maintain a sizable allowance for loan losses against these exposures and continue to closely monitor the portfolio.

We utilize the lease financing portfolio as part of our tax management strategy.

Other residential mortgages

The other residential mortgage portfolio primarily consists of 1-4 family residential mortgage loans and totaled $1.8 billion at June 30, 2012 compared with $1.9 billion at Dec. 31, 2011. Included in this portfolio at June 30, 2012 are $542 million of

mortgage loans purchased in 2005, 2006 and the first quarter of 2007 that are predominantly prime mortgage loans, with a small portion of Alt-A loans. As of June 30, 2012, the purchased loans in this portfolio had a weighted-average loan-to-value ratio of 75% at origination, and 29% of these loans were at least 60 days delinquent. The properties securing the prime and Alt-A mortgage loans were located (in order of concentration) in California, Florida, Virginia, Maryland and the tri-state area (New York, New Jersey and Connecticut).

To determine the projected loss on the prime and Alt-A mortgage portfolio, we calculate the total estimated defaults of these mortgages and multiply that amount by an estimate of realizable value upon sale in the marketplace (severity).

At June 30, 2012, we had less than $15 million in subprime mortgages included in our other residential mortgage portfolio. The subprime loans were issued to support our Community Reinvestment Act requirements.

Overdrafts

Overdrafts primarily relate to custody and securities clearance clients. Overdrafts occur on a daily basis in the custody and securities clearance business and are generally repaid within two business days.

Other loans

Other loans primarily include loans to consumers that are fully collateralized with equities, mutual funds and fixed income securities, as well as bankers’ acceptances.

Margin loans

Margin loans are collateralized with marketable securities, and borrowers are required to maintain a daily collateral margin in excess of 100% of the value of the loan. Margin loans also include $5.1 billion related to a term loan program that offers fully collateralized loans to broker-dealers.

Asset quality and allowance for credit losses

Over the past several years, we have improved our risk profile through greater focus on clients who are active users of our non-credit services, de-emphasizing broad-based loan growth. Our primary exposure to the credit risk of a customer consists of

 

 

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funded loans, unfunded formal contractual commitments to lend, standby letters of credit and overdrafts associated with our custody and securities clearance businesses.

The role of credit has shifted to one that complements our other services instead of as a lead product. Credit solidifies customer relationships and, through a disciplined allocation of capital, can earn acceptable rates of return as part of an overall relationship.

The following table details changes in our allowance for credit losses.

 

Allowance for credit losses activity  
(dollar amounts in millions)   June 30,
2012
    March 31,
2012
    Dec. 31,
2011
    June 30,
2011
 

Margin loans

  $ 13,462      $ 13,144      $ 12,760      $ 9,520   

Non-margin loans

    31,969        29,884        31,219        32,627   

Total loans

  $ 45,431      $ 43,028      $ 43,979      $ 42,147   

Beginning balance of allowance for credit losses

  $ 494      $ 497      $ 498      $ 554   

Provision for credit losses

    (19     5        23          

Net (charge-offs) recoveries:

       

Other residential mortgages

    (5     (8     (14     (9

Commercial

    1                      (3

Foreign

                  (2     (6

Commercial real estate

                  (1     (1

Financial institutions

    (4            (7       

Net (charge-offs)

  $ (8   $ (8   $ (24   $ (19

Ending balance of allowance for credit losses

  $ 467      $ 494      $ 497      $ 535   

Allowance for loan losses

  $ 362      $ 386      $ 394      $ 441   

Allowance for lending-related commitments

  $ 105      $ 108      $ 103      $ 94   

Allowance for loan losses as a percentage of total loans

    0.80     0.90     0.90     1.05

Allowance for loan losses as a percentage of non-margin loans

    1.13     1.29     1.26     1.35

Total allowance for credit losses as a percentage .of total loans

    1.03     1.15     1.13     1.27

Total allowance for credit losses as a percentage of non-margin loans

    1.46     1.65     1.59     1.64

Net charge-offs were $8 million in the second quarter of 2012, $19 million in the second quarter of 2011, and $8 million in the first quarter of 2012. Net charge-offs in the second quarter of 2012 were primarily driven by the financial institution and other residential mortgages portfolios. In the first quarter of 2012, net charge-offs were driven by the other residential mortgage portfolio. Net charge offs in the second quarter of 2011 were driven by the other residential mortgage and foreign portfolios.

The provision for credit losses was a credit of $19 million in the second quarter of 2012 primarily

resulting from a decline in the expected loss related to a broker-dealer customer that previously filed for bankruptcy, as well as improvements in the mortgage portfolio. There was no provision in the second quarter of 2011 and a provision of $5 million in the first quarter of 2012. We anticipate the quarterly provision for credit losses to be approximately $0 to $15 million in the third quarter of 2012.

The total allowance for credit losses was $467 million at June 30, 2012, a decrease of $30 million compared with Dec. 31, 2011 and $68 million compared with June 30, 2011. The decrease compared with Dec. 31, 2011 primarily resulted from a decline in the expected loss related to a broker-dealer customer that previously filed for bankruptcy, as well as improvements in the mortgage portfolio. The decrease compared with June 30, 2011 primarily resulted from improvements in the mortgage portfolio.

The ratio of the total allowance for credit losses to non-margin loans was 1.46% at June 30, 2012, 1.59% at Dec. 31, 2011 and 1.64% at June 30, 2011. The ratio of the allowance for loan losses to non-margin loans was 1.13% at June 30, 2012, 1.26% at Dec. 31, 2011 and 1.35% at June 30, 2011. The decrease in these ratios at June 30, 2012 compared with Dec. 31, 2011 resulted from a decline in the expected loss related to a broker-dealer customer that previously filed for bankruptcy, as well as improvements in the mortgage portfolio.

We had $13.5 billion of secured margin loans on our balance sheet at June 30, 2012 compared with $12.8 billion at Dec. 31, 2011. We have rarely suffered a loss on these types of loans and do not allocate any of our allowance for credit losses to them. As a result, we believe that the ratio of total allowance for credit losses to non-margin loans is a more appropriate metric to measure the adequacy of the reserve.

We utilize a quantitative methodology and qualitative framework for determining the allowance for credit losses. The three elements of the quantitative methodology are:

 

   

an allowance for impaired credits of $1 million or greater;

   

an allowance for higher risk-rated credits and pass-rated credits; and

   

an allowance for residential mortgage loans.

 

 

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Our lending is primarily to institutional customers. As a result, our loans are generally larger than $1 million. Therefore, the first element, impaired credits, is based on individual analysis of all impaired loans of $1 million or greater. The allowance is measured by the difference between the recorded value of impaired loans and their impaired value. Impaired value is either the present value of the expected future cash flows from the borrower, the market value of the loan or the fair value of the collateral.

The second element, higher risk-rated credits and pass-rated credits, is based on our probable loss model. All borrowers are assigned to pools based on their credit ratings. The probable loss inherent in each loan in a pool incorporates the borrower’s credit rating, loss given default rating and maturity. The loss given default incorporates a recovery expectation. The borrower’s probability of default is derived from the associated credit rating. Borrower ratings are reviewed at least annually and are periodically mapped to third-party databases, including rating agency and default and recovery databases, to ensure ongoing consistency and validity. Higher risk-rated credits are reviewed quarterly. Commercial loans over $1 million are individually analyzed before being assigned a credit rating. We also apply this technique to our lease financing and wealth management portfolios.

The third element, the allowance for residential mortgage loans, is determined by segregating six mortgage pools into delinquency periods ranging from current through foreclosure. Each of these delinquency periods is assigned a probability of default. A specific loss given default based on a combination of external loss data from third-party databases and internal loss history is assigned for each mortgage pool. For each pool, the inherent loss is calculated using the above factors. The resulting probable loss factor is applied against the loan balance to determine the allowance held for each pool.

Within this framework, management applies judgment when assessing internal risk factors and environmental factors to compute an additional allowance for each component of the loan portfolio. The qualitative framework is used to determine an additional allowance for each portfolio based on the factors below:

Internal risk factors:

 

   

Nonperforming loans to total non-margin loans;

   

Criticized assets to total loans and lending-related commitments;

   

Ratings volatility;

   

Borrower concentration; and

   

Significant concentration in high-risk industry.

Environmental risk factors:

 

   

U.S. noninvestment grade default rate;

   

Unemployment rate; and

   

Change in real GDP (quarter-over-quarter).

To the extent actual results differ from forecasts or management’s judgment, the allowance for credit losses may be greater or less than future charge-offs.

Based on an evaluation of these three elements and our qualitative framework, we have allocated our allowance for credit losses as follows:

 

Allocation of allowance

to our portfolio

  June 30,
2012
    March 31,
2012
    Dec. 31,
2011
    June 30,
2011
 

Other residential mortgages

    33     33     31     37

Commercial

    22        20        18        18   

Lease financing

    12        12        13        17   

Foreign

    12        10        12        12   

Financial institutions

    8        11        13        5   

Commercial real estate

    7        7        7        5   

Wealth management (a)

    6        7        6        6   

Total

    100     100     100     100

 

(a) Includes the allowance for wealth management mortgages.

The allocation of allowance for credit losses is inherently judgmental, and the entire allowance for credit losses is available to absorb credit losses regardless of the nature of the loss.

The credit rating assigned to each credit is a significant variable in determining the allowance. If each credit were rated one grade better, the allowance would have decreased by $58 million, while if each credit were rated one grade worse, the allowance would have increased by $91 million. Similarly, if the loss given default were one rating worse, the allowance would have increased by $40 million, while if the loss given default were one rating better, the allowance would have decreased by $34 million. For impaired credits, if the net carrying value of the loans was 10% higher or lower, the allowance would have decreased or increased by $2 million, respectively.

 

 

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Nonperforming assets

The following table shows the distribution of non-performing assets.

 

Nonperforming assets

(dollar amounts in millions)

  June 30,
2012
    March 31,
2012
    Dec. 31,
2011
 

Nonperforming loans:

     

Other residential mortgages

  $ 177      $ 188      $ 203   

Wealth management

    35        35        32   

Commercial

    31        32        21   

Commercial real estate

    30        39        40   

Foreign

    9        10        10   

Financial institutions

    3        14        23   

Total nonperforming loans

    285        318        329   

Other assets owned

    9        13        12   

Total nonperforming assets (a)

  $ 294      $ 331      $ 341   

Nonperforming assets ratio

    0.65     0.77     0.78

Nonperforming assets ratio, excluding margin loans

    0.92        1.11        1.09   

Allowance for loan losses/nonperforming loans

    127.0        121.4        119.8   

Allowance for loan losses/nonperforming assets

    123.1        116.6        115.5   

Total allowance for credit losses/nonperforming loans

    163.9        155.3        151.1   

Total allowance for credit losses/nonperforming assets

    158.8        149.2        145.7   

 

(a) Loans of consolidated investment management funds are not part of BNY Mellon’s loan portfolio. Included in these loans are nonperforming loans of $155 million at June 30, 2012, $180 million at March 31, 2012 and $101 million at Dec. 31, 2011. These loans are recorded at fair value and therefore do not impact the provision for credit losses and allowance for loan losses, and accordingly are excluded from the nonperforming assets table above.

 

Nonperforming assets

quarterly activity

(in millions)

   June 30,
2012
    March 31,
2012
    Dec. 31,
2011
 

Balance at beginning of period

   $ 331      $ 341      $ 344   

Additions

     15        36        69   

Return to accrual status

     (6     (13     (8

Net charge-offs

     (11     (8     (24

Paydowns/sales

     (30     (22     (37

Net change in other real estate owned

     (5     (3     (3

Balance at end of period

   $ 294      $ 331      $ 341   

Nonperforming assets were $294 million at June 30, 2012, a decrease of $37 million compared with March 31, 2012. The decrease primarily resulted from paydowns/sales primarily in the residential mortgage, commercial real estate and financial institutions portfolios, net charge-offs of residential mortgage and financial institutions loans and the return to accrual status of residential mortgage loans. The decrease was partially offset by additions of residential mortgage loans.

See Note 5 of the Notes to Consolidated Financial Statements for additional information on our past due loans. See “Nonperforming assets” in Note 1 of the Notes to Consolidated Financial Statements in the 2011 Annual Report for our policy for placing loans on nonaccrual status.

Deposits

Total deposits were $221.1 billion at June 30, 2012 compared with $219.1 billion at Dec. 31, 2011. The slight increase reflects higher foreign and domestic interest-bearing deposits primarily offset by lower noninterest-bearing deposits.

Noninterest-bearing deposits were $76.9 billion at June 30, 2012 compared with $95.3 billion at Dec. 31, 2011. Interest-bearing deposits were $144.2 billion at June 30, 2012 compared with $123.8 billion at Dec. 31, 2011.

Short-term borrowings

We fund ourselves primarily through deposits and, to a lesser extent, other borrowings, which are comprised of federal funds purchased and securities sold under repurchase agreements, payables to customers and broker-dealers, commercial paper, other borrowed funds and long-term debt. Certain other borrowings, for example, securities sold under repurchase agreements, require the delivery of securities as collateral.

See “Liquidity and dividends” below for a discussion of long-term debt and liquidity metrics that we monitor and an additional discussion on the Parent’s reliance on short-term borrowings.

Information related to federal funds purchased and securities sold under repurchase agreements is presented below.

 

Federal funds purchased and securities

sold under repurchase agreements

   Quarter ended  
(dollar amounts in millions)    June 30,
2012
    March 31,
2012
    June 30,
2011
 

Maximum daily balance during the quarter

   $ 21,818      $ 15,636      $ 21,005   

Average daily balance

   $ 11,254      $ 8,584      $ 10,894   

Weighted-average rate during the quarter

     0.01     (0.02 )%      0.06

Ending balance

   $ 9,162      $ 8,285      $ 7,572   

Weighted-average rate at period end

     (0.03 )%      (0.03 )%      0.03
 

 

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Federal funds purchased and securities sold under repurchase agreements were $9.2 billion at June 30, 2012, $8.3 billion at March 31, 2012 and $7.6 billion at June 30, 2011. Average federal funds purchased and securities sold under repurchase agreements were $11.3 billion in the second quarter of 2012, $8.6 billion in the first quarter of 2012 and $10.9 billion in the second quarter of 2011. The higher average federal funds purchased and securities sold under repurchase agreements in the second quarter of 2012 was primarily a function of attractive overnight rate opportunities. The maximum daily balance in the second quarter of 2012 was $21.8 billion and resulted from the same attractive overnight borrowing opportunities. The weighted-average rates in the second quarter of 2012, the first quarter of 2012 and the second quarter of 2011, reflect revenue earned on securities sold under repurchase agreements related to certain securities for which we were able to charge for lending them.

Information related to payables to customers and broker-dealers is presented below.

 

Payables to customers and broker-dealers    Quarter ended  

(dollar amounts in millions)

    
 
June 30,
2012
  
  
   
 
March 31,
2012
  
  
   
 
June 30,
2011
  
  

Maximum daily balance during the quarter

   $ 15,812      $ 14,176      $ 12,194   

Average daily balance

   $ 13,255      $ 13,123      $ 11,031   

Weighted-average rate during the quarter (a)

     0.10     0.11     0.09

Ending balance

   $ 13,305      $ 12,959      $ 11,512   

Weighted-average rate at period end

     0.10     0.12     0.10
(a) The weighted-average rate is calculated based on, and is applied to, the average interest-bearing payables to customers and broker-dealers, which were $7,895 million in the second quarter of 2012, $7,555 million in the first quarter of 2012 and $6,843 million in the second quarter of 2011.

Payables to customers and broker-dealers represent funds awaiting reinvestment and short sale proceeds, payable on demand. Payables to customers and broker-dealers were $13.3 billion at June 30, 2012, $13.0 billion at March 31, 2012 and $11.5 billion at June 30, 2011. Payables to customers and broker-dealers are driven by customer trading activity and market volatility.

Information related to commercial paper is presented below.

 

Commercial paper    Quarter ended  
(dollar amounts in millions)    June 30,
2012
    March 31,
2012
    June 30,
2011
 

Maximum daily balance during the quarter

   $ 2,547      $ 1,126      $ 101   

Average daily balance

   $ 1,436      $ 67      $ 24   

Weighted-average rate during the quarter

     0.29     0.08     0.03

Ending balance

   $ 1,564      $ 1,070      $ 36   

Weighted-average rate at period end

     0.14     0.11     0.03

Commercial paper outstanding was $1.6 billion at June 30, 2012, $1.1 billion at March 31, 2012 and $36 million at June 30, 2011. The increase compared with both prior periods was driven by attractive short-term borrowing opportunities and Parent funding requirements. Average commercial paper outstanding was $1.4 billion in the second quarter of 2012, $67 million in the first quarter of 2012 and $24 million in the second quarter of 2011. Our commercial paper matures within 397 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment.

Information related to other borrowed funds is presented below.

 

Other borrowed funds    Quarter ended  
(dollar amounts in millions)    June 30,
2012
    March 31,
2012
    June 30,
2011
 

Maximum daily balance during the quarter

   $ 2,795      $ 5,506      $ 2,959   

Average daily balance

   $ 1,114      $ 2,512      $ 1,853   

Weighted-average rate during the quarter

     1.87     0.81     2.09

Ending balance

   $ 1,374      $ 2,062      $ 2,337   

Weighted-average rate at period end

     2.75     1.13     2.46

Other borrowed funds primarily include borrowings under lines of credit by our Pershing subsidiaries; and overdrafts of sub-custodian account balances in our Investment Services business. Overdrafts in these accounts typically relate to timing differences for settlements. Other borrowed funds were $1.4 billion at June 30, 2012, $2.1 billion at March 31, 2012 and $2.3 billion at June 30, 2011. The decrease compared with both prior periods reflects a change in the source of funding for the borrowing under lines of credit by our Pershing subsidiaries.

 

 

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Liquidity and dividends

BNY Mellon defines liquidity as the ability of the Parent and its subsidiaries to access funding or convert assets to cash quickly and efficiently, especially during periods of market stress. Liquidity risk is the risk that BNY Mellon cannot meet its cash and collateral obligations at a reasonable cost for both expected and unexpected cash flows, without adversely affecting daily operations or financial conditions. Liquidity risk can arise from cash flow mismatches, market constraints from inability to convert assets to cash, inability to raise cash in the markets or deposit run-off.

Our overall approach to liquidity management is to ensure that sources of liquidity are sufficient in amount and diversity such that changes in funding requirements at the Parent and at the various bank subsidiaries can be accommodated routinely without material adverse impact on earnings, daily operations or our financial condition.

BNY Mellon seeks to maintain an adequate liquidity cushion in both normal and stressed environments and seeks to diversify funding sources by line of business, customer and market segment. Additionally, we seek to maintain liquidity ratios within approved limits and liquidity risk tolerance; maintain a liquid asset buffer that can be liquidated, financed and/or pledged as necessary; and control the levels and sources of wholesale funds.

Potential uses of liquidity include withdrawals of customer deposits and client drawdowns on unfunded credit or liquidity facilities. We actively monitor unfunded lending-related commitments, thereby reducing unanticipated funding requirements.

 

When monitoring liquidity, we evaluate multiple metrics to ensure ample liquidity for expected and unexpected events. Metrics include cashflow mismatches, asset maturities, access to debt and money markets, debt spreads, peer ratios, unencumbered collateral, funding sources and balance sheet liquidity ratios. We monitor the Basel III liquidity coverage ratio as applied to us, based on our current interpretation of Basel III. Ratios we currently monitor as part of our standard analysis include total loans as a percentage of total deposits, deposits as a percentage of total interest-earning assets, foreign deposits as a percentage of total interest-earnings assets, purchased funds as a percentage of total interest-earning assets, liquid assets as a percentage of total interest-earning assets and liquid assets as a percentage of purchased funds. All of these ratios exceeded our minimum guidelines at June 30, 2012.

We also perform stress tests to verify sufficient funding capacity is accessible under multiple stress scenarios.

Available funds are defined as liquid funds (which include interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements), cash and due from banks, and interest-bearing deposits with the Federal Reserve and other central banks. The table below presents our total available funds, including liquid funds, at period end and on an average basis. The decline in available funds at June 30, 2012 compared with Dec. 31, 2011 resulted from a decrease in interest-bearing deposits with the Federal Reserve and other central banks as we increased the level of our securities portfolio.

 

 

Available and liquid funds    June 30,     Dec. 31,     Average  
(in millions)    2012     2011     2Q12     1Q12     2Q11     YTD12     YTD11  

Available funds:

              

Liquid funds:

              

Interest-bearing deposits with banks

   $ 39,743      $ 36,321      $ 38,474      $ 35,095      $ 59,291      $ 36,784      $ 58,468   

Federal funds sold and securities purchased under resale agreements

     8,543        4,510        5,493        5,174        4,577        5,333        4,546   

Total liquid funds

     48,286        40,831        43,967        40,269        63,868        42,117        63,014   

Cash and due from banks

     4,522        4,175        4,412        4,271        4,335        4,341        4,215   

Interest-bearing deposits with the Federal

              

Reserve and other central banks

     76,243        90,243        57,904        63,526        34,068        60,715        27,255   

Total available funds

   $ 129,051      $ 135,249      $ 106,283      $ 108,066      $ 102,271      $ 107,173      $ 94,484   

Total available funds as a percentage of total assets

     39     42     35     36     37     35     35

 

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On an average basis for the first six months of 2012 and the first six months of 2011, non-core sources of funds, such as money market rate accounts, federal funds purchased, trading liabilities and other borrowings, were $20.0 billion and $16.8 billion, respectively. The increase primarily reflects higher levels of money market rate accounts, federal funds purchased and other borrowings, partially offset by lower levels of trading liabilities. Average foreign deposits, primarily from our European-based Investment Services business, were $87.4 billion and $81.4 billion for the first six months of 2012 and the first six months of 2011. The increase primarily reflects growth in client deposits. Domestic savings and time deposits averaged $34.1 billion for the first six months of 2012 compared with $35.0 billion for the first six months of 2011. The decrease reflects a decline in client savings deposits.

Average payables to customers and broker-dealers were $7.7 billion for the first six months of 2012 and $6.8 billion for the first six months of 2011. Long-term debt averaged $20.3 billion in the first six months of 2012 and $17.2 billion in the first six months of 2011. The increase in average long-term debt was driven by planned capital actions and anticipated maturities. Average noninterest-bearing deposits increased to $64.7 billion in the first six months of 2012 from $40.8 billion in the first six months of 2011, reflecting growth in client deposits. A significant reduction in our Investment Services businesses would reduce our access to deposits.

The Parent has four major sources of liquidity:

 

   

cash on hand;

   

dividends from its subsidiaries;

   

access to the commercial paper market; and

   

access to the long-term debt and equity markets.

Our bank subsidiaries can declare dividends to the Parent of approximately $3.9 billion, subsequent to June 30, 2012, without the need for a regulatory waiver. In addition, at June 30, 2012, non-bank subsidiaries of the Parent had liquid assets of approximately $1.4 billion.

In the second quarter of 2012, BNY Mellon’s quarterly cash dividend was $0.13 per common share. The Federal Reserve’s current guidance provides that, for large bank holding companies like us, dividend payout ratios exceeding 30% of after-tax net income will receive particularly close scrutiny.

Restrictions on our ability to obtain funds from our subsidiaries are discussed in more detail in Note 20 of the Notes to Consolidated Financial Statements contained in the 2011 Annual Report.

For the quarter ended June 30, 2012, the Parent’s quarterly average commercial paper borrowings were $1.4 billion compared with $24 million for the quarter ended June 30, 2011. In addition to issuing commercial paper for funding purposes, the Parent issues commercial paper, on an overnight basis, to certain custody clients with excess demand deposit balances. Overnight commercial paper issued by the Parent was $1.6 billion at June 30, 2012 and $10 million at Dec. 31, 2011. The Parent had cash of $5.1 billion at June 30, 2012 compared with $4.6 billion at Dec. 31, 2011. Net of commercial paper outstanding, the Parent’s cash position at June 30, 2012 decreased $1.0 billion compared with Dec. 31, 2011, primarily reflecting increased loans to subsidiaries which replaced external funding sources and share repurchases.

The Parent’s major uses of funds are payment of dividends, repurchases of common stock, principal and interest payments on its borrowings, acquisitions and additional investments in its subsidiaries.

In the second quarter of 2012, we repurchased 12.2 million common shares in the open market at an average price of $23.38 per share for a total of $286 million.

While the Parent’s liquidity policy is to have sufficient cash on hand to meet its obligations over the next 12 months without the need to receive dividends from its bank subsidiaries or issue debt, our practice has been to maintain sufficient cash for the next 24 months. As of June 30, 2012, the Parent was in compliance with its liquidity policy.

In addition to our other funding sources, we also have the ability to access the capital markets. In June 2010, we filed shelf registration statements on Form S-3 with the Securities and Exchange Commission (“SEC”) covering the issuance of certain securities, including an unlimited amount of debt, common stock, preferred stock and trust preferred securities, as well as common stock issued under the Direct Stock Purchase and Dividend Reinvestment Plans. These registration statements will expire in June 2013, at which time we plan to file new shelf registration statements.

 

 

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Our ability to access capital markets on favorable terms, or at all, is partially dependent on our credit ratings, which, as of June 30, 2012, were as follows:

 

 

Debt ratings at June 30, 2012

 

      Moody’s      Standard &
Poor’s
     Fitch      DBRS  

Parent:

           

Long-term senior debt

     Aa3         A+         AA-         AA (low)   

Subordinated debt

     A1         A         A+         A (high)   

Trust preferred securities

     A2         BBB         BBB+         A (high)   

Short-term

     P1         A-1         F1+         R-1 (middle)   

Outlook – Parent:

     Negative         Negative         Stable         Stable   

The Bank of New York Mellon:

           

Long-term senior debt

     Aa1         AA-         AA-         AA   

Long-term deposits

     Aa1         AA-         AA         AA   

Short-term deposits

     P1         A-1+         F1+         R-1 (high)   

BNY Mellon, N.A.:

           

Long-term senior debt

     Aa1         AA-         AA-(a)         AA   

Long-term deposits

     Aa1         AA-         AA         AA   

Short-term deposits

     P1         A-1+         F1+         R-1 (high)   

Outlook—Banks:

     Stable         Negative         Stable         Stable   

 

(a) Represents senior debt issuer default rating.

As a result of Moody’s & Standard & Poor’s (“S&P”) government support assumptions on U.S. financial institutions, the Parent’s Moody’s and S&P ratings benefit from one notch of “lift”. Similarly, The Bank of New York Mellon’s and BNY Mellon, N.A.’s ratings benefit from two notches of “lift” from Moody’s and one notch of “lift” from S&P.

Subsequent to June 30, 2012, S&P, Fitch and DBRS reaffirmed all of our debt ratings.

Long-term debt decreased to $19.5 billion at June 30, 2012 from $19.9 billion at Dec. 31, 2011, primarily due to the maturity of $1.4 billion of senior debt and $300 million of subordinated debt as well as the redemption of $500 million of junior subordinated debentures, partially offset by the issuance of $1.75 billion of senior debt.

The Parent has $1.8 billion of long-term debt that will mature in the remainder of 2012 and has the option to call $82 million of subordinated debt in the remainder of 2012, which it may call and refinance if market conditions are favorable.

At June 30, 2012, we had approximately $1.2 billion of trust preferred securities outstanding that will be impacted by the Dodd-Frank Act. These securities currently qualify as Tier 1 capital. The $1.2 billion includes $850 million of trust preferred securities that are currently callable. Any decision to call these

securities will be based on interest rates, the availability of cash and capital, and regulatory conditions, as well as the implementation of the Dodd-Frank Act, which will disqualify these trust preferred securities from being treated as Tier 1 capital over a three-year period beginning Jan. 1, 2013.

Our outstanding trust preferred securities include $500 million of Fixed-to-Floating Rate Normal Preferred Capital Securities (“PCS”) issued by Mellon Capital IV. As contractually obligated under the terms of the PCS, a remarketing occurred in May 2012. In this remarketing, junior subordinated notes issued by BNY Mellon and held by Mellon Capital IV were sold to third party investors and then exchanged for BNY Mellon’s senior notes, which were sold in a public offering. The proceeds of the sale of the senior notes were used to fund the purchase by Mellon Capital IV of $500 million of BNY Mellon’s Series A non-cumulative perpetual preferred stock, which was issued on June 20, 2012. As a result of the remarketing, the PCS are expected to pay distributions at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.565% for the related distribution period; and (ii) 4.000%. The non-cumulative perpetual preferred stock qualifies as Tier 1 capital under the recently released NPRs.

The double leverage ratio is the ratio of investment in subsidiaries divided by our consolidated equity, which includes our non-cumulative perpetual preferred stock, plus trust preferred securities. Our double leverage ratio was 108.5% at June 30, 2012 and 107.3% at Dec. 31, 2011. The double leverage ratio is monitored by regulators and rating agencies and is an important constraint on our ability to invest in our subsidiaries and expand our businesses.

Pershing LLC, an indirect subsidiary of BNY Mellon, has committed and uncommitted lines of credit in place for liquidity purposes, which are guaranteed by the Parent. The committed line of credit for $750 million extended by 17 financial institutions matures in March 2013. Pershing has another committed line of credit for $125 million extended by one financial institution that matures in September 2012. There were no borrowings under either of these lines of credit during the second quarter of 2012. Pershing LLC has nine separate uncommitted lines of credit amounting to $1.6 billion in aggregate. Average daily borrowing under these lines was $15 million, in aggregate, during the second quarter of 2012. See “Liquidity and dividends” in the 2011 Annual Report for a

 

 

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description of the covenants required to be maintained by the Parent for the committed line of credit maintained by Pershing LLC. We are currently in compliance with these covenants.

Pershing Limited, an indirect U.K.-based subsidiary of BNY Mellon, has uncommitted lines of credit in place for liquidity purposes, which are guaranteed by the Parent. Pershing Limited has two separate uncommitted lines of credit amounting to $250 million in aggregate. Average daily borrowing under these lines was $40 million, in aggregate, during the second quarter of 2012.

Statement of cash flows

Cash provided by operating activities was $374 million for the six months ended June 30, 2012 compared with $997 million for the six months ended June 30, 2011. In the first six months of 2012 and 2011, earnings, partially offset by changes in accruals and other balances, were a significant source of funds.

Through June 30, 2012, cash used for investing activities was $5.8 billion compared with $52.0 billion in the first six months of 2011. In the first six months of 2012, purchases of securities, changes in federal funds sold and securities purchased under resale agreements and changes in interest-bearing deposits with banks were a significant use of funds, partially offset by decreases in deposits with the Federal Reserve and other central banks and sales, paydowns, and maturities of securities. In the first six months of 2011, increases in interest-bearing deposits with banks, and with the Federal Reserve and other central banks, and purchases of securities were a significant use of funds, partially offset by sales, paydowns and maturities of securities.

In the first six months of 2012, cash provided by financing activities was $5.8 billion compared with $52.9 billion in the first six months of 2011. In the first six months of 2012, increases in federal funds purchased and securities sold under repurchase agreements, deposits, commercial paper and the issuance of long-term debt were significant sources of funds, partially offset by repayment of long-term debt, a decrease in other borrowed funds and treasury stock repurchases. In the first six months of 2011, an increase in deposits was a significant source of funds partially offset by a decrease in other borrowed funds.

 

 

Capital

 

Capital data                             

(dollar amounts in millions except per share

amounts; common shares in thousands)

   June 30,
2012
    March 31,
2012
    Dec. 31,
2011
    June 30,
2011
 

Average common equity to average assets

     11.2     11.2     10.7     12.0

At period end:

        

BNY Mellon shareholders’ equity to total assets ratio

     10.5     11.3     10.3     11.1

BNY Mellon common shareholders’ equity to total assets ratio

     10.3     11.3     10.3     11.1

Total BNY Mellon shareholders’ equity – GAAP

   $ 34,533      $ 34,000      $ 33,417      $ 33,851   

Total BNY Mellon common shareholders’ equity – GAAP

   $ 34,033      $ 34,000      $ 33,417      $ 33,851   

Tangible BNY Mellon common shareholders’ equity – Non-GAAP (a)

   $ 13,544      $ 13,326      $ 12,787      $ 12,671   

Book value per common share – GAAP

   $ 28.81      $ 28.51      $ 27.62      $ 27.46   

Tangible book value per common share – Non-GAAP (a)

   $ 11.47      $ 11.17      $ 10.57      $ 10.28   

Closing common stock price per share

   $ 21.95      $ 24.13      $ 19.91      $ 25.62   

Market capitalization

   $ 25,929      $ 28,780      $ 24,085      $ 31,582   

Common shares outstanding

     1,181,298        1,192,716        1,209,675        1,232,691   

Cash dividends per common share

   $ 0.13      $ 0.13      $ 0.13      $ 0.13   

Common dividend yield (annualized)

     2.4     2.2     2.6     2.0

Common dividend payout ratio

     33     25     31     22
(a) See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for the reconciliation of GAAP to Non-GAAP.

 

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Total The Bank of New York Mellon Corporation shareholders’ equity increased compared with Dec. 31, 2011, primarily reflecting earnings retention, the issuance of $500 million of non-cumulative perpetual preferred stock and the increased value of our investment securities portfolio, partially offset by share repurchases.

During the second quarter of 2012, we repurchased 12.2 million shares in the open market at an average price of $23.38 per share for a total of $286 million. In March 2012, BNY Mellon received confirmation that the Federal Reserve did not object to our 2012 comprehensive capital plan. Our 2012 capital plan includes the repurchase of up to $1.16 billion of outstanding common stock and the continuation of the 13 cents per share quarterly cash dividend.

The unrealized net of tax gain on our available-for-sale securities portfolio recorded in accumulated other comprehensive income was $784 million at June 30, 2012 compared with $417 million at Dec. 31, 2011. The increase in the valuation of the investment securities portfolio was driven by a decline in market interest rates.

On July 18, 2012, the Board of Directors declared a quarterly common stock dividend of $0.13 per common share. This cash dividend was paid on Aug. 7, 2012, to shareholders of record as of the close of business on July 30, 2012.

Capital adequacy

Regulators establish certain levels of capital for bank holding companies and banks, including BNY Mellon and our bank subsidiaries, in accordance with established quantitative measurements. For the Parent to maintain its status as a financial holding company, our bank subsidiaries and BNY Mellon must, among other things, qualify as well capitalized.

As of June 30, 2012 and Dec. 31, 2011, BNY Mellon and our bank subsidiaries were considered well capitalized on the basis of the Basel I Total and Tier 1 capital to risk-weighted assets ratios and the leverage ratio (Basel I Tier 1 capital to quarterly average assets as defined for regulatory purposes).

 

 

Our consolidated and largest bank subsidiary, The Bank of New York Mellon, capital ratios are shown below.

 

 

Consolidated and largest bank subsidiary capital ratios

      Well
capitalized
    Adequately
capitalized
    June 30,
2012
    March 31,
2012
    Dec. 31,
2011
    June 30,
2011
 

Consolidated capital ratios:

            

Estimated Basel III Tier 1 common equity ratio – Non-GAAP (a)(b)

     N/A        N/A        8.7     N/A        N/A        N/A   

Tangible BNY Mellon shareholders’ equity to tangible assets of operations ratio – Non-GAAP (b)

     N/A        N/A        6.1     6.5     6.4     6.0

Determined under Basel I-based guidelines (c):

            

Tier 1 common equity to risk-weighted assets ratio – Non-GAAP (b)

     N/A        N/A        13.2     13.9     13.4     12.6

Tier 1 capital

     6     N/A        14.7        15.6        15.0        14.1   

Total capital

     10        N/A        16.4        17.5        17.0        16.7   

Leverage – guideline

     5        N/A        5.5        5.6        5.2        5.8   

The Bank of New York Mellon capital ratios (c):

            

Tier 1 capital

     6     4     13.7     14.8     14.3     12.1

Total capital

     10        8        14.5        18.0        17.7        15.7   

Leverage

     5        3        5.7        5.7        5.3        5.3   

 

(a) The estimated Basel III Tier 1 common equity ratio at June 30, 2012 is based on the NPRs and final market risk rule released on June 7, 2012. The estimated Basel III Tier 1 common equity ratios of 7.6% at March 31, 2012, 7.1% at Dec. 31, 2011 and 6.5% at June 30, 2011 were based on prior Basel III guidance and the proposed market risk rule.
(b) See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 50 for a calculation of this ratio.
(c) When in this Form 10-Q we refer to BNY Mellon’s or our bank subsidiary’s “Basel I” capital measures (e.g., Basel I Total capital or Basel I Tier 1 capital), we mean Total or Tier 1 capital, as applicable, as calculated under the Federal Reserve’s risk-based capital guidelines that are based on the 1988 Basel Accord, which is often referred to as “Basel I”.
N/A – Not applicable at the consolidated company level. Well capitalized and adequately capitalized have not been defined for Basel III.

