XFRA:BN9 Bank of New York Mellon Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

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

of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2012

or

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

of the Securities Exchange Act of 1934

Commission File No. 000-52710

THE BANK OF NEW YORK MELLON CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   13-2614959

(State or other jurisdiction of

incorporation or organization)

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

One Wall Street

New York, New York 10286

(Address of principal executive offices)(Zip Code)

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

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

Yes ü     No         

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

Yes ü     No         

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

 

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

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

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

 

Class  

Outstanding as of

June 30, 2012

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


Table of Contents

THE BANK OF NEW YORK MELLON CORPORATION

Second Quarter 2012 Form 10-Q

Table of Contents

 

 

     Page  

Consolidated Financial Highlights (unaudited)

     2   

Part I – Financial Information

  

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

  

General

     4   

Overview

     4   

Second quarter 2012 and subsequent events

     4   

Highlights of second quarter 2012 results

     5   

Fee and other revenue

     7   

Net interest revenue

     11   

Average balances and interest rates

     12   

Noninterest expense

     14   

Income taxes

     16   

Review of businesses

     16   

Critical accounting estimates

     27   

Consolidated balance sheet review

     27   

Liquidity and dividends

     40   

Capital

     43   

Trading activities and risk management

     47   

Foreign exchange and other trading

     48   

Asset/liability management

     49   

Off-balance sheet arrangements

     50   

Supplemental information – Explanation of Non-GAAP financial measures

     50   

Recent accounting and regulatory developments

     54   

Government monetary policies and competition

     62   

Website information

     62   

Item 1. Financial Statements:

  

Consolidated Income Statement (unaudited)

     63   

Consolidated Comprehensive Income Statement (unaudited)

     65   

Consolidated Balance Sheet (unaudited)

     66   

Consolidated Statement of Cash Flows (unaudited)

     67   

Consolidated Statement of Changes in Equity (unaudited)

     68   

Notes to Consolidated Financial Statements:

  

Note 1 – Basis of presentation

     69   

Note 2 – Accounting changes and new accounting guidance

     69   

Note 3 – Acquisitions and dispositions

     70   

Note 4 – Securities

     71   

Note 5 – Loans and asset quality

     74   

Note 6 – Goodwill and intangible assets

     81   

Note 7 – Other assets

     82   

Note 8 – Net interest revenue

     83   

Note 9 – Employee benefit plans

     84   

Note 10 – Restructuring charges

     84   

Note 11 – Income taxes

     85   

Note 12 – Securitizations and variable interest entities

     86   

Note 13 – Other comprehensive income

     88   

Note 14 – Fair value measurement

     90   

Note 15 – Fair value option

     104   

Note 16 – Derivative instruments

     104   

Note 17 – Commitments and contingent liabilities

     109   

Note 18 – Review of businesses

     114   

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

     117   

Item 4. Controls and Procedures

     118   

Forward-looking Statements

     119   

Part II – Other Information

  

Item 1. Legal Proceedings

     121   

Item 1A. Risk Factors

     121   

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

     122   

Item 6. Exhibits

     122   

Signature

     123   

Index to Exhibits

     124   


Table of Contents

The Bank of New York Mellon Corporation

Consolidated Financial Highlights (unaudited)

      Quarter ended     Year-to-date  

(dollar amounts in millions, except per common share

amounts and unless otherwise noted)

   June 30,
2012
    March 31,
2012
   

June 30,

2011

    June 30,
2012
   

June 30,

2011

 

Results applicable to common shareholders of

          

The Bank of New York Mellon Corporation:

          

Net income

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

Basic EPS

     0.39        0.52        0.59        0.91        1.09   

Diluted EPS

     0.39        0.52        0.59        0.90        1.08   

Fee and other revenue

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

Income from consolidated investment management funds

     57        43        63        100        173   

Net interest revenue

     734        765        731        1,499        1,429   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

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

Return on common equity (annualized) (a)

