BK Q2 2013 10-Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

[ X ] Quarterly Report Pursuant To Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2013

or

[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

Commission File No. 001-35651


THE BANK OF NEW YORK MELLON CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
13-2614959
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

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 X     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 X     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 [ X ]
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 X

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, 2013

 
 
Common Stock, $0.01 par value
1,150,476,690

 





THE BANK OF NEW YORK MELLON CORPORATION

Second Quarter of 2013 Form 10-Q
Table of Contents 
 
 
Page
 
 
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:
 
 
 
Item 1. Financial Statements:
 
 
 
Page
Notes to Consolidated Financial Statements:
 
 
 
 
 
Part II - Other Information
 
 
 





The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Financial Highlights (unaudited)
 
Quarter ended
 
Year-to-date
(dollar amounts in millions, except per share amounts and unless otherwise noted)
June 30,
2013

March 31,
2013

 
June 30,
2012

 
June 30,
2013

June 30,
2012

Results applicable to common shareholders of The Bank of New York Mellon Corporation:
 
 
 
 
 
 
 
Net income (loss)
$
833

$
(266
)
 
$
466

 
$
567

$
1,085

Basic EPS
0.71

(0.23
)
 
0.39

 
0.48

0.91

Diluted EPS (a)
0.71

(0.23
)
 
0.39

 
0.48

0.90

 
 
 
 
 
 
 
 
Fee and other revenue
$
3,187

$
2,844

 
$
2,826

 
$
6,031

$
5,664

Income from consolidated investment management funds
65

50

 
57

 
115

100

Net interest revenue
757

719

 
734

 
1,476

1,499

Total revenue
$
4,009

$
3,613

 
$
3,617

 
$
7,622

$
7,263

 
 
 
 
 
 
 
 
Return on common equity (annualized) (b)
9.7
%
N/M

 
5.5
%
 
3.3
%
6.4
%
Non-GAAP (b)
10.5
%
7.8
%
 
8.9
%
 
9.1
%
8.9
%
 
 
 
 
 
 
 
 
Return on tangible common equity
(annualized) – Non-GAAP (b)
25.0
%
N/M

 
15.7
%
 
9.5
%
18.3
%
Non-GAAP adjusted (b)
25.2
%
18.5
%
 
22.4
%
 
21.9
%
22.7
%
 
 
 
 
 
 
 
 
Return on average assets (annualized)
0.99
%
N/M

 
0.61
%
 
0.34
%
0.72
%
 
 
 
 
 
 
 
 
Fee revenue as a percentage of total revenue excluding net securities gains
79
%
78
%
 
78
%
 
79
%
78
%
 
 
 
 
 
 
 
 
Annualized fee revenue per employee (based on average headcount) (in thousands)
$
254

$
229

 
$
233

 
$
242

$
233

 
 
 
 
 
 
 
 
Percentage of non-U.S. total revenue (c)
36
%
35
%
 
37
%
 
36
%
37
%
 
 
 
 
 
 
 
 
Pre-tax operating margin (b)
30
%
22
%
 
16
%
 
26
%
20
%
Non-GAAP adjusted (b)
32
%
26
%
 
29
%
 
29
%
29
%
 
 
 
 
 
 
 
 
Net interest margin (FTE)
1.15
%
1.11
%
 
1.25
%
 
1.13
%
1.28
%
 
 
 
 
 
 
 
 
Assets under management at period end (in billions) (d)
$
1,432

$
1,429

 
$
1,299

 
$
1,432

$
1,299

Assets under custody and/or administration at
period end (in trillions) (e)
$
26.2

$
26.3

 
$
25.2

 
$
26.2

$
25.2

Market value of securities on loan at period
end (in billions) (f)
$
255

$
244

 
$
267

 
$
255

$
267

 
 
 
 
 
 
 
 
Average common shares and equivalents
outstanding (in thousands):


 
 
 
 
 
 
Basic
1,152,545

1,158,819

 
1,181,350

 
1,155,667

1,187,649

Diluted
1,155,981

1,158,819

(a)
1,182,985

 
1,159,169

1,189,264

 
 
 
 
 
 
 
 
Capital ratios:
 
 
 
 
 
 
 
Estimated Basel III Tier 1 common equity
ratio – Non-GAAP (b)(g)
9.3
%
9.4
%
 
8.7
%
 
9.3
%
8.7
%
Basel I Tier 1 common equity to risk-weighted assets
ratio – Non-GAAP (b)
13.2
%
12.2
%
(h)
13.2
%
 
13.2
%
13.2
%
Basel I Tier 1 capital ratio
14.8
%
13.6
%
(h)
14.7
%
 
14.8
%
14.7
%
Basel I Total (Tier 1 plus Tier 2) capital ratio
15.8
%
14.7
%
(h)
16.4
%
 
15.8
%
16.4
%
Basel I leverage capital ratio
5.3
%
5.2
%
 
5.5
%
 
5.3
%
5.5
%
BNY Mellon shareholders’ equity to total assets ratio (b)
10.0
%
10.0
%
 
10.5
%
 
10.0
%
10.5
%
BNY Mellon common shareholders’ equity to total
assets ratio (b)
9.5
%
9.7
%
 
10.3
%
 
9.5
%
10.3
%
BNY Mellon tangible common shareholders’ equity to tangible assets of operations ratio – Non-GAAP (b)
5.8
%
5.9
%
 
6.1
%
 
5.8
%
6.1
%


2 BNY Mellon


Consolidated Financial Highlights (unaudited) (continued)

 
Quarter ended
 
Year-to-date
(dollar amounts in millions, except per share amounts and unless otherwise noted)
June 30,
2013

March 31,
2013

 
June 30,
2012

 
June 30,
2013

June 30,
2012

Selected average balances:
 
 
 
 
 
 
 
Interest-earning assets
$
268,481

$
265,754

 
$
239,755

 
$
267,124

$
238,042

Assets of operations
$
325,931

$
322,161

 
$
293,718

 
$
324,055

$
291,808

Total assets
$
337,455

$
333,664

 
$
305,002

 
$
335,569

$
303,172

Interest-bearing deposits
$
151,219

$
147,728

 
$
130,482

 
$
149,484

$
127,959

Noninterest-bearing deposits
$
70,648

$
70,337

 
$
62,860

 
$
70,493

$
64,737

Preferred stock
$
1,350

$
1,068

 
$
60

 
$
1,210

$
30

Total The Bank of New York Mellon Corporation common shareholders’ equity
$
34,467

$
34,898

 
$
34,123

 
$
34,681

$
33,920

 
 
 
 
 
 
 
 
Other information at period end:
 
 
 
 
 
 
 
Cash dividends per common share
$
0.15

$
0.13

 
$
0.13

 
$
0.28

$
0.26

Common dividend payout ratio (i)
21
%
N/M

 
33
%
 
58
%
29
%
Common dividend yield (annualized)
2.1
%
1.9
%
 
2.4
%
 
2.0
%
2.4
%
Closing common stock price per common share
$
28.05

$
27.99

 
$
21.95

 
$
28.05

$
21.95

Market capitalization
$
32,271

$
32,487

 
$
25,929

 
$
32,271

$
25,929

Book value per common share – GAAP (b)
$
29.83

$
29.83

 
$
28.81

 
$
29.83

$
28.81

Tangible book value per common share – Non-GAAP (b)
$
12.41

$
12.47

 
$
11.47

 
$
12.41

$
11.47

 
 
 
 
 
 
 
 
Full-time employees
49,800

49,700

 
48,300

 
49,800

48,300

 
 
 
 
 
 
 
 
Common share outstanding (in thousands)
1,150,477

1,160,647

 
1,181,298

 
1,150,477

1,181,298

(a)
Diluted earnings per share for the three months ended March 31, 2013 was calculated using average basic shares. Adding back the dilutive shares would result in anti-dilution.
(b)
See “Supplemental information – Explanation of Non-GAAP financial measures” beginning on page 52 for a calculation of these ratios.
(c)
Includes fee revenue, net interest revenue and income of consolidated investment management funds, net of net income attributable to noncontrolling interests.
(d)
Excludes securities lending cash management assets and assets managed in the Investment Services business.
(e)
Includes the AUC/A of CIBC Mellon Global Securities Services Company (“CIBC Mellon”), a joint venture with the Canadian Imperial Bank of Commerce, of $1.1 trillion at June 30, 2013 and $1.2 trillion at both March 31, 2013 and June 30, 2012.
(f)
Represents the total amount of securities on loan managed by the Investment Services business. Excludes securities on loan at CIBC Mellon.
(g)
At June 30, 2013, the estimated Basel III Tier 1 common equity ratio is based on our preliminary interpretation of and expectations regarding the final rules released by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) on July 2, 2013 and is presented under the Standardized Approach. This ratio was 9.8% under the Advanced Approach. For periods prior to June 30, 2013, these ratios were estimated using our interpretation of the Federal Reserve’s Notices of Proposed Rulemaking (“NPRs”) dated June 7, 2012, except as otherwise noted. Both the final rules and the NPRs require the Tier 1 common equity ratio to be the lower of the Standardized Approach or Advanced Approach. At March 31, 2013, this ratio was 9.4% under the Standardized Approach compared with 9.7% under the Advanced Approach. For all periods prepared under the NPRs prior to March 31, 2013, this ratio was higher under the Standardized Approach, and therefore was presented under the Advanced Approach. For all periods prior to June 30, 2013, Basel III risk-weightings for certain repo-style transactions were calculated under the Standardized Approach using the simple value-at-risk (“VaR”) method. At June 30, 2013, Basel III risk-weightings for these transactions were calculated under the Standardized Approach using the collateral haircut approach.
(h)
In the first quarter of 2013, BNY Mellon was required to implement the Basel 2.5 - final market risk rule. Implementation of these rules resulted in an approximately 35-40 basis points decrease to the Basel I Tier 1 common equity to risk-weighted assets ratio, the Basel I Tier 1 capital ratio and the Basel I Total capital ratio.
(i)
The common dividend payout ratio was 23% for the first six months of 2013 after adjusting for the charge related to the disallowance of certain foreign tax credits.
N/M – Not meaningful.



BNY Mellon 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

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 report are defined in the Glossary included in our Annual Report on Form 10-K for the year ended Dec. 31, 2012 (“2012 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 financial measures,” 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 52 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 investments company dedicated to helping its clients manage and service their financial assets throughout the investment lifecycle. Whether providing financial services for institutions, corporations or individual investors, BNY Mellon delivers informed investment management and investment services in 35 countries and more than 100 markets. As of June 30, 2013, BNY Mellon had $26.2 trillion in assets under custody and/or administration, and $1.4 trillion in assets under management. BNY Mellon can act as a single point of contact for clients looking to create trade, hold, manage, service, distribute or restructure investments.

Key second quarter 2013 and subsequent events

ConvergEx

In the second quarter of 2013, ConvergEx, an entity in which BNY Mellon has a minority interest, completed a divestiture of its software platform business. As a result of the divestiture and other events, we recognized an after-tax gain of $109 million, or $0.09 per diluted common share, on our investment in ConvergEx in the second quarter of 2013.

Sale of SourceNet Solutions

On May 31, 2013, BNY Mellon sold SourceNet Solutions, our accounts payable outsourcing support services provider that was part of our Investment Services business. The impact of the sale was not significant on net income.

Agreement to Sell Newton’s Private Client Business

On Feb. 27, 2013, Newton Management Limited, together with Newton Investment Management Limited, an investment boutique of BNY Mellon, announced an agreement to sell Newton’s private client business. The agreement covers 7% of



4 BNY Mellon


Newton’s assets under management valued at signing at £3.6 billion. The transaction is anticipated to close in the third quarter of 2013, subject to regulatory approval. We expect this transaction to be immaterial to our results of operations.

New Risk-Based and Leverage Regulatory Capital Rules

In July 2013, the federal banking agencies finalized rules (the “Final Rules”) revising the capital framework applicable to U.S. bank holding companies (“BHCs”) and banks. The Final Rules implement Basel III and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”) for U.S. BHCs and banks (including by redefining the components of capital and establishing higher minimum percentages for applicable capital ratios) and substantially revise the agencies’ general risk-based capital rules in a manner designed to make them more risk sensitive. The Final Rules establish a graduated implementation schedule and will be principally phased-in by 2019. In general, the Final Rules largely adhere to the rules as initially proposed in June 2012 and as summarized in the Company’s 2012 Annual Report. At June 30, 2013, our estimated Basel III Tier 1 common equity ratio (Non-GAAP), which was based on our preliminary interpretation of and expectations regarding the Final Rules, was 9.3%. Our estimated Basel III Tier 1 common equity ratio (Non-GAAP) was 9.4% at March 31, 2013 and 8.7% at Dec. 31, 2012 and was calculated using our interpretations of the Notices of Proposed Rulemaking (“NPRs”) dated June 7, 2012 released by Board of Governors of the Federal Reserve System (the “Federal Reserve”), except as otherwise noted in our discussions on our Basel III capital ratios. For additional information on the Final Rules, see “Capital” and “Recent accounting and regulatory developments - Regulatory developments”.

Supplementary Leverage Ratio Proposals

The Final Rules implement, among other things, for Advanced Approaches banking organizations, including the Company, a new Basel III-based supplementary leverage ratio of 3%, to become effective Jan. 1, 2018. The Basel Committee and the U.S. banking agencies are each independently considering potential changes to the supplementary leverage ratio that, individually or taken together, could make it substantially more restrictive.
 
In June 2013, the Basel Committee issued a consultative document proposing revisions to the supplementary leverage ratio’s denominator. The proposed revisions would broaden the denominator’s scope to expand exposure calculations for derivatives and related collateral, written credit derivatives (from the perspective of the organization serving as the seller of credit protection), and securities financing transactions, including indemnified agented securities lending transactions.

Separately, on July 9, 2013, the U.S. banking agencies proposed revisions to the supplementary leverage ratio under a notice of proposed rulemaking that would only apply to the largest U.S. BHCs and banks. The July 9 proposal would increase the supplementary leverage requirement for affected holding companies to exceed 5%. In addition, this proposal would establish a supplementary leverage ratio “well-capitalized” threshold of 6% for affected insured depository institutions under the U.S. banking agencies prompt corrective action framework. The proposal indicated the agencies would also be considering the principles set forth in the Basel Committee’s consultative document.

For additional information regarding the supplementary leverage ratio proposals, see “Recent accounting and regulatory developments - Regulatory developments”.

Highlights of second quarter 2013 results

In the second quarter of 2013, we reported net income applicable to common shareholders of BNY Mellon of $833 million, or $0.71 per diluted common share, including an after-tax gain of $109 million, or $0.09 per diluted common share, related to an equity investment. These results compare with net income applicable to common shareholders 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. In the first quarter of 2013, we recorded a net loss of $266 million, or $0.23 per diluted common share, which included a charge of $854 million, or $0.73 per common share, related to the U.S. Tax Court’s disallowance of certain foreign tax credits.




BNY Mellon 5


Highlights of second quarter 2013 include:

Assets under custody and/or administration (“AUC/A”) totaled $26.2 trillion at June 30, 2013 compared with $25.2 trillion at June 30, 2012 and $26.3 trillion at March 31, 2013. The increase of 4% year-over-year primarily reflects higher equity market values and net new business. (See the “Investment Services business” beginning on page 22.)
Assets under management (“AUM”) totaled a $1.43 trillion at June 30, 2013 compared with $1.30 trillion at June 30, 2012 and $1.43 trillion at March 31, 2013. The year-over-year increase of 10% primarily resulted from net new business and higher equity market values. (See the “Investment Management business” beginning on page 19).
Investment services fees increased 4% in the second quarter of 2013 compared with the second quarter of 2012. The increase was driven by higher asset servicing, issuer services, and clearing services revenue, partially offset by lower securities lending revenue. (See the “Investment Services business” beginning on page 22).
Investment management and performance fees increased 6% in the second quarter of 2013 compared with the second quarter of 2012. The increase was driven by higher market values and net new business, partially offset by the stronger U.S. dollar and higher money market fee waivers. (See the “Investment Management business” beginning on page 19).
Foreign exchange and other trading revenue totaled $207 million in the second quarter of 2013 compared with $180 million in the second quarter of 2012. In the second quarter of 2013, foreign exchange revenue increased 14% year-over-year, driven by higher volatility and increased volumes. (See “Fee and other revenue” beginning on page 7).
Investment income and other revenue totaled $269 million in the second quarter of 2013 compared with $48 million in the second quarter of 2012. The increase primarily resulted from a
 
gain related to an equity investment. (See “Fee and other revenue” beginning on page 7).
Net interest revenue totaled $757 million in the second quarter of 2013 compared with $734 million in the second quarter of 2012. The increase is primarily driven by a change in the mix of interest-earning assets, lower funding costs, higher rates and higher average interest-earning assets driven by higher deposit levels. (See “Net interest revenue” beginning on page 11).
The provision for credit losses was a credit of $19 million in both the second quarter of 2013 and the second quarter of 2012. (See “Asset quality and allowance for credit losses” beginning on page 35).
Noninterest expense totaled $2.8 billion in the second quarter of 2013 compared with $3.0 billion the second quarter of 2012. The decrease primarily resulted from a decrease in litigation charges. (See “Noninterest expense” beginning on page 14).
BNY Mellon recorded an income tax provision of $321 million (26.6% effective tax rate) in the second quarter of 2013. This compared with an income tax provision of $93 million (15.8% effective tax rate) in the second quarter of 2012, which included a reduction in the tax rate of approximately 9% related to a litigation charge. (See “Income taxes” on page 15).
The net unrealized pre-tax gain on our total investment securities portfolio was $656 million at June 30, 2013 compared with $2.2 billion at March 31, 2013. The decrease primarily reflects an increase in long-term interest rates. (See “Investment securities” beginning on page 30).
At June 30, 2013, our estimated Basel III Tier 1 common equity ratio (Non-GAAP) was 9.3% compared with 9.4% at March 31, 2013. (See “Capital” beginning on page 44).
In the second quarter of 2013, we repurchased 11.9 million common shares in the open market, at an average price of $27.79 per share, for a total of $330 million.




6 BNY Mellon


Fee and other revenue 

Fee and other revenue






 
 
 
 
 
YTD13
 
 
 
 
 
2Q13 vs.
 
Year-to-date
 
vs.
(dollars in millions, unless otherwise noted)
2Q13

1Q13

2Q12

 
2Q12

1Q13

 
2013

2012

 
YTD12
Investment services fees:
 
 
 
 
 
 
 
 
 
 
 
Asset servicing (a)
$
988

$
969

$
950

 
4
 %
2
 %
 
$
1,957

$
1,893

 
3
 %
Issuer services
294

237

275

 
7

24

 
531

526

 
1

Clearing services
321

304

309

 
4

6

 
625

612

 
2

Treasury services
139

141

134

 
4

(1
)
 
280

270

 
4

Total investment services fees
1,742

1,651

1,668

 
4

6

 
3,393

3,301

 
3

Investment management and performance fees
848

822

797

 
6

3

 
1,670

1,542

 
8

Foreign exchange and other trading revenue
207

161

180

 
15

29

 
368

371

 
(1
)
Distribution and servicing
45

49

46

 
(2
)
(8
)
 
94

92

 
2

Financing-related fees
44

41

37

 
19

7

 
85

81

 
5

Investment and other income
269

72

48

 
N/M

N/M

 
341

187

 
N/M

Total fee revenue
3,155

2,796

2,776

 
14

13

 
5,951

5,574

 
7

Net securities gains
32

48

50

 
N/M

N/M

 
80

90

 
N/M

Total fee and other revenue - GAAP
$
3,187

$
2,844

$
2,826

 
13
 %
12
 %
 
$
6,031

$
5,664

 
6
 %
 
 
 
 
 
 
 
 
 
 
 
 
Fee revenue as a percentage of total revenue excluding net securities gains
79
%
78
%
78
%
 
 
 
 
79
%
78
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AUM at period end (in billions) (b)
$
1,432

$
1,429

$
1,299

 
10
 %
 %
 
$
1,432

$
1,299

 
10
 %
AUC/A at period end (in trillions) (c)
$
26.2

$
26.3

$
25.2

 
4
 %
 %
 
$
26.2

$
25.2

 
4
 %
(a)
Asset servicing fees include securities lending revenue of $50 million in the second quarter of 2013, $39 million in the first quarter of 2013, $59 million in the second quarter of 2012, $89 million in the first six months of 2013 and $108 million in the first six months of 2012.
(b)
Excludes securities lending cash management assets, as well as, assets managed in the Investment Services business.
(c)
Includes the AUC/A of CIBC Mellon of $1.1 trillion at June 30, 2013 and $1.2 trillion at both March 31, 2013 and June 30, 2012.


Fee and other revenue

Fee and other revenue totaled $3.2 billion in the second quarter of 2013, an increase of 13% year-over-year and 12% (unannualized) sequentially. Both increases were driven by improvements in nearly all fee revenue categories.

Investment services fees

Investment services fees were impacted by the following compared with the second quarter of 2012 and the first quarter of 2013:

Asset servicing fees increased 4% year-over-year and 2% (unannualized) sequentially. The year-over-year increase primarily reflects increased core asset servicing fees driven by organic growth and higher market values, partially offset by lower securities lending revenue. The sequential increase primarily resulted from seasonally higher securities lending revenue and increased core asset servicing fees driven by organic growth.
 
Issuer services fees increased 7% year-over-year and 24% (unannualized) sequentially. Both increases primarily resulted from higher fees related to corporate actions and expense reimbursements related to customer technology expenditures. The year-over-year increase was partially offset by the continued run-off of higher margin structured debt securitizations. We continue to estimate that the run-off of high margin securitizations could reduce the Company’s total annual revenue by up to one-half of 1% if the structured debt markets do not recover.
Clearing services fees increased 4% year-over-year and 6% (unannualized) sequentially. Both increases were driven by higher mutual fund fees, and clearance revenue reflecting an increase in DARTs, partially offset by higher money market fee waivers.
Treasury services fees increased 4% year-over-year and decreased of 1% (unannualized) sequentially. The year-over-year increase primarily reflects higher cash management fees.




BNY Mellon 7


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

Investment management and performance fees

Investment management and performance fees totaled $848 million in the second quarter of 2013, an increase of 6% year-over-year and 3% (unannualized) sequentially. The year-over-year increase was primarily driven by higher market values and net new business, partially offset by the stronger U.S. dollar and higher money market fee waivers. The sequential increase was primarily driven by net new business and higher equity market values, partially offset by higher money market fee waivers and the stronger U.S. dollar. Performance fees were $33 million in the second quarter of 2013, $54 million in the second quarter of 2012 and $15 million in the first quarter of 2013.

Total AUM for the Investment Management business was a record $1.4 trillion at June 30, 2013, a 10% increase compared with the prior year and a slight increase (unannualized) sequentially. The year-over-year increase primarily resulted from net new business and higher market values. Sequentially, net new business was primarily offset by lower fixed income market values. Long-term inflows totaled $21 billion and short-term outflows totaled $1 billion for the second quarter of 2013. Long-term inflows benefited from liability-driven investments, equity and fixed income funds.

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)
2Q13

1Q13

2Q12

2013

2012

Foreign exchange
$
179

$
149

$
157

$
328

$
293

Other trading revenue:






 
 
Fixed income
12

8

16

20

63

Equity/other
16

4

7

20

15

Total other trading revenue
28

12

23

40

78

Total
$
207

$
161

$
180

$
368

$
371



 
Foreign exchange and other trading revenue totaled $207 million in the second quarter of 2013, $180 million in the second quarter of 2012 and $161 million in the first quarter of 2013. In the second quarter of 2013, foreign exchange revenue totaled $179 million, an increase of 14% year-over-year and 20% (unannualized) sequentially. Both increases primarily reflect higher volatility and increased volumes. Other trading revenue was $28 million in the second quarter of 2013 compared with $23 million in the second quarter of 2012 and $12 million in the first quarter of 2013. Foreign exchange revenue and fixed income trading revenue is reported in the Investment Services business and the Other segment. Equity/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 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



8 BNY Mellon


program, including a 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 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 either our estimation of the current market rate for a particular currency or 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 other emerging market currencies. A shift by custody clients from the standing instruction program to other trading options combined with competitive market pressures on the foreign exchange business may negatively impact our foreign exchange revenue. For the quarter ended June 30, 2013, our total revenue for all types of foreign exchange trading transactions was $179 million, or approximately 4%, of our total revenue and approximately 42% 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 $45 million in the second quarter of 2013, $46 million in the second quarter of 2012 and $49 million in the first quarter of 2013. Both decreases were impacted by the stronger U.S. dollar.

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 $44 million in the second quarter of 2013, $37 million in the second quarter of 2012 and $41 million in the first quarter of 2013. The increase from both prior periods was primarily a result of higher capital markets fees.

Investment and other income

Investment and other income
 
 
 
 
 
 
 
Year-to-date
(in millions)
2Q13

1Q13

2Q12

2013

2012

Equity investment revenue (loss)
$
200

$
13

$
(5
)
$
213

$
1

Corporate/bank-owned life insurance
32

34

32

66

66

Expense reimbursements from joint ventures
8

11

9

19

19

Asset-related gains (losses)
7

7

(3
)
14

(5
)
Lease residual gains
10

1

3

11

37

Transitional services agreements
4

5

6

9

13

Seed capital gains
1

6


7

24

Private equity gains (losses)
5

(2
)
1

3

5

Other income (loss)
2

(3
)
5

(1
)
27

Total investment and other income
$
269

$
72

$
48

$
341

$
187



Investment and other income, which is primarily reported in the Other segment and Investment Management business, includes income from equity investment revenue and loss, insurance contracts, expense reimbursements from joint ventures, asset-related gains and losses, lease residual gains, transitional services agreements, gains or losses on seed capital investments, gains and losses on private equity investments, and other income and loss.



BNY Mellon 9


Expense reimbursements from joint ventures relate to expenses incurred by BNY Mellon on behalf of joint ventures. Asset-related gains (losses) include loan, real estate and other asset dispositions. Transitional services agreements primarily relate to the Shareowner Services business, which was sold on Dec. 31, 2011. Other income (loss) primarily includes foreign currency remeasurement gain (loss), other investments and various miscellaneous revenues. Investment and other income increased $221 million compared with the second quarter of 2012 and $197 million compared with the first quarter of 2013. Both increases reflect a gain related to an equity investment.

Net securities gains

Net securities gains totaled $32 million in the second quarter of 2013, $50 million in the second quarter of 2012 and $48 million in the first quarter of 2013.
 
Year-to-date 2013 compared with year-to-date 2012

Fee and other revenue for the first six months of
2013 totaled $6.0 billion compared with $5.7 billion in the first six months of 2012. The increase
primarily reflects higher investment and other income, investment management and performance fees and investment services fees.

The increase in investment and other income primarily reflects a gain related to an equity investment. The increase in investment management and performance fees primarily reflects higher market values and net new business, partially offset by the stronger U.S. dollar. The increase in investment services fees primarily reflects increased core asset servicing fees driven by organic growth and higher market values, higher corporate actions and expense reimbursements related to customer technology expenditures and higher mutual fund fees and clearance revenue, partially offset by lower securities lending revenue and higher money market fee waivers. Net securities gains decreased $10 million in the first six months of 2013 compared with the first six months of 2012.



10 BNY Mellon


Net interest revenue 

Net interest revenue
 
 
 
 
 
 
 
 
YTD13
 
 
 
 
 
 
2Q13 vs.
 
Year-to-date
 
vs.
 
(dollars in millions)
2Q13

1Q13

2Q12

 
2Q12

 
1Q13

 
 
2013

2012

 
YTD12
 
Net interest revenue (non-FTE)
$
757

$
719

$
734

 
3

%
5

%
 
$
1,476

$
1,499

 
(2
)
%
Tax equivalent adjustment
14

14

13

 
8

 

 
 
28

24

 
17

 
Net interest revenue (FTE) – Non-GAAP
771

733

747

 
3

%
5

%
 
1,504

1,523

 
(1
)
%
Average interest-earning assets
$
268,481

$
265,754

$
239,755

 
12

%
1

%
 
$
267,124

$
238,042

 
12

%
Net interest margin (FTE)
1.15
%
1.11
%
1.25
%
 
(10
)
bps 
4

bps 
 
1.13
%
1.28
%
 
(15
)
bps 


Net interest revenue totaled $757 million in the second quarter of 2013, an increase of $23 million compared with the second quarter of 2012 and $38 million sequentially. Both increases were primarily driven by a change in the mix of interest-earning assets, lower funding costs, higher rates and higher average interest-earning assets driven by higher deposit levels.

