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 March 31, 2008

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 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

March 31, 2008

Common Stock, $0.01 par value   1,143,817,682

 

 


Table of Contents

THE BANK OF NEW YORK MELLON CORPORATION

FIRST QUARTER 2008 FORM 10-Q

TABLE OF CONTENTS

 

 

 

     Page No.

Introduction

   2

Consolidated Financial Highlights (unaudited)

   3
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.

  

Overview

   5

First quarter 2008 highlights

   6

Revenue overview

   7

Sector/segment overview

   8

Fee and other revenue

   9

Net interest revenue

   12

Average balances and interest rates

   13

Noninterest expense

   14

Income taxes

   15

Credit loss provision and net charge-offs

   16

Business segments review

   16

Critical accounting estimates

   31

Consolidated balance sheet review

   36

Capital support agreements

   45

Liquidity and dividends

   45

Capital

   48

Trading activities

   50

Foreign exchange and other trading – counterparty risk ratings profile

   52

Asset/liability management

   52

Off-balance-sheet financial instruments

   53

The Bank of New York historical earnings per share and average shares outstanding

   54

Supplemental information – Reconciliation of earnings per share-GAAP to non-GAAP

   55

Recent accounting developments

   55

Government monetary policies and competition

   57

Website information

   57

Item 1. Financial Statements:

  

Consolidated Income Statement (unaudited)

   58

Consolidated Balance Sheet (unaudited)

   60

Consolidated Statement of Cash Flows (unaudited)

   61

Consolidated Statement of Changes in Shareholders’ Equity (unaudited)

   62

Notes to Consolidated Financial Statements

   63

Item 4. Controls and Procedures.

   83

Forward-looking Statements and Risk Factors.

   84
Part II – Other Information   

Item 1. Legal and Regulatory Proceedings.

   85

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

   86

Item 6. Exhibits.

   87

Signature

   89

Index to Exhibits

   90


Table of Contents

Introduction

 

 

On July 1, 2007, The Bank of New York Company, Inc. (“The Bank of New York”) and Mellon Financial Corporation (“Mellon”) merged into The Bank of New York Mellon Corporation (“The Bank of New York Mellon” or “BNY Mellon”), with BNY Mellon being the surviving entity. For accounting and financial reporting purposes, the merger was accounted for as a purchase of Mellon. Financial results for periods subsequent to July 1, 2007 reflect the combined companies’ results. Financial results prior to July 1, 2007 reflect legacy The Bank of New York only.

The merger transaction resulted in The Bank of New York shareholders receiving ..9434 shares of The Bank of New York Mellon common stock for each share of The Bank of New York common stock outstanding on the closing date of the merger. All legacy The Bank of New York earnings per share and common share outstanding amounts in this Form 10-Q have been restated to reflect this exchange ratio. See page 54 for additional information.

We expect to realize annual merger-related expense synergies of $700 million by 2010 and our targeted run rate for merger-related revenue synergies is $250-400 million by 2011. Merger and integration expenses to combine the operations of The Bank of New York and Mellon were approximately $121 million in the first quarter of 2008. Total merger and integration expenses are currently expected to be approximately $1.325 billion.

 

The Bank of New York Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset and wealth management, asset servicing, issuer services, clearing and execution services and treasury services through a worldwide client-focused team. We have more than $23 trillion in assets under custody and administration, more than $1.1 trillion in assets under management and service $12 trillion in outstanding debt.

Throughout this Form 10-Q, certain measures, which are noted, exclude certain items. We believe the presentation of this information enhances investors’ understanding of period-to-period results. In addition, these measures reflect the principal basis on which our management monitors financial performance.

In this Quarterly Report on Form 10-Q, references to “our,” “we,” “us,” the “Company,” the “Corporation” and similar terms for periods prior to July 1, 2007, refer to The Bank of New York and references to “our,” “we,” “us,” the “Company,” the “Corporation” and similar terms for periods on or after July 1, 2007 refer to BNY Mellon.


 

2     The Bank of New York Mellon Corporation


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited)

 

The Bank of New York Mellon Corporation (and its subsidiaries)        
     Quarter ended  
(dollar amounts in millions, except per share amounts and unless otherwise noted)     
 
March 31,
2008
    
 
Dec. 31,
2007
 
 
   
 
March 31,
2007 (a)
 
 

Reported results:

       

Net income

   $ 746    $ 520     $ 434  

Basic EPS (b)

     0.66      0.46       0.61  

Diluted EPS (b)

     0.65      0.45       0.60  

Continuing operations:

       

Fee and other revenue

   $ 2,978    $ 3,044     $ 1,475  

Net interest revenue

     767      752       427  
                       

Total revenue

   $ 3,745    $ 3,796     $ 1,902  

Income from continuing operations

   $ 749    $ 700     $ 437  

EPS from continuing operations (b):

       

Basic

   $ 0.66    $ 0.62     $ 0.61  

Diluted

     0.65      0.61       0.61  

Diluted excluding merger and integration expense (c)

     0.72      0.67       0.62  

Diluted excluding merger and integration and intangible amortization expenses (c)

     0.78      0.74       0.65  

Return on tangible common equity (annualized)

     49.11%      44.96%  (d)     39.20%  

Return on tangible common equity excluding merger and integration and intangible amortization expenses (annualized)

     53.60%      48.93%  (d)     40.09%  

Return on common equity (annualized)

     10.20%      9.53%  (d)     15.70%  

Return on common equity excluding merger and integration and intangible amortization expenses (annualized)

     12.24%      11.54%  (d)     16.75%  

Fee and other revenue as a percentage of total revenue (FTE)

     79%      80%       77%  

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

   $ 281    $ 291     $ 263  

Non-U.S. percent of revenue (FTE)

     33%      32%  (e)     30%  

Pre-tax operating margin (FTE)

     30%      27%       34%  

Pre-tax operating margin (FTE) excluding merger and integration and intangible amortization expenses (c)

     36%      34%       36%  

Net interest margin (FTE)

     2.14%      2.16%       2.18%  

Net interest revenue (FTE)

   $ 773    $ 757     $ 429  

Assets under management (in billions)

   $ 1,105    $ 1,121     $ 142  

Assets under custody and administration (in trillions)

   $ 23.1    $ 23.1     $ 15.9  (f)

Equity securities

     30%      32%       32%  

Fixed income securities

     70%      68%       68%  

Cross-border assets (in trillions)

   $ 10.0    $ 10.0     $ 6.7  (f)

Market value of securities on loan (in billions)

   $ 676    $ 633     $ 397  

Average common shares and equivalents outstanding (in thousands) (b):

       

Basic

     1,134,280      1,133,804       710,147  

Diluted

     1,147,906      1,148,176       719,976  

Capital ratios

       

Tier I capital ratio

     8.76%      9.32%       8.43%  

Total (Tier I plus Tier II ratio)

     12.14%      13.25%       12.81%  

Adjusted tangible shareholders’ equity to assets ratio (g)

     4.14%      4.96%       5.47%  

Return on average assets (annualized)

     1.50%      1.44%  (d)     1.73%  

 

The Bank of New York Mellon Corporation     3


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited) (continued)

 

The Bank of New York Mellon Corporation (and its subsidiaries)      
     Quarter ended
(dollar amounts in millions, except per share amounts and unless otherwise noted)    March 31,
2008
   Dec. 31,
2007
   March 31,
2007 
(a)

Selected average balances:

        

Interest-earning assets

   $ 145,118    $ 140,622    $ 79,075

Total assets

   $ 200,790    $ 192,987    $ 102,041

Interest-bearing deposits

   $ 92,881    $ 86,278    $ 43,862

Noninterest-bearing deposits

   $ 26,240    $ 28,449    $ 14,903

Shareholders’ equity

   $ 29,551    $ 29,136    $ 11,277

Other:

        

Employees

     42,600      42,500      23,100

Dividends per share (b)

   $ 0.24    $ 0.24    $ 0.23

Dividend yield (annualized)

     2.3%      2.0%      2.1%

Closing common stock price per share (b)

   $ 41.73    $ 48.76    $ 42.98

Market capitalization

   $ 47,732    $ 55,878    $ 30,750

Book value per common share (b)

   $ 24.89    $ 25.66    $ 16.11

Tangible book value per common share (b)

   $ 4.84    $ 5.82    $ 6.92

Period-end shares outstanding (in thousands) (b)

     1,143,818      1,145,983      715,403
(a) Legacy The Bank of New York only.
(b) Per share data prior to July 1, 2007 are presented in post-merger share count terms. See page 54 for additional information.
(c) Calculated excluding pre-tax merger and integration expenses $126 million, $124 million and $15 million and pre-tax intangible amortization expense of $122 million, $131 million and $28 million.
(d) Before the extraordinary loss resulting from the consolidation of Three Rivers Funding Corporation.
(e) Calculated excluding the $200 million CDO write-down in the fourth quarter of 2007.
(f) Revised for Acquired Corporate Trust Business and harmonization adjustments.
(g) Includes deferred tax liabilities of $1.986 billion, $2.006 billion and $154 million.

 

4     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk.

 

 

Certain business terms used in this document are defined in the glossary included in our 2007 Annual Report on Form 10-K.

Overview

Our businesses

The Bank of New York Mellon Corporation (NYSE: BK) is a global leader in providing a comprehensive array of services that enable institutions and individuals to manage and service their financial assets in more than 100 markets worldwide. We have a long tradition of collaborating with clients to deliver innovative solutions through our core competencies: asset and wealth management, securities servicing and treasury services. Our extensive global client base includes a broad range of leading financial institutions, corporations, government entities, endowments/foundations and high-net-worth individuals. One of our two principal subsidiaries, The Bank of New York (the “Bank”), founded in 1784, is the oldest bank in the United States. Our other principal subsidiary, Mellon Bank, N.A. (“Mellon Bank”) was founded in 1869. Both institutions have consistently played a prominent role in the evolution of financial markets worldwide.

BNY Mellon’s businesses benefit from the global growth in financial assets. Our success is based on continuing to provide superior client service, strong investment performance and the highest fiduciary standards. We seek to deploy capital effectively to our businesses to accelerate their long-term growth and deliver top-tier returns to our shareholders. Our long-term financial goals are focused on achieving superior total returns to shareholders by generating first quartile earnings per share growth over time relative to a group of 12 peer companies. Key components of this strategy include: providing the best client service versus peers (as measured through independent surveys); strong investment performance (relative to investment benchmarks); above median revenue growth (relative to peer companies for each of our businesses); competitive margins; and positive operating leverage.

Based on the growth opportunities in our businesses, we expect that an increasing percentage of our revenue and income will be derived outside the U.S.

 

As measurements of efficiency, over time we expect to increase both our level of fee revenue per employee and pre-tax margins.

We believe that our businesses are compatible with our strategy and goals for the following reasons:

 

  ·  

Demand for our products and services is driven by market and demographic trends in the markets in which we compete. These trends include: growth in worldwide retirement and financial assets; the growth and concentration of the wealth segments; global growth in assets managed by financial institutions; and the globalization of the investment process.

  ·  

Many of our products complement one another.

  ·  

We are able to leverage sales, distribution and technology across our businesses, benefiting our clients and shareholders.

  ·  

The revenue generated by our businesses is principally fee-based.

  ·  

Our businesses generally do not require as much capital for growth as traditional banking.

We pursue our long-term financial goals by focusing on organic revenue growth, expense management, superior client service, successful integration of acquisitions and disciplined capital management.

We have established a Tier I capital target of 8% as our principal capital measure. We have also established a secondary target capital ratio of 5% for adjusted tangible common equity. The adjusted tangible common equity ratio reflects the impact of the merger with Mellon and associated goodwill, intangibles and deferred tax liability. The goodwill and intangibles created in the merger have no economic impact but reduce tangible equity. For a discussion of our capital ratios, see pages 48-50.


 

The Bank of New York Mellon Corporation     5


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

How we reported results

All information in this Quarterly Report on Form 10-Q is reported on a continuing operations basis, unless otherwise noted. For a description of discontinued operations, see Note 4 in the Notes to Consolidated Financial Statements.

Certain amounts are presented 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. The adjustment to an FTE basis has no impact on net income. In addition, results for the first quarter of 2008 and fourth quarter of 2007 reflect the results of The Bank of New York Mellon combined. Results for the first quarter of 2007 include legacy The Bank of New York only.

In the first quarter of 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 157 Fair Value Measurements (“SFAS 157”) and SFAS No. 159 Fair Value Option (“SFAS 159”). For a discussion of SFAS 157 and SFAS 159, see Note 12 and Note 13 in the Notes to Consolidated Financial Statements.