     5.5     7.4     8.8     6.4     8.3

Non-GAAP adjusted (a)

     8.9     8.9     10.1     8.9     9.6

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

     15.7     21.0     26.3     18.3     25.3

Non-GAAP adjusted (a)

     22.4     23.0     27.6     22.7     26.6

Return on average assets (annualized)

     0.61     0.83     1.06     0.72     1.02

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

     78     78     79     78     78

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

   $ 233      $ 233      $ 248      $ 233      $ 243   

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

     37     37     37     37     37

Pre-tax operating margin (a)

     16     24     27     20     26

Non-GAAP adjusted (a)

     29     30     31     29     30

Net interest margin (FTE)

     1.25     1.32     1.41     1.28     1.43

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

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

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

   $ 27.1      $ 26.6      $ 26.3      $ 27.1      $ 26.3   

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

   $ 9.9      $ 10.4      $ 10.1      $ 9.9      $ 10.1   

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

   $ 275      $ 265      $ 273      $ 275      $ 273   

Average common shares and equivalents outstanding (in thousands):

          

Basic

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

Diluted

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

Capital ratios (d):

          

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

     8.7     N/A        N/A        8.7     N/A   

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

          

Non-GAAP (a)

     13.2     13.9     12.6     13.2     12.6

Basel I Tier 1 capital ratio

     14.7     15.6     14.1     14.7     14.1

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

     16.4     17.5     16.7     16.4     16.7

Basel I leverage capital ratio

     5.5     5.6     5.8     5.5     5.8

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

     10.5     11.3     11.1     10.5     11.1

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

     10.3     11.3     11.1     10.3     11.1

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

     6.1     6.5     6.0     6.1     6.0

 

2    BNY Mellon


Table of Contents

The Bank of New York Mellon Corporation

Consolidated Financial Highlights (unaudited) continued

 

      Quarter ended     Year-to-date  

(dollar amounts in millions, except per common share

amounts and unless otherwise noted)

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

Selected average balances:

          

Interest-earning assets

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

Assets of operations

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

Total assets

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

Interest-bearing deposits

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

Noninterest-bearing deposits

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

Preferred stock

   $ 60      $ -      $ -      $ 30      $ -   

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

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

Other information at period end:

          

Cash dividends per common share

   $ 0.13      $ 0.13      $ 0.13      $ 0.26      $ 0.22   

Common dividend payout ratio

     33     25     22     29     20

Common dividend yield (annualized)

     2.4     2.2     2.0     2.4     1.7

Closing common stock price per common share

   $ 21.95      $ 24.13      $ 25.62      $ 21.95      $ 25.62   

Market capitalization

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

Book value per common share – GAAP (a)

   $ 28.81      $ 28.51      $ 27.46      $ 28.81      $ 27.46   

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

   $ 11.47      $ 11.17      $ 10.28      $ 11.47      $ 10.28   

Full-time employees

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

Common shares outstanding (in thousands)

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

 

BNY Mellon    3


Table of Contents

Part I – Financial Information

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

 

 

General

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

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

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

How we reported results

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

Overview

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

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

Second quarter 2012 and subsequent events

Settlement of securities lending matter

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

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

Proposed risk-based capital rules

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

 

 

4    BNY Mellon


Table of Contents

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

European Central Bank interest rate cut

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

Highlights of second quarter 2012 results

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

Highlights for the second quarter of 2012 include:

 

   

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

   

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

   

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

   

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

   

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

   

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

   

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

   

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

 

 

BNY Mellon    5


Table of Contents
 

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

   

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

   

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

   

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

   

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

   

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

   

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

   

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

 

 

6    BNY Mellon


Table of Contents

Fee and other revenue

 

Fee and other revenue (a)

 

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

Investment services fees:

                

Asset servicing (b)

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

Issuer services

     275        251        365        (25     10        526        716        (27

Memo: Issuer services excluding

                