The net interest margin (FTE) was 1.15% in the second quarter of 2013 compared with 1.25% in the second quarter of 2012 and 1.11% in the first quarter of 2013. The year-over-year decrease in the net interest margin (FTE) primarily reflects higher average interest-earning assets and lower yields, partially offset by a change in the mix of interest-earning assets.
 
Year-to-date 2013 compared with year-to-date 2012

Net interest revenue totaled $1.5 billion in the first six months of 2013 a decrease of 2% compared with the first six months of 2012. The decrease primarily reflects lower yields on the reinvestment of securities and the elimination of interest on European Central Bank deposits, partially offset by a change in the mix of interest-earning assets, lower funding costs, higher rates and higher average interest-earning assets driven by higher client deposits. The net interest margin (FTE) was 1.13% in the first six months of 2013, compared with 1.28% in the first six months of 2012. The decline in the net interest margin (FTE) was primarily driven by higher average interest-earning assets and lower yields, partially offset by a change in the mix of interest-earning assets.




BNY Mellon 11


Average balances and interest rates
Quarter ended
 
June 30, 2013
 
March 31, 2013
 
June 30, 2012
(dollar amounts in millions, presented on an FTE basis)
Average balance

 
Average rates

 
Average balance

 
Average rates

 
Average balance

 
Average rates

Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with banks (primarily foreign banks)
$
42,772

 
0.64
 %
 
$
40,967

 
0.70
 %
 
$
38,474

 
0.98
%
Interest-bearing deposits held at the Federal Reserve and other central banks
55,911

 
0.22

 
63,240

 
0.20

 
57,904

 
0.27

Federal funds sold and securities purchased under resale agreements
7,878

 
0.52

 
7,478

 
0.54

 
5,493

 
0.62

Margin loans
13,906

 
1.14

 
13,346

 
1.17

 
13,331

 
1.27

Non-margin loans:
 
 
 
 
 
 
 
 
 
 
 
Domestic offices
21,689

 
2.40

 
21,358

 
2.38

 
19,663

 
2.52

Foreign offices
12,318

 
1.32

 
11,575

 
1.36

 
9,998

 
1.86

Total non-margin loans
34,007

 
2.01

 
32,933

 
2.02

 
29,661

 
2.30

Securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. government obligations
19,887

 
1.62

 
18,814

 
1.54

 
15,387

 
1.65

U.S. government agency obligations
47,631

 
1.80

 
42,397

 
1.85

 
39,070

 
2.23

State and political subdivisions – tax-exempt
6,377

 
2.26

 
6,194

 
2.38

 
4,777

 
2.65

Other securities
33,243

 
1.93

 
34,507

 
2.03

 
32,625

 
2.51

Trading securities
6,869

 
2.33

 
5,878

 
2.40

 
3,033

 
2.57

Total securities
114,007

 
1.86

 
107,790

 
1.91

 
94,892

 
2.26

Total interest-earning assets
$
268,481

 
1.27
 %
 
$
265,754

 
1.26
 %
 
$
239,755

 
1.48
%
Allowance for loan losses
(237
)
 
 
 
(264
)
 
 
 
(382
)
 
 
Cash and due from banks
5,060

 
 
 
4,534

 
 
 
4,412

 
 
Other assets
52,627

 
 
 
52,137

 
 
 
49,933

 
 
Assets of consolidated investment management funds
11,524

 
 
 
11,503

 
 
 
11,284

 
 
Total assets
$
337,455

 
 
 
$
333,664

 
 
 
$
305,002

 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Money market rate accounts and demand deposit accounts
$
8,183

 
0.22
 %
 
$
8,778

 
0.19
 %
 
$
8,421

 
0.24
%
Savings
897

 
0.24

 
819

 
0.29

 
702

 
0.13

Time deposits
41,706

 
0.04

 
39,091

 
0.05

 
33,180

 
0.11

Foreign offices
100,433

 
0.07

 
99,040

 
0.08

 
88,179

 
0.13

Total interest-bearing deposits
151,219

 
0.07

 
147,728

 
0.08

 
130,482

 
0.13

Federal funds purchased and securities sold under repurchase agreements
9,206

 
(0.28
)
 
9,187

 
(0.12
)
 
11,254

 
0.01

Trading liabilities
3,036

 
1.40

 
2,552

 
1.35

 
1,256

 
1.87

Other borrowed funds
1,385

 
0.20

 
1,152

 
0.90

 
1,114

 
1.88

Commercial paper
58

 
0.04

 
245

 
0.09

 
1,436

 
0.29

Payables to customers and broker-dealers
9,073

 
0.08

 
9,019

 
0.09

 
7,895

 
0.10

Long-term debt
19,002

 
0.94

 
18,878

 
1.18

 
20,084

 
1.67

Total interest-bearing liabilities
$
192,979

 
0.16
 %
 
$
188,761

 
0.20
 %
 
$
173,521

 
0.32
%
Total noninterest-bearing deposits
70,648

 
 
 
70,337

 
 
 
62,860

 
 
Other liabilities
26,779

 
 
 
27,416

 
 
 
23,588

 
 
Liabilities and obligations of consolidated investment management funds
10,242

 
 
 
10,186

 
 
 
10,072

 
 
Total liabilities
300,648

 
 
 
296,700

 
 
 
270,041

 
 
Temporary equity
 
 
 
 
 
 
 
 
 
 
 
Redeemable noncontrolling interests
189

 
 
 
175

 
 
 
78

 
 
Permanent equity
 
 
 
 
 
 
 
 
 
 
 
Total BNY Mellon shareholders’ equity
35,817

 
 
 
35,966

 
 
 
34,183

 
 
Noncontrolling interests
801

 
 
 
823

 
 
 
700

 
 
Total permanent equity
36,618

 
 
 
36,789

 
 
 
34,883

 
 
Total liabilities, temporary equity and
permanent equity
$
337,455

 
 
 
$
333,664

 
 
 
$
305,002

 
 
Net interest margin (FTE)
 
 
1.15
 %
 
 
 
1.11
 %
 
 
 
1.25
%
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.




12 BNY Mellon


Average balances and interest rates
Year-to-date
 
June 30, 2013
 
June 30, 2012
(dollar amounts in millions, presented on an FTE basis)
Average balance

 
Average rates

 
Average balance

 
Average rates

Assets
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
Interest-bearing deposits with banks (primarily foreign banks)
$
41,874

 
0.67
 %
 
$
36,784

 
1.14
%
Interest-bearing deposits held at the Federal Reserve and other central banks
59,555

 
0.21

 
60,715

 
0.27

Federal funds sold and securities purchased under resale agreements
7,679

 
0.53

 
5,333

 
0.67

Margin loans
13,627

 
1.15

 
13,116

 
1.28

Non-margin loans:
 
 
 
 
 
 
 
Domestic offices
21,524

 
2.39

 
19,895

 
2.49

Foreign offices
11,949

 
1.34

 
10,089

 
1.81

Total non-margin loans
33,473

 
2.02

 
29,984

 
2.26

Securities:
 
 
 
 
 
 
 
U.S. government obligations
19,353

 
1.57

 
16,328

 
1.61

U.S. government agency obligations
45,028

 
1.82

 
35,709

 
2.33

State and political subdivisions – tax-exempt
6,286

 
2.32

 
4,066

 
2.78

Other securities
33,873

 
1.98

 
33,231

 
2.67

Trading securities
6,376

 
2.36

 
2,776

 
2.67

Total securities
110,916

 
1.88

 
92,110

 
2.36

Total interest-earning assets
$
267,124

 
1.26
 %
 
$
238,042

 
1.53
%
Allowance for loan losses
(250
)
 
 
 
(387
)
 
 
Cash and due from banks
4,798

 
 
 
4,341

 
 
Other assets
52,383

 
 
 
49,812

 
 
Assets of consolidated investment management funds
11,514

 
 
 
11,364

 
 
Total assets
$
335,569

 
 
 
$
303,172

 
 
Liabilities
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
Money market rate accounts and demand deposit accounts
$
8,479

 
0.20
 %
 
$
6,433

 
0.25
%
Savings
859

 
0.26

 
703

 
0.12

Time deposits
40,406

 
0.05

 
33,399

 
0.10

Foreign offices
99,740

 
0.08

 
87,424

 
0.14

Total interest-bearing deposits
149,484

 
0.08

 
127,959

 
0.14

Federal funds purchased and securities sold under repurchase agreements
9,197

 
(0.20
)
 
9,919

 

Trading liabilities
2,795

 
1.38

 
1,205

 
1.72

Other borrowed funds
1,269

 
0.51

 
1,813

 
1.14

Commercial paper
151

 
0.08

 
751

 
0.29

Payables to customers and broker-dealers
9,046

 
0.08

 
7,725

 
0.11

Long-term debt
18,940

 
1.06

 
20,311

 
1.73

Total interest-bearing liabilities
$
190,882

 
0.19
 %
 
$
169,683

 
0.34
%
Total noninterest-bearing deposits
70,493

 
 
 
64,737

 
 
Other liabilities
27,095

 
 
 
23,919

 
 
Liabilities and obligations of consolidated investment management funds
10,214

 
 
 
10,115

 
 
Total liabilities
298,684

 
 
 
268,454

 
 
Temporary equity
 
 
 
 
 
 
 
Redeemable noncontrolling interests
182

 
 
 
75

 
 
Permanent equity
 
 
 
 
 
 
 
Total BNY Mellon shareholders’ equity
35,891

 
 
 
33,950

 
 
Noncontrolling interests
812

 
 
 
693

 
 
Total permanent equity
36,703

 
 
 
34,643

 
 
Total liabilities, temporary equity and permanent equity
$
335,569

 
 
 
$
303,172

 
 
Net interest margin (FTE)
 
 
1.13
 %
 
 
 
1.28
%
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.





BNY Mellon 13


Noninterest expense
Noninterest expense
 
 
 
 
 
 
 
 
YTD13
 
 
 
 
 
2Q13 vs.
 
Year-to-date
 
vs.
(dollars in millions)
2Q13

1Q13

2Q12

 
2Q12

1Q13

 
2013

2012

 
YTD12

Staff:
 
 
 
 
 
 
 
 
 
 
 
Compensation
$
891

$
885

$
866

 
3
 %
1
 %
 
$
1,776

$
1,727

 
3
 %
Incentives
364

338

311

 
17

8

 
702

663

 
6

Employee benefits
254

249

238

 
7

2

 
503

478

 
5

Total staff
1,509

1,472

1,415

 
7

3

 
2,981

2,868

 
4

Professional, legal and other purchased services
317

295

309

 
3

7

 
612

608

 
1

Net occupancy
159

163

141

 
13

(2
)
 
322

288

 
12

Software
157

140

127

 
24

12

 
297

246

 
21

Distribution and servicing
111

106

103

 
8

5

 
217

204

 
6

Furniture and equipment
81

88

82

 
(1
)
(8
)
 
169

168

 
1

Business development
90

68

71

 
27

32

 
158

127

 
24

Sub-custodian
77

64

70

 
10

20

 
141

140

 
1

Other
215

307

254

 
(15
)
(30
)
 
522

474

 
10

Amortization of intangible assets
93

86

97

 
(4
)
8

 
179

193

 
(7
)
M&I, litigation and restructuring charges
13

39

378

 
N/M
N/M
 
52

487

 
N/M
Total noninterest expense - GAAP
$
2,822

$
2,828

$
3,047

 
(7
)%
 %
 
$
5,650

$
5,803

 
(3
)%
Total staff expense as a percentage of total revenue
38
%
41
%
39
%
 
 
 
 
39
%
39
%
 
 
Full-time employees at period end
49,800

49,700

48,300

 
3
 %
 %
 
49,800

48,300

 
3
 %

 
 
 
 
 
 
 
 
 
 
 
Memo:
 
 
 
 
 
 
 
 
 
 
 
Total noninterest expense excluding amortization of intangible assets and M&I, litigation and restructuring charges - Non-GAAP
$
2,716

$
2,703

$
2,572

 
6
 %
 %
 
$
5,419

$
5,123

 
6
 %
N/M - Not meaningful.


Total noninterest expense decreased $225 million, or 7%, compared with the second quarter of 2012 and was essentially unchanged compared with the first quarter of 2013. Excluding amortization of intangible assets, merger and integration (“M&I”), litigation and restructuring charges, noninterest expense increased 6% year-over-year and was stable sequentially. The year-over-year increase primarily reflects higher staff, software and business development expenses, partially offset by a decrease in the reserve for administrative errors in certain offshore tax-exempt funds.

Staff expense

Given our mix of fee-based businesses, which are staffed with high-quality professionals, staff expense comprised 56% of total noninterest expense in the second quarter of 2013, 55% in the second quarter of 2012 and 54% in the first quarter of 2013, excluding amortization of intangible assets and M&I, litigation and restructuring charges.

Staff expense was $1.5 billion in the second quarter of 2013, an increase of 7% compared with the second quarter of 2012 and an increase of 3% compared with
 
the first quarter of 2013. Both increases primarily reflect higher incentive expense driven by improved performance. The year-over-year increase was also impacted by higher compensation and pension expenses.

Non-staff expense

Non-staff expense, excluding amortization of intangible assets and M&I, litigation and restructuring charges, totaled $1.2 billion in the second quarter of 2013, an increase of 4% compared with the second quarter of 2012 and a decrease of 2% compared with the first quarter of 2013. The increase primarily reflects higher software, business development, occupancy and volume-related expenses, partially offset by a decrease in the reserve for administrative errors in certain offshore tax-exempt funds. The increase in software expense was largely related to periodic reimbursable customer technology expenditures. Reimbursement for these expenses is included in fee revenue. The increase in business development expense primarily reflects our corporate branding investments. The sequential decrease primarily reflects a decrease in the reserve for administrative errors in certain offshore tax-



14 BNY Mellon


exempt funds, partially offset by higher business development, consulting, volume-related and software expenses.

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 our legal proceedings, see Note 18 of the Notes to Consolidated Financial Statements.
 
Year-to-date 2013 compared with year-to-date 2012

Noninterest expense in the first six months of 2013 decreased $153 million, or 3% compared with the first six months of 2012. The decrease primarily reflects the litigation charge recorded in the second quarter of 2012, partially offset by higher staff, software, occupancy and business development expenses and a reserve for administrative errors in certain offshore tax-exempt funds.


Operational excellence initiatives update

Expense initiatives (pre-tax)
 
 
Original annualized
 
 
Program savings
 
targeted savings by
 
(dollar amounts in millions)
FY12

 
1Q13

 
2Q13

 
the end of 2013 (a)
 
Business operations
$
238

 
$
84

 
$
93

 
 
$
310

-
$
320

Technology
82

 
27

 
30

 
 
$
105

-
$
110

Corporate services
77

 
26

 
27

 
 
$
85

-
$
90

Gross savings (b)
$
397

 
$
137

 
$
150

 
 
$
500

-
$
520

 
 
 
 
 
 
 
 
 
 
 
Incremental program expenses to achieve goals (c)
$
88

 
$
16

 
$
11

 
 
$
70

-
$
90

(a)
Original target established at the inception of the program in 2011.
(b)
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.
(c)
Program costs include incremental costs to plan and execute the programs including dedicated program managers, consultants, severance and other costs. These costs will fluctuate by quarter. Program costs may include restructuring expenses, where applicable.


During the first half of 2013, we accomplished the following operational excellence initiatives:

Continued global footprint position migrations. Lowered operating costs as we ramped up the Eastern European Global Delivery Center and continued job migrations to our existing Global Delivery Centers.
Realized savings from business restructuring and management rationalization in Investment Services.
Realized savings from reengineering activities relating to investment management boutique restructurings and Dreyfus back office operations consolidation.
Realized compensation savings from efficiencies and additional staff moves to Global Delivery Centers in the Technology organization.
Consolidated offices and reduced real estate by an additional 100,000 square feet, primarily in the New York Metro region.

 
Income taxes

The provision for income taxes and effective tax rate were $321 million and 26.6%, respectively, in the second quarter of 2013 and $93 million and 15.8%, respectively, in the second quarter of 2012. The provision for income taxes and the effective tax rate for the second quarter of 2013 primarily reflect a gain related to an equity investment and the termination of investments in certain tax credits. The effective tax rate in the second quarter of 2012 included a reduction of approximately 9% related to a litigation charge. The provision for income taxes was $1.0 billion in the first quarter of 2013, including the $854 million charge related to the disallowance of certain foreign tax credits. The effective tax rate on an operating basis (Non-GAAP) was 23.7% in the first quarter of 2013. See “Supplemental information - Explanation of Non-GAAP financial measures” beginning on page 52 for additional information.

We expect the effective tax rate to be approximately 26% in third quarter of 2013.



BNY Mellon 15


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.

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 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 19 of the Notes to Consolidated Financial Statements.

Business results are subject to reclassification whenever improvements are made in the measurement principles or when organizational
 
changes are made. Internal crediting rates for deposits are regularly updated to reflect the value of deposit balances and distribution of overall interest revenue. In the second quarter of 2013, lower internal crediting rates were applied to deposits in the Investment Management and Investment Services businesses. There was no impact to our consolidated financial results.

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.


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

Market indices
 
 
 
 
 
 
 
 
 
 
 
 
YTD13
vs.
YTD12

  
  
  
 
 
 
2Q13 vs.
 
Year-to-date
 
  
2Q12

3Q12

4Q12

1Q13

2Q13

 
2Q12

1Q13

 
2013

2012

 
S&P 500 Index (a)
1362

1441

1426

1569

1606

 
18
 %
2
 %
 
1606

1362

 
18
 %
S&P 500 Index – daily average
1351

1400

1419

1513

1609

 
19

6

 
1562

1349

 
16

FTSE 100 Index (a)
5571

5742

5898

6412

6215

 
12

(3
)
 
6215

5571

 
12

FTSE 100 Index – daily average
5555

5742

5842

6294

6438

 
16

2

 
6365

5690

 
12

MSCI World Index (a)
1236

1312

1339

1435

1434

 
16


 
1434

1236

 
16

MSCI World Index – daily average
1235

1273

1312

1404

1463

 
18

4

 
1434

1250

 
15

Barclay’s Capital Aggregate Bondsm Index (a)
353

368

366

356

343

 
(3
)
(4
)
 
343

353

 
(3
)
NYSE and NASDAQ share volume (in billions)
192

173

174

174

186

 
(3
)
7

 
360

378

 
(5
)
JPMorgan G7 Volatility Index – daily
average (b)
10.30

8.70

7.56

9.02

9.84

 
(4
)
9

 
9.43

10.35

 
(9
)
(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 in Investment Services, is impacted by the value of market indices. At June 30, 2013, using the Standard & Poor’s (“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
 
spread evenly throughout the year, would impact fee revenue by less than 1% and diluted earnings per common share by $0.02 to $0.04. If however, global equity markets do not perform in line with the S&P 500 Index, the impact to fee revenue and earnings per share could be different.




16 BNY Mellon


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

For the quarter ended June 30, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
922

 (a) 
$
1,972

 
$
319

 
$
3,213

(a) 
Net interest revenue
63

 
633

 
61

 
757

 
Total revenue
985

 
2,605

 
380

 
3,970

 
Provision for credit losses

 

 
(19
)
 
(19
)
 
Noninterest expense
713

 
1,878

 
231

 
2,822

 
Income before taxes
$
272

 (a) 
$
727

 
$
168

 
$
1,167

(a) 
Pre-tax operating margin (b)
28
%
 
28
%
 
N/M

 
29
%
 
Average assets
$
37,953

 
$
244,803

 
$
54,699

 
$
337,455

 
Excluding amortization of intangible assets:
 
 
 
 
 
 
 
 
Noninterest expense
$
674

 
$
1,824

 
$
231

 
$
2,729

 
Income (loss) before taxes
311

(a)
781

 
168

 
1,260

(a) 
Pre-tax operating margin (b)
32
%
 
30
%
 
N/M

 
32
%
 
(a)
Total fee and other revenue includes income from consolidated investment management funds of $65 million, net of noncontrolling interests of $39 million, for a net impact of $26 million. Income before taxes includes noncontrolling interests of $39 million.
(b)
Income before taxes divided by total revenue.
N/M - Not meaningful.


For the quarter ended March 31, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
891

 (a) 
$
1,862

 
$
125

 
$
2,878

(a) 
Net interest revenue
62

 
653

 
4

 
719

 
Total revenue
953

 
2,515

 
129

 
3,597

 
Provision for credit losses

 
1

 
(25
)
 
(24
)
 
Noninterest expense
743

 
1,843

 
242

 
2,828

 
Income (loss) before taxes
$
210

 (a) 
$
671

 
$
(88
)
 
$
793

(a) 
Pre-tax operating margin (b)
22
%
 
27
%
 
N/M

 
22
%
 
Average assets
$
38,743

 
$
240,188

 
$
54,733

 
$
333,664

 
Excluding amortization of intangible assets:
 
 
 
 
 
 
 
 
Noninterest expense
$
704

 
$
1,796

 
$
242

 
$
2,742

 
Income (loss) before taxes
249

(a)
718

 
(88
)
 
879

(a) 
Pre-tax operating margin (b)
26
%
 
29
%
 
N/M

 
24
%
 
(a)
Total fee and other revenue includes income from consolidated investment management funds of $50 million, net of noncontrolling interests of $16 million, for a net impact of $34 million. Income before taxes includes noncontrolling interests of $16 million.
(b)
Income before taxes divided by total revenue.
N/M - Not meaningful.


For the quarter ended June 30, 2012
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
858

 (a) 
$
1,880

 
$
116

 
$
2,854

(a) 
Net interest revenue
52

 
607

 
75

 
734

 
Total revenue
910

 
2,487

 
191

 
3,588

 
Provision for credit losses

 
(14
)
 
(5
)
 
(19
)
 
Noninterest expense
690

 
2,141

 
216

 
3,047

 
Income (loss) before taxes
$
220

 (a) 
$
360

 
$
(20
)
 
$
560

(a) 
Pre-tax operating margin (b)
24
%
 
14
%
 
N/M

 
16
%
 
Average assets
$
35,603

 
$
210,064

 
$
59,335

 
$
305,002

 
Excluding amortization of intangible assets:
 
 
 
 
 
 
 
 
Noninterest expense
$
642

 
$
2,092

 
$
216

 
$
2,950

 
Income (loss) before taxes
268

(a)
409

 
(20
)
 
657

(a) 
Pre-tax operating margin (b)
29
%
 
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.



BNY Mellon 17


For the six months ended June 30, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
1,813

 (a) 
$
3,834

 
$
444

 
$
6,091

(a) 
Net interest revenue
125

 
1,286

 
65

 
1,476

 
Total revenue
1,938

 
5,120

 
509

 
7,567

 
Provision for credit losses

 
1

 
(44
)
 
(43
)
 
Noninterest expense
1,456

 
3,721

 
473

 
5,650

 
Income before taxes
$
482

 (a) 
$
1,398

 
$
80

 
$
1,960

(a) 
Pre-tax operating margin (b)
25
%
 
27
%
 
N/M

 
26
%
 
Average assets
$
38,346

 
$
242,508

 
$
54,715

 
$
335,569

 
Excluding amortization of intangible assets:
 
 
 
 
 
 
 
 
Noninterest expense
$
1,378

 
$
3,620

 
$
473

 
$
5,471

 
Income before taxes
560

(a)
1,499

 
80

 
2,139

(a) 
Pre-tax operating margin (b)
29
%
 
29
%
 
N/M

 
28
%
 
(a)
Total fee and other revenue includes income from consolidated investment management funds of $115 million, net of noncontrolling interests of $55 million, for a net impact of $60 million. Income before taxes includes noncontrolling interests of $55 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
$
1,707

 (a) 
$
3,730

 
$
287

 
$
5,724

(a) 
Net interest revenue
107

 
1,249

 
143

 
1,499

 
Total revenue
1,814

 
4,979

 
430

 
7,223

 
Provision for credit losses

 
2

 
(16
)
 
(14
)
 
Noninterest expense
1,358

 
3,977

 
468

 
5,803

 
Income (loss) before taxes
$
456

 (a) 
$
1,000

 
$
(22
)
 
$
1,434

(a) 
Pre-tax operating margin (b)
25
%
 
20
%
 
N/M

 
20
%
 
Average assets
$
35,857

 
$
212,328

 
$
54,987

 
$
303,172

 
Excluding amortization of intangible assets:
 
 
 
 
 
 
 
 
Noninterest expense
$
1,262

 
$
3,880

 
$
468

 
$
5,610

 
Income (loss) before taxes
552

(a)
1,097

 
(22
)
 
1,627

(a) 
Pre-tax operating margin (b)
30
%
 
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.




18 BNY Mellon


Investment Management business

 
 
 
 
 
 
 
 
 
 
 
 
 
YTD13

(dollar amounts in millions, unless otherwise noted)
 
 
 
 
 
 
2Q13 vs.
 
Year-to-date
 
vs.
2Q12

3Q12

4Q12

1Q13

2Q13

 
2Q12

1Q13

 
2013

2012

 
YTD12

Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment management fees:
 
 
 
 
 
 
 
 
 
 
 
 
 
Mutual funds
$
270

$
283

$
293

$
295

$
295

 
9
 %
 %
 
$
590

$
530

 
11
 %
Institutional clients
321

334

349

355

360

 
12

1

 
715

643

 
11

Wealth management
156

154

157

161

165

 
6

2

 
326

310

 
5

Investment management fees
747

771

799

811

820

 
10

1

 
1,631

1,483

 
10

Performance fees
54

10

57

15

33

 
(39
)
N/M

 
48

70

 
(31
)
Distribution and servicing
45

47

50

46

44

 
(2
)
(4
)
 
90

90

 

Other (a)
12

41

25

19

25

 
N/M

N/M

 
44

64

 
(31
)
Total fee and other revenue (a)
858

869

931

891

922

 
7

3

 
1,813

1,707

 
6

Net interest revenue
52

51

56

62

63

 
21

2

 
125

107

 
17

Total revenue
910

920

987

953

985

 
8

3

 
1,938

1,814

 
7

Noninterest expense (ex. amortization of intangible assets)
642

644

713

704

674

 
5

(4
)
 
1,378

1,262

 
9

Income before taxes (ex. amortization of intangible assets)
268

276

274

249

311

 
16

25

 
560

552

 
1

Amortization of intangible assets
48

48

48

39

39

 
(19
)

 
78

96

 
(19
)
Income before taxes
$
220

$
228

$
226

$
210

$
272

 
24
 %
30
 %
 
$
482

$
456

 
6
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pre-tax operating margin
24
%
25
%
23
%
22
%
28
%
 
 
 
 
25
%
25
%
 
 
Pre-tax operating margin (ex. amortization of intangible assets and net of distribution and servicing expense) (b)
33
%
34
%
31
%
29
%
36
%
 
 
 
 
32
%
34
%
 
 
Wealth management:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average loans
$
7,763

$
8,122

$
8,478

$
8,972

$
9,253

 
19
 %
3
 %
 
$
9,113

$
7,597

 
20
 %
Average deposits
$
10,893

$
10,882

$
12,332

$
13,646

$
13,306

 
22
 %
(2
)%
 
$
13,475

$
11,011

 
22
 %
(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 52. 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 $102 million, $107 million, $106 million, $104 million, $110 million, $214 million and $202 million for each of the periods presented above, respectively.
N/M - Not meaningful.