First quarter 2008 highlights

We reported first quarter net income of $746 million, or $0.65 per share, and income from continuing operations of $749 million, or $0.65 per share. This compares to net income of $434 million, or $0.60 per share, and income from continuing operations of $437 million, or $0.61 per share, in the first quarter of 2007. The first quarter of 2008 included merger and integration expenses of $126 million (pre-tax), or $0.07 per share. The first quarter of 2007 included merger and integration expenses of $15 million (pre-tax) or $0.01 per share. Excluding these amounts, earnings per share from continuing operations were $0.72 in the first quarter of 2008 and $0.62 in the first quarter of 2007.

Adjusting for the impact of merger and integration expenses ($126 million pre-tax) and intangible amortization ($122 million pre-tax), diluted earnings per share for the first quarter of 2008 were $0.78, which compares to $0.65 a year ago (an increase of 20%) and $0.74 sequentially (an annualized increase

of 5%). See the table on page 55 for a reconciliation of GAAP to non-GAAP net income and earnings per share.

The results for the first quarter of 2008 included net pre-tax costs associated with the write down of certain investments in the securities portfolio ($74 million), the write-down of seed capital investments related to a formerly affiliated hedge fund manager ($25 million), and an expense associated with capital support agreements ($12 million). The results for the first quarter also included the pre-tax benefit of $42 million associated with the initial public offering by VISA. The net impact of these items decreased earnings per share by approximately $0.04.

Performance highlights for the first quarter of 2008 included:

 

  ·  

Assets under management totaled $1.105 trillion at March 31, 2008 compared with $142 billion at March 31, 2007. Assets under custody and administration totaled $23.1 trillion at March 31, 2008 compared with $15.9 trillion at March 31, 2007. Both increases primarily resulted from the merger with Mellon;

  ·  

Asset and wealth management fees totaled $842 million in the first quarter of 2008 compared with $151 million in the first quarter of 2007. The increase reflects the merger with Mellon as well as the benefit of strong money market flows and other new business, partially offset by the prior loss of business at one of our investment boutiques and lower equity market values;

  ·  

Asset servicing revenue was $897 million in the first quarter of 2008 compared with $393 million in the first quarter of 2007. The increase was primarily due to the merger with Mellon, the benefit of market volatility, strong new business activity and the fourth quarter of 2007 acquisition of the remaining 50% interest in BNY Mellon Asset Servicing B.V., the former joint venture with ABN AMRO;

  ·  

Issuer services revenue was $376 million in the first quarter of 2008 compared with $319 million in the first quarter of 2007. The increase primarily reflects the merger with Mellon as well as higher global corporate trust fees;


 

6     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

  ·  

Revenue from foreign exchange and other trading activities was $259 million in the first quarter of 2008 compared with $127 million in the first quarter of 2007. The increase reflects the merger with Mellon, the benefit of increased client volumes and currency volatility;

  ·  

Securities losses totaled $73 million in the first quarter of 2008 compared to a gain of $2 million in the first quarter of 2007. The first quarter of 2008 includes a $28 million loss related to securities backed by home equity lines of credit in the portfolio of Three Rivers Funding Corporation (“TRFC”), a $24 million loss related to asset-backed securities (“ABS”) collateralized debt obligations (“CDOs”) and $22 million related to structured investment vehicles (“SIVs”);

  ·  

Net interest revenue was $767 million in the first quarter of 2008 compared with $427 million in the first quarter of 2007. The increase was primarily due to the merger with Mellon as well as a higher level of interest-earning assets associated primarily with the growth in Securities Servicing and wider spreads on investment securities, partially offset by the lower value of noninterest-bearing deposits in a declining interest rate environment; and

  ·  

Noninterest expense was $2.619 billion in the first quarter of 2008 compared with $1.272 billion in the first quarter of 2007. The increase resulted from the merger with Mellon and in support of business growth as well as increases in merger and integration expense of $111 million and intangible amortization expense of $94 million, partially offset by $118 million of merger-related synergies generated in the first quarter of 2008.

Revenue overview

The vast majority of BNY Mellon’s revenue consists of fee and other revenue, given our mix of businesses, with net interest revenue comprising the balance.

 

Fee and other revenue represented 79% of total revenue, on an FTE basis in the first quarter of 2008, compared with 77% in the first quarter of 2007.

Since fee and other revenue constitutes the majority of our total revenue, we discuss it in greater detail by type of fee in the fee and other revenue and the business segments sections. In these sections, we note the more specific drivers of such revenue and the factors that caused the various types of fee and other revenue to increase or decline in the first quarter of 2008 compared with the first quarter of 2007. The business segments discussion combines, for each business segment, all types of fee and other revenue generated directly by that segment as well as fee and other revenue transferred between segments under revenue transfer agreements, with net interest revenue generated directly by or allocated to that segment. The discussion of revenue by business segment is fundamental to an understanding of BNY Mellon’s results as it represents a principal measure by which management reviews the performance of our businesses compared with performance in prior periods, with our operating plan and with the performance of our competitors.

Net interest revenue comprised 21% of total revenue, on an FTE basis, in the first quarter of 2008 compared with 23% the first quarter of 2007. Net interest revenue is generated from a combination of loans, investment securities, interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements. For more information, see the net interest revenue section.


 

The Bank of New York Mellon Corporation     7


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Sector/segment overview

 

Sector/Segment    Primary types of fee revenue

Asset & Wealth Management sector

    

    Asset Management segment

  

·       Asset and wealth management fees from:

Institutional clients

Mutual funds

Private clients

·       Performance fees

·       Distribution and servicing fees

    Wealth Management segment

  

·       Wealth management fees from high-net-worth individuals, families, family offices and business enterprises, charitable gift programs and foundations and endowments

Institutional Services sector

    

    Asset Servicing segment

  

·       Asset servicing fees, including:

Institutional trust and custody fees

Broker-dealer services

Securities lending

·       Foreign exchange

    Issuer Services segment

  

·       Issuer services fees, including:

Corporate trust

Depositary receipts

Employee investment plan services

Shareowner services

    Clearing & Execution Services segment

  

·       Clearing and execution services fees, including:

Broker-dealer and Registered Investment Advisor services

    Treasury Services segment

  

·       Treasury services fees, including:

Global payment services

Working capital solutions

·       Financing-related fees

Other segment

  

·       Leasing operations

·        Corporate treasury activities

·       Business exits

·       Global markets and institutional banking services

·       Merger and integration expenses

 

8     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Fee and other revenue

 

Fee and other revenue    1Q08     4Q07     1Q07 (a)     1Q08
vs.
4Q07
   1Q08
vs.
1Q07

(dollars in millions unless otherwise noted)

           

Securities servicing fees:

           

Asset servicing

   $ 897     $ 809     $ 393     11%    128%

Issuer services

     376       438       319     (14)      18   

Clearing and execution services

     267       314       282     (15)      (5)  

Total securities servicing fees

     1,540       1,561       994     (1)      55   

Asset and wealth management fees

     842       887       151     (5)      458   

Performance fees

     20       62       14     (68)      43   

Foreign exchange and other trading activities

     259       305       127     (15)      104   

Treasury services

     124       121       50     2       148   

Distribution and servicing

     98       113       2     (13)      N/M   

Financing-related fees

     48       52       52     (8)      (8)  

Investment income

     23       52       36     (56)      (36)  

Securities gains (losses)

     (73 )     (191 )     2     N/M       N/M   

Other

     97       82       47     18        106   

Total fee and other revenue

   $ 2,978     $ 3,044     $ 1,475     (2)%    102%

Fee and other revenue as a percentage of total revenue (FTE)

     79%       80%       77%       

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

   $ 1,105     $ 1,121     $ 142     (1)%    678%

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

   $ 23.1     $ 23.1     $ 15.9  (b)   -%    45%
(a) Legacy The Bank of New York only.
(b) Revised for Acquired Corporate Trust Business and harmonization adjustments.
N/M – Not meaningful.

 

Fee and other revenue

The results of many of our businesses are influenced by client and market activities that vary by quarter. For instance, we experience seasonal increases in securities lending and depositary receipts reflecting European dividend distributions during the second quarter of the year, and to a lesser extent, in the fourth quarter of the year. Performance fees tend to be seasonally highest in the fourth quarter when the measurement period for many products ends.

The increase in fee and other revenue versus the year-ago quarter primarily reflects the merger with Mellon, higher securities servicing fees and foreign exchange and other trading activities. The first quarter 2008 also includes, in other fee revenue, a $42 million gain associated with the initial public offering by VISA. The sequential-quarter decrease in fee and other revenue primarily reflects seasonal declines in the Depositary Receipts business and performance fees, the sale of the B-Trade and G-Trade execution businesses in Clearing and execution services, lower foreign exchange and other trading activities revenue, and lower investment

income, partially offset by higher asset servicing fees.

Securities servicing fees

The increase in securities servicing fees over the first quarter of 2007 reflects the merger with Mellon and strong securities lending revenue. Securities servicing fees were down sequentially reflecting lower issuer services fees reflecting a seasonal decline in the Depositary Receipts business, and lower clearing and execution service fees due to the first quarter 2008 sale of the B-Trade and G-Trade execution businesses. These decreases were partially offset by higher securities lending revenue. See the “Institutional Services Sector” in “Business segments review” for additional details.

Asset and wealth management fees

Asset and wealth management fees increased from the first quarter of 2007 primarily due to the merger with Mellon as well as strong money market flows and other new business, partially offset by the prior loss of business at one of our investment boutiques, as well as lower equity market values. The decrease


 

The Bank of New York Mellon Corporation     9


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

compared to the fourth quarter of 2007 primarily resulted from a combination of lower equity market values and negative long-term flows. See the “Asset and Wealth Management Sector” in “Business segments review” for additional details regarding the drivers of asset and wealth management fees.

Total assets under management for the Asset and Wealth Management sector were $1.105 trillion at March 31, 2008, compared with $142 billion at March 31, 2007 and $1.121 trillion at Dec. 31, 2007. The increase compared with March 31, 2007 resulted from the merger with Mellon, new business and strong money market inflows. The decrease compared with Dec. 31, 2007 primarily resulted from lower equity market values primarily offset by strong money market inflows.

A significant portion of asset and wealth management fees are generated in the Asset Management segment from managed mutual funds. These fees are based on the daily average net assets of each fund and the basis point management fee paid by that fund. Managed mutual fund revenue was $323 million compared with $3 million in the first quarter of 2007. The increase resulted from the merger with Mellon and strong money market inflows.

Performance fees

Performance fees, which are reported in the Asset Management segment, are generally calculated as a percentage of a portfolio’s performance in excess of a benchmark index or a peer group’s performance. There is an increase/decrease in incentive expense with a related change in performance fees. Performance fees increased $6 million compared with the first quarter of 2007 and decreased $42 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 reflects the merger with Mellon, partially offset by a lower level of performance fees generated from alternative and other quantitative products. The sequential quarter decrease principally reflects a typical seasonal decline.

Foreign exchange and other trading activities

Foreign exchange and other trading activities revenue, which is reported primarily in the Asset Servicing segment, increased by $132 million, or 104%, to $259 million compared with the first

quarter of 2007, and decreased 15% (unannualized) compared with the fourth quarter of 2007. The increase compared to the first quarter of 2007 was due to the merger with Mellon and also reflected the benefit of significant increases in currency volatility as well as higher client volumes. The decrease compared with the fourth quarter of 2007 primarily reflects a lower valuation of the credit derivatives portfolio and the impact of the adoption of SFAS 157 on the valuation of the interest rate derivatives portfolio.

Treasury services

Treasury services, which is primarily reported in the Treasury Services segment, includes fees related to funds transfer, cash management and liquidity management. Treasury services fees increased $74 million from the first quarter of 2007 reflecting the merger with Mellon as well as higher global payment and cash management fees due primarily to higher client volumes.

Distribution and servicing fees

Distribution and servicing fees earned from mutual funds are primarily based on average assets in the funds and the sales of funds managed or administered by BNY Mellon and are primarily reported in the Asset Management segment. These fees, which include 12b-1 fees, fluctuate with the overall level of net sales, the relative mix of sales between share classes and the funds’ market values.

The $96 million increase in distribution and servicing fee revenue in the first quarter of 2008

compared with the first quarter of 2007 primarily reflects the merger with Mellon. The $15 million decrease compared with the fourth quarter of 2007 reflects higher redemption fees received in the fourth quarter of 2007. The impact of distribution and servicing fees on income in any one period can be more than offset by distribution and servicing expense paid to other financial intermediaries to cover their costs for distribution and servicing of mutual funds. Distribution and servicing expense is recorded as noninterest expense on the income statement.