Shareowner Services

     275        251        314        (12     10        526        606        (13

Clearing services

     309        303        292        6        2        612        584        5   

Treasury services

     134        136        134               (1     270        268        1   

Total investment services fees

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

Investment management and performance fees

     797        745        779        2        7        1,542        1,543          

Foreign exchange and other trading revenue

     180        191        222        (19     (6     371        420        (12

Distribution and servicing

     46        46        49        (6            92        102        (10

Financing-related fees

     37        44        49        (24     (16     81        92        (12

Investment and other income

     48        139        145        (67     (65     187        226        (17

Total fee revenue

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

Net securities gains (losses)

     50        40        48        4        25        90        53        70   

Total fee and other revenue – GAAP

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

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

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

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

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

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

     78     78     79         78     78  

Market value of AUM at period end (in billions)

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

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

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

 

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

 

Fee and other revenue

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

Investment services fees

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

 

   

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

 

 

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

   

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

   

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

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

Investment management and performance fees

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

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

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

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

Foreign exchange and other trading revenue

 

Foreign exchange and other trading revenue

  

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

Foreign exchange

   $ 157       $ 136      $ 184      $ 293      $ 357   

Fixed income

     16         47        28        63        45   

Credit derivatives (a)

     1         (2     (1     (1     (2

Other

     6         10        11        16        20   

Total

   $ 180       $ 191      $ 222      $ 371      $ 420   

 

(a) Used as economic hedges of loans.

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

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

 

 

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

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

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

Distribution and servicing fees

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

Financing-related fees

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

 

 

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Investment and other income

 

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

Corporate/bank-owned life insurance

   $ 32      $ 34      $ 42      $ 66      $ 79   

Lease residual gains (losses)

     3        34        (5     37        8   

Seed capital gains

            24        3        24        5   

Expense reimbursements from joint ventures

     9        10        8        19        17   

Equity investment revenue (loss)

     (5     6        19        1        24   

Private equity gains (losses)

     1        4        12        5        22   

Asset-related gains (losses)

            (2     66        (2     80   

Other income (loss)

     8        29               37        (9

Total

   $ 48      $ 139      $ 145      $ 187      $ 226   

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

Net securities gains (losses)

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

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

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

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

 

 

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Net interest revenue

 

 

 

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

Net interest revenue (non-FTE)

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

Tax equivalent adjustment

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

Net interest revenue (FTE) – Non-GAAP

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

Average interest-earning assets

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

Net interest margin (FTE)

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

bps—basis points.

FTE - fully taxable equivalent.

 

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

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

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

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

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

 

 

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Average balances and interest rates

 

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

Assets

            

Interest-earning assets:

            

Interest-bearing deposits with banks

            

(primarily foreign banks)

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

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

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

Federal funds sold and securities purchased under resale agreements

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

Margin loans

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

Non-margin loans:

            

Domestic offices

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

Foreign offices

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

 

 

     

 

 

     

 

 

   

Total non-margin loans

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

Securities:

            

U.S. government obligations

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

U.S. government agency obligations

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

State and political subdivisions – tax exempt

     4,777        2.65        3,354        2.97        934        5.32   

Other securities

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

Trading securities

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

 

 

     

 

 

     

 

 

   

Total securities

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

 

 

     

 

 

     

 

 

   

Total interest-earning assets

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

Allowance for loan losses

     (382       (392       (463  

Cash and due from banks

     4,412          4,271          4,335     

Other assets

     49,933          49,690          50,459     

Assets of consolidated investment management funds

     11,284                11,444                14,226           

Total assets

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

Liabilities

            

Interest-bearing liabilities:

            

Interest-bearing deposits:

            

Money market rate accounts

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

Savings

     702        0.13        704        0.10        1,561        0.12   

Time deposits

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

Demand deposits

     185        0.32        147        0.36        85        0.91   

Foreign offices

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

 

 

     

 

 

     

 

 

   

Total interest-bearing deposits

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

Federal funds purchased and securities sold under repurchase agreements

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

Trading liabilities

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

Other borrowed funds

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

Payables to customers and broker-dealers

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

Long-term debt

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

 