 

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Our estimated Basel III Tier 1 common equity ratio was 8.7% at June 30, 2012 based on the NPRs and final market risk rule. The increase in the ratio from 7.6% at March 31, 2012, which was calculated under prior Basel III guidance and the proposed market risk rule, was primarily due to the reduction in risk-weighted assets related to the treatment of sub-investment grade securities, partially offset by the treatment of investment grade securitizations and financial institution exposure. The positive impact of the NPRs was partially offset by balance sheet growth in the second quarter of 2012.

At June 30, 2012, the amounts of capital by which BNY Mellon and our largest bank subsidiary, The Bank of New York Mellon, exceed the “well capitalized” guidelines are as follows.

 

Capital above guidelines at June 30, 2012  
(in millions)    Consolidated     

The Bank of

New York

Mellon

 

Tier 1 capital

   $ 9,316       $ 7,240   

Total capital

     6,832         4,199   

Leverage

     1,483         1,519   

Failure to satisfy regulatory standards, including “well-capitalized” status or capital adequacy guidelines more generally, could result in limitations on our activities and adversely affect our financial condition. See the discussion of these matters in our 2011 Annual Report in Item 1 (Business–Supervision and Regulation–Regulated Entities of BNY Mellon) and Item 1A (Risk Factors–Supervisory Standards–Failure to satisfy regulatory standards, including ‘well-capitalized’ status or capital adequacy guidelines more generally, could result in limitations on our activities and adversely affect our financial condition.)

Our Basel I Tier 1 capital ratio was 14.7% at June 30, 2012 compared with 15.0% at Dec. 31, 2011. The decrease from Dec. 31, 2011 primarily reflects higher risk-weighted assets. Our Basel I Tier 1 leverage ratio was 5.5% at June 30, 2012 compared with 5.2% at Dec. 31, 2011. The leverage ratio of The Bank of New York Mellon was 5.7% at June 30, 2012 compared with 5.3% at Dec. 31, 2011. The improvement in the leverage ratio of both BNY Mellon and The Bank of New York Mellon reflects a lower level of average assets driven by a decrease in average noninterest-bearing client deposits, and earnings retention.

The Basel I Tier 1 capital ratio varies depending on the size of the balance sheet at quarter end and the level and types of investments. The balance sheet size fluctuates from quarter to quarter based on levels of client and market activity. In general, when servicing clients are more actively trading securities, deposit balances and the balance sheet as a whole are higher. In addition, when markets experience significant volatility, our balance sheet size may increase considerably as client deposit levels increase.

In the second quarter of 2012, we generated $527 million of gross Basel I Tier 1 common equity, which was primarily driven by earnings retention.

 

Basel I Tier 1 common equity generation  
     Quarter ended  
(in millions)   

June 30,

2012

   

March 31,

2012

 

Net income applicable to common shareholders of The Bank of New York Mellon Corporation – GAAP

   $ 466      $ 619   

Add: Amortization of intangible assets, net of tax

     61        61   

Gross Basel I Tier 1 common equity generated

     527        680   

Less capital deployed:

    

Dividends

     156        158   

Common stock repurchases

     286        371   

Total capital deployed

     442        529   

Add: Other

     (53     146   

Net Basel I Tier 1 common equity generated

   $ 32      $ 297   

The following table shows the impact of a $1 billion increase or decrease in risk-weighted assets or a $100 million increase or decrease in common equity on the consolidated capital ratios at June 30, 2012.

 

Potential impact to capital ratios as of June 30, 2012  
     Increase or decrease of  
(basis points)   

$100 million in

common equity

     $1 billion in risk-
weighted assets/
quarterly
average assets 
(a)
 

Basel I:

     

Tier 1 capital

     9 bp         14 bp   

Total capital

     9         15   

Leverage

     4         2   

Basel III:

     

Estimated Tier 1 common equity ratio

     7 bp         6 bp   
(a) Quarterly average assets determined under Basel I regulatory guidelines.
 

 

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Our tangible BNY Mellon shareholders’ equity to tangible assets of operations ratio was 6.1% at June 30, 2012 compared with 6.4% at Dec. 31, 2011. The decrease compared with Dec. 31, 2011 was primarily due to lower cash on deposit with the Federal Reserve and other central banks, as we increased our investment in securities.

At June 30, 2012, we had approximately $1.2 billion of trust preferred securities outstanding. These securities currently qualify as Tier 1 capital. The implementation of the Dodd-Frank Act will disqualify these trust preferred securities from being treated as Tier 1 capital over a three-year period beginning Jan. 1, 2013.

Our outstanding trust preferred securities include $500 million of Fixed-to-Floating Rate Normal Preferred Capital Securities (“PCS”) issued by Mellon Capital IV. As contractually obligated under the terms of the PCS, a remarketing occurred in May 2012. In this remarketing, junior subordinated notes issued by BNY Mellon and held by Mellon Capital IV were sold to third party investors and then exchanged for BNY Mellon’s senior notes, which were sold in a public offering. The proceeds of the sale of the senior notes were used to fund the purchase by Mellon Capital IV of $500 million of BNY Mellon’s Series A non-cumulative perpetual preferred stock, which was issued on June 20, 2012. As a result of the remarketing, the PCS are expected to pay distributions at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.565% for the related distribution period; and (ii) 4.000%. The non-cumulative perpetual preferred stock qualifies as Tier 1 capital under the recently released NPRs.

 

 

The following table presents the components of our Basel I Tier 1 and Total risk-based capital at June 30, 2012, March 31, 2012, Dec. 31, 2011 and June 30, 2011, respectively.

 

Components of Basel I Tier 1 and total risk-based capital (a)

(in millions)

  

June 30,

2012

   

March 31,

2012

   

Dec. 31,

2011

   

June 30,

2011

 

Tier 1 capital:

        

Common shareholders’ equity

   $ 34,033      $ 34,000      $ 33,417      $ 33,851   

Preferred stock

     500        -          -          -     

Trust preferred securities

     1,164        1,669        1,659        1,669   

Adjustments for:

        

Goodwill and other intangibles (b)

     (20,489     (20,674     (20,630     (21,180

Pensions/cash flow hedges

     1,372        1,397        1,426        1,018   

Securities valuation allowance

     (825     (663     (450     (433

Merchant banking investments

     (33     (34     (33     (33

Total Tier 1 capital

     15,722        15,695        15,389        14,892   

Tier 2 capital:

        

Qualifying unrealized gains on equity securities

     2        2        2        5   

Qualifying subordinated debt

     1,317        1,414        1,545        2,120   

Qualifying allowance for credit losses

     467        494        497        535   

Total Tier 2 capital

     1,786        1,910        2,044        2,660   

Total risk-based capital

   $ 17,508      $ 17,605      $ 17,433      $ 17,552   

Total risk-weighted assets

   $ 106,764      $ 100,763      $ 102,255      $ 105,316   

Average assets for leverage capital purposes

   $ 284,776      $ 281,281      $ 296,484      $ 257,714   
(a) On a regulatory basis as determined under Basel I guidelines.
(b) Reduced by deferred tax liabilities associated with non-tax deductible identifiable intangible assets of $1,400 million at June 30, 2012, $1,428 million at March 31, 2012, $1,459 million at Dec. 31, 2011 and $1,630 million at June 30, 2011, and deferred tax liabilities associated with tax deductible goodwill of $982 million at June 30, 2012, $972 million at March 31, 2012, $967 million at Dec. 31, 2011 and $895 million at June 30, 2011.

 

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The following table presents the calculation of our estimated Basel III Tier 1 common equity ratio, based on the NPRs and final market risk rule released on June 7, 2012, on a fully phased-in basis.

 

Estimated Basel III Tier 1 common equity ratio (a)

(dollars in millions)

  

June 30,

2012

   

March 31,

2012

   

Dec. 31,

2011

   

June 30,

2011

 

Total Tier 1 capital – Basel I

   $ 15,722      $ 15,695      $ 15,389      $ 14,892   

Less: Trust preferred securities

     1,164        1,669        1,659        1,669   

Preferred stock

     500        -          -          -     

Adjustments related to available-for-sale securities and pension liabilities included in accumulated other comprehensive income (b)

     513        700        944        551   

Adjustments related to equity method investments (b)

     558        571        555        578   

Deferred tax assets

     46        -          -          -     

Net pension fund assets (b)

     43        100        90        542   

Other

     2        (2     (3     (4

Total estimated Basel III Tier 1 common equity

   $ 12,896      $ 12,657      $ 12,144      $ 11,556   

Total risk-weighted assets – Basel I

   $ 106,790      $ 100,763      $ 102,255      $ 105,316   

Add: Adjustments (c)

     41,467        65,997        67,813        71,965   

Total estimated Basel III risk-weighted assets

   $ 148,257      $ 166,760      $ 170,068      $ 177,281   

Estimated Basel III Tier 1 common equity ratio – Non-GAAP

     8.7     7.6     7.1     6.5
(a) The estimated Basel III Tier 1 common equity ratio at June 30, 2012 is based on the NPRs and final market risk rule released on June 7, 2012. The estimated Basel III Tier 1 common equity ratios at March 31, 2012, Dec. 31, 2011 and June 30, 2011 were based on our interpretation of prior Basel III guidance and the proposed market risk rule.
(b) The NPRs and prior Basel III guidance do not add back to capital the adjustment to other comprehensive income that Basel I makes for pension liabilities and available-for-sale securities. Also, under the NPRs and prior Basel III guidance, pension assets recorded on the balance sheet and adjustments related to equity method investments are a deduction from capital.
(c) Primary differences between risk-weighted assets determined under Basel I compared with the NPRs and prior Basel III guidance include: the determination of credit risk under Basel I uses predetermined risk weights and asset classes, while the NPRs use an investment grade standard and internal risk models. Securitization exposure receives a higher risk-weighting under the NPRs and prior Basel III guidance than Basel I; also, the NPRs and prior Basel III guidance includes additional adjustments for operational risk, market risk, counterparty credit risk and equity exposures.

 

Trading activities and risk management

Our trading activities are focused on acting as a market maker for our customers and facilitating customer trades. Positions managed for our own account are immaterial to our foreign exchange and other trading revenue and to our overall results of operations. The risk from market-making activities for customers is managed by our traders and limited in total exposure through a system of position limits, a value-at-risk (“VaR”) methodology based on a Monte Carlo simulation, stop loss advisory triggers and other market sensitivity measures. See Note 16 of the Notes to Consolidated Financial Statements for additional information on the VaR methodology.

The following tables indicate the calculated VaR amounts for the trading portfolio for the periods indicated:

VaR (a)    2nd Quarter 2012      June 30,  
(in millions)    Average      Minimum      Maximum      2012  

Interest rate

   $ 8.9       $ 5.0       $ 13.2       $ 11.2   

Foreign exchange

     1.7         0.5         3.7         0.5   

Equity

     2.0         1.3         3.2         1.4   

Credit

     -         -         -         -   

Diversification

     (3.7)         N/M         N/M         (3.1)   

Overall portfolio

     8.9         5.0         13.6         10.0   
     
VaR (a)    1st Quarter 2012      March 31,  
(in millions)    Average      Minimum      Maximum      2012  

Interest rate

   $ 9.7       $ 6.0       $ 13.0       $ 8.2   

Foreign exchange

     3.3         1.8         4.8         3.1   

Equity

     2.3         1.4         3.4         2.1   

Credit

     -         -         -         -   

Diversification

     (4.4)         N/M         N/M         (4.4)   

Overall portfolio

     10.9         6.8         14.8         9.0   
     
VaR (a)    2nd Quarter 2011      June 30,  
(in millions)    Average      Minimum      Maximum      2011  

Interest rate

   $ 6.1       $ 3.5       $ 10.4       $ 6.7   

Foreign exchange

     2.9         0.8         5.2         3.2   

Equity

     2.7         2.1         3.3         2.8   

Credit

     0.2         0.1         0.2         0.2   

Diversification

     (4.6)         N/M         N/M         (4.8)   

Overall portfolio

     7.3         5.2         10.2         8.1   
 

 

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VaR (a)    Year-to-date 2012  
(in millions)    Average      Minimum      Maximum  

Interest rate

   $ 9.3       $ 5.0       $ 13.2   

Foreign exchange

     2.5         0.5         4.8   

Equity

     2.2         1.3         3.4   

Credit

     -         -         -   

Diversification

     (4.0)         N/M         N/M   

Overall portfolio

     10.0         5.0         14.8   
   
VaR (a)    Year-to-date 2011  
(in millions)    Average      Minimum      Maximum  

Interest rate

   $ 5.5       $ 3.0       $ 10.4   

Foreign exchange

     2.3         0.4         5.2   

Equity

     2.6         1.8         6.1   

Credit

     0.2         0.1         0.3   

Diversification

     (4.0)         N/M         N/M   

Overall portfolio

     6.6         4.1         10.2   
(a) VaR figures do not reflect the impact of CVA guidance in ASC 820. This is consistent with the Regulatory treatment. VaR exposure does not include the impact of the Company’s consolidated investment management funds and seed capital investments.
N/M - Because the minimum and maximum may occur on different days for different risk components, it is not meaningful to compute a portfolio diversification effect.

During the second quarter of 2012, interest rate risk generated 71% of average VaR, foreign exchange risk generated 13% of average VaR and equity risk generated 16% of average VaR. During the second quarter of 2012, our daily trading loss did not exceed our calculated VaR amount on any given day.

BNY Mellon monitors a volatility index of global currency using a basket of 30 major currencies. In the second quarter of 2012, the volatility of this index decreased approximately 3 basis points from the first quarter of 2012.

The following table of total daily trading revenue or loss illustrates the number of trading days in which our revenue or loss fell within particular ranges during the past year.

 

Distribution of trading revenues (losses) (a)  
      Quarter ended  
(dollar amounts
in millions)
  

June 30,

2011

    

Sept. 30,

2011

    

Dec. 31,

2011

    

March 31,

2012

    

June 30,

2012

 

Revenue range:

     Number of days   

Less than $(2.5)

     -           -           -           -           -     

$(2.5) - $0

     1         2         1         1         4   

$0 - $2.5

     20         21         19         25         25   

$2.5 - $5.0

     31         26         33         32         29   

More than $5.0

     12         15         8         4         6   

 

(a) Distribution of trading revenues (losses) does not reflect the impact of the CVA and corresponding hedge.

Foreign exchange and other trading

Under our mark-to-market methodology for derivative contracts, an initial “risk-neutral” valuation is performed on each position assuming time-discounting based on a AA credit curve. In addition, we consider credit risk in arriving at the fair value of our derivatives.

As required by ASC 820—Fair Value Measurements and Disclosures, we reflect external credit ratings as well as observable credit default swap spreads for both ourselves as well as our counterparties when measuring the fair value of our derivative positions. Accordingly, the valuation of our derivative positions is sensitive to the current changes in our own credit spreads, as well as those of our counterparties. In addition, in cases where a counterparty is deemed impaired, further analyses are performed to value such positions.

At June 30, 2012, our over-the-counter (“OTC”) derivative assets of $5.0 billion included a CVA deduction of $183 million, including $7 million related to the credit quality of certain CDO counterparties and Lehman. Our OTC derivative liabilities of $6.3 billion included a debit valuation adjustment (“DVA”) of $42 million related to our own credit spread. Net of hedges, the CVA decreased $2 million and the DVA decreased $1 million in the second quarter of 2012. The net impact of these adjustments increased foreign exchange and other trading revenue by $1 million in the second quarter of 2012.

In the first quarter of 2012, net of hedges, the CVA decreased $16 million and the DVA decreased $5 million in the first quarter of 2012. The net impact of these adjustments increased foreign exchange and other trading revenue by $11 million

In the second quarter of 2011, net of hedges, the CVA decreased $3 million and the DVA decreased $1 million. The net impact of these adjustments increased foreign exchange and other trading revenue by $2 million.

The table below summarizes the risk ratings for our foreign exchange and interest rate derivative counterparty credit exposure. This information indicates the degree of risk to which we are exposed and significant changes in ratings classifications for which our foreign exchange and other trading activity could result in increased risk for us. The internal risk ratings for our foreign exchange and

 

 

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interest rate derivative counterparty credit exposure were remapped to external ratings in the second quarter of 2012. All prior periods have been restated. The decrease in the counterparties rated AAA to AA- primarily reflects the June 2012 action by Moody’s to downgrade several large financial institutions.

 

Foreign exchange and other trading

counterparty risk rating profile (a)

 
     Quarter ended  
     

June 30,

2011

   

Sept. 30,

2011

   

Dec. 31,

2011

   

March 31,

2012

    June 30,
2012
 

Rating:

          

AAA to AA-

     51     48     47     45     40

A+ to A-

     23        27        27        29        31   

BBB+ to BBB-

     22        21        22        22        22   

Noninvestment grade

          

(BB+ and lower)

     4        4        4        4        7   

Total

     100     100     100     100     100
(a) Represents credit rating agency equivalent of internal credit ratings.

Asset/liability management

Our diversified business activities include processing securities, accepting deposits, investing in securities, lending, raising money as needed to fund assets and other transactions. The market risks from these activities are interest rate risk and foreign exchange risk. Our primary market risk is exposure to movements in U.S. dollar interest rates and certain foreign currency interest rates. We actively manage interest rate sensitivity and use earnings simulation and discounted cash flow models to identify interest rate exposures.

An earnings simulation model is the primary tool used to assess changes in pre-tax net interest revenue. The model incorporates management’s assumptions regarding interest rates, balance changes on core deposits, market spreads, changes in the prepayment behavior of loans and securities and the impact of derivative financial instruments used for interest rate risk management purposes. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior and are inherently uncertain. As a result, the earnings simulation model cannot precisely estimate net interest revenue or the impact of higher or lower interest rates on net interest revenue. Actual results may differ from projected results due to timing, magnitude and frequency of interest rate changes, and changes in market conditions and management’s strategies, among other factors.

These scenarios do not reflect strategies that management could employ to limit the impact as interest rate expectations change. The table below relies on certain critical assumptions regarding the balance sheet and depositors’ behavior related to interest rate fluctuations and the prepayment and extension risk in certain of our assets. To the extent that actual behavior is different from that assumed in the models, there could be a change in interest rate sensitivity.

We evaluate the effect on earnings by running various interest rate ramp scenarios from a baseline scenario. These scenarios are reviewed to examine the impact of large interest rate movements. Interest rate sensitivity is quantified by calculating the change in pre-tax net interest revenue between the scenarios over a 12-month measurement period.

The following table shows net interest revenue sensitivity for BNY Mellon:

 

Estimated changes in net interest revenue at June 30, 2012

(dollar amounts in millions)

 

up 200 bps parallel rate shift vs. baseline (a)

   $ 541   

up 100 bps parallel rate shift vs. baseline (a)

     400   

Long-term up 50 bps, short-term unchanged (b)

     134   

Long-term down 50 bps, short-term unchanged (b)

     (121
(a) In the parallel rate shift, both short-term and long-term rates move equally.
(b) Long-term is equal to or greater than one year.

bps—basis points.

The 100 basis point ramp scenario assumes rates increase 25 basis points in each of the next four quarters and the 200 basis point ramp scenario assumes a 50 basis point per quarter increase.

Our net interest revenue sensitivity table above incorporates assumptions about the impact of changes in interest rates on depositor behavior based on historical experience. Given the exceptionally low interest rate environment, a rise in interest rates could lead to higher depositor withdrawals than historically experienced.

Growth or contraction of deposits could also be affected by the following factors:

 

   

Global economic uncertainty, particularly in Europe;

   

Our ratings relative to other financial institutions’ ratings;

   

Money market mutual fund reform; and

 

 

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Extension of existing unlimited FDIC insurance on transaction accounts.

Any of these events could change our assumptions about depositor behavior and have a significant impact on our balance sheet and net interest revenue.

Off-balance sheet arrangements

Off-balance sheet arrangements discussed in this section are limited to guarantees, retained or contingent interests, support agreements, and obligations arising out of unconsolidated variable interest entities. For BNY Mellon, these items include certain credit guarantees and securitizations. Guarantees include: lending-related guarantees issued as part of our corporate banking business; securities lending indemnifications issued as part of our servicing and fiduciary businesses; and support agreements issued to customers in our Investment Services businesses. See Note 17 of the Notes to Consolidated Financial Statements for a further discussion of our off-balance sheet arrangements.

Supplemental information – Explanation of Non-GAAP financial measures

BNY Mellon has included in this Form 10-Q certain Non-GAAP financial measures based upon tangible common shareholders’ equity. BNY Mellon believes that the return on tangible common equity measure, which excludes goodwill and intangible assets net of deferred tax liabilities, is a useful additional measure for investors because it presents a measure of BNY Mellon’s performance in reference to those assets which are productive in generating income. The tangible common shareholders’ equity ratio is expressed as a percentage of the actual book value of assets, as opposed to a percentage of a risk-based reduced value established in accordance with regulatory requirements, although BNY Mellon in its calculation has excluded certain assets which are given a zero percent risk-weighting for regulatory purposes. BNY Mellon has provided a measure of tangible book value per share, which it believes provides additional useful information as to the level of such assets in relation to shares of common stock outstanding.

BNY Mellon has presented revenue measures which exclude the effect of noncontrolling interests related to consolidated investment management funds and other revenue related to the Shareowner Services business, which was sold on Dec. 31, 2011, and

expense measures which exclude M&I expenses, litigation charges, restructuring charges, amortization of intangible assets and direct expenses related to the Shareowner Services business. Return on equity measures and operating margin measures, which exclude some or all of these items, are also presented. BNY Mellon believes that these measures are useful to investors because they permit a focus on period-to-period comparisons which relate to the ability of BNY Mellon to enhance revenues and limit expenses in circumstances where such matters are within BNY Mellon’s control. The excluded items in general relate to certain ongoing charges as a result of prior transactions or where we have incurred charges. M&I expenses primarily relate to the acquisitions of Global Investment Servicing on July 1, 2010 and BHF Asset Servicing GmbH on Aug. 2, 2010. M&I expenses generally continue for approximately three years after the transaction and can vary on a year-to-year basis depending on the stage of the integration. BNY Mellon believes that the exclusion of M&I expenses provides investors with a focus on BNY Mellon’s business as it would appear on a consolidated going-forward basis, after such M&I expenses have ceased. Future periods will not reflect such M&I expenses, and thus may be more easily compared with our current results if M&I expenses are excluded. Litigation charges represent accruals for loss contingencies that are both probable and reasonably estimable, but exclude standard business-related legal fees. Restructuring charges relate to our operational excellence initiatives and migrating positions to global delivery centers. Excluding these charges permits investors to view expense on a basis consistent with how management views the business. BNY Mellon also presents revenue and noninterest expense results relating to the Shareowner Services business so that an investor may compare those results with other periods, which do not include the Shareowner Services business.

The presentation of income (loss) of consolidated investment management funds, net of net income (loss) attributable to noncontrolling interests related to the consolidation of certain investment management funds, permits investors the ability to view revenue on a basis consistent with prior periods. BNY Mellon believes that these presentations, as a supplement to GAAP information, give investors a clearer picture of the results of its primary businesses.

In this Form 10-Q, the net interest margin is presented on an FTE basis. We believe that this presentation provides comparability of amounts

 

 

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arising from both taxable and tax-exempt sources, and is consistent with industry practice. The adjustment to an FTE basis has no impact on net income.

Each of these measures as described above is used by management to monitor financial performance, both on a company-wide and business-level basis.

 

 

The following table presents a reconciliation of the tax rate from an effective rate to an operating rate for the second quarter of 2012.

 

Reconciliation of effective tax rate

     2Q12   

Effective tax rate – GAAP

     15.8

Tax reduction related to litigation charge

     8.7   

Other

     1.6   

Effective tax rate – Operating basis – Non-GAAP

     26.1

The following table presents investment management fees net of performance fees.

 

Investment management and performance fees                            2Q12 vs.  
(dollars in millions)    2Q12      1Q12      2Q11      2Q11     1Q12  

Investment management and performance fees

   $ 797       $ 745       $ 779         2     7

Less:     Performance fees

     54         16         18         N/M        N/M   

Investment management fees

   $ 743       $ 729       $ 761         (2 )%      2

The following table presents the calculation of the return on common equity and the return on tangible common equity.

 

Return on common equity and tangible common equity                                    

(dollars in millions)

     2Q12        1Q12        2Q11        YTD12        YTD11   

Net income applicable to common shareholders of The Bank of

New York Mellon Corporation – GAAP

   $ 466      $ 619      $ 735      $ 1,085      $ 1,360   

Add:     Amortization of intangible assets, net of tax

     61        61        68        122        136   

Net income applicable to common shareholders of The Bank of New York Mellon Corporation excluding amortization of intangible assets – Non-GAAP

     527        680        803        1,207        1,496   

Add:     M&I, litigation and restructuring charges

     225        65        41        290        75   

Net income applicable to common shareholders of The Bank of New York Mellon Corporation excluding amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP

   $ 752      $ 745      $ 844      $ 1,497      $ 1,571   

Average common shareholders’ equity

   $ 34,123      $ 33,718      $ 33,464      $ 33,920      $ 33,147   

Less:     Average goodwill

     17,941        17,962        18,193        17,951        18,157   

Average intangible assets

     5,024        5,121        5,547        5,073        5,605   

Add:     Deferred tax liability – tax deductible goodwill

     982        972        895        982        895   

Deferred tax liability – non-tax deductible intangible assets

     1,400        1,428        1,630        1,400        1,630   

Average tangible common shareholders’ equity – Non-GAAP

   $ 13,540      $ 13,035      $ 12,249      $ 13,278      $ 11,910   

Return on common equity – GAAP (a)

     5.5     7.4     8.8     6.4     8.3

Return on common equity excluding amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP (a)

     8.9     8.9     10.1     8.9     9.6

Return on tangible common equity – Non-GAAP (a)

     15.7     21.0     26.3     18.3     25.3

Return on tangible common equity excluding M&I, litigation and restructuring charges – Non-GAAP (a)

     22.4     23.0     27.6     22.7     26.6

(a)    Annualized.

          

 

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The following table presents the calculation of the pre-tax operating margin ratio.

 

Pre-tax operating margin                                    
(dollars in millions)    2Q12     1Q12     2Q11     YTD12     YTD11  

Income before income taxes – GAAP

   $ 589      $ 885      $ 1,034      $ 1,474      $ 1,983   

Less:     Net income (loss) attributable to noncontrolling interests of consolidated investment management funds

     29        11        21        40        65   

Add:     Amortization of intangible assets

     97        96        108        193        216   

             M&I, litigation and restructuring charges

     378        109        63        487        122   

Income before income taxes excluding net income (loss) attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP

   $ 1,035      $ 1,079      $ 1,184      $ 2,114      $ 2,256   

Fee and other revenue – GAAP

   $ 2,826      $ 2,838      $ 3,056      $ 5,664      $ 5,894   

Income from consolidated investment management funds – GAAP

     57        43        63        100        173   

Net interest revenue – GAAP

     734        765        731        1,499        1,429   

Total revenue – GAAP

     3,617        3,646        3,850        7,263        7,496   

Less:     Net income (loss) attributable to noncontrolling interests of consolidated investment management funds

     29        11        21        40        65   

Total revenue excluding net income (loss) attributable to noncontrolling interests of consolidated investment management funds – Non-GAAP

   $ 3,588      $ 3,635      $ 3,829      $ 7,223      $ 7,431   

Pre-tax operating margin (a)

     16     24     27     20     26

Pre-tax operating margin excluding net income (loss) attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP (a)

     29     30     31     29     30

(a)    Income before taxes divided by total revenue.

          

The following table presents the calculation of the equity to assets ratio and book value per common share.

 

Equity to assets and book value per common share

(dollars in millions, unless otherwise noted)

   June 30,
2012
    March 31,
2012
   

Dec. 31,

2011

   

June 30,

2011

 

BNY Mellon shareholders’ equity at period end – GAAP

   $ 34,533      $ 34,000      $ 33,417      $ 33,851   

Less:     Preferred stock

     500        -        -        -   

BNY Mellon common shareholders’ equity at period end – GAAP

     34,033        34,000        33,417        33,851   

Less:     Goodwill

     17,909        18,002        17,904        18,191   

             Intangible assets

     4,962        5,072        5,152        5,514   

Add:     Deferred tax liability – tax deductible goodwill

     982        972        967        895   

             Deferred tax liability – non-tax deductible intangible assets

     1,400        1,428        1,459        1,630   

Tangible BNY Mellon common shareholders’ equity at period end –

Non-GAAP

   $ 13,544      $ 13,326      $ 12,787      $ 12,671   

Total assets at period end – GAAP

   $ 330,283      $ 300,169      $ 325,266      $ 304,706   

Less: Assets of consolidated investment management funds

     10,955        11,609        11,347        13,533   

Subtotal assets of operations – Non-GAAP

     319,328        288,560        313,919        291,173   

Less:     Goodwill

     17,909        18,002        17,904        18,191   

             Intangible assets

     4,962        5,072        5,152        5,514   

             Cash on deposit with the Federal Reserve and other central banks (a)

     72,838        61,992        90,230        56,478   

Tangible total assets of operations at period end – Non-GAAP

   $ 223,619      $ 203,494      $ 200,633      $ 210,990   

BNY Mellon shareholders’ equity to total assets – GAAP

     10.5     11.3     10.3     11.1

BNY Mellon common shareholders’ equity to total assets – GAAP

     10.3     11.3     10.3     11.1

Tangible BNY Mellon common shareholders’ equity to tangible assets of operations – Non-GAAP

     6.1     6.5     6.4     6.0

Period-end common shares outstanding (in thousands)

     1,181,298        1,192,716        1,209,675        1,232,691   

Book value per common share

   $ 28.81      $ 28.51      $ 27.62      $ 27.46   

Tangible book value per common share – Non-GAAP

   $ 11.47      $ 11.17      $ 10.57      $ 10.28   
(a) Assigned a zero percent risk weighting by the regulators.

 

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The following table presents the calculation of Basel I Tier 1 common equity to risk-weighted assets ratio – Non-GAAP.

 

Calculation of Basel I Tier 1 common equity to

risk-weighted assets ratio – Non-GAAP

(dollars in millions)

   June 30,
2012
    March 31,
2012
    Dec. 31,
2011
    June 30,
2011
 

Total Tier 1 capital – Basel 1

   $ 15,722      $ 15,695      $ 15,389      $ 14,892   

Less:    Trust preferred securities

     1,164        1,669        1,659        1,669   

Preferred stock

     500        -        -        -   

Total Tier 1 common equity

   $ 14,058      $ 14,026      $ 13,730      $ 13,223   

Total risk-weighted assets – Basel I

   $ 106,764      $ 100,763      $ 102,255      $ 105,316   

Basel I Tier 1 common equity to risk-weighted assets ratio – Non-GAAP

     13.2     13.9     13.4     12.6

The following table presents income from consolidated investment management funds, net of net income (loss) attributable to noncontrolling interests.

 

Income from consolidated investment management funds, net of noncontrolling interests

(dollars in millions)

   2Q12      1Q12      2Q11      YTD12      YTD11  

Income (loss) from consolidated investment management funds

   $ 57       $ 43       $ 63       $ 100       $ 173   

Less:    Net income (loss) attributable to noncontrolling interests of consolidated investment management funds

     29         11         21         40         65   

Income from consolidated investment management funds, net of noncontrolling interests

   $ 28       $ 32       $ 42       $ 60       $ 108   

The following table presents the line items in the Investment Management business impacted by the consolidated investment management funds.

 

Income from consolidated investment management funds, net of noncontrolling interests

(dollars in millions)

   2Q12      1Q12      2Q11      YTD12      YTD11  

Investment management and performance fees

   $ 20       $ 22       $ 29       $ 42       $ 60   

Other (Investment income)

     8         10         13         18         48   

Income from consolidated investment management funds, net of noncontrolling interests

   $ 28       $ 32       $ 42       $ 60       $ 108   

The following table presents fee and other revenue excluding the impact of the Shareowner Services business.

 

Fee and other revenue excluding Shareowner Services                                                   

YTD12

vs.

YTD11

 
                          2Q12 vs.     Year-to-date     
(dollars in millions)    2Q12      1Q12      2Q11      2Q11     1Q12     2012      2011     

Investment services fees:

                     

Asset servicing

   $ 950       $ 943       $ 973         (2 )%      1   $ 1,893       $ 1,890        

Issuer services

     275         251         314         (12     10        526         606         (13

Clearing services

     309         303         292         6        2        612         584         5   

Treasury services

     134         136         134         -        (1     270         268         1   

Total investment services fees

     1,668         1,633         1,713         (3     2        3,301         3,348         (1

Investment management and performance fees

     797         745         779         2        7        1,542         1,543         -   

Foreign exchange and other trading revenue

     180         191         221         (19     (6     371         418         (11

Distribution and servicing

     46         46         49         (6     -        92         102         (10

Financing-related fees

     37         44         47         (21     (16     81         88         (8

Investment and other income

     51         139         145         (65     (63     190         226         (16

Total fee revenue

     2,779         2,798         2,954         (6     (1     5,577         5,725         (3

Net securities gains (losses)

     50         40         48         N/M        N/M        90         53         N/M   

Total fee and other revenue

   $ 2,829       $ 2,838       $ 3,002         (6 )%        $ 5,667       $ 5,778         (2 )% 

 

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Recent accounting and regulatory developments

Recently Issued Accounting Standards

ASU 2011-11 – Disclosures about Offsetting Assets and Liabilities

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities”. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. The amendments are effective for annual reporting periods beginning on or after Jan. 1, 2013. An entity would be required to provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU will not impact our results of operations.

ASU 2012-02 – Testing Indefinite-Lived Intangible Assets for Impairment

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment”. This guidance allows an entity an option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired. If the intangible asset is impaired, an entity is required to perform the quantitative impairment test. An entity is not required to calculate the fair value of an indefinite-lived intangible asset and perform the quantitative impairment test unless the entity determines that it is more likely than not that the asset is impaired. An entity choosing to perform the qualitative assessment would need to identify and consider the events and circumstances that, individually or in the aggregate, most significantly affect an indefinite-lived intangible asset’s fair value. Examples of events and circumstances that should be considered, include deterioration in the entity’s operating environment, entity-specific events, such as a change

in management, and overall financial performance, such as negative or declining cash flows. An entity also should consider any positive and mitigating events and circumstances, as well as whether there have been changes to the carrying amount of the indefinite-lived intangible asset. An entity can choose to perform the qualitative assessment on none, some, or all of its indefinite-lived intangible assets. An entity can bypass the qualitative assessment and perform the quantitative impairment test for any indefinite-lived intangible in any period. This ASU is effective for annual and interim impairment tests performed for fiscal years beginning after Sept. 15, 2012. Early adoption is permitted.

Proposed Accounting Standards

Proposed ASU – Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities

In May 2010, the FASB issued a proposed ASU, “Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.” Under this proposed ASU, most financial instruments would be measured at fair value in the balance sheet. In January 2011, the FASB preliminarily determined not to require certain financial assets to be measured at fair value on the balance sheet.

Measurement of a financial instrument would be determined based on its characteristics and an entity’s business strategy and would fall into one of the following three classifications:

 

   

Fair value – Net income – encompasses financial assets used in an entity’s trading or held-for-sale activities. Changes in fair value would be recognized in net income.