 

10     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Financing-related fees

Financing-related fees, which are primarily reported in the Treasury Services segment, include capital markets fees, loan commitment fees and credit-related trade fees. Financing-related fees decreased $4 million from both a year-ago quarter and sequentially reflecting a lower level of credit-related activities consistent with our strategic direction.

Investment income

Investment income, which is primarily reported in the Other and Asset Management segments, includes the gains and losses on private equity investments and seed capital investments, income from insurance contracts, and lease residual gains and losses. The decreases in investment income from the first quarter of 2007 and the fourth quarter of 2007 primarily resulted from seed capital investment losses of $19 million in the first quarter of 2008 as well as lower private equity investment revenue. The first quarter of 2008 excludes the $25 million loss on seed capital investments related to a formerly affiliated hedge fund manager, which was recognized in other expense. Private equity investment income was $7 million in the first quarter of 2008, down from $14 million in the fourth quarter of 2007 and $17 million in the first quarter of 2007.

Securities gains (losses)

Securities losses totaled $73 million in the first quarter of 2008 compared to a gain of $2 million in the first quarter of 2007 and a loss of $191 million in the fourth quarter of 2007. The losses in the first quarter of 2008 primarily reflected $24 million related to ABS CDOs, $22 million related to SIVs and $28 million related to securities backed by home equity lines of credit in the TRFC portfolio. The loss in the fourth quarter of 2007 included a $200 million CDO write-down. See Consolidated balance sheet review for further information on the investment securities portfolio.

 

Other revenue

Other revenue is comprised of expense reimbursements from joint ventures, merchant card fees, asset-related gains, equity investment income, net economic value payments and other transactions. Expense reimbursements from joint ventures relate to expenses incurred by BNY Mellon on behalf of joint ventures. Asset-related gains include loan, real estate dispositions and other assets. Equity investment income primarily reflects our proportionate share of the income from our investment in Wing Hang Bank Limited. Other transactions primarily include low income housing, other investments and various miscellaneous revenues. The breakdown among these categories is shown in the following table:

 

Other revenue   Quarter ended
(in millions)   March 31,
2008
  Dec. 31,
2007
  March 31,
2007 
(a)

Asset-related gains

  $46   $  5   $  4

Equity investment income

  12   18   13

Merchant card fees

  6   10   -

Expense reimbursements from joint ventures

  4   27   -

Net economic value payments

  2   1   24

Other

  27   21   6

Total other revenue

  $97   $82   $47
(a) Legacy The Bank of New York only.

Other revenue increased compared to the first quarter of 2007 reflecting the merger with Mellon, partially offset by lower net economic value payments. The first quarter of 2008 included the $42 million gain associated with the initial public offering by VISA.


 

The Bank of New York Mellon Corporation     11


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Net interest revenue

 

Net interest revenue    1Q08    4Q07    1Q07 (a)    1Q08
vs.
4Q07
   1Q08
vs.
1Q07
(dollar amounts in millions)               

Net interest revenue

   $ 767    $ 752    $ 427    2%    80%

Tax equivalent adjustment

     6      5      2    N/M    N/M

Net interest revenue on an FTE basis

   $ 773    $ 757    $ 429    2%    80%

Net interest margin (FTE)

     2.14%      2.16%      2.18%    (2) bps    (4) bps

(a)

Legacy The Bank of New York only.

bps - basis points.

 

Net interest revenue on an FTE basis totaled $773 million in the first quarter of 2008, compared with $429 million in the first quarter of 2007 and $757 million in the fourth quarter of 2007. The net interest margin was 2.14% in the first quarter of 2008, compared with 2.18% in the first quarter of 2007 and 2.16% in the fourth quarter of 2007.

The increase in net interest revenue compared with both the first quarter and fourth quarter of 2007 reflects a higher level of average interest-earning assets associated primarily with the growth in Securities Servicing and wider spreads on investment securities, partially offset by a lower value of noninterest-bearing deposits in a declining interest rate environment. Additionally, the increase in net interest revenue compared with the first quarter of 2007 was impacted by the merger with Mellon.

 

Average interest-earning assets were $145.1 billion in the first quarter of 2008 compared with $140.6 billion sequentially and $79.1 billion in the first quarter of 2007. The increase in interest-earning assets compared with the first quarter of 2007 reflects the merger with Mellon as well as the impact of a higher level of interest and noninterest-bearing deposits driven by higher client activity across all businesses.

The net interest margin decreased 4 bps year-over-year and 2 bps sequentially. Both decreases principally reflect the lower value of noninterest-bearing deposits in a declining interest rate environment. The sequential quarter decrease also reflects a lower level of noninterest-bearing deposits given a fourth quarter increase related to corporate actions in Shareowner Services.


 

12     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

AVERAGE BALANCES AND INTEREST RATES

 

       Quarter ended
     March 31, 2008     Dec. 31, 2007     March 31, 2007(a)
(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)

   $ 38,658      4.28 %   $ 37,107      4.75 %   $ 13,546      4.36%

Federal funds sold and securities under resale agreements

     8,199      3.15       7,096      4.66       4,435      5.23   

Margin loans

     5,258      4.47       5,313      5.74       5,401      6.33   

Non-margin loans:

               

Domestic offices

     29,357      4.49       28,527      4.95       19,231      5.11   

Foreign offices

     13,881      4.55       13,269      5.02       11,321      5.85   
                                 

Total non-margin loans

     43,238      4.51       41,796      4.97       30,552      5.38   

Securities

               

U.S. government obligations

     430      3.48       502      4.18       86      4.95   

U.S. government agency obligations

     11,333      4.74       11,761      5.27       2,905      5.07   

Obligations of states and political subdivisions

     703      7.58       724      6.58       86      8.22   

Other securities

     35,840      5.26       33,972      5.44       19,311      5.30   

Trading securities

     1,459      5.36       2,351      5.35       2,753      4.99   
                                 

Total securities

     49,765      5.16       49,310      5.40       25,141      5.25   
                                 

Total interest-earning assets

     145,118      4.59       140,622      5.08       79,075      5.22   

Allowance for credit losses

     (311 )        (332 )        (286 )   

Cash and due from banks

     5,831          5,663          2,424     

Other assets

     50,152              47,034              20,828       

Total assets

   $ 200,790            $ 192,987            $ 102,041       

Liabilities and shareholders’ equity

               

Interest-bearing liabilities:

               

Money market rate accounts

   $ 13,296      1.63 %   $ 16,190      2.74 %   $ 6,169      2.98%

Savings

     913      2.33       802      2.72       416      1.85   

Certificates of deposit of $100,000 & over

     2,313      4.09       2,547      5.37       3,133      5.43   

Other time deposits

     8,445      2.42       1,374      6.13       584      5.18   

Foreign offices

     67,914      2.85       65,365      3.38       33,560      3.67   
                                 

Total interest-bearing deposits

     92,881      2.66       86,278      3.36       43,862      3.70   

Federal funds purchased and securities under repurchase agreements

     4,750      2.18       3,956      3.89       1,527      4.97   

Other borrowed funds

     3,343      3.50       3,079      2.41       1,870      2.88   

Payables to customers and broker-dealers

     4,942      1.94       5,226      3.12       4,747      3.59   

Long-term debt

     17,125      4.51       15,510      5.29       8,888      5.42   
                                 

Total interest-bearing liabilities

     123,041      2.90       114,049      3.60       60,894      3.95   

Total noninterest-bearing deposits

     26,240          28,449          14,903     

Other liabilities

     21,958              21,353              14,967       

Total liabilities

     171,239              163,851              90,764       

Shareholders’ equity

     29,551              29,136              11,277       

Total liabilities and shareholders’ equity

   $ 200,790            $ 192,987            $ 102,041       

Net interest margin—Taxable equivalent basis

            2.14 %            2.16 %            2.18%
(a) Legacy The Bank of New York only.

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

 

The Bank of New York Mellon Corporation     13


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Noninterest expense

 

Noninterest expense

(dollar amounts in millions)

     1Q08      4Q07      1Q07(a)    1Q08
vs.
4Q07
   1Q08
vs.
1Q07

Staff:

              

Compensation

   $ 795    $ 758    $ 459    5%    73%

Incentives

     366      443      147    (17)      149   

Employee benefits

     191      164      114    16       68   

Total staff

     1,352      1,365      720    (1)      88   

Professional, legal and other purchased services

     252      272      130    (7)      94   

Distribution and servicing

     130      133      4    (2)      N/M   

Net occupancy

     129      145      79    (11)      63   

Furniture and equipment

     79      82      50    (4)      58   

Software

     79      78      54    1       46   

Business development

     66      72      30    (8)      120   

Sub-custodian

     61      66      34    (8)      79   

Communications

     32      34      19    (6)      68   

Clearing and execution

     9      49      37    (82)      (76)  

Other

     182      198      72    (8)      153   

Subtotal

     2,371      2,494      1,229    (5)      93   

Amortization of intangible assets

     122      131      28    (7)      N/M   

Merger and integration expense:

              

The Bank of New York Mellon

     121      111      4    9       N/M   

Acquired Corporate Trust Business

     5      13      11    (62)      (55)  

Total noninterest expense

   $ 2,619    $ 2,749    $ 1,272    (5)%    106%

Total staff expense as a percentage of total revenue (FTE)

     36%      36%      38%      

Employees at period-end

     42,600      42,500      23,100    -%    84%
(a) Legacy The Bank of New York only.

N/M—Not meaningful

 

Total noninterest expense increased compared with the first quarter of 2007 and decreased compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 resulted primarily from the merger with Mellon, as well as the acquisition of the remaining 50% interest in BNY Mellon Asset Servicing B.V., partially offset by the sale of the B-Trade and G-Trade execution businesses to BNY ConvergEx. The sequential quarter decrease reflects the impact of expense synergies and the sale of the B-Trade and G-Trade execution businesses, partially offset by the purchase of the remaining 50% interest in BNY Mellon Asset Servicing B.V. The increase in merger and integration expense and intangible amortization expense compared to the first quarter of 2007 resulted from the merger with Mellon.

Staff expense

Given our mix of fee-based businesses, which are staffed with high quality professionals, staff expense

comprised approximately 57% of total noninterest expense, excluding merger and integration and intangible amortization expense, in the first quarter of 2008.

Staff expense is comprised of:

  ·  

compensation expense, which includes:

  ·  

base salary expense, primarily driven by headcount;

  ·  

the cost of temporary help and overtime; and

  ·  

severance expense;

  ·  

incentive expense, which includes:

  ·  

additional compensation earned under a wide range of sales commission and incentive plans designed to reward a combination of individual, business unit and corporate performance goals; as well as

  ·  

stock-based compensation expense; and

  ·  

employee benefit expense, primarily medical benefits, payroll taxes, pension and other retirement benefits.


 

14     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

The increase in staff expense compared with the first quarter of 2007 reflects a net increase in headcount associated with the Mellon merger as well as the acquisition of the remaining 50% interest in BNY Mellon Asset Servicing B.V., partially offset by the sale of B-Trade and G-Trade execution businesses.

Non-staff expense

Non-staff expense includes certain expenses that vary with the levels of business activity and levels of expensed business investments, fixed infrastructure costs and expenses associated with corporate activities related to technology, compliance, productivity initiatives and corporate development.

Non-staff expense excluding merger and integration expense and intangible amortization expense, totaled $1.019 billion in the first quarter of 2008 compared with $509 million in the first quarter of 2007. Non-staff expenses were impacted by the merger with Mellon as well as the following activities:

 

  ·  

A $126 million increase in distribution and servicing expense. Distribution and servicing expense represents amounts paid to other financial intermediaries to cover their costs for distribution (marketing support, administration and record keeping) and servicing of mutual funds. Generally, increases in distribution and servicing expense reflect higher net sales. Distribution and servicing expense in any one year is not expected to be fully recovered by higher distribution and service revenue; rather it contributes to future growth in mutual fund management revenue reflecting the growth in mutual fund assets generated through certain distribution channels;

  ·  

The increase in professional, legal and other purchased services, sub-custodian, business development, furniture and equipment, software and communications expense reflect business growth and strategic initiatives; and

  ·  

The increase in other expense reflects organic business growth, a $25 million write-down of seed capital investments related to a formerly affiliated hedge fund manager and a $12 million expense associated with capital support agreements.

 

In the first quarter of 2008, we incurred $121 million of merger and integration expenses related to the merger with Mellon, comprised of the following:

 

  ·  

Personnel related—includes severance, retention, relocation expenses, accelerated vesting of stock options and restricted stock expense ($34 million);

  ·  

Integration/conversion costs—including consulting, system conversions and staff ($82 million); and

  ·  

One-time costs—includes facilities related costs, asset write-offs, vendor contract modifications, rebranding and net gain (loss) on disposals ($5 million).