BNY Mellon 19


AUM trends (a)
 
 
 
 
 
 
 
 
 
 
2Q13 vs.
(dollar amounts in billions)
2Q12

 
3Q12

 
4Q12

 
1Q13

 
2Q13

 
2Q12

 
1Q13

AUM at period end, by product type:
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities
$
417

 
$
446

 
$
451

 
$
487

 
$
493

 
18
 %
 
1
 %
Fixed income securities (b)
480

 
506

 
532

 
559

 
558

 
16
 %
 
 %
Money market
299

 
307

 
302

 
278

 
277

 
(7
)%
 
 %
Alternative investments and overlay
103

 
100

 
101

 
105

 
104

 
1
 %
 
(1
)%
Total AUM
$
1,299

 
$
1,359

 
$
1,386

 
$
1,429

 
$
1,432

 
10
 %
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AUM at period end, by client type:
 
 
 
 
 
 
 
 
 
 
 
 
 
Institutional
$
835

 
$
883

 
$
894

 
$
939

 
$
969

 
16
 %
 
3
 %
Mutual funds
388

 
398

 
411

 
405

 
378

 
(3
)%
 
(7
)%
Private client
76

 
78

 
81

 
85

 
85

 
12
 %
 
 %
Total AUM
$
1,299

 
$
1,359

 
$
1,386

 
$
1,429

 
$
1,432

 
10
 %
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Changes in AUM:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance of AUM
$
1,308

 
$
1,299

 
$
1,359

 
$
1,386

 
$
1,429

 
 
 
 
Net inflows (outflows):
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term
26

 
9

 
14

 
40

 
21

 
 
 
 
Money market
(14
)
 
9

 
(6
)
 
(13
)
 
(1
)
 
 
 
 
Total net inflows (outflows)
12

 
18

 
8

 
27

 
20

 
 
 
 
Net market/currency impact
(21
)
 
42

 
19

 
16

 
(17
)
 
 
 
 
Ending balance of AUM
$
1,299

 
$
1,359

 
$
1,386

 
$
1,429

 
$
1,432

 
10
 %
 
 %
(a)
Excludes securities lending cash management assets and assets managed in the Investment Services business.
(b)
Includes liability-driven investments.


Business description

Our Investment Management business is comprised of our affiliated investment management boutiques, wealth management business and global distribution companies. See page 22 of our 2012 Annual Report for additional information on our Investment Management business.

Review of financial results

Investment management and performance fees are dependent on the overall level and mix of AUM and the management fees expressed in basis points (one-hundredth of one percent) charged for managing those assets. Assets under management were $1.43 trillion at June 30, 2013 compared with $1.30 trillion at June 30, 2012 and $1.43 trillion at March 31, 2013. The increase compared with June 30, 2012 primarily resulted from net new business and higher market values. Sequentially, net new business was primarily offset by lower fixed income market values. Net long-term inflows were $21 billion in the second quarter of 2013 and benefited from liability-driven investment as well as equity and fixed income funds. Net short-term outflows were $1 billion in the second quarter of 2013.

 
Revenue generated in the Investment Management business included 47% from non-U.S. sources in the second quarter of 2013 compared with 44% in both the second quarter of 2012 and first quarter of 2013.

In the second quarter of 2013, Investment Management had pre-tax income of $272 million compared with $220 million in the second quarter of 2012 and $210 million in the first quarter of 2013. Excluding amortization of intangible assets, pre-tax income was $311 million in the second quarter of 2013 compared with $268 million in the second quarter of 2012 and $249 million in the first quarter of 2013. Both increases primarily reflect higher equity market values and net new business, partially offset by a stronger U.S. dollar and higher money market fee waivers. The year-over-year increase also reflects the impact of the acquisition of the remaining 50% interest in Meriten Investment Management (“Meriten”).

Investment management fees in the Investment Management business were $820 million in the second quarter of 2013 compared with $747 million in the second quarter of 2012 and $811 million in the first quarter of 2013. The year-over-year increase was primarily driven by higher market values, net new business and the impact of the Meriten acquisition, partially offset by the stronger U.S. dollar and higher money market fee waivers. The sequential increase was primarily driven by net new business



20 BNY Mellon


and higher equity market values, partially offset by higher money market fee waivers and the stronger U.S. dollar.

Performance fees were $33 million in the second quarter of 2013 compared with $54 million in the second quarter of 2012 and $15 million in the first quarter of 2013. The sequential increase was due to seasonality.

In the second quarter of 2013, 36% of investment management fees in the Investment Management business were generated from managed mutual fund fees. These fees are based on the daily average net assets of each fund and the management fee paid by that fund. Managed mutual fund fee revenue was $295 million in the second quarter of 2013 compared with $270 million in the second quarter of 2012 and $295 million in the first quarter of 2013. The increase compared with the second quarter of 2012 primarily resulted from higher market values and net new business.

Net interest revenue was $63 million in the second quarter of 2013 compared with $52 million in the second quarter of 2012 and $62 million in the first quarter of 2013. The year-over-year increase resulted from higher average loans and deposits driven by new business. The sequential increase primarily reflects higher average loans, partially offset by lower internal crediting rates for deposits in the second quarter of 2013. Average loans increased 19% year-over-year and 3% sequentially, while average deposits increased 22% year-over-year and decreased 2% sequentially.

 
Noninterest expense excluding amortization of intangible assets was $674 million in the second quarter of 2013 compared with $642 million in the second quarter of 2012 and $704 million in the first quarter of 2013. The year-over-year increase primarily reflects higher incentive expense, the impact of the Meriten acquisition and higher distribution and servicing expense, partially offset by a decrease in the reserve for administrative errors in certain offshore tax-exempt funds and a stronger U.S. dollar. The sequential decrease primarily reflects a decrease in the reserve for administrative errors in certain offshore tax-exempt funds and a stronger U.S. dollar, partially offset by higher incentive expense.

Year-to-date 2013 compared with year-to-date 2012

Income before taxes totaled $482 million in the first six months of 2013 compared with $456 million in the first six months of 2012. Income before taxes (excluding intangible amortization) was $560 million in the first six months of 2013 compared with $552 million in the first six months of 2012. Fee and other revenue increased $106 million compared to the first six months of 2012, primarily due to higher market values, net new business and the impact of the Meriten acquisition, partially offset by lower performance fees, a stronger U.S. dollar and lower seed capital gains. Net interest revenue increased $18 million compared to the first six months of 2012 primarily as a result of higher average loan and deposit levels. Noninterest expense (excluding intangible amortization) increased $116 million compared to the first six months of 2012, primarily due to the impact of the Meriten acquisition, higher incentives, the provision for administrative errors in certain offshore tax-exempt funds and higher distribution and servicing expense.




BNY Mellon 21


Investment Services business 
 
 
 
 
 
 
 
 
 
 
 
 
 
YTD13
(dollar amounts in millions,
unless otherwise noted)
 
 
 
 
 
 
2Q13 vs.
 
Year-to-date
 
vs.
2Q12

3Q12

4Q12

1Q13

2Q13

 
2Q12

1Q13

 
2013

2012

 
YTD12

Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment services fees:
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset servicing
$
919

$
913

$
916

$
943

$
961

 
5
 %
2
 %
 
$
1,904

$
1,834

 
4
 %
Issuer services
275

310

213

236

294

 
7

25

 
$
530

526

 
1

Clearing services
309

287

294

304

321

 
4

6

 
$
625

612

 
2

Treasury services
129

131

136

137

135

 
5

(1
)
 
$
272

260

 
5

Total investment services fees
1,632

1,641

1,559

1,620

1,711

 
5

6

 
3,331

3,232

 
3

Foreign exchange and other trading revenue
179

158

128

172

194

 
8

13

 
$
366

355

 
3

Other (a)
69

77

75

70

67

 
(3
)
(4
)
 
$
137

143

 
(4
)
Total fee and other
  revenue (a)
1,880

1,876

1,762

1,862

1,972

 
5

6

 
3,834

3,730

 
3

Net interest revenue
607

608

583

653

633

 
4

(3
)
 
$
1,286

1,249

 
3

Total revenue
2,487

2,484

2,345

2,515

2,605

 
5

4

 
5,120

4,979

 
3

Provision for credit losses
(14
)
(4
)

1


 
N/M

N/M

 
$
1

2

 
(50
)
Noninterest expense (ex. amortization of intangible assets)
2,092

1,734

1,766

1,796

1,824

 
(13
)
2

 
$
3,620

3,880

 
(7
)
Income before taxes (ex. amortization of intangible assets)
409

754

579

718

781

 
91

9

 
1,499

1,097

 
37

Amortization of intangible assets
49

47

48

47

54

 
10

15

 
$
101

97

 
4

Income before taxes
$
360

$
707

$
531

$
671

$
727

 
102
 %
8
 %
 
$
1,398

$
1,000

 
40
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pre-tax operating margin
14
%
28
%
23
%
27
%
28
%
 
 
 
 
27
%
20
%
 
 
Pre-tax operating margin (ex. amortization of intangible assets)
16
%
30
%
25
%
29
%
30
%
 
 
 
 
29
%
22
%
 
 
Investment services fees as a percentage of noninterest
  expense (b)
94
%
96
%
90
%
92
%
94
%
 
 
 
 
93
%
94
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities lending revenue
$
48

$
37

$
31

$
31

$
39

 
(19
)%
26
 %
 
$
70

$
87

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Metrics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average loans
$
25,611

$
24,917

$
24,868

$
26,697

$
27,814

 
9
 %
4
 %
 
$
27,259

$
26,121

 
4
 %
Average deposits
$
173,087

$
188,743

$
204,164

$
200,221

$
204,499

 
18
 %
2
 %
 
$
202,372

$
174,307

 
16
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AUC/A at period end
  (in trillions) (c)
$
25.2

$
26.4

$
26.3

$
26.3

$
26.2

 
4
 %
 %
 
 
 
 
 
Market value of securities on loan at period end (in billions) (d)
$
267

$
251

$
237

$
244

$
255

 
(4
)%
5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset servicing:
 
 
 
 
 
 
 
 
 
 
 
 
 
Estimated new business wins (AUC/A) (in billions)
$
314

$
522

$
190

$
205

$
201

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depositary Receipts:
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of sponsored programs
1,393

1,393

1,379

1,359

1,349

 
(3
)%
(1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Clearing services:
 
 
 
 
 
 
 
 
 
 
 
 
 
Global DARTS volume
  (in thousands)
191.9

175.5

187.9

221.4

227.5

 
19
 %
3
 %
 
 
 
 
 
Average active clearing accounts
(U.S. platform) (in thousands)
5,421

5,447

5,489

5,552

5,591

 
3
 %
1
 %
 
 
 
 
 
Average long-term mutual fund assets (U.S. platform)
$
306,973

$
323,289

$
334,883

$
357,647

$
371,196

 
21
 %
4
 %
 
 
 
 
 
Average investor margin loans (U.S. platform)
$
8,231

$
7,922

$
7,987

$
8,212

$
8,235

 
 %
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Broker-Dealer:
 
 
 
 
 
 
 
 
 
 
 
 
 
Average tri-party repo balances
(in billions)
$
2,001

$
2,005

$
2,113

$
2,070

$
2,037

 
2
 %
(2
)%
 
 
 
 
 
(a)
Total fee and other revenue includes investment management fees and distribution and servicing revenue.
(b)
Noninterest expense excludes amortization of intangible assets, support agreement charges and litigation expense.
(c)
Includes the AUC/A of CIBC Mellon Global Securities Services Company (“CIBC Mellon”), a joint venture with the Canadian Imperial Bank of Commerce, of $1.2 trillion at June 30, 2012 and Sept. 30, 2012, $1.1 trillion at Dec. 31, 2012, $1.2 trillion at March 31, 2013 and $1.1 trillion at June 30, 2013.
(d)
Represents the total amount of securities on loan managed by the Investment Services business. Excludes securities on loan at CIBC Mellon.




22 BNY Mellon


Business description

Our Investment Services business provides global custody and related services, broker-dealer services, collateral services, alternative investment services, corporate trust and depositary receipt services, as well as clearing services and global payment/working capital solutions to institutional clients.

Our comprehensive suite of financial solutions includes: global custody, global fund services, securities lending, investment manager outsourcing, performance and risk analytics, alternative investment services, securities clearance, collateral management, corporate trust, American and global depositary receipt programs, cash management solutions, payment services, liquidity services and other linked revenues, principally foreign exchange, global clearing and execution, managed account services and global prime brokerage solutions. Our clients include corporations, public funds and government agencies, foundations and endowments; global financial institutions including banks, broker-dealers, asset managers, insurance companies and central banks; financial intermediaries and independent registered investment advisors and hedge fund managers. We help our clients service their financial assets through a network of offices and operations centers in 35 countries across six continents.

The results of this business are driven by a number of factors which include: the level of transaction activity; the range of services provided, including custody, accounting, fund administration, daily valuations, performance measurement and risk analytics, securities lending, and investment manager back-office outsourcing; the number of accounts; and the market value of assets under custody and/or administration. Market interest rates impact both securities lending revenue and the earnings on client deposit balances. Business expenses are driven by staff, technology investment, equipment and space required to support the services provided by the business and the cost of execution, clearance and custody of securities.

We are one of the leading global securities servicing providers with $26.2 trillion of assets under custody and/or administration at June 30, 2013. We are the largest custodian for U.S. corporate and public pension plans and we service 46% of the top 50 endowments. We are a leading custodian in the UK
 
and service 20% of UK pensions that require a custodian. Globalization tends to drive cross-border investment and capital flows, which increases the opportunity to provide solutions to our clients. The changing regulatory environment is also driving demand for new products and services among clients.

BNY Mellon is a leader in both global securities and U.S. Government securities clearance. We clear and settle equity and fixed income transactions in over 100 markets and handle most of the transactions cleared through the Federal Reserve Bank of New York for 17 of the 21 primary dealers. We are a leader in servicing tri-party repo collateral with approximately $2.0 trillion globally. We currently service approximately $1.4 trillion of the $1.7 trillion tri-party repo market in the U.S.

BNY Mellon offers tri-party agent services to dealers and cash investors active in the tri-party repurchase, or tri-party repo, market. We currently have an approximately 82% market share of the U.S. tri-party repo market. As a tri-party repo agent, we facilitate settlement between dealers (cash borrowers) and investors (cash lenders). Our involvement in a transaction commences after a dealer and a cash investor agree to a tri-party repo trade and send instructions to us. We maintain custody of the collateral (the subject securities of the repo) and execute the payment and delivery instructions agreed to and provided by the principals.

BNY Mellon is working to significantly reduce the risk associated with the secured intraday credit we provide with respect to the tri-party repo market. BNY Mellon has implemented several measures in that regard, including reducing the amount of time we extend intraday credit, implementing three-way trade confirmations, and automating the way dealers can substitute collateral in their tri-party repo trades. Additionally, in 2013, we have limited the eligibility for intraday credit associated with tri-party repo transactions to certain more liquid asset classes that will result in a reduction of exposures secured by less liquid forms of collateral by dealers. These efforts are consistent with the recommendations of the Tri-Party Repo Infrastructure Reform Task Force that was sponsored by the Payments Risk Committee of the Federal Reserve Bank of New York and included representatives from a diverse group of market participants, including BNY Mellon. We anticipate that the combination of these measures will reduce risks substantially in our tri-party repo activity in the



BNY Mellon 23


near term and, together with technology enhancements currently in development, will achieve the practical elimination of intraday credit in this activity by the end of 2014.

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

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

In securities lending, we are one of the largest lenders of U.S. Treasury securities and depositary receipts and service a lending pool of approximately $3 trillion in 30 markets.

We serve as depositary for 1,349 sponsored American and global depositary receipt programs at June 30, 2013, acting in partnership with leading companies from 64 countries - an estimated 60% global market share.

Pershing and its affiliates provide business solutions to approximately 1,600 financial organizations globally by delivering dependable operational support; robust trading services; flexible technology; an expansive array of investment solutions, practice management support and service excellence.

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

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

Review of financial results

AUC/A at June 30, 2013 were $26.2 trillion, an increase of 4% from $25.2 trillion at June 30, 2012 and a slight decrease from $26.3 trillion at March 31, 2013. The year-over-year increase was driven by higher equity market values and net new business. The slight sequential decrease primarily reflects lower fixed income market values. AUC/A were comprised of 34% equity securities and 66% fixed income securities at June 30, 2013 and 33% equity securities and 67% fixed income securities at March 31, 2013.

Income before taxes was $727 million in the second quarter of 2013 compared with $360 million in the second quarter of 2012 and $671 million in the first quarter of 2013. Income before taxes, excluding amortization of intangible assets, was $781 million in the second quarter of 2013 compared with $409 million in the second quarter of 2012 and $718 million in the first quarter of 2013. The increase compared with the second quarter of 2012 primarily reflects lower litigation expense and increased core asset servicing fees. The increase sequentially was driven by increased issuer services fees and higher foreign exchange revenue.

Revenue generated in the Investment Services business included 36% from non-U.S. sources in the second quarter of 2013 compared with 36% in the second quarter of 2012 and 32% in the first quarter of 2013.




24 BNY Mellon


Investment services fees increased $79 million, or 5%, in the second quarter of 2013 compared with the second quarter of 2012 and $91 million, or 6% (unannualized), compared with the first quarter of 2013, reflecting the following factors:

Asset servicing fees (global custody, broker-dealer services and global collateral services) were $961 million in the second quarter of 2013 compared with $919 million in the second quarter of 2012 and $943 million in the first quarter of 2013. The year-over-year increase primarily reflects increased core asset servicing fees driven by organic growth and higher market values, partially offset by lower securities lending revenue. The sequential increase primarily resulted from seasonally higher securities lending revenue and increased core asset servicing fees driven by organic growth.
Issuer services fees (Corporate Trust and Depositary Receipts) were $294 million in the second quarter of 2013, compared with $275 million in the second quarter of 2012 and $236 million in the first quarter of 2013. Both increases primarily resulted from higher fees related to corporate actions and expense reimbursements related to customer technology expenditures.
Clearing services fees were $321 million in the second quarter of 2013 compared with $309 million in the second quarter of 2012 and $304 million in the first quarter of 2013. Both increases were driven by higher mutual fund fees and clearance revenue reflecting an increase in DARTs, partially offset by higher money market fee waivers.
Treasury services fees were $135 million in the second quarter of 2013 compared with $129 million in the second quarter of 2012 and $137 million in the first quarter of 2013. The year-over-year increase primarily reflects higher cash management fees.

Foreign exchange and other trading revenue totaled $194 million in the second quarter of 2013, compared with $179 million in the second quarter of 2012 and $172 million in the first quarter of 2013. Both increases primarily reflect higher volatility and increased volumes.

 
Net interest revenue was $633 million in the second quarter of 2013 compared with $607 million in the second quarter of 2012 and $653 million in the first quarter of 2013. The year-over-year increase primarily reflects higher average deposits and loans. The sequential decrease primarily reflects lower internal crediting rates for deposits in the second quarter of 2013.

Noninterest expense, excluding amortization of intangible assets, was $1.8 billion in the second quarter of 2013, compared with $2.1 billion in the second quarter of 2012 and $1.8 billion in the first quarter of 2013. Comparisons with both prior periods reflect higher software and equipment expense related to reimbursable customer technology expenditures, and a decrease in the deposit levy imposed on Belgian banks. Expense reimbursements are included in fee revenue. The year-over-year decrease resulted from lower litigation expense, partially offset by higher staff and volume-related expenses. Sequentially, higher volume-related and staff expenses partially offset lower litigation expense.

Year-to-date 2013 compared with year-to-date 2012

Income before taxes totaled $1.4 billion in the first six months of 2013 compared with $1.0 billion in the first six months of 2012. Excluding intangible amortization, income before taxes increased $402 million. Fee and other revenue increased $104 million reflecting increased core asset servicing fees driven by organic growth and higher market values, higher mutual fund fees, clearance revenue and higher cash management fees, partially offset by lower securities lending revenue and higher money market fee waivers. The $37 million increase in net interest revenue primarily reflects higher average deposits and loans. Noninterest expense (excluding intangible amortization) decreased $260 million primarily due to lower litigation expense, partially offset by higher staff and volume-related expenses.




BNY Mellon 25


Other segment 

 
 
 
 
 
 
Year-to-date
(dollars in millions)
2Q12

3Q12

4Q12

1Q13

2Q13

2013

2012

Revenue:
 
 
 
 
 
 
 
Fee and other revenue
$
116

$
156

$
188

$
125

$
319

$
444

$
287

Net interest revenue
75

90

86

4

61

65

143

Total revenue
191

246

274

129

380

509

430

Provision for credit losses
(5
)
(1
)
(61
)
(25
)
(19
)
(44
)
(16
)
Noninterest expense (ex. M&I and restructuring charges)
194

219

223

237

228

465

437

Income (loss) before taxes (ex. M&I and restructuring charges)
2

28

112

(83
)
171

88

9

M&I and restructuring charges
22

13

27

5

3

8

31

Income (loss) before taxes
$
(20
)
$
15

$
85

$
(88
)
$
168

$
80

$
(22
)
Average loans and leases
$
9,618

$
9,389

$
10,267

$
10,610

$
10,846

$
10,728

$
9,382



See pages 27 and 28 of our 2012 Annual Report for a description of the Other segment.

Review of financial results

The Other segment had pre-tax income of $168 million in the second quarter of 2013 compared with a pre-tax loss of $20 million in the second quarter of 2012 and a pre-tax loss of $88 million in the first quarter of 2013.

Total fee and other revenue increased $203 million compared with the second quarter of 2012 and $194 million compared with the first quarter of 2013. Both increases were driven by the gain related to our ConvergEx equity investment.

Net interest revenue decreased $14 million compared with the second quarter of 2012 and increased $57 million compared with the first quarter of 2013. The sequential increase reflects lower internal crediting rates to the businesses for deposits in the second quarter of 2013.

The provision for credit losses was a credit of $19 million in the second quarter of 2013 driven by the continued improvement in the credit quality of the loan portfolio.

Noninterest expense (excluding M&I and restructuring charges) increased $34 million compared with the second quarter of 2012 and decreased $9 million compared with the first quarter of 2013. The year-over-year increase resulted from higher staff, net occupancy, and business development expenses related to our corporate branding investments. Sequentially, the decrease primarily reflects a decrease in the cost of generating certain tax credits.
 
Year-to-date 2013 compared with year-to-date 2012

Income before taxes totaled $80 million in the first six months of 2013 compared with a pre-tax loss of $22 million first six months of 2012. Total revenue increased $79 million primarily reflecting the gain related to our ConvergEx equity investment, partially offset by lower leasing gains and lower foreign currency remeasurement. Noninterest expenses (excluding amortization of intangible assets and M&I and restructuring charges) increased $28 million, reflecting higher staff and net occupancy expenses, as well as higher business development expenses related to our corporate branding initiatives.

Critical accounting estimates

Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in our 2012 Annual Report. Our critical accounting estimates are those related to the allowance for loan losses and allowance for lending-related commitments, fair value of financial instruments and derivatives, other-than-temporary impairment (“OTTI”), goodwill and other intangibles, and pension accounting, as referenced below.

Critical policy
Reference
Allowance for loan losses and allowance for lending-related commitments
2012 Annual Report, pages 34 and 35. This policy is also disclosed in the “Asset quality and allowance for credit loss” section of this Form 10-Q.
Fair value of financial instruments and derivatives
2012 Annual Report, pages 35 - 37.
OTTI
2012 Annual Report, page 37.
Goodwill and other intangibles
2012 Annual Report, pages 37 and 38.
Pension accounting
2012 Annual Report, pages 38 - 40.



26 BNY Mellon


Consolidated balance sheet review

At June 30, 2013, total assets were $361 billion compared with $359 billion at Dec. 31, 2012. Total assets averaged $337 billion in the second quarter of 2013 compared with $305 billion in the second quarter of 2012 and $334 billion in the first quarter of 2013. Fluctuations in the average total assets were primarily driven by the level of client deposits. Deposits totaled $245 billion at June 30, 2013, and $246 billion at Dec. 31, 2012. Total deposits averaged $222 billion in the second quarter of 2013, $193 billion in the second quarter of 2012 and $218 billion in the first quarter of 2013. At June 30, 2013, total interest-bearing deposits were 56% of total interest-earning assets compared with 52% at Dec. 31, 2012.

At June 30, 2013, we had $52 billion of liquid funds and $84 billion of cash (including $77 billion of overnight deposits with the Federal Reserve and other central banks) for a total of $136 billion of available funds. This compares with available funds of $145 billion at Dec. 31, 2012. The decrease in available funds resulted from the redeployment of funds on our balance sheet from interest-bearing deposits with the Federal Reserve and other central banks as we increased our investment in high-quality securities and the loan portfolio, as well as a lower level of client deposits. Our percentage of available funds to total assets was 38% at June 30, 2013 compared with 40% at Dec. 31, 2012. Of the $52 billion in liquid funds held at June 30, 2013, $42 billion was placed in interest-bearing deposits with large, highly-rated global financial institutions with a weighted-average life to maturity of approximately 68 days. Of the $42 billion, $7 billion was placed with banks in the Eurozone.

Investment securities were $105 billion or 29% of total assets at June 30, 2013, compared with $101 billion or 28% of total assets at Dec. 31, 2012. The increase primarily reflects larger investments in agency RMBS, partially offset by a decrease in the unrealized gain of our investment securities.

Trading assets were $11 billion at June 30, 2013 compared with $9 billion at Dec. 31, 2012. The increase in trading assets resulted from higher levels of securities inventory, partially offset by an increase in long-term interest rates.

 
Loans were $50 billion or 14% of total assets at June 30, 2013, compared with $47 billion or 13% of total assets at Dec. 31, 2012. The increase in loan levels primarily reflects higher loans in the financial institutions and margin loan portfolios.

Long-term debt totaled $18.5 billion at both June 30, 2013 and Dec. 31, 2012. We issued $1.5 billion of senior debt in the first six months of 2013 which was offset by $750 million of maturities, $300 million of repayments of trust preferred securities and a decrease in the fair value of hedged long-term debt.

Total The Bank of New York Mellon Corporation’s shareholders’ equity was $35.9 billion at June 30, 2013 and $36.4 billion at Dec. 31, 2012. The decrease primarily reflects a decline in the value of the investment securities portfolio, partially offset by $500 million of non-cumulative perpetual preferred stock issued in the second quarter of 2013 and earnings retention.

Exposure in Ireland, Italy, Spain, Portugal and Greece

The following tables present our on- and off-balance sheet exposure in Ireland, Italy and Spain at June 30, 2013 and Dec. 31, 2012. We have provided expanded disclosure on these countries as they have experienced particular market focus on credit quality and are countries experiencing economic concerns. Where appropriate, we are offsetting the risk associated with the gross exposure in these countries with collateral that has been pledged, which primarily consists of cash or marketable securities, or by transferring the risk to a third-party guarantor in another country.

BNY Mellon has a limited economic interest in the performance of assets of consolidated investment management funds, and therefore they are excluded from this presentation. The liabilities of consolidated investment management funds represent the interest of the noteholders of the funds and are solely dependent on the value of the assets. Any loss in the value of assets of consolidated investment management funds would be incurred by the fund’s noteholders.

At June 30, 2013 and at Dec. 31, 2012, BNY Mellon had exposure of less than $1 million in Portugal and no exposure in Greece. Additionally, BNY Mellon



BNY Mellon 27


had no sovereign exposure to the countries disclosed below at either June 30, 2013 or Dec. 31, 2012.
Our exposure in Ireland is principally related to Irish-domiciled investment funds. Servicing provided to these funds and fund families may result in overdraft exposure.
 
See “Risk management” in our 2012 Annual Report for additional information on how our exposures are managed.