   

Fair value – Other comprehensive income – includes financial assets held primarily for investing activities, including those used to manage interest rate or liquidity risk. Changes in fair value would be recognized in other comprehensive income.

   

Amortized cost – includes financial assets related to the advancement of funds (through a lending or customer-financing activity) that are managed with the intent to collect those cash flows (including interest and fees).

 

 

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The FASB reached tentative decisions in other areas, including classification and measurement of financial liabilities and the equity method of accounting.

The FASB tentatively decided that the business strategy should be determined by the business activities that an entity uses in acquiring and managing financial assets. The FASB plans to re-expose the proposed amendments for public comment. Both the FASB and the International Accounting Standards Board (“IASB”) discussed effective dates pertaining to the financial instruments project and noted that such a date would not be for several years.

Supplementary Document – Impairment

On Jan. 31, 2011, the FASB issued a Supplementary Document, “Impairment.” The Supplementary Document proposes to replace the incurred loss impairment model under U.S. GAAP with an expected loss impairment model. The document focuses on when and how credit impairment should be recognized. The proposal is limited to open portfolios of assets, such as portfolios that are constantly changing through originations, purchases, transfers, write-offs, sales and repayments. The proposal in the Supplementary Document would apply to loans and debt instruments under U.S. GAAP that are managed on an “open” portfolio basis, provided they are not measured at fair value with changes in fair value recognized in net income. In the second quarter of 2011, the FASB and the IASB revised the model from a two-category approach for splitting the debt investment portfolio to a three category approach to better reflect the general pattern of credit quality deterioration. The FASB and the IASB continue to develop the revised impairment model. An exposure draft with the new proposed model is targeted for 2012.

Proposed ASU – Revenue from Contracts with Customers

In June 2010, the FASB issued a proposed ASU, “Revenue from Contracts with Customers.” This proposed ASU is the result of a joint project of the FASB and the IASB to clarify the principles for recognizing revenue and develop a common standard for U.S. GAAP and IFRS. This proposed ASU would establish a broad principle that would require an entity to identify the contract with a customer, identify the separate performance obligations in the contract, determine the

transaction price, allocate the transaction price to the separate performance obligations and recognize revenue when each separate performance obligation is satisfied. In 2011, the FASB and the IASB revised several aspects of the original proposal to include distinguishing between goods and services, segmenting contracts, accounting for warranty obligations and deferring contract origination costs.

In November 2011, the FASB re-exposed the proposed ASU. A final standard is expected to be issued in 2013. A retrospective application transition method would be required, but the FASB and IASB provided certain “transition reliefs” to reduce the burden on preparers. The FASB and IASB tentatively decided that the effective date of the proposed standard would not be earlier than annual reporting periods beginning on or after Jan. 1, 2015. The FASB decided to prohibit early application while the IASB decided to permit early application.

Proposed ASU – Principal versus Agent Analysis

In November 2011, the FASB issued a proposed ASU “Principal versus Agent Analysis”. This proposed ASU would rescind the 2010 indefinite deferral of FAS 167 for certain investment funds, including mutual funds, hedge funds, mortgage real estate investment funds, private equity funds, and venture capital funds, and amends the pre-existing guidance for evaluating consolidation of voting general partnerships and similar entities. The proposed ASU also amends the criteria for determining whether an entity is a variable interest entity under FAS 167, which could affect whether an entity is within its scope. Accordingly, certain funds that previously were not consolidated must be reviewed to determine whether they will now be required to be consolidated. The proposed accounting standard will continue to require BNY Mellon to determine whether or not it has a variable interest in a variable interest entity. However, consolidation of its variable interest entity and voting general partnership asset management funds will be based on whether or not BNY Mellon, as the asset manager, uses its power as a decision maker as either a principal or an agent. Based on a preliminary review of the proposed ASU, we do not expect to be required to consolidate additional mutual funds, hedge funds, mortgage real estate investment funds, private equity funds, and venture capital funds. In addition, we expect to de-consolidate a substantial portion of the CLOs we currently consolidate, with further deconsolidation

 

 

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possible depending on future changes to BNY Mellon’s investment in subordinated notes. The FASB is currently evaluating comment letters received and expects to issue a final ASU in the fourth quarter of 2012.

FASB and IASB project on Leases

In August 2010, the FASB and IASB issued a joint proposed ASU, “Leases”. FASB has tentatively decided that lessees would apply a “right-of-use” accounting model. This would require the lessee to recognize both a right-of-use asset and a corresponding liability to make lease payments at the lease commencement date, both measured at the present value of the lease payments. The right-of-use asset would be amortized on a systematic basis that would reflect the pattern of consumption of the economic benefits of the leased asset. The liability to make lease payments would be subsequently de-recognized over time by applying the effective interest method to apportion the periodic payment to reductions in the liability to make lease payments and interest expense. Lessors would account for leases by applying a “receivable and residual” accounting approach. The lessor would recognize a right to receive lease payments and a residual asset at the date of the commencement of the lease. The lessor would initially measure the right to receive lease payments at the sum of the present value of the lease payments, discounted using the rate the lessor charges the lessee. The lessor would initially measure the residual asset as an allocation of the carrying amount of the underlying asset and would subsequently measure the residual asset by accreting it over the lease term, using the rate the lessor charges the lessee. The FASB is expected to re-expose the standard during 2012. A final standard is expected in 2013 with an effective date of 2016 or later.

Proposed ASU — Disclosures about Liquidity Risk and Interest Rate Risk

In June 2012, the FASB issued a proposed ASU, “Disclosures about Liquidity Risk and Interest Rate Risk.” This proposed ASU requires new qualitative and quantitative disclosures about liquidity and interest rate risk. The proposed disclosures are required for both interim and annual periods. Financial institutions would be required to provide a tabular liquidity gap maturity analysis that discloses carrying amounts of various classes of financial assets and liabilities categorized by their expected maturities. In addition, all companies would need to

disclose in a tabular form by asset class, their available liquid funds and additional borrowing capacity. This disclosure would also be supplemented with a qualitative analysis. For interest rate risk, financial institutions would be required to disclose repricing gap analysis in a tabular form that would show how the carrying amounts of different classes of financial assets and liabilities reprice over specified time periods. In addition, financial institutions would also provide certain interest rate sensitivity disclosures about the effects on its net income. The proposed ASU does not include an effective date.

Adoption of new accounting standards

For a discussion of the adoption of new accounting standards, see Note 2 of the Notes to Consolidated Financial Statements.

Regulatory developments

The following discussion should be read in conjunction with the “Business – Supervision and Regulation” and “Regulatory developments” sections in our 2011 Annual Report. We are currently assessing the following regulatory developments, which may have an impact on BNY Mellon’s business.

Federal Reserve’s Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies

As required by the Dodd-Frank Act, the Federal Reserve has proposed enhanced prudential standards applicable to bank holding companies (“BHCs”) with total consolidated assets of $50 billion or more – like BNY Mellon (often referred to as “systemically important financial institutions” or “SIFIs”). The Dodd-Frank Act mandates that the requirements applicable to SIFIs be more stringent than those applicable to other financial companies. In December 2011, the Federal Reserve issued a Notice of Proposed Rulemaking establishing enhanced prudential standards for:

 

   

risk-based capital requirements and leverage limits;

   

stress testing of capital;

   

liquidity requirements;

   

overall risk management requirements; and

   

concentration/credit exposure limits.

 

 

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These “Proposed SIFI Rules” address a wide, diverse array of regulatory areas, each of which is highly complex. In some cases they would implement financial regulatory requirements being proposed for the first time, and in others overlap with related regulatory reforms. The Proposed SIFI Rules also address the Dodd-Frank Act’s early remediation requirements for BHCs with total consolidated assets of $50 billion or more. The proposed remediation rules are designed to require action beginning in the earlier stages of a company’s financial distress based on certain triggers, including capital and leverage, stress test results, liquidity and risk management. The full impact of the Proposed SIFI Rules will not be known until the rules, and other regulatory initiatives that overlap with the rules, are finalized.

Resolution Planning

As required by the Dodd-Frank Act, the Federal Reserve and FDIC jointly issued a final rule requiring certain organizations, including each BHC with consolidated assets of $50 billion or more, to report periodically to regulators a resolution plan for its rapid and orderly resolution in the event of material financial distress or failure. In addition, the FDIC has issued a final rule that requires insured depository institutions with $50 billion or more in total assets, such as The Bank of New York Mellon, to submit to the FDIC periodic plans for resolution in the event of the institution’s failure.

The two resolution plan rules are complementary and we are currently developing our initial resolution plans. Our initial plans are required to be submitted to the regulators by Oct. 1, 2012. Following the initial submissions, we are required to submit annual resolution plans by July 1 of each subsequent year.

Federal Reserve’s Comprehensive Capital Analysis and Review

In November 2011, the Federal Reserve published a final rule requiring BHCs (including BNY Mellon) with $50 billion or more of total consolidated assets to submit annual capital plans to their respective Federal Reserve Bank. The capital analysis and review process provided for in the rule is known as the Comprehensive Capital Analysis and Review, or “CCAR”.

The capital plans are required to be submitted on an annual basis. Covered BHCs are required to collect and report certain related data on a quarterly basis to allow the Federal Reserve to monitor the companies’ progress against their annual capital plans. The comprehensive capital plans, which are prepared using Basel I capital guidelines, include a view of capital adequacy under four scenarios – a BHC-defined baseline scenario, a baseline scenario provided by the Federal Reserve, at least one BHC-defined stress scenario, and a stress scenario provided by the Federal Reserve. Covered BHCs, including BNY Mellon, may pay dividends and repurchase stock only in accordance with a capital plan that has been reviewed by the Federal Reserve and as to which the Federal Reserve has not objected. The rules provide that the Federal Reserve may object to a capital plan if the plan does not show that the covered BHC will meet all minimum regulatory capital ratios and maintain a ratio of Basel I Tier 1 common equity to risk-weighted assets of at least 5% on a pro forma basis under expected and stressful conditions throughout the nine-quarter planning horizon covered by the capital plan. The rules also require, among other things, that a covered BHC may not make a capital distribution unless, after giving effect to the distribution, it will meet all minimum regulatory capital ratios and have a ratio of Basel I Tier 1 common equity to risk-weighted assets of at least 5%. As part of this process, BNY Mellon also provides the Federal Reserve with projections covering the time period it will take us to fully comply with Basel III guidelines, including the 7% Tier 1 common equity, 8.5% Tier 1 capital and 3% leverage ratios as well as granular components of those elements, as described further under “Basel III and U.S. Capital Reform”. Our capital plan was submitted on Jan. 9, 2012. On March 13, 2012, BNY Mellon received notice that the Federal Reserve did not object to our capital plan for 2012, which includes the repurchase of up to $1.16 billion of outstanding common stock and the continuation of our 13 cents per share quarterly cash dividend.

The purpose of the Federal Reserve’s capital plan review is to ensure that these BHCs have robust, forward-looking capital planning processes that account for each BHC’s unique risks and that permit continued operations during times of economic and financial stress. The Federal Reserve will apply particularly close scrutiny to capital plans contemplating dividend payout ratios exceeding 30% of projected after-tax net income.

 

 

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Volcker Rule

The section in the Dodd-Frank Act that is commonly referenced as the “Volcker Rule” requires the U.S. financial regulatory agencies to adopt implementing rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain hedge funds, private equity funds and other designated funds (“covered funds”). The Federal regulators proposed rules to implement the Volcker Rule, and until those rules are finalized, their application and impact will remain uncertain. BNY Mellon may be affected by an overly inclusive designation of covered funds, proposed limits on inter-affiliate transactions that may constrain some of our custody services and the treatment of overseas directed trustee arrangements. The Federal Reserve recently issued guidance that gives banks and their affiliates until July 21, 2014 to bring their covered activities and investments into conformance with the regulations of the Volcker Rule, which have yet to be finalized and adopted.

Proposed rules removing references to credit ratings

The Dodd-Frank Act requires that all Federal agencies remove from their regulations references to and requirements of reliance on credit ratings and replace them with appropriate alternatives for evaluating creditworthiness. The Federal banking agencies have recently issued Notices of Proposed Rulemaking (and applicable related guidance) in connection with implementing these requirements. In December 2011, the Office of the Comptroller of the Currency (“OCC”), Federal Reserve, and FDIC issued a joint Notice of Proposed Rulemaking applicable to certain U.S. banking organizations with significant trading operations that proposed standards of creditworthiness to be used in place of credit ratings when calculating the specific risk capital requirements for covered debt and securitization positions. The agencies finalized rules relating to capital requirements and investment securities in June 2012.

Task Force on Tri-Party Repo Infrastructure

Regulatory agencies worldwide have begun to re-examine systemic risks to various financial markets. One of the markets that regulatory agencies are reviewing, and in which we participate as a clearing and custody bank, is the tri-party repurchase transaction market, or “tri-party repo market.” The Federal Reserve Bank of New York sponsored a Task Force on Tri-Party Repo Infrastructure Reform

to examine the risks in the tri-party repo market and to decide what changes should be implemented so that such risks may be mitigated or avoided in future financial crises. The Task Force issued its final report regarding the tri-party repo market on Feb. 15, 2012. BNY Mellon is working to implement the Task Force’s recommendations on its tri-party repo business activities, including the practical elimination of secured intra-day credit. BNY Mellon has taken several steps in that regard, such as the reduction of the length of time for a majority of the intra-day credit exposure, the implementation of auto substitution of collateral and the introduction of three-way trade confirmations.

Since May 2010, the Federal Reserve Bank of New York has released monthly reports on the tri-party repo market, including information on aggregate volumes of collateral used in all tri-party repo transactions by asset class, concentrations, and margin levels, which is available at http://www.newyorkfed.org/tripartyrepo/margin_data.html.

Basel III and U.S. Capital Reform

The U.S. federal bank regulatory agencies’ current general risk-based capital guidelines are based upon the 1988 Capital Accord (“Basel I”) of the Basel Committee on Banking Supervision (the “Basel Committee”). The Basel Committee issued in June 2004, and updated in November 2005, a revised framework for capital adequacy commonly known as “Basel II” that sets capital requirements for operational risk and refines the existing capital requirements for credit risk. The U.S. banking agencies have adopted Basel II’s advanced internal ratings based approach for credit risk and its advanced measurement approach for operational risk for advanced approaches banks (applicable to banking institutions like BNY Mellon and its depository institution subsidiaries with $250 billion or more of total consolidated assets or $10 billion or more of foreign exposures). The U.S. banking agencies’ Basel I risk-based capital guidelines, their Basel II advanced approaches and the Basel Committee’s Basel III standards are described under “Business – Supervision and Regulation” in Part I, Item 1 of our 2011 Annual Report.

In response to Section 171 of the Dodd-Frank Act, known as the “Collins Amendment”, the U.S. banking agencies adopted a final rule in 2011 to replace the transitional floors in the Federal banking agencies’ Basel II approaches with a permanent capital floor equal to the risk-based capital

 

 

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requirements under the banking agencies’ Basel I risk-based capital guidelines. As a result, U.S. advanced approaches banking organizations will be required to calculate their risk-based capital ratios under both the agencies general risk-based capital rules and their Basel II-based advanced approaches. The advanced approaches banking organizations will continue to use the current Basel I rules for purposes of the Collins Amendment floor until Jan. 1, 2015 which is the effective date of the standardized approach, discussed below, unless they elect to early adopt.

In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III”. The NPRs, released by the U.S. banking agencies in June 2012, would both implement the capital provisions of Basel III for U.S. banking institutions and substantially revise the agencies’ Basel I risk-based capital guidelines – as proposed, referred to in the NPRs as the “standardized approach”—to make them more risk sensitive. Although the NPRs have not yet been published in the Federal Register, the agencies indicated preliminarily that comments on the NPRs would be due on Sept. 7, 2012. As proposed by the NPRs, the implementation of Basel III advanced approach will become effective Jan. 1, 2013, with phase-in periods that are consistent with Basel III and described under “Business – Supervision and Regulation” in our 2011 Annual Report. If adopted, these rules will be fully phased-in by Jan. 1, 2019. The new risk-weight categories in the standardized approach will not become effective until Jan. 1, 2015. The general impact of the NPRs is described below.

Basel III, including as proposed by the NPRs to be implemented in the U.S., would redefine the components of capital in the numerators of regulatory capital ratios in a more narrow way than existing Basel I and Basel II standards, would increase the minimum risk-based capital ratios under both the agencies’ Basel II advanced approaches and Basel I risk-based capital guidelines, and primarily, with respect to securitizations and exposures to certain counterparties, would change the measure of risk-weighted assets in the denominators of regulatory capital ratios. At June 30, 2012, our estimated Basel III Tier 1 common equity ratio was 8.7%, on a fully phased-in basis, based upon our understanding of the NPRs and the final market risk rules approved by the U.S. banking agencies. The increase in the ratio from 7.6% at March 31, 2012, which was calculated under

prior Basel III guidance and the proposed market risk rule, was primarily due to the reduction in risk-weighted assets relating to the treatment of sub-investment grade securities, partially offset by the treatment of investment grade securitizations and financial institution exposure. The positive impact of the NPRs was partially offset by balance sheet growth in the second quarter of 2012.

The components of the NPRs related to the standardized approach would amend the agencies’ Basel I risk-based capital guidelines and replace the risk-weighting categories currently used to calculate risk-weighted assets in the denominator of capital ratios with a broader array of risk weighting categories that are intended to be more risk sensitive. The new risk-weights for the standardized approach range from 0% to 600% as compared to the risk-weights of 0% to 100% in the agencies’ existing Basel I risk-based capital guidelines. Higher risk-weights would apply to a variety of exposures, including certain securitization exposures, equity exposures, claims on securities firms and exposures to counterparties on OTC derivatives. Compared with Basel I, the risk-weighting changes likely to be most significant for BNY Mellon are the replacement of the 20% risk-weight for banks with OECD country risk classification ratings, increased risk-weights for residential mortgages, the removal of the 50% risk-weight cap on derivative transactions and the elimination of the 0% risk-weight for commitments of less than one year.

The NPRs, consistent with Basel III, re-defined the components of capital and require higher capital ratios for all banks. As a result, when fully phased-in on Jan. 1, 2019, banking institutions will be required to satisfy three risk-based capital ratios:

 

   

A Tier 1 common equity ratio of at least 7.0%, 4.5% attributable to a minimum Tier 1 common equity ratio and 2.5% attributable to a “capital conservation buffer”;

   

A Tier 1 capital ratio of at least 6.0%, exclusive of the capital conservation buffer (8.5% upon full implementation of the capital conservation buffer); and

   

A total capital ratio of at least 8.0%, exclusive of the capital conservation buffer (10.5% upon full implementation of the capital conservation buffer).

Additionally, the ratios above could be impacted by a new Tier 1 common equity surcharge to certain

 

 

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“domestic” systemically important banks (“D-SIBs”) and “global” systemically important banks (“G-SIBs”) described below.

All banking institutions will continue to be subject to the U.S. banking agencies’ existing minimum leverage ratio of 4.0% (calculated as the ratio of Tier 1 capital to average consolidated assets as reflected on the institution’s consolidated financial statements, net of amounts deducted from capital). Additionally, advanced approaches banking institutions would become subject to a new leverage ratio commencing Jan. 1, 2015 with full implementation on Jan. 1, 2018. The new leverage ratio would have a minimum of 3% (calculated as the ratio of Tier 1 capital to average balance sheet exposures plus certain average off-balance sheet exposures).

The NPRs apply Basel III’s capital conservation buffer to all banking institutions but apply its countercyclical capital buffer only to advance approaches banks. These buffers are described under “Business – Supervision and Regulation” in our 2011 Annual Report.

In November 2011 the Basel Committee issued final provisions applying a new Tier 1 common equity surcharge to certain G-SIBs, including BNY Mellon. In its Proposed SIFI Rules and the NPRs, the Federal Reserve indicated that it intends to propose, in a separate rulemaking, a Tier 1 common equity surcharge for G-SIBs based on the Basel Committee’s final rules. Each G-SIB would initially be assigned to one of four “buckets”, with the capital surcharges for those buckets ranging from 1% to 2.5%. There would be an additional 3.5% bucket that could be applied to a G-SIB that materially increases its global systemic importance, for example, by increasing total assets. The G-SIB equity surcharge provisions, like the rest of Basel III and the Dodd-Frank Act provisions referenced above, are subject to interpretation and implementation by U.S. regulatory authorities.

In June 2012, the Basel Committee published a consultative document proposing principles to be applied by national regulators to apply a new Tier 1 common equity surcharge to certain D-SIBs. Comments were due by Aug. 1, 2012. The consultative document is much less detailed than the G-SIB proposal and does not, for example, specify the amount or potential range of a surcharge. It provides that if a banking institution in a particular country is identified as both a G-SIB

and a D-SIB, then the surcharge will be the higher of the applicable G-SIB or D-SIB surcharge. Because of the generality of the proposal, BNY Mellon is not able to evaluate its potential impact on BNY Mellon at this point.

Our fee-based model enables us to maintain a relatively low risk asset mix, primarily composed of high-quality securities, central bank deposits, liquid placements and predominantly investment grade loans. As a result of our asset mix, we have the flexibility to manage to a lower level of risk-weighted assets over time.

Capital disclosure requirements

In December 2011, the Basel Committee issued a consultative document on the Definition of capital disclosure requirements, which proposes disclosure requirements that aim to improve the transparency and comparability of a bank’s capital base. The consultative document includes the following:

 

   

A common template for banks to use in reporting the breakdown of their regulatory capital when the transition period for the phasing-in of deductions ends on Jan. 1, 2018;

   

A 3-step approach for banks to follow to ensure that there is full reconciliation of all regulatory capital elements back to the published financial statements;

   

A common template for banks to use to meet the Basel III requirement to provide a description of the main features of capital instruments;

   

Proposals on how banks should meet the Basel III requirement to provide the full terms and conditions of capital instruments on their websites and the requirement to report the calculation of any ratios involving components of regulatory capital; and

   

A template for banks to use during the transition period.

The Basel Committee proposes that banks comply with the disclosure requirements set out in the consultative document from the date of publication of their first set of financial statements relating to a balance sheet date on or after Jan. 1, 2013 (with the exception of the post-Jan. 1, 2018 template). Furthermore, it is proposed that banks publish this disclosure with the same frequency as the publication of their financial statements.

 

 

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IFRS

International Financial Reporting Standards (“IFRS”) are a set of standards and interpretations adopted by the International Accounting Standards Board. The SEC is currently considering a potential IFRS adoption process in the United States, which would, in the near term, provide domestic issuers with an alternative accounting method and ultimately could replace U.S. GAAP reporting requirements with IFRS reporting requirements. The intention of this adoption would be to provide the capital markets community with a single set of high-quality, globally accepted accounting standards. The adoption of IFRS for U.S. companies with global operations would allow for streamlined reporting, allow for easier access to foreign capital markets and investments, and facilitate cross-border acquisitions, ventures or spin-offs.

In November 2008, the SEC proposed a “roadmap” for phasing in mandatory IFRS filings by U.S. public companies. The roadmap is conditional on progress towards milestones that would demonstrate improvements in both the infrastructure of international standard setting and the preparation of the U.S. financial reporting community.

In February 2010, the SEC issued a statement confirming their position that they continue to believe that a single set of high-quality, globally accepted accounting standards would benefit U.S. investors. The SEC continues to support the dual goals of improving financial reporting in the United States and reducing country-by-country disparities in financial reporting. The SEC is developing a work plan to aid in its evaluation of the impact of IFRS on the U.S. securities market.

In May 2011, the SEC published a staff paper, “Exploring a Possible Method of Incorporation,” that presents a possible framework for incorporating IFRS into the U.S. financial reporting system. In the staff paper, the SEC staff elaborates on an approach that combines elements of convergence and endorsement. This approach would establish an endorsement protocol for the FASB to incorporate newly issued or amended IFRS into U.S. GAAP. During a transition period (e.g., five to seven years), differences between IFRS and U.S. GAAP would be potentially eliminated through ongoing FASB standard setting.

In July 2012, the SEC staff released its final report on IFRS. This Final Report will be used by the SEC Commissioners to decide whether and, if so, when and how to incorporate IFRS into the financial reporting system for U.S. companies. The staff has not specifically requested comments on the Final Report. It is expected that the SEC will not make a final decision on IFRS adoption in 2012.

While the SEC decides whether IFRS will be required to be used in the preparation of our consolidated financial statements, a number of countries have mandated the use of IFRS by BNY Mellon’s subsidiaries in their statutory reports. Such countries include Belgium, Brazil, the Netherlands, Australia, Hong Kong, Canada and South Korea.

Proposed Update to Internal Controls – Integrated Framework

In December 2011, The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued for public comment a proposed update to Internal Control—Integrated Framework. The original Framework, issued in 1992, is used by most U.S. public companies and many others to evaluate and report on the effectiveness of their internal control over external financial reporting.

Since the original Framework was introduced, business has become increasingly global and complex. Regulatory regimes also have expanded, and additional forms of external reporting are emerging. The COSO Board has updated the original Framework to make it more relevant to investors and other stakeholders.

The more significant proposed changes to the original Framework include: applying a principles-based approach, clarifying the role of objective-setting in internal control, reflecting the increased relevance of technology, enhancing governance concepts, expanding the objectives of financial reporting, enhancing consideration of anti-fraud expectations, and considering different business models and organizational structures.

The final document is expected to be issued in the first quarter of 2013.

 

 

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Government monetary policies and competition

Government monetary policies

The Federal Reserve Board has the primary responsibility for U.S. monetary policy. Its actions have an important influence on the demand for credit and investments and the level of interest rates, and thus on the earnings of BNY Mellon.

Competition

BNY Mellon is subject to intense competition in all aspects and areas of our business. Our Investment Management business competes with asset management firms, hedge funds, investment banking companies, and other financial services companies, including trust banks, brokerage firms, and insurance companies. These firms and companies may be domiciled domestically or internationally. Our Investment Services business competes with domestic and foreign banks that offer institutional trust, custody and cash management products, as well as a wide range of technologically capable service providers, such as data processing and other firms that rely on automated data transfer services for institutional and retail customers. Competition is based on a number of factors including, among others, customer service, quality and range of products and services offered, price, reputation, interest rates, lending limits and customer convenience.

Many of our competitors, with the particular exception of bank and financial holding companies, banks and trust companies, are not subject to regulation as extensive as BNY Mellon, and, as a result, may have a competitive advantage over us and our subsidiaries in certain respects.

In recent years there has been substantial consolidation among companies in the financial services industry. Many broad-based financial services firms now have the ability to offer a wide range of products, from loans, deposit-taking and insurance to brokerage and asset management, which may enhance their competitive position.

As part of our business strategy, we seek to distinguish ourselves from competitors by the level of service we deliver to our clients. We also believe that technological innovation is an important competitive factor, and, for this reason, have made and continue to make substantial investments in this area. The ability to recover quickly from unexpected events is a competitive factor, and we have devoted significant resources to being able to implement this. See Item 1, “Business – Competition” and Item 1A “Risk Factors – Competition – We are subject to intense competition in all aspects of our business, which could negatively affect our ability to maintain or increase our profitability” in our 2011 Annual Report.

Website information

Our website is www.bnymellon.com. We currently make available the following information on our website as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.

 

   

All of our SEC filings, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports, SEC Forms 3, 4 and 5 and any proxy statement mailed in connection with the solicitation of proxies;

   

Financial statements and footnotes prepared using Extensible Business Reporting Language (“XBRL”);

   

Our earnings releases and selected management conference calls and presentations; and

   

Our Corporate Governance Guidelines, Directors Code of Conduct and the charters of the Audit, Corporate Governance and Nominating, Human Resources and Compensation, Risk, Technology and Corporate Social Responsibility Committees of our Board of Directors.

The contents of the website listed above or any other websites referenced herein are not incorporated into this Quarterly Report on Form 10-Q.

The SEC reports, the Corporate Governance Guidelines, Directors Code of Conduct and committee charters are available in print to any shareholder who requests them. Requests should be sent by email to corpsecretary@bnymellon.com or by mail to the Secretary of The Bank of New York Mellon Corporation, One Wall Street, New York, NY 10286.

 

 

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Item 1. Financial Statements

The Bank of New York Mellon Corporation (and its subsidiaries)

 

Consolidated Income Statement (unaudited)                                    
     

Quarter ended

    Year-to-date  
(in millions)    June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Fee and other revenue

          

Investment services fees:

          

Asset servicing

   $ 950      $ 943      $ 973      $ 1,893      $ 1,890   

Issuer services

     275        251        365        526        716   

Clearing services

     309        303        292        612        584   

Treasury services

     134        136        134        270        268   

Total investment services fees

     1,668        1,633        1,764        3,301        3,458   

Investment management and performance fees

     797        745        779        1,542        1,543   

Foreign exchange and other trading revenue

     180        191        222        371        420   

Distribution and servicing

     46        46        49        92        102   

Financing-related fees

     37        44        49        81        92   

Investment and other income

     48        139        145        187        226   

Total fee revenue

     2,776        2,798        3,008        5,574        5,841   

Net securities gains (losses) – including other-than-temporary impairment

     70        73        54        142        32   

Noncredit-related gains (losses) on securities not expected to be sold (recognized in OCI)

     20        33        6        52        (21

Net securities gains (losses)

     50        40        48        90        53   

Total fee and other revenue

     2,826        2,838        3,056        5,664        5,894   

Operations of consolidated investment management funds

          

Investment income

     152        153        171        305        393   

Interest of investment management fund note holders

     95        110        108        205        220   

Income (loss) from consolidated investment management funds

     57        43        63        100        173   

Net interest revenue

          

Interest revenue

     875        912        887        1,787        1,735   

Interest expense

     141        147        156        288        306   

Net interest revenue

     734        765        731        1,499        1,429   

Provision for credit losses

     (19     5        -        (14     -   

Net interest revenue after provision for credit losses

     753        760        731        1,513        1,429   

Noninterest expense

          

Staff

     1,415        1,453        1,463        2,868        2,887   

Professional, legal and other purchased services

     309        299        301        608        584   

Net occupancy

     141        147        161        288        314   

Software

     127        119        121        246        243   

Distribution and servicing

     103        101        109        204        220   

Furniture and equipment

     82        86        82        168        166   

Sub-custodian

     70        70        88        140        156   

Business development

     71        56        73        127        129   

Other

     254        220        247        474        476   

Amortization of intangible assets

     97        96        108        193        216   

Merger and integration, litigation and restructuring charges

     378        109        63        487        122   

Total noninterest expense

     3,047        2,756        2,816        5,803        5,513   

Income

          

Income before income taxes

     589        885        1,034        1,474        1,983   

Provision for income taxes

     93        254        277        347        556   

Net income

     496        631        757        1,127        1,427   

Net (income) loss attributable to noncontrolling interests (includes $(29), $(11), $(21), $(40) and $(65) related to consolidated investment management funds, respectively)

     (30     (12     (22     (42     (67

Net income applicable to common shareholders of The Bank of New York Mellon Corporation

   $ 466      $ 619      $ 735      $ 1,085      $ 1,360   

 

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Table of Contents

The Bank of New York Mellon Corporation (and its subsidiaries)

 

Consolidated Income Statement (unaudited) – continued

Reconciliation of net income to the net income applicable to the

  common shareholders of The Bank of New York Mellon Corporation

(in millions)

   Quarter ended     Year-to-date  
   June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Net income

   $ 496      $ 631      $ 757      $ 1,127      $ 1,427   

Net (income) loss attributable to noncontrolling interests

     (30     (12     (22     (42     (67

Net income applicable to the common shareholders of The Bank of New York Mellon Corporation

     466        619        735        1,085        1,360   

Less: Earnings allocated to participating securities

     7        8        8        15        14   

Change in the excess of redeemable value over the fair value of noncontrolling interests

     1        (6     -        (5     6   

Net income applicable to the common shareholders of The Bank of New York Mellon Corporation after required adjustments for the calculation of basic and diluted earnings per share

   $ 458      $ 617      $ 727      $ 1,075      $ 1,340   
                                          

Average common shares and equivalents outstanding

  of The Bank of New York Mellon Corporation

(in thousands)

   Quarter ended     Year-to-date  
   June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Basic

     1,181,350        1,193,931        1,230,406        1,187,649        1,232,232   

Common stock equivalents

     9,414        8,688        9,318        9,263        10,138   

Less: Participating securities

     (7,779     (7,061     (6,014     (7,648     (6,354

Diluted

     1,182,985        1,195,558        1,233,710        1,189,264        1,236,016   

Anti-dilutive securities (a)

     94,650        94,498        88,938        93,315        86,988   
                                          

Earnings per share applicable to the common shareholders

  of The Bank of New York Mellon Corporation (b)

(in dollars)

   Quarter ended     Year-to-date  
   June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Basic

   $ 0.39      $ 0.52      $ 0.59      $ 0.91      $ 1.09   

Diluted

   $ 0.39      $ 0.52      $ 0.59      $ 0.90      $ 1.08   

 

(a) Represents stock options, restricted stock, restricted stock units and participating securities outstanding but not included in the computation of diluted average common shares because their effect would be anti-dilutive.
(b) Basic and diluted earnings per share under the two-class method are determined on the net income reported on the income statement less earnings allocated to participating securities, and the change in the excess of redeemable value over the fair value of noncontrolling interests.

See accompanying Notes to Consolidated Financial Statements.

 

64    BNY Mellon


Table of Contents

The Bank of New York Mellon Corporation (and its subsidiaries)

 

Consolidated Comprehensive Income Statement (unaudited)                                         
     Quarter ended     Year-to-date  
(in millions)    June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Net income

   $ 496      $ 631      $ 757      $ 1,127      $ 1,427   

Other comprehensive income (loss), net of tax:

          

Foreign currency translation adjustments arising during the period

     (265     172        121        (93     359   

Unrealized gain (loss) on assets available-for-sale:

          

Unrealized gain (loss) arising during the period

     197        237        159        434        294   

Reclassification adjustment

     (35     (24     (28     (59     (30

Total unrealized gain (loss) on assets available-for-sale

     162        213        131        375        264   

Defined benefit plans:

          

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     24        27        17        51        34   

Total defined benefit plans

     24        27        17        51        34   

Net unrealized gain (loss) on cash flow hedges:

          

Unrealized hedge gain (loss) arising during the period

     6        -        (1     6        (1

Reclassification adjustment

     (6     3        1        (3     1   

Total unrealized gain (loss) on cash flow hedges

     -        3        -        3        -   

Total other comprehensive income (loss), net of tax (a)

     (79     415        269        336        657   

Net (income) loss attributable to noncontrolling interests

     (30     (12     (22     (42     (67

Other comprehensive (income) loss attributable to noncontrolling interests

     28        (17     (17     11        (53

Net comprehensive income (loss) applicable to the common shareholders of The Bank of New York Mellon Corporation

   $ 415      $ 1,017      $ 987      $ 1,432      $ 1,964   
(a) Other comprehensive income (loss) attributable to The Bank of New York Mellon Corporation shareholders was $(51) million for the quarter ended June 30, 2012, $398 million for the quarter ended March 31, 2012, $252 million for the quarter ended June 30, 2011, $347 million for the six months ended June 30, 2012 and $604 million for the six months ended June 30, 2011.