We also incurred $5 million of merger and integration expense associated with the Acquired Corporate Trust Business in the first quarter of 2008.

Amortization of intangible assets increased to $122 million in the first quarter of 2008 compared with $28 million in the first quarter of 2007, primarily reflecting the merger with Mellon.

Income taxes

On a continuing operations basis, the effective tax rate for the first quarter of 2008 was 32.5%, compared with 32.2% in the first quarter of 2007 and 31.8% in the fourth quarter of 2007. The higher effective tax rate in the first quarter of 2008 compared with the fourth quarter of 2007 reflects higher state and local income taxes.


 

The Bank of New York Mellon Corporation     15


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Credit loss provision and net charge-offs

 

Credit loss provision
and net charge-offs
  Quarter ended
(in millions)   March 31,
2008
  Dec. 31,
2007
  March 31,
2007
(a)

Provision for credit losses

  $16   $20   $(15)

Net charge-offs (recoveries)

     

Commercial

  $  6   $17   $   5 

Leasing

  -   -   (8)

Foreign

  5   18  

Other

  2   1  

Total net charge-off (recoveries)

  $13   $36   $  (3)
(a) Legacy The Bank of New York only.

The provision for credit losses was $16 million in the first quarter of 2008, compared with $20 million in the fourth quarter of 2007 and a credit of $15 million in the first quarter of 2007. We recorded a net charge-off of $13 million in the first quarter of 2008, compared with a net charge off of $36 million in the fourth quarter of 2007. Net charge-offs in the first quarter of 2008 include $6 million related to a retail trade customer and $5 million related to foreign SIV exposure.

Business segments review

We have an internal information system that produces performance data for our seven business segments along product and service lines.

Business segments accounting principles

Our segment 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 segments will track their economic performance.

The accounting policies of the business segments are the same as those described in Note 1 to the Consolidated Financial Statements contained in The Bank of New York Mellon’s 2007 Annual Report on Form 10-K except other fee revenue and net interest revenue differ from the amounts shown in the Consolidated Income Statement because amounts presented in Business segments are on an FTE basis. Segment results are subject to reclassification

whenever improvements are made in the measurement principles or when organizational changes are made.

The operations of acquired businesses are integrated with the existing business segments soon after most acquisitions 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.

We provide segment data for seven segments with certain segments combined into sectors groupings as shown below:

 

  ·  

Asset and Wealth Management sector

  ·  

Asset Management segment

  ·  

Wealth Management segment

  ·  

Institutional Services sector

  ·  

Asset Servicing segment

  ·  

Issuer Services segment

  ·  

Clearing and Execution Services segment

  ·  

Treasury Services segment

  ·  

Other segment

Business segment information is reported on a continuing operations basis for all periods presented. See Note 4 in the Notes to the Consolidated Financial Statements for a discussion of discontinued operations.

The results of our business segments are presented and analyzed on an internal management reporting basis:

 

  ·  

Revenue amounts reflect fee and other revenue generated by each segment, as well as fee and other revenue transferred between segments under revenue transfer agreements.

  ·  

Revenues and expenses associated with specific client bases are included in those segments. For example, foreign exchange activity associated with clients using custody products is allocated to the Asset Servicing segment.

  ·  

Balance sheet assets and liabilities and their related income or expense are specifically assigned to each segment. Segments with a

 


16     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

 

net liability position have also been allocated assets from the securities portfolio.

  ·  

Net interest revenue is allocated to segments based on the yields on the assets and liabilities generated by each segment. We employ a funds transfer pricing system that matches funds with the specific assets and liabilities of each segment based on their interest sensitivity and maturity characteristics.

  ·  

The measure of revenues and profit or loss by a segment has been adjusted to present segment data on an FTE basis.

  ·  

Support and other indirect expenses are allocated to segments based on internally-developed methodologies.

  ·  

Goodwill and intangible assets are reflected within individual business segments.

  ·  

The operations of Mellon are included only from July 1, 2007, the effective date of the merger.

The merger with Mellon in July 2007 had a considerable impact on the business segment results in the first quarter of 2008 compared with the first quarter of 2007. The merger with Mellon significantly impacted Asset Management, Wealth Management and the Asset Servicing segments and,

to a lesser extent, the Issuer Services, Treasury Services and Other segments. The volatile market environment also impacted business segments in the first quarter of 2008 compared with the first quarter of 2007 as reflected by strong securities lending and foreign exchange and other trading activities and weakness in other businesses.

Non-program equity trading volumes were up 6% sequentially and 22% year-over-year. In addition, average daily U.S. fixed-income trading volume was up 16% sequentially and 24% year-over-year. Total debt issuance increased 7% sequentially and decreased 44% year-over-year. The issuance of global collateralized debt obligations was down 94% versus the first quarter of 2007.

The changes in the value of market indices impact fee revenue in the Asset and Wealth Management segments and our securities servicing businesses. Using the S&P 500 as a proxy for the equity markets, we estimate that a 100 point change in the value of the S&P 500, sustained for one year, impacts fee revenue by approximately 1% and fully diluted EPS on a continuing operations basis by $0.05 per share.


 

Market indices    1Q07    2Q07    3Q07    4Q07    1Q08    1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

S&P 500 Index (a)

   1421    1503    1527    1468    1323    (10 )%   (7 )%

FTSE 100 Index (a)

   6308    6608    6467    6457    5702    (12 )   (10 )

NASDAQ Composite Index (a)

   2422    2603    2702    2652    2279    (14 )   (6 )

Lehman Brothers Aggregate Bondsm Index (a)

   230.8    227.9    246.2    257.5    281.2    9     22  

MSCI EAFE® Index (a)

   2147.5    2262.2    2300.3    2253.4    2038.6    (10 )   (5 )

NYSE Volume (in billions)

   123.8    127.7    145.5    135.0    158.5    17     28  

NASDAQ Volume (in billions)

   131.4    134.0    137.0    137.4    148.9    8     13  
(a) Period end.

The consolidating schedules below show the

contribution of our segments to our overall

profitability.

 

The Bank of New York Mellon Corporation     17


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

For the quarter ended

March 31, 2008

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Sector

  Asset
Servicing
  Issuer
Services
  Clearing &
Execution
Services
  Treasury
Services
  Total
Institutional
Services
Sector
  Other
Segment
    Total
Continuing
Operations

Fee and other revenue

  $ 752     $ 169   $ 921   $ 1,095   $ 407   $ 319   $ 233   $ 2,054   $ 12     $ 2,987

Net interest revenue

    15       95     110     221     153     74     183     631     32       773

Total revenue

    767       264     1,031     1,316     560     393     416     2,685     44       3,760

Provision for credit losses

    -       -     -     -     -     -     -     -     16       16

Noninterest expense

    624       187     811     752     337     280     212     1,581     227       2,619

Income before taxes

  $ 143     $ 77   $ 220   $ 564   $ 223   $ 113   $ 204   $ 1,104   $ (199 )   $ 1,125

Pre-tax operating margin (a)

    19%       29%     21%     43%     40%     29%     49%     41%     N/M       30%

Average assets

  $ 12,919     $ 16,627   $ 29,546   $ 53,123   $ 32,182   $ 16,574   $ 23,615   $ 125,494   $ 45,750     $ 200,790

Excluding intangible amortization:

                   

Noninterest expense

  $ 562     $ 167   $ 729   $ 745   $ 317   $ 274   $ 205   $ 1,541   $ 227     $ 2,497

Income before taxes

    205       97     302     571     243     119     211     1,144     (199 )     1,247

Pre-tax operating margin (a)

    27%       37%     29%     43%     43%     30%     51%     43%     N/M       33%
                                                                 

For the quarter ended

Dec. 31, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Sector

  Asset
Servicing
  Issuer
Services
  Clearing &
Execution
Services
  Treasury
Services
  Total
Institutional
Services
Sector
  Other
Segment
    Total
Continuing
Operations

Fee and other revenue

  $ 888     $ 170   $ 1,058   $ 1,027   $ 457   $ 357   $ 249   $ 2,090   $ (93 )   $ 3,055

Net interest revenue

    17       86     103     224     175     78     162     639     15       757

Total revenue

    905       256     1,161     1,251     632     435     411     2,729     (78 )     3,812

Provision for credit losses

    -       -     -     -     -     -     -     -     20       20

Noninterest expense

    629       187     816     813     345     311     208     1,677     256       2,749

Income before taxes

  $ 276     $ 69   $ 345   $ 438   $ 287   $ 124   $ 203   $ 1,052   $ (354 )   $ 1,043

Pre-tax operating margin (a)

    30%       27%     30%     35%     45%     29%     49%     39%     N/M       27%

Average assets

  $ 13,079     $ 15,849   $ 28,928   $ 48,353   $ 32,708   $ 16,698   $ 21,803   $ 119,562   $ 44,497     $ 192,987

Excluding intangible amortization:

                   

Noninterest expense

  $ 559     $ 166   $ 725   $ 807   $ 324   $ 305   $ 201   $ 1,637   $ 256     $ 2,618

Income before taxes

    346       90     436     444     308     130     210     1,092     (354 )     1,174

Pre-tax operating margin (a)

    38%       35%     38%     35%     49%     30%     51%     40%     N/M       31%
                                                                 

For the quarter ended

Sept. 30, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Sector

  Asset
Servicing
  Issuer
Services
  Clearing &
Execution
Services
  Treasury
Services
  Total
Institutional
Services
Sector
  Other
Segment
    Total
Continuing
Operations

Fee and other revenue

  $ 745     $ 161   $ 906   $ 906   $ 460   $ 372   $ 222   $ 1,960   $ 74     $ 2,940

Net interest revenue

    (4 )     85     81     195     159     77     140     571     22       674

Total revenue

    741       246     987     1,101     619     449     362     2,531     96       3,614

Provision for credit losses

    -       -     -     -     -     -     -     -     -       -

Noninterest expense

    608       183     791     759     311     322     201     1,593     322       2,706

Income before taxes

  $ 133     $ 63   $ 196   $ 342   $ 308   $ 127   $ 161   $ 938   $ (226 )   $ 908

Pre-tax operating margin (a)

    18%       26%     20%     31%     50%     28%     44%     37%     N/M       25%

Average assets

  $ 13,021     $ 15,817   $ 28,838   $ 43,948   $ 30,738   $ 15,854   $ 21,070   $ 111,610   $ 43,380     $ 183,828

Excluding intangible amortization:

                   

Noninterest expense

  $ 538     $ 162   $ 700   $ 753   $ 291   $ 316   $ 194   $ 1,554   $ 321     $ 2,575

Income before taxes

    203       84     287     348     328     133     168     977     (225 )     1,039

Pre-tax operating margin (a)

    27%       34%     29%     32%     53%     30%     46%     39%     N/M       29%

 

18     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Legacy The Bank of New York only

 

For the quarter ended

June 30, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Sector

  Asset
Servicing
  Issuer
Services
  Clearing &
Execution
Services
  Treasury
Services
  Total
Institutional
Services
Sector
  Other
Segment
    Total
Continuing
Operations
 

Fee and other revenue

  $ 127     $ 50   $ 177   $ 520   $ 390   $ 321   $ 143   $ 1,374   $ 29     $ 1,580  

Net interest revenue

    (2 )     14     12     148     131     75     102     456     (15 )     453  

Total revenue

    125       64     189     668     521     396     245     1,830     14       2,033  

Provision for credit losses

    -       -     -     -     -     -     -     -     (15 )     (15 )

Noninterest expense

    76       53     129     466     257     300     127     1,150     110       1,389  

Income before taxes

  $ 49     $ 11   $ 60   $ 202   $ 264   $ 96   $ 118   $ 680   $ (81 )   $ 659  

Pre-tax operating margin (a)

    39%       17%     32%     30%     51%     24%     48%     37%     N/M       32%  

Average assets

  $ 1,557     $ 1,427   $ 2,984   $ 30,819   $ 23,189   $ 14,392   $ 15,803   $ 84,203   $ 27,136     $ 114,323  

Excluding intangible amortization:

                   

Noninterest expense

  $ 72     $ 53   $ 125   $ 464   $ 240   $ 294   $ 127   $ 1,125   $ 110     $ 1,360  

Income before taxes

    53       11     64     204     281     102     118     705     (81 )     688  

Pre-tax operating margin (a)

    42%       17%     34%     31%     54%     26%     48%     39%     N/M       34%  

 

Legacy The Bank of New York only

 

For the quarter ended

March 31, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
 

Total

Asset &
Wealth
Management
Sector

  Asset
Servicing
  Issuer
Services
  Clearing &
Execution
Services
  Treasury
Services
  Total
Institutional
Services
Sector
  Other
Segment
    Total
Continuing
Operations
 

Fee and other revenue

  $ 106   $ 50   $ 156   $ 472   $ 353   $ 310   $ 137   $ 1,272   $ 47     $ 1,475  

Net interest revenue

    7     14     21     125     102     74     109     410     (2 )     429  

Total revenue

    113     64     177     597     455     384     246     1,682     45       1,904  

Provision for credit losses

    —       —       —       —       —       —       —       —       (15 )     (15 )

Noninterest expense

    70     51     121     433     246     283     119     1,081     70       1,272  

Income before taxes

  $ 43   $ 13   $ 56   $ 164   $ 209   $ 101   $ 127   $ 601   $ (10 )   $ 647  

Pre-tax operating margin (a)

    38%     20%     32%     27%     46%     26%     52%     36%     N/M       34%  

Average assets

  $ 1,819   $ 1,418   $ 3,237   $ 28,453   $ 15,701   $ 14,985   $ 15,010   $ 74,149   $ 24,655     $ 102,041  

Excluding intangible amortization:

                   

Noninterest expense

  $ 66   $ 51   $ 117   $ 432   $ 229   $ 277   $ 119   $ 1,057   $ 70     $ 1,244  

Income before taxes

    47     13     60     165     226     107     127     625     (10 )     675  

Pre-tax operating margin (a)

    42%     20%     34%     28%     50%     28%     52%     37%     N/M       35%  
(a) Income before taxes divided by total revenue.