 

     

 

 

     

 

 

   

Total interest-bearing liabilities

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

Total noninterest-bearing deposits

     62,860          66,613          43,038     

Other liabilities

     23,588          24,248          23,694     

Liabilities and obligations of consolidated investment management funds

     10,072                10,159                12,966           

Total liabilities

     270,041          266,867          244,174     

Temporary equity

            

Redeemable noncontrolling interests

     78          72          65     

Permanent equity

            

Total BNY Mellon shareholders’ equity

     34,183          33,718          33,464     

Noncontrolling interests

     700                687                777           

Total permanent equity

     34,883                34,405                34,241           

Total liabilities, temporary equity and permanent equity

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

Net interest margin (FTE)

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

 

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

Assets

        

Interest-earning assets:

        

Interest-bearing deposits with banks (primarily foreign banks)

   $ 36,784        1.14   $ 58,468        0.94

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

     60,715        0.27        27,255        0.32   

Federal funds sold and securities purchased under resale agreements

     5,333        0.67        4,546        0.47   

Margin loans

     13,116        1.28        8,502        1.40   

Non-margin loans:

        

Domestic offices

     19,895        2.49        21,472        2.55   

Foreign offices

     10,089        1.81        9,478        1.49   
  

 

 

     

 

 

   

Total non-margin loans

     29,984        2.26        30,950        2.22   

Securities:

        

U.S. government obligations

     16,328        1.61        13,597        1.61   

U.S. government agency obligations

     35,709        2.33        20,344        3.02   

State and political subdivisions – tax exempt

     4,066        2.78        747        5.66   

Other securities

     33,231        2.67        32,411        3.31   

Trading securities

     2,776        2.67        3,285        2.44   
  

 

 

     

 

 

   

Total securities

     92,110        2.36        70,384        2.89   
  

 

 

     

 

 

   

Total interest-earning assets

   $  238,042        1.53   $  200,105        1.75

Allowance for loan losses

     (387       (479  

Cash and due from banks

     4,341          4,215     

Other assets

     49,812          50,022     

Assets of consolidated investment management funds

     11,364                14,284           

Total assets

   $ 303,172              $ 268,147           

Liabilities

        

Interest-bearing liabilities:

        

Interest-bearing deposits:

        

Money market rate accounts

   $ 6,267        0.25   $ 4,719        0.38

Savings

     703        0.12        1,539        0.12   

Time deposits

     33,399        0.10        33,494        0.09   

Demand deposits

     166        0.33        84        0.89   

Foreign offices

     87,424        0.14        81,427        0.22   
  

 

 

     

 

 

   

Total interest-bearing deposits

     127,959        0.14        121,263        0.19   

Federal funds purchased and securities sold under repurchase agreements

     9,919        —          8,049        0.06   

Trading liabilities

     1,205        1.72        2,141        2.04   

Other borrowed funds

     2,564        0.89        1,849        1.30   

Payables to customers and broker-dealers

     7,725        0.11        6,772        0.09   

Long-term debt

     20,311        1.73        17,198        1.75   
  

 

 

     

 

 

   

Total interest-bearing liabilities

   $ 169,683        0.34   $ 157,272        0.39

Total noninterest-bearing deposits

     64,737          40,839     

Other liabilities

     23,919          23,026     

Liabilities and obligations of consolidated investment management funds

     10,115                13,040           

Total liabilities

     268,454          234,177     

Temporary equity

        

Redeemable noncontrolling interests

     75          70     

Permanent equity

        

Total BNY Mellon shareholders’ equity

     33,950          33,147     

Noncontrolling interests

     693                753           

Total permanent equity

     34,643                33,900           

Total liabilities, temporary equity and permanent equity

   $ 303,172              $ 268,147           

Net interest margin (FTE)

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

 

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Noninterest expense

 

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

Staff:

                