 

BNY Mellon    65


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Consolidated Balance Sheet (unaudited)

(dollar amounts in millions, except per share amounts)    June 30,
2012
    Dec. 31,
2011
 

Assets

    

Cash and due from:

    

Banks

   $ 4,522      $ 4,175   

Interest-bearing deposits with the Federal Reserve and other central banks

     76,243        90,243   

Interest-bearing deposits with banks

     39,743        36,321   

Federal funds sold and securities purchased under resale agreements

     8,543        4,510   

Securities:

    

Held-to-maturity (fair value of $8,869 and $3,540)

     8,794        3,521   

Available-for-sale

     84,540        78,467   

Total securities

     93,334        81,988   

Trading assets

     6,909        7,861   

Loans

     45,431        43,979   

Allowance for loan losses

     (362     (394

Net loans

     45,069        43,585   

Premises and equipment

     1,711        1,681   

Accrued interest receivable

     628        660   

Goodwill

     17,909        17,904   

Intangible assets

     4,962        5,152   

Other assets (includes $1,410 and $1,848, at fair value)

     19,755        19,839   

Subtotal assets of operations

     319,328        313,919   

Assets of consolidated investment management funds, at fair value:

    

Trading assets

     10,399        10,751   

Other assets

     556        596   

Subtotal assets of consolidated investment management funds, at fair value

     10,955        11,347   

Total assets

   $ 330,283      $ 325,266   

Liabilities

    

Deposits:

    

Noninterest-bearing (principally U.S. offices)

   $ 76,933      $ 95,335   

Interest-bearing deposits in U.S. offices

     49,956        41,231   

Interest-bearing deposits in Non-U.S. offices

     94,255        82,528   

Total deposits

     221,144        219,094   

Federal funds purchased and securities sold under repurchase agreements

     9,162        6,267   

Trading liabilities

     6,940        8,071   

Payables to customers and broker-dealers

     13,305        12,671   

Commercial paper

     1,564        10   

Other borrowed funds

     1,374        2,174   

Accrued taxes and other expenses

     5,969        6,235   

Other liabilities (includes allowance for lending related commitments of $105 and $103, also includes $455 and $382, at fair value)

     6,114        6,525   

Long-term debt (includes $339 and $326, at fair value)

     19,536        19,933   

Subtotal liabilities of operations

     285,108        280,980   

Liabilities of consolidated investment management funds, at fair value:

    

Trading liabilities

     9,752        10,053   

Other liabilities

     38        32   

Subtotal liabilities of consolidated investment management funds, at fair value

     9,790        10,085   

Total liabilities

     294,898        291,065   

Temporary equity

    

Redeemable noncontrolling interest

     130        114   

Permanent equity

    

Preferred stock – par value $0.01 per share; authorized 100,000,000 preferred shares; issued 5,001 and - shares

     500        —     

Common stock – par value $0.01 per share; authorized 3,500,000,000 common shares; issued 1,251,527,230 and 1,249,061,305 shares

     12        12   

Additional paid-in capital

     23,366        23,185   

Retained earnings

     13,588        12,812   

Accumulated other comprehensive loss, net of tax

     (1,280     (1,627

Less: Treasury stock of 70,229,278 and 39,386,698 common shares, at cost

     (1,653     (965

Total The Bank of New York Mellon Corporation shareholders’ equity

     34,533        33,417   

Non-redeemable noncontrolling interests of consolidated investment management funds

     722        670   

Total permanent equity

     35,255        34,087   

Total liabilities, temporary equity and permanent equity

   $ 330,283      $ 325,266   

See accompanying Notes to Consolidated Financial Statements.

 

66    BNY Mellon


Table of Contents

The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Statement of Cash Flows (unaudited)

      Six  months
ended June 30,
 
(in millions)    2012     2011  

Operating activities

    

Net income

   $ 1,127      $ 1,427   

Net (income) attributable to noncontrolling interests

     (42     (67

Net income applicable to common shareholders of The Bank of New York Mellon Corporation

     1,085        1,360   

Adjustments to reconcile net income to net cash provided by (used for) operating activities:

    

Provision for credit losses

     (14     -   

Depreciation and amortization

     598        366   

Deferred tax (benefit) expense

     (285     251   

Net securities (gains) and venture capital (income)

     (95     (74

Change in trading activities

     (179     36   

Change in accruals and other, net

     (736     (942

Net cash provided by operating activities

     374        997   

Investing activities

    

Change in interest-bearing deposits with banks

     (3,502     (8,684

Change in interest-bearing deposits with Federal Reserve and other central banks

     14,000        (37,729

Change in loans

     (1,424     (4,702

Purchases of securities held-to-maturity

     (3,123     (833

Paydowns of securities held-to-maturity

     189        99   

Maturities of securities held-to-maturity

     403        505   

Purchases of securities available-for-sale

     (24,126     (12,885

Sales of securities available-for-sale

     5,577        5,315   

Paydowns of securities available-for-sale

     4,784        4,451   

Maturities of securities available-for-sale

     5,447        2,774   

Sales of loans and other real estate

     160        362   

Change in federal funds sold and securities purchased under resale agreements

     (4,034     120   

Change in seed capital investments

     (2     228   

Purchases of premises and equipment/capitalized software

     (276     (367

Acquisitions, net cash

     (4     (20

Proceeds from the sale of premises and equipment

     5        5   

Other, net

     133        (663

Net cash (used for) investing activities

     (5,793     (52,024

Financing activities

    

Change in deposits

     2,373        50,576   

Change in federal funds purchased and securities sold under repurchase agreements

     2,895        1,970   

Change in payables to customers and broker-dealers

     634        1,550   

Change in other borrowed funds

     (773     (1,084

Change in commercial paper

     1,554        26   

Net proceeds from the issuance of long-term debt

     1,264        1,199   

Repayments of long-term debt

     (1,714     (748

Proceeds from the exercise of stock options

     6        16   

Issuance of common stock

     13        12   

Issuance of preferred stock

     500        -   

Treasury stock acquired

     (687     (333

Common cash dividends paid

     (314     (274

Other, net

     30        (10

Net cash provided by financing activities

     5,781        52,900   

Effect of exchange rate changes on cash

     (15     12   

Change in cash and due from banks

    

Change in cash and due from banks

     347        1,885   

Cash and due from banks at beginning of period

     4,175        3,675   

Cash and due from banks at end of period

   $ 4,522      $ 5,560   

Supplemental disclosures

    

Interest paid

   $ 292      $ 347   

Income taxes paid

     460        249   

Income taxes refunded

     7        168   

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Statement of Changes in Equity (unaudited)

      The Bank of New York Mellon Corporation shareholders                       
(in millions, except per share amounts)    Preferred
stock
     Common
stock
     Additional
paid-in
capital
    Retained
earnings
   

Accumulated

other

comprehensive

income (loss),

net of tax

    Treasury
stock
   

Non-redeemable

noncontrolling

interests of

consolidated

investment

management

funds

   

Total

permanent

equity

   

Redeemable

non-

controlling

interests/

temporary

equity

 

Balance at Dec. 31, 2011

   $ -       $ 12       $ 23,185      $ 12,812      $ (1,627   $ (965   $ 670      $ 34,087  (a)    $ 114   

Shares issued to shareholders of noncontrolling interests

     -         -         -        -        -        -        -        -        24   

Redemption of subsidiary shares from noncontrolling interests

     -         -         -        -        -        -        -        -        (4

Other net changes in noncontrolling interests

     -         -         (5     5        -        -        23        23        (6

Net income

     -         -         -        1,085        -        -        40        1,125        2   

Other comprehensive income

     -         -         -        -        347        -        (11     336        -   

Dividends on common stock at $0.26 per share

     -         -         -        (314     -        -        -        (314     -   

Repurchase of common stock

     -         -         -        -        -        (687     -        (687     -   

Common stock issued under:

                    

Employee benefit plans

     -         -         15        -        -        -        -        15        -   

Direct stock purchase and dividend reinvestment plan

     -         -         10        -        -        -        -        10        -   

Preferred stock issued

     500         -         -        -        -        -        -        500        -   

Stock awards and options exercised

     -         -         161        -        -        (1     -        160        -   

Balance at June 30, 2012

   $ 500       $ 12       $ 23,366      $ 13,588      $ (1,280   $ (1,653   $ 722      $ 35,255  (a)    $ 130   
(a) Includes total The Bank of New York Mellon Corporation common shareholders’ equity of $33,417 million at Dec. 31, 2011 and $34,533 million at June 30, 2012.

See accompanying Notes to Consolidated Financial Statements.

 

68    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Note 1 – Basis of presentation

Basis of presentation

The accounting and financial reporting policies of BNY Mellon, a global financial services company, conform to U.S. generally accepted accounting principles (“GAAP”) and prevailing industry practices.

The accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of financial position, results of operations and cash flows for the periods have been made. These financial statements should be read in conjunction with BNY Mellon’s Annual Report on Form 10-K for the year ended Dec. 31, 2011. Certain immaterial reclassifications have been made to prior periods to place them on a basis comparable with current period presentation.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates based upon assumptions about future economic and market conditions which affect reported amounts and related disclosures in our financial statements. Although our current estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual conditions could be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Amounts subject to estimates are items such as the allowance for loan losses and lending-related commitments, goodwill and intangible assets, pension accounting, the fair value of financial instruments and other-than-temporary impairments. Among other effects, such changes in estimates could result in future impairments of investment securities, goodwill and intangible assets and establishment of allowances for loan losses and lending-related commitments as well as increased pension and post-retirement expense.

Note 2 – Accounting changes and new accounting guidance

ASU 2011-04 – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU intends to improve consistency in the application of fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The ASU clarifies the application of existing fair value measurement and disclosure requirements including 1) the application of concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of non-financial assets and are not relevant when measuring the fair value of financial assets or any liabilities, 2) measuring the fair value of an instrument classified in shareholders’ equity from the perspective of a market participant that holds that instrument as an asset, and 3) disclosures about quantitative information regarding the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. This ASU also requires the disclosure of the level of the fair value hierarchy for financial instruments not reported at fair value on the balance sheet. This ASU did not impact our results of operations. See Note 14 “Fair value measurement” for the disclosures.

ASU 2011-05 – Presentation of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” This ASU increased the prominence of other comprehensive income in the financial statements. The guidance eliminated the option to present comprehensive income and its components in the Statement of Changes in Shareholders’ Equity, and requires the disclosure of comprehensive income and its components in one of two ways: a single continuous statement or in two separate but consecutive statements. The single continuous statement presents other comprehensive income and its components on the income statement. Under the two-statement approach, the first statement would include components of net income and the second statement would include other comprehensive

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

income and its components. The ASU did not change the components of other comprehensive income. This ASU did not impact our results of operations. BNY Mellon adopted the two-statement approach. See the Consolidated Comprehensive Income Statement and Note 13 “Other comprehensive income” for the disclosures.

ASU 2011- 08 - Testing Goodwill for Impairment

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment”, which amended the guidance in ASC 350 for goodwill impairment. This ASU permits entities performing goodwill impairment tests the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., Step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The ASU did not change how goodwill was calculated or assigned to reporting units, or the annual goodwill impairment testing requirement. In addition, the ASU does not amend the requirement to perform interim goodwill impairment tests if events or circumstances warrant; however, it does revise the examples of events and circumstances that an entity should consider. The amendments were effective for annual and interim goodwill impairment tests performed for fiscal years beginning after Dec. 15, 2011.

Note 3 – Acquisitions and dispositions

We sometimes structure our acquisitions with both an initial payment and later contingent payments tied to post-closing revenue or income growth. For acquisitions completed prior to Jan. 1, 2009, we record the fair value of contingent payments as an additional cost of the entity acquired in the period that the payment becomes probable. For acquisitions completed after Jan. 1, 2009, subsequent changes in the fair value of a contingent consideration liability will be recorded through the income statement. Contingent payments totaled $1 million in the second quarter of 2012 and $4 million in the first six months of 2012.

At June 30, 2012, we were potentially obligated to pay additional consideration which, using reasonable assumptions for the performance of the acquired companies and joint ventures based on contractual agreements, could range from $3 million to $35 million over the next two years.

Acquisitions in 2011

On July 1, 2011, BNY Mellon acquired the wealth management operations of Chicago-based Talon Asset Management (“Talon”) for cash of $11 million. We are obligated to pay, upon occurrence of certain events, contingent additional consideration of $5 million, which was recorded as goodwill at the acquisition date. Talon manages assets of wealthy families and institutions. Goodwill related to this acquisition, including contingent additional consideration, is included in our Investment Management business and totaled $10 million and is deductible for tax purposes. Customer relationship intangible assets related to this acquisition are included in our Investment Management business, with a life of 20 years, and totaled $6 million.

On Nov. 30, 2011, BNY Mellon acquired Penson Financial Services Australia Pty Ltd, a clearing firm located in Australia, in a $33 million share purchase transaction. Goodwill related to this acquisition is included in our Investment Services business and totaled $10 million and is non-tax deductible. Customer relationship intangible assets related to this acquisition are included in our Investment Services business, with a life of nine years, and totaled $6 million.

Dispositions in 2011

On Dec. 31, 2011, BNY Mellon sold its Shareowner Services business. The sales price of $550 million resulted in a pre-tax gain of $98 million. We recorded an immaterial after-tax gain primarily due to the write-off of non-tax deductible goodwill associated with the business.

 

 

70    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Note 4 – Securities

The following tables present the amortized cost, the gross unrealized gains and losses and the fair value of securities at June 30, 2012 and Dec. 31, 2011.

 

Securities at June 30, 2012     

Gross

             
     Amortized      unrealized      Fair      
(in millions)    cost      Gains      Losses      value      

Available-for-sale:

             

U.S. Treasury

   $ 13,915       $ 555       $ -       $ 14,470     

U.S. Government agencies

     1,066         31         -         1,097     

State and political subdivisions

     5,561         78         37         5,602     

Agency RMBS

     32,262         774         4         33,032     

Alt-A RMBS

     267         16         25         258     

Prime RMBS

     816         2         54         764     

Subprime RMBS

     555         3         136         422     

Other RMBS

     2,654         9         176         2,487     

Commercial MBS

     3,269         123         72         3,320     

Asset-backed CLOs

     1,103         2         25         1,080     

Other asset-backed securities

     1,182         10         3         1,189     

Foreign covered bonds

     3,870         60         2         3,928     

Corporate bonds

     1,571         59         2         1,628     

Other debt securities

     10,980         301         1         11,280  (a)   

Equity securities

     24         4         -         28     

Money market funds

     918         -         -         918     

Alt-A RMBS (b)

     1,677         213         27         1,863     

Prime RMBS (b)

     956         111         8         1,059     

Subprime RMBS (b)

     112         6         3         115     

Total securities

available-for-sale

     82,758         2,357         575         84,540     

Held-to-maturity:

             

U.S. Treasury

     862         60         -         922     

State and political subdivisions

     79         3         -         82     

Agency RMBS

     6,336         79         6         6,409     

Alt-A RMBS

     126         6         12         120     

Prime RMBS

     108         1         6         103     

Subprime RMBS

     28         -         3         25     

Other RMBS

     1,226         39         83         1,182     

Commercial MBS

     26         -         3         23     

Other securities

     3         -         -         3     

Total securities held-to-maturity

     8,794         188         113         8,869     

Total securities

   $ 91,552       $ 2,545       $ 688       $ 93,409     
(a) Includes $9.0 billion, at fair value, of government-sponsored and guaranteed entities, and sovereign debt.
(b) Previously included in the Grantor Trust. The Grantor Trust was dissolved in the first quarter of 2011.

 

Securities at Dec. 31, 2011    Amortized      Gross
unrealized
     Fair  
(in millions)    cost      Gains      Losses      value  

Available-for-sale:

           

U.S. Treasury

   $ 16,814       $ 514       $ 2       $ 17,326   

U.S. Government agencies

     932         26         -         958   

State and political subdivisions

     2,724         62         47         2,739   

Agency RMBS

     26,232         575         11         26,796   

Alt-A RMBS

     306         9         42         273   

Prime RMBS

     916         1         102         815   

Subprime RMBS

     606         2         190         418   

Other RMBS

     1,133         -         230         903   

Commercial MBS

     3,327         89         77         3,339   

Asset-backed CLOs

     1,480         1         37         1,444   

Other asset-backed securities

     527         8         3         532   

Foreign covered bonds

     2,410         18         3         2,425   

Corporate bonds

     1,696         47         5         1,738   

Other debt securities

     14,320         292         33         14,579  (a) 

Equity securities

     26         4         -         30   

Money market funds

     973         -         -         973   

Alt-A RMBS (b)

     1,790         157         68         1,879   

Prime RMBS (b)

     1,090         106         21         1,175   

Subprime RMBS (b)

     122         6         3         125   

Total securities available-for-sale

     77,424         1,917         874         78,467   

Held-to-maturity:

           

U.S. Treasury

     813         53         -         866   

State and political subdivisions

     100         3         -         103   

Agency RMBS

     658         39         -         697   

Alt-A RMBS

     153         4         19         138   

Prime RMBS

     121         -         10         111   

Subprime RMBS

     28         -         3         25   

Other RMBS

     1,617         47         93         1,571   

Commercial MBS

     28         -         2         26   

Other securities

     3         -         -         3   

Total securities held-to-maturity

     3,521         146         127         3,540   

Total securities

   $ 80,945       $ 2,063       $ 1,001       $ 82,007   
(a) Includes $13.1 billion, at fair value, of government-sponsored and guaranteed entities, and sovereign debt.
(b) Previously included in the Grantor Trust. The Grantor Trust was dissolved in the first quarter of 2011.

 

 

Net securities gains (losses)

(in millions)    2Q12     1Q12     2Q11     YTD12     YTD11  

Realized gross gains

   $ 122      $ 62      $ 67      $ 184      $ 86   

Realized gross losses

     (5     -        (11     (5     (20

Recognized gross impairments

     (67     (22     (8     (89     (13

Total net securities gains (losses)

   $ 50      $ 40      $ 48      $ 90      $ 53   

Temporarily impaired securities

At June 30, 2012, substantially all of the unrealized losses on the investment securities portfolio were attributable to credit spreads widening since purchase, and interest rate movements. We do not intend to sell these securities and it is not more likely than not that we will have to sell.

 

 

BNY Mellon    71


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

The following tables show the aggregate related fair value of investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or more.

 

Temporarily impaired securities at June 30, 2012    Less than 12 months      12 months or more      Total  
   Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
(in millions)    value      losses      value      losses      value      losses  

Available-for-sale:

                 

State and political subdivisions

   $ 1,659       $ 7       $ 165       $ 30       $ 1,824       $ 37   

Agency RMBS

     2,657         3         118         1         2,775         4   

Alt-A RMBS

     92         7         48         18         140         25   

Prime RMBS

     99         7         489         47         588         54   

Subprime RMBS

     26         11         375         125         401         136   

Other RMBS

     663         5         697         171         1,360         176   

Commercial MBS

     180         1         433         71         613         72   

Asset-backed CLOs

     783         13         111         12         894         25   

Other asset-backed securities

     435         1         8         2         443         3   

Foreign covered bonds

     429         2         13         -         442         2   

Corporate bonds

     36         2         -         -         36         2   

Other debt securities

     1,044         1         17         -         1,061         1   

Alt-A RMBS (a)

     282         15         95         12         377         27   

Prime RMBS (a)

     159         7         23         1         182         8   

Subprime RMBS (a)

     31         3         -         -         31         3   

Total securities available-for-sale

   $ 8,575       $ 85       $ 2,592       $ 490       $ 11,167       $ 575   

Held-to-maturity:

                 

Agency RMBS

   $ 1,652       $ 6       $ -       $ -       $ 1,652       $ 6   

Alt-A RMBS

     25         2         39         10         64         12   

Prime RMBS

     -         -         55         6         55         6   

Subprime RMBS

     -         -         25         3         25         3   

Other RMBS

     60         2         468         81         528         83   

Commercial MBS

     -         -         23         3         23         3   

Total securities held-to-maturity

   $ 1,737       $ 10       $ 610       $ 103       $ 2,347       $ 113   

Total temporarily impaired securities

   $ 10,312       $ 95       $ 3,202       $ 593       $ 13,514       $ 688   
(a) Previously included in the Grantor Trust. The Grantor Trust was dissolved in the first quarter of 2011.

 

Temporarily impaired securities at Dec. 31, 2011    Less than 12 months      12 months or more      Total  
   Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
(in millions)    value      losses      value      losses      value      losses  

Available-for-sale:

                 

U.S. Treasury

   $ 118       $ 2       $ -       $ -       $ 118       $ 2   

State and political subdivisions

     483         2         157         45         640         47   

Agency RMBS

     3,844         10         140         1         3,984         11   

Alt-A RMBS

     132         16         69         26         201         42   

Prime RMBS

     324         25         447         77         771         102   

Subprime RMBS

     -         -         400         190         400         190   

Other RMBS

     5         4         895         226         900         230   

Commercial MBS

     340         2         495         75         835         77   

Asset-backed CLOs

     1,143         26         211         11         1,354         37   

Other asset-backed securities

     60         1         18         2         78         3   

Foreign covered bonds

     368         1         406         2         774         3   

Corporate bonds

     254         5         -         -         254         5   

Other debt securities

     2,613         7         54         26         2,667         33   

Alt-A RMBS (a)

     595         53         29         15         624         68   

Prime RMBS (a)

     437         21         -         -         437         21   

Subprime RMBS (a)

     50         3         -         -         50         3   

Total securities available-for-sale

   $ 10,766       $ 178       $ 3,321       $ 696       $ 14,087       $ 874   

Held-to-maturity:

                 

Alt-A RMBS

   $ 69       $ 3       $ 42       $ 16       $ 111       $ 19   

Prime RMBS

     -         -         56         10         56         10   

Subprime RMBS

     -         -         25         3         25         3   

Other RMBS

     107         2         573         91         680         93   

Commercial MBS

     -         -         26         2         26         2   

Total securities held-to-maturity

   $ 176       $ 5       $ 722       $ 122       $ 898       $ 127   

Total temporarily impaired securities

   $ 10,942       $ 183       $ 4,043       $ 818       $ 14,985       $ 1,001   
(a) Previously included in the Grantor Trust. The Grantor Trust was dissolved in the first quarter of 2011.

 

72    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

The following table shows the maturity distribution by carrying amount and yield (on a tax equivalent basis) of our investment securities portfolio at June 30, 2012.

Investment securities portfolio    U.S. Treasury     U.S.
Government
agency
    State and political
subdivisions
    Other bonds, notes
and debentures
    Mortgage/
asset-backed and
equity securities
        
(dollars in millions)    Amount      Yield (a)     Amount      Yield(a)     Amount      Yield (a)     Amount      Yield (a)     Amount      Yield (a)     Total  

Securities available-for-sale:

                           
One year or less    $ 174         0.65   $ -         -   $ 110         1.53   $ 3,268         1.09   $ -         -   $ 3,552   
Over 1 through 5 years      9,180         0.95        1,011         1.62        2,397         1.58        10,984         1.45        -         -        23,572   
Over 5 through 10 years      1,868         2.91        86         2.06        2,548         3.10        2,406         2.83        -         -        6,908   
Over 10 years      3,248         3.13        -         -        547         4.15        178         2.48        -         -        3,973   
Mortgage-backed securities      -         -        -         -        -         -        -         -        43,320         2.92        43,320   
Asset-backed securities      -         -        -         -        -         -        -         -        2,269         1.72        2,269   
Equity securities (b)      -         -        -         -        -         -        -         -        946         -        946   

Total

   $ 14,470         1.69   $ 1,097         1.65   $ 5,602         2.52   $ 16,836         1.59   $ 46,535         2.80   $ 84,540   
Securities held-to-maturity:                            
One year or less    $ -         -   $ -         -   $ 1         6.87   $ 3         0.07   $ -         -   $ 4   
Over 1 through 5 years      559         1.82        -         -        -         -        -         -        -         -        559   
Over 5 through 10 years      363         2.66        -         -        31         6.59        -         -        -         -        394   
Over 10 years      -         -        -         -        50         6.55        -         -        -         -        50   
Mortgage-backed securities      -         -        -         -        -         -        -         -        7,862         2.99        7,862   

Total

   $ 922         2.15   $ -         -   $ 82         6.57   $ 3         0.07   $ 7,862         2.99   $ 8,869   
(a) Yields are based upon the amortized cost of securities.
(b) Includes money market funds.

 

Other-than-temporary impairment

We routinely conduct periodic reviews of all securities using economic models to identify and evaluate each investment security to determine whether OTTI has occurred. Various inputs to the economic models are used to determine if an unrealized loss on securities is other-than-temporary. For example, the most significant inputs related to non-agency RMBS are:

 

 

Default rate – the number of mortgage loans expected to go into default over the life of the transaction, which is driven by the roll rate of loans in each performance bucket that will ultimately migrate to default; and

 

Severity – the loss expected to be realized when a loan defaults.

To determine if an unrealized loss is other-than-temporary, we project total estimated defaults of the underlying assets (mortgages) and multiply that calculated amount by an estimate of realizable value upon sale of these assets in the marketplace (severity) in order to determine the projected collateral loss. We also evaluate the current credit enhancement underlying the bond to determine the impact on cash flows. If we determine that a given security will be subject to a write-down or loss, we record the expected credit loss as a charge to earnings.

In addition, we have estimated the expected loss by taking into account observed performance of the underlying securities, industry studies, market forecasts, as well as our view of the economic outlook affecting collateral.

The table below shows the projected weighted-average default rates and loss severities for the 2007, 2006 and late 2005 non-agency RMBS at June 30, 2012 and Dec. 31, 2011.

 

Projected weighted-average default rates and severities  
     June 30, 2012     Dec. 31, 2011  
     Default Rate     Severity     Default Rate     Severity  

Alt-A

     43     57     44     57

Subprime

     62     72     63     73

Prime

     24     43     25     43
 

 

BNY Mellon    73


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

The following table provides pre-tax net securities gains (losses) by type.

 

Net securities gains                         Year-to-date  
(in millions)    2Q12     1Q12     2Q11     2012     2011  

U.S. Treasury

   $ 44      $ 38      $ 41      $ 82      $ 41   

Sovereign debt

     61        7        -        68        -   

FDIC-insured debt

     -        10        -        10        -   

Corporate bonds

     7        2        -        9        -   

Prime RMBS

     (1     (1     -        (2     9   

Alt-A RMBS

     (3     (10     (1     (13     4   

Trust preferred

     (18     -        -        (18     -   

European floating rate notes

     (22     (1     (12     (23     (15

Subprime RMBS

     (23     (3     (6     (26     (12

Agency RMBS

     -        -        8        -        8   

Other

     5        (2     18        3        18   

Net securities gains (losses)

   $ 50      $ 40      $ 48      $ 90      $ 53   

The following table reflects investment securities credit losses recorded in earnings. The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods. The additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred. The deductions represent credit losses on securities that have been sold, are required to be sold or it is our intention to sell.

 

Debt securities credit loss roll forward

(in millions)

   2Q12      2Q11  
                   

Beginning balance as of March 31

   $ 266       $ 183   

Add:

  Initial OTTI credit losses      38         7   
 

Subsequent OTTI credit losses

     29         1   

Less:

  Realized losses for securities sold / consolidated      -         4   
Ending balance as of June 30    $ 333       $ 187   

 

Debt securities credit loss roll forward

(in millions)

   Year-to-date  
           2012      2011  

Beginning balance as of Jan. 1

   $ 253       $ 182   

Add:

  Initial OTTI credit losses      49         9   
 

Subsequent OTTI credit losses

     39         4   

Less:

  Realized losses for securities sold / consolidated      8         8   
Ending balance as of June 30    $ 333       $ 187   

Note 5 – Loans and asset quality

Loans

The table below provides the details of our loan distribution and industry concentrations of credit risk at June 30, 2012 and Dec. 31, 2011.

 

Loans

(in millions)

  

June 30,

2012

    

Dec. 31,

2011

 

Domestic:

     

Financial institutions

   $ 4,835       $ 4,606   

Commercial

     814         752   

Wealth management loans and mortgages

     7,916         7,342   

Commercial real estate

     1,595         1,449   

Lease financings (a)

     1,505         1,558   

Other residential mortgages

     1,773         1,923   

Overdrafts

     2,750         2,958   

Other

     599         623   

Margin loans

     13,462         12,760   

Total domestic

     35,249         33,971   

Foreign:

     

Financial institutions

     5,681         6,538   

Commercial

     573         528   

Lease financings (a)

     1,023         1,051   

Other (primarily overdrafts)

     2,905         1,891   

Total foreign

     10,182         10,008   

Total loans

   $ 45,431       $ 43,979   
(a) Net of unearned income on domestic and foreign lease financings of $1,225 million at June 30, 2012 and $1,343 million at Dec. 31, 2011.

Our loan portfolio is comprised of three portfolio segments: commercial, lease financings and mortgages. We manage our portfolio at the class level which is comprised of six classes of financing receivables: commercial, commercial real estate, financial institutions, lease financings, wealth management loans and mortgages, and other residential mortgages. The following tables are presented for each class of financing receivable, and provide additional information about our credit risks and the adequacy of our allowance for credit losses.

 

 

74    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Allowance for credit losses

Transactions in the allowance for credit losses are summarized as follows:

 

Allowance for credit losses activity for the quarter ended June 30, 2012            Wealth                               
(in millions)    Commercial      Commercial
real estate
     Financial
institutions
    Lease
financing
    management
loans and
mortgages
    Other
residential
mortgages
   

All

Other (a)

    Foreign      Total  

Beginning balance

   $ 97       $ 33       $ 53      $ 62      $ 34      $ 165      $ -      $ 50       $ 494   

Charge-offs

     -         -         (4     -        -        (7     -        -         (11

Recoveries

     1         -         -        -        -        2        -        -         3   

Net (charge-offs) recoveries

     1         -         (4     -        -        (5     -        -         (8

Provision

     5         -         (10     (6     (8     (7     -        7         (19

Ending balance

   $ 103       $ 33       $ 39      $ 56      $ 26      $ 153      $ -      $ 57       $ 467   

Allowance for:

                     

Loans losses

   $ 42       $ 23       $ 18      $ 56      $ 21      $ 153      $ -      $ 49       $ 362   

Unfunded commitments

     61         10         21        -        5        -        -        8         105   

Individually evaluated for impairment:

                     

Loan balance

   $ 62       $ 29       $ 3      $ -      $ 31      $ -      $ -      $ 9       $ 134   

Allowance for loan losses

     16         6         -        -        7        -        -        5         34   

Collectively evaluated for impairment:

                     

Loan balance

   $ 752       $ 1,566       $ 4,832      $ 1,505      $ 7,885      $ 1,773      $  16,811  (a)    $ 10,173       $ 45,297   

Allowance for loan losses

     26         17         18        56        14        153        -        44         328   
(a) Includes $2,750 million of domestic overdrafts, $13,462 million of margin loans and $599 million of other loans at June 30, 2012.

 

Allowance for credit losses activity for the quarter ended March 31, 2012            Wealth                               
(in millions)    Commercial      Commercial
real estate
    Financial
institutions
    Lease
financing
    management
loans and
mortgages
     Other
residential
mortgages
    All
Other (a)
    Foreign     Total  

Beginning balance

   $ 91       $ 34      $ 63      $ 66      $ 29       $ 156      $ -      $ 58      $ 497   

Charge-offs

     -         -        -        -        -         (10     -        -        (10

Recoveries

     -         -        -        -        -         2        -        -        2   

Net (charge-offs) recoveries

     -         -        -        -        -         (8     -        -        (8

Provision

     6         (1     (10     (4     5         17        -        (8     5   

Ending balance

   $ 97       $ 33      $ 53      $ 62      $ 34       $ 165      $ -      $ 50      $ 494   

Allowance for:

                    

Loans losses

   $ 36       $ 22      $ 30      $ 62      $ 29       $ 165      $ -      $ 42      $ 386   

Unfunded commitments

     61         11        23        -        5         -        -        8        108   

Individually evaluated for impairment:

                    

Loan balance

   $ 66       $ 38      $ 14      $ -      $ 31       $ -      $ -      $ 10      $ 159   

Allowance for loan losses

     17         6        5        -        7         -        -        3        38   

Collectively evaluated for impairment:

                    

Loan balance

   $ 697       $ 1,403      $ 4,881      $ 1,518      $ 7,281       $ 1,854      $  15,964  (a)    $ 9,271      $ 42,869   

Allowance for loan losses

     19         16        25        62        22         165        -        39        348   
(a) Includes $1,971 million of domestic overdrafts, $13,144 million of margin loans and $849 million of other loans at March 31, 2012.

 

BNY Mellon    75


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Allowance for credit losses activity for the quarter ended June 30, 2011            Wealth                               
(in millions)    Commercial     Commercial
real estate
    Financial
institutions
    Lease
financing
    management
loans and
mortgages
     Other
residential
mortgages
    All
Other (a)
    Foreign     Total  

Beginning balance

   $ 100      $ 34      $ 17      $ 93      $ 29       $ 213      $ 2      $ 66      $ 554   

Charge-offs

     (4     (1     (1     -        -         (9     -        (6     (21

Recoveries

     1        -        1        -        -         -        -        -        2   

Net (charge-offs) recoveries

     (3     (1     -        -        -         (9     -        (6     (19

Provision

     (1     (6     7        (2     2         (4     (2     6        -   

Ending balance

   $ 96      $ 27      $ 24      $ 91      $ 31       $ 200      $ -      $ 66      $ 535   

Allowance for:

                   

Loans losses

   $ 42      $ 21      $ 4      $ 91      $ 25       $ 200      $ -      $ 58      $ 441   

Unfunded commitments

     54        6        20        -        6         -        -        8        94   

Individually evaluated for impairment:

                   

Loan balance

   $ 31      $ 28      $ 3      $ -      $ 28       $ -      $ -      $ 13      $ 103   

Allowance for loan losses

     13        3        -        -        5         -        -        6        27   

Collectively evaluated for impairment:

                   

Loan balance

   $ 823      $ 1,443      $ 5,506      $ 1,562      $ 6,790       $ 2,080      $  14,746  (a)    $ 9,094      $ 42,044   

Allowance for loan losses

     29        18        4        91        20         200        -        52        414   

(a) Includes $4,629 million of domestic overdrafts, $9,520 million of margin loans and $597 million of other loans at June 30, 2011.

 

Allowance for credit losses activity for the six months ended June 30, 2012            Wealth                               
(in millions)    Commercial      Commercial
real estate
    Financial
institutions
    Lease
financing
    management
loans and
mortgages
    Other
residential
mortgages
    All
Other
     Foreign     Total  

Beginning balance

   $ 91       $ 34      $ 63      $ 66      $ 29      $ 156      $ -       $ 58      $ 497   

Charge-offs

     -         -        (4     -        -        (16     -         -        (20

Recoveries

     1         -        -        -        -        3        -         -        4   

Net (charge-offs) recoveries

     1         -        (4     -        -        (13     -         -        (16

Provision

     11         (1     (20     (10     (3     10        -         (1     (14

Ending balance

   $ 103       $ 33      $ 39      $ 56      $ 26      $ 153      $ -       $ 57      $ 467   

 

Allowance for credit losses activity for the six months ended June 30, 2011             Wealth                              
(in millions)    Commercial     Commercial
real estate
    Financial
institutions
    Lease
financing
     management
loans and
mortgages
    Other
residential
mortgages
    All
Other
    Foreign     Total  

Beginning balance

   $ 93      $ 40      $ 11      $ 90       $ 41      $ 235      $ 1      $ 60      $ 571   

Charge-offs

     (4     (4     (1     -         -        (25     -        (6     (40

Recoveries

     2        -        2        -         -        -        -        -        4   

Net (charge-offs) recoveries

     (2     (4     1        -         -        (25     -        (6     (36

Provision

     5        (9     12        1         (10     (10     (1     12        -   

Ending balance

   $ 96      $ 27      $ 24      $ 91       $ 31      $ 200      $ -      $ 66      $ 535   

 

76    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Nonperforming assets

The table below sets forth information about our nonperforming assets.

 

Nonperforming assets

(in millions)

   June 30,
2012
     March 31,
2012
     Dec. 31,
2011
 

Loans:

        

Other residential mortgages

   $ 177       $ 188       $ 203   

Wealth management

     35         35         32   

Commercial

     31         32         21   

Commercial real estate

     30         39         40   

Foreign

     9         10         10   

Financial institutions

     3         14         23   

Total nonperforming loans

   $ 285       $ 318       $ 329   

Other assets owned

     9         13         12   

Total nonperforming assets (a)

   $ 294       $ 331       $ 341   
(a) Loans of consolidated investment management funds are not part of BNY Mellon’s loan portfolio. Included in these loans are nonperforming loans of $155 million at June 30, 2012, $180 million at March 31, 2012 and $101 million at Dec. 31, 2011. These loans are recorded at fair value and therefore do not impact the provision for credit losses and allowance for loan losses, and accordingly are excluded from the nonperforming assets table above.