N/M - Not meaningful

 

Asset and Wealth Management Sector

Asset and Wealth Management fee revenue is dependent on the overall level and mix of assets under management (“AUM”) and the management fees expressed in basis points (one-hundredth of one percent) charged for managing those assets. AUM were $1.105 trillion at March 31, 2008, compared with $142 billion at March 31, 2007, and $1.121 trillion at Dec. 31, 2007. The year-over-year increase in AUM primarily reflects the merger with Mellon, new business and strong money market flows, partially offset by lower equity market levels. The decrease from Dec. 31, 2007 reflects lower equity markets, primarily offset by strong money market flows.


 

The Bank of New York Mellon Corporation     19


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Assets under management at period-end, by

product type

(in billions)

   March 31,
2007
(a)
   June 30,
2007
(a)
   Sept. 30,
2007
   Dec. 31,
2007
   March 31,
2008

Equity securities

   $ 41    $ 43    $ 456    $ 460    $ 424

Money market

     34      41      275      296      320

Fixed income securities

     22      22      215      218      219

Alternative investments and overlay

     45      47      160      147      142

Total assets under management

   $ 142    $ 153    $ 1,106    $ 1,121    $ 1,105
(a) Legacy The Bank of New York only.

 

Assets under management at period-end, by

client type

(in billions)

   March 31,
2007
(a)
   June 30,
2007
(a)
   Sept. 30,
2007
   Dec. 31,
2007
   March 31,
2008

Institutional

   $ 106    $ 113    $ 682    $ 671    $ 636

Mutual funds

     15      18      323      349      373

Private client

     21      22      101      101      96

Total assets under management

   $ 142    $ 153    $ 1,106    $ 1,121    $ 1,105
(a) Legacy The Bank of New York only.

 

Changes in market value of assets under management from

Dec. 31, 2007 to March 31, 2008 - by business segment

(in billions)    Asset
Management
    Wealth
Management
     Total 

Market value of assets under management at Dec. 31, 2007

   $ 1,035     $ 86      $ 1,121 

Net inflows (outflows):

       

Long-term

     (8 )     2        (6)

Money market

     29       -        29 
                       

Total net inflows

     21       2        23 

Net market depreciation (a)

     (35 )     (4 )      (39)

Market value of assets under management at March 31, 2008

   $ 1,021  (b)   $ 84      $ 1,105 
(a) Includes the effect of changes in foreign exchange rates.
(b) Excludes $8 billion subadvised for other segments.

 

At March 31, 2008, the investment portfolio of money market funds and short duration products under management included approximately $3.5 billion of senior notes issued by structured investment vehicles (“SIVs”) which represented 1% of the portfolio. Approximately 90% of these securities have been issued by bank-sponsored SIVs and the sponsors have agreed to support the notes. More than 95% of these securities are scheduled to mature in 2008.


 

20     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Asset Management segment

 

(dollar amounts in millions, unless otherwise noted; presented on an FTE basis)      1Q07 (a)      2Q07 (a)       3Q07       4Q07      1Q08     1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

Revenue:

                

Asset and wealth management:

                

Mutual funds

   $ 3    $ 4     $ 307     $ 323    $ 323     - %   N/M %

Institutional clients

     68      80       331       342      304     (11 )   347  

Private clients

     14      16       47       47      45     (4 )   221  
                                          

Total asset and wealth management revenue

     85      100       685       712      672     (6 )   691  

Performance fees

     14      20       (3 )     62      20     (68 )   43  

Distribution and servicing

     -      -       89       104      86     (17 )   N/M  

Other

     7      7       (26 )     10      (26 )   N/M     N/M  
                                          

Total fee and other revenue

     106      127       745       888      752     (15 )   609  

Net interest revenue (expense)

     7      (2 )     (4 )     17      15     (12 )   114  
                                          

Total revenue

     113      125       741       905      767     (15 )   579  

Noninterest expense (ex. intangible amortization)

     66      72       538       559      562     1     752  
                                          

Income before taxes (ex. intangible amortization)

     47      53       203       346      205     (41 )   336  

Amortization of intangible assets

     4      4       70       70      62     (11 )   N/M  
                                          

Income before taxes

   $ 43    $ 49     $ 133     $ 276    $ 143     (48 )   233  
                                          

Memo: Income before taxes (ex. intangible amortization and non-operating items)

   $ 47    $ 53     $ 235  (b)   $ 346    $ 205     (41 )   336  

Pre-tax operating margin (ex. intangible amortization)

     42%      42%       32%  (b)     38%      27%      

Average assets

   $ 1,819    $ 1,557     $ 13,021     $ 13,079    $ 12,919     (1 )%   610 %
(a) Legacy The Bank of New York only.
(b) Results for the third quarter of 2007 exclude a pre-tax charge ($32 million) related to the write-off of the value of the remaining interest in a legacy Mellon hedge fund manager that was disposed of in 2006.

 

Business description

BNY Mellon Asset Management is the umbrella organization for all of our affiliated investment management boutiques and is responsible, through various subsidiaries, for U.S. and non-U.S. retail, intermediary and institutional distribution of investment management and related services. The investment management boutiques offer a broad range of equity, fixed income, cash and alternative/overlay products. In addition to the investment subsidiaries, BNY Mellon Asset Management includes BNY Mellon Asset Management International which is responsible for the distribution of investment management products internationally, and the Dreyfus Corporation, which is responsible for U.S. distribution of retail mutual funds, separate accounts and annuities.

BNY Mellon Asset Management is the 13th largest global asset manager, the 9th largest U.S. asset manager and the 7th largest asset manager in Europe.

We are also a top five tax-exempt, institutional U.S. asset manager.

In the first quarter of 2008, we acquired ARX Capital Management (“ARX”), a leading independent asset management business headquartered in Rio de Janeiro, Brazil. ARX has more than $2.8 billion in assets under management. Also, in the first quarter, we sold a portion of Estabrook Capital Management LLC. This sale reduced our assets under management by $2.4 billion.

The results of the Asset Management segment are mainly driven by the period-end and average levels of assets managed as well as the mix of those assets, as shown on the previous page. Results for this segment are also impacted by sales of fee-based products such as fixed and variable annuities and separately managed accounts. Expenses in this segment are mainly driven by staffing costs, incentives, distribution and servicing expense, and product distribution costs.


 

The Bank of New York Mellon Corporation     21


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Review of financial results

Income before taxes was $143 million in the first quarter of 2008 compared with $43 million in the first quarter of 2007 and $276 million in the fourth quarter of 2007. Income before taxes (excluding intangible amortization) was $205 million in the first quarter of 2008 compared with $47 million in the first quarter of 2007 and $346 million in the fourth quarter of 2007. Results in the first quarter of 2008 include $24 million of write-downs related to securities previously purchased from investment boutiques and a $25 million write-down of seed capital investments related to a formerly affiliated hedge fund manager.

Asset and wealth management revenue in the Asset Management segment was $672 million in the first quarter of 2008 compared with $85 million in the first quarter of 2007 and $712 million in the fourth quarter of 2007. The increase compared to the first quarter of 2007 reflects the merger with Mellon, the benefit of strong money market flows and growth in business outside the U.S., partially offset by the prior loss of business at one of the investment boutiques, as well as lower equity market values.

The decrease from the fourth quarter of 2007 primarily reflects lower equity market values partially offset by money market inflows. Performance fees were $20 million in the first quarter of 2008 compared with $14 million in the first quarter of 2007 and $62 million in the fourth quarter of 2007. The sequential quarter decrease reflects seasonality.

Other fee revenue was a loss of $26 million in the first quarter of 2008 reflecting $24 million of write-downs related to securities previously purchased from funds managed by the investment boutiques and $19 million of seed capital investment losses.

Noninterest expense (excluding intangible amortization) was $562 million in the first quarter of 2008 compared with $66 million in the first quarter of 2007 and $559 million in the fourth quarter of 2007. The increase compared with the first quarter of 2007 principally reflects the merger with Mellon as well as expenses in support of business growth and the previously mentioned seed capital write-down. The increase from the fourth quarter of 2007 reflects the seed capital write-down primarily offset by strong expense management.


 

Wealth Management segment

 

(dollar amounts in millions,

unless otherwise noted;

presented on an FTE basis)

     1Q07 (a)      2Q07 (a)      3Q07      4Q07      1Q08    1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

Revenue:

                   

Asset and wealth management

   $ 48    $ 48    $ 151    $ 157    $ 153    (3 )%   219 %

Other

     2      2      10      13      16    23     N/M  
                                       

Total fee and other revenue

     50      50      161      170      169    (1 )   238  

Net interest revenue

     14      14      85      86      95    10     579  
                                       

Total revenue

     64      64      246      256      264    3     313  

Noninterest expense (ex. intangible amortization)

     51      53      162      166      167    1     227  
                                       

Income before taxes (ex. intangible amortization)

     13      11      84      90      97    8     646  

Amortization of intangible assets

     -      -      21      21      20    (5 )   N/M  
                                       

Income before taxes

   $ 13    $ 11    $ 63    $ 69    $ 77    12     492  
                                       

Pre-tax operating margin (ex. intangible amortization)

     20%      17%      34%      35%      37%     

Average loans

   $ 1,336    $ 1,342    $ 6,586    $ 6,867    $ 6,996    2     424  

Average assets

     1,418      1,427      15,817      15,849      16,627    5     1,073  

Average deposits

     1,105      1,065      11,289      11,240      11,789    5     967  

Market value of total client assets at period-end (in billions)

   $ 59    $ 59    $ 170    $ 170    $ 164    (4 )   178  
(a) Legacy The Bank of New York only.
N//M - Not meaningful.

 

22     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Business description

In the Wealth Management segment, we offer a full array of investment management, wealth and estate planning and private banking solutions to help clients protect, grow and transfer their wealth. Clients include high-net-worth individuals and families, family offices and business enterprises, charitable gift programs, and endowments and foundations. BNY Mellon Wealth Management is a top ten U.S. wealth manager with $164 billion in client assets. We serve our clients through an expansive network of offices in 16 states and 3 countries. The activities of Mellon 1st Business Bank, N.A. and Mellon United National Bank are included in this segment. On March 28, 2008, we announced that we had reached an agreement to sell Mellon 1st Business Bank to U.S. Bancorp, which is expected to close in the second quarter of 2008. The sale is expected to reduce loan and deposit levels by $1.1 billion and $2.7 billion, respectively. The transaction is expected to have an immaterial impact on net income. We also expect that this transaction will increase our adjusted tangible common equity ratio 15-20 basis points.

The results of the Wealth Management segment are driven by the level and mix of assets managed and custodied and the level of activity in client accounts.

Net interest revenue is determined by the level of interest spread between loans and deposits. Expenses of this segment are driven mainly by staff expense in the investment management, sales, service and support groups.

Review of financial results

Income before taxes was $77 million in the first quarter of 2008, compared with $13 million in the first quarter of 2007 and $69 million in the fourth quarter of 2007. Income before taxes, excluding intangible amortization, was $97 million in the first quarter of 2008, compared with $13 million in the first quarter of 2007 and $90 million in the fourth quarter of 2007.