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

On- and off-balance sheet exposure at June 30, 2013
 
 
 
 
 
 
 
(in millions)
Ireland

 
Italy

 
Spain

 
Total

On-balance sheet exposure
 
 
 
 
 
 
 
Gross:
 
 
 
 
 
 
 
Interest-bearing deposits with banks (a)
$
96

 
$
334

 
$
23

 
$
453

Investment securities (primarily European Floating Rate Notes) (b)
158

 
114

 

 
272

Loans and leases (c)
365

 
63

 
4

 
432

Trading assets (d)
92

 
29

 
17

 
138

Total gross on-balance sheet exposure
711

 
540

 
44

 
1,295

Less:
 
 
 
 
 
 
 
Collateral
72

 
28

 
15

 
115

Guarantees

 
2

 
1

 
3

Total collateral and guarantees
72

 
30

 
16

 
118

Total net on-balance sheet exposure
$
639

 
$
510

 
$
28

 
$
1,177

Off-balance sheet exposure
 
 
 
 
 
 
 
Gross:
 
 
 
 
 
 
 
Lending-related commitments (e)
$
110

 
$

 
$

 
$
110

Letters of credit (f)
75

 
4

 
14

 
93

Total gross off-balance sheet exposure
185

 
4

 
14

 
203

Less:
 
 
 
 
 
 
 
Collateral
100

 

 
14

 
114

Total net off-balance sheet exposure
$
85

 
$
4

 
$

 
$
89

Total exposure:
 
 
 
 
 
 
 
Total gross on- and off-balance sheet exposure
$
896

 
$
544

 
$
58

 
$
1,498

Less: Total collateral and guarantees
172

 
30

 
30

 
232

Total net on- and off-balance sheet exposure
$
724

 
$
514

 
$
28

 
$
1,266

(a)
Interest-bearing deposits with banks represent a $95 million placement with an Irish subsidiary of a UK holding company and $358 million of nostro accounts related to our custody activities located in Italy, Spain and Ireland.
(b)
Represents $250 million, fair value, of residential mortgage-backed securities located in Ireland and Italy, of which 45% were investment grade, and $22 million, fair value, of investment grade asset-backed CLOs located in Ireland.
(c)
Loans and leases include $296 million of overdrafts primarily to Irish-domiciled investment funds resulting from our custody business, a $68 million commercial lease to a company located in Ireland, which was fully collateralized by U.S. Treasuries, a $1 million loan to a financial institution located in Ireland, a $61 million overdraft to a financial institution located in Italy, a $3 million overdraft to financial institutions located in Spain and $3 million of leases to airline manufacturing companies located in Italy and Spain, which are under joint and several guarantee arrangements with guarantors outside of the Eurozone. There is no impairment associated with these loans and leases. Overdrafts occur on a daily basis in our Investment Services businesses and are generally repaid within two business days. The overdrafts in Spain and Italy have been repaid.
(d)
Trading assets represent over-the-counter mark-to-market on foreign exchange and interest rate receivables, net of master netting agreements. Trading assets include $92 million of receivables primarily due from Irish-domiciled investment funds and $46 million of receivables due from financial institutions in Italy and Spain. Cash collateral on the trading assets totaled $4 million in Ireland, $28 million in Italy and $4 million in Spain. Trading assets located in Spain are also collateralized by $11 million of U.S. Treasuries.
(e)
Lending-related commitments include $100 million to an insurance company, collateralized by $24 million of marketable securities, and $10 million to an oil and gas company, fully collateralized by receivables.
(f)
Represents $73 million of letters of credit extended to an insurance company in Ireland, collateralized by $66 million of marketable securities, a $2 million letter of credit to an oil and gas company in Ireland, a $4 million letter of credit extended to a financial institution in Italy and a $14 million letter of credit extended to an insurance company in Spain, fully collateralized by marketable securities.



28 BNY Mellon


On- and off-balance sheet exposure at Dec. 31, 2012
 
 
 
 
 
 
 
(in millions)
Ireland

 
Italy

 
Spain

 
Total

On-balance sheet exposure
 
 
 
 
 
 
 
Gross:
 
 
 
 
 
 
 
Interest-bearing deposits with banks (a)
$
101

 
$
125

 
$

 
$
226

Investment securities (primarily European Floating Rate Notes) (b)
164

 
130

 

 
294

Loans and leases (c)
166

 
7

 
3

 
176

Trading assets (d)
48

 
39

 
15

 
102

Total gross on-balance sheet exposure
479

 
301

 
18

 
798

Less:
 
 
 
 
 
 
 
Collateral
74

 
38

 
6

 
118

Guarantees

 
2

 
1

 
3

Total collateral and guarantees
74

 
40

 
7

 
121

Total net on-balance sheet exposure
$
405

 
$
261

 
$
11

 
$
677

Off-balance sheet exposure
 
 
 
 
 
 
 
Gross:
 
 
 
 
 
 
 
Lending-related commitments (e)
$
101

 
$

 
$

 
$
101

Letters of credit (f)
74

 
4

 
14

 
92

Total gross off-balance sheet exposure
175

 
4

 
14

 
193

Less:
 
 
 
 
 
 
 
Collateral
91

 

 
14

 
105

Total net off-balance sheet exposure
$
84

 
$
4

 
$

 
$
88

Total exposure:
 
 
 
 
 
 
 
Total gross on- and off-balance sheet exposure
$
654

 
$
305

 
$
32

 
$
991

Less: Total collateral and guarantees
165

 
40

 
21

 
226

Total net on- and off-balance sheet exposure
$
489

 
$
265

 
$
11

 
$
765

(a)
Interest-bearing deposits with banks represent a $101 million placement with an Irish subsidiary of a UK holding company and $125 million of nostro accounts related to our custody activities.
(b)
Represents $266 million, fair value, of residential mortgage-backed securities located in Ireland and Italy, of which 49% were investment grade, $25 million, fair value, of investment grade asset-backed CLOs located in Ireland, and $3 million, fair value, of money market fund investments located in Ireland.
(c)
Loans and leases include $97 million of overdrafts primarily to Irish-domiciled investment funds resulting from our custody business, a $67 million commercial lease to an Irish company, which was fully collateralized by U.S. Treasuries, a $2 million loan to a security company located in Ireland, a $5 million overdraft to a financial institution located in Italy, a $2 million custody overdraft to financial institutions located in Spain and $3 million of leases to airline manufacturing companies located in Italy and Spain, which are under joint and several guarantee arrangements with guarantors outside of the Eurozone. There is no impairment associated with these loans and leases. Overdrafts occur on a daily basis in our Investment Services businesses and are generally repaid within two business days. The overdrafts in Italy and Spain have been repaid.
(d)
Trading assets represent over-the-counter mark-to-market on foreign exchange and interest rate receivables, net of master netting agreements. Trading assets include $48 million of receivables primarily due from Irish-domiciled investment funds and $54 million of receivables due from financial institutions in Italy and Spain. Cash collateral on the trading assets totaled $7 million in Ireland, $38 million in Italy and $6 million in Spain.
(e)
Lending-related commitments include $100 million to an insurance company, collateralized by $25 million of marketable securities, and $1 million to an oil and gas company, fully collateralized by receivables.
(f)
Represents $72 million of letters of credit extended to an insurance company in Ireland, collateralized by $65 million of marketable securities, a $2 million letter of credit to an oil and gas company in Ireland, a $4 million letter of credit extended to a financial institution in Italy and a $14 million letter of credit extended to an insurance company in Spain, fully collateralized by marketable securities.




BNY Mellon 29


Investment securities

In the discussion of our investment securities portfolio, we have included certain credit ratings information because the information indicates the degree of credit risk to which we are exposed, and significant changes in ratings classifications for our
 
investment securities portfolio could indicate increased credit risk for us and could be accompanied by a reduction in the fair value of our investment securities portfolio.

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


Investment securities
portfolio


(dollars in millions)
March 31, 2013

 
2Q13
change in
unrealized
gain/(loss)

June 30, 2013
Fair value
as a % of amortized
cost (a)

Net unrealized
gain/(loss)

Ratings
 
 
 
BB+
and
lower
 
 Fair
value

Amortized
cost

Fair
value

 
AAA/
AA-
A+/
A-
BBB+/
BBB-
Not
rated
Agency RMBS
$
44,371

 
$
(946
)
$
45,615

$
45,464

 
100
%
$
(151
)
100
%
%
%
%
%
U.S. Treasury securities
20,073

 
(144
)
18,168

18,411

 
101

243

100





Sovereign debt/sovereign guaranteed (b)
10,103

 
(67
)
10,971

11,032

 
101

61

100





Non-agency RMBS (c)
3,083

 
(104
)
2,320

2,880

 
76

560


1

2

97


Non-agency RMBS
1,563

 
(21
)
1,482

1,469

 
91

(13
)
2

16

17

65


European floating rate  notes (d)
3,681

 
12

3,318

3,231

 
96

(87
)
72

20

2

6


Commercial MBS
3,181

 
(84
)
3,646

3,677

 
101

31

91

8

1



State and political subdivisions
6,305

 
(130
)
6,522

6,482

 
99

(40
)
82

16

1

1


Foreign covered bonds (e)
3,390

 
(25
)
3,195

3,211

 
100

16

100





Corporate bonds
1,572

 
(40
)
1,512

1,527

 
101

15

20

72

8



CLO
1,382

 
(1
)
1,363

1,373

 
101

10

100





U.S. Government agency debt
1,060

 
(23
)
1,545

1,548

 
100

3

100





Consumer ABS
2,020

 
(17
)
2,021

2,012

 
100

(9
)
91

9




Other (f)
4,828

 
(1
)
3,150

3,167

 
101

17

27

67



6

Total investment securities
$
106,612

(g)
$
(1,591
)
$
104,828

$
105,484

(g)
101
%
$
656

89
%
5
%
1
%
4
%
1
%
(a)
Amortized cost before impairments.
(b)
Primarily comprised of exposure to UK, Germany, Netherlands and France.
(c)
These RMBS were included in the former Grantor Trust and were marked-to-market in 2009. We believe these RMBS would receive higher credit ratings if these ratings incorporated, as additional credit enhancement, the difference between the written-down amortized cost and the current face amount of each of these securities.
(d)
Includes RMBS, commercial MBS and other securities. Primarily comprised of exposure to UK and Netherlands.
(e)
Primarily comprised of exposure to Canada, UK and Germany.
(f)
Includes commercial paper of $2.2 billion and $2.1 billion, fair value, and money market funds of $2.5 billion and $918 million, fair value, at March 31, 2013 and June 30, 2013, respectively.
(g)
Includes net unrealized losses on derivatives hedging securities available-for-sale of $111 million at March 31, 2013 and net unrealized gains on derivatives hedging securities available-for-sale of $318 million at June 30, 2013.


The fair value of our investment securities portfolio was $105.5 billion at June 30, 2013 compared with $100.7 billion at Dec. 31, 2012. The increase in the fair value of the investment securities portfolio primarily reflects larger investments in agency RMBS, partially offset by a decrease in the unrealized gain of our investment securities. In the second quarter of 2013, we received $248 million of paydowns and sold $11 million of sub-investment grade securities.

At June 30, 2013, the total investment securities portfolio had a net unrealized pre-tax gain of $656 million compared with $2.4 billion at Dec. 31, 2012. The decline in the valuation of the investment securities portfolio was primarily driven by an increase in long-term interest rates. The unrealized
 
net of tax gain on our investment securities available-for-sale portfolio included in accumulated other comprehensive income was $488 million at June 30, 2013, compared with $1.3 billion at Dec. 31, 2012.

At June 30, 2013 and Dec. 31, 2012, 89% of the securities in our portfolio were rated AAA/AA-.

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

The following table presents the amortizable net purchase premium related to the investment securities portfolio and accretable discount related to the restructuring of the investment securities portfolio.



30 BNY Mellon


Net premium amortization and discount accretion of investment securities (a)
 
 
 
 
 
 
(dollars in millions)
 
2Q12

3Q12

4Q12

1Q13

2Q13

Amortizable net purchase premium relating to investment securities:
 
 
 
 
 
 
Balance at period end
 
$
2,334

$
2,616

$
2,476

$
2,685

$
2,720

Estimated average life remaining at period end (in years)
 
4.3

4.0

4.2

4.6

5.1

Amortization
 
$
130

$
163

$
169

$
164

$
172

Accretable discount related to the restructuring of the investment securities portfolio:
 
 
 
 
 
 
Balance at period end
 
$
1,041

$
943

$
871

$
789

$
743

Estimated average life remaining at period end (in years)
 
4.4

5.4

5.3

5.6

6.0

Accretion
 
$
74

$
66

$
60

$
57

$
54

(a)
Amortization of purchase premium decreased net interest revenue while accretion of discount increased net interest revenue. Both were recorded on a level yield basis.


The increase in the net premium amortization in the second quarter of 2013 primarily related to the purchase of agency RMBS and state and political subdivision securities in the first half of 2013.

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

Net securities gains (losses)
 
 
 
(in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

U.S. Treasury
$
31

$
(4
)
$
44

$
27

$
82

Commercial MBS
7

8


15


Foreign covered bonds

8


8


Non-agency RMBS
(3
)
4

(27
)
1

(41
)
Sovereign debt

1

61

1

68

European floating rate notes
(10
)
4

(22
)
(6
)
(23
)
Other
7

27

(6
)
34

4

Total net securities gains
$
32

$
48

$
50

$
80

$
90



On a quarterly basis, we perform our impairment analysis using several factors, including projected loss severities and default rates. In the second quarter of 2013, this analysis resulted in $19 million of credit losses primarily on European floating rate notes. If we were to increase or decrease each of our projected loss severities and default rates by 100 basis points on each of the positions in our Alt-A, subprime and prime RMBS portfolios, including the securities previously held by the Grantor Trust, credit-related impairment charges on these securities would have increased by $1 million (pre-tax) or decreased by $1 million (pre-tax) at June 30, 2013. See Note 4 of the Notes to Consolidated Financial Statements for the projected weighted-average default rates and loss severities.

 
At June 30, 2013, the investment securities portfolio included $42 million of assets not accruing interest. These securities are held at market value.

The following table shows the fair value of the European floating rate notes by geographical location at June 30, 2013. The unrealized loss on these securities was $87 million at June 30, 2013, an improvement of $12 million compared with $99 million at March 31, 2013.

European floating rate notes at June 30, 2013 (a)
(in millions)
RMBS

 
Other

 
Total
fair
value

United Kingdom
$
1,739

 
$
156

 
$
1,895

Netherlands
882

 
52

 
934

Ireland
136

 
22

 
158

Italy
114

 

 
114

Australia
65

 

 
65

Germany
2

 
63

 
65

Total fair value
$
2,938

 
$
293

 
$
3,231

(a)
72% of these securities are in the AAA to AA- ratings category.


See Note 15 of the Notes to Consolidated Financial Statements for details of securities by level in the fair value hierarchy.




BNY Mellon 31


Loans 

Total exposure – consolidated
June 30, 2013
 
Dec. 31, 2012
(in billions)
Loans

Unfunded
commitments

Total
exposure

 
Loans

Unfunded
commitments

Total
exposure

Non-margin loans:
 
 
 
 
 
 
 
Financial institutions
$
12.9

$
15.5

$
28.4

 
$
11.3

$
15.7

$
27.0

Commercial
1.6

19.3

20.9

 
1.4

18.3

19.7

Subtotal institutional
14.5

34.8

49.3

 
12.7

34.0

46.7

Wealth management loans and mortgages
9.3

1.8

11.1

 
8.9

1.7

10.6

Commercial real estate
2.1

1.9

4.0

 
1.7

1.9

3.6

Lease financings
2.3


2.3

 
2.4


2.4

Other residential mortgages
1.5


1.5

 
1.6


1.6

Overdrafts
5.5


5.5

 
5.3


5.3

Other
0.7


0.7

 
0.6

0.2

0.8

Subtotal non-margin loans
35.9

38.5

74.4

 
33.2

37.8

71.0

Margin loans
14.4

0.7

15.1

 
13.4

0.9

14.3

Total
$
50.3

$
39.2

$
89.5

 
$
46.6

$
38.7

$
85.3

 


At June 30, 2013, total exposures were $89.5 billion, an increase of 5% from $85.3 billion at Dec. 31, 2012. The increase in total exposure primarily reflects higher loans in the financial institutions portfolio and higher margin loans as well as an increase in unfunded commitments in the commercial loan portfolio.

 
Our financial institutions and commercial portfolios comprise our largest concentrated risk. These portfolios made up 55% of our total lending exposure at both June 30, 2013 and Dec. 31, 2012. Additionally, a substantial portion of our overdrafts relate to financial institutions and commercial customers.

Financial institutions

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

Financial institutions
portfolio exposure
(dollar amounts in billions)
June 30, 2013
 
Dec. 31, 2012
Loans

 
Unfunded
commitments

 
Total
exposure

 
% Inv.
grade

 
% due
<1 yr

 
Loans

 
Unfunded
commitments

 
Total
exposure

Banks
$
9.0

 
$
2.0

 
$
11.0

 
87
%
 
93
%
 
$
5.6

 
$
2.0

 
$
7.6

Asset managers
1.2

 
3.6

 
4.8

 
99

 
70

 
1.1

 
3.8

 
4.9

Securities industry
2.5

 
1.7

 
4.2

 
92

 
94

 
4.2

 
2.1

 
6.3

Insurance
0.1

 
4.1

 
4.2

 
99

 
24

 
0.1

 
4.3

 
4.4

Government

 
3.0

 
3.0

 
97

 
26

 

 
2.1

 
2.1

Other
0.1

 
1.1

 
1.2

 
97

 
40

 
0.3

 
1.4

 
1.7

Total
$
12.9

 
$
15.5

 
$
28.4

 
93
%
 
69
%
 
$
11.3

 
$
15.7

 
$
27.0

 


The financial institutions portfolio exposure was $28.4 billion at June 30, 2013 compared with $27.0 billion at Dec. 31, 2012. The increase primarily reflects higher exposure to banks driven by a higher level of trade finance loans.

Financial institution exposures are high quality, with 93% of the exposures meeting the investment grade equivalent criteria of our internal credit rating classification at June 30, 2013. Each customer is assigned an internal credit rating, which is mapped to an equivalent external rating agency grade based upon a number of dimensions which are continually
 
evaluated and may change over time. The exposure to financial institutions is generally short-term. Of these exposures, 69% expire within one year, and 37% expire within 90 days. In addition, 34% of the financial institutions exposure is secured. For example, securities industry and asset managers often borrow against marketable securities held in custody.

For ratings of non-U.S. counterparties, as a conservative measure, our internal credit rating is generally capped at a rating equivalent to the sovereign rating of the country where the counterparty resides regardless of the internal credit



32 BNY Mellon


rating assigned to the counterparty or the underlying collateral.

Our bank exposure primarily relates to our global trade finance and U.S. dollar-clearing businesses. These exposures are predominately to investment grade counterparties and are short term in nature.
 
The asset manager portfolio exposures are high- quality, with 99% of the exposures meeting our investment grade equivalent ratings criteria as of June 30, 2013. These exposures are generally short-term liquidity facilities, with the vast majority to regulated mutual funds.


Commercial

The diversity of the commercial portfolio is presented in the following table.

Commercial portfolio exposure
June 30, 2013
 
Dec. 31, 2012
(dollar amounts in billions)
Loans

 
Unfunded
commitments

 
Total
exposure

 
% Inv.
grade

 
% due
<1 yr

 
Loans

 
Unfunded
commitments

 
Total
exposure

Services and other
$
0.6

 
$
6.0

 
$
6.6

 
95
%
 
14
%
 
$
0.5

 
$
5.6

 
$
6.1

Energy and utilities
0.7

 
6.0

 
6.7

 
98

 
10

 
0.5

 
5.5

 
6.0

Manufacturing
0.2

 
5.7

 
5.9

 
88

 
10

 
0.3

 
5.6

 
5.9

Media and telecom
0.1

 
1.6

 
1.7

 
90

 
4

 
0.1

 
1.6

 
1.7

Total
$
1.6

 
$
19.3

 
$
20.9

 
94
%
 
11
%
 
$
1.4

 
$
18.3

 
$
19.7

 


The commercial portfolio exposure increased 6% to $20.9 billion at June 30, 2013, from $19.7 billion at Dec. 31, 2012, primarily reflecting an increase in exposure to the energy and utilities and the services and other portfolios.

The table below summarizes the percentage of the financial institutions and commercial portfolio exposures that are investment grade.

Investment grade percentage of the portfolios
 
June 30,
2012

Sept. 30, 2012

Dec. 31, 2012

March 31, 2013

June 30, 2013

Financial institutions
92
%
93
%
93
%
93
%
93
%
Commercial
93
%
93
%
93
%
94
%
94
%


Our credit strategy is to focus on investment grade names to support cross-selling opportunities and avoid single name/industry concentrations and our goal is to maintain a predominantly investment grade loan portfolio. The execution of our strategy has resulted in 93% of our financial institutions portfolio and 94% of our commercial portfolio rated as investment grade at June 30, 2013.

Wealth management loans and mortgages

Our Wealth management exposure was $11.1 billion at June 30, 2013 compared with $10.6 billion at Dec. 31, 2012. Wealth management loans and mortgages are primarily comprised of loans to high-net-worth
 
individuals, which are secured by marketable securities and/or residential property. Wealth management mortgages are primarily interest-only adjustable rate mortgages with an average loan to value ratio of 64% at origination. In the wealth management portfolio, less than 1% of the mortgages were past due at June 30, 2013.

At June 30, 2013, the wealth management mortgage portfolio was comprised of the following geographic concentrations: New York - 21%; California - 20%; Massachusetts - 16%; Florida - 8%; and other - 35%.

Commercial real estate

Our income producing commercial real estate facilities are focused on experienced owners and are structured with moderate leverage based on existing cash flows. Our commercial real estate lending activities also include construction and renovation facilities. Our client base consists of experienced developers and long-term holders of real estate assets. Loans are approved on the basis of existing or projected cash flows, and supported by appraisals and knowledge of local market conditions. Development loans are structured with moderate leverage, and in many instances, involve some level of recourse to the developer. Our commercial real estate exposure totaled $4.0 billion at June 30, 2013 compared with $3.6 billion at Dec. 31, 2012.




BNY Mellon 33


At June 30, 2013, 60% of our commercial real estate portfolio is secured. The secured portfolio is diverse by project type, with 52% secured by residential buildings, 16% secured by office buildings, 12% secured by retail properties, and 20% secured by other categories. Approximately 97% of the unsecured portfolio is comprised of investment grade real estate investment trusts (“REITs”) under revolving credit agreements.

At June 30, 2013, our commercial real estate portfolio is comprised of the following concentrations: New York metro - 46%; investment grade REITs - 39%; and other - 15%.

Lease financings

The leasing portfolio exposure totaled $2.3 billion and included $173 million of airline exposures at June 30, 2013, compared with $2.4 billion of leasing exposures, including $191 million of airline exposures, at Dec. 31, 2012. At June 30, 2013, approximately 85% of the leasing exposure was investment grade.

At June 30, 2013, the $2.1 billion non-airline lease financing portfolio consisted of exposures backed by well-diversified assets, primarily large-ticket transportation equipment.

At June 30, 2013, our $173 million of exposure to the airline industry consisted of $67 million to major U.S. carriers, $86 million to foreign airlines and $20 million to U.S. regional airlines.

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

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

 
Other residential mortgages

The other residential mortgage portfolio primarily consists of 1-4 family residential mortgage loans and totaled $1.5 billion at June 30, 2013, compared with $1.6 billion at Dec. 31, 2012. Included in this portfolio at June 30, 2013 are $461 million of mortgage loans purchased in 2005, 2006 and the first quarter of 2007 that are predominantly prime mortgage loans, with a small portion of Alt-A loans. As of June 30, 2013, the purchased loans in this portfolio had a weighted-average loan-to-value ratio of 75% at origination and 25% of these loans were at least 60 days delinquent. The properties securing the prime and Alt-A mortgage loans were located (in order of concentration) in California, Florida, Virginia, the tri-state area (New York, New Jersey and Connecticut) and Maryland.

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

At June 30, 2013, we had $12 million in subprime mortgages included in the other residential mortgage portfolio. The subprime loans were issued to support our Community Reinvestment Act requirements.

Overdrafts

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

Other loans

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

Margin loans

Margin loans are collateralized with marketable securities and borrowers are required to maintain a daily collateral margin in excess of 100% of the value of the loan. Margin loans included $5.7 billion of loans at June 30, 2013 and $5.1 billion at Dec. 31, 2012 related to a term loan program that offers fully collateralized loans to broker-dealers.



34 BNY Mellon


Asset quality and allowance for credit losses

Over the past several years, we have improved our risk profile through greater focus on clients who are active users of our non-credit services, de-emphasizing broad-based loan growth. Our primary exposure to the credit risk of a customer consists of funded loans, unfunded formal contractual commitments to lend, standby letters of credit and overdrafts associated with our custody and securities clearance businesses.
 
The role of credit has shifted to one that complements our other services instead of as a lead product. We believe credit solidifies customer relationships and, through a disciplined allocation of capital, can earn acceptable rates of return as part of an overall relationship.

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


Allowance for credit losses activity
(dollar amounts in millions)
June 30,
2013

March 31,
2013

Dec. 31,
2012

June 30,
2012

Margin loans
$
14,434

$
13,242

$
13,397

$
13,462

Non-margin loans
35,873

35,982

33,232

31,969

Total loans
$
50,307

$
49,224

$
46,629

$
45,431

Beginning balance of allowance for credit losses
$
358

$
387

$
456

$
494

Provision for credit losses
(19
)
(24
)
(61
)
(19
)
Net (charge-offs):
 
 
 
 
Other residential mortgages
(2
)
(3
)
(3
)
(5
)
Commercial

(2
)

1

Financial institutions


(5
)
(4
)
Net (charge-offs)
(2
)
(5
)
(8
)
(8
)
Ending balance of allowance for credit losses
$
337

$
358

$
387

$
467

Allowance for loan losses
$
212

$
237

$
266

$
362

Allowance for lending-related commitments
125

121

121

105

Allowance for loan losses as a percentage of total loans
0.42
%
0.48
%
0.57
%
0.80
%
Allowance for loan losses as a percentage of non-margin loans
0.59
%
0.66
%
0.80
%
1.13
%
Total allowance for credit losses as a percentage of total loans
0.67
%
0.73
%
0.83
%
1.03
%
Total allowance for credit losses as a percentage of non-margin loans
0.94
%
0.99
%
1.16
%
1.46
%


Net charge-offs were $2 million in the second quarter of 2013, $8 million in the second quarter of 2012 and $5 million in the first quarter of 2013. Net charge-offs in these periods primarily reflect charge-offs in the other residential mortgage portfolio.

The provision for credit losses was a credit of $19 million in the second quarter of 2013 primarily driven by the continued improvement in the credit quality of the loan portfolio. The provision for credit losses was a credit of $19 million in the second quarter of 2012 and a credit of $24 million in the first quarter of 2013. We anticipate the provision for credit losses to be up to $15 million in the third quarter of 2013.

Given the continuing improvement in U.S. housing prices, the improved demand in major U.S. housing markets, and the improvement in the majority of the internal and environmental risk factors tracked in our qualitative framework, management concluded that a reduction in the qualitative allowance in the first quarter of 2013 was appropriate. Management
 
believes our quantitative allowance and reduced level of qualitative allowance adequately reflects incurred losses associated with the aggregate risk at this stage of the economic recovery.

The total allowance for credit losses was $337 million at June 30, 2013 and $387 million at Dec. 31, 2012. The decrease in the allowance for credit losses was primarily driven by the factors mentioned above.

The ratio of the total allowance for credit losses to non-margin loans was 0.94% at June 30, 2013, 1.16% at Dec. 31, 2012 and 1.46% at June 30, 2012. The ratio of the allowance for loan losses to non-margin loans was 0.59% at June 30, 2013 compared with 0.80% at Dec. 31, 2012 and 1.13% at June 30, 2012. The lower ratios at June 30, 2013 compared with both prior periods primarily reflect the decrease in the allowance for credit losses driven by the continued improvement in the credit quality of the loan portfolio.




BNY Mellon 35


We had $14.4 billion of secured margin loans on our balance sheet at June 30, 2013 compared with $13.4 billion at Dec. 31, 2012 and $13.5 billion at June 30, 2012. We have rarely suffered a loss on these types of loans and do not allocate any of our allowance for credit losses to them. As a result, we believe that the ratio of total allowance for credit losses as a percentage of non-margin loans is a more appropriate metric to measure the adequacy of the reserve.

The allowance for loan losses and allowance for lending-related commitments represent management’s estimate of probable losses inherent in our credit portfolio. This evaluation is subject to numerous estimates and judgments.

We utilize a quantitative methodology and qualitative framework for determining the allowance for loan losses and the allowance for lending-related commitments. Within this qualitative framework, management applies judgment when assessing internal risk factors and environmental factors to compute an additional allowance for each component of the loan portfolio.

The three elements of the allowance for loan losses and the allowance for lending-related commitments include the qualitative allowance framework. The three elements are:

an allowance for impaired credits of $1 million or greater;
an allowance for higher risk-rated credits and pass-rated credits; and
an allowance for residential mortgage loans.