At June 30, 2012, undrawn commitments to borrowers whose loans were classified as nonaccrual or reduced rate were not material.

Lost interest

 

Lost interest

(in millions)

  2Q12     1Q12     2Q11     YTD12     YTD11  

Amount by which interest income recognized on nonperforming loans exceeded reversals

  $ 1      $ -      $ 1      $ 2      $ 1   

Amount by which interest income would have increased if nonperforming loans at period-end had been performing for the entire year

  $ 5      $ 5      $ 5      $ 10      $ 10   
 

 

Impaired loans

The table below sets forth information about our impaired loans. We use the discounted cash flow method as the primary method for valuing impaired loans.

 

Impaired loans    Quarter ended  
     June 30, 2012      March 31, 2012      June 30, 2011  
(in millions)    Average
recorded
investment
     Interest
income
recognized
     Average
recorded
investment
     Interest
income
recognized
     Average
recorded
investment
     Interest
income
recognized
 

Impaired loans with an allowance:

                 

Commercial

   $ 64       $ 1       $ 46       $ 1       $ 28       $ -   

Commercial real estate

     31         -         35         -         18         -   

Financial institutions

     6         -         16         -         4         -   

Wealth management loans and mortgages

     28         -         28         -         39         1   

Foreign

     10         -         10         -         10         -   

Total impaired loans with an allowance

     139         1         135         1         99         1   

Impaired loans without an allowance:

                 

Commercial

     -         -         -         -         2         -   

Commercial real estate

     3         -         3         -         14         -   

Financial institutions

     2         -         3         -         -         -   

Wealth management loans and mortgages

     3         -         3         -         2         -   

Total impaired loans without an allowance (a)

     8         -         9         -         18         -   

Total impaired loans

   $ 147       $ 1       $ 144       $ 1       $ 117       $ 1   

 

(a) When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.

 

BNY Mellon    77


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Impaired loans    Year-to-date  
     June 30, 2012      June 30, 2011  
(in millions)    Average
recorded
investment
     Interest
income
recognized
     Average
recorded
Investment
     Interest
income
recognized
 

Impaired loans with an allowance:

           

Commercial

   $ 51       $ 2       $ 28       $ -   

Commercial real estate

     32         -         21         -   

Financial institutions

     11         -         4         -   

Wealth management loans and mortgages

     28         -         43         1   

Foreign

     10         -         9         -   

Total impaired loans with an allowance

     132         2         105         1   

Impaired loans without an allowance:

           

Commercial

     -         -         2         -   

Commercial real estate

     3         -         16         -   

Financial institutions

     2         -         -         -   

Wealth management loans and mortgages

     3         -         1         -   

Total impaired loans without an allowance (a)

     8         -         19         -   

Total impaired loans

   $ 140       $ 2       $ 124       $ 1   

 

(a) When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.

 

Impaired loans    June 30, 2012      Dec. 31, 2011  
(in millions)    Recorded
investment
     Unpaid
principal
balance
     Related
allowance (a)
     Recorded
investment
     Unpaid
principal
balance
    

Related

allowance (a)

 

Impaired loans with an allowance:

                 

Commercial (a)

   $ 62       $ 66       $ 16       $ 26       $ 31       $ 9   

Commercial real estate

     27         28         6         35         41         7   

Financial institutions

     1         1         -         21         21         7   

Wealth management loans and mortgages

     28         28         7         27         27         5   

Foreign

     9         17         5         10         18         4   

Total impaired loans with an allowance

     127         140         34         119         138         32   

Impaired loans without an allowance:

                 

Commercial

     -         -         N/A         -         -         N/A   

Commercial real estate

     2         2         N/A         3         3         N/A   

Financial institutions

     2         9         N/A         3         9         N/A   

Wealth management loans and mortgages

     3         3         N/A         3         3         N/A   

Total impaired loans without an allowance (b)

     7         14         N/A         9         15         N/A   

Total impaired loans (c)

   $ 134       $ 154       $ 34       $ 128       $ 153       $ 32   
(a) The allowance for impaired loans is included in the allowance for loan losses.
(b) When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.
(c) Excludes an aggregate of $2 million of impaired loans in amounts individually less than $1 million at both June 30, 2012 and Dec. 31, 2011. The allowance for loan loss associated with these loans totaled less than $1 million at both June 30, 2012 and Dec. 31, 2011.

N/A –  Not applicable.

 

78    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Past due loans

The table below sets forth information about our past due loans.

 

Past due loans and still accruing    June 30, 2012      Dec. 31, 2011  
     Days past due      Total      Days past due      Total  
(in millions)    30-59      60-89      >90      past due      30-59      60-89      >90      past due  

Domestic:

                       

Wealth management loans and mortgages

   $ 49       $ 21       $ -       $ 70       $ 89       $ 3       $ -       $ 92   

Other residential mortgages

     31         6         11         48         36         10         13         59   

Financial institutions

     19         -         -         19         36         -         -         36   

Commercial

     -         -         -         -         60         7         -         67   

Commercial real estate

     7         1         -         8         47         9         -         56   

Total domestic

     106         28         11         145         268         29         13         310   

Foreign

     -         -         -         -         -         -         -         -   

Total past due loans

   $ 106       $ 28       $ 11       $ 145       $ 268       $ 29       $ 13       $ 310   

 

Troubled debt restructurings (“TDRs”)

A modified loan is considered a TDR if the debtor is experiencing financial difficulties and the creditor grants a concession to the debtor that would not otherwise be considered. A TDR may include a transfer of real estate or other assets from the debtor to the creditor, or a modification of the term of the loan. Not all modified loans are considered TDRs.

The following table presents TDRs that occurred during the second quarter of 2012.

 

TDRs during the second quarter of 2012          
            Outstanding
recorded investment
 
(dollars in millions)    Number of
contracts
     Pre-
modification
     Post-
modification
 

Other residential mortgages

     52       $ 15       $ 16   

Commercial

     1         4         4   

Total TDRs

     53       $ 19       $ 20   

Other residential mortgages

The modifications of the other residential mortgage loans consisted of reducing the stated interest rate and in certain cases, extending the maturity date. The value of modified loans is based on the fair value of the collateral. Probable loss factors are applied to the value of the modified loans to determine the allowance for credit losses.

Commercial

The modification of the commercial loan and unfunded lending-related commitment consisted of changing the maturity date of the loan. The difference between the book value and the market price of the loan is included in the allowance for credit losses.

TDRs that subsequently defaulted

There were six residential mortgage loans and one wealth management loan that had been restructured in a TDR during the previous 12 months and have subsequently defaulted during the second quarter of 2012. The total recorded investment of these loans was $2 million.

Credit quality indicators

Our credit strategy is to focus on investment grade names to support cross-selling opportunities, avoid single name/industry concentrations and exit high risk portfolios. Each customer is assigned an internal rating grade which is mapped to an external rating agency grade equivalent based upon a number of dimensions which are continually evaluated and may change over time.

The following tables set forth information about credit quality indicators.

 

 

BNY Mellon    79


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Commercial loan portfolio

 

Commercial loan portfolio—Credit risk profile by creditworthiness category  
     Commercial      Commercial real estate      Financial institutions  
(in millions)    June 30,
2012
     Dec. 31,
2011
     June 30,
2012
     Dec. 31,
2011
     June 30,
2012
     Dec. 31,
2011
 

Investment grade

   $ 1,018       $ 906       $ 1,113       $ 1,062       $ 8,899       $ 9,643   

Non investment grade

     369         374         482         387         1,617         1,501   

Total

   $ 1,387       $ 1,280       $ 1,595       $ 1,449       $ 10,516       $ 11,144   

 

The commercial loan portfolio is divided into investment grade and noninvestment grade categories based on rating criteria largely consistent with those of the public rating agencies. Each customer in the portfolio is assigned an internal rating grade. These internal rating grades are generally consistent with the ratings categories of the public rating agencies. Customers with ratings consistent with BBB- (S&P)/Baa3 (Moody’s) or better are considered to be investment grade. Those clients with ratings lower than this threshold are considered to be noninvestment grade.

Wealth management loans and mortgages

 

Wealth management loans and mortgages –

Credit risk profile by internally assigned grade

               
(in millions)    June 30,
2012
     Dec. 31,
2011
 

Wealth management loans:

     

Investment grade

   $ 3,905       $ 3,450   

Noninvestment grade

     109         111   

Wealth management mortgages

     3,902         3,781   

Total

   $ 7,916       $ 7,342   

Wealth management non-mortgage loans are not typically rated by external rating agencies. A majority of the wealth management loans are secured by the customers’ investment management accounts or custody accounts. Eligible assets pledged for these loans are typically investment grade, fixed income securities, equities and/or mutual funds. Internal ratings for this portion of the wealth management portfolio, therefore, would equate to investment-grade external ratings. Wealth management loans are provided to select customers based on the pledge of other types of assets, including business assets, fixed assets, or a modest amount of commercial real estate. For the loans collateralized by other assets, the credit quality of the obligor is carefully analyzed, but we do not consider this portfolio of loans to be investment grade.

Credit quality indicators for wealth management mortgages are not correlated to external ratings. Wealth management mortgages are typically loans to high-net-worth individuals, which are secured primarily by residential property. These loans are primarily interest-only adjustable rate mortgages with an average loan to value ratio of 63% at origination. In the wealth management portfolio, 1% of the mortgages were past due at June 30, 2012.

At June 30, 2012, the private wealth mortgage portfolio was comprised of the following geographic concentrations: New York – 23%; California – 18%; Massachusetts – 17%; Florida – 8%; and other – 34%.

Other residential mortgages

The other residential mortgage portfolio primarily consists of 1-4 family residential mortgage loans and totaled $1,773 million at June 30, 2012 and $1,923 million at Dec. 31, 2011. These loans are not typically correlated to external ratings. Included in this portfolio at June 30, 2012 are $542 million of mortgage loans purchased in 2005, 2006 and the first quarter of 2007 that are predominantly prime mortgage loans, with a small portion of Alt-A loans. As of June 30, 2012, the purchased loans in this portfolio had a weighted-average original loan-to-value ratio of 75% and 29% of these loans were at least 60 days delinquent. The properties securing the prime and Alt-A mortgage loans were located (in order of concentration) in California, Florida, Virginia, Maryland and the tri-state area (New York, New Jersey and Connecticut).

Overdrafts

Overdrafts primarily relate to custody and securities clearance clients and totaled $5,655 million at June 30, 2012 and $4,849 million at Dec. 31, 2011. Overdrafts occur on a daily basis in the custody and securities clearance business and are generally repaid within two business days.

 

 

80    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Margin loans

We had $13,462 million of secured margin loans on our balance sheet at June 30, 2012 compared with $12,760 million at Dec. 31, 2011. Margin loans are collateralized with marketable securities and borrowers are required to maintain a daily collateral margin in excess of 100% of the value of the loan. We have rarely suffered a loss on these types of loans and do not allocate any of our allowance for credit losses to them.

Other loans

Other loans primarily include loans to consumers that are fully collateralized with equities, mutual funds and fixed income securities, as well as bankers’ acceptances.

Reverse repurchase agreements

Reverse repurchase agreements are transactions fully collateralized with high-quality liquid securities. These transactions carry minimal credit risk and therefore are not allocated an allowance for credit losses.

Note 6 – Goodwill and intangible assets

Impairment testing

Goodwill impairment testing is performed at least annually at the reporting unit level. Intangible assets not subject to amortization are tested annually for impairment or more often if events or circumstances indicate they may be impaired.

BNY Mellon’s three business segments include seven reporting units for which goodwill impairment testing is performed on an annual basis. In the second quarter of 2012, BNY Mellon conducted an annual goodwill impairment test on all seven reporting units. The estimated fair value of the seven reporting units exceeded the carrying value and no goodwill impairment was recognized.

Goodwill

The tables below provide a breakdown of goodwill by business.

 

 

Goodwill by business

(in millions)

   Investment
Management
     Investment
Services
    Other      Consolidated  

Balance at Dec. 31, 2011

   $ 9,373       $ 8,491      $ 40       $ 17,904   

Foreign exchange translation

     13         (7     -         6   

Other (a)

     -         (11     10         (1

Balance at June 30, 2012

   $ 9,386       $ 8,473      $ 50       $ 17,909   
(a) Other changes in goodwill include purchase price adjustments and certain other reclassifications.

 

Goodwill by business

(in millions)

   Investment
Management
     Investment
Services(a)
    Other(a)      Consolidated  

Balance at Dec. 31, 2010

   $ 9,359       $ 8,515      $ 168       $ 18,042   

Foreign exchange translation

     64         82        -         146   

Other (b)

     7         (4     -         3   

Balance at June 30, 2011

   $ 9,430       $ 8,593      $ 168       $ 18,191   
(a) Includes the reclassification of goodwill associated with the Shareowner Services business from Investment Services to the other segment.
(b) Other changes in goodwill include purchase price adjustments and certain other reclassifications.

Intangible assets

The tables below provide a breakdown of intangible assets by business.

 

Intangible assets – net carrying amount by business

(in millions)

   Investment
Management
    Investment
Services
    Other      Consolidated  

Balance at Dec. 31, 2011

   $ 2,382      $ 1,922      $ 848       $ 5,152   

Amortization

     (96     (97     -         (193

Foreign exchange translation

     4        (1     -         3   

Other (a)

     -        (1     1         -   

Balance at June 30, 2012

   $ 2,290      $ 1,823      $ 849       $ 4,962   
(a) Other changes in intangible assets include purchase price adjustments and certain other reclassifications.

 

BNY Mellon    81


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Intangible assets – net carrying amount by business

(in millions)

   Investment
Management
    Investment
Services (a)
    Other (a)     Consolidated  

Balance at Dec. 31, 2010

   $ 2,592      $ 2,113      $ 991      $ 5,696   

Acquisitions

     -        12        -        12   

Amortization

     (108     (100     (8     (216

Foreign exchange translation

     16        10        -        26   

Impairment

     -        (6     -        (6

Other (b)

     -        2        -        2   

Balance at June 30, 2011

   $ 2,500      $ 2,031      $ 983      $ 5,514   
(a) Includes the reclassification of intangible assets associated with the Shareowner Services business from Investment Services to the Other segment.
(b) Other changes in intangible assets include purchase price adjustments and certain other reclassifications.

The table below provides a breakdown of intangible assets by type.

 

Intangible assets    June 30, 2012      Dec. 31, 2011  
(in millions)    Gross
carrying
amount
     Accumulated
amortization
    Net
carrying
amount
     Remaining
weighted-
average
amortization
period
    

Net

carrying
amount

 

Subject to amortization:

             

Customer relationships - Investment Management

   $ 2,093       $ (1,267   $ 826         12 yrs.       $ 920   

Customer contracts - Investment Services

     2,348         (925     1,423         13         1,517   

Other

     131         (101     30         5         36   

Total subject to amortization

     4,572         (2,293     2,279         13 yrs.         2,473   

Not subject to amortization: (a)

             

Trade name

     1,367         N/A        1,367         N/A         1,366   

Customer relationships

     1,316         N/A        1,316         N/A         1,313   

Total not subject to amortization

     2,683         N/A        2,683         N/A         2,679   

Total intangible assets

   $ 7,255       $ (2,293   $ 4,962         N/A       $ 5,152   
(a) Intangible assets not subject to amortization have an indefinite life.

N/A—Not applicable.

Estimated annual amortization expense for current

intangibles for the next five years is as follows:

 

For the year ended

Dec. 31,

   Estimated amortization
expense (in millions)
 

2012

   $ 385   

2013

     334   

2014

     298   

2015

     266   

2016

     238   

Note 7 – Other assets

 

Other assets    June 30,      Dec. 31,  
(in millions)    2012      2011  

Accounts receivable

   $ 4,286       $ 4,208   

Corporate/bank owned life insurance

     4,260         4,216   

Equity in joint ventures and other investments (a)

     2,748         2,677   

Income taxes receivable

     2,681         2,573   

Fails to deliver

     1,277         961   

Fair value of hedging derivatives

     1,232         1,600   

Software

     1,046         986   

Prepaid expenses

     605         784   

Due from customers on acceptances

     355         321   

Prepaid pension assets

     176         144   

Other

     1,089         1,369   

Total other assets

   $ 19,755       $ 19,839   
(a) Includes Federal Reserve Bank stock of $434 million and $429 million, respectively, at cost.
 

 

82    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Seed capital and private equity investments valued using net asset value per share

In our Investment Management business, we manage investment assets, including equities, fixed income, money market and alternative investment funds for institutions and other investors; as part of that activity, we make seed capital investments in certain funds. BNY Mellon also holds private equity investments, which consist of investments in private equity funds, mezzanine financings and direct equity

investments. Seed capital and private equity investments are included in other assets. Consistent with our policy to focus on our core activities, we continue to reduce our exposure to private equity investments.

The fair value of these investments has been estimated using the net asset value (“NAV”) per share of BNY Mellon’s ownership interest in the funds. The table below presents information about BNY Mellon’s investments in seed capital and private equity investments.

 

 

 

Seed capital and private equity investments valued using NAV

     June 30, 2012     Dec. 31, 2011  

(dollar amounts

in millions)

   Fair
value
     Unfunded
commitments
     Redemption
Frequency
     Redemption
notice
Period
    Fair
Value
     Unfunded
commitments
     Redemption
frequency
     Redemption
notice
period
 

Hedge funds (a)

   $ 16       $ -         Monthly-quarterly         3-45 days      $ 9       $ -         Monthly-quarterly         3-45 days   

Private equity funds (b)

     107         22         N/A         N/A        122         24         N/A         N/A   

Other funds (c)

     115         18         Monthly-yearly         (c )      63         -         Monthly-yearly         (c ) 

Total

   $ 238       $ 40                        $ 194       $ 24                     

 

(a) Hedge funds include multi-strategy funds that utilize a variety of investment strategies and equity long-short hedge funds that include various funds that invest over both long-term investment and short-term investment horizons.
(b) Private equity funds primarily include numerous venture capital funds that invest in various sectors of the economy. Private equity funds do not have redemption rights. Distributions from such funds will be received as the underlying investments in the funds are liquidated.
(c) Other funds include various market neutral, leveraged loans, real estate and structured credit funds. Redemption notice periods vary by fund.

N/A – Not applicable.

Note 8 – Net interest revenue

 

Net interest revenue    Quarter ended      Year-to-date  

(in millions)

    
 
June 30,
2012
  
  
    
 
March 31,
2012
  
  
    
 
June 30,
2011
  
  
    
 
June 30,
2012
  
  
    
 
June 30,
2011
  
  

Interest revenue

              

Non-margin loans

   $ 169       $ 169       $ 171       $ 338       $ 342   

Margin loans

     42         42         32         84         59   

Securities:

              

Taxable

     484         503         483         987         956   

Exempt from federal income taxes

     20         15         8         35         13   

Total securities

     504         518         491         1,022         969   

Deposits in banks

     93         114         144         207         272   

Deposits with the Federal Reserve and other central banks

     39         43         27         82         43   

Federal funds sold and securities purchased under resale agreements

     9         9         5         18         11   

Trading assets

     19         17         17         36         39   

Total interest revenue

     875         912         887         1,787         1,735   

Interest expense

              

Deposits

     43         43         68         86         116   

Federal funds purchased and securities sold under repurchase agreements

     -         -         1         -         2   

Trading liabilities

     6         4         9         10         22   

Other borrowed funds

     6         5         5         11         12   

Customer payables

     2         2         1         4         3   

Long-term debt

     84         93         72         177         151   

Total interest expense

     141         147         156         288         306   

Net interest revenue

   $ 734       $ 765       $ 731       $ 1,499       $ 1,429   

 

BNY Mellon    83


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Note 9 – Employee benefit plans

The components of net periodic benefit cost are as follows:

 

Net periodic benefit cost (credit)    Quarter ended  
     June 30, 2012     March 31, 2012     June 30, 2011  
(in millions)    Domestic
pension
benefits
    Foreign
pension
benefits
    Health
care
benefits
    Domestic
pension
benefits
    Foreign
pension
benefits
    Health
care
benefits
    Domestic
pension
benefits
    Foreign
pension
benefits
    Health
care
benefits
 

Service cost

   $ 15      $ 8      $ 1      $ 15      $ 8      $ 1      $ 16      $ 8      $ 1   

Interest cost

     42        9        3        42        9        3        44        9        3   

Expected return on assets

     (68     (12     (2     (68     (12     (2     (71     (11     (2

Other

     38        3        3        38        3        3        23        4        2   

Net periodic benefit cost

   $ 27      $ 8      $ 5      $ 27      $ 8      $ 5      $ 12      $ 10      $ 4   

 

Net periodic benefit cost (credit)    Year-to-date  
     June 30, 2012     June 30, 2011  
(in millions)    Domestic
pension
benefits
    Foreign
pension
benefits
    Health
care
benefits
    Domestic
pension
benefits
    Foreign
pension
benefits
    Health
care
benefits
 

Service cost

   $ 30      $ 16      $ 2      $ 32      $ 16      $ 2   

Interest cost

     84        18        6        88        17        6   

Expected return on assets

     (136     (24     (4     (141     (22     (4

Other

     76        6        6        46        8        4   

Net periodic benefit cost

   $ 54      $ 16      $ 10      $ 25      $ 19      $ 8   

 

Note 10 – Restructuring charges

Operational excellence initiatives

In the fourth quarter of 2011, we announced our operational excellence initiatives which include an expense reduction initiative that was expected to impact approximately 1,500 positions or approximately 3% of our global workforce, as well as additional initiatives to transform operations, technology and corporate services that will increase productivity and reduce the growth rate of expenses. Severance payments related to these positions are primarily paid over the salary continuance period in accordance with the separation plan. In 2011, we recorded a pre-tax restructuring charge of $107 million related to the operational excellence initiatives. The aggregate restructuring charge is included in the merger and integration, litigation and restructuring charges expense category on the income statement.

The following table presents the activity in the restructuring reserve related to the operational excellence initiatives through June 30, 2012.

 

Operational excellence initiatives 2011 –

restructuring charge reserve activity

 

(in millions)    Severance     Other     Total  

Original restructuring charge

   $ 78      $ 29      $ 107   

Additional charges (recovery)

     (2     -        (2

Utilization

     (14     (29     (43

Balance at March 31, 2012

     62        -        62   

Utilization

     (11     -        (11

Balance at June 30, 2012

   $ 51      $ -      $ 51   

This restructuring charge was recorded in the Other segment as it is a corporate initiative and not directly related to the operating performance of the businesses. The table below presents the restructuring charge if it had been allocated by business.

 

Operational excellence initiatives 2011 –

restructuring charge (recovery) by business

    Total  
(in millions)    2Q12     1Q12    

charges

since
inception

 

Investment Management

   $ 4      $ -      $ 21   

Investment Services

     -        (2     39   

Other segment (including

      

Business Partners)

     (4     -        45   

Total restructuring charge (recovery)

   $ -      $ (2   $ 105   
 

 

84    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Global location strategy

BNY Mellon continues to execute its global location strategy. This strategy includes migrating positions to our global growth centers and was expected to result in moving and/or eliminating approximately 2,400 positions. Severance payments related to these positions are primarily paid over the salary continuance period in accordance with the separation plan. In 2009, we recorded a pre-tax restructuring charge of $139 million related to this strategy. In the second quarter of 2012, we recorded a recovery of $4 million associated with the global location strategy.

The following table presents the activity in the restructuring reserve related to the global location strategy through June 30, 2012.

 

Global location strategy 2009 –

restructuring charge reserve activity

 

(in millions)

   Severance     Asset
write-offs/
other
    Total  

Original restructuring charge

   $ 102      $ 37      $ 139   

Additional charges

     7        6        13   

Utilization

     (96     (32     (128

Balance at March 31, 2012

     13        11        24   

Additional charges (recovery)

     (4     -        (4

Utilization

     (4     -        (4

Balance at June 30, 2012

   $ 5      $ 11      $ 16   

This restructuring charge was recorded in the Other segment as it is a corporate initiative and not directly related to the operating performance of the businesses. The table below presents the restructuring charge if it had been allocated by business.

 

Global location strategy 2009 – restructuring charge (recovery) by business  
(in millions)    2Q12     1Q12     2Q11     Total charges
since inception
 

Investment Management

   $ -      $ (1   $ 2      $ 54   

Investment Services

     (4     (7     (5     65   

Other segment (including Business Partners)

     -        1        (1     29   

Total restructuring charge (recovery)

   $ (4   $ (7   $ (4   $ 148   

Note 11 – Income taxes

The statutory federal income tax rate is reconciled to our effective income tax rate below:

 

Effective tax rate    Six months ended  
     

June 30,

2012

   

June 30,

2011

 

Federal rate

     35.0     35.0

State and local income taxes, net of federal income tax benefit

     2.4        3.0   

Credit for low-income housing investments

     (2.3     (1.6

Tax-exempt income

     (3.3     (3.7

Foreign operations

     (5.3     (3.5

Other – net

     (3.0     (1.2

Effective tax rate

     23.5     28.0

Our total tax reserves as of June 30, 2012 were $263 million compared with $261 million at March 31, 2012. If these tax reserves were unnecessary, $263 million would affect the effective tax rate in future periods. We recognize accrued interest and penalties, if applicable, related to income taxes in income tax expense. Included in the balance sheet as of June 30, 2012 is accrued interest, where applicable, of $67 million. The additional tax expense related to interest for the six months ended June 30, 2012 was $8 million compared with $5 million for the six months ended June 30, 2011.

As previously disclosed, on November 10, 2009 BNY Mellon filed a petition with the U.S. Tax Court challenging the IRS’ disallowance of certain foreign tax credits claimed for the 2001 and 2002 tax years. The aggregate tax for all of the years in question is approximately $900 million, including interest. BNY Mellon continues to believe the tax treatment of the transaction was consistent with statutory and judicial authority existing at the time of the transaction. The trial was held from April 16 to May 17, 2012. Post-trial briefing is scheduled to conclude Sept. 13, 2012. See Note 17 of the Notes to Consolidated Financial Statements for additional information. The Tax Court could reach a decision within the next 12 months. If there is an adverse decision, BNY Mellon will be required to re-evaluate its uncertain tax position with respect to this matter.

 

 

BNY Mellon    85


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Pursuant to ASC 740 (FASB Interpretation 48), it is reasonably possible the total reserve for uncertain tax positions, could increase within the next 12 months by an amount up to $930 million as a result of the above matter and adjustments related to tax years that are still subject to examination.

As of June 30, 2012, our federal consolidated income tax returns are closed to examination through 2002. Our New York State and New York City returns are closed to examination through 2008. Our United Kingdom income tax returns are closed to examination through 2008.

Note 12 – Securitizations and variable interest entities

Variable interest entities

Accounting guidance on the consolidation of VIEs is included in ASC 810, Consolidation, and ASU 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.”

Effective Jan. 1, 2010, the FASB approved ASU 2010-10 “Amendments for Certain Investment Funds,” which defers the requirements of ASU 2009-17 for asset managers’ interests in entities that apply the specialized accounting guidance for investment companies or that have the attributes of investment companies and for interests in money market funds.

Accounting guidance on the consolidation of VIEs applies to certain entities in which the equity investors:

 

 

do not have sufficient equity at risk for the entity to finance its activities without additional financial support, or

 

 

lack one or more of the following characteristics of a controlling financial interest:

 

  - The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance (ASU 2009-17 model).

 

  - The direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights (ASC 810 model).

 

  - The obligation to absorb the expected losses of the entity.

 

  - The right to receive the expected residual returns of the entity.

BNY Mellon’s VIEs generally include retail, institutional and alternative investment funds offered to its retail and institutional customers in which it acts as the fund’s investment manager. BNY Mellon earns management fees on these funds as well as performance fees in certain funds. It may also provide start-up capital in its new funds. These VIEs are included in the scope of ASU 2010-10 and

are reviewed for consolidation based on the guidance in ASC 810.

BNY Mellon applies ASC 810 to its mutual funds, hedge funds, private equity funds, collective investment funds and real estate investment trusts. If these entities are determined to be VIEs, primary beneficiary calculations are prepared in accordance with ASC 810 to determine whether or not BNY Mellon is the primary beneficiary and required to consolidate the VIE. The primary beneficiary of a VIE is the party that absorbs a majority of the variable interests’ expected losses, receives a majority of its expected residual returns or both.

The primary beneficiary calculations include estimates of ranges and probabilities of losses and returns from the funds. The calculated expected gains and expected losses are allocated to the variable interest holders of the funds, which are generally the fund’s investors and which may include BNY Mellon, in order to determine which entity is required to consolidate the VIE, if any.

BNY Mellon has other VIEs, including securitization trusts, which are no longer considered qualified special purpose entities, and CLOs, in which BNY Mellon serves as the investment manager. In addition, we provide trust and custody services for a fee to entities sponsored by other corporations in which we have no other interest. These VIEs are evaluated under the guidance included in ASU 2009-17. BNY Mellon has two securitizations and several CLOs, which are assessed for consolidation in accordance with ASU 2009-17.

The primary beneficiary of these VIEs is the entity whose variable interests provide it with a controlling financial interest, which includes the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE.

In order to determine if it has a controlling financial interest in these VIEs, BNY Mellon assesses the VIE’s purpose and design along with the risks it was designed to create and pass through to its variable interest holders. We also assess our involvement in the VIE and the involvement of any other variable interest holders in the VIE.

Generally, as the sponsor and the manager of its VIEs, BNY Mellon has the power to control the

 

 

86    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

activities that significantly impact the VIE’s economic performance. Both a qualitative and quantitative analysis of BNY Mellon’s variable interests are performed to determine if BNY Mellon has the obligation to absorb losses of the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE. The analyses included assessments related to the expected performance of the VIEs and its related impact on BNY Mellon’s seed capital, management fees or residual interests in the VIEs. We also assess any potential impact the VIE’s expected performance has on our performance fees.

The following tables present the incremental assets and liabilities included in BNY Mellon’s consolidated financial statements, after applying intercompany eliminations, as of June 30, 2012 and Dec. 31, 2011, based on the assessments performed in accordance with ASC 810 and ASU 2009-17. The net assets of any consolidated VIE are solely available to settle the liabilities of the VIE and to settle any investors’ ownership liquidation requests, including any seed capital invested in the VIE by BNY Mellon.

 

Investments consolidated under ASC 810 and ASU 2009-17

at June 30, 2012

 
(in millions)    Investment
Management
funds
     Securitizations      Total
consolidated
investments
 

Available-for-sale

   $ -       $ 495       $ 495   

Trading assets

     10,399         -         10,399   

Other assets

     556         -         556   

Total assets

   $ 10,955       $ 495       $ 11,450   

Trading liabilities

     9,752         -         9,752   

Other liabilities

     38         457         495   

Total liabilities

   $ 9,790       $ 457       $ 10,247   

Non-redeemable noncontrolling interests

   $ 722       $ -       $ 722   

Investments consolidated under ASC 810 and ASU 2009-17

at Dec. 31, 2011

 
(in millions)    Investment
Management
funds
     Securitizations      Total
consolidated
investments
 

Available-for-sale

   $ -       $ 479       $ 479   

Trading assets

     10,751         -         10,751   

Other assets

     596         -         596   

Total assets

   $ 11,347       $ 479       $ 11,826   

Trading liabilities

     10,053         -         10,053   

Other liabilities

     32         443         475   

Total liabilities

   $ 10,085       $ 443       $ 10,528   

Non-redeemable noncontrolling interests

   $ 670       $ -       $ 670   

BNY Mellon voluntarily provided capital support agreements to certain VIEs (see below). With the exception of these agreements, we are not contractually required to provide financial or any other support to any of our VIEs. Additionally, creditors of any consolidated VIEs do not have any recourse to the general credit of BNY Mellon.

Non-consolidated VIEs

As of June 30, 2012 and Dec. 31, 2011, the following assets related to the VIEs, where BNY Mellon is not the primary beneficiary, are included in our consolidated financial statements.

 

Non-consolidated VIEs at June 30, 2012          
(in millions)    Assets      Liabilities     

Maximum

loss
exposure

 

Other

   $ 87       $ -       $ 87   

 

Non-consolidated VIEs at Dec. 31, 2011          
(in millions)    Assets      Liabilities     

Maximum

loss
exposure

 

Trading

   $ 1       $ -       $ 1   

Other

     41         -         41   

Total

   $ 42       $ -       $ 42   

The maximum loss exposure indicated in the above tables relates solely to BNY Mellon’s seed capital or residual interests invested in the VIEs.

 

 

BNY Mellon    87


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Consolidated credit supported VIEs

Certain funds have been created solely with securities that are subject to credit support agreements where we have agreed to absorb the majority of loss. Accordingly, these funds have been consolidated into BNY Mellon and have affected the following financial statement items at June 30, 2012 and Dec. 31, 2011.

 

Consolidated credit supported VIEs at June 30, 2012  
(in millions)    Assets      Liabilities      Maximum
loss
exposure
 

Available-for-sale

   $ 9       $ -       $ 9   

Other

     -         18         1   

Total

   $ 9       $ 18       $ 10   

 

Consolidated credit supported VIEs at Dec. 31, 2011  
(in millions)    Assets      Liabilities      Maximum
loss
exposure
 

Available-for-sale

   $ 14       $ -       $ 14   

Other

     -         22         10   

Total

   $ 14       $ 22       $ 24   

The maximum loss exposure shown above for the credit support agreements provided to BNY Mellon’s VIEs primarily assumes a complete loss on the Lehman Brothers Holdings Inc. securities for BNY Mellon’s clients that accepted our offer of support. As of June 30, 2012, BNY Mellon recorded $18 million in liabilities related to its VIEs for which credit support agreements were provided.