Total fee and other revenue was $169 million in the first quarter of 2008, compared with $50 million in the first quarter of 2007 and $170 million in the fourth quarter of 2007. The increase compared with

the first quarter of 2007 primarily resulted from the merger with Mellon, new business and organic growth, partially offset by unfavorable market conditions. The decrease compared with the fourth quarter of 2007 resulted from lower market levels which more than offset the impact of organic growth and new business.

Net interest revenue increased $81 million compared with the first quarter of 2007, and $9 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 reflects the merger with Mellon and increased loan and deposit levels. The increase compared with the fourth quarter of 2007 was primarily due to higher loan and deposit levels, partially offset by the impact of lower spreads due to the lower interest rate environment.

Noninterest expense (excluding intangible amortization) increased $116 million compared with the first quarter of 2007 and $1 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 primarily reflects the merger with Mellon as well as expenses associated with new distribution channels. Noninterest expense increased less than 1% (unannualized) sequentially as higher incentive expense was primarily offset by lower seasonal expense.

Institutional Services Sector

At March 31, 2008, our assets under custody and administration were $23.1 trillion, unchanged from Dec. 31, 2007 and up from $15.9 trillion at March 31, 2007. The increase in assets under custody and administration, compared with March 31, 2007 primarily reflects the merger with Mellon and growth in the custody business, partially offset by lower market values. Equity securities comprised 30% and fixed-income securities were 70% of the assets under custody and administration at March 31, 2008, compared with 32% equity securities and 68% fixed-income securities at Dec. 31, 2007. Assets under custody and administration at March 31, 2008 consisted of assets related to custody, mutual fund, and corporate trust businesses of $18.1 trillion, broker-dealer service assets of $2.7 trillion, and all other assets of $2.3 trillion.


 

The Bank of New York Mellon Corporation     23


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

      March 31,
2007 
(a)
    June 30,
2007 
(a)
    Sept. 30,
2007
    Dec. 31,
2007
   March 31,
2008

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

   $ 15.9  (c)   $ 16.7  (c)   $ 22.7  (c)   $ 23.1    $ 23.1

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

     397       397       663       633      676
(a) Legacy The Bank of New York only.
(b) Includes the assets under custody or administration of CIBC Mellon Global Securities Services, a joint venture between BNY Mellon and the Canadian Imperial Bank of Commerce of $930 billion at March 31, 2008, $989 billion at Dec. 31, 2007, and $957 billion at Sept. 30, 2007.
(c) Revised for Acquired Corporate Trust Business and harmonization adjustments.
(d) Represents the total amount of securities on loan, both cash and non-cash, managed by the Asset Servicing segment.

Asset Servicing segment

 

(dollar amounts in millions,

unless otherwise noted;

presented on an FTE basis)

     1Q07 (a)      2Q07 (a)      3Q07      4Q07      1Q08    1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

Revenue:

                   

Securities servicing fees - Asset Servicing

   $ 390    $ 424    $ 689    $ 768    $ 851    11 %   118 %

Foreign exchange and other trading activities

     67      77      161      206      200    (3 )   199  

Other

     15      19      56      53      44    (17 )   193  
                                       

Total fee and other revenue

     472      520      906      1,027      1,095    7     132  

Net interest revenue

     125      148      195      224      221    (1 )   77  
                                       

Total revenue

     597      668      1,101      1,251      1,316    5     120  

Noninterest expense (ex. intangible amortization)

     432      464      753      807      745    (8 )   72  
                                       

Income before taxes (ex. intangible amortization)

     165      204      348      444      571    29     246  

Amortization of intangible assets

     1      2      6      6      7    17     600  
                                       

Income before taxes

   $ 164    $ 202    $ 342    $ 438    $ 564    29     244  
                                       

Pre-tax operating margin (ex. intangible amortization)

     28%      31%      32%      35%      43%     

Average assets

   $ 28,453    $ 30,819    $ 43,948    $ 48,353    $ 53,123    10     87  

Average deposits

     25,652      28,119      37,971      42,338      46,964    11     83  

Securities lending revenue

     36      55      110      164      242    48     572  

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

     397      397      663      633      676    7     70  
(a) Legacy The Bank of New York only.

 

Business description

The Asset Servicing segment includes global custody, global fund services, securities lending, global liquidity services, outsourcing, government securities clearance, collateral management and credit-related services and other linked revenues, principally foreign exchange. Clients include corporate and public retirement funds, foundations and endowments and global financial institutions including banks, broker-dealers, investment managers, insurance companies and mutual funds.

The results of the Asset Servicing segment are driven by a number of factors which include the level of transactional activity and extent of services provided including custody, accounting, fund administration, daily valuations, performance measurement and risk

analytics, securities lending and investment manager backoffice outsourcing, as well as the market value of assets under administration and custody. Market interest rates impact both securities lending revenue and the earnings on client cash balances. Broker-dealer fees depend on the level of activity in the fixed income markets and the financing needs of customers, which are typically higher when the equity and fixed income markets are active. Also, the adoption of tri-party repo arrangements continues to remain a key revenue driver in broker-dealer services. Foreign exchange trading revenues are influenced by the volume of client transactions and the spread realized on these transactions, market volatility in major currencies, the level of cross-border assets held in custody for clients, the level and nature of underlying cross-border investment and other


 

24     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

transactions undertaken by corporate and institutional clients. Segment expenses are principally driven by staffing levels and technology investments necessary to process transaction volumes. Fees paid to subcustodians are driven by market values of global assets and related transaction volumes.

We are one of the leading global securities servicing companies with a total of $23.1 trillion of assets under custody and administration at March 31, 2008. We are one of the largest providers of fund services in the world, servicing over $4.7 trillion in assets. We also service more than 45% of the exchange-traded funds in the U.S. BNY Mellon Asset Servicing clients include 55% of the top 20 endowments. Additionally, we service 42% of the top 50 endowments.

We are a leading custodian in the U.K. and service 35% of U.K. pensions. European asset servicing continues to grow across all products, reflecting significant cross-border investment interest and capital flow. In securities lending, we are one of the largest lenders of U.S. Treasury securities and depositary receipts and service a lending pool of more than $3.5 trillion in 30 markets around the world. We are one of the largest global providers of performance and risk analytics with $9.6 trillion in assets under measurement.

Our broker-dealer service business is a leader in global clearance, clearing equity and fixed income transactions in more than 100 markets. We clear approximately 50% of transactions in U.S. Government securities. With $1.8 trillion in tri-party balances worldwide, we are a leading collateral management agent.

Review of financial results

Income before taxes was $564 million in the first quarter of 2008 compared with $164 million in the first quarter of 2007, and $438 million in the fourth quarter of 2007.

 

Total fee and other revenue increased $623 million in the first quarter of 2008 compared with the first quarter of 2007 driven by the merger with Mellon, higher securities lending revenue related to market volatility, as well as net new business and the fourth quarter 2007 acquisition of the remaining 50% interest in BNY Mellon Asset Servicing B.V.

Securities lending revenue increased $206 million from the first quarter of 2007 and $78 million on a sequential quarter basis. The increase from the first quarter of 2007 resulted from the merger with Mellon, favorable spreads in the short-term credit markets and the acquisition of the remaining interest in BNY Mellon Asset Servicing B.V. The sequential quarter increase reflects the favorable spreads in the short-term credit markets and acquisition of the remaining 50% interest in BNY Mellon Asset Servicing B.V.

Foreign exchange and other trading activity increased $133 million compared with the first quarter of 2007 and decreased $6 million sequentially. The increase compared to a year ago reflects the merger with Mellon as well as higher client volumes and a significant increase in currency volatility. The sequential quarter decrease reflects lower volumes primarily offset by higher volatility.

Net interest revenue increased $96 million compared with the first quarter of 2007, and decreased $3 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 was primarily driven by the merger with Mellon, deposit growth and improved spreads. The sequential quarter decrease primarily reflects lower spreads.

Noninterest expense (excluding intangible amortization) increased $313 million compared with the first quarter of 2007 and decreased $62 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 reflects the merger with Mellon and the impact of new business and other growth initiatives as well as $12 million of expense related to capital support agreements, partially offset by the impact of merger-related synergies. The sequential decrease principally reflects the impact of merger-related synergies, lower sub-custodian fees and seasonality.


 

The Bank of New York Mellon Corporation     25


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Issuer Services segment

 

(dollar amounts in

 millions, unless otherwise

 noted; presented on an

 FTE basis)

     1Q07 (a)       2Q07 (a)       3Q07       4Q07       1Q08     1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

Revenue:

              

Securities servicing fees – Issuer services

   $ 319     $ 367     $ 436     $ 438     $ 374     (15 )%   17 %

Other

     34       23       24       19       33     74     (3 )
                                            

Total fee and other revenue

     353       390       460       457       407     (11 )   15  

Net interest revenue

     102       131       159       175       153     (13 )   50  
                                            

Total revenue

     455       521       619       632       560     (11 )   23  

Noninterest expense (ex. intangible amortization)

     229       240       291       324       317     (2 )   38  
                                            

Income before taxes (ex. intangible amortization)

     226       281       328       308       243     (21 )   8  

Amortization of intangible assets

     17       17       20       21       20     (5 )   18  
                                            

Income before taxes

   $ 209     $ 264     $ 308     $ 287     $ 223     (22 )%   7 %
                                            

Pre-tax operating margin (ex. intangible amortization)

     50 %     54 %     53 %     49 %     43 %    

Average assets

   $ 15,701     $ 23,189     $ 30,738     $ 32,708     $ 32,182     (2 )%   105 %

Average deposits

     11,652       19,183       26,153       28,272       27,608     (2 )   137  

Depositary receipts outstanding (in billions)

     642       779       1,178       1,360       1,221     (10 )   90  

Depositary receipt trading value (in billions)

     233       248       354       519       499     (4 )   114  
(a) Legacy The Bank of New York only.

 

Business description

The Issuer Services segment provides a diverse array of products and services to fixed income and equity issuers, including corporations and shareholders, corporate trust, depositary receipts, employee investment plan services, and shareowner services.

As the world’s largest trustee, we provide diverse services for corporate, municipal, structured, and international debt issuers. We serve as trustee or agent for approximately 90,000 issues and service $12 trillion in outstanding debt from offices in 54 locations around the world, including 18 non-U.S. locations. We serve as depositary for more than 1,300 American and global depositary receipt programs, with a 64% market share, acting in partnership with leading companies from 63 countries. In addition to its top-ranked stock transfer agency services, BNY Mellon Shareowner Services offers a comprehensive suite of equity solutions ranging from record keeping and corporate actions processing, demutualizations, direct investment, dividend reinvestment, proxy solicitation and employee stock plan administration.

 

Fee revenue in the Issuer Services segment depends on:

  ·  

the volume of issuance of fixed income securities;

  ·  

depositary receipts issuance and cancellation volume;

  ·  

corporate actions impacting depositary receipts; and

  ·  

transfer agency and corporate action volumes.

Expenses in the Issuer Services segment are driven by staff, equipment, and space required to support the services provided by the segment.

Review of financial results

Income before taxes was $223 million in the first quarter of 2008, compared with $209 million in the first quarter of 2007 and $287 million in the fourth quarter of 2007.

Total fee and other revenue increased $54 million, or 15%, in the first quarter of 2008 compared with the first quarter of 2007. The growth in total fee and other revenue compared to the first quarter of 2007 reflects the merger with Mellon as well as an increase in non-U.S. revenue related to the Corporate Trust business. Total fee and other revenue decreased sequentially resulting from the


 

26     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

seasonality associated with the Depositary Receipts business.

Net interest revenue increased $51 million, or 50%, in the first quarter of 2008 compared with the first quarter of 2007, reflecting a significant increase in deposits in both the Corporate Trust and Shareowner Services businesses, driven by the transition of deposits related to the Acquired Corporate Trust Business, increased client volumes, as well as the merger with Mellon. The sequential-quarter decrease in net interest revenue was driven primarily by a lower level of noninterest-bearing deposits given a fourth quarter 2007 increase related to corporate actions in Shareowner Services. Average deposits were $27.6 billion in the first quarter of 2008, compared with $11.7 billion in the first quarter of

2007 and $28.3 billion in the fourth quarter of 2007. The higher levels of deposits compared to the first quarter of 2007 reflects the impact of the merger with Mellon and the Acquired Corporate Trust Business and increased liquidity from our other issuer services customers.

Noninterest expense (excluding intangible amortization) increased $88 million, or 38%, in the first quarter of 2008 compared with the first quarter of 2007, reflecting the merger with Mellon, expenses associated with revenue growth and monitoring of trusteeships in a volatile environment and severance expense, partially offset by merger-related synergies. Noninterest expense declined by 2% (unannualized) sequentially, primarily reflecting the impact of merger-related synergies.