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

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

The third element, the allowance for residential mortgage loans, is determined by segregating six mortgage pools into delinquency periods ranging from current through foreclosure. Each of these delinquency periods is assigned a probability of default. A specific loss given default is assigned for each mortgage pool. All residential mortgage pools, except home equity lines of credit, are assigned a probability of default and loss given default based on five years of default and loss data derived from our residential mortgage portfolio. For each pool, the inherent loss is calculated using the above factors. The resulting probable loss factor (the probability of default multiplied by the loss given default) is applied against the loan balance to determine the allowance held for each pool. For home equity lines of credit, probability of default and loss given default are based on external data from third party databases due to the small size of the portfolio and insufficient internal data.

The qualitative framework is used to determine an additional allowance for each portfolio based on the factors below:

Internal risk factors:

Nonperforming loans to total non-margin loans;
Criticized assets to total loans and lending-related commitments;
Ratings volatility;
Borrower concentration; and
Significant concentration in high risk industries.

Environmental risk factors:

U.S. non-investment grade default rate;
Unemployment rate; and
Change in real GDP (quarter over quarter).




36 BNY Mellon


The objective of the qualitative framework is to capture incurred losses that may not have been fully captured in the quantitative reserve, which is based primarily on historical data. Management determines the qualitative allowance each period based on judgment informed by consideration of internal and external risk factors. Once determined in the aggregate, our qualitative allowance is then allocated to each of our loan classes based on the respective classes’ quantitative allowance balances with the allocations adjusted, when necessary, for class specific risk factors.

For each risk factor, we calculate the minimum and maximum values, and percentiles in-between, to evaluate the distribution of our historical experience. The distribution of historical experience is compared to the risk factor’s current quarter observed experience to assess the current risk inherent in the portfolio and overall direction/trend of a risk factor relative to our historical experience.

Based on this analysis, we assign a risk levelno impact, low, moderate, high and elevatedto each risk factor for the current quarter. Management assesses the impact of each risk factor to determine an aggregate risk level. We do not quantify the impact of any particular risk factor. Management’s assessment of the risk factors, as well as the trend in the quantitative allowance, supports management’s judgment for the overall required qualitative allowance. A smaller qualitative allowance may be required when our quantitative allowance has reflected incurred losses associated with the aggregate risk level. A greater qualitative allowance may be required if our quantitative allowance does not yet reflect the incurred losses associated with the aggregate risk level.

Our consideration of these factors has remained consistent for the quarter ended June 30, 2013. As discussed above, the improvements in the U.S. housing market, as well as internal and environmental risk factors, resulted in a decrease in the qualitative allowance from Dec. 31, 2012 to March 31, 2013. The qualitative allowance as a percentage of the total allowance was unchanged from March 31, 2013 to June 30, 2013.

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

Based on an evaluation of the allowance for credit losses as discussed in “Critical accounting estimates” on pages 34 and 35 in our 2012 Annual Report, we have allocated our allowance for credit losses as follows:

Allocation of allowance
June 30,
2013

March 31,
2013

Dec. 31,
2012

June 30,
2012

Commercial
28
%
27
%
27
%
22
%
Other residential mortgages
22

23

23

33

Foreign
13

13

12

12

Lease financing
12

11

13

12

Financial institutions
10

9

9

8

Commercial real estate
9

9

8

7

Wealth management (a)
6

8

8

6

Total
100
%
100
%
100
%
100
%
(a)
Includes the allowance for wealth management mortgages.


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

The credit rating assigned to each credit is a significant variable in determining the allowance. If such credits were rated one grade better, the allowance would have decreased by $56 million, while if each credit were rated one grade worse, the allowance would have increased by $82 million. Similarly, if the loss given default were one rating worse, the allowance would have increased by $55 million, while if the loss given default were one rating better, the allowance would have decreased by $40 million. For impaired credits, if the net carrying value of the loans was 10% higher or lower, the allowance would have decreased or increased by $1 million, respectively.




BNY Mellon 37


Nonperforming assets

The following table presents the distribution of nonperforming assets.

Nonperforming assets
(dollars in millions)
June 30,
2013

March 31,
2013

Dec. 31, 2012

Nonperforming loans:
 
 
 
Other residential mortgages
$
135

$
148

$
158

Commercial
24

24

27

Commercial real estate
18

17

18

Wealth management loans and mortgages
13

30

30

Foreign loans
9

9

9

Financial institutions
2

3

3

Total nonperforming loans
201

231

245

Other assets owned
3

3

4

Total nonperforming
  assets (a)
$
204

$
234

$
249

Nonperforming assets ratio
0.41
%
0.48
%
0.53
%
Nonperforming assets ratio, excluding margin loans
0.6
%
0.7
%
0.7
%
Allowance for loan losses/nonperforming loans
105.5
%
102.6
%
108.6
%
Allowance for loan losses/nonperforming assets
103.9
%
101.3
%
106.8
%
Total allowance for credit losses/nonperforming loans
167.7
%
155.0
%
158.0
%
Total allowance for credit losses/nonperforming assets
165.2
%
153.0
%
155.4
%
(a)
Loans of consolidated investment management funds are not part of BNY Mellon’s loan portfolio. Included in these loans are nonperforming loans of $44 million at June 30, 2013, $161 million at March 31, 2013 and $174 million at Dec. 31, 2012. These loans are recorded at fair value and therefore do not impact the provision for credit losses and allowance for loan losses, and accordingly are excluded from the nonperforming assets table above.


Nonperforming assets quarterly activity
(in millions)
June 30,
2013

March 31,
2013

Dec. 31, 2012

Balance at beginning of period
$
234

$
249

$
274

Additions
9

12

12

Return to accrual status
(11
)
(11
)
(16
)
Charge-offs
(3
)
(3
)
(3
)
Paydowns/sales
(24
)
(12
)
(16
)
Transferred to other real estate owned
(1
)
(1
)
(2
)
Balance at end of period
$
204

$
234

$
249



Nonperforming assets were $204 million at June 30, 2013, a decrease of $30 million compared with $234 million at March 31, 2013. The decrease primarily resulted from paydowns in the wealth management loan portfolio and returns to accrual status in the other residential mortgage loan portfolio.

 
See Note 5 of the Notes to Consolidated Financial Statements for additional information on our past due loans. See “Nonperforming assets” in Note 1 of the Notes to Consolidated Financial Statements in our 2012 Annual Report for our policy for placing loans on nonaccrual status.

Deposits

Total deposits were $244.9 billion at June 30, 2013, a decrease of less than 1% compared with $246.1 billion at Dec. 31, 2012. The slight decrease in deposits reflects lower levels of noninterest-bearing deposits primarily offset by higher interest-bearing deposits in non-U.S. offices.

Noninterest-bearing deposits were $82.9 billion at June 30, 2013 compared with $93.0 billion at Dec. 31, 2012. Interest-bearing deposits were $161.9 billion at June 30, 2013 compared with $153.1 billion at Dec. 31, 2012.

Short-term borrowings

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

See “Liquidity and dividends” below for a discussion of long-term debt and liquidity metrics that we monitor.

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

Federal funds purchased and securities sold under
repurchase agreements
 
Quarter ended
(dollar amounts in millions)
June 30, 2013

 
March 31, 2013

 
June 30, 2012

Maximum daily balance during the quarter
$13,484
 
$22,123
 
$21,818
Average daily balance
$9,206
 
$9,187
 
$11,254
Weighted-average rate during the quarter
(0.28
)%
 
(0.12
)%
 
0.01
 %
Ending balance
$12,600
 
$8,602
 
$9,162
Weighted-average rate at period end
(0.26
)%
 
(0.19
)%
 
(0.03
)%



38 BNY Mellon


Federal funds purchased and securities sold under repurchase agreements were $12.6 billion at June 30, 2013 compared with $8.6 billion at March 31, 2013 and $9.2 billion at June 30, 2012. The increase compared with both prior periods resulted from attractive overnight borrowing opportunities. The maximum daily balance in the second quarter of 2013 was $13.5 billion compared with $22.1 billion in the first quarter of 2013 and $21.8 billion in the second quarter of 2012. The weighted average rates in the first and second quarters of 2013 and at June 30, 2013, March 31, 2013 and June 30, 2012 reflect revenue earned on securities sold under repurchase agreements related to certain securities for which we were able to charge for lending them.

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

Payables to customers and broker-dealers
 
Quarter ended
(dollar amounts in millions)
June 30, 2013

 
March 31, 2013

 
June 30, 2012

Maximum daily balance during the quarter
$16,458
 
$16,027
 
$15,812
Average daily balance (a)
$15,055
 
$15,026
 
$13,255
Weighted-average rate during the quarter
0.08
%
 
0.09
%
 
0.10
%
Ending balance
$15,267
 
$14,986
 
$13,305
Weighted-average rate at period end
0.09
%
 
0.10
%
 
0.10
%
(a)
The weighted average rate is calculated based on, and is applied to, the average interest-bearing payables to customers and broker-dealers, which were $9,073 million in the second quarter of 2013, $9,019 million in the first quarter of 2013 and $7,895 million in the second quarter of 2012.


Payables to customers and broker-dealers represent funds awaiting re-investment and short sale proceeds payable on demand. Payables to customers and broker-dealers were $15.3 billion at June 30, 2013, $15.0 billion at March 31, 2013 and $13.3 billion at June 30, 2012. Payables to customers and broker-dealers are driven by customer trading activity levels and market volatility.

Information related to commercial paper is presented below.

 
Commercial paper
Quarter ended
(dollar amounts in millions)
June 30, 2013

 
March 31, 2013

 
June 30, 2012

Maximum daily balance during the quarter
$924
 
$1,428
 
$2,547
Average daily balance
$58
 
$245
 
$1,436
Weighted-average rate during the quarter
0.04
%
 
0.09
%
 
0.29
%
Ending balance
$111
 
$78
 
$1,564
Weighted-average rate at period end
0.03
%
 
0.03
%
 
0.14
%


Commercial paper outstanding was $111 million at June 30, 2013 compared with $78 million at March 31, 2013, and $1.6 billion at June 30, 2012. Average commercial paper outstanding was $58 million in the second quarter of 2013, $245 million in the first quarter of 2013 and $1.4 billion in the second quarter of 2012. The maximum daily balance in the second quarter of 2013 was $924 million compared with $1.4 billion in the first quarter of 2013 and $2.5 billion in the second quarter of 2012. Fluctuations between periods were a result of Parent funding requirements. Our commercial paper matures within 397 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment.

Information related to other borrowed funds is presented below.

Other borrowed funds
Quarter ended
(dollar amounts in millions)
June 30, 2013

 
March 31, 2013

 
June 30, 2012

Maximum daily balance during the quarter
$3,720
 
$2,514
 
$2,795
Average daily balance
$1,385
 
$1,152
 
$1,114
Weighted-average rate during the quarter
0.20
%
 
0.90
%
 
1.88
%
Ending balance
$1,060
 
$789
 
$1,374
Weighted-average rate at period end
0.34
%
 
1.37
%
 
2.75
%


Other borrowed funds primarily include overdrafts of sub-custodian account balances in our Investment Services businesses and borrowings under lines of credit by our Pershing subsidiaries. Overdrafts typically relate to timing differences for settlements. Other borrowed funds were $1.1 billion at June 30, 2013 compared with $789 million at March 31, 2013 and $1.4 billion at June 30, 2012. Other borrowed funds averaged $1.4 billion in the second quarter of 2013, $1.2 billion in the first quarter of 2013 and $1.1 billion in the second quarter of 2012. The maximum daily balance in the second quarter of 2013 was $3.7 billion compared with $2.5 billion in



BNY Mellon 39


the first quarter of 2013 and $2.8 billion in the second quarter of 2012. Changes compared with prior periods primarily reflect higher overdrafts of sub-custodian account balances in our Investment Services businesses.

Liquidity and dividends

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

For additional information on our liquidity policy, see “Risk Management - Liquidity risk” in our 2012 Annual Report.

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

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

Potential uses of liquidity include withdrawals of customer deposits and client drawdowns on unfunded credit or liquidity facilities. We actively monitor unfunded lending-related commitments, thereby reducing unanticipated funding requirements.
 
When monitoring liquidity, we evaluate multiple metrics in order to have ample liquidity for expected and unexpected events. Metrics include cashflow mismatches, asset maturities, access to debt and money markets, debt spreads, peer ratios, liquid assets, unencumbered collateral, funding sources and balance sheet liquidity ratios. We monitor the Basel III liquidity coverage ratio as applied to us, based on our current interpretation of the Final Rules regarding Basel III. Ratios we currently monitor as part of our standard analysis include total loans as a percentage of total deposits, deposits as a percentage of total interest-earning assets, foreign deposits as a percentage of total interest-earning assets, purchased funds as a percentage of total interest-earning assets, liquid assets as a percentage of total interest-earning assets, liquid assets as a percentage of purchased funds, and discount window collateral and central bank deposits as a percentage of total deposits. All of these ratios exceeded our minimum guidelines at June 30, 2013.

We also perform liquidity stress tests to ensure the Company maintains sufficient liquidity resources under multiple stress scenarios. Stress tests are based on scenarios that measure liquidity risks under unlikely but plausible events. The Company performs these tests under various time horizons ranging from one day to one year in a base case, as well as supplemental tests to determine whether the Company’s liquidity is sufficient for severe market events and firm-specific events. Under our scenario testing program, the results of the tests indicate that the Company has sufficient liquidity.

We define available funds as liquid funds (which include interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements), cash and due from banks, and interest-bearing deposits with the Federal Reserve and other central banks. The table below presents our total available funds including liquid funds at period-end and on an average basis. The lower level of available funds at June 30, 2013 compared with Dec. 31, 2012 resulted from the redeployment of funds on our balance sheet from interest-bearing deposits with the Federal Reserve and other central banks as we increased the level of our investment securities and our loan portfolio, as well as a slight decrease in client deposits.




40 BNY Mellon


Available and liquid funds
June 30, 2013

 
Dec. 31,
2012

 
Average
(in millions)
2Q13

 
1Q13

 
2Q12

 
YTD13

 
YTD12

Available funds:
 
 
 
 
 
 
 
 
 
 
 
 
 
Liquid funds:
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits with banks
$
42,145

 
$
43,910

 
$
42,772

 
$
40,967

 
$
38,474

 
$
41,874

 
$
36,784

Federal funds sold and securities purchased under resale agreements
9,978

 
6,593

 
7,878

 
7,478

 
5,493

 
7,679

 
5,333

Total liquid funds
52,123

 
50,503

 
50,650

 
48,445

 
43,967

 
49,553

 
42,117

Cash and due from banks
6,940

 
4,727

 
5,060

 
4,534

 
4,412

 
4,798

 
4,341

Interest-bearing deposits with the Federal Reserve and other central banks
77,150

 
90,110

 
55,911

 
63,240

 
57,904

 
59,555

 
60,715

Total available funds
$
136,213

 
$
145,340

 
$
111,621

 
$
116,219

 
$
106,283

 
$
113,906

 
$
107,173

Total available funds as a percentage of total assets
38
%
 
40
%
 
33
%
 
35
%
 
35
%
 
34
%
 
35
%
 


On an average basis for the first six months of 2013 and the first six months of 2012, non-core sources of funds such as money market rate accounts, federal funds purchased, trading liabilities and other borrowings were $19.1 billion and $20.0 billion, respectively. The decrease primarily reflects lower levels of money market rate accounts. Average foreign deposits, primarily from our European-based Investment Services business, were $99.7 billion for the first six months of 2013 compared with $87.4 billion for the first six months of 2012. The increase primarily reflects growth in client deposits. Domestic savings and time deposits averaged $41.3 billion for the first six months of 2013 compared with $34.1 billion for the first six months of 2012. The increase primarily reflects higher time deposits. Deposit volumes could be impacted by proposed money market fund reform.

Average payables to customers and broker-dealers were $9.0 billion for the first six months of 2013 and $7.7 billion for the first six months of 2012. Payables to customers and broker-dealers are driven by customer trading activity and market volatility. Long-term debt averaged $18.9 billion for the first six months of 2013 and $20.3 billion for the first six months of 2012. The decrease in average long-term debt was driven by planned capital actions and debt maturities. Average noninterest-bearing deposits increased to $70.5 billion for the first six months of 2013 from $64.7 billion for the first six months of 2012 reflecting growth in client deposits. A significant reduction in our Investment Services business would reduce our access to deposits.

 
The Parent has four major sources of liquidity:

cash on hand;
dividends from its subsidiaries;
access to the commercial paper market; and
access to the debt and equity markets.

Subsequent to June 30, 2013, our bank subsidiaries could declare dividends to the Parent of approximately $2.2 billion, without the need for a regulatory waiver. In addition, at June 30, 2013, non-bank subsidiaries of the Parent had liquid assets of approximately $1.5 billion.

In April 2013, BNY Mellon announced a 15% increase in the quarterly common stock dividend, from $0.13 to $0.15 per share. As a result, in the second quarter of 2013, BNY Mellon paid a quarterly cash dividend of $0.15 per common share. Our common stock dividend payout ratio was 58% for the first six months of 2013, or 23% after adjusting for the charge related to the disallowance of certain foreign tax credits. The Federal Reserve’s current guidance provides that, for large bank holding companies like us, dividend payout ratios exceeding 30% of after-tax net income will receive particularly close scrutiny.

Restrictions on our ability to obtain funds from our subsidiaries are discussed in more detail in “Supervision and Regulation - Capital Planning - Payment of Dividends, Stock Repurchases and Other Capital Distributions” and in Note 20 of the Notes to Consolidated Financial Statements, both contained in our 2012 Annual Report.




BNY Mellon 41


The Parent’s average commercial paper borrowings were $58 million in the second quarter of 2013 compared with $1.4 billion in the second quarter of 2012. The Parent had cash of $4.6 billion at June 30, 2013, compared with $4.0 billion at Dec. 31, 2012. In addition to issuing commercial paper for funding purposes, the Parent issues commercial paper, on an overnight basis, to certain custody clients with excess demand deposit balances. Overnight commercial paper outstanding issued by the Parent was $111 million at June 30, 2013 and $338 million at Dec. 31, 2012. Net of commercial paper outstanding, the Parent’s cash position at June 30, 2013, increased by $876 million compared with Dec. 31, 2012, primarily reflecting the issuance of senior debt and preferred stock.

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

In the second quarter of 2013, we repurchased 11.9 million common shares in the open market, at an average price of $27.79 per share, for a total of $330 million.

The Parent’s liquidity policy is to have sufficient cash on hand to meet its obligations over the next 18 to 24 months without the need to receive dividends from its bank subsidiaries or issue debt. As of June 30, 2013, the Parent was in compliance with its liquidity policy.

In addition to our other funding sources, we also have the ability to access the capital markets. In June 2013, we filed shelf registration statements on Form S-3 with the SEC covering the issuance of certain securities, including an unlimited amount of debt, common stock, preferred stock and trust preferred securities, as well as common stock issued under the Direct Stock Purchase and Dividend Reinvestment Plans. These registration statements will expire in June 2016, at which time we plan to file new shelf registration statements.

Our ability to access the capital markets on favorable terms, or at all, is partially dependent on our credit ratings, which, as of July 2, 2013, were as follows:

 
Credit ratings
  
Moody’s
S&P
Fitch
 
DBRS
Parent:
 
 
 
 
 
Long-term senior debt
Aa3
A+
AA-
 
AA (low)
Subordinated debt
A1
A
A+
 
A (high)
Preferred stock
Baa1
BBB
BBB
 
A (low)
Trust-preferred securities
A2
BBB
BBB+
 
A (high)
Short-term debt
P1
A-1
F1+
 
R-1 (middle)
Outlook - Parent:
(a)
Negative
Stable
 
Stable
 
The Bank of New York Mellon:
Long-term senior debt
Aa1
AA-
AA-
 
AA
Long-term deposits
Aa1
AA-
AA
 
AA
Short-term deposits
P1
A-1+
F1+
 
R-1 (high)
 
 
 
 
 
 
BNY Mellon, N.A.:
 
 
 
 
 
Long-term senior debt
Aa1
AA-
AA- 
(b)
AA
Long-term deposits
Aa1
AA-
AA
 
AA
Short-term deposits
P1
A-1+
F1+
 
R-1 (high)
 
 
 
 
 
 
Outlook - Banks:
(a)
Stable
Stable
 
Stable
(a)
Long-term ratings under review for downgrade.
(b)
Represents senior debt issuer default rating.


As a result of Moody’s Investors Service (“Moody’s”) and S&P’s government support assumptions on certain U.S. financial institutions, the Parent’s ratings by Moody’s and S&P benefit from one notch of “lift”. Similarly, The Bank of New York Mellon’s and BNY Mellon, N.A.’s ratings benefit from two notches of “lift” from Moody’s and one notch of “lift” from S&P. On June 11, 2013, S&P indicated that it is reconsidering its inclusion of government support in its ratings on the eight U.S. bank holding companies that it views as having high systemic importance, including The Bank of New York Mellon Corporation. On June 11, 2013, S&P also revised its outlook on the operating subsidiaries of The Bank of New York Mellon Corporation to stable from negative reflecting the outlook revision on the long-term sovereign credit rating of the United States to stable from negative.

On July 2, 2013, Moody’s placed the long-term ratings of three large U.S. trust and custody banks on review for downgrade, including The Bank of New York Mellon Corporation. The short-term debt and deposit ratings for all three banks, including The Bank of New York Mellon Corporation were affirmed at both the bank and holding company levels.  Moody’s indicated that the review will focus on the long-term profitability challenges facing these very highly-rated institutions, which are driven by aggressive pricing of all three banks’ core custody products and services. According to Moody’s, the review will also examine the banks’ ability to



42 BNY Mellon


generate more revenue from custody-related services and cut costs, and consider the level of the banks’ dependence on ancillary revenues that have come under pressure. For further discussion on the impact of a credit rating downgrade, see Note 17 of the Notes to Consolidated Financial Statements.

Long-term debt totaled $18.5 billion at both June 30, 2013 and Dec. 31, 2012. In the first six months of 2013, the Parent issued $1.5 billion of senior debt, partially offset by the maturity of $750 million of senior debt and the decline in the fair value of the hedged long-term debt. The fair value of the derivatives hedging long-term debt is recorded in other assets. Additionally, the Parent called $65 million of subordinated debt, and has the option to call $42 million of subordinated debt in the remainder of 2013, which it may call and refinance if market conditions are favorable.

On Aug. 1, 2013, we issued $600 million of senior medium-term notes maturing in 2018 at an annual interest rate of 2.1% and $500 million of senior medium-term notes maturing in 2018 at an annual interest rate of 3-month LIBOR plus 56 basis points.

In the second quarter of 2013, we issued 500,000 depositary shares (the “Series D depositary shares”), each representing a 1/100th ownership interest in a share of Series D Noncumulative Perpetual Preferred Stock, with a liquidation preference of $100,000 per share (the “Series D preferred stock”), of The Bank of New York Mellon Corporation. BNY Mellon will pay a dividend on the Series D preferred stock if declared by our board of directors, at an annual rate of 4.5% on each June 20 and December 20, to but excluding June 20, 2023; and a floating rate equal to three-month LIBOR plus 2.46% on each March 20, June 20, September 20 and December 20, from and including June 20, 2023. The proceeds of the offering totaled $494 million, net of issuance costs, a portion of which was used to redeem $300 million of 7.78% Trust Preferred Securities of BNY Institutional Capital Trust A.

At June 30, 2013, we had $303 million of trust preferred securities outstanding, which currently qualify as Tier 1 capital. Any decision to take action with respect to these trust preferred securities will be based on several considerations including interest rates, the availability of cash and capital, as well as the implementation of the Final Rules.

 
The double leverage ratio is the ratio of investment in subsidiaries divided by our consolidated equity, which included our noncumulative perpetual preferred stock plus trust preferred securities. Our double leverage ratio was 110.1% at June 30, 2013 and 109.9% at Dec. 31, 2012. The double leverage ratio is monitored by regulators and rating agencies and is an important constraint on our ability to invest in our subsidiaries and expand our businesses.

Pershing LLC, an indirect subsidiary of BNY Mellon, has committed and uncommitted lines of credit in place for liquidity purposes which are guaranteed by the Parent. The committed line of credit of $750 million extended by 16 financial institutions matures in March 2014. There were no borrowings against this line in the second quarter of 2013. Pershing LLC has nine separate uncommitted lines of credit amounting to $1.6 billion in aggregate. Average daily borrowing under these lines was $22 million, in aggregate, in the second quarter of 2013. See “Liquidity and dividends” in our 2012 Annual Report for a description of the covenants required to be maintained by the Parent for the committed lines of credit maintained by Pershing LLC. We are currently in compliance with these covenants.

Pershing Limited, an indirect UK-based subsidiary of BNY Mellon, has uncommitted lines of credit in place for liquidity purposes, which are guaranteed by the Parent. Pershing Limited has two separate uncommitted lines of credit amounting to $250 million in aggregate. Average daily borrowing under these lines was $84 million, in aggregate, in the second quarter of 2013.

Statement of cash flows

Cash used for operating activities was $959 million for the six months ended June 30, 2013 compared with cash provided by operating activities of $374 million for the six months ended June 30, 2012. In the first six months of 2013, cash flows used for operations were principally the result of changes in trading activity and accruals and other balances, partially offset by earnings. In the first six months of 2012, earnings, partially offset by changes in accruals and other balances, were a significant source of funds.

In the six months ended June 30, 2013, cash used for investing activities was $632 million compared with $5.8 billion in the six months ended June 30, 2012.



BNY Mellon 43


In the first six months of 2013, purchases of securities and changes in loans and federal funds sold and securities purchased under resale agreements were a significant use of funds, partially offset by sales, paydowns and maturities of securities and a decrease in deposits with the Federal Reserve and other central banks. In the first six months of 2012, purchases of securities, changes in federal funds sold and securities purchased under resale agreements and changes in interest-bearing deposits with banks were a significant use of funds, partially offset by decreases in deposits with the Federal Reserve and other central banks and sales, paydowns, and maturities of securities.

 
In the six months ended June 30, 2013, cash provided by financing activities was $3.9 billion compared with $5.8 billion for the six months ended June 30, 2012. In the first six months of 2013, an increase in federal funds purchased and securities sold under repurchase agreements and the proceeds from the issuance of long-term debt were significant sources of funds partially offset by repayment of long-term debt, a decrease in payables to customers and treasury stock repurchases. In the first six months of 2012, increases in federal funds purchased and securities sold under repurchase agreements, deposits, commercial paper and the issuance of long-term debt were significant sources of funds, partially offset by repayment of long-term debt, a decrease in other borrowed funds and treasury stock repurchases.


Capital

Capital data
(dollar amounts in millions except per share amounts; common shares in thousands)
June 30,
2013

March 31,
2013

Dec. 31, 2012

June 30,
2012

Average common equity to average assets
10.2
%
10.5
%
10.4
%
11.2
%
 
 
 
 
 
At period end:
 
 
 
 
BNY Mellon shareholders’ equity to total assets ratio (a)
10.0
%
10.0
%
10.1
%
10.5
%
BNY Mellon common shareholders’ equity to total assets ratio (a)
9.5
%
9.7
%
9.9
%
10.3
%
Tangible BNY Mellon common shareholders’ equity to tangible assets of operations ratio – Non-GAAP (a)
5.8
%
5.9
%
6.4
%
6.1
%
Total BNY Mellon shareholders’ equity – GAAP
$
35,882

$
35,690

$
36,431

$
34,533

Total BNY Mellon common shareholders’ equity – GAAP
$
34,320

$
34,622

$
35,363

$
34,033

Tangible BNY Mellon shareholders’ equity – Non-GAAP (a)
$
14,282

$
14,469

$
14,919

$
13,544

Book value per common share – GAAP (a)
$
29.83

$
29.83

$
30.39

$
28.81

Tangible book value per common share – Non-GAAP (a)
$
12.41

$
12.47

$
12.82

$
11.47

Closing common stock price per share
$
28.05

$
27.99

$
25.70

$
21.95

Market capitalization
32,271

$
32,487

$
29,902

$
25,929

Common shares outstanding
1,150,477

1,160,647

1,163,490

1,181,298

 
 
 
 
 
Cash dividends per common share
$
0.15

$
0.13

$
0.13

$
0.13

Common dividend payout ratio
21
%
N/M
25
%
33
%
Common dividend yield (annualized)
2.1
%
1.9
%
2.0
%
2.4
%
(a)
See “Supplemental information - Explanation of Non-GAAP financial measures” beginning on page 52 for a reconciliation of GAAP to non-GAAP.