Compensation

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

Incentives

     311        352        328        (5     (12     663        653        2   

Employee benefits

     238        240        232        3        (1     478        455        5   

Total staff

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

Professional, legal and other purchased services

     309        299        301        3        3        608        584        4   

Net occupancy

     141        147        161        (12     (4     288        314        (8

Software

     127        119        121        5        7        246        243        1   

Distribution and servicing

     103        101        109        (6     2        204        220        (7

Furniture and equipment

     82        86        82        —          (5     168        166        1   

Sub-custodian

     70        70        88        (20     —          140        156        (10

Business development

     71        56        73        (3     27        127        129        (2

Other

     254        220        247        3        15        474        476        —     

Amortization of intangible assets

     97        96        108        (10     1        193        216        (11

M&I, litigation and restructuring charges

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

Total noninterest expense – GAAP

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

Total staff expense as a percent of total revenue

     39     40     38         39     39  

Full-time employees at period end

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

N/M—Not meaningful.

 

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

Staff:

                

Compensation

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

Incentives

     311        352        327        (5     (12     663        650        2   

Employee benefits

     238        240        229        4        (1     478        448        7   

Total staff

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

Professional, legal and other purchased services

     309        299        289        7        3        608        561        8   

Net occupancy

     141        147        158        (11     (4     288        308        (6

Software

     127        119        119        7        7        246        238        3   

Distribution and servicing

     103        101        109        (6     2        204        220        (7

Furniture and equipment

     82        86        82        —          (5     168        165        2   

Sub-custodian

     70        70        88        (20     —          140        156        (10

Business development

     71        56        72        (1     27        127        128        (1

Other

     254        220        237        7        15        474        458        3   

Subtotal

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

Amortization of intangible assets

     97        96        104        (7     1        193        209        (8

M&I, litigation and restructuring charges

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

Total noninterest expense – Non-GAAP

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

Total staff expense as a percent of total revenue

     39     40     38         39     38  

Full-time employees at period end

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

N/M—Not meaningful.

 

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

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

 

 

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

Staff expense

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

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

Non-staff expense

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

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

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

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

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

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

 

 

Operational excellence initiatives update

 

Expense initiatives (pre-tax)    Program savings     

Annualized

targeted savings

by the end of 2012

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

Business operations

   $ 45       $ 55       $ 100       $  225 - 240   

Technology

     16         21         37       $ 75 - 85   

Corporate services

     14         18         32       $ 60 - 65   

Gross savings (a)

     75         94         169       $ 360 - 390   

Less: Incremental program costs (b)

     5         23         28       $ 120 - 130   

Net savings (c)

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

 

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

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

Business Operations

 

   

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

   

Continued global footprint position migrations.

   

Reengineered Dreyfus and Global Fund Accounting operations to reduce headcount.

   

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

Technology

 

   

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

   

Insourced software engineers to Global Delivery Centers.

   

Standardized infrastructure through server elimination and software rationalization.

Corporate Services

 

   

Consolidated real estate in Los Angeles and New York.

   

Benefited from the new global procurement program.

Income taxes

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

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

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

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

Review of businesses

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

Organization of our business

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

Business accounting principles

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

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

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

 

 

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

 

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

S&P 500 Index (a)

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

S&P 500 Index – daily average

     1318         1227         1224         1347         1351         3        —          1349         1310         3   

FTSE 100 Index (a)

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

FTSE 100 Index – daily average

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

MSCI World Index (a)

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

MSCI World Index – daily average

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

Barclays Capital Aggregate BondSM Index (a)

     341         346         347         351         353         4        1        353         341         4   

NYSE and NASDAQ share volume (in billions)

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

JPMorgan G7 Volatility Index – daily average (b)

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

 

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

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

 

 

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

 

For the quarter ended June 30, 2012

(dollar amounts
in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  
                               

Fee and other revenue

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

Net interest revenue

     52        607        75        734   

Total revenue

     913        2,488        187        3,588   

Provision for credit losses

     —          (14     (5     (19

Noninterest expense

     690        2,146        211        3,047   

Income (loss) before taxes

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

Pre-tax operating margin (b)