 

Clearing & Execution Services segment

 

(dollar amounts in millions,

 unless otherwise noted;

 presented on an FTE basis)

     1Q07 (a)       2Q07 (a)       3Q07       4Q07       1Q08     1Q08
vs.
4Q07
 
 
 
  1Q08
vs.
1Q07
 
 
 

Revenue:

              

Securities servicing fees –
Clearing and execution services

   $ 282     $ 292     $ 302     $ 310     $ 265     (15 )%   (6 )%

Other

     28       29       70       47       54     15     93  
                                            

Total fee and other revenue

     310       321       372       357       319     (11 )   3  

Net interest revenue

     74       75       77       78       74     (5 )   -  
                                            

Total revenue

     384       396       449       435       393     (10 )   2  

Noninterest expense (ex. intangible amortization)

     277       294       316       305       274     (10 )   (1 )
                                            

Income before taxes (ex. intangible amortization)

     107       102       133       130       119     (8 )   11  

Amortization of intangible assets

     6       6       6       6       6     -     -  
                                            

Income before taxes

   $ 101     $ 96     $ 127     $ 124     $ 113     (9 )%   12 %
                                            

Pre-tax operating margin (ex. intangible amortization)

     28 %     26 %     25 % (b)     30 %     30 %    

Memo: Income before taxes (ex. intangible amortization and non-operating item)

   $ 107     $ 102     $ 106 (b)   $ 130     $ 119     (8 )%   11 %

Average assets

   $ 14,985     $ 14,392     $ 15,854     $ 16,698     $ 16,574     (1 )%   11 %

Average active accounts (in thousands)

     5,149       5,195       5,064       5,069       5,170     2     -  

Average margin loans (in millions)

   $ 5,396     $ 5,551     $ 5,287     $ 5,301     $ 5,245     (1 )%   (3 )%
(a) Legacy The Bank of New York only.
(b) Results for the third quarter of 2007 exclude the pre-tax benefit ($27 million) of the negotiated settlement received for the early termination of a contract that occurred in 2005.

 

The Bank of New York Mellon Corporation     27


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Business description

Our Clearing & Execution Services segment consists of the Pershing clearing business and a 35% equity interest in BNY ConvergEx Group LLC, which includes the B-Trade and G-Trade execution businesses that were sold by the Company to BNY ConvergEx Group on Feb. 1, 2008. The B-Trade and G-Trade execution businesses have historically contributed approximately $50-60 million of revenue and $10-15 million of pre-tax income on a quarterly basis. These businesses were sold at book value with the potential for an earnout to be realized in the first quarter of 2009.

Our Pershing LLC and Pershing Advisor Solutions LLC subsidiaries provide financial institutions and independent registered investment advisors with operational support, trading services, flexible technology, an expansive array of investment solutions, practice management support and service excellence. Pershing services more than 1,150 retail and institutional financial organizations and independent registered investment advisors who collectively represent more than five million investors.

Through our affiliate, BNY ConvergEx Group, we provide liquidity and execution management, investment technologies, intermediary and clearing services and a full suite of broker assisted and electronic trading capabilities in more than 90 global markets, executing approximately 160 million U.S. shares and more than $900 million in non-U.S. principal each day and clearing nearly one million trades daily.

Revenue in this segment includes broker-dealer and Registered Investment Advisor services and electronic trading services which are primarily driven by:

 

  ·  

trading volumes, particularly those related to retail customers;

  ·  

overall market levels; and

  ·  

the amount of assets under administration.

A substantial amount of revenue in this segment is generated from non-transactional activities, such as asset gathering, mutual fund, money fund and

retirement programs, administration and other services. Segment expenses are driven by staff, equipment and space required to support the services provided by the segment and the cost of execution and clearance of trades.

Review of financial results

Income before taxes increased 12% to $113 million for the first quarter of 2008 from $101 million in the first quarter of 2007, and decreased $11 million, or 9% (unannualized), from $124 million in the fourth quarter of 2007.

Total fee and other revenue increased $9 million in the first quarter of 2008 compared with the first quarter of 2007 and decreased $38 million compared with the fourth quarter of 2007. The increase compared with the first quarter of 2007 reflects continued strong growth in trading activity along with growth in money market and mutual fund positions, which were primarily offset by the sale of the B-Trade and G-Trade execution businesses. The sequential quarter decrease resulted from the sale of B-Trade and G-Trade.

Net interest revenue was unchanged compared with the first quarter of 2007 as the benefit of higher customer balances was offset by the impact of the lower rate environment. The $4 million decrease compared with the fourth quarter of 2007 resulted from the impact of the lower rate environment.

Noninterest expense (excluding intangible amortization) decreased $3 million compared with the first quarter of 2007 and $31 million compared with the fourth quarter 2007. The decreases from the first and fourth quarters of 2007 reflect the sale of B-Trade and G-Trade primarily offset by increased expenses in support of business growth.


 

28     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Treasury Services segment

 

(dollar amounts in millions,

 unless otherwise noted;

 presented on an FTE basis)

   1Q07 (a)     2Q07 (a)     3Q07     4Q07     1Q08     1Q08
vs.
4Q07
    1Q08
vs.
1Q07
 

Revenue:

              

Treasury services

   $ 47     $ 49     $ 114     $ 118     $ 121     3 %   157 %

Other

     90       94       108       131       112     (15 )   24  
                                            

Total fee and other revenue

     137       143       222       249       233     (6 )   70  

Net interest revenue

     109       102       140       162       183     13     68  
                                            

Total revenue

     246       245       362       411       416     1     69  

Noninterest expense (ex. intangible amortization)

     119       127       194       201       205     2     72  
                                            

Income before taxes (ex. intangible amortization)

     127       118       168       210       211     -     66  

Amortization of intangible assets

     -       -       7       7       7     -     N/M  
                                            

Income before taxes

   $ 127     $ 118     $ 161     $ 203     $ 204     - %   61 %
                                            

Pre-tax operating margin (ex. intangible amortization)

     52 %     48 %     46 %     51 %     51 %    

Average loans

   $ 11,899     $ 12,528     $ 13,715     $ 14,330     $ 15,341     7 %   29 %

Average assets

     15,010       15,803       21,070       21,803       23,615     8     57  

Average deposits

     10,635       11,213       17,677       17,991       19,833     10     86  
(a) Legacy The Bank of New York only.
N/M - Not meaningful.

 

Business description

The Treasury Services segment includes treasury services, global payment services, working capital solutions, capital markets business and large corporate banking.

Treasury services revenue is directly influenced by the volume of transactions and payments processed, loan levels, types of service provided and net interest revenue earned from deposit balances generated by activity across our business operations. Treasury services revenue is indirectly influenced by other factors including market volatility in major currencies and the level and nature of underlying cross-border investments and other transactions undertaken by corporate and institutional clients. Segment expenses are driven by staff, equipment and space required to support the services provided.

Treasury Services offers leading-edge technology, innovative products, and industry expertise to help its clients optimize cash flow, manage liquidity, and make payments around the world in more than 100 different countries. We maintain a global network of branches, representative offices and correspondent banks to provide comprehensive payment services including funds transfer, cash management, trade services and liquidity management. We are one of the largest funds transfer banks in the U.S.,

transferring over $1.8 trillion daily via more than 170,000 wire transfers.

We provide a broad range of capital markets related services to large public and private corporations, as well as various governmental and not-for-profit entities. Such services include underwriting of debt and equity instruments, securities sales and trading and securities execution.

Our corporate lending strategy is to focus on those clients and industries that are major users of securities servicing and treasury services. Revenue from our lending activities is primarily driven by loan levels and spreads over funding costs.

Review of financial results

Income before taxes was $204 million in the first quarter of 2008 compared with $127 million in the first quarter of 2007, and $203 million in the fourth quarter of 2007.

Total fee and other revenue increased $96 million, compared with the first quarter of 2007 and decreased $16 million compared with the fourth

quarter of 2007. Treasury services fees were up $74 million from the first quarter of 2007 and $3 million from the fourth quarter of 2007. The increase compared with the first quarter of 2007 reflects the


 

The Bank of New York Mellon Corporation     29


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

merger with Mellon and higher global payment and cash management fees due primarily to higher client volumes. The sequential quarter increase reflects higher global payment and cash management fees due to higher client volumes. The increase in other income from the year-ago quarter reflects a higher valuation of the credit derivative portfolio. The decrease sequentially reflects the lower value of the credit derivative portfolio.

The increase in net interest revenue compared with the first quarter of 2007 reflects the merger with Mellon as well as higher deposit levels, including compensation balances (in lieu of treasury services fees), and wider spreads. The increase in net interest revenue sequentially primarily reflects a large government agency deposit in the first quarter of 2008.

 

Noninterest expense (excluding intangible amortization) increased $86 million compared with the first quarter of 2007 primarily due to the merger with Mellon, partially offset by the impact of merger-related expense synergies. The $4 million increase compared to the fourth quarter reflects business growth partially offset by merger-related expense synergies.


 

Other Segment

 

(dollar amounts in millions,

 unless otherwise noted;

 presented on an FTE basis)

   1Q07 (a)     2Q07 (a)     3Q07     4Q07     1Q08  

Revenue:

          

Fee and other revenue

   $ 47     $ 29     $ 74     $ (93 )   $ 12  

Net interest revenue

     (2 )     (15 )     22       15       32  
                                        

Total revenue

     45       14       96       (78 )     44  

Provision for credit losses

     (15 )     (15 )     -       20       16  

Noninterest expense (ex. intangible amortization and merger and integration expense)

     55       63       103       132       101  
                                        

Income (loss) before taxes (ex. intangible amortization and merger and integration expense)

     5       (34 )     (7 )     (230 )     (73 )

Amortization of intangible assets

     -       -       1       -       -  
                                        

Merger and integration expense:

          

The Bank of New York Mellon

     4       35       205       111       121  

Acquired Corporate Trust Business

     11       12       13       13       5  
                                        

Total merger and integration expense

     15       47       218       124       126  
                                        

Income (loss) before taxes

   $ (10 )   $ (81 )   $ (226 )   $ (354 )   $ (199 )
                                        

Memo: Income before taxes (ex. intangible amortization, merger and integration expense and non-operating items)

   $ 5     $ (34 )   $ 21  (b)   $ (230 )   $ (73 )

Average assets

   $ 24,655     $ 27,136     $ 43,380     $ 44,497     $ 45,750  

Average deposits

     9,718       9,355       14,180       14,815       12,871  
(a) Legacy The Bank of New York only.
(b) Results for the third quarter of 2007 include a reduction in net interest revenue resulting from a recalculation of the yield on the leverage lease portfolio caused by the impact of the merger with Mellon and on the New York state marginal tax rate ($22 million) and a write-off of internally developed software ($6 million).

 

30     The Bank of New York Mellon Corporation


Table of Contents

Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Business description

The Other segment primarily includes:

  ·  

the results of leasing operations;

  ·  

corporate treasury activities; and

  ·  

business exits and corporate overhead.

Revenue primarily reflects:

  ·  

net interest revenue from the leasing portfolio;

  ·  

revenue from corporate and bank owned life insurance;

  ·  

any residual interest income resulting from transfer pricing algorithms relative to actual results; and

  ·  

gains (losses) from the sale of securities and other assets.

Noninterest expense includes:

  ·  

merger and integration charges;

  ·  

direct expenses supporting leasing, investing and funding activities; and

  ·  

certain corporate overhead not directly attributable to the operations of other segments.

Review of financial results

Income before taxes was a loss of $199 million for the first quarter of 2008, compared with a loss of $10 million in the first quarter of 2007, and a loss of $354 million in the fourth quarter of 2007.

Total fee and other revenue decreased $35 million compared with the first quarter of 2007 and increased $105 million sequentially. The decrease compared with the first quarter of 2007 reflects a $28 million other than temporary impairment (“OTTI”) pre-tax loss related to securities backed by home equity lines of credit in our TRFC portfolio, a $24 million pre-tax OTTI loss related to ABS CDOs and the impact of adopting SFAS 157, partially offset by the benefit associated with the initial public offering by VISA. The increase sequentially reflects the $200 million (pre-tax) CDO write-down recorded in the fourth quarter of 2007.

Net interest revenue was $32 million in the first quarter of 2008, an increase of $34 million from the first quarter of 2007 and $17 million from the fourth quarter of 2007. Both increases are primarily due to the impact of the changing interest rate environment on our funds transfer pricing system.

 

The provision for credit losses was $16 million in the first quarter of 2008 compared with $20 million in the fourth quarter of 2007 and a credit of $15 million in the first quarter of 2007.