 

Note 13 – Other comprehensive income

 

Components of other comprehensive income

  for the quarter ended June 30, 2012

 
(in millions)    Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
 

Foreign currency translation adjustment arising during the period

   $ (223   $ (42   $ (265

Unrealized gain (loss) on assets available-for-sale:

      

Unrealized gain (loss) arising during period

     318        (121     197   

Reclassification adjustment

     (50     15        (35

Net unrealized gain (loss) on assets available-for-sale

     268        (106     162   

Defined benefit plans:

      

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     42        (18     24   

Total defined benefit plans

     42        (18     24   

Unrealized gain (loss) on cash flow hedges:

      

Unrealized hedge gain (loss) arising during period

     8        (2     6   

Reclassification adjustment

     (9     3        (6

Net unrealized gain (loss) on cash flow hedges

     (1     1        -   

Total other comprehensive income (loss)

   $ 86      $ (165   $ (79

 

Components of other comprehensive income

  for the quarter ended March 31, 2012

 
(in millions)    Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
 

Foreign currency translation adjustment arising during the period

   $ 129      $ 43      $ 172   

Unrealized gain (loss) on assets available-for-sale:

      

Unrealized gain (loss) arising during period

     378        (141     237   

Reclassification adjustment

     (40     16        (24

Net unrealized gain (loss) on assets available-for-sale

     338        (125     213   

Defined benefit plans:

      

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     44        (17     27   

Total defined benefit plans

     44        (17     27   

Unrealized gain (loss) on cash flow hedges:

      

Unrealized hedge gain (loss) arising during period

     1        (1     -   

Reclassification adjustment

     5        (2     3   

Net unrealized gain (loss) on cash flow hedges

     6        (3     3   

Total other comprehensive income (loss)

   $ 517      $ (102   $ 415   

 

 

88    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Components of other comprehensive income

  for the quarter ended June 30, 2011

 
(in millions)    Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
 

Foreign currency translation adjustment arising during the period

   $ 120      $ 1      $ 121   

Unrealized gain (loss) on assets available-for-sale:

      

Unrealized gain (loss) arising during period

     244        (85     159   

Reclassification adjustment

     (48     20        (28

Net unrealized gain (loss) on assets available-for-sale

     196        (65     131   

Defined benefit plans:

      

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     28        (11     17   

Total defined benefit plans

     28        (11     17   

Unrealized gain (loss) on cash flow hedges:

      

Unrealized hedge gain (loss) arising during period

     (1     -        (1

Reclassification adjustment

     1        -        1   

Net unrealized gain (loss) on cash flow hedges

     -        -        -   

Total other comprehensive income (loss)

   $ 344      $ (75   $ 269   

 

Components of other comprehensive income

  for the six months ended June 30, 2012

                        
(in millions)    Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
 

Foreign currency translation adjustment arising during the period

   $ (94   $ 1      $ (93

Unrealized gain (loss) on assets available-for-sale:

      

Unrealized gain (loss) arising during period

     696        (262     434   

Reclassification adjustment

     (90     31        (59

Net unrealized gain (loss) on assets available-for-sale

     606        (231     375   

Defined benefit plans:

      

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     86        (35     51   

Total defined benefit plans

     86        (35     51   

Unrealized gain (loss) on cash flow hedges:

      

Unrealized hedge gain (loss) arising during period

     9        (3     6   

Reclassification adjustment

     (4     1        (3

Net unrealized gain (loss) on cash flow hedges

     5        (2     3   

Total other comprehensive income (loss)

   $ 603      $ (267   $ 336   

 

Components of other comprehensive income

  for the six months ended June 30, 2011

                        
(in millions)    Pre-tax
amount
    Tax (expense)
benefit
    After-tax
amount
 

Foreign currency translation adjustment arising during the period

   $ 313      $ 46      $ 359   

Unrealized gain (loss) on assets available-for-sale:

      

Unrealized gain (loss) arising during period

     470        (176     294   

Reclassification adjustment

     (53     23        (30

Net unrealized gain (loss) on assets available-for-sale

     417        (153     264   

Defined benefit plans:

      

Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost

     54        (20     34   

Total defined benefit plans

     54        (20     34   

Unrealized gain (loss) on cash flow hedges:

      

Unrealized hedge gain (loss) arising during period

     -        (1     (1

Reclassification adjustment

     1        -        1   

Net unrealized gain (loss) on cash flow hedges

     1        (1     -   

Total other comprehensive income (loss)

   $ 785      $ (128   $ 657   

 

BNY Mellon    89


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Note 14 – Fair value measurement

The guidance related to “Fair Value Measurement” included in ASC 820 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date and establishes a framework for measuring fair value. It establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and expands the disclosures about instruments measured at fair value. ASC 820 requires consideration of a company’s own creditworthiness when valuing liabilities.

The standard provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The objective is to determine from weighted indicators of fair value a reasonable point within the range that is most representative of fair value under current market conditions.

Determination of fair value

Following is a description of our valuation methodologies for assets and liabilities measured at fair value. We have established processes for determining fair values. Fair value is based upon quoted market prices in active markets, where available. For financial instruments where quotes from recent exchange transactions are not available, we determine fair value based on discounted cash flow analysis, comparison to similar instruments, and the use of financial models. Discounted cash flow analysis is dependent upon estimated future cash flows and the level of interest rates. Model-based pricing uses inputs of observable prices, where available, for interest rates, foreign exchange rates, option volatilities and other factors. Models are benchmarked and validated by an independent internal risk management function. Our valuation process takes into

consideration factors such as counterparty credit quality, liquidity, concentration concerns, and observability of model parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.

Most derivative contracts are valued using internally developed models which are calibrated to observable market data and employ standard market pricing theory for their valuations. An initial “risk-neutral” valuation is performed on each position assuming time-discounting based on a AA credit curve. Then, to arrive at a fair value that incorporates counterparty credit risk, a credit adjustment is made to these results by discounting each trade’s expected exposures to the counterparty using the counterparty’s credit spreads, as implied by the credit default swap market. We also adjust expected liabilities to the counterparty using BNY Mellon’s own credit spreads, as implied by the credit default swap market. Accordingly, the valuation of our derivative position is sensitive to the current changes in our own credit spreads as well as those of our counterparties.

In certain cases, recent prices may not be observable for instruments that trade in inactive or less active markets. Upon evaluating the uncertainty in valuing financial instruments subject to liquidity issues, we make an adjustment to their value. The determination of the liquidity adjustment includes the availability of external quotes, the time since the latest available quote and the price volatility of the instrument.

Certain parameters in some financial models are not directly observable and, therefore, are based on management’s estimates and judgments. These financial instruments are normally traded less actively. We apply valuation adjustments to mitigate the possibility of error and revision in the model-based estimate value. Examples include products where parameters such as correlation and recovery rates are unobservable.

The methods described above for instruments that trade in inactive or less active markets may produce a current fair value calculation that may not be indicative of net realizable value or reflective of future fair values. We believe our methods of determining fair value are appropriate and consistent with other market participants. However, the use of different methodologies or different assumptions to value certain financial instruments could result in a different estimate of fair value.

 

 

90    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Valuation hierarchy

ASC 820 established a three-level valuation hierarchy for disclosure of fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are described below.

Level 1: Inputs to the valuation methodology are recent quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 assets and liabilities include debt and equity securities and derivative financial instruments actively traded on exchanges, and U.S. Treasury securities and U.S. Government agency securities that are actively traded in highly liquid over-the-counter markets.

Level 2: Observable inputs other than Level 1 prices, for example, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs that are observable or can be corroborated, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 assets and liabilities include debt instruments that are traded less frequently than exchange-traded securities and derivative instruments whose model inputs are observable in the market or can be corroborated by market observable data. Examples in this category are certain variable and fixed rate agency and non-agency securities, corporate debt securities and derivative contracts.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Examples in this category include interests in certain securitized financial assets, certain private equity investments, and derivative contracts that are highly structured or long-dated.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities

Where quoted prices are available in an active market, we classify the securities within Level 1 of the valuation hierarchy. Securities are defined as both long and short positions. Level 1 securities include highly liquid government bonds, money market mutual funds and exchange-traded equities.

If quoted market prices are not available, we estimate fair value using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include certain agency and non-agency mortgage-backed securities, commercial mortgage-backed securities and European floating rate notes.

For securities where quotes from recent transactions are not available for identical securities, we determine fair value primarily based on pricing sources with reasonable levels of price transparency that employ financial models or obtain comparisons to similar instruments to arrive at “consensus” prices.

Specifically, the pricing sources obtain recent transactions for similar types of securities (e.g., vintage, position in the securitization structure) and ascertain variables such as discount rate and speed of prepayment for the types of transaction and apply such variables to similar types of bonds. We view these as observable transactions in the current marketplace and classify such securities as Level 2. Pricing sources discontinue pricing any specific security whenever they determine there is insufficient observable data to provide a good faith opinion on price.

In addition, we have significant investments in more actively traded agency RMBS and other types of securities such as FDIC-insured debt and sovereign debt. The pricing sources derive the prices for these securities largely from quotes they obtain from three major inter-dealer brokers. The pricing sources receive their daily observed trade price and other information feeds from the inter-dealer brokers.

For securities with bond insurance, the financial strength of the insurance provider is analyzed and that information is included in the fair value assessment for such securities.

 

 

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In certain cases where there is limited activity or less transparency around inputs to the valuation, we classify those securities in Level 3 of the valuation hierarchy. Securities classified within Level 3 primarily include other debt securities and securities of state and political subdivisions.

At June 30, 2012, approximately 99% of our securities were valued by pricing sources with reasonable levels of price transparency. Less than 1% of our securities were priced based on economic models and non-binding dealer quotes, and are included in Level 3 of the ASC 820 hierarchy.

Consolidated collateralized loan obligations

BNY Mellon values assets in consolidated CLOs using observable market prices observed from the secondary loan market. The returns to the note holders are solely dependent on the assets and accordingly equal the value of those assets. Based on the structure of the CLOs, the valuation of the assets is attributable to the senior note holders. Changes in the values of assets and liabilities are reflected in the income statement as investment income and interest of investment management fund note holders, respectively.

Derivatives

We classify exchange-traded derivatives valued using quoted prices in Level 1 of the valuation hierarchy. Examples include exchanged-traded equity and foreign exchange options. Since few other classes of derivative contracts are listed on an exchange, most of our derivative positions are valued using internally developed models that use as their basis readily observable market parameters, and we classify them in Level 2 of the valuation hierarchy. Such derivatives include basic swaps and options and credit default swaps.

Derivatives valued using models with significant unobservable market parameters in markets that lack two-way flow are classified in Level 3 of the valuation hierarchy. Examples include long-dated interest rate or currency swaps and options, where parameters may be unobservable for longer maturities; and certain products, where correlation rates are unobservable. The fair value of these derivatives compose less than 1% of our derivative financial instruments. Additional disclosures of derivative instruments are provided in Note 16 of the Notes to Consolidated Financial Statements.

Loans and unfunded lending-related commitments

Where quoted market prices are not available, we generally base the fair value of loans and unfunded lending-related commitments on observable market prices of similar instruments, including bonds, credit derivatives and loans with similar characteristics. If observable market prices are not available, we base the fair value on estimated cash flows adjusted for credit risk which are discounted using an interest rate appropriate for the maturity of the applicable loans or the unfunded lending-related commitments.

Unrealized gains and losses on unfunded lending-related commitments carried at fair value are classified in Other assets and Other liabilities, respectively. Loans and unfunded lending-related commitments carried at fair value are generally classified within Level 2 of the valuation hierarchy.

Seed capital

In our Investment Management business we manage investment assets, including equities, fixed income, money market and alternative investment funds for institutions and other investors; as part of that activity we make seed capital investments in certain funds. Seed capital is included in other assets. When applicable, we value seed capital based on the published NAV of the fund. We include funds in which ownership interests in the fund are publicly traded in an active market and institutional funds in which investors trade in and out daily in Level 1 of the valuation hierarchy. We include open-end funds where investors are allowed to sell their ownership interest back to the fund less frequently than daily and where our interest in the fund contains no other rights or obligations in Level 2 of the valuation hierarchy. However, we generally include investments in funds that allow investors to sell their ownership interest back to the fund less frequently than monthly in Level 3, unless actual redemption prices are observable.

For other types of investments in funds, we consider all of the rights and obligations inherent in our ownership interest, including the reported NAV as well as other factors that affect the fair value of our interest in the fund. To the extent the NAV measurements reported for the investments are based on unobservable inputs or include other rights and obligations (e.g., obligation to meet cash calls), we generally classify them in Level 3 of the valuation hierarchy.

 

 

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Certain interests in securitizations

For certain interests in securitizations which are classified in securities available-for-sale, trading assets and long-term debt, we use discounted cash flow models which generally include assumptions of projected finance charges related to the securitized assets, estimated net credit losses, prepayment assumptions and estimates of payments to third-party investors. When available, we compare our fair value estimates and assumptions to market activity and to the actual results of the securitized portfolio.

Private equity investments

Our Other segment includes holdings of nonpublic private equity investment through funds managed by third-party investment managers. We value private equity investments initially based upon the transaction price, which we subsequently adjust to reflect expected exit values as evidenced by financing and sale transactions with third parties or through ongoing reviews by the investment managers.

Private equity investments also include publicly held equity investments, generally obtained through the initial public offering of privately held equity investments. These equity investments are often held in a partnership structure. Publicly held investments are marked-to-market at the quoted public value less adjustments for regulatory or contractual sales restrictions or adjustments to reflect the difficulty in selling a partnership interest.

Discounts for restrictions are quantified by analyzing the length of the restriction period and the volatility of the equity security. Publicly held private equity investments are primarily classified in Level 2 of the valuation hierarchy.

The following tables present the financial instruments carried at fair value at June 30, 2012 and Dec. 31, 2011, by caption on the consolidated balance sheet and by ASC 820 valuation hierarchy (as described above). We have included credit ratings information in certain of the tables because the information indicates the degree of credit risk to which we are exposed, and significant changes in ratings classifications could result in increased risk for us. There were no transfers between Level 1 and Level 2 during the second quarter of 2012.

 

 

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Assets and liabilities measured at fair value on a recurring basis at June 30, 2012  
(dollar amounts in millions)    Level 1     Level 2     Level 3     Netting (a)     Total carrying
value
 

Available-for-sale securities:

          

U.S. Treasury

   $ 14,470      $ -      $ -      $ -      $ 14,470   

U.S. Government agencies

     -        1,097        -        -        1,097   

Sovereign debt

     40        8,989        -        -        9,029   

State and political subdivisions (b)

     -        5,560        42        -        5,602   

Agency RMBS

     -        33,032        -        -        33,032   

Alt-A RMBS

     -        258        -        -        258   

Prime RMBS

     -        764        -        -        764   

Subprime RMBS

     -        422        -        -        422   

Other RMBS

     -        2,487        -        -        2,487   

Commercial MBS

     -        3,320        -        -        3,320   

Asset-backed CLOs

     -        1,080        -        -        1,080   

Other asset-backed securities

     -        1,189        -        -        1,189   

Equity securities

     28        -        -        -        28   

Money market funds (b)

     918        -        -        -        918   

Corporate bonds

     -        1,628        -        -        1,628   

Other debt securities

     -        2,251        -        -        2,251   

Foreign covered bonds

     3,158        770        -        -        3,928   

Alt-A RMBS (c)

     -        1,863        -        -        1,863   

Prime RMBS (c)

     -        1,059        -        -        1,059   

Subprime RMBS (c)

     -        115        -        -        115   

Total available-for-sale

     18,614        65,884        42        -        84,540   

Trading assets:

          

Debt and equity instruments (d)

     751        2,205        60        -        3,016   

Derivative assets (e):

          

Interest rate

     37        27,601        34        N/A     

Foreign exchange

     3,014        165        -        N/A     

Equity

     123        237        39        N/A           

Total derivative assets

     3,174        28,003        73        (27,357     3,893   

Total trading assets

     3,925        30,208        133        (27,357     6,909   

Loans

     -        8        -        -        8   

Other assets (f)

     187        1,085        138        -        1,410   

Subtotal assets of operations at fair value

     22,726        97,185        313        (27,357     92,867   

Percentage of assets prior to netting

     19     81     -                

Assets of consolidated investment management funds:

          

Trading assets

     320        10,079        -        -        10,399   

Other assets

     393        163        -        -        556   

Total assets of consolidated investment management funds

     713        10,242        -        -        10,955   

Total assets

   $ 23,439      $ 107,427      $ 313      $ (27,357   $ 103,822   

Percentage of assets prior to netting

     18     82     -                

Trading liabilities:

          

Debt and equity instruments

   $ 535      $ 525      $ -      $ -      $ 1,060   

Derivative liabilities (e):

          

Interest rate

     -        28,406        231        N/A     

Foreign exchange

     3,010        104        -        N/A     

Equity

     86        288        71        N/A           

Total derivative liabilities

     3,096        28,798        302        (26,316     5,880   

Total trading liabilities

     3,631        29,323        302        (26,316     6,940   

Long-term debt (b)

     -        339        -        -        339   

Other liabilities (g)

     -        455        -        -        455   

Subtotal liabilities at fair value

     3,631        30,117        302        (26,316     7,734   

Percentage of liabilities prior to netting

     11     88     1                

Liabilities of consolidated investment management funds:

          

Trading liabilities

     -        9,752        -        -        9,752   

Other liabilities

     -        38        -        -        38   

Total liabilities of consolidated investment management funds

     -        9,790        -        -        9,790   

Total liabilities

   $ 3,631      $ 39,907      $ 302      $ (26,316   $ 17,524   

Percentage of liabilities prior to netting

     8     91     1                

 

(a) ASC 815 permits the netting of derivative receivables and derivative payables under legally enforceable master netting agreements and permits the netting of cash collateral. Netting cannot be disaggregated by product.
(b) Includes certain interests in securitizations.
(c) Previously included in the Grantor Trust.
(d) Includes loans classified as trading assets and certain interests in securitizations.
(e) The Level 1, 2 and 3 fair values of derivative assets and derivative liabilities are presented on a gross basis.
(f) Includes private equity investments, seed capital, a brokerage account, and derivatives in designated hedging relationships.
(g) Includes the fair value adjustment for certain unfunded lending-related commitments and derivatives in designated hedging relationships and support agreements.

 

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Notes to Consolidated Financial Statements (continued)

 

 

Assets and liabilities measured at fair value on a recurring basis at Dec. 31, 2011  
(dollar amounts in millions)    Level 1     Level 2     Level 3     Netting (a)     Total carrying
value
 

Available-for-sale securities:

          

U.S. Treasury

   $ 17,326      $ -      $ -      $ -      $ 17,326   

U.S. Government agencies

     -        958        -        -        958   

Sovereign debt

     44        11,910        -        -        11,954   

State and political subdivisions (b)

     -        2,694        45        -        2,739   

Agency RMBS

     -        26,796        -        -        26,796   

Alt-A RMBS

     -        273        -        -        273   

Prime RMBS

     -        815        -        -        815   

Subprime RMBS

     -        418        -        -        418   

Other RMBS

     -        903        -        -        903   

Commercial MBS

     -        3,339        -        -        3,339   

Asset-backed CLOs

     -        1,444        -        -        1,444   

Other asset-backed securities

     -        532        -        -        532   

Equity securities

     9        21        -        -        30   

Money market funds (b)

     973        -        -        -        973   

Corporate bonds

     -        1,738        -        -        1,738   

Other debt securities

     -        2,622        3        -        2,625   

Foreign covered bonds

     1,820        605        -        -        2,425   

Alt-A RMBS (c)

     -        1,879        -        -        1,879   

Prime RMBS (c)

     -        1,175        -        -        1,175   

Subprime RMBS (c)

     -        125        -        -        125   

Total available-for-sale

     20,172        58,247        48        -        78,467   

Trading assets:

          

Debt and equity instruments (d)

     485        1,655        63        -        2,203   

Derivative assets (e):

          

Interest rate

     164        26,434        54        N/A     

Foreign exchange

     4,519        113        -        N/A     

Equity

     91        284        43        N/A     

Other

     -        3        -        N/A           

Total derivative assets

     4,774        26,834        97        (26,047     5,658   

Total trading assets

     5,259        28,489        160        (26,047     7,861   

Loans

     -        10        -        -        10   

Other assets (f)

     672        1,019        157        -        1,848   

Subtotal assets of operations at fair value

     26,103        87,765        365        (26,047     88,186   

Percentage of assets prior to netting

     23     77     -                

Assets of consolidated investment management funds:

          

Trading assets

     323        10,428        -        -        10,751   

Other assets

     453        143        -        -        596   

Total assets of consolidated investment management funds

     776        10,571        -        -        11,347   

Total assets

   $ 26,879      $ 98,336      $ 365      $ (26,047   $ 99,533   

Percentage of assets prior to netting

     22     78     -                

Trading liabilities:

          

Debt and equity instruments

   $ 418      $ 537      $ -      $ -      $ 955   

Derivative liabilities(e):

          

Interest rate

     -        27,201        239        N/A     

Foreign exchange

     4,311        44        -        N/A     

Equity

     55        200        75        N/A           

Total derivative liabilities

     4,366        27,445        314        (25,009     7,116   

Total trading liabilities

     4,784        27,982        314        (25,009     8,071   

Long-term debt (b)

     -        326        -        -        326   

Other liabilities (g)

     14        368        -        -        382   

Subtotal liabilities at fair value

     4,798        28,676        314        (25,009     8,779   

Percentage of liabilities prior to netting

     14     85     1                

Liabilities of consolidated investment management funds:

          

Trading liabilities

     -        10,053        -        -        10,053   

Other liabilities

     2        30        -        -        32   

Total liabilities of consolidated investment management funds

     2        10,083        -        -        10,085   

Total liabilities

   $ 4,800      $ 38,759      $ 314      $ (25,009   $ 18,864   

Percentage of liabilities prior to netting

     11     88     1                
(a) ASC 815 permits the netting of derivative receivables and derivative payables under legally enforceable master netting agreements and permits the netting of cash collateral. Netting cannot be disaggregated by product.
(b) Includes certain interests in securitizations.
(c) Previously included in the Grantor Trust.
(d) Includes loans classified as trading assets and certain interests in securitizations.
(e) The Level 1, 2 and 3 fair values of derivative assets and derivative liabilities are presented on a gross basis.
(f) Includes private equity investments, seed capital, a brokerage account, and derivatives in designated hedging relationships.
(g) Includes the fair value adjustment for certain unfunded lending-related commitments and derivatives in designated hedging relationships and support agreements.

 

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Notes to Consolidated Financial Statements (continued)

 

 

Details of certain items measured at fair value on a recurring basis  
     June 30, 2012     Dec. 31, 2011  
            Ratings            Ratings  
(dollar amounts in millions)   

Total

carrying
value (a)

     AAA/
AA-
    A+/
A-
    BBB+/
BBB-
    BB+ and
lower
    Total
carrying
value (a)
     AAA/
AA-
    A+/
A-
    BBB+/
BBB-
    BB+ and
lower
 

Alt-A RMBS, originated in:

                      

2006-2007

   $ 97         -         -     100   $ 99         -     -         100

2005

     101         -        -        -        100        113         -        -        -        100   

2004 and earlier

     60         24        14        38        24        61         27        13        47        13   

Total Alt-A RMBS

   $ 258         6     3     9     82   $ 273         6     3     11     80

Prime RMBS, originated in:

                      

2007

   $ 109         42     4     -     54   $ 121         38     4         58

2006

     72         -        -        -        100        75         -        -        -        100   

2005

     223         33        -        -        67        230         32        -        -        68   

2004 and earlier

     360         21        41        6        32        389         29        38        11        22   

Total prime RMBS

   $ 764         25     20     3     52   $ 815         28     19     5     48

Subprime RMBS, originated in:

                      

2007

   $ 1         -         100     -   $ 2         -     2     98     -

2005

     94         22        12        26        40        82         23        12        29        36   

2004 and earlier

     327         3        7        15        75        334         5        15        18        62   

Total subprime RMBS

   $ 422         7     8     18     67   $ 418         8     14     21     57

Commercial MBS—Domestic, originated in:

                      

2009-2012

   $ 198         100         -     -   $ 200         100     -         -

2008

     25         15        85        -        -        25         16        84        -        -   

2007

     867         49        37        14        -        789         66        26        8        -   

2006

     1,038         78        22        -        -        892         85        15        -        -   

2005

     796         94        6        -        -        696         94        6        -        -   

2004 and earlier

     396         95        4        1        -        403         97        2        1        -   

Total commercial MBS—Domestic

   $ 3,320         77     19     4     -   $ 3,005         84     14     2     -

Foreign covered bonds:

                      

Germany

   $ 1,299         99     1     -     -   $ 1,461         99     1         -

Canada

     963         100        -        -        -        795         100        -        -        -   

United Kingdom

     660         100        -        -        -        25         100        -        -        -   

Other

     1,006         100        -        -        -        144         100        -        -        -   

Total foreign covered bonds

   $ 3,928         100     -     -     -   $ 2,425         100     -         -

European floating rate notes – available-for-sale:

                      

United Kingdom

   $ 1,550         78     21     1     -   $ 686         72     28         -

Netherlands

     804         100        -        -        -        47         35        65        -        -   

Ireland

     182         12        -        22        66        203         -        50        47        3   

Italy

     133         100        -        -        -        150         100        -        -        -   

Luxembourg

     -         -        -        -        -        140         -        100        -        -   

Australia

     85         93        7        -        -        101         91        9        -        -   

Spain

     23         100        -        -        -        -         -        -        -        -   

Germany

     62         -        10        89        1        93         21        6        73        -   

France

     9         100        -        -        -        9         100        -        -        -   

Total European floating rate notes – available-for-sale

   $ 2,848         80     12     4     4   $ 1,429         55     34     11     -

Sovereign debt:

                      

United Kingdom

   $ 4,738         100         -     -   $ 4,526         100     -         -

Netherlands

     2,182         100        -        -        -        2,230         100        -        -        -   

France

     1,564         100        -        -        -        2,790         100        -        -        -   

Germany

     489         100        -        -        -        2,347         100        -        -        -   

Other

     56         98        2        -        -        61         97        3        -        -   

Total sovereign debt

   $ 9,029         100         -     -   $ 11,954         100     -     -     -

Alt-A RMBS (b), originated in:

                      

2007

   $ 552         -         -     100   $ 554         -     -         100

2006

     495         -        -        -        100        488         -        -        -        100   

2005

     606         4        -        1        95        628         5        -        1        94   

2004 and earlier

     210         -        4        23        73        209         -        4        27        69   

Total Alt-A RMBS (b)

   $ 1,863         1     1     3     95   $ 1,879         2     -     3     95

Prime RMBS (b), originated in:

                      

2007

   $ 327         -         -     100   $ 370         -     -         100

2006

     285         -        -        -        100        308         -        -        -        100   

2005

     414         1        2        -        97        465         -        4        -        96   

2004 and earlier

     33         5        3        23        69        32         9        -        22        69   

Total prime RMBS (b)

   $ 1,059         -     1     1     98   $ 1,175         -     2     1     97

Subprime RMBS (b), originated in:

                      

2005-2007

   $ 80         -         -     100   $ 88         -     -         100

2004 and earlier

     35         6        -        34        60        37         5        34        -        61   

Total subprime RMBS (b)

   $ 115         2         3     95   $ 125         2     10         88

 

(a) At June 30, 2012 and Dec. 31, 2011, the German foreign covered bonds were considered Level 1 in the valuation hierarchy. All other assets in the table above are primarily Level 2 assets in the valuation hierarchy.
(b) Previously included in the Grantor Trust.

 

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Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Changes in Level 3 fair value measurements

The tables below include a roll forward of the balance sheet amounts (including the change in fair value) for financial instruments classified in Level 3 of the valuation hierarchy.

Our classification of a financial instrument in Level 3 of the valuation hierarchy is based on the significance of the unobservable factors to the overall fair value measurement. However, these instruments generally include other observable

components that are actively quoted or validated to third-party sources; accordingly, the gains and losses in the table below include changes in fair value due to observable parameters as well as the unobservable parameters in our valuation methodologies. We also frequently manage the risks of Level 3 financial instruments using securities and derivatives positions that are Level 1 or 2 instruments which are not included in the table; accordingly, the gains or losses below do not reflect the effect of our risk management activities related to the Level 3 instruments.

 

 

 

Fair value measurements for assets using significant unobservable inputs

for three months ended June 30, 2012

     Available-for-sale securities     Trading assets              
(in millions)    State and political
subdivisions
    Debt and equity
instruments
    Derivative
assets (a)
    Other
assets
    Total
assets
 

Fair value at March 31, 2012

   $ 43      $ 58      $ 72      $ 151      $ 324   

Total gains or (losses) for the period:

          

Included in earnings (or changes in net assets)

     -  (b)      3  (c)      1  (c)      (2 ) (d)      2   

Purchases, sales and settlements:

          

Purchases

     -        -        -        2        2   

Sales

     -        (1     -        (13     (14

Settlements

     (1     -        -        -        (1

Fair value at June 30, 2012

   $ 42      $ 60      $ 73      $ 138      $ 313   

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period

           $ 2      $ 4      $ -      $ 6   
(a) Derivative assets are reported on a gross basis.
(b) Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c) Reported in foreign exchange and other trading revenue.
(d) Reported in investment and other income.

 

 

Fair value measurements for liabilities using significant unobservable inputs

for three months ended June 30, 2012

     Trading liabilities     Total  
(in millions)   

Derivative

liabilities (a)

    liabilities  

Fair value at March 31, 2012

   $ 246      $ 246   

Total (gains) or losses for the period:

    

Included in earnings (or changes in net liabilities)

     56  (b)      56   

Fair value at June 30, 2012

   $ 302      $ 302   

Change in unrealized (gains) or losses for the period included in earnings

    

(or changes in net assets) for liabilities held at the end of the reporting period

   $ 66      $ 66   

 

(a) Derivative liabilities are reported on a gross basis.
(b) Reported in foreign exchange and other trading revenue.

 

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Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

 

 

Fair value measurements for assets using significant unobservable inputs
for three months ended June 30, 2011
 
     Available-for-sale securities     Trading assets                     
(in millions)    State and
political
subdivisions
    Other debt
securities
    Debt and
equity
instruments
    Derivative
assets (a)
    Loans      Other
assets
    Total
assets
 

Fair value at March 31, 2011

   $ 10      $ 64      $ 32      $ 131      $ 4       $ 120      $ 361   

Transfers into Level 3

     -        2        27        2        -         -        31   

Transfers out of Level 3

     -        -        (23     (29     -         -        (52

Total gains or (losses):

               

Included in earnings (or changes in net assets)

     -  (b)      -  (b)      -  (c)      4  (c)      -         (4 (d)      -   

Purchases, issuances, sales and settlements:

               

Issuances

     -        -        -        -        1         -        1   

Settlements

     -        -        -        (1     -         -        (1

Fair value at June 30, 2011

   $ 10      $ 66      $ 36      $ 107      $ 5       $ 116      $ 340   

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period

                   $ -      $ 7      $ -       $ -      $ 7   
(a) Derivative assets are reported on a gross basis.
(b) Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c) Reported in foreign exchange and other trading revenue.
(d) Reported in investment and other income.

 

Fair value measurements for liabilities using significant unobservable inputs
for three months ended June 30, 2011
 
     Trading
liabilities
             
(in millions)   

Derivative

liabilities (a)

    Other
liabilities
    Total
liabilities
 

Fair value at March 31, 2011

   $ 126      $ 2      $ 128   

Transfers into Level 3

     1        -        1   

Total (gains) or losses:

      

Included in earnings (or changes in net assets)

     37  (b)      (2     35   

Purchases, issuances, sales and settlements:

      

Settlements

     (9     -        (9

Fair value at June 30, 2011

   $ 155      $ -      $ 155   

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period

   $ 45      $ (2   $ 43   
(a) Derivative liabilities are reported on a gross basis.
(b) Reported in foreign exchange and other trading revenue.

 

 

Fair value measurements for assets using significant unobservable inputs for six months ended June 30, 2012  
     Available-for-sale securities     Trading assets              
(in millions)    State and
political
subdivisions
    Other debt
securities
    Debt and
equity
instruments
    Derivative
assets (a)
    Other
assets
    Total
assets
 

Fair value at Dec. 31, 2011

   $ 45      $ 3      $ 63      $ 97      $ 157      $ 365   

Total gains or (losses) for the period:

            

Included in earnings (or changes in net assets)

     -  (b)      (3 (b)      -  (c)      (24 ) (c)      (d)      (26

Purchases, sales and settlements:

            

Purchases

     -        -        -        -        5        5   

Sales

     -        -        (3     -        (17     (20

Settlements

     (3     -        -        -        (8     (11

Fair value at June 30, 2012

   $ 42      $ -      $ 60      $ 73      $ 138      $ 313   

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period

                   $ -      $ (7   $ -      $ (7
(a) Derivative assets are reported on a gross basis.
(b) Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c) Reported in foreign exchange and other trading revenue.
(d) Reported in investment and other income.

 

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Notes to Consolidated Financial Statements (continued)

 

 

Fair value measurements for liabilities using significant unobservable inputs
for six months ended June 30, 2012
 
     Trading liabilities        
(in millions)   

Derivative

liabilities (a)

   

Total

liabilities

 

Fair value at Dec. 31, 2011

   $ 314      $ 314   

Total (gains) or losses for the period: Included in earnings (or changes in net liabilities)

     (12 (b)      (12

Fair value at June 30, 2012

   $ 302      $ 302   

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period

   $ (8   $ (8
(a) Derivative liabilities are reported on a gross basis.
(b) Reported in foreign exchange and other trading revenue.

 

Fair value measurements for assets using significant unobservable inputs
for six months ended June 30, 2011
 
     Available-for-sale securities     Trading assets                    
(in millions)    State and
political
subdivisions
    Other debt
securities
    Debt and
equity
instruments
    Derivative
assets (a)
    Loans     Other
assets
    Total
assets
 

Fair value at Dec. 31, 2010

   $ 10      $ 58      $ 32      $ 119      $ 6      $ 113      $ 338   

Transfers into Level 3

     -        8        27        3        -        -        38   

Transfers out of Level 3

     -        -        (23     (43     (2     -        (68

Total gains or (losses):

              

Included in earnings (or changes in net assets)

     - (b)      - (b)      - (c)      29 (c)      -        2 (d)      31   

Purchases, issuances, sales and settlements:

              

Purchases

     -        -        -        -        -        1        1   

Issuances

     -        -        -        -        1        -        1   

Settlements

     -        -        -        (1     -        -        (1

Fair value at June 30, 2011

   $ 10      $ 66      $ 36      $ 107      $ 5      $ 116      $ 340   

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period

                   $ -      $ 39      $ -      $ -      $ 39   
(a) Derivative assets are reported on a gross basis.
(b) Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c) Reported in foreign exchange and other trading revenue.
(d) Reported in investment and other income.

 

Fair value measurements for liabilities using significant unobservable inputs
for six months ended June 30, 2011
 
     Trading liabilities              
(in millions)    Debt and
equity
instruments
    Derivative
liabilities (a)
    Other
liabilities
    Total
liabilities
 

Fair value at Dec. 31, 2010

   $ 6      $ 171      $ 2      $ 179   

Transfer into Level 3

     -        1        -        1   

Total (gains) or losses:

        

Included in earnings (or changes in net assets)

     -        (4 ) (b)      (2     (6

Purchases, issuances, sales and settlements:

        

Settlements

     (6     (13     -        (19

Fair value at June 30, 2011

   $ -      $ 155      $ -      $ 155   

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period

   $ -      $ 19      $ (2   $ 17   
(a) Derivative liabilities are reported on a gross basis.
(b) Reported in foreign exchange and other trading revenue.

 

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Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Level 3 unobservable inputs

The following tables present the unobservable inputs used in valuation of assets and liabilities classified as Level 3 within the fair value hierarchy.

 

Quantitative information about Level 3 fair value measurements of assets  
(dollars in millions)    Fair value at
June 30, 2012
    

Valuation

techniques

  

Unobservable

input

   Range  

Measured on a recurring basis:

           

Available-for-sale securities:

           

State and political subdivisions

   $ 42       Discounted cash flow    Expected credit loss      8% - 39%   

Trading assets:

           

Debt and equity instruments:

           

Structured debt

     30       Option pricing model (a)    Correlation risk      15%   
         Long-term foreign exchange volatility      13%-17%   

Distressed debt

     30       Discounted cash flow    Expected maturity      2-10 years   
         Credit spreads      100-800 bps   

Derivative assets:

           

Interest rate:

           

Structured foreign exchange swaptions

     34       Option pricing model (a)    Correlation risk      0%-25%   
         Long-term foreign exchange volatility      12%-17%   

Equity:

           

Equity options

     39       Option pricing model (a)    Long-term equity volatility      24%-33%   

Measured on a nonrecurring basis:

           

Loans

     35       Discounted cash flows    Timing of sale      0-18 months   
         Cap rate      5.5%-8.0%   
                   Cost to complete/sell      0%-29%   

 

Quantitative information about Level 3 fair value measurements of liabilities  
(dollars in millions)    Fair value at
June 30, 2012
    

Valuation

techniques

  

Unobservable

input

   Range  

Measured on a recurring basis:

           

Trading liabilities:

           

Derivative liabilities:

           

Interest rate:

           

Structured foreign exchange swaptions

   $ 231       Option pricing model (a)    Correlation risk      0 %-25% 
         Long-term foreign exchange volatility      12 %-17% 

Equity:

           

Equity options

     71       Option pricing model (a)    Long-term equity volatility      24 %-33% 

(a) The option pricing model uses market inputs such as foreign currency exchange rates, interest rates and volatility to calculate the fair value of the option.

bps – basis points.

 

At June 30, 2012, the available-for-sale securities categorized as Level 3 within the fair value hierarchy primarily consist of a security issued by a municipality that has filed for bankruptcy. The fair value of this security was determined based on expected credit losses. A significant deviation from the expected credit losses would result in a significantly higher or lower fair value.

At June 30, 2012, debt and equity instruments reported as trading assets on the balance sheet include structured debt and distressed debt. For our structured debt, changes in foreign exchange volatility generally results in a higher or lower fair value, while changes in the correlation of interest and foreign exchange factors generally increases or decreases the fair value

of the instrument. The principal unobservable inputs for distressed debt include credit spreads and expected maturity. Changes in credit spreads or the expected period until maturity would result in an increase or decrease in the fair value of these instruments.