     24     14     N/M        16

Average assets

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

Excluding amortization of intangible assets:

        

Noninterest expense

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

Income (loss) before taxes

     271 (a)      405        (19     657 (a) 

Pre-tax operating margin (b)

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

 

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For the quarter ended March 31, 2012

 

        

(dollar amounts

in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

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

Net interest revenue

     55        642        68        765   

Total revenue

     907        2,494        234        3,635   

Provision for credit losses

     -        16        (11     5   

Noninterest expense

     667        1,827        262        2,756   

Income (loss) before taxes

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

Pre-tax operating margin (b)

     26     26     N/M        24

Average assets

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

Excluding amortization of intangible assets:

        

Noninterest expense

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

Income (loss) before taxes

     288 (a)      699        (17     970 (a) 

Pre-tax operating margin (b)

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

 

For the quarter ended June 30, 2011

 

                            
(dollar amounts
in millions)
  

Investment

Management

   

Investment

Services

    Other     Consolidated  

Fee and other revenue

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

Net interest revenue

     48        649        34        731   

Total revenue

     910        2,616        303        3,829   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     694        1,827        295        2,816   

Income (loss) before taxes

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

Pre-tax operating margin (b)

     24     30     N/M        26

Average assets

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

Excluding amortization of intangible assets:

        

Noninterest expense

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

Income (loss) before taxes

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

Pre-tax operating margin (b)

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

 

For the six months ended June 30, 2012

 

                            
(dollar amounts
in millions)
  

Investment

Management

   

Investment

Services

    Other     Consolidated  

Fee and other revenue

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

Net interest revenue

     107        1,249        143        1,499   

Total revenue

     1,820        4,982        421        7,223   

Provision for credit losses

     -        2        (16     (14

Noninterest expense

     1,357        3,973        473        5,803   

Income (loss) before taxes

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

Pre-tax operating margin (b)

     25     20     N/M        20

Average assets

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

Excluding amortization of intangible assets:

        

Noninterest expense

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

Income (loss) before taxes

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

Pre-tax operating margin (b)

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

 

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For the six months ended June 30, 2011

 

(dollar amounts

in millions)

   Investment
Management
    Investment
Services
    Other     Consolidated  

Fee and other revenue

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

Net interest revenue

     100        1,270        59        1,429   

Total revenue

     1,830        5,126        475        7,431   

Provision for credit losses

     1        -        (1     -   

Noninterest expense

     1,376        3,579        558        5,513   

Income (loss) before taxes

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

Pre-tax operating margin (b)

     25     30     N/M        26

Average assets

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

Excluding amortization of intangible assets:

        

Noninterest expense

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

Income (loss) before taxes

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

Pre-tax operating margin (b)

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

 

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Investment Management business

 

                                                                         
                                   2Q12 vs.     Year-to-date    

YTD12

vs.

YTD11

 

(dollar amounts in millions,

unless otherwise noted)

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

Revenue:

                    

Investment management fees:

                    

Mutual funds

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

Institutional clients

     319        311        299        322        321        1        -        643        638        1   

Wealth management

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

Investment management fees

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

Performance fees

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

Distribution and servicing

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

Other (a)

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

Total fee and other revenue (a)

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

Net interest revenue

     48        51        55        55        52        8        (5     107        100        7   

Total revenue

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

Provision for credit losses

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

Noninterest expense (ex. amortization of intangible assets)

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

Income before taxes (ex. amortization of intangible assets)

     268        186        190        288        271        1        (6     559        561        -   

Amortization of intangible assets

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

Income before taxes

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

Pre-tax operating margin

     24     16     17     26     24         25     25  

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

     33     26     26     36     34         35     35  

Wealth management:

                    

Average loans

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

Average deposits

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

 

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

AUM at period end, by product type:

               

Equity securities

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

Fixed income securities

     398        419