Noninterest expense (excluding intangible amortization and merger and integration expense) increased $46 million compared with the first quarter of 2007 and decreased $31 million sequentially. The increase compared with the first quarter of 2007 reflects the merger with Mellon. The decrease from the fourth quarter of 2007 reflects higher corporate incentives and changes in allocation methodology in the fourth quarter of 2007. Merger and integration expenses associated with the Mellon merger were $121 million in the first quarter of 2008 and include amounts for integration/conversion costs ($82 million), personnel-related costs ($34 million) and one-time costs ($5 million).

Critical accounting estimates

Our significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements contained in The Bank of New York Mellon’s 2007 Annual Report on Form 10-K. Our critical accounting estimates are those related to the allowance for credit losses, fair value of financial instruments, goodwill and other intangibles, and pension accounting.

Allowance for credit losses

The allowance for credit losses and allowance for lending-related commitments consist of four elements: (1) an allowance for impaired credits; (2) an allowance for higher risk rated loans and exposures; (3) an allowance for pass rated loans and exposures; and (4) an unallocated allowance based on general economic conditions and certain risk factors in our individual portfolio and markets. Further discussion of the four elements can be found under “Consolidated Balance Sheet Review”.

The allowance for credit losses represents management’s estimate of probable losses inherent in our credit portfolio. This evaluation process is


 

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Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

subject to numerous estimates and judgments. Probability of default ratings are assigned after analyzing the credit quality of each borrower/ counterparty and our internal ratings are generally consistent with external ratings agencies default databases. Loss given default ratings are driven by the collateral, structure, and seniority of each individual asset and are consistent with external loss given default/recovery databases. The portion of the allowance related to impaired credits is based on the present value of future cash flows; however, as a practical expedient, it may be based on the credit’s observable market price. Additionally, it may be based on the fair value of collateral if the credit is collateral dependent. Changes in the estimates of probability of default, risk ratings, loss given default/recovery rates, and cash flows could have a direct impact on the allocated allowance for loan losses.

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.

We consider it difficult to quantify the impact of changes in forecast on our allowance for credit losses. Nevertheless, we believe the following discussion may enable investors to better understand the variables that drive the allowance for credit losses.

A key variable in determining the allowance is management’s judgment in determining the size of the unallocated allowance. At March 31, 2008, the unallocated allowance was $111 million or 23% of the total allowance. At March 31, 2008, if the unallocated allowance, as a percent of the total allowance, was five percent higher or lower, the allowance would have increased or decreased by approximately $25 million, respectively.

The credit rating assigned to each credit is another significant variable in determining the allowance. If each credit were rated one grade better, the allowance would have decreased by $108 million, while if each credit were rated one grade worse, the allowance would have increased by $275 million. Similarly, if the loss given default were one rating worse, the allowance would have increased by $38 million, while if the loss given default were one

rating better, the allowance would have decreased by $58 million.

For impaired credits, if the fair value of the loans were 10% higher or lower, the allowance would have decreased or increased by $3 million, respectively.

Fair value of financial instruments

On Jan. 1, 2008, we adopted SFAS 157 and SFAS 159. For further information, see Accounting changes and new accounting pronouncements in Note 3 to the Notes to Consolidated Financial Statements.

SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. The new standard provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. The standard also 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. SFAS 157 nullifies the guidance in EITF 02-3, which required deferral of profit at inception of a derivative transaction in the absence of observable data supporting the valuation technique. The standard also eliminates large position discounts for financial instruments quoted in active markets and requires consideration of our own credit quality when valuing liabilities.

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 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 results of stress tests. We apply judgment in the


 

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Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

application of these factors. In addition, we must apply judgment when no external parameters exist.

In order to test the appropriateness of our valuations, we subject the models to review and approval by an independent internal risk management function, benchmark the models against similar instruments and validate model estimates to actual cash transactions. In addition, we perform detailed reviews and analyses of profit and loss. Valuation adjustments are determined and controlled by a function independent of the area initiating the risk position. As markets and products develop and the pricing for certain products becomes more transparent, we refine our valuation methods. Any changes to the valuation models are reviewed by management to ensure the changes are justified.

In times of financial stress, actual prices and valuations may significantly diverge from results predicted by models. In addition, other factors can affect our estimate of fair value, including market dislocations, incorrect model assumptions, and unexpected correlations.

These valuation methods could expose us to materially different results should the models used or underlying assumptions be inaccurate. See “Basis of Presentation” in Note 1 to the Consolidated Financial Statements contained in our 2007 Annual Report on Form 10-K.

To confirm that our valuation policies are consistent with exit price as prescribed by SFAS 157, we reviewed our securities and derivative valuations including recent transactions in the marketplace, pricing services and the results of similar types of transactions. As a result of maximizing observable inputs as required by SFAS 157, in the first quarter of 2008 we began to reflect external credit ratings as well as other observable inputs when measuring the fair value of our derivative positions. The cumulative effect of making this derivative valuation adjustment was immaterial to our first quarter 2008 earnings. The adoption of SFAS 157 primarily affected our Global markets business. We currently price over 95% of our assets and liabilities carried at fair value using observable prices and market based inputs. See consolidated balance sheet review – investment securities, as well as Note 12 in the Notes to

Consolidated Financial Statements for additional disclosure regarding SFAS 157.

SFAS 159 provides the option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments. Under SFAS 159, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes in fair value recognized in income. Effective Jan. 1, 2008, we elected the fair value option for $390 million of existing loans and unfunded loan commitments where the related credit risks are partially managed utilizing other financial instruments which are fair valued in earnings and, as a result, recorded a cumulative effect decrease to retained earnings of $36 million. See Note 13 in the Notes to Consolidated Financial Statements for additional disclosure regarding SFAS 159.

Goodwill and other intangibles

We record all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles, and other intangibles, at fair value as required by FASB Statements No. 141 and No. 142 (“SFAS 141” and “SFAS 142”), “Business Combinations” and “Goodwill and Other Intangible Assets.” Goodwill ($16.6 billion at March 31, 2008) and indefinite-lived intangible assets ($2.7 billion at March 31, 2008) are not amortized but are subject to annual tests for impairment or more often if events or circumstances indicate they may be impaired. Other intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount.

The initial recording of goodwill, indefinite-lived intangibles, and other intangibles requires subjective judgments concerning estimates of the fair value of acquired assets and liabilities.

The goodwill impairment test is performed in two phases. The first step compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however,


 

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Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

if the carrying amount of the reporting unit exceeds its fair value, an additional procedure would be performed. That additional procedure would compare the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. Indefinite-lived intangible assets are evaluated for impairment at least annually by comparing their fair value to their carrying value. Other intangible assets ($3.7 billion at March 31, 2008) are evaluated for impairment if events and circumstances indicate a possible impairment. Such evaluation of other intangible assets is based on undiscounted cash flow projections.

Fair value may be determined using market prices, comparison to similar assets, market multiples, discounted cash flow analysis and other determinants. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates and specific industry or market sector conditions. Other key judgments in accounting for intangibles include useful life and classification between goodwill and indefinite-lived intangibles or other intangibles which require amortization. See Note 5 of the Notes to Consolidated Financial Statements for additional information regarding intangible assets.

Pension accounting

BNY Mellon has defined benefit pension plans covering approximately 25,200 U.S. employees and approximately 4,400 non-U.S. employees.

Legacy The Bank of New York has one qualified and two non-qualified defined benefit pension plans in the U.S. and five outside the U.S. As of Dec. 31, 2007, the U.S. plans accounted for 75% of the projected benefit obligation.

In addition to its pension plans, legacy The Bank of New York has an Employee Stock Ownership Plan (“ESOP”). Benefits payable under the U.S. qualified

pension plan are offset by the equivalent value of benefits earned under the ESOP.

Legacy Mellon has two qualified and several non-qualified defined benefit pension plans in the U.S. and two outside the U.S. As of Dec. 31, 2007, the U.S. plans accounted for 87% of the projected benefit obligation.

A number of key assumption and measurement date values determine pension expense. The key elements include the long-term rate of return on plan assets, the discount rate, the market-related value of plan assets, and for the legacy The Bank of New York U.S. plan the price used to value stock in the ESOP. Since 2005, these key elements have varied as follows:

 

(dollars in millions,  except per share  amounts)

 

 

2008

 

 

 

2007

 

   
 
Legacy The Bank
of New York only
 
 
            2006           2005  

Domestic plans:

       

Long-term rate of return on plan assets

    8.00 %     8.00 %     7.88 %     8.25 %

Discount rate

    6.38       6.00       5.88       6.00  

Market-related value of plan assets (a)

  $ 3,628     $ 1,352     $ 1,324     $ 1,502  

ESOP stock price (a)

  $ 47.15     $ 34.85     $ 30.46     $ 30.67  

Net U.S. pension credit/(expense)

    N/A     $ 16  (c)   $ (26 )   $ (17 )

All other net pension credit/(expense)

    N/A     $ (12 (d)     (12 )   $ (9 )

Total net pension credit/(expense) (b)

    N/A     $ 4     $ (38 )   $ (26 )
(a) See Note 1 “Summary of Significant Accounting and Reporting Policies” in the Bank of New York Mellon’s 2007 Annual Report.
(b) Pension benefits expense includes discontinued operations expense of $6 million in 2006 and 2005.
(c) Includes a $21 million credit for legacy Mellon plans based on a discount rate of 6.25% as of July 1, 2007, and a long-term rate of return on plan assets of 8.25%.
(d) Includes $4 million of expense for legacy Mellon’s foreign plans.

The discount rate for U.S. pension plans was determined after reviewing a number of high quality long-term bond indices whose yields were adjusted to match the duration of BNY Mellon’s pension liability. We also reviewed the results of several models that matched bonds to our pension cash flows. After reviewing the various indices and models, we selected a discount rate of 6.38% as of


 

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Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Dec. 31, 2007. The discount rates for foreign pension plans are based on high quality corporate bonds rates in countries that have an active corporate bond market. In those countries with no active corporate bond market, discount rates are based on local government bond rates plus a credit spread.

Our expected long-term rate of return on plan assets is based on anticipated returns for each asset class. Anticipated returns are weighted for the target allocation for each asset class. Anticipated returns are based on forecasts for prospective returns in the equity and fixed income markets, which should track the long-term historical returns for these markets. We also consider the growth outlook for U.S. and global economies, as well as current and prospective interest rates.

The market-related value of plan assets also influences the level of pension expense. Differences

between expected and actual returns are recognized over five years to compute an actuarially derived market-related value of plan assets. For the legacy Mellon plans, the market-related value of assets was set equal to the assets’ market value as of July 1, 2007. The averaging of actuarial gains and losses for the legacy Mellon plan assets will be phased in over the next five years.

Unrecognized actuarial gains and losses are amortized over the future service period of active employees if they exceed a threshold amount. BNY Mellon currently has $183 million of unrecognized losses which are being amortized.

The annual impacts of hypothetical changes in the key elements on pension costs are shown in the table below.


 

Pension expense (a)

(dollar amounts in millions, except per share amounts)

    

 

Increase in

pension expense

 

 

   

 

(Decrease) in

pension expense

 

 

Long-term rate of return on plan assets

     (100 ) bps     (50 ) bps     50 bps        100 bps  

Change in pension expense

   $ 46.3     $ 23.3     $ (23.2 )    $ (46.1 )

Discount rate

     (50 ) bps     (25 ) bps     25 bps        50 bps  

Change in pension expense

   $ 20.9     $ 10.4     $ (9.5 )    $ (18.0 )

Market-related value of plan assets

     (20.00 )%     (10.00 )%     10.00%        20.00%  

Change in pension expense

   $ 138.6     $ 62.8     $ (40.2 )    $ (81.8 )

ESOP stock price

   $ (10 )   $ (5 )   $ 5      $ 10  

Change in pension expense

   $ 11.5     $ 5.5     $ (5.2 )    $ (9.9 )
(a) Pension expense totaled $7 million in the first quarter of 2008, $45 million for the full year 2007 and $74 million for the full year 2006.

 

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Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and

Results of Operations; Quantitative and Qualitative Disclosures about Market Risk. (continued)

 

 

Consolidated balance sheet review

Total assets were $204.9 billion at March 31, 2008 and $197.7 billion at Dec. 31, 2007. Total shareholders’ equity was $28.5 billion at March 31, 2008, compared with $29.4 billion at Dec. 31, 2007. The increase in assets from Dec. 31, 2007 primarily reflects the growth in deposits. The decrease in shareholder’s equity reflects higher unrealized mark-to-market losses in the securities portfolio.

Interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements totaled $49.6 billion or 24% of assets at March 31, 2008, compared with $43.4 billion, or 22% of assets at Dec. 31, 2007. This increase in liquid assets reflects the growth in deposits.