At June 30, 2012, our trading assets and trading liabilities included interest rate derivative assets and liabilities, respectively, and equity derivative assets and liabilities, respectively, classified as Level 3 within the fair value hierarchy. For our structured foreign exchange swaptions, changes in foreign exchange volatility generally results in an increased

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

or decreased liability while changes in the correlation of interest and foreign exchange factors generally results in a favorable or unfavorable movement in the fair value of the instrument. The Company purchases and sells certain long-term equity options based on changes in volatility, which in turn offset option values.

At June 30, 2012, loans measured at fair value on a nonrecurring basis that are included in Level 3 of the fair value hierarchy include collateral dependent loans. Principal unobservable inputs may include forecast timing of sales, cap rates and costs to complete/sell. An increase in holding period, cap rate or costs to complete/sell would generally result in a decrease of the fair value of loans. A decrease in holding period, cap rate or costs to complete/sell would generally result in an increase in fair value of the loans.

Assets and liabilities measured at fair value on a nonrecurring basis

Under certain circumstances, we make adjustments to fair values of our assets, liabilities and unfunded lending-related commitments although they are not measured at fair value on an ongoing basis. An example would be the recording of an impairment of an asset.

The following tables present the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy as of June 30, 2012 and Dec. 31, 2011, for which a nonrecurring change in fair value has been recorded during the quarters ended June 30, 2012 and Dec. 31, 2011.

 

 

Assets measured at fair value on a nonrecurring basis at June 30, 2012      Total  
(in millions)    Level 1      Level 2      Level 3      carrying value  

Loans (a)

   $ -       $ 184       $ 35       $ 219   

Other assets (b)

     -         88         -         88   

Total assets at fair value on a nonrecurring basis

   $ -       $ 272       $ 35       $ 307   

 

Assets measured at fair value on a nonrecurring basis at Dec. 31, 2011      Total  
(in millions)    Level 1      Level 2      Level 3      carrying value  

Loans (a)

   $ -       $ 178       $ 43       $ 221   

Other assets (b)

     -         126         -         126   

Total assets at fair value on a nonrecurring basis

   $ -       $ 304       $ 43       $ 347   
(a) During the quarters ended June 30, 2012 and Dec. 31, 2011, the fair value of these loans was reduced $7 million and $32 million, respectively, based on the fair value of the underlying collateral as allowed by ASC 310, Accounting by Creditors for Impairment of a Loan, with an offset to the allowance for credit losses.
(b) Includes other assets received in satisfaction of debt and loans held for sale. Loans held for sale are carried on the balance sheet at the lower of cost or market value.

 

Estimated fair value of financial instruments

The carrying amounts of our financial instruments (i.e., monetary assets and liabilities) are determined under different accounting methods – see Note 1 to the Consolidated Financial Statements contained in the 2011 Annual Report. The following disclosure discusses these instruments on a uniform fair value basis. However, active markets do not exist for a significant portion of these instruments. For financial instruments where quoted prices from identical assets and liabilities in active markets do not exist, we determine fair value based on discounted cash flow analysis and comparison to similar instruments. Discounted cash flow analysis is dependent upon

estimated future cash flows and the level of interest rates. Other judgments would result in different fair values. Among the assumptions we used at Dec. 31, 2011 and June 30, 2012 are discount rates ranging principally from 0.01% to 4.53%. The fair value information supplements the basic financial statements and other traditional financial data presented throughout this report.

A summary of the practices used for determining fair value and the respective level in the valuation hierarchy for financial assets and liabilities not recorded at fair value is as follows.

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

Interest-bearing deposits with the Federal Reserve and other central banks and interest-bearing deposits with banks

The estimated fair value of interest-bearing deposits with the Federal Reserve and other central banks is equal to the book value as these interest-bearing deposits are generally considered cash equivalents. These instruments are classified as Level 2 within the valuation hierarchy. The estimated fair value of interest-bearing deposits with banks is generally determined using discounted cash flows and duration of the instrument to maturity. The primary inputs used to value these transactions are interest rates based on current LIBOR market rates and time to maturity. Interest-bearing deposits with banks are classified as Level 2 within the valuation hierarchy.

Federal funds sold and securities purchased under resale agreements

The estimated fair value of federal funds sold and securities purchased under resale agreements is based on inputs such as interest rates and tenors. Federal funds sold and securities purchased under resale agreements are classified as Level 2 within the valuation hierarchy.

Securities held-to-maturity

Where quoted prices are available in an active market for identical assets and liabilities, we classify the securities as Level 1 within the valuation hierarchy. Securities are defined as both long and short positions. Level 1 includes U.S. Treasury securities.

If quoted market prices are not available for identical assets and liabilities, we estimate fair value using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of such instruments, which would generally be classified as Level 2 within the valuation hierarchy, include certain agency and non-agency mortgage-backed securities, commercial mortgage-backed securities and state and political subdivision securities.

For securities where quotes from active markets are not available for identical securities, we determine fair value primarily based on pricing sources with reasonable levels of price transparency that employ financial models or obtain comparison to similar instruments to arrive at “consensus” prices.

Specifically, the pricing sources obtain active market prices for similar types of securities (e.g., vintage, position in the securitization structure) and ascertain variables such as discount rate and speed of prepayment for the types of transaction and apply such variables to similar types of bonds. We view these as observable transactions in the current marketplace and classify such securities as Level 2 within the valuation hierarchy.

Loans

For residential mortgage loans, fair value is estimated using discounted cash flow analyses, adjusting where appropriate for prepayment estimates, using interest rates currently being offered for loans with similar terms and maturities to borrowers. The estimated fair value of margin loans and overdrafts is equal to the book value due to the short-term nature of these assets. The estimated fair value of other types of loans is determined using discounted cash flows. Inputs include current LIBOR market rates adjusted for credit spreads. These loans are generally classified as Level 2 within the valuation hierarchy.

Other financial assets

Other financial assets include cash, Federal Reserve Bank stock and accrued interest receivable. Cash is classified as Level 1 within the valuation hierarchy. The Federal Reserve Bank stock is not redeemable or transferable. The estimated fair value of the Federal Reserve Bank stock is based on the redemption price and is classified as Level 2 within the valuation hierarchy. Accrued interest receivable is generally short-term. As a result, book value is considered to equal fair value. Accrued interest receivable is included as Level 2 within the valuation hierarchy.

Noninterest-bearing and interest-bearing deposits

Interest-bearing deposits are comprised of demand, money markets, savings deposits and time deposits. Except for time deposits, book value is considered to equal fair value for these deposits due to their short duration to maturity or payable on demand feature. The fair value of interest-bearing time deposits is determined using discounted cash flow analysis. Inputs primarily consist of current LIBOR market rates and time to maturity. For all noninterest-bearing deposits, book value is considered to equal fair value as a result of the short duration of the deposit. Interest-bearing and noninterest-bearing

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

deposits are classified as Level 2 within the valuation hierarchy.

Federal funds purchased and securities sold under repurchase agreements

The estimated fair value of federal funds purchased and securities sold under repurchase agreements is based on inputs such as interest rates and tenors. Federal funds purchased and securities sold under repurchase agreements are classified as Level 2 within the valuation hierarchy.

Payables to customers and broker-dealers

The estimated fair value of payables to customers and broker-dealers is equal to the book value due to demand feature of the payables to customers and broker-dealers and are classified as Level 2 within the valuation hierarchy.

Borrowings

Borrowings primarily consist of overdrafts of subcustodian account balances in our Investment Services businesses, commercial paper and accrued

interest payable. The estimated fair value of overdrafts of subcustodian account balances in our Investment Services businesses is considered to equal book value as a result of the short duration of the overdrafts. Overdrafts are typically repaid within two days. The estimated fair value of our commercial paper is based on discount and duration of the commercial paper. Our commercial paper matures within 397 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment. Our commercial paper is included in Level 2 of the valuation hierarchy. Accrued interest payable is generally short-term. As a result, book value is considered to equal fair value. Accrued interest payable is included as Level 2 within the valuation hierarchy.

Long-term debt

The estimated fair value of long-term debt is based on current rates for instruments of the same remaining maturity or quoted market prices for the same or similar issues. Long-term debt is classified as Level 2 within the valuation hierarchy.

 

 

Summary of financial instruments    June 30, 2012      Dec. 31, 2011  
(in millions)    Level 1      Level 2      Level 3      Total
estimated
fair value
     Carrying
amount
     Estimated
fair value
     Carrying
amount
 

Assets:

                    

Interest-bearing deposits with the Federal

                    

Reserve and other central banks

   $ -       $ 76,243       $ -       $ 76,243       $ 76,243       $ 90,243       $ 90,243   

Interest-bearing deposits with banks

     -         39,782         -         39,782         39,743         36,381         36,321   

Federal funds sold and securities purchased under resale agreements

     -         8,543         -         8,543         8,543         4,510         4,510   

Securities held-to-maturity

     922         7,947         -         8,869         8,794         3,540         3,521   

Loans

     -         42,689         -         42,689         42,549         41,166         40,970   

Other financial assets

     4,522         1,190         -         5,712         5,712         5,336         5,336   

Total

   $ 5,444       $ 176,394       $ -       $ 181,838       $ 181,584       $ 181,176       $ 180,901   

Liabilities:

                    

Noninterest-bearing deposits

   $ -       $ 76,933       $ -       $ 76,933       $ 76,933       $ 95,335       $ 95,335   

Interest-bearing deposits

     -         144,214         -         144,214         144,211         123,759         123,759   

Federal funds purchased and securities sold under repurchase agreements

     -         9,162         -         9,162         9,162         6,267         6,267   

Payables to customers and broker-dealers

     -         13,305         -         13,305         13,305         12,671         12,671   

Borrowings

     -         3,127         -         3,127         3,127         2,376         2,376   

Long-term debt

     -         20,357         -         20,357         19,536         20,459         19,933   

Total

   $ -       $ 267,098       $ -       $ 267,098       $ 266,274       $ 260,867       $ 260,341   

 

BNY Mellon    103


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

The table below summarizes the carrying amount of the hedged financial instruments, the notional amount of the hedge and the unrealized gain (loss) (estimated fair value) of the derivatives.

 

Hedged financial instruments   

Carrying
amount

    

Notional

amount
of hedge

     Unrealized  
(in millions)          Gain      (Loss)  

At June 30, 2012:

           

Interest-bearing deposits with banks

   $ 7,500       $ 7,500       $ 173       $ -   

Securities available-for-sale

     5,317         4,919         -         (450

Deposits

     10         10         1         -   

Long-term debt

     16,239         15,396         988         (8

At Dec. 31, 2011:

           

Interest-bearing deposits with banks

   $ 8,789       $ 8,789       $ 441       $ (17

Securities available-for-sale

     4,354         4,009         -         (289

Deposits

     10         10         1         -   

Long-term debt

     15,048         14,262         964         (9

 

Note 15 – Fair value option

ASC 825 provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments and written loan commitments.

The following table presents the assets and liabilities, by type, of consolidated investment management funds recorded at fair value.

 

Assets and liabilities of consolidated investment
  management funds, at fair value
               
(in millions)    June 30,
2012
     Dec. 31,
2011
 

Assets of consolidated investment management funds:

     

Trading assets

   $ 10,399       $ 10,751   

Other assets

     556         596   

Total assets of consolidated investment management funds

   $ 10,955       $ 11,347   

Liabilities of consolidated investment management funds:

     

Trading liabilities

   $ 9,752       $ 10,053   

Other liabilities

     38         32   

Total liabilities of consolidated investment management funds

   $ 9,790       $ 10,085   

BNY Mellon values assets in consolidated CLOs using observable market prices observed from the secondary loan market. The returns to the note holders are solely dependent on the assets and accordingly equal the value of those assets. Accordingly, mark-to-market best reflects the limited interest BNY Mellon has in the economic performance of the consolidated CLOs. Changes in the values of assets and liabilities are reflected in the income statement as investment income (loss) from consolidated investment management funds.

We have elected the fair value option on $240 million of long-term debt in connection with ASC 810. At June 30, 2012, the fair value of this long-term debt was $339 million. The long-term debt is valued using observable market inputs and is included in Level 2 of the ASC 820 hierarchy.

The following table presents the changes in fair value of the long-term debt included in foreign exchange and other trading revenue in the consolidated income statement.

 

Foreign exchange and other trading revenue                
     Quarter ended     Year-to-date  
(in millions)    June 30,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 

Long-term debt (a)

   $ (19   $ (11   $ (13   $ (10
(a) The change in fair value of the long-term debt is approximately offset by an economic hedge included in trading.

Note 16 – Derivative instruments

We use derivatives to manage exposure to market risk, interest rate risk, credit risk and foreign currency risk. Our trading activities are focused on acting as a market-maker for our customers and facilitating customer trades. In addition, we periodically manage positions for our own account. Positions managed for our own account are immaterial to our overall results of operations.

The notional amounts for derivative financial instruments express the dollar volume of the transactions; however, credit risk is much smaller. We perform credit reviews and enter into netting agreements to minimize the credit risk of derivative financial instruments. We enter into offsetting

 

 

104    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

positions to reduce exposure to foreign exchange, interest rate and equity risk.

Use of derivative financial instruments involves reliance on counterparties. Failure of a counterparty to honor its obligation under a derivative contract is a risk we assume whenever we engage in a derivative contract. There were no counterparty default losses in the second quarter of 2012 or 2011.

Hedging derivatives

We utilize interest rate swap agreements to manage our exposure to interest rate fluctuations. For hedges of investment securities available-for-sale, deposits and long-term debt, the hedge documentation specifies the terms of the hedged items and the interest rate swaps and indicates that the derivative is hedging a fixed rate item and is a fair value hedge, that the hedge exposure is to the changes in the fair value of the hedged item due to changes in benchmark interest rates, and that the strategy is to eliminate fair value variability by converting fixed-rate interest payments to LIBOR.

The securities hedged consist of sovereign debt and U.S. Treasury bonds that had original maturities of 30 years or less at initial purchase. The swaps on the sovereign debt and U.S. Treasury bonds are not callable. All of these securities are hedged with “pay fixed rate, receive variable rate” swaps of similar maturity, repricing and fixed rate coupon. At June 30, 2012, $4.7 billion face amount of securities were hedged with interest rate swaps that had notional values of $4.9 billion.

The fixed rate deposits hedged generally have original maturities of three to six years and are not callable. These deposits are hedged with “receive fixed rate, pay variable” rate swaps of similar maturity, repricing and fixed rate coupon. The swaps are not callable. At June 30, 2012, $10 million face amount of deposits were hedged with interest rate swaps that had notional values of $10 million.

The fixed rate long-term debts hedged generally have original maturities of five to 30 years. We issue both callable and non-callable debt. The non-callable debt is hedged with simple interest rate swaps similar to those described for deposits. Callable debt is hedged with callable swaps where the call dates of the swaps exactly match the call dates of the debt. At June 30, 2012, $15.4 billion

par value of debt was hedged with interest rate swaps that had notional values of $15.4 billion.

In addition, we enter into foreign exchange hedges. We use forward foreign exchange contracts with maturities of nine months or less to hedge our British Pound, Euro and Indian Rupee foreign exchange exposure with respect to foreign currency forecasted revenue and expense transactions in entities that have the U.S. dollar as their functional currency. As of June 30, 2012, the hedged forecasted foreign currency transactions and designated forward foreign exchange contract hedges were $133 million (notional), with $2 million of pre-tax gain recorded in accumulated other comprehensive income. This gain will be reclassified to income or expense over the next nine months.

We use forward foreign exchange contracts with remaining maturities of six months or less as hedges against our foreign exchange exposure to Australian Dollar, Euro, Danish Krona, British Pound, Swiss Franc and Japanese Yen with respect to interest-bearing deposits with banks and their associated forecasted interest revenue. These hedges are designated as cash flow hedges. These hedges are effected such that their maturities and notional values match those of the deposits with banks. As of June 30, 2012, the hedged interest-bearing deposits with banks and their designated forward foreign exchange contract hedges were $7.5 billion (notional), with a pre-tax gain of less than $1 million recorded in accumulated other comprehensive income. This gain will be reclassified to net interest revenue over the next six months.

Forward foreign exchange contracts are also used to hedge the value of our net investments in foreign subsidiaries. These forward foreign exchange contracts usually have maturities of less than two years. The derivatives employed are designated as hedges of changes in value of our foreign investments due to exchange rates. Changes in the value of the forward foreign exchange contracts offset the changes in value of the foreign investments due to changes in foreign exchange rates. The change in fair market value of these forward foreign exchange contracts is deferred and reported within accumulated translation adjustments in shareholders’ equity, net of tax. At June 30, 2012, forward foreign exchange contracts with notional amounts totaling $5.1 billion were designated as hedges.

 

 

BNY Mellon    105


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

In addition to forward foreign exchange contracts, we also designate non-derivative financial instruments as hedges of our net investments in foreign subsidiaries. Those non-derivative financial instruments designated as hedges of our net investments in foreign subsidiaries were all long-term liabilities of BNY Mellon in various currencies, and, at June 30, 2012, had a combined U.S. dollar equivalent value of $494 million.

Ineffectiveness related to derivatives and hedging relationships was recorded in income as follows:

 

Ineffectiveness    Six months ended  
(in millions)    June 30,
2012
    June 30,
2011
 

Fair value hedge of securities

   $ 0.7      $ (4.0

Fair value hedge of deposits and long-term debt

     (1.4     (4.2

Cash flow hedges

     0.1        (0.1

Other (a)

     (0.1     (0.1

Total

   $ (0.7   $ (8.4
(a) Includes ineffectiveness recorded on foreign exchange hedges.
 

 

Impact of derivative instruments on the balance sheet  
     Notional Value      Asset Derivatives
Fair Value
    Liability Derivatives
Fair Value
 
(in millions)    June 30,
2012
     Dec. 31,
2011
     June 30,
2012
    Dec. 31,
2011
    June 30,
2012
    Dec. 31,
2011
 

Derivatives designated as hedging instruments (a):

              

Interest rate contracts

   $ 20,325       $ 18,281       $ 995      $ 965      $ 458      $ 298   

Foreign exchange contracts

     12,729         14,160         237        635        4        21   

Total derivatives designated as hedging instruments

                     $ 1,232      $ 1,600      $ 462      $ 319   

Derivatives not designated as hedging instruments (b):

              

Interest rate contracts

   $ 896,213       $ 975,308       $ 27,672      $ 26,652      $ 28,637      $ 27,440   

Equity contracts

     11,612         8,205         399        418        445        330   

Credit contracts

     221         333         -        3        -        -   

Foreign exchange contracts

     379,003         379,235         3,179        4,632        3,114        4,355   

Total derivatives not designated as hedging instruments

                     $ 31,250      $ 31,705      $ 32,196      $ 32,125   

Total derivatives fair value (c)

         $ 32,482      $ 33,305      $ 32,658      $ 32,444   

Effect of master netting agreements (d)

                       (27,357     (26,047     (26,316     (25,009

Fair value after effect of master netting agreements

                     $ 5,125      $ 7,258      $ 6,342      $ 7,435   

 

(a) The fair value of asset derivatives and liability derivatives designated as hedging instruments is recorded as other assets and other liabilities, respectively, on the balance sheet.
(b) The fair value of asset derivatives and liability derivatives not designated as hedging instruments is recorded as trading assets and trading liabilities, respectively, on the balance sheet.
(c) Fair values are on a gross basis, before consideration of master netting agreements, as required by ASC 815.
(d) Master netting agreements are reported net of cash collateral received and paid of $1,298 million and $257 million, respectively, at June 30, 2012, and $1,269 million and $231 million, respectively at Dec. 31, 2011.

 

At June 30, 2012, $481 billion (notional) of interest rate contracts will mature within one year, $227 billion between one and five years, and $209 billion after five years. At June 30, 2012, $376 billion

(notional) of foreign exchange contracts will mature within one year, $8 billion between one and five years, and $8 billion after five years.

 

 

 

Impact of derivative instruments on the income statement

(in millions)

 

Derivatives in fair

value hedging

   Location of gain or (loss)
recognized in income on
     Gain or (loss) recognized
in income on derivatives
     Location of gain or (loss)
recognized in income on
     Gain or (loss) recognized
in hedged item
 
relationships    derivatives      2Q12     1Q12      2Q11      hedged item      2Q12      1Q12     2Q11  

Interest rate contracts

     Net interest revenue       $ (249   $ 127       $ 95         Net interest revenue       $ 248       $ (127   $ (97

 

106    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Derivatives

in cash

flow hedging

   Gain or (loss)
recognized in
accumulated OCI
on derivatives
(effective portion)
   

Location of gain or
(loss) reclassified
from accumulated
OCI into income

(effective portion)

   gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
   

Location of gain or
(loss) recognized in
income on derivatives
(ineffective portion  and
amount excluded from

effectiveness testing)

   Gain or (loss)
recognized

in income on
derivatives
(ineffectiveness

portion and
amount excluded from
effectiveness testing)
 
relationships    2Q12     1Q12     2Q11        2Q12     1Q12     2Q11        2Q12      1Q12      2Q11  

FX contracts

   $ 9      $ (2   $ (56   Net interest revenue    $ 8      $ (4   $ (50   Net interest revenue    $ -       $ -       $ -   

FX contracts

     (1     3        (3   Other revenue      (1     2        (3   Other revenue      -         0.1         -   

FX contracts

     81        342        155      Trading revenue      81        342        156      Trading revenue      -         -         -   

FX contracts

     1        (1     1      Salary expense      -        (1     1      Salary expense      -         -         -   

Total

   $ 90      $ 342      $ 97           $ 88      $ 339      $ 104           $ -       $ 0.1       $ -   

 

Derivatives in

net investment

hedging

   Gain or (loss)
recognized in
accumulated OCI

on derivatives
(effective portion)
    Location of gain or
(loss) reclassified
from accumulated
OCI into income
   Gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
     Location of gain or
(loss) recognized in
income on derivatives
(ineffective  portion and
amount excluded from
   Gain or (loss) recognized
in income on derivatives
(ineffectiveness

portion and
amount excluded from
effectiveness testing)
 
relationships    2Q12      1Q12     2Q11     (effective portion)    2Q12      1Q12      2Q11      effectiveness testing)    2Q12      1Q12     2Q11  

FX contracts

   $ 110       $ (139   $ (12   Net interest revenue    $  -       $ -       $  -       Other revenue    $  -       $ (0.1   $ -   

 

 

Impact of derivative instruments on the income statement

(in millions)

 

Derivatives in fair

value hedging

relationships

  

Location of gain or (loss)

recognized in income on

derivatives

     Gain or (loss) recognized
in income on derivatives
Six months ended
    

Location of gain or (loss)

recognized in income on

hedged item

     Gain or (loss)
in hedged item
Six months ended
 
      June 30,
2012
    June 30,
2011
        June 30,
2012
     June 30,
2011
 

Interest rate contracts

     Net interest revenue       $ (122   $ 16         Net interest revenue       $ 121       $ (24

 

Derivatives

in cash

flow hedging

relationships

   Gain or (loss)
recognized in
accumulated OCI
on derivatives
(effective portion)
Six months ended
    Location of gain  or
(loss) reclassified
from accumulated

OCI into income
(effective portion)
     Gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
Six months ended
    Location of gain  or
(loss) recognized in
income on derivatives
(ineffective portion and

amount excluded from
effectiveness testing)
     Gain or (loss)
recognized in income on
derivatives (ineffectiveness
portion and amount

excluded from
effectiveness testing) Six
months ended
 
   June 30,
2012
     June 30,
2011
       June 30,
2012
    June 30,
2011
       June 30,
2012
     June 30,
2011
 

FX contracts

   $ 7       $ (61     Net interest revenue       $ 4      $ (61     Net interest revenue       $ -       $ -   

FX contracts

     2         (8     Other revenue         1        (4     Other revenue         0.1         (0.1

FX contracts

     423         (331     Trading revenue         423        (331     Trading revenue         -         -   

FX contracts

     -         4        Salary expense         (1     1        Salary expense         -         -   

Total

   $ 432       $ (396            $ 427      $ (395            $ 0.1       $ (0.1

 

Derivatives in

net investment

hedging

relationships

   Gain or (loss)
recognized in
accumulated OCI

on derivatives
(effective portion)
Six months ended
    Location of gain  or
(loss) reclassified
from accumulated

OCI into income
(effective portion)
     Gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
Six months ended
     Location of gain or
(loss) recognized in
income on derivatives
(ineffective portion and

amount excluded from
effectiveness testing)
   Gain or (loss)
recognized in income on
derivatives (ineffectiveness
portion and amount

excluded from
effectiveness testing)
Six months ended
 
   June 30,
2012
    June 30,
2011
       June 30,
2012
     June 30,
2011
        June 30,
2012
    June 30,
2011
 

FX contracts

   $ (29   $ (181     Net interest revenue       $  -       $  -       Other revenue    $ (0.1   $    (0.1) 

 

BNY Mellon    107


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Trading activities (including trading derivatives)

We manage trading risk through a system of position limits, a VaR methodology based on Monte Carlo simulations, stop loss advisory triggers, and other market sensitivity measures. Risk is monitored and reported to senior management by a separate unit on a daily basis. Based on certain assumptions, the VaR methodology is designed to capture the potential overnight pre-tax dollar loss from adverse changes in fair values of all trading positions. The calculation assumes a one-day holding period for most instruments, utilizes a 99% confidence level, and incorporates the non-linear characteristics of options. The VaR model is one of several statistical models used to develop economic capital results, which is allocated to lines of business for computing risk-adjusted performance.

As the VaR methodology does not evaluate risk attributable to extraordinary financial, economic or other occurrences, the risk assessment process includes a number of stress scenarios based upon the risk factors in the portfolio and management’s assessment of market conditions. Additional stress scenarios based upon historic market events are also performed. Stress tests, by their design, incorporate the impact of reduced liquidity and the breakdown of observed correlations. The results of these stress tests are reviewed weekly with senior management.

Revenue from foreign exchange and other trading included the following:

 

Foreign exchange and other trading revenue  
                        Year-to-date  
(in millions)    2Q12      1Q12     2Q11     2012     2011  

Foreign exchange

   $ 157       $ 136      $ 184      $ 293      $ 357   

Fixed income

     16         47        28        63        45   

Credit derivatives (a)

     1         (2     (1     (1     (2

Other

     6         10        11        16        20   

Total

   $ 180       $ 191      $ 222      $ 371      $ 420   
(a) Used as economic hedges of loans.

Foreign exchange includes income from purchasing and selling foreign currencies and currency forwards, futures, and options. Fixed income reflects results from futures and forward contracts, interest rate swaps, foreign currency swaps, options, and fixed income securities. Credit derivatives include revenue from credit default swaps. Other primarily includes income from equity securities and equity derivatives.

Counterparty credit risk and collateral

We assess credit risk of our counterparties through regular examination of their financial statements, confidential communication with the management of those counterparties and regular monitoring of publicly available credit rating information. This and other information is used to develop proprietary credit rating metrics used to assess credit quality.

Collateral requirements are determined after a comprehensive review of the credit quality of each counterparty. Collateral is generally held or pledged in the form of cash or highly liquid government securities. Collateral requirements are monitored and adjusted daily.

Additional disclosures concerning derivative financial instruments are provided in Note 14 of the Notes to Consolidated Financial Statements.

Disclosure of contingent features in over-the-counter (“OTC”) derivative instruments

Certain OTC derivative contracts and/or collateral agreements of The Bank of New York Mellon, our largest banking subsidiary and the subsidiary through which BNY Mellon enters into the substantial majority of all of its OTC derivative contracts and/or collateral agreements, contain provisions that may require us to take certain actions if The Bank of New York Mellon’s public debt rating fell to a certain level. Early termination provisions, or “close-out” agreements, in those contracts could trigger immediate payment of outstanding contracts that are in net liability positions. Certain collateral agreements would require The Bank of New York Mellon to immediately post additional collateral to cover some or all of The Bank of New York Mellon’s liabilities to a counterparty.

The following table shows the fair value of contracts falling under early termination provisions that were in net liability positions as of June 30, 2012 for three key ratings triggers:

 

If The Bank of New York

Mellon’s rating was changed

to (Moody’s/S&P)

  

Potential close-out

exposures (fair value) (a)

 

A3/A-

   $  893 million   

Baa2/BBB

   $  1,235 million   

Bal/BB+

   $ 2,912 million   
(a) The change between rating categories is incremental, not cumulative.
 

 

108    BNY Mellon


Table of Contents

Notes to Consolidated Financial Statements (continued)

 

 

Additionally, if The Bank of New York Mellon’s debt rating had fallen below investment grade on June 30, 2012, existing collateral arrangements would have required us to have posted an additional $504 million of collateral.

Note 17 – Commitments and contingent liabilities

In the normal course of business, various commitments and contingent liabilities are outstanding which are not reflected in the accompanying consolidated balance sheets.

Our significant trading and off-balance sheet risks are foreign currency and interest rate risk management products, commercial lending commitments, letters of credit, securities lending indemnifications and support agreements. We assume these risks to reduce interest rate and foreign currency risks, to provide customers with the ability to meet credit and liquidity needs and to hedge foreign currency and interest rate risks. These items involve, to varying degrees, credit, foreign exchange, and interest rate risk not recognized in the balance sheet. Our off-balance sheet risks are managed and monitored in manners similar to those used for on-balance sheet risks. Significant industry concentrations related to credit exposure at June 30, 2012 are disclosed in the Financial institutions portfolio exposure table and the Commercial portfolio exposure table below.

 

Financial institutions

portfolio exposure

   June 30, 2012  
(in billions)    Loans      Unfunded
commitments
     Total
exposure
 

Banks

   $ 5.5       $ 1.7       $ 7.2   

Securities industry

     3.5         2.0         5.5   

Insurance

     0.2         4.4         4.6   

Asset managers

     1.1         3.5         4.6   

Government

     -         1.7         1.7   

Other

     0.2         1.3         1.5   

Total

   $ 10.5       $ 14.6       $ 25.1   

 

Commercial portfolio exposure    June 30, 2012  
(in billions)    Loans      Unfunded
commitments
     Total
exposure
 

Services and other

   $ 0.7       $ 5.4       $ 6.1   

Manufacturing

     0.3         5.4         5.7   

Energy and utilities

     0.3         4.9         5.2   

Media and telecom

     0.1         1.6         1.7   

Total

   $ 1.4       $ 17.3       $ 18.7   

Major concentrations in securities lending are primarily to broker-dealers and are generally collateralized with cash. Securities lending transactions are discussed below.

The following table presents a summary of our off-balance sheet credit risks, net of participations.

 

Off-balance sheet credit risks

(in millions)

   June 30,
2012
     Dec 31,
2011
 

Lending commitments (a)

   $ 29,448       $ 28,406   

Standby letters of credit (b)

     6,462         6,707   

Commercial letters of credit

     217         437   

Securities lending indemnifications

     275,093         268,812   

Support agreements

     40         63   

 

(a) Net of participations totaling $285 million at June 30, 2012 and $326 million at Dec. 31, 2011.
(b) Net of participations totaling $1.4 billion at June 30, 2012 and $1.2 billion at Dec. 31, 2011.

Included in lending commitments are facilities that provide liquidity for variable rate tax-exempt securities wrapped by monoline insurers. The credit approval for these facilities is based on an assessment of the underlying tax-exempt issuer and considers factors other than the financial strength of the monoline insurer.

The total potential loss on undrawn lending commitments, standby and commercial letters of credit, and securities lending indemnifications is equal to the total notional amount if drawn upon, which does not consider the value of any collateral.

Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements. A summary of lending commitment maturities is as follows: $8.5 billion less than one year, $20.8 billion in one to five years, and $155 million over five years.

Standby letters of credit (“SBLC”) principally support corporate obligations. As shown in the off-balance sheet credit risks table, the maximum potential exposure of SBLCs was $6.5 billion at June 30, 2012 and $6.7 billion at Dec. 31, 2011, and includes $538 million and $485 million that were collateralized with cash and securities at June 30, 2012 and Dec. 31, 2011, respectively. At June 30, 2012, approximately $4.2 billion of the SBLCs will expire within one year and $2.3 billion in one to five years.

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

We must recognize, at the inception of standby letters of credit and foreign and other guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. As required by ASC 460 – Guarantees, the fair value of the liability, which was recorded with a corresponding asset in other assets, was estimated as the present value of contractual customer fees.

The estimated liability for losses related to these commitments and SBLCs, if any, is included in the allowance for lending-related commitments. The allowance for lending-related commitments was $105 million at June 30, 2012 and $103 million at Dec. 31, 2011.

Payment/performance risk of SBLCs is monitored using both historical performance and internal ratings criteria. BNY Mellon’s historical experience is that SBLCs typically expire without being funded. SBLCs below investment grade are monitored closely for payment/performance risk. The table below shows SBLCs by investment grade:

 

Standby letters of credit   

June 30,

2012

   

Dec. 31,

2011

 

Investment grade

     91     91

Non investment grade

     9     9

A commercial letter of credit is normally a short-term instrument used to finance a commercial contract for the shipment of goods from a seller to a buyer. Although the commercial letter of credit is contingent upon the satisfaction of specified conditions, it represents a credit exposure if the buyer defaults on the underlying transaction. As a result, the total contractual amounts do not necessarily represent future cash requirements. Commercial letters of credit totaled $217 million at June 30, 2012 compared with $437 million at Dec. 31, 2011.

A securities lending transaction is a fully collateralized transaction in which the owner of a security agrees to lend the security (typically through an agent, in our case, The Bank of New York Mellon), to a borrower, usually a broker-dealer or bank, on an open, overnight or term basis, under the terms of a prearranged contract, which normally matures in less than 90 days.

We typically lend securities with indemnification against borrower default. We generally require the borrower to provide cash collateral with a value of 102% of the fair value of the securities borrowed,

which is monitored on a daily basis, thus reducing credit risk. Market risk can also arise in securities lending transactions. These risks are controlled through policies limiting the level of risk that can be undertaken. Securities lending transactions are generally entered into only with highly rated counterparties. Securities lending indemnifications were secured by collateral of $283 billion at June 30, 2012 and $276 billion at Dec. 31, 2011.

At June 30, 2012, our potential maximum exposure to support agreements was approximately $40 million, after deducting the reserve, assuming the securities subject to these agreements being valued at zero and the NAV of the related funds declining below established thresholds. This compares with $63 million at Dec. 31, 2011.

Trust activities

As a result of the Global Investment Servicing acquisition, at June 30, 2012, our clients maintained approximately $236 million of custody cash on deposit with other institutions. Revenue generated from these balances is included in investment and other income on the income statement. These deposits are expected to transition to BNY Mellon in 2012.

Indemnification Arrangements under Ordinary Course Contracts

We have provided standard representations for underwriting agreements, acquisition and divestiture agreements, sales of loans and commitments, and other similar types of arrangements and customary indemnification for claims and legal proceedings related to providing financial services that are not otherwise included above. Insurance has been purchased to mitigate certain of these risks. Generally, there are no stated or notional amounts included in these indemnifications and the contingencies triggering the obligation for indemnification are not expected to occur. Furthermore, often counterparties to these transactions provide us with comparable indemnifications. We are unable to develop an estimate of the maximum payout under these indemnifications for several reasons. In addition to the lack of a stated or notional amount in a majority of such indemnifications, we are unable to predict the nature of events that would trigger indemnification or the level of indemnification for a certain event. We believe, however, that the possibility that we will have to make any material

 

 

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payments for these indemnifications is remote. At June 30, 2012 and Dec. 31, 2011, we have not recorded any material liabilities under these arrangements.