Total The Bank of New York Mellon Corporation shareholders’ equity at June 30, 2013 decreased to $35.9 billion from $36.4 billion at Dec. 31, 2012. The decrease primarily reflects a decline in the value of our investment securities portfolio and share repurchases, partially offset by the issuance of $500 million of noncumulative perpetual preferred stock and earnings retention.

The unrealized net of tax gain on our available-for-sale investment securities portfolio recorded in
 
accumulated other comprehensive income was $488 million at June 30, 2013 compared with $1.3 billion at Dec. 31, 2012. The decrease in the valuation of the investment securities portfolio was driven by an increase in long-term interest rates and $80 million of net realized securities gains in the first six months of 2013.

In the first six months of 2013, we repurchased 21.1 million common shares for a total of $583 million, including open market purchases of 11.9 million



44 BNY Mellon


common shares for a total of $330 million in the second quarter of 2013.

In the first half of 2013, we generated $300 million of capital through the exercise of stock options and awards and employee benefit plan contributions.

From July 1, 2013 through Aug. 7, 2013, we repurchased 2.35 million common shares in the open market, at an average price of $31.75 per common share for a total of $75 million.

On July 17, 2013, the board of directors declared a quarterly common stock dividend of $0.15 per share. This cash dividend was paid on Aug. 6, 2013, to shareholders of record as of the close of business on July 29, 2013.

 
Capital adequacy

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

As of June 30, 2013 and Dec. 31, 2012, BNY Mellon and our bank subsidiaries were considered “well capitalized” on the basis of the Basel I Total and Tier 1 capital to risk-weighted assets ratios and the leverage ratio (Basel I Tier 1 capital to quarterly average assets as defined for regulatory purposes).



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

Consolidated and largest bank subsidiary capital ratios
 
 
 
 
 
 
 
Well
capitalized

Adequately
capitalized

 
June 30, 2013

March 31, 2013

Dec. 31, 2012

June 30, 2012

  
 
Consolidated capital ratios:
 
 
 
 
 
 
 
Estimated Basel III Tier 1 common equity
ratio – Non-GAAP (a)(b)
N/A

N/A

 
9.3
%
9.4
%
9.8
%
8.7
%
 
 
 
 
 
 
 
 
Determined under Basel I-based guidelines (c):
 
 
 
 
 
 
 
Tier 1 common equity to risk-weighted assets ratio – Non-GAAP (b)
N/A

N/A

 
13.2
%
12.2
%
13.5
%
13.2
%
Tier 1 capital
6
%
N/A

 
14.8
%
13.6
%
15.0
%
14.7
%
Total capital
10
%
N/A

 
15.8
%
14.7
%
16.3
%
16.4
%
Leverage – guideline
5
%
N/A

 
5.3
%
5.2
%
5.3
%
5.5
%
 
 
 
 
 
 
 
 
The Bank of New York Mellon capital ratios (c):
 
 
 
 
 
 
 
Tier 1 capital
6
%
4
%
 
13.4
%
13.0
%
14.0
%
13.7
%
Total capital
10
%
8
%
 
13.9
%
13.6
%
14.6
%
14.5
%
Leverage
5
%
3% - 4%

(d)
5.3
%
5.2
%
5.4
%
5.7
%
(a)
At June 30, 2013, the estimated Basel III Tier 1 common equity ratio is based on our preliminary interpretation of and expectations regarding the final rules released by the Federal Reserve on July 2, 2013 and is presented under the Standardized Approach. This ratio was 9.8% under the Advanced Approach. For periods prior to June 30, 2013, these ratios were estimated using our interpretations of the Federal Reserve’s Notices of Proposed Rulemaking (“NPRs”) dated June 7, 2012, except as otherwise noted. Both the final rules and the NPRs require the Tier 1 common equity ratio to be the lower of the Standardized Approach or Advanced Approach. At March 31, 2013, this ratio was 9.4% under the Standardized Approach compared with 9.7% under the Advanced Approach. For all periods prepared under the NPRs prior to March 31, 2013, this ratio was higher under the Standardized Approach, and therefore was presented under the Advanced Approach. For all periods prior to June 30, 2013, Basel III risk-weightings for certain repo-style transactions were calculated under the Standardized Approach using the simple value-at-risk (“VaR”) method. At June 30, 2013, Basel III risk-weightings for these transactions were calculated under the Standardized Approach using the collateral haircut approach.
(b)
See “Supplemental Information - Explanation of Non-GAAP financial measures” beginning on page 52 for a calculation of this ratio.
(c)
When in this Form 10-Q we refer to BNY Mellon’s or our bank subsidiary’s “Basel I” capital measures (e.g., Basel I Total capital or Basel I Tier 1 capital), we mean Total or Tier 1 capital, as applicable, as calculated under the Federal Reserve’s risk-based capital guidelines that are based on the 1988 Basel Accord, which is often referred to as “Basel I”. Includes full capital credit for certain capital instruments outstanding at June 30, 2013. A phase-out of non-qualifying instruments will begin on Jan. 1, 2014.
(d)
The minimum leverage ratio for state member banks is 3% or 4%, depending on factors specified in regulations.
N/A - Not applicable at the consolidated company level. Well capitalized and adequately capitalized have not been defined for Basel III.




BNY Mellon 45


Quarterly impact to the estimated Basel III Tier 1 common equity ratio - Non-GAAP
 
 
 
Standardized
Approach

Advanced
Approach

Estimated Basel III Tier 1 common equity ratio - Non-GAAP at March 31, 2013 (a)
9.4
%
9.7
%
Impacted by:
 
 
Capital generation
40 bps

40 bps

Change in accumulated other comprehensive income
(50) bps

(50) bps

Change in risk-weighted assets
25 bps

10 bps

Impact of final rules
(25) bps

10 bps

Estimated Basel III Tier 1 common equity ratio - Non-GAAP at June 30, 2013 (a)
9.3
%
9.8
%
(a)
See “Supplemental information - Explanation of Non-GAAP financial measures” beginning on page 52 for a calculation of this ratio.
bps - basis points.


Our estimated Basel III Tier 1 common equity ratio (non-GAAP), which was based on our preliminary interpretation of and expectations regarding the final rules, was 9.3% at June 30, 2013, compared with 9.4% at March 31, 2013 calculated using our interpretation of the NPRs, except as otherwise noted. The decrease primarily resulted from the decrease in the value of our investment securities portfolio, partially offset by capital generation. For additional information on the Basel III final rules, see “Recent accounting and regulatory developments - Regulatory developments”.

At June 30, 2013, the amounts of capital by which BNY Mellon and our largest bank subsidiary, The Bank of New York Mellon, exceed the Basel I “well capitalized” guidelines are as follows.

Capital above guidelines at June 30, 2013 
(in millions)
Consolidated

 
The Bank of
New York
Mellon

Tier 1 capital
$
10,080

 
$
7,290

Total capital
6,693

 
3,855

Leverage
1,074

 
647


Failure to satisfy regulatory standards, including “well capitalized” status or capital adequacy guidelines more generally, could result in limitations on our activities and adversely affect our financial condition. See the discussion of these matters in our 2012 Annual Report in “Supervision and Regulation-Regulated Entities of BNY Mellon and Ancillary Regulatory Requirements” and “Risk Factors-Operational and Business Risk-Failure to satisfy regulatory standards, including “well capitalized” and “well managed” status or capital adequacy guidelines more generally, could result in limitations on our activities and adversely affect our business and financial condition.”

Capital ratios vary depending on the size of the balance sheet at quarter-end and the level and types of
 
investments. The balance sheet size fluctuates from quarter to quarter based on levels of customer and market activity. In general, when servicing clients are more actively trading securities, deposit balances and the balance sheet as a whole are higher. In addition, when markets experience significant volatility or stress, our balance sheet size may increase considerably as client deposit levels increase.

In the second quarter of 2013, net Basel I Tier 1 common equity increased $544 million, primarily driven by earnings retention, partially offset by share repurchases.

Our Basel I Tier 1 capital ratio was 14.8% at June 30, 2013 compared with 15.0% at Dec. 31, 2012. The decrease in the Basel I Tier 1 capital ratio primarily reflects higher risk-weighted assets driven by the required implementation of the Basel II.5 - final market risk rule in the first quarter of 2013 and the redemption of trust preferred securities, partially offset by the issuance of noncumulative perpetual preferred stock.

Our Basel I Tier 1 leverage ratio was 5.3% at both June 30, 2013 and Dec. 31, 2012. The leverage ratio of The Bank of New York Mellon was 5.3% at June 30, 2013 compared with 5.4% at Dec. 31, 2012. The decrease in the leverage ratio of The Bank of New York Mellon primarily resulted from the net loss recorded in the first quarter of 2013.

The Tier 1 capital and total capital ratios for The Bank of New York Mellon decreased at June 30, 2013 compared with Dec. 31, 2012. The decreases in these ratios primarily reflect the impact of the net loss recorded in the first quarter of 2013 and higher risk-weighted assets driven by the required implementation of the Basel II.5 - final market risk rule in the first quarter of 2013.




46 BNY Mellon


The following table shows the impact of a $1 billion increase or decrease in risk-weighted assets/quarterly average assets or a $100 million increase or decrease in common equity on the consolidated capital ratios at June 30, 2013.

Potential impact to capital ratios as of June 30, 2013
 
 
Increase or decrease of
(basis points)
$100 million in
common equity
$1 billion in risk-weighted assets/quarterly average assets (a)
Basel I:
 
 
 
 
Tier 1 capital
9
bps
13
bps
Total capital
9
 
14
  
Leverage
3
 
2

Basel III:
 
 
 
 
Estimated Tier 1 common equity ratio
7
bps
6
bps
(a)
Quarterly average assets determined under Basel I regulatory guidelines.


Our tangible BNY Mellon common shareholders’ equity to tangible assets of operations ratio was 5.8% at June 30, 2013 compared with 6.4% at Dec. 31, 2012. The decrease in the ratio primarily reflects a decrease in the unrealized gain on our available-for-sale investment securities portfolio, and a change in asset mix.
 
In the second quarter of 2013, we issued 500,000 Series D depositary shares each representing a 1/100th ownership interest in a share of the Series D preferred stock of The Bank of New York Mellon Corporation. BNY Mellon will pay a dividend on the Series D preferred stock if declared by our board of directors, at an annual rate of 4.5% on each June 20 and December 20, to but excluding June 20, 2023; and a floating rate equal to three-month LIBOR plus 2.46% on each March 20, June 20, September 20 and December 20, from and including June 20, 2023. The proceeds of the offering totaled $494 million, net of issuance costs, a portion of which was used to redeem $300 million of 7.78% Trust Preferred Securities of BNY Institutional Capital Trust A (liquidation amount $1,000 per security).

At June 30, 2013, we had $303 million of trust preferred securities outstanding which currently qualify as Tier 1 capital. Any decision to take action with respect to these trust preferred securities will be based on several considerations including interest rates, the availability of cash and capital, as well as the implementation of the final Basel III rules.


The following tables present the components of our Basel I Tier 1 and Total risk-based capital, the Basel I risk-weighted assets as well as average assets used for leverage capital purposes at June 30, 2013, March 31, 2013, Dec. 31, 2012 and June 30, 2012.

Components of Basel I Tier 1 and total risk-based capital (a)
June 30,

 
March 31,

 
Dec. 31,

 
June 30,

(in millions)
2013

 
2013

 
2012

 
2012

Tier 1 capital:
 
 
 
 
 
 
 
Common shareholders’ equity
$
34,320

 
$
34,622

 
$
35,363

 
$
34,033

Preferred stock
1,562

 
1,068

 
1,068

 
500

Trust preferred securities
303

 
603

 
623

 
1,164

Adjustments for:
 
 
 
 
 
 
 
Goodwill and other intangibles (b)
(20,038
)
 
(20,153
)
 
(20,445
)
 
(20,489
)
Pensions/cash flow hedges
1,387

 
1,410

 
1,454

 
1,372

Securities valuation allowance
(560
)
 
(1,314
)
 
(1,350
)
 
(825
)
Merchant banking investments
(23
)
 
(17
)
 
(19
)
 
(33
)
Total Tier 1 capital
16,951

 
16,219

 
16,694

 
15,722

Tier 2 capital:
 
 
 
 
 
 
 
Qualifying unrealized gains on equity securities
3

 
4

 
2

 
2

Qualifying subordinated debt
853

 
922

 
1,058

 
1,317

Qualifying allowance for credit losses
337

 
358

 
386

 
467

Total Tier 2 capital
1,193

 
1,284

 
1,446

 
1,786

Total risk-based capital
$
18,144

 
$
17,503

 
$
18,140

 
$
17,508

Total risk-weighted assets
$
114,511

 
$
119,382

 
$
111,180

 
$
106,764

Average assets for leverage capital purposes
$
317,542

 
$
313,482

 
$
315,273

 
$
284,776

(a)
On a regulatory basis as determined under Basel I guidelines.
(b)
Reduced by deferred tax liabilities associated with non-tax deductible identifiable intangible assets of $1,269 million at June 30, 2013, $1,293 million at March 31, 2013, $1,310 million at Dec. 31, 2012 and $1,400 million at June 30, 2012 and deferred tax liabilities associated with tax deductible goodwill of $1,200 million at June 30, 2013, $1,170 million at March 31, 2013, $1,130 million at Dec. 31, 2012 and $982 million at June 30, 2012.


BNY Mellon 47


Trading activities and risk management

Our trading activities are focused on acting as a market maker for our customers and facilitating customer trades. Positions managed for our own account are immaterial to our foreign exchange and other trading revenue and to our overall results of operations. The risk from market-making activities for customers is managed by our traders and limited in total exposure through a system of position limits, a value-at-risk (“VaR”) methodology based on a Monte Carlo simulation, stop loss advisory triggers, and other market sensitivity measures. The calculation of our VaR used by management and presented below, assumes a one-day holding period, utilizes a 99% confidence level, and incorporates the non-linear characteristics of options. See Note 17 of the Notes to Consolidated Financial Statements for additional information on the VaR methodology.

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

VaR (a)
2nd Quarter 2013
June 30,
2013

(in millions)
Average
Minimum
Maximum
Interest rate
$
11.4

$
8.7

$
14.2

$
9.9

Foreign exchange
1.1

0.5

2.3

1.0

Equity
3.1

1.4

4.4

3.3

Diversification
(3.3
)
N/M

N/M

(2.9
)
Overall portfolio
$
12.3

$
10.0

$
14.8

$
11.3

 

VaR (a)
1st Quarter 2013
March 31,
2013

(in millions)
Average
Minimum
Maximum
Interest rate
$
11.3

$
8.6

$
14.8

$
12.4

Foreign exchange
1.0

0.5

2.0

0.9

Equity
1.9

1.1

3.9

3.1

Diversification
(2.6
)
N/M

N/M

(3.4
)
Overall portfolio
$
11.6

$
8.8

$
14.8

$
13.0


VaR (a)
2nd Quarter 2012
June 30, 2012

(in millions)
Average
Minimum
Maximum
Interest rate
$
8.9

$
5.0

$
13.2

$
11.2

Foreign exchange
1.7

0.5

3.7

0.5

Equity
2.0

1.3

3.2

1.4

Diversification
(3.7
)
N/M

N/M

(3.1
)
Overall portfolio
$
8.9

$
5.0

$
13.6

$
10.0


VaR (a)
Year-to-date 2013
(in millions)
Average
Minimum
Maximum
Interest rate
$
11.3

$
8.6

$
14.8

Foreign exchange
1.1

0.5

2.3

Equity
2.5

1.1

4.4

Diversification
(3.0
)
N/M

N/M

Overall portfolio
$
11.9

$
8.8

$
14.8

 
VaR (a)
Year-to-date 2012
(in millions)
Average
Minimum
Maximum
Interest rate
$
9.3

$
5.0

$
13.2

Foreign exchange
2.5

0.5

4.8

Equity
2.2

1.3

3.4

Diversification
(4.0
)
N/M

N/M

Overall portfolio
$
10.0

$
5.0

$
14.8

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


The interest rate component of VaR represents instruments whose values predominantly vary with the level or volatility of interest rates. These instruments include, but are not limited to: debt securities, mortgage-backed securities, swaps, swaptions, forward rate agreements, exchange traded futures and options, and other interest rate derivative products.

The foreign exchange component of VaR represents instruments whose values predominantly vary with the level or volatility of currency exchange rates or interest rates. These instruments include, but are not limited to: currency balances, spot and forward transactions, currency options, and exchange traded futures and options, and other currency derivative products.

The equity component of VaR is comprised of instruments that represent an ownership interest in the form of domestic and foreign common stock or other equity-linked instruments. These instruments include, but are not limited to: common stock, exchange traded funds, American Depositary Receipts, listed equity options (puts and calls), OTC equity options, equity total return swaps, equity index futures and other equity derivative products.

The diversification component of VaR is the risk reduction benefit that occurs when combining portfolios and offsetting positions, and from the correlated behavior of risk factor movements.

During the second quarter of 2013, interest rate risk generated 73% of average VaR, equity risk generated 20% of average VaR and foreign exchange risk accounted for 7% of average VaR. During the second quarter of 2013, our daily trading loss did not exceed



48 BNY Mellon


our calculated VaR amount of the overall portfolio on any given day.

The following table of total daily trading revenue or loss illustrates the number of trading days in which our trading revenue or loss fell within particular ranges during the past five quarters. The increase in the number of days greater than $5 million is attributable to higher foreign exchange revenue and the volatility of the derivative revenue related to the implementation of the overnight index swap (“OIS”) curve.

Distribution of trading revenues (losses) (a)
(dollar amounts
in millions)
Quarter ended
June 30,
2012

Sept. 30, 2012

Dec. 31, 2012

March 31,
2013

June 30, 2013

Revenue range:
Number of days
Less than $(2.5)


1



$(2.5) - $0
4

2


4

1

$0 - $2.5
25

35

41

24

27

$2.5 - $5.0
29

23

20

32

24

More than $5.0
6

3


1

12

(a)
For quarters prior to June 30, 2013, the distribution of trading revenues (losses) does not reflect the impact of the CVA and corresponding hedge and OIS discounting.


Foreign exchange and other trading

Foreign exchange and other trading revenue totaled $207 million in the second quarter of 2013, $180 million in the second quarter of 2012 and $161 million in the first quarter of 2013. In the second quarter of 2013, foreign exchange revenue totaled $179 million, an increase of 14% year-over-year and 20% (unannualized) sequentially. Both increases primarily reflect higher volatility and increased volumes. Foreign exchange revenue continues to be impacted by competitive market pressures. Other trading revenue totaled $28 million in the second quarter of 2013, compared with $23 million in the second quarter of 2012 and $12 million in the first quarter of 2013. Foreign exchange revenue and fixed income trading revenue is reported in the Investment Services business and the Other segment. Equity/other trading revenue is primarily reported in the Other segment.

Trading assets include debt and equity instruments and derivative assets, primarily interest rate and foreign exchange contracts, not designated as hedging instruments. Trading assets totaled $11 billion at June 30, 2013 compared with $9 billion at Dec. 31, 2012. The increase in trading assets primarily
 
resulted from higher levels of securities inventory, partially offset by an increase in long-term interest rates.

Trading liabilities include debt and equity instruments, and derivative liabilities, primarily interest rate and foreign exchange contracts, not designated as hedging instruments. Trading liabilities totaled $8 billion at June 30, 2013 compared with $8 billion at Dec. 31, 2012.

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

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

At June 30, 2013, our over-the-counter (“OTC”) derivative assets of $5.1 billion included a credit valuation adjustment (“CVA”) deduction of $47 million. Our OTC derivative liabilities of $5.9 billion included a debit valuation adjustment (“DVA”) of $9 million related to our own credit spread. Net of hedges, the CVA and DVA were unchanged in the second quarter of 2013. Foreign exchange and other trading revenue was not impacted by the CVA and DVA in the second quarter of 2013.

In the first quarter of 2013, net of hedges, the CVA decreased $31 million and the DVA decreased $13 million. The net impact of these adjustments increased foreign exchange and other trading revenue by $18 million in the first quarter of 2013.

In the second quarter of 2012, net of hedges, the CVA decreased $2 million and the DVA decreased $1 million. The net impact of these adjustments increased foreign exchange and other trading revenue by $1 million in the second quarter of 2012.




BNY Mellon 49


The table below summarizes the risk ratings for our foreign exchange and interest rate derivative counterparty credit exposure. This information indicates the degree of risk to which we are exposed. Significant changes in ratings classifications for our foreign exchange and other trading activity could result in increased risk for us. The year-over-year increase in the percentage of exposure to counterparties with a risk rating profile of A+ to A- reflects a general increase in foreign exchange activity within this ratings category as well as increases in existing exposure to certain large inter-bank counterparties.

Foreign exchange and other trading counterparty risk rating profile (a)
 
Quarter ended
 
June 30,
2012

Sept. 30, 2012

Dec. 31, 2012

March 31,
2013

June 30, 2013

Rating:
 
 
 
 
 
AAA to AA-
40
%
43
%
38
%
37
%
41
%
A+ to A-
31

27

35

40

38

BBB+ to
  BBB-
22

23

22

19

17

Non-investment
  grade (BB+
  and lower)
7

7

5

4

4

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


Asset/liability management

Our diversified business activities include processing securities, accepting deposits, investing in securities, lending, raising money as needed to fund assets, and other transactions. The market risks from these activities are interest rate risk and foreign exchange risk. Our primary market risk is exposure to movements in U.S. dollar interest rates and certain foreign currency interest rates. We actively manage interest rate sensitivity and use earnings simulation and discounted cash flow models to identify interest rate exposures.
An earnings simulation model is the primary tool used to assess changes in pre-tax net interest revenue. The model incorporates management’s assumptions regarding interest rates, balance changes on core deposits, market spreads, changes in the prepayment behavior of loans and securities and the impact of derivative financial instruments used for interest rate risk management purposes. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior and are inherently uncertain. As a result, the earnings simulation model cannot precisely estimate net
 
interest revenue or the impact of higher or lower interest rates on net interest revenue. Actual results may differ from projected results due to timing, magnitude and frequency of interest rate changes, and changes in market conditions and management’s strategies, among other factors.

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

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

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

Estimated changes in net
   interest revenue
(dollars in millions)
June 30,
2013

March 31, 2013

up 200 bps parallel rate shift vs.
baseline (a)
$
402

$
351

up 100 bps parallel rate shift vs.
baseline (a)
324

311

Long-term up 50 bps, short-term unchanged (b)
130

142

Long-term down 50 bps, short-term unchanged (b)
(123
)
(114
)
(a)
In the parallel rate shift, both short-term and long-term rates move equally.
(b)
Long-term is equal to or greater than one year.
bps - basis points.


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

Our net interest revenue sensitivity table above incorporates assumptions about the impact of changes in interest rates on depositor behavior based on historical experience. Given the current historically low interest rate environment, a rise in interest rates



50 BNY Mellon


could lead to higher depositor withdrawals than historically experienced.

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

Global economic uncertainty, particularly in Europe;
Our ratings relative to other financial institutions’ ratings; and
Money market mutual fund reform.

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

Off-balance sheet arrangements

Off-balance sheet arrangements discussed in this section are limited to guarantees, retained or contingent interests and obligations arising out of unconsolidated variable interest entities. For BNY Mellon, these items include certain credit guarantees and securitizations. Guarantees include: lending-related guarantees issued as part of our corporate banking business, and securities lending indemnifications issued as part of our Investment Services business. See Note 18 of the Notes to Consolidated Financial Statements for a further discussion of our off-balance sheet arrangements.




BNY Mellon 51


Supplemental information - Explanation of Non-GAAP financial measures

BNY Mellon has included in this Form 10-Q certain Non-GAAP financial measures based upon Tier 1 common equity and tangible common shareholders’ equity. BNY Mellon believes that the ratio of Tier 1 common equity to risk-weighted assets and the ratio of tangible common shareholders’ equity to tangible assets of operations are measures of capital strength that provide additional useful information to investors, supplementing the Tier 1 and Total capital ratios which are utilized by regulatory authorities. The ratio of Basel I Tier 1 common equity to risk-weighted assets excludes preferred stock and trust preferred securities from the numerator of the ratio. Unlike the Basel I Tier 1 and Total capital ratios, the tangible common shareholders’ equity ratio fully incorporates those changes in investment securities valuations which are reflected in total shareholders’ equity. In addition, this ratio is expressed as a percentage of the actual book value of assets, as opposed to a percentage of a risk-based reduced value established in accordance with regulatory requirements, although BNY Mellon in its calculation has excluded certain assets which are given a zero percent risk-weighting for regulatory purposes. Further, BNY Mellon believes that the return on tangible common equity measure, which excludes goodwill and intangible assets net of deferred tax liabilities, is a useful additional measure for investors because it presents a measure of BNY Mellon’s performance in reference to those assets which are productive in generating income. BNY Mellon has provided a measure of tangible book value per share, which it believes provides additional useful information as to the level of such assets in relation to shares of common stock outstanding. BNY Mellon has presented its estimated Basel III Tier 1 common equity ratio based on its current interpretation, expectations and understanding of the final Basel III rules released by the Federal Reserve on July 2, 2013 and on the application of such rules to BNY Mellon’s businesses as currently conducted. The estimated Basel III Tier 1 common equity ratio is necessarily subject to, among other things, BNY Mellon’s further review and implementation of the final Basel III rules, anticipated compliance with all necessary enhancements to model calibration, and other refinements, further implementation guidance from regulators and any changes BNY Mellon may make to its businesses. Consequently, BNY Mellon’s Basel III Tier 1 common equity ratio estimate may change
 
based on these factors. Management views the Basel III Tier 1 common equity ratio as a key measure in monitoring BNY Mellon’s capital position and progress against future regulatory capital standards. Additionally, the presentation of the Basel III Tier 1 common equity ratio is intended to allow investors to compare BNY Mellon’s Basel III Tier 1 common equity ratio with estimates presented by other companies.

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

The presentation of income from consolidated investment management funds, net of net income attributable to noncontrolling interest related to the



52 BNY Mellon


consolidation of certain investment management funds permits investors to view revenue on a basis consistent with how management views the business. BNY Mellon believes that these presentations, as a supplement to GAAP information, give investors a clearer picture of the results of its primary businesses.

 
In this Form 10-Q, the net interest margin is presented on an FTE basis. We believe that this presentation provides comparability of amounts arising from both taxable and tax-exempt sources, and is consistent with industry practice. The adjustment to an FTE basis has no impact on net income. Each of these measures as described above is used by management to monitor financial performance, both on a company-wide and business-level basis.


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

Reconciliation of income before income taxes – pre-tax operating margin
(dollars in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

Income before income taxes – GAAP
$
1,206

$
809

$
589

$
2,015

$
1,474

Less: Net income attributable to noncontrolling interests of consolidated investment management funds
39

16

29

55

40

Add: Amortization of intangible assets
93

86

97

179

193

M&I, litigation and restructuring charges
13

39

378

52

487

Income before income taxes excluding net income attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP
$
1,273

$
918

$
1,035

$
2,191

$
2,114

Fee and other revenue – GAAP
$
3,187

$
2,844

$
2,826

$
6,031

$
5,664

Income from consolidated investment management funds – GAAP
65

50

57

115

100

Net interest revenue – GAAP
757

719

734

1,476

1,499

Total revenue – GAAP
4,009

3,613

3,617

7,622

7,263

Less: Net income attributable to noncontrolling interests of consolidated investment management funds
39

16

29

55

40

Total revenue excluding net income attributable to noncontrolling interests of consolidated investment management funds – Non-GAAP
$
3,970

$
3,597

$
3,588

$
7,567

$
7,223

 
 
 
 
 
 
Pre-tax operating margin (a)
30
%
22
%
16
%
26
%
20
%
Pre-tax operating margin, excluding net income attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP (a)
32
%
26
%
29
%
29
%
29
%
(a)
Income before taxes divided by total revenue.




BNY Mellon 53


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

Return on common equity and tangible common equity
(dollars in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

Net income (loss) applicable to common shareholders of The Bank of New York Mellon Corporation – GAAP
$
833

$
(266
)
$
466

$
567

$
1,085

Add:     Amortization of intangible assets, net of tax
59

56

61

115

122

Net income (loss) applicable to common shareholders of The Bank of New York Mellon Corporation excluding amortization of intangible assets – Non-GAAP
892

(210
)
527

682

1,207

Add: M&I, litigation and restructuring charges
8

24

225

32

290

Charge related to the disallowance of certain foreign tax credits

854


854


Net income applicable to common shareholders of The Bank of New York Mellon Corporation excluding amortization of intangible assets, M&I, litigation and restructuring charges and the charge related to the disallowance of certain foreign tax credits – Non-GAAP
$
900

$
668

$
752

$
1,568

$
1,497

 
 
 
 
 
 
Average common shareholders’ equity
$
34,467

$
34,898

$
34,123

$
34,681

$
33,920

Less: Average goodwill
17,957

17,993

17,941

17,975

17,951

Average intangible assets
4,661

4,758

5,024

4,709

5,073

Add: Deferred tax liability – tax deductible goodwill
1,200

1,170

982

1,200

982

Deferred tax liability – non-tax deductible intangible assets
1,269

1,293

1,400

1,269

1,400

Average tangible common shareholders’ equity – Non-GAAP
$
14,318

$
14,610

$
13,540

$
14,466

$
13,278

 
 
 
 
 
 
Return on common equity – GAAP (a)
9.7
%
N/M

5.5
%
3.3
%
6.4
%
Return on common equity excluding amortization of intangible assets, M&I, litigation and restructuring charges and the charge related to the disallowance of certain foreign tax credits – Non-GAAP (a)
10.5
%
7.8
%
8.9
%
9.1
%
8.9
%
Return on tangible common equity – Non-GAAP (a)
25.0
%
N/M

15.7
%
9.5
%
18.3
%
Return on tangible common equity excluding M&I, litigation and restructuring charges and the charge related to the disallowance
  of certain foreign tax credits – Non-GAAP (a)
25.2
%
18.5
%
22.4
%
21.9
%
22.7
%
(a)
Annualized.
N/M – Not meaningful.



The following table presents income from consolidated investment management funds, net of noncontrolling interests.


Income from consolidated investment management funds, net of
noncontrolling interests 
(in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

Income from consolidated investment management funds
$
65

$
50

$
57

$
115

$
100

Less: Net income attributable to noncontrolling interests of consolidated investment management funds
39

16

29

55

40

Income from consolidated investment management funds, net of noncontrolling interests
$
26

$
34

$
28

$
60

$
60



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

Income from consolidated investment management funds, net of
noncontrolling interests
(in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

Investment management fees
$
20

$
20

$
20

$
40

$
42

Other (Investment income)
6

14

8

20

18

Income from consolidated investment management funds, net of noncontrolling interests
$
26

$
34

$
28

$
60

$
60





54 BNY Mellon


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

Equity to assets and book value per common share 
(dollars in millions, unless otherwise noted)
June 30,
2013

March 31,
2013

Dec. 31,
2012

June 30,
2012

BNY Mellon shareholders’ equity at period end – GAAP
$
35,882

$
35,690

$
36,431

$
34,533

Less: Preferred stock
1,562

1,068

1,068

500

BNY Mellon common shareholders’ equity at period end – GAAP
34,320

34,622

35,363

34,033

Less: Goodwill
17,919

17,920

18,075

17,909

Intangible assets
4,588

4,696

4,809

4,962

Add: Deferred tax liability – tax deductible goodwill
1,200

1,170

1,130

982

Deferred tax liability – non-tax deductible intangible assets
1,269

1,293

1,310

1,400

Tangible BNY Mellon shareholders’ equity at period end – Non-GAAP
$
14,282

$
14,469

$
14,919

$
13,544

 
 
 
 
 
Total assets at period end – GAAP
$
360,505

$
355,942

$
358,990

$
330,283

Less: Assets of consolidated investment management funds
11,471

11,236

11,481

10,955

Subtotal assets of operations – Non-GAAP
349,034

344,706

347,509

319,328

Less: Goodwill
17,919

17,920

18,075

17,909

Intangible assets
4,588

4,696

4,809

4,962

Cash on deposit with the Federal Reserve and other central banks (a)
78,671

78,059

90,040

72,838

Tangible total assets of operations at period end – Non-GAAP
$
247,856

$
244,031

$
234,585

$
223,619

 
 
 
 
 
BNY Mellon shareholders’ equity to total assets – GAAP
10.0
%
10.0
%
10.1
%
10.5
%
BNY Mellon common shareholders’ equity to total assets – GAAP
9.5
%
9.7
%
9.9
%
10.3
%
Tangible BNY Mellon common shareholders’ equity to tangible assets of operations – Non-GAAP
5.8
%
5.9
%
6.4
%
6.1
%
 
 
 
 
 
Period end common shares outstanding (in thousands)
1,150,477

1,160,647

1,163,490

1,181,298

 
 
 
 
 
Book value per common share
$
29.83

$
29.83

$
30.39

$
28.81

Tangible book value per common share – Non-GAAP
$
12.41

$
12.47

$
12.82

$
11.47

(a)
Assigned a zero percentage risk weighting by the regulators.


The following table presents the calculation of the effective tax rate.

Effective tax rate
 
(dollars in millions)
1Q13

Provision for income taxes
$
1,046

Less: Charge related to the disallowance of certain foreign tax credits
854

Provision for income taxes – Non-GAAP
$
192

 
 
Income before taxes
$
809

 
 
Effective tax rate – GAAP
129.3
%
Effective tax rate – Operating basis – Non-GAAP
23.7
%




BNY Mellon 55


The following table presents the calculation of our Basel I Tier 1 common equity ratio.

Calculation of Basel I Tier 1 common equity to risk-weighted assets ratio (a)
(dollars in millions)
June 30,
2013

March 31,
2013

Dec. 31,
2012

June 30,
2012

Total Tier 1 capital – Basel I
$
16,951

$
16,219

$
16,694

$
15,722

Less: Trust preferred securities
303

603

623

1,164

Preferred stock
1,562

1,068

1,068

500

Total Tier 1 common equity
$
15,086

$
14,548

$
15,003

$
14,058

 
 
 
 
 
Total risk-weighted assets – Basel I
$
114,511

$
119,382

$
111,180

$
106,764

 
 
 
 
 
Basel I Tier 1 common equity to risk-weighted assets ratio – Non-GAAP
13.2
%
12.2
%
13.5
%
13.2
%
(a)
Determined under Basel I regulatory guidelines.


The following table presents the calculation of our estimated Basel III Tier 1 common equity ratio. 

Estimated Basel III Tier 1 common equity ratio – Non-GAAP (a)
(dollars in millions)
June 30,
2013

March 31, 2013

Dec. 31,
2012

June 30,
2012

Total Tier 1 capital - Basel I
$
16,951

$
16,219

$
16,694

$
15,722

Add: Deferred tax liability - tax deductible intangible assets
81

78

78

N/A

Less: Preferred stock
1,562

1,068

1,068

500

Trust preferred securities
303

603

623

1,164

Adjustments related to available-for-sale securities and pension
liabilities included in accumulated other comprehensive income (b)
796

78

85

513

Adjustments related to equity method investments (b)
500

488

501

558

Net pension fund assets (b)
268

258

249

43

Deferred tax assets
26

52

47

46

Other

1


2

Total estimated Basel III Tier 1 common equity
$
13,577

$
13,749

$
14,199

$
12,896

 
 
 
 
 
Total risk-weighted assets - Basel I
$
114,511

$
119,382

$
111,180

$
106,764

Add: Adjustments (c)
31,330

26,898

33,104

41,493

Total estimated Basel III risk-weighted assets
$
145,841

$
146,280

$
144,284

$
148,257

Estimated Basel III Tier 1 common equity ratio - Non-GAAP
9.3
%
9.4
%
9.8
%
8.7
%
(a)
At June 30, 2013, the estimated Basel III Tier 1 common equity ratio is based on our preliminary interpretation of and expectations regarding the final rules released by the Federal Reserve on July 2, 2013 and presented under the Standardized Approach. This ratio was 9.8% under the Advanced Approach. For periods prior to June 30, 2013, these ratios were estimated using our interpretations of the NPRs dated June 7, 2012, except as otherwise noted. Both the final rules and the NPRs require the Tier 1 common equity ratio to be the lower of the Standardized Approach or Advanced Approach. At March 31, 2013, this ratio was 9.4% under the Standardized Approach compared with 9.7% under the Advanced Approach. For all periods prepared under the NPRs prior to March 31, 2013, this ratio was higher under the Standardized Approach, and therefore was presented under the Advanced Approach. For all periods prior to June 30, 2013, Basel III risk-weightings for certain repo-style transactions were calculated under the Standardized Approach using the simple VaR method. At June 30, 2013, Basel III risk-weightings for these transactions were calculated under the Standardized Approach using the collateral haircut approach.
(b)
Basel III does not add back to capital the adjustment to other comprehensive income that Basel I makes for pension liabilities and available-for-sale securities. Also, pension assets recorded on the balance sheet and adjustments related to equity method investments are a deduction from capital.
(c)
Following are the primary differences between risk-weighted assets determined under Basel I and Basel III. Credit risk is determined under Basel I using predetermined risk-weights and asset classes and relies in part on the use of external credit ratings. Under Basel III both the Standardized and Advanced Approaches use a broader range of predetermined risk-weights and asset classes and certain alternatives to external credit ratings. Securitization exposure receives a higher risk-weighting under Basel III than Basel I, and Basel III includes additional adjustments for market risk, counterparty credit risk and equity exposures. Additionally, the Standardized Approach eliminates the use of the VaR approach for determining risk-weighted assets on certain repo-style transactions. Risk-weighted assets calculated under the Advanced Approach also include an adjustment for operational risk.



56 BNY Mellon


Recent accounting and regulatory developments

Proposed Accounting Standards

Proposed ASU - Revenue from Contracts with Customers

In June 2010, the FASB issued a proposed ASU, “Revenue from Contracts with Customers.” This proposed ASU is the result of a joint project of the FASB and the IASB to clarify the principles for recognizing revenue and develop a common standard for U.S. GAAP and IFRS. This proposed ASU would establish a broad principle that would require an entity to identify the contract with a customer, identify the separate performance obligations in the contract, determine the transaction price, allocate the transaction price to the separate performance obligations and recognize revenue when each separate performance obligation is satisfied. In 2011, the FASB and the IASB revised several aspects of the original proposal to include distinguishing between goods and services, segmenting contracts, accounting for warranty obligations and deferring contract origination costs.

In November 2011, the FASB re-exposed the proposed ASU. A final standard is expected to be issued during the second half of 2013. The FASB and IASB tentatively decided that the effective date of the proposed standard would be annual reporting periods beginning on or after Jan. 1, 2017.

Proposed ASU - Principal versus Agent Analysis

In November 2011, the FASB issued a proposed ASU “Principal versus Agent Analysis.” This proposed ASU would rescind the 2010 indefinite deferral of FAS 167 for certain investment funds, including mutual funds, hedge funds, mortgage real estate investment funds, private equity funds, and venture capital funds, and amends the pre-existing guidance for evaluating consolidation of voting general partnerships and similar entities. The proposed ASU also amends the criteria for determining whether an entity is a variable interest entity under FAS 167, which could affect whether an entity is within its scope. Accordingly, certain funds that previously were not consolidated must be reviewed to determine whether they will now be required to be consolidated. The proposed accounting standard will continue to require BNY Mellon to determine whether or not it
 
has a variable interest in a variable interest entity. However, consolidation of its variable interest entity and voting general partnership asset management funds will be based on whether or not BNY Mellon, as the asset manager, uses its power as a decision maker as either a principal or an agent. Based on a preliminary review of the proposed ASU, we do not expect to be required to consolidate additional mutual funds, hedge funds, mortgage real estate investment funds, private equity funds, and venture capital funds. In addition, we expect to de-consolidate a portion of the CLOs we currently consolidate, with further deconsolidation possible depending on future changes to BNY Mellon’s investment in subordinated notes. The FASB is currently evaluating comment letters received. A final ASU is expected to be issued during the second half of 2013.

Proposed ASU - Leases

On May 16, 2013, the FASB and IASB issued a revised proposed ASU on leases. The proposed ASU introduces new accounting models for both lessees and lessors, primarily to address concerns related to off-balance-sheet financing arrangements available to lessees under current guidance. The proposal would require lessees to account for all leases on the balance sheet, except for certain short-term leases that have a maximum possible lease term of 12 months or less, including any options to renew. A lessee would recognize on its balance sheet (1) an asset for its right to use the underlying asset over the lease term and (2) a liability representing its obligation to make lease payments over the lease term. The income statement impact for lessees would depend on the nature of the underlying asset - that is, whether the underlying asset is property or an asset other than property - and the terms and conditions of the lease. The proposed ASU also introduces new accounting guidance for lessors. Lessors would account for leases under either the new receivable-and-residual approach or an approach similar to current operating-lease accounting. The appropriate approach to use would depend on the nature of the underlying asset - that is, whether the underlying asset is property or an asset other than property - and the terms and conditions of the lease. If finalized, the proposed ASU would converge most significant aspects of the FASB’s and IASB’s accounting for lease contracts. Comments on this proposed ASU are due by Sept. 13, 2013. A final standard may be issued in 2014 and would be effective no earlier than reporting periods beginning on Jan. 1, 2017.



BNY Mellon 57


Proposed ASU - Financial Instruments - Credit Losses

In December 2012, the FASB issued a proposed ASU, “Financial Instruments-Credit Losses.” This proposed ASU would result in a single model to account for credit losses on financial assets. The proposal would remove the probable threshold for recognizing credit losses and require an estimate of the contractual cash flows an entity does not expect to collect on financial assets not measured at fair value through the income statement. The proposal would also change current practice for recognizing other-than-temporary impairment and interest income on debt securities. In addition, the proposal would result in the recognition of an allowance for credit losses for nearly all types of debt instruments. The proposal would expand the credit quality disclosures to require information about changes in the factors that influence estimates of credit losses and the reasons for those changes. Comments on this proposed ASU were due in May 2013.

Proposed ASU - Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings

In January 2013, the FASB issued a proposed ASU, “Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings.” This proposed ASU would require certain repurchase agreements to be accounted for as secured borrowings. For repurchase agreements and similar transactions accounted for as secured borrowings, an entity would be required to disclose the carrying value of the borrowing disaggregated by the type of collateral pledged. Comments on this proposed ASU were due in March 2013.

Proposed ASU - Recognition and Measurement of Financial Assets and Financial Liabilities

In February 2013, the FASB issued a proposed ASU, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This proposed ASU would affect entities that hold financial assets and liabilities and would change the methodology related to recognition, classification, measurement and presentation of financial instruments. The scope of the proposed ASU would exclude instruments classified in shareholders’ equity, share-based arrangements, pension plans, leases, guarantees and
 
derivative instruments accounted under ASC 815, “Derivatives and Hedging.” Financial assets would be classified and measured based on the instrument’s cash flow characteristics and an entity’s business model for managing the instrument. Financial liabilities would generally be measured initially at their transaction price. The proposal includes three principal classification and measurement categories: (1) fair value for which all changes in fair value are recognized in net income; (2) fair value with qualifying changes in fair value recognized in other comprehensive income; and (3) amortized cost. This proposed ASU requires financial assets and liabilities to be presented separately on the balance sheet by measurement category. In addition, the fair value of financial assets and liabilities accounted for under amortized cost would be presented parenthetically on the balance sheet. Comments on this proposed ASU were due in May 2013.

Proposed ASU - Reporting Discontinued Operations

In April 2013, the FASB issued a proposed ASU, “Reporting Discontinued Operations.” This proposed ASU would change the criteria and enhance the reporting for discontinued operations. The proposal would also enhance disclosure requirements and add new disclosures for individually material dispositions that do not qualify as discontinued operations. Under the proposal, a discontinued operation is a component of an entity, or group of components of an entity, that either has been disposed of, or is classified as held for sale and (1) is part of a single coordinated plan to dispose of a separate major line of business or separate major geographical area of operations, or (2) is a business that, on acquisition, meets the criteria for classification as held for sale. The proposal no longer precludes the presentation of a discontinued operation if there is significant continuing involvement with the component after the disposal or if there are ongoing operations or cash flows. Under the proposal, for disposals that are material but do not qualify as discontinued operations, disclosures of pre-tax income or losses of the disposed component and a reconciliation of the major classes of assets and liabilities held for sale to the amounts presented separately on the balance sheet would be required. Comments on this proposed ASU are due on Aug. 30, 2013.




58 BNY Mellon


Proposed ASU - Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)

In April 2013, the FASB issued a proposed ASU, “Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” This proposed ASU would permit reporting entities that invest in a qualified affordable housing project through a limited liability entity to elect to account for the investment using the effective yield method if certain conditions are met. For those investments in qualified affordable housing projects not accounted for using the effective yield method, the investment would be accounted for as an equity method investment or cost investment in accordance with Topic 970. The amendments in this proposed Update would be applied retrospectively. Early adoption would be permitted. The effective date will be determined after the Task Force considers feedback on the proposed Update. Comments were due in June 2013.

Adoption of new accounting standards

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

IFRS

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

 
In November 2008, the SEC proposed a “roadmap” for phasing in mandatory IFRS filings by U.S. public companies. The roadmap is conditional on progress towards milestones that would demonstrate improvements in both the infrastructure of international standard setting and the preparation of the U.S. financial reporting community. In February 2010, the SEC issued a statement confirming their position that they continue to believe that a single set of high-quality, globally accepted accounting standards would benefit U.S. investors. The SEC continues to support the dual goals of improving financial reporting in the United States and reducing country-by-country disparities in financial reporting. The SEC developed a work plan to aid in its evaluation of the impact of IFRS on the U.S. securities market.

In May 2011, the SEC published a staff paper, “Exploring a Possible Method of Incorporation”, that presented a possible framework for incorporating IFRS into the U.S. financial reporting system. In the staff paper, the SEC staff elaborates on an approach that combines elements of convergence and endorsement. This approach would establish an endorsement protocol for the FASB to incorporate newly issued or amended IFRS into U.S. GAAP. During a transition period (e.g., five to seven years), differences between IFRS and U.S. GAAP would be potentially eliminated through ongoing FASB standard setting.

In July 2012, the SEC staff released its final report on IFRS. This Final Report will be used by the SEC Commissioners to decide whether and, if so, when and how to incorporate IFRS into the financial reporting system for U.S. companies. The staff has not specifically requested comments on the Final Report. It is not known when the SEC will make a final decision on the adoption of IFRS in the U.S.

While the SEC decides whether IFRS will be required to be used in the preparation of our consolidated financial statements, a number of countries have mandated the use of IFRS by BNY Mellon’s subsidiaries in their statutory reports filed in those countries. Such countries include Belgium, Brazil, the Netherlands, Australia, Hong Kong, Canada and South Korea.




BNY Mellon 59


Update to Internal Controls - Integrated Framework

On May 14, 2013, The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued an updated version of its Internal Control - Integrated Framework. Originally issued in 1992, the framework helps organizations design, implement and evaluate the effectiveness of internal controls. Updates to the framework were intended to clarify internal control concepts and simplify their use and application. The 1992 framework will remain available during the transition period, which extends to Dec. 15, 2014, after which time COSO will consider it as superseded by the 2013 Framework. Along with the 2013 framework, COSO issued a document containing examples illustrating various approaches to assessing the effectiveness of internal controls.

Regulatory developments

For a summary of additional regulatory matters relevant to our operations, see “Supervision and regulation” in our 2012 Annual Report.

New Risk-Based and Leverage Regulatory Capital Rules

As a BHC, we are subject to consolidated regulatory capital rules administered by the Federal Reserve. Our bank subsidiaries are subject to similar capital requirements, administered by the Federal Reserve in the case of The Bank of New York Mellon and by the Office of the Comptroller of the Currency (“OCC”) in the case of our national bank subsidiaries, BNY Mellon, N.A. and The Bank of New York Mellon Trust Company, National Association. These requirements are intended to ensure that banking organizations have adequate capital given the risk levels of their assets and off-balance sheet financial instruments.

In July 2013, the federal banking agencies finalized rules (the “Final Rules”) revising the capital framework applicable to U.S. BHCs and banks. The Final Rules implement Basel III and certain provisions of the Dodd-Frank Act for U.S. BHCs and banks (including by redefining the components of capital and establishing higher minimum percentages for applicable capital ratios) and substantially revise the agencies’ general risk-based capital rules in a manner designed to make them more risk sensitive. The Final Rules establish a graduated implementation
 
schedule that commences on Jan. 1, 2014 for Advanced Approaches banking organizations, including BNY Mellon and will be principally phased-in by 2019. On Jan. 1, 2014, the applicable transition periods for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions begin.   Also on Jan. 1, 2014, BNY Mellon must begin using the Advanced Approaches rule for determining risk-weighted assets, assuming successful completion of our parallel run. BNY Mellon must: begin using the risk-weightings in the Final Rules’ new Standardized Approach on Jan. 1, 2015; meet the minimum ratios for the capital conservation buffer and countercyclical capital buffer during the transition period which begins on Jan. 1, 2016; and begin compliance with the new Basel III-based supplementary leverage ratio on Jan. 1, 2018.

In general, the Final Rules largely adhere to the rules as initially proposed in June 2012 and as summarized in the Company’s 2012 Annual Report. Consistent with the terms of the Basel III Framework, the Final Rules will, when fully phased-in, require banking institutions to satisfy three minimum risk-based capital ratios:

A Tier 1 common equity ratio of at least 7%, 4.5% attributable to a minimum Tier 1 common equity ratio and 2.5% attributable to a “capital conservation buffer” (during periods of excessive growth the capital conservation buffer may be expanded up to an additional 2.5% through the imposition of a countercyclical capital buffer);
A Tier 1 capital ratio of at least 8.5%, 6% attributable to a minimum Tier 1 capital ratio and 2.5% attributable to the capital conservation buffer; and
A total capital ratio of at least 10.5%, 8% attributable to a minimum total capital ratio and 2.5% attributable to the capital conservation buffer.

In addition, in November 2012, BNY Mellon was provisionally assigned to a 1.5% Tier 1 common equity surcharge bucket applicable to global systemically important banks (“G-SIBs”) based on certain Basel Committee final rules, resulting in a total Tier 1 common equity ratio of 8.5%, a total Tier 1 capital ratio of 10% and a total capital ratio of 12%, if implemented.




60 BNY Mellon


Under the Final Rules all banking institutions will be subject to a minimum leverage ratio of 4.0% (calculated as the ratio of Tier 1 capital to quarterly average consolidated total assets as reflected on the institution’s consolidated financial statements, net of amounts deducted from capital). In addition, Advanced Approaches banking organizations and their subsidiary insured depository institutions will be subject to a new Basel III-based supplementary leverage ratio of 3% to become effective Jan. 1, 2018 (calculated as the ratio of Tier 1 capital to the sum of quarterly average consolidated total assets as reflected on the institution’s consolidated financial statements, net of amounts deducted from capital, plus certain off-balance sheet items, including the potential future credit exposure of derivative contracts and 10% of the notional amount of unconditionally cancellable commitments.)

The Final Rules do not establish new standards for determining if a BHC is “well-capitalized”, which currently requires a Tier 1 capital ratio of 6% and a total capital ratio of 10%. However, the Final Rules establish revised “well-capitalized” thresholds for insured depository institutions under the federal banking agencies’ prompt corrective action framework of:

A Tier 1 common equity ratio of at least 6.5%;
A Tier 1 capital ratio of at least 8%;
A total capital ratio of at least 10%; and
A Basel I-based Tier 1 leverage ratio of at least 5%.

At June 30, 2013, BNY Mellon’s Basel I Tier 1 capital to risk-adjusted assets and Total capital to risk-adjusted assets ratios were 14.8% and 15.8%, respectively; and our estimated Basel III Tier 1 common equity ratio (Non-GAAP) was 9.3%, on a fully phased-in basis. For additional information on capital ratios, see “Capital”.

The Final Rules differ, in limited respects, from the 2012 proposed rules. For BNY Mellon, the most notable changes or clarifications in the Final Rules relative to the 2012 proposed rule or prior standards pertain to the application of the phase-out requirements for trust preferred securities and exposure measurement methodologies for securities finance transactions.

Regarding the phase-out requirements contained in Section 171 of the Dodd-Frank Act - the so-called
 
“Collins Amendment” - the Final Rules clarify the computation date for trust preferred securities. The Final Rules concerning the applicable transition period state that non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 (and that are also outstanding on the effective date of the final rule) may continue to be included in Tier 1 or Tier 2 capital up to the following percentages: Calendar year 2014:  50%; Calendar year 2015:  25%; and Calendar year 2016 and later dates:  0%. Certain non-qualifying instruments no longer eligible for inclusion in Tier 1 capital may still be included in Tier 2 capital over a gradual phase-out schedule terminating in 2022. At June 30, 2013, BNY Mellon had approximately $303 million of outstanding trust preferred securities.

Concerning securities finance transactions, including transactions in which we serve as agent and provide securities replacement indemnification to a securities lender, consistent with the approach in the June 2012 NPRs, the Final Rules do not permit a banking organization to use a simple VaR approach to calculate exposure amounts for repo-style transactions or to use internal models to calculate the exposure amount for the counterparty credit exposure for repo-style transactions under the Standardized Approach. These methodologies are included in the Advanced Approaches.

Under the Standardized Approach, a banking organization may use a collateral haircut approach to recognize the credit risk mitigation benefits of financial collateral that secures a repo-style transaction, including an agented securities lending transaction, among other transactions.  To apply the collateral haircut approach, a banking organization must determine the exposure amount and the relevant risk weight for the counterparty or guarantor.  Banking organizations may calculate market price volatility and foreign exchange volatility using their own internal estimates with prior written approval of their primary Federal supervisor.

The Final Rules do not address certain matters concerning financial institution capital, liquidity and related matters expected to be the subject of regulation in the near term. These items include U.S. implementation of capital surcharges for G-SIBs (for which BNY Mellon has been provisionally assigned a 1.5% surcharge, as indicated above), Basel III’s liquidity standards, loss absorbency standards designed to facilitate a holding company “single point



BNY Mellon 61


of entry” resolution under Title II of the Dodd-Frank Act, and capital charges designed to discourage overreliance on short-term wholesale funding practices.

Supplementary Leverage Ratio Proposals

As noted above, the U.S. banking agencies’ recently released Final Rules retained their existing Basel I-based leverage ratio (although establishing 4% as the new minimum required leverage ratio and eliminating the existing permission for a banking organization with a composite 1 supervisory rating to comply with a 3% minimum).  They also implement for Advanced Approaches banking organizations, including BNY Mellon, the new 3% Basel III-based supplementary leverage ratio, to become effective Jan. 1, 2018. The Basel Committee and the U.S. banking agencies are each independently considering potential changes to the supplementary leverage ratio that, individually or taken together, could make it substantially more restrictive.

In June 2013, the Basel Committee issued a consultative document proposing revisions to the supplementary leverage ratio’s denominator. The proposed revisions would broaden the denominator’s scope to expand the exposure calculations for derivatives and related collateral, written credit derivatives (from the perspective of the organization serving as the seller of credit protection), and securities financing transactions, including indemnified agented securities lending transactions. The Basel Committee’s proposal, if ultimately adopted and applied in the United States without adjustment, is expected to result in an expanded denominator for BNY Mellon.

Separately on July 9, 2013, the U.S. banking agencies proposed revisions to the supplementary leverage ratio under a notice of proposed rulemaking that would only apply to the largest U.S. BHCs and banks.  The proposed enhancements, if adopted, would apply to BNY Mellon and its banking subsidiaries. In contrast to the Basel Committee’s June document, this proposal principally focuses on the supplementary leverage ratio’s numerator. The U.S. proposal would increase the supplementary leverage requirement for affected BHCs and their depository institution subsidiaries. BHCs with a supplementary leverage ratio of less than 5.0% would face constraints on dividends, equity repurchases and compensation. The application of such limitations
 
would use the approach applied under the capital conservation buffer. In addition, this proposal would establish a supplementary leverage ratio “well-capitalized” threshold of 6% for affected insured depository institutions under the U.S. banking agencies’ prompt corrective action framework. The proposal indicated that the agencies would also be considering the principles set forth in the Basel Committee’s Consultative document.

On June 30, 2013, the Basel I leverage ratio for each of The Bank of New York Mellon Corporation and our primary banking subsidiary, The Bank of New York Mellon, was 5.3%.

Basel Committee Large Exposures Framework

In March 2013, the Basel Committee released a Consultative Document outlining a potential supervisory framework for measuring and controlling large exposures. The framework is conceptually analogous to the single-counterparty exposure limits proposed by the Federal Reserve in December 2011. The proposed Basel framework would limit a banking organization’s exposure to an individual counterparty (which, as proposed, is broadly defined and includes entities under control of or economically interdependent with the borrower) to 10-15% of the banking organization’s Tier 1 common equity.

From BNY Mellon’s perspective, perhaps the most notable component of the large exposures proposal is the treatment of securities finance transactions, particularly securities lending transactions. As proposed, the framework eschews credit exposure measurement methodologies for securities finance transactions that firms have developed to comply with previous risk-based capital rules. Instead, the proposal includes a risk-insensitive measurement methodology that relies on static collateral haircuts.

Money Market Fund (“MMF”) Reform

On June 5, 2013, the SEC issued proposed rules for institutional prime MMFs. The proposal sets forth two potential requirements, which could be adopted independently or combined. First, the SEC is proposing to require institutional prime funds to float their net asset values. The second proposed alternative seeks to limit redemptions during times of stress. Under this alternative, non-government MMFs would be required to impose a 2% liquidity fee and 30-day redemption gate if the fund’s level of



62 BNY Mellon


weekly liquid assets fell below 15% of its total assets, unless the fund’s board determined that it was not in the best interest of the fund. That determination would be subject to the board’s fiduciary duty.

Beyond these primary reform proposals, the SEC release proposes other potential changes, including tightening diversification requirements, enhancing disclosure requirements, strengthening stress testing and new reporting requirements for both MMFs and unregistered liquidity funds (these funds could serve as alternatives to money market funds for some investors).

Meanwhile, the European Commission (“EC”) has been working on related MMF proposals that include restrictions on relying on external ratings, MMF capital and liquidity requirements, changes to permitted valuation methodologies, restrictions on certain repo and securities lending transactions, and stricter disclosure requirements. In addition, on July 23, 2013 the EC announced that it plans to publish additional regulations concerning MMFs in September 2013.

EMEA Regulatory Update and Developments

The Bank of New York Mellon SA/NV (“BNY Mellon SA/NV”) is a public limited liability company incorporated under the laws of Belgium. BNY Mellon SA/NV, which has been granted a banking license by the National Bank of Belgium, is authorized to carry out all banking and savings activities as a credit institution. Effective Feb. 1, 2013, The Bank of New York Mellon (Ireland) Limited (the “Irish Bank”) merged with the BNY Mellon SA/NV. As part of the merger process, BNY Mellon SA/NV established a branch in Ireland. As of and from Feb. 1, 2013, this branch carried on the business activity in Ireland which was previously conducted by the Irish Bank.

Certain of our financial services operations in the UK are subject to regulation by and supervision of the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”), whose functions were transferred to them from the previous Financial Services Authority effective April 1, 2013. The PRA is responsible for the authorization and prudential regulation of firms that carry on PRA-regulated activities, including banks. PRA-authorized firms are also subject to regulation by the FCA for conduct purposes. In contrast, FCA-
 
authorized firms (such as investment management firms) have the FCA as their sole regulator for both prudential and conduct purposes. As a result, FCA-authorized firms must comply with FCA prudential and conduct rules and the FCA’s Principles for Businesses, while dual-regulated firms must comply with the FCA conduct rules and FCA Principles, as well as the applicable PRA prudential rules and the PRA’s Principles for Businesses.

The PRA regulates The Bank of New York Mellon (International) Limited, our UK chartered bank, as well as the UK branches of The Bank of New York Mellon and BNY Mellon SA/NV. Certain of BNY Mellon’s UK incorporated subsidiaries are authorized to conduct investment business in the UK. Their investment management advisory activities and their sale and marketing of retail investment products are regulated by the FCA. Certain UK investment funds, including BNY Mellon Investment Funds, are registered with the FCA and are offered for retail sale in the UK.

The European Union (“EU”) Commission has proposed a regulation conferring powers on the European Central Bank (the “ECB”) for the prudential supervision of all banks in the Eurozone, with a mechanism for non-EU countries to join on a voluntary basis. The ECB and EU Member State National Competent Authorities will together be a Single Supervisory Mechanism (“SSM”). Certain of BNY Mellon’s European subsidiaries are expected to fall within the SSM, including BNY Mellon SA/NV.

The European Parliament considered a Recovery and Resolution Directive on May 14, 2013, which contemplates a recovery and resolution framework for the EU. This directive would provide for resolution planning and a set of harmonized powers to resolve or implement recovery of relevant institutions, including branches of non-European Economic Area (“EEA”) banks operating within the EEA. The directive includes the preparation of recovery and resolution plans, giving relevant EEA regulators powers to impose requirements on an institution before resolution actions become necessary, giving authorities a set of resolution tools and powers to facilitate the resolution of failing entities, such as the power to “bail-in” the debt of an institution (including certain deposit obligations), and the power to require a firm to change its structure to remove impediments to resolvability. Various BNY



BNY Mellon 63


Mellon subsidiaries and branches could fall within the scope of this directive.

In addition, the Capital Requirements Directive IV (and related regulation) (“CRD IV”) is expected to affect BNY Mellon’s EU subsidiaries by implementing Basel III and other changes, including the enhancement of the quality of capital and the strengthening of capital requirements for counterparty credit risk, resulting in higher capital requirements. Elements of CRD IV will apply not only to BNY Mellon banking branches and subsidiaries but also to investment management and brokerage entities. The Directive is expected to become effective Jan. 1, 2014.

Businesses within BNY Mellon’s Investment Management and Investment Services segments are subject to significant foreign regulation relating to, among other things, the safeguarding, administration and management of client assets and client funds. Certain European directives are expected to affect our provision of these services, including revisions to the Markets in Financial Instruments Directive, the new Alternative Investment Fund Managers Directive, the Directive on Undertakings for Collective Investments in Transferable Securities, the Central Securities Depository Regulation, the European Market Infrastructure Regulation and the Securities Law Legislation. These new and revised European directives are expected to impact our operations and risk profile, and also to provide new opportunities for the provision of BNY Mellon products and services.

Website information

Our website is www.bnymellon.com. We currently make available the following information under the Investor Relations portion of our website. With respect to SEC filings, we post such information as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.

All of our SEC filings, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports, SEC Forms 3, 4 and 5 and any proxy statement mailed in connection with the solicitation of proxies;
Financial statements and footnotes prepared using Extensible Business Reporting Language (“XBRL”);
 
Our earnings releases and selected management conference calls and presentations;
Other regulatory disclosures, including:  Basel II.5 Market Risk Disclosures; Basel II Pillar 3 Disclosures; Federal Financial Institutions Examination Council - Consolidated Reports of Condition and Income for a Bank With Domestic and Foreign Offices; Consolidated Financial Statements for Bank Holding Companies; and the Dodd-Frank Act Stress Test Results for BNY Mellon and The Bank of New York Mellon; and
Our Corporate Governance Guidelines, Directors Code of Conduct and the charters of the Audit, Corporate Governance and Nominating, Human Resources and Compensation, Risk, Technology and Corporate Social Responsibility Committees of our Board of Directors.

The contents of the website listed above or any other websites referenced herein are not incorporated into this Quarterly Report on Form 10-Q. The SEC reports, the Corporate Governance Guidelines, Directors Code of Conduct and committee charters are available in print to any shareholder who requests them. Requests should be sent by email to corpsecretary@bnymellon.com or by mail to the Office of the Secretary of The Bank of New York Mellon Corporation, One Wall Street, New York, NY 10286.




64 BNY Mellon


The Bank of New York Mellon Corporation (and its subsidiaries)


Consolidated Income Statement (unaudited)
  
Quarter ended
 
Year-to-date
(in millions)
June 30,
2013

 
March 31,
2013

 
June 30,
2012

 
June 30,
2013

 
June 30,
2012

Fee and other revenue
 
 
 
 
 
 
 
 
 
Investment services fees:
 
 
 
 
 
 
 
 
 
Asset servicing
$
988

 
$
969

 
$
950

 
$
1,957

 
$
1,893

Issuer services
294

 
237

 
275

 
531

 
526

Clearing services
321

 
304

 
309

 
625

 
612

Treasury services
139

 
141

 
134

 
280

 
270

Total investment services fees
1,742

 
1,651

 
1,668

 
3,393

 
3,301

Investment management and performance fees
848

 
822

 
797

 
1,670

 
1,542

Foreign exchange and other trading revenue
207

 
161

 
180

 
368

 
371

Distribution and servicing
45

 
49

 
46

 
94

 
92

Financing-related fees
44

 
41

 
37

 
85

 
81

Investment and other income
269

 
72

 
48

 
341

 
187

Total fee revenue
3,155

 
2,796

 
2,776

 
5,951

 
5,574

Net securities gains—including other-than-temporary impairment
35

 
48

 
70

 
83

 
142

Noncredit-related gains on securities not expected to be
  sold (recognized in OCI)
3

 

 
20

 
3

 
52

Net securities gains
32

 
48

 
50

 
80

 
90

Total fee and other revenue
3,187

 
2,844

 
2,826

 
6,031

 
5,664

Operations of consolidated investment management funds
 
 
 
 
 
 
 
 
 
Investment income
159

 
146

 
152

 
305

 
305

Interest of investment management fund note holders
94

 
96

 
95

 
190

 
205

Income from consolidated investment management funds
65

 
50

 
57

 
115

 
100

Net interest revenue
 
 
 
 
 
 
 
 
 
Interest revenue
836

 
815

 
875

 
1,651

 
1,787

Interest expense
79

 
96

 
141

 
175

 
288

Net interest revenue
757

 
719

 
734

 
1,476

 
1,499

Provision for credit losses
(19
)
 
(24
)
 
(19
)
 
(43
)
 
(14
)
Net interest revenue after provision for credit losses
776

 
743

 
753

 
1,519

 
1,513

Noninterest expense
 
 
 
 
 
 
 
 
 
Staff
1,509

 
1,472

 
1,415

 
2,981

 
2,868

Professional, legal and other purchased services
317

 
295

 
309

 
612

 
608

Net occupancy
159

 
163

 
141

 
322

 
288

Software
157

 
140

 
127

 
297

 
246

Distribution and servicing
111

 
106

 
103

 
217

 
204

Furniture and equipment
81

 
88

 
82

 
169

 
168

Business development
90

 
68

 
71

 
158

 
127

Sub-custodian
77

 
64

 
70

 
141

 
140

Other
215

 
307

 
254

 
522

 
474

Amortization of intangible assets
93

 
86

 
97

 
179

 
193

Merger and integration, litigation and restructuring charges
13

 
39

 
378

 
52

 
487

Total noninterest expense
2,822

 
2,828

 
3,047

 
5,650

 
5,803

Income (loss)
 
 
 
 
 
 
 
 
 
Income before income taxes
1,206

 
809

 
589

 
2,015

 
1,474

Provision for income taxes
321

 
1,046

 
93

 
1,367

 
347

Net income (loss)
885

 
(237
)
 
496

 
648

 
1,127

Net (income) attributable to noncontrolling interests (includes $(39), $(16), $(29), $(55) and $(40) related to consolidated investment management funds, respectively)
(40
)
 
(16
)
 
(30
)
 
(56
)
 
(42
)
Net income (loss) applicable to shareholders of The Bank of New York Mellon Corporation
845

 
(253
)
 
466

 
592

 
1,085

Preferred stock dividends
(12
)
 
(13
)
 

 
(25
)
 

Net income (loss) applicable to common shareholders of The Bank of New York Mellon Corporation
$
833

 
$
(266
)
 
$
466

 
$
567

 
$
1,085

 


BNY Mellon 65


The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Income Statement (unaudited) (continued) 
Net income (loss) applicable to common shareholders of The Bank of New York Mellon Corporation used for the earnings per share calculation
Quarter ended
 
Year-to-date
(in millions)
June 30,
2013

 
March 31,
2013

 
June 30,
2012

 
June 30,
2013

 
June 30,
2012

Net income (loss) applicable to common shareholders of The Bank of New York Mellon Corporation
$
833

 
$
(266
)
 
$
466

 
$
567

 
$
1,085

Less:  Earnings allocated to participating securities (a)
15

 
2

 
7

 
10

 
15

Change in the excess of redeemable value over the fair value of noncontrolling interests

 
1

 
1

 
1

 
(5
)
Net income (loss) applicable to the common shareholders of The Bank of New York Mellon Corporation after required adjustments for the calculation of basic and diluted earnings per common share
$
818

 
$
(269
)
 
$
458

 
$
556

 
$
1,075

 
(a)
In a period with net income, both earnings and dividends are allocated to participating securities. In a period with a net loss, only dividends are allocated to participating securities. As a result, the earnings allocated to participating securities for the six months ended June 30, 2013 do not equal the earnings allocated to participating securities for the three months ended June 30, 2013 and March 31, 2013 in aggregate.


Average common shares and equivalents outstanding
of The Bank of New York Mellon Corporation
Quarter ended
 
Year-to-date
(in thousands)
June 30,
2013

 
March 31,
2013

 
June 30,
2012

 
June 30,
2013

 
June 30,
2012

Basic
1,152,545

 
1,158,819

 
1,181,350

 
1,155,667

 
1,187,649

Common stock equivalents
15,589

 

 
9,414

 
15,746

 
9,263

Less: Participating securities
(12,153
)
 

 
(7,779
)
 
(12,244
)
 
(7,648
)
Diluted (a)
1,155,981

 
1,158,819

 
1,182,985

 
1,159,169

 
1,189,264

 
 
 
 
 
 
 
 
 
 
Anti-dilutive securities (b)
78,825

 
81,659

 
94,650

 
78,418

 
93,315



Earnings per share applicable to the common shareholders
of The Bank of New York Mellon Corporation (c)
Quarter ended
 
Year-to-date
(in dollars)
June 30,
2013

 
March 31,
2013

 
June 30,
2012

 
June 30,
2013

 
June 30,
2012

Basic
$
0.71

 
$
(0.23
)
 
$
0.39

 
$
0.48

 
$
0.91

Diluted (a)
$
0.71

 
$
(0.23
)
 
$
0.39

 
$
0.48

 
$
0.90

(a)
Diluted earnings per share for the three months ended March 31, 2013 was calculated using average basic shares. Adding back the dilutive shares would result in anti-dilution.
(b)
Represents stock options, restricted stock, restricted stock units and participating securities outstanding but not included in the computation of diluted average common shares because their effect would be anti-dilutive.
(c)
Basic and diluted earnings per share under the two-class method are determined on the net income applicable to common shareholders of The Bank of New York Mellon Corporation reported on the income statement less earnings allocated to participating securities, and the change in the excess of redeemable value over the fair value of noncontrolling interests.


See accompanying Notes to Consolidated Financial Statements.



66 BNY Mellon


The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Comprehensive Income Statement (unaudited)
 
Quarter ended
 
Year-to-date
(in millions)
June 30, 2013

 
March 31, 2013

 
June 30, 2012

 
June 30, 2013

 
June 30, 2012

Net income (loss)
$
885

 
$
(237
)
 
$
496

 
$
648

 
$
1,127

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
5

 
(309
)
 
(265
)
 
(304
)
 
(93
)
Unrealized gain (loss) on assets available-for-sale:
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) arising during the period
(736
)
 
(6
)
 
197

 
(742
)
 
434

Reclassification adjustment
(17
)
 
(30
)
 
(35
)
 
(47
)
 
(59
)
Total unrealized gain (loss) on assets available-for-sale
(753
)
 
(36
)
 
162

 
(789
)
 
375

Defined benefit plans:
 
 
 
 
 
 
 
 
 
Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost
31

 
43

 
24

 
74

 
51

Total defined benefit plans
31

 
43

 
24

 
74

 
51

Net unrealized gain (loss) on cash flow hedges
(9
)
 
1

 

 
(8
)
 
3

Total other comprehensive income (loss), net of tax (a)
(726
)
 
(301
)
 
(79
)
 
(1,027
)
 
336

Net (income) attributable to noncontrolling interests
(40
)
 
(16
)
 
(30
)
 
(56
)
 
(42
)
Other comprehensive (income) loss attributable to noncontrolling interests
(10
)
 
29

 
28

 
19

 
11

Net comprehensive income (loss)
$
109

 
$
(525
)
 
$
415

 
$
(416
)
 
$
1,432

(a)
Other comprehensive income (loss) attributable to The Bank of New York Mellon Corporation shareholders was $(736) million for the quarter ended June 30, 2013, $(272) million for the quarter ended March 31, 2013, $(51) million for the quarter ended June 30, 2012, $(1,008) million for the six months ended June 30, 2013 and $347 million for the six months ended June 30, 2012.


See accompanying Notes to Consolidated Financial Statements.




BNY Mellon 67


The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Balance Sheet (unaudited)
  
June 30,
2013

 
Dec. 31, 2012

(dollars in millions, except per share amounts)
 
Assets
 
 
 
Cash and due from:
 
 
 
Banks
$
6,940

 
$
4,727

Interest-bearing deposits with the Federal Reserve and other central banks
77,150

 
90,110

Interest-bearing deposits with banks
42,145

 
43,910

Federal funds sold and securities purchased under resale agreements
9,978

 
6,593

Securities:
 
 
 
Held-to-maturity (fair value of $13,596 and $8,389)
13,785

 
8,205

Available-for-sale
91,570

 
92,619

Total securities
105,355

 
100,824

Trading assets
10,908

 
9,378

Loans
50,307

 
46,629

Allowance for loan losses
(212
)
 
(266
)
Net loans
50,095

 
46,363

Premises and equipment
1,595

 
1,659

Accrued interest receivable
614

 
593

Goodwill
17,919

 
18,075

Intangible assets
4,588

 
4,809

Other assets (includes $1,625 and $1,321, at fair value)
21,747

 
20,468

Subtotal assets of operations
349,034

 
347,509

Assets of consolidated investment management funds, at fair value:
 
 
 
Trading assets
10,766

 
10,961

Other assets
705

 
520

Subtotal assets of consolidated investment management funds, at fair value
11,471

 
11,481

Total assets
$
360,505

 
$
358,990

Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing (principally U.S. offices)
$
82,948

 
$
93,019

Interest-bearing deposits in U.S. offices
54,428

 
53,826

Interest-bearing deposits in Non-U.S. offices
107,506

 
99,250

Total deposits
244,882

 
246,095

Federal funds purchased and securities sold under repurchase agreements
12,600

 
7,427

Trading liabilities
8,014

 
8,176

Payables to customers and broker-dealers
15,267

 
16,095

Commercial paper
111

 
338

Other borrowed funds
1,060

 
1,380

Accrued taxes and other expenses
7,340

 
7,316

Other liabilities (including allowance for lending-related commitments of $125 and $121,
also includes $216 and $704, at fair value)
5,677

 
6,010

Long-term debt (includes $324 and $345, at fair value)
18,481

 
18,530

Subtotal liabilities of operations
313,432

 
311,367

Liabilities of consolidated investment management funds, at fair value:
 
 
 
Trading liabilities
10,110

 
10,152

Other liabilities
32

 
29

Subtotal liabilities of consolidated investment management funds, at fair value
10,142

 
10,181

Total liabilities
323,574

 
321,548

Temporary equity
 
 
 
Redeemable noncontrolling interests
189

 
178

Permanent equity
 
 
 
Preferred stock - par value $0.01 per share; authorized 100,000,000 shares; issued 15,826 and 10,826 shares
1,562

 
1,068

Common stock – par value $0.01 per share; authorized 3,500,000,000 shares; issued 1,262,295,165 and 1,254,182,209 shares
13

 
13

Additional paid-in capital
23,796

 
23,485

Retained earnings
14,859

 
14,622

Accumulated other comprehensive loss, net of tax
(1,651
)
 
(643
)
Less: Treasury stock of 111,818,475 and 90,691,868 common shares, at cost
(2,697
)
 
(2,114
)
Total The Bank of New York Mellon Corporation shareholders’ equity
35,882

 
36,431

Nonredeemable noncontrolling interests of consolidated investment management funds
860

 
833

Total permanent equity
36,742

 
37,264

Total liabilities, temporary equity and permanent equity
$
360,505

 
$
358,990

See accompanying Notes to Consolidated Financial Statements.


68 BNY Mellon


The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Statement of Cash Flows (unaudited)
  
Six months ended June 30,
(in millions)
2013

 
2012

Operating activities
 
 
 
Net income
$
648

 
$
1,127

Net (income) attributable to noncontrolling interests
(56
)
 
(42
)
Net income applicable to shareholders of The Bank of New York Mellon Corporation
592

 
1,085

Adjustments to reconcile net income to net cash provided by (used for) operating activities:
 
 
 
Provision for credit losses
(43
)
 
(14
)
Pension plan contribution
(22
)
 
(21
)
Depreciation and amortization
706

 
598

Deferred tax (benefit) expense
(34
)
 
(285
)
Net securities (gains) and venture capital (income)
(83
)
 
(95
)
Change in trading activities
(1,692
)
 
(179
)
Change in accruals and other, net
(383
)
 
(715
)
Net cash (used for) provided by operating activities
(959
)
 
374

Investing activities
 
 
 
Change in interest-bearing deposits with banks
2,682

 
(3,502
)
Change in interest-bearing deposits with the Federal Reserve and other central banks
12,960

 
14,000

Purchases of securities held-to-maturity
(6,724
)
 
(3,123
)
Paydowns of securities held-to-maturity
687

 
189

Maturities of securities held-to-maturity
24

 
403

Purchases of securities available-for-sale
(17,468
)
 
(24,126
)
Sales of securities available-for-sale
9,218

 
5,577

Paydowns of securities available-for-sale
5,266

 
4,784

Maturities of securities available-for-sale
1,442

 
5,447

Net change in loans
(3,800
)
 
(1,424
)
Sales of loans and other real estate
80

 
160

Change in federal funds sold and securities purchased under resale agreements
(3,385
)
 
(4,034
)
Change in seed capital investments
(38
)
 
(2
)
Purchases of premises and equipment/capitalized software
(258
)
 
(276
)
Proceeds from the sale of premises and equipment

 
5

Acquisitions, net of cash
(5
)
 
(4
)
Other, net
(1,313
)
 
133

Net cash (used for) investing activities
(632
)
 
(5,793
)
Financing activities
 
 
 
Change in deposits
164

 
2,373

Change in federal funds purchased and securities sold under repurchase agreements
5,173

 
2,895

Change in payables to customers and broker-dealers
(828
)
 
634

Change in other borrowed funds
(304
)
 
(773
)
Change in commercial paper
(227
)
 
1,554

Net proceeds from the issuance of long-term debt
1,497

 
1,264

Repayments of long-term debt
(1,128
)
 
(1,714
)
Proceeds from the exercise of stock options
136

 
6

Issuance of preferred stock
494

 
500

Issuance of common stock
12

 
13

Treasury stock acquired
(583
)
 
(687
)
Common cash dividends paid
(330
)
 
(314
)
Preferred cash dividends paid
(25
)
 

Other, net
(120
)
 
30

Net cash provided by financing activities
3,931

 
5,781

Effect of exchange rate changes on cash
(127
)
 
(15
)
Change in cash and due from banks
 
 
 
Change in cash and due from banks
2,213

 
347

Cash and due from banks at beginning of period
4,727

 
4,175

Cash and due from banks at end of period
$
6,940

 
$
4,522

Supplemental disclosures
 
 
 
Interest paid
$
178

 
$
292

Income taxes paid
175

 
460

Income taxes refunded
17

 
7

See accompanying Notes to Consolidated Financial Statements.



BNY Mellon 69


The Bank of New York Mellon Corporation (and its subsidiaries)

Consolidated Statement of Changes in Equity (unaudited)

 
The Bank of New York Mellon Corporation  shareholders
Non-
redeemable
noncontrolling
interests of
consolidated
investment
management
funds

Total
permanent
equity

 
Redeemable
non-
controlling
interests/
temporary
equity

(in millions, except per
share amounts)
Preferred stock

Common
stock

Additional
paid-in
capital

Retained
earnings

Accumulated
other
comprehensive
(loss),
net of tax

Treasury
stock

Balance at Dec. 31, 2012
$
1,068

$
13

$
23,485

$
14,622

$
(643
)
$
(2,114
)
$
833

$
37,264

(a)
$
178

Shares issued to shareholders of noncontrolling interests








 
24

Redemption of subsidiary shares from noncontrolling interests








 
(26
)
Other net changes in noncontrolling interests


11




(18
)
(7
)
 
21

Net income



592



55

647

 
1

Other comprehensive (loss)




(1,008
)

(10
)
(1,018
)
 
(9
)
Dividends:
 
 
 
 
 
 
 
 
 
 
Common stock at $0.28 per share



(330
)



(330
)
 

Preferred stock



(25
)



(25
)
 

Repurchase of common stock





(583
)

(583
)
 

Common stock issued under:
 
 
 
 
 
 
 
 
 
 
Employee benefit plans


13





13

 

Direct stock purchase and dividend reinvestment plan


10





10

 

Preferred stock issued
494







494

 

Stock awards and options exercised


277





277

 

Balance at June 30, 2013
$
1,562

$
13

$
23,796

$
14,859

$
(1,651
)
$
(2,697
)
$
860

$
36,742

(a)
$
189

(a)
Includes total The Bank of New York Mellon Corporation common shareholders’ equity of $35,363 million at Dec. 31, 2012, and $34,320 million at June 30, 2013.

See accompanying Notes to Consolidated Financial Statements.





70 BNY Mellon

Notes to Consolidated Financial Statements
 


Note 1 - Basis of presentation

Basis of Presentation

The accounting and financial reporting policies of BNY Mellon, a global financial services company, conform to U.S. generally accepted accounting principles (“GAAP”) and prevailing industry practices.

The accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of financial position, results of operations and cash flows for the periods have been made. These financial statements should be read in conjunction with BNY Mellon’s Annual Report on Form 10-K for the year ended Dec. 31, 2012. Certain immaterial reclassifications have been made to prior periods to place them on a basis comparable with current period presentation.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates based upon assumptions about future economic and market conditions which affect reported amounts and related disclosures in our financial statements. Although our current estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual conditions could be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Amounts subject to estimates are items such as the allowance for loan losses and lending-related commitments, the fair value of financial instruments and other-than-temporary impairments, goodwill and intangible assets and pension accounting. Among other effects, such changes in estimates could result in future impairments of investment securities, goodwill and intangible assets and establishment of allowances for loan losses and lending-related commitments as well as changes in pension and post-retirement expense.

 
Note 2 - Accounting changes and new accounting guidance

ASU 2011-11 - Disclosures about Offsetting Assets and Liabilities

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-11, “Disclosures about Offsetting Assets and Liabilities”. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. See Note 17 “Derivative instruments” for our disclosure.

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

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment.” This guidance allows an entity an option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired. If the intangible asset is impaired, an entity is required to perform the quantitative impairment test. An entity is not required to calculate the fair value of an indefinite-lived intangible asset and perform the quantitative impairment test unless the entity determines that it is more likely than not that the asset is impaired.

ASU 2013-02 - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

In February 2013, the FASB issued ASU 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This ASU requires the presentation of the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. See Note 14 “Other comprehensive income (loss)” for our disclosure.




BNY Mellon 71

Notes to Consolidated Financial Statements (continued)
 

Note 3—Acquisitions and dispositions

We sometimes structure our acquisitions with both an initial payment and later contingent payments tied to post-closing revenue or income growth. For acquisitions completed prior to Jan. 1, 2009, we record the fair value of contingent payments as an additional cost of the entity acquired in the period that the payment becomes probable. For acquisitions completed after Jan. 1, 2009, subsequent changes in the fair value of a contingent consideration liability are recorded through the income statement. Contingent payments totaled $1 million in the second quarter of 2013 and $5 million in the first six months of 2013.

At June 30, 2013, we were potentially obligated to pay additional consideration which, using reasonable assumptions for the performance of the acquired companies and joint ventures based on contractual agreements, could range from $10 million to $22 million over the next one year.

Disposition in 2013

On May 31, 2013, BNY Mellon sold SourceNet Solutions, our accounts payable outsourcing support services provider that was part of our Investment Services business, for $11 million. As a result of this sale, we recorded a pre-tax gain of $2 million and an after-tax gain of $10 million.

Acquisitions