Clearing and Settlement Exchanges

We are a minority equity investor in, and member of, several industry clearing or settlement exchanges through which foreign exchange, securities, or other transactions settle. Certain of these industry clearing or settlement exchanges require their members to guarantee their obligations and liabilities or to provide financial support in the event other members do not honor their obligations. We believe the likelihood that a clearing or settlement exchange (of which we are a member) would become insolvent is remote. Additionally, certain settlement exchanges have implemented loss allocation policies which enable the exchange to allocate settlement losses to the members of the exchange. It is not possible to quantify such mark-to-market loss until the loss occurs. In addition, any ancillary costs that occur as a result of any mark-to-market loss cannot be quantified. At June 30, 2012 and Dec. 31, 2011, we have not recorded any material liabilities under these arrangements.

Legal proceedings

In the ordinary course of business, BNY Mellon and its subsidiaries are routinely named as defendants in or made parties to pending and potential legal actions and regulatory matters. Claims for significant monetary damages are often asserted in many of these legal actions, while claims for disgorgement, penalties and/or other remedial sanctions may be sought in regulatory matters. It is inherently difficult to predict the eventual outcomes of such matters given their complexity and the particular facts and circumstances at issue in each of these matters. However, on the basis of our current knowledge and understanding, we do not believe that judgments or settlements, if any, arising from these matters (either individually or in the aggregate, after giving effect to applicable reserves and insurance coverage) will have a material adverse effect on the consolidated financial position or liquidity of BNY Mellon, although they could have a material effect on net income in a given period.

In view of the inherent unpredictability of outcomes in litigation and regulatory matters, particularly where (i) the damages sought are substantial or indeterminate, (ii) the proceedings are in the early

stages, or (iii) the matters involve novel legal theories or a large number of parties, as a matter of course there is considerable uncertainty surrounding the timing or ultimate resolution of litigation and regulatory matters, including a possible eventual loss, fine, penalty or business impact, if any, associated with each such matter. In accordance with applicable accounting guidance, BNY Mellon establishes reserves for litigation and regulatory matters when those matters proceed to a stage where they present loss contingencies that are both probable and reasonably estimable. In such cases, there may be a possible exposure to loss in excess of any amounts accrued. BNY Mellon will continue to monitor such matters for developments that could affect the amount of the reserve, and will adjust the reserve amount as appropriate. If the loss contingency in question is not both probable and reasonably estimable, BNY Mellon does not establish a reserve and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. BNY Mellon believes that its accruals for legal proceedings are appropriate and, in the aggregate, are not material to the consolidated financial position of BNY Mellon, although future accruals could have a material effect on net income in a given period.

For certain of those matters described herein for which a loss contingency may, in the future, be reasonably possible (whether in excess of a related accrued liability or where there is no accrued liability), BNY Mellon is currently unable to estimate a range of reasonably possible loss. For those matters where BNY Mellon is able to estimate a reasonably possible loss, exclusive of matters described in Note 11 of the Notes to Consolidated Financial Statements, subject to the accounting and reporting requirements of ASC 740 (FASB Interpretation 48), the aggregate range of such reasonably possible loss is up to $520 million in excess of the accrued liability (if any) related to those matters.

The following describes certain judicial, regulatory and arbitration proceedings involving BNY Mellon:

Sentinel Matters

As previously disclosed, on Jan. 18, 2008, The Bank of New York Mellon filed a proof of claim in the Chapter 11 bankruptcy proceeding of Sentinel Management Group, Inc. (“Sentinel”) pending in federal court in the Northern District of Illinois, seeking to recover approximately $312 million

 

 

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loaned to Sentinel and secured by securities and cash in an account maintained by Sentinel at The Bank of New York Mellon. On March 3, 2008, the bankruptcy trustee filed an adversary complaint against The Bank of New York Mellon seeking to disallow The Bank of New York Mellon’s claim and seeking damages for allegedly aiding and abetting Sentinel insiders in misappropriating customer assets and improperly using those assets as collateral for the loan. In a decision dated Nov. 3, 2010, the court found for The Bank of New York Mellon and against the bankruptcy trustee, holding that The Bank of New York Mellon’s loan to Sentinel is valid, fully secured and not subject to equitable subordination. The bankruptcy trustee appealed this decision on Dec. 1, 2010.

As previously disclosed, in November 2009, the Division of Enforcement of the U.S. Commodities Futures Trading Commission (“CFTC”) indicated that it is considering a recommendation to the CFTC that it file a civil enforcement action against The Bank of New York Mellon for possible violations of the Commodity Exchange Act and CFTC regulations in connection with its relationship to Sentinel. The Bank of New York Mellon responded in writing to the CFTC on Jan. 29, 2010 and provided an explanation as to why an enforcement action is unwarranted.

Securities Lending Matters

As previously disclosed, BNY Mellon or its affiliates have been named as defendants in a number of lawsuits initiated by participants in BNY Mellon’s securities lending program, which is a part of BNY Mellon’s Investment Services business. The lawsuits were filed on various dates from December 2008 to 2012, and are currently pending in courts in Oklahoma, New York, South Carolina and North Carolina and in commercial court in London. The complaints assert contractual, statutory, and common law claims, including claims for negligence and breach of fiduciary duty. The plaintiffs allege losses in connection with the investment of securities lending collateral, including losses related to investments in Sigma Finance Inc. (“Sigma”), Lehman Brothers Holdings, Inc. and certain asset-backed securities, and seek damages as to those losses. Three of the pending cases seek to proceed as class actions.

On July 5, 2012, BNY Mellon, N.A. and The Bank of New York Mellon entered into a Stipulation of Settlement in the Oklahoma class action lawsuit concerning Sigma losses. Under the terms of the settlement,

The Bank of New York Mellon will make a payment of $280 million in exchange for a complete release of claims in the class action. The settlement is subject to final court approval.

Matters Relating To Bernard L. Madoff

As previously disclosed, on May 11, 2010, the New York State Attorney General commenced a civil lawsuit against Ivy Asset Management LLC (“Ivy”), a subsidiary of BNY Mellon that manages primarily funds-of-hedge-funds, and two of its former officers in New York state court. The lawsuit alleges that Ivy, in connection with its role as sub-advisor to investment managers whose clients invested with Madoff, did not disclose certain material facts about Madoff. The complaint seeks an accounting of compensation received from January 1997 to the present by the Ivy defendants in connection with the Madoff investments, and unspecified damages, including restitution, disgorgement, costs and attorneys’ fees.

As previously disclosed, on Oct. 21, 2010, the U.S. Department of Labor commenced a civil lawsuit against Ivy, two of its former officers, and others in federal court in the Southern District of New York. The lawsuit alleges that Ivy violated the Employee Retirement Income Security Act (“ERISA”) by failing to disclose certain material facts about Madoff to investment managers subadvised by Ivy whose clients included employee benefit plan investors. The complaint seeks disgorgement and damages. On Dec. 8, 2010, the Trustee overseeing the Madoff liquidation sued many of the same defendants in bankruptcy court in New York, seeking to avoid withdrawals from Madoff investments made by various funds-of-funds (including six funds-of-funds managed by Ivy).

As previously disclosed, Ivy or its affiliates have been named in a number of civil lawsuits filed beginning Jan. 27, 2009 relating to certain investment funds that allege losses due to the Madoff investments. Ivy acted as a sub-advisor to the investment managers of some of those funds. Plaintiffs assert various causes of action including securities and common-law fraud. Certain of the cases have been certified as class actions and/or assert derivative claims on behalf of the funds. Most of the cases have been consolidated in two actions in federal court in the Southern District of New York, with certain cases filed in New York State Supreme Court for New York and Nassau counties.

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

Medical Capital Litigations

As previously disclosed, The Bank of New York Mellon has been named as a defendant in a number of class actions and non-class actions brought by numerous plaintiffs in connection with its role as indenture trustee for debt issued by affiliates of Medical Capital Corporation. The actions, filed in late 2009 and currently pending in federal court in the Central District of California, allege that The Bank of New York Mellon breached its fiduciary and contractual obligations to the holders of the underlying securities, and seek unspecified damages. On June 7, 2012, The Bank of New York Mellon reached a conditional settlement with the Federal Equity Receiver for Medical Capital Corporation and its affiliates.

Foreign Exchange Matters

As previously disclosed, beginning in December 2009, government authorities have been conducting inquiries seeking information relating primarily to standing instruction foreign exchange transactions in connection with custody services BNY Mellon provides to public pension plans and certain other custody clients. BNY Mellon is cooperating with these inquiries.

In addition, in early 2011, as previously disclosed, the Virginia Attorney General’s Office and the Florida Attorney General’s Office each filed a Notice of Intervention in a qui tam lawsuit pending in its jurisdiction. These offices filed complaints superseding the qui tam lawsuits on Aug. 11, 2011. On May 1, 2012, the Virginia court dismissed the lawsuit in its entirety. On July 10, 2012, the Virginia Attorney General’s office filed a motion seeking leave of the court to file an amended complaint. On Oct. 4, 2011, the New York Attorney General’s Office, the New York City Comptroller and various city pension and benefit funds filed a lawsuit whereby, among other things, the plaintiffs assert claims under the Martin Act and state and city false claims acts. Also, on Oct. 4, 2011, the United States Department of Justice (“DOJ”) filed a civil lawsuit seeking civil penalties under 12 U.S.C. Section 1833a and injunctive relief under 18 U.S.C. Section 1345 based on alleged ongoing violations of 18 U.S.C. Sections 1341 and 1343 (mail and wire fraud). On Jan. 17, 2012, the court approved a partial settlement resolving the DOJ’s claim for injunctive relief. In October 2011, several political subdivisions of the state of California intervened in a qui tam lawsuit pending in California state court, previously under seal, and, on Nov. 28, 2011, BNY Mellon removed the lawsuit to federal district court

in California. On March 30, 2012, the court dismissed certain of plaintiffs’ claims, including all claims under the California False Claims Act, and provided plaintiffs an opportunity to file a motion seeking leave to replead. On Oct. 26, 2011, the Massachusetts Securities Division filed an Administrative Complaint against BNY Mellon.

BNY Mellon has also been named as a defendant in several putative class action federal lawsuits filed on various dates in 2011. The complaints, which assert varying claims, including breach of contract, and violations of ERISA, state and federal law, all allege that the prices BNY Mellon charged and reported for standing instruction foreign exchange transactions executed in connection with custody services provided by BNY Mellon were improper. In addition, BNY Mellon has been named as a nominal defendant in several derivative lawsuits filed on various dates in 2011 and 2012 in state and federal court in New York. BNY Mellon has also been named as a defendant in a lawsuit filed on March 12, 2012 in Ohio state court, and subsequently removed to federal district court in Ohio, asserting claims including breach of contract and fraud. BNY Mellon was also named in a qui tam lawsuit originally filed under seal in October 2009 in Massachusetts state court, but the plaintiff voluntarily dismissed the lawsuit on May 16, 2012. To the extent these lawsuits are pending in federal court, they have been consolidated for pre-trial purposes in federal court in New York.

Lyondell Litigation

As previously disclosed, in an action filed in New York State Supreme Court for New York County, on Sept. 14, 2010, plaintiffs as holders of debt issued by Basell AF in 2005 allege that The Bank of New York Mellon, as indenture trustee, breached its contractual and fiduciary obligations by executing an intercreditor agreement in 2007 in connection with Basell’s acquisition of Lyondell Chemical Company. Plaintiffs are seeking damages for their alleged losses resulting from the execution of the 2007 intercreditor agreement that allowed the company to increase the amount of its senior debt.

Tax Litigation

As previously disclosed, on Aug. 17, 2009, BNY Mellon received a Statutory Notice of Deficiency disallowing tax benefits for the 2001 and 2002 tax years in connection with a 2001 transaction that involved the payment of U.K. corporate income taxes that were credited against BNY Mellon’s U.S. corporate income tax liability. On Nov. 10, 2009,

 

 

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BNY Mellon filed a petition with the U.S. Tax Court contesting the disallowance of the benefits. Trial was held from April 16 to May 17, 2012. Post-trial briefing is scheduled to conclude September 13, 2012. The aggregate tax benefit for all six years in question is approximately $900 million, including interest. In the event BNY Mellon is unsuccessful in defending its position, the IRS has agreed not to assess underpayment penalties. See Note 11 of the Notes to Consolidated Financial Statements for additional information.

Mortgage-Securitization Trusts Proceeding

As previously disclosed, The Bank of New York Mellon as trustee is the petitioner in a legal proceeding filed in New York State Supreme Court, New York County on June 29, 2011, seeking approval of a proposed settlement involving Bank of America Corporation and bondholders in certain Countrywide residential mortgage-securitization trusts. The New York and Delaware Attorneys General have intervened in this proceeding.

Note 18 – Review of businesses

We have an internal information system that produces performance data for our two principal businesses and the Other segment. The following discussion of our businesses satisfies the disclosure requirements for ASC 280, Segment Reporting.

Organization of our business

On Dec. 31, 2011, BNY Mellon sold its Shareowner Services business. In the first quarter of 2012, we reclassified the results of the Shareowner Services business from the Investment Services business to the Other segment. The reclassification did not impact the consolidated results. All prior periods have been restated.

Business accounting principles

Our business data has been determined on an internal management basis of accounting, rather than the generally accepted accounting principles used for consolidated financial reporting. These measure-ment principles are designed so that reported results of the businesses will track their economic performance.

Business results are subject to reclassification whenever improvements are made in the measurement principles, or when organizational changes are made.

The accounting policies of the businesses are the same as those described in Note 1 of the Notes to Consolidated Financial Statements in BNY Mellon’s 2011 Annual Report.

The operations of acquired businesses are integrated with the existing businesses soon after they are completed. As a result of the integration of staff support functions, management of customer relationships, operating processes and the financial impact of funding acquisitions, we cannot precisely determine the impact of acquisitions on income before taxes and therefore do not report it.

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

The primary types of revenue for two principal businesses and the Other segment are presented below:

 

Business    Primary types of revenue

Investment Management

  

•      Investment management and performance fees from:

Mutual funds

Institutional clients

Private clients

High-net-worth individuals and families, endowments and foundations and related entities

•      Distribution and servicing fees

Investment Services

  

•      Asset servicing fees, including institutional trust and custody fees, broker-dealer services and securities lending

•      Issuer services fees, including Corporate Trust and Depositary Receipts

•      Clearing services fees, including broker-dealer services, registered investment advisor services and prime brokerage services

•      Treasury services fees, including global payment services and working capital solutions

•      Foreign exchange

Other segment

  

•      Credit-related activities

•      Leasing operations

•      Corporate treasury activities

•      Global markets and institutional banking services

•      Business exits

 

The results of our businesses are presented and analyzed on an internal management reporting basis:

 

   

Revenue amounts reflect fee and other revenue generated by each business. Fee and other revenue transferred between businesses under revenue transfer agreements is included within other revenue in each business.

   

Revenues and expenses associated with specific client bases are included in those businesses. For example, foreign exchange activity associated with clients using custody products is allocated to Investment Services.

   

Net interest revenue is allocated to businesses based on the yields on the assets and liabilities generated by each business. We employ a funds transfer pricing system that matches funds with the specific assets and liabilities of each business based on their interest sensitivity and maturity characteristics.

   

Support and other indirect expenses are allocated to businesses based on internally-developed methodologies.

   

Recurring FDIC expense is allocated to the businesses based on average deposits generated within each business.

   

Litigation expense is generally recorded in the business in which the charge occurs.

   

Management of the investment securities portfolio is a shared service contained in the Other segment. As a result, gains and losses associated with the valuation of the securities portfolio are included in the Other segment.

   

Client deposits serve as the primary funding source for our investment securities portfolio. We typically allocate all interest revenue to the businesses generating the deposits. Accordingly, accretion related to the restructured investment securities portfolio has been included in the results of the businesses.

   

Restructuring charges are related to corporate initiatives and are therefore recorded in the Other segment.

   

M&I expenses are corporate level items and are therefore recorded in the Other segment.

   

Balance sheet assets and liabilities and their related income or expense are specifically assigned to each business. Businesses with a net liability position have been allocated assets.

   

Goodwill and intangible assets are reflected within individual businesses.

 

 

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Notes to Consolidated Financial Statements (continued)

 

 

The following consolidating schedules show the contribution of our businesses to our overall profitability.

 

For the quarter ended June 30, 2012

 

(dollar amounts in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $ 861  (a)    $ 1,881      $ 112      $ 2,854  (a) 

Net interest revenue

     52        607        75        734   

Total revenue

     913        2,488        187        3,588   

Provision for credit losses

     -        (14     (5     (19

Noninterest expense

     690        2,146        211        3,047   

Income (loss) before taxes

   $ 223  (a)    $ 356      $ (19   $ 560 (a) 

Pre-tax operating margin (b)

     24     14     N/M        16

Average assets

   $ 35,970      $ 209,454      $ 59,578      $ 305,002   
(a) Total fee and other revenue includes income from consolidated investment management funds of $57 million, net of noncontrolling interests of $29 million, for a net impact of $28 million. Income before taxes includes noncontrolling interests of $29 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

For the quarter ended March 31, 2012

 

(dollar amounts in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $ 852  (a)    $ 1,852      $ 166      $ 2,870  (a) 

Net interest revenue

     55        642        68        765   

Total revenue

     907        2,494        234        3,635   

Provision for credit losses

     -        16        (11     5   

Noninterest expense

     667        1,827        262        2,756   

Income (loss) before taxes

   $ 240  (a)    $ 651      $ (17   $ 874 (a) 

Pre-tax operating margin (b)

     26     26     N/M        24

Average assets

   $ 36,475      $ 214,135      $ 50,734      $ 301,344   
(a) Total fee and other revenue includes income from consolidated investment management funds of $43 million, net of noncontrolling interests of $11 million, for a net impact of $32 million. Income before taxes includes noncontrolling interests of $11 million.
(b) Income before taxes divided by total revenue.
N/M – Not meaningful.

 

For the quarter ended June 30, 2011

 

(dollar amounts in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $ 862 (a)    $ 1,967      $ 269      $ 3,098 (a) 

Net interest revenue

     48        649        34        731   

Total revenue

     910        2,616        303        3,829   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     694        1,827        295        2,816   

Income (loss) before taxes

   $ 215 (a)    $ 789      $ 9      $ 1,013 (a) 

Pre-tax operating margin (b)

     24     30     N/M        26

Average assets

   $ 36,741      $ 191,756      $ 49,983      $ 278,480   
(a) Total fee and other revenue includes income from consolidated investment management funds of $63 million, net of noncontrolling interests of $21 million, for a net impact of $42 million. Income before taxes includes noncontrolling interests of $21 million.
(b) Income before taxes divided by total revenue.

N/M – Not meaningful.

 

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For the six months ended June 30, 2012

(dollar amounts in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $ 1,713  (a)    $ 3,733      $ 278      $  5,724  (a) 

Net interest revenue

     107        1,249        143        1,499   

Total revenue

     1,820        4,982        421        7,223   

Provision for credit losses

     -        2        (16     (14

Noninterest expense

     1,357        3,973        473        5,803   

Income (loss) before taxes

   $  463  (a)    $ 1,007      $ (36   $  1,434  (a) 

Pre-tax operating margin (b)

     25     20     N/M        20

Average assets

   $ 36,222      $ 211,795      $ 55,155      $ 303,172   
(a) Total fee and other revenue includes income from consolidated investment management funds of $100 million, net of noncontrolling interests of $40 million, for a net impact of $60 million. Income before taxes includes noncontrolling interests of $40 million.
(b) Income before taxes divided by total revenue.

N/M – Not meaningful.

 

For the six months ended June 30, 2011

(dollar amounts in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

   $  1,730  (a)    $ 3,856      $ 416      $  6,002  (a) 

Net interest revenue

     100        1,270        59        1,429   

Total revenue

     1,830        5,126        475        7,431   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     1,376        3,579        558        5,513   

Income (loss) before taxes

   $  453  (a)    $ 1,547      $ (82   $  1,918  (a) 

Pre-tax operating margin (b)

     25     30     N/M        26

Average assets

   $ 37,027      $ 184,002      $ 47,118      $ 268,147   
(a) Total fee and other revenue includes income from consolidated investment management funds of $173 million, net of noncontrolling interests of $65 million, for a net impact of $108 million. Income before taxes includes noncontrolling interests of $65 million.
(b) Income before taxes divided by total revenue.

N/M – Not meaningful.

Note 19 – Supplemental information to the Consolidated Statement of Cash Flows

Noncash investing and financing transactions that, appropriately, are not reflected in the Consolidated Statement of Cash Flows are listed below.

 

Noncash investing and

financing transactions

   Six months
ended June 30,
 
(in millions)    2012      2011  

Transfers from loans to other assets for OREO

   $ 6       $ 7   

Assets of consolidated VIEs

     392         1,233   

Liabilities of consolidated VIEs

     295         1,476   

Noncontrolling interests of consolidated VIEs

     52         56   

 

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Item 4. Controls and Procedures

 

 

Disclosure controls and procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, with participation by the members of the Disclosure Committee, has responsibility for ensuring that there is an adequate and effective process for establishing, maintaining, and evaluating disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in our SEC reports is timely recorded, processed, summarized and reported and that information required to be disclosed by BNY Mellon is accumulated and communicated to BNY Mellon’s management to allow timely decisions regarding the required disclosure. In addition, our ethics hotline can also be used by employees and others for the anonymous communication of concerns about financial controls or reporting matters. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

Changes in internal control over financial reporting

In the ordinary course of business, we may routinely modify, upgrade or enhance our internal controls and procedures for financial reporting. There have not been any changes in our internal controls over financial reporting as defined in Rule 13a-15(f) of the Exchange Act during the second quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

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Forward-looking Statements

 

 

Some statements in this document are forward-looking. These include all statements about the future results of BNY Mellon; our financial goals and strategies; areas of our business expected to be impacted by the current market environment; the impact of changes in the value of market indices; and factors affecting the performance of our businesses. In addition, these forward-looking statements relate to: the usefulness of Non-GAAP measures; estimated Basel III capital ratios; expectations regarding the impact of the ECB deposit rate cut and our ability to mitigate any adverse impact; expectations regarding our foreign exchange revenue; expectations regarding legal and litigation costs; expectations regarding our operational excellence initiatives, including our annualized targeted savings by the end of 2012; expectations regarding our effective tax rate and the impact of the expiration of the active financing deferral provision; expectations regarding the seasonality impact on our business; statements with respect to our tri-party repo business; estimations of market value impact on fee revenue; expectations regarding the impact that a goodwill impairment charge would have on our regulatory capital ratios; statements regarding the impact of money market fee waivers or changes in levels of assets under management on the fair value of Asset Management; impact of significant changes in ratings classifications for our investment portfolio; assumptions with respect to residential mortgage-backed securities; effects of changes in projected loss severities and default rates on impairment charges; statements on our credit strategies; goals with respect to our commercial portfolio; statements regarding our leasing portfolio; estimates of provisions for credit losses; the effect of credit ratings on allowances, estimates and cash flow models; statements regarding our liquidity cushion, liquidity ratios, liquidity asset buffer and potential uses of liquidity; statements regarding a reduction in our Investment Services businesses; statements with respect to our liquidity policy; access to capital markets and our shelf registration statements; the impact of a change in rating agencies’ assumptions on ratings of the Parent, The Bank of New York Mellon and BNY Mellon, N.A.; expectations with respect to capital, including anticipated repayment and call of outstanding securities; expectations regarding PCS distributions; statements regarding the capitalization status of BNY Mellon and its bank subsidiaries; our plans to repurchase shares of common stock; statements regarding our balance sheet size and client deposit levels; assumptions with respect to the effects of changes in risk-weighted

assets on capital ratios; estimations and assumptions on net interest revenue and net interest rate sensitivities; impact of certain events on the growth or contraction of deposits, our assumptions about depositor behavior, our balance sheet and net interest revenue; timing and impact of adoption of recent accounting guidance; the timing and effects of pending and proposed legislation and regulation, including the Dodd-Frank Act; Basel III and the NPRs; the Federal Reserve’s proposed rules regarding enhanced prudential standards and early remediation requirements; the Federal Reserve’s and FDIC’s implementation of its resolution planning rules; the Federal Reserve’s rules regarding its comprehensive capital analysis and review; the Volcker rule; proposed rules removing references to credit ratings; our expectations and statements regarding Basel II and Basel III requirements and the impact on our capital ratios; statements regarding the impact of being identified as a G-SIB or D-SIB; the implementation of IFRS; our ability to compete and our investment in technology; BNY Mellon’s anticipated actions with respect to legal or regulatory proceedings; future litigation costs, the expected outcome and the impact of judgments and settlements, if any, arising from pending or potential legal or regulatory proceedings and BNY Mellon’s expectations with respect to litigation accruals.

In this report, any other report, any press release or any written or oral statement that BNY Mellon or its executives may make, words such as “estimate,” “forecast,” “project,” “anticipate,” “confident,” “target,” “expect,” “intend,” “seek,” “believe,” “plan,” “goal,” “could,” “should,” “may,” “will,” “strategy,” “opportunities,” “trends” and words of similar meaning, signify forward-looking statements.

Forward-looking statements, including discussions and projections of future results of operations and discussions of future plans contained in the Management’s Discussion and Analysis, are based on management’s current expectations and assumptions that involve risk and uncertainties and that are subject to change based on various important factors (some of which are beyond BNY Mellon’s control), including adverse changes in market conditions, and the timing of such changes, and the actions that management could take in response to these changes. Actual results may differ materially from those expressed or implied as a result of a number of factors, including those discussed in the “Risk Factors” section of BNY Mellon’s Annual Report on Form 10-K for the year ended Dec. 31, 2011 and Item 1A in this Form 10-Q,

 

 

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Forward-looking Statements (continued)

 

 

such as: uncertainty in financial markets and weakness in the economy; disruptions in European economies, or the failure or instability of any of our significant counterparties in Europe; continued market volatility; write-downs of financial instruments that we own or other losses related to volatile or illiquid market conditions; adverse publicity, regulatory actions or litigation with respect to us, other well-known companies and the financial services industry generally; government regulation and supervision, and associated limitations on our ability to pay dividends or make other capital distributions; recent legislative and regulatory actions; low or volatile interest rates and its impact on money market fund sponsors; changes to deposit insurance premiums; the level of regulation applicable to, and the costs associated therewith of, our competitors, the degree of consolidation and the breadth of products and services offerings of companies in the financial services industry and the ability of BNY Mellon to distinguish itself from its competitors; declines in capital markets on our fee-based businesses; stable exchange-rate environment and declines in cross-border activity; dependence on consistent execution of fee-based services that we perform; the failure to successfully integrate strategic acquisitions; the failure or instability of any of our significant counterparties, and our assumption of credit and counterparty risk; changes to credit ratings; supervisory standards; access to capital markets; monetary policy and other governmental regulations;

failures relating to operational risk and circumvention of controls and procedures; disruption or breaches in security of our information systems that results in a loss of confidential client information or impacts our ability to provide services to our clients; dependence on technology and intellectual property; global operations and regulation; acts of terrorism and global conflicts; risks relating to new lines of business; attracting and retaining employees; tax and accounting laws and regulations; inadequate credit reserves; risks associated with being a holding company including our dependence on dividends from our subsidiary banks; the impact of provisions of Delaware law and the Federal Reserve on our ability to pay dividends; anti-takeover provisions in our certificate of incorporation and bylaws and the impact of continued litigation and regulatory investigations and proceedings involving our foreign exchange standing instruction program. Investors should consider all risks in BNY Mellon’s Annual Report on Form 10-K for the year ended Dec. 31, 2011 and any subsequent reports filed with the SEC by BNY Mellon pursuant to the Exchange Act.

All forward-looking statements speak only as of the date on which such statements are made, and BNY Mellon undertakes no obligation to update any statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

 

 

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Part II — Other Information

 

 

Item 1. Legal Proceedings

The information required by this Item is set forth in the “Legal proceedings” section in Note 17 of the Notes to Consolidated Financial Statements, which portion is incorporated herein by reference in response to this item.

Item 1A. Risk Factors

The following discussion supplements the discussion of risk factors that could affect our business, financial condition or results of operations set forth in Part I, Item 1A, Risk Factors, on pages 21 through 35 of our Form 10-K for the year ended Dec. 31, 2011. The discussion of Risk Factors, as so supplemented, sets forth our most significant risk factors that could affect our business, financial condition or results of operations. However, other factors, besides those discussed below or in Item 1A of our Form 10-K for the year ended Dec. 31, 2011 or other of our reports filed with or furnished to the SEC, also could adversely affect our business or results. We cannot assure you that the risk factors described below or elsewhere in this report and such other reports address all potential risks that we may face. These risk factors also serve to describe factors which may cause our results to differ materially from those described in forward-looking statements included herein or in other documents or statements that make reference to this Form 10-Q. See “Forward-looking Statements.”

Continued litigation and regulatory investigations and proceedings involving our foreign exchange standing instruction program and resulting adverse publicity could affect our reputation and negatively impact our foreign exchange business.

Beginning in 2009, our foreign exchange standing instruction program became the subject of litigation and regulatory investigations and proceedings. See “Legal proceedings” in Note 17 of the Notes to the Consolidated Financial Statements. These litigation and regulatory investigations and proceedings have generated substantial scrutiny of, and adverse publicity concerning, our foreign exchange standing instruction program. Continued litigation involving our foreign exchange standing instruction program, and the resulting scrutiny and adverse publicity, could affect our reputation and discourage clients from doing business with us. For example, these proceedings have resulted in the loss of Ohio public fund custody clients, which has attracted media attention and led to inquiries from other clients,

investors and employees. If we continue to be subject to these proceedings and the resulting adverse publicity relating to our foreign exchange standing instruction program, our reputation could be further affected, adversely impacting our business and results of operations. For example, pressure on pricing may cause our foreign exchange revenue to decline. See “Foreign exchange and other trading revenue” in the MD&A – Results of Operations section of our Form 10-Q for more information regarding our foreign exchange business, including business practices, results of operations and trends.

If our information systems experience a disruption or breach in security that results in a loss of confidential client information or impacts our ability to provide services to our clients, our business and results of operations may be adversely affected.

We rely heavily on communications and information systems to conduct our business. While our information systems have been subjected to cyber threats, including hacker attacks, viruses, denial of service efforts and unauthorized access attempts, we deploy a broad range of sophisticated defenses and we have avoided a material breach. The security of our computer systems, software and networks, and those functions that we may outsource, may continue to be subjected to cyber threats that could result in failures or disruptions in our business, customer relationship management, general ledger, deposit and loan systems. Our businesses that rely heavily on technology, such as our Investment Services business, are particularly vulnerable to security breaches and technology disruptions. Breaches of security may occur through intentional or unintentional acts by those having authorized or unauthorized access to our or our clients’ or counterparties’ confidential information, including employees and customers, as well as hackers. A breach of security that results in the loss of confidential client information may require us to reimburse clients for data and credit monitoring efforts and would be costly and time-consuming, and may negatively impact our results of operations and reputation. Additionally, security breaches or disruptions of our information systems could impact our ability to provide services to our clients, which could expose us to liability for damages, result in the loss of customer business, damage our reputation, subject us to regulatory scrutiny or expose us to civil litigation, any of which could have a material adverse effect on our financial condition and results of operations. In addition, the failure to upgrade or

 

 

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Part II – Other Information (continued)

 

 

maintain our computer systems, software and networks, as necessary, could also make us susceptible to breaches and unauthorized access and misuse. There can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. We may be required to

expend significant additional resources to modify, investigate or remediate vulnerabilities or other exposures arising from information systems security risks. For a discussion of operational risk, see “Risk management – Operational risk” in the MD&A – Results of Operations section in the 2011 Annual Report.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

(c) The following table discloses repurchases of our common stock made in the second quarter of 2012.

Issuer purchases of equity securities

 

Share repurchases in the second quarter of 2012                         

(dollars in millions,

except per share information;

common shares in thousands)

   Total
shares
repurchased
    Average price
per share
     Total shares
repurchased as
part of a publicly
announced plans
    

Maximum number

(or approximate dollar
value) of shares that may
yet be purchased under
the plans or programs

 

During the month of:

          

April 2012

     6,112      $ 23.28         6,000       $  1,020   

May 2012

     6,239        23.46         6,229         874   

June 2012

     27        20.50         -         874   

Second quarter 2012

     12,378 (a)    $ 23.36         12,229       $  874 (b) 
(a) Includes shares purchased at a purchase price of approximately $3 million from employees, primarily in connection with the employees’ payment of taxes upon the vesting of restricted stock.
(b) On March 13, 2012, the Board of Directors authorized a new stock purchase program providing for the repurchase of an aggregate of $1.16 billion of common stock. The share repurchase program may be executed through open market purchases or privately negotiated transactions at such prices, times and upon such other terms as may be determined from time to time.

 

Item 6. Exhibits

Pursuant to the rules and regulations of the Securities and Exchange Commission, BNY Mellon has filed certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent

developments, which may not be fully reflected in our public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe our actual state of affairs at the date hereof and should not be relied upon.

The list of exhibits required to be filed as exhibits to this report are listed on page 124 hereof, under “Index to Exhibits”, which is incorporated herein by reference.

 

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    THE BANK OF NEW YORK MELLON CORPORATION
        (Registrant)
Date: August 8, 2012     By:   /s/ John A. Park
      John A. Park
      Corporate Controller
      (Duly Authorized Officer and
      Principal Accounting Officer of
      the Registrant)

 

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Index to Exhibits

 

 

Exhibit
    No.    

  

Description

  

Method of Filing

  2.1

   Amended and Restated Agreement and Plan of Merger, dated as of Dec. 3, 2006, as amended and restated as of Feb. 23, 2007, and as further amended and restated as of March 30, 2007, between The Bank of New York Company, Inc., Mellon Financial Corporation and The Bank of New York Mellon Corporation (the “Company”).    Previously filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K (File Nos. 000-52710 and 001-06152) as filed with the Commission on July 2, 2007, and incorporated herein by reference.

  2.2

   Stock Purchase Agreement, dated as of Feb. 1, 2010, by and between The PNC Financial Services Group, Inc. and The Bank of New York Mellon Corporation.    Previously filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 000-52710) as filed with the Commission on Feb. 3, 2010, and incorporated herein by reference.

  3.1

   Restated Certificate of Incorporation of The Bank of New York Mellon Corporation.    Previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File Nos. 000-52710 and 001-06152) as filed with the Commission on July 2, 2007, and incorporated herein by reference.

  3.2

   Certificate of Designations of The Bank of New York Mellon Corporation with respect to Series A Non-Cumulative Preferred Stock dated June 15, 2007.    Previously filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K (File Nos. 000-52710) as filed with the Commission on July 5, 2007, and incorporated herein by reference.

  3.3

   Amended and Restated By-Laws of The Bank of New York Mellon Corporation, as amended and restated on Oct. 12, 2010.    Previously filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K (File No. 000-52710) for the year ended Dec. 31, 2010, as filed with the Commission on Feb. 28, 2011, and incorporated herein by reference.

  4.1

   None of the instruments defining the rights of holders of long-term debt of the Parent or any of its subsidiaries represented long-term debt in excess of 10% of the total assets of the Company as of June 30, 2012. The Company hereby agrees to furnish to the Commission, upon request, a copy of any such instrument.    N/A

  10.1

   Stipulation of Settlement    Previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 000-52710) as filed with the Commission on June 7, 2012, and incorporated herein by reference.

  12.1

   Computation of Ratio of Earnings to Fixed Charges.    Filed herewith.

 

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Index to Exhibits (continued)

 

 

Exhibit
    No.    

  

Description

  

Method of Filing

31.1

   Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    Filed herewith.

31.2

   Certification of the Chief Financial Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    Filed herewith.

32.1

   Certification of the Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    Furnished herewith.

32.2

   Certification of the Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    Furnished herewith.

101.INS

   XBRL Instance Document.    Filed herewith.

101.SCH

   XBRL Taxonomy Extension Schema Document.    Filed herewith.

101.CAL

   XBRL Taxonomy Extension Calculation Linkbase Document.    Filed herewith.

101.DEF

   XBRL Taxonomy Extension Definition Linkbase Document.    Filed herewith.

101.LAB

   XBRL Taxonomy Extension Label Linkbase Document.    Filed herewith.

101.PRE

   XBRL Taxonomy Extension Presentation Linkbase Document.    Filed herewith.

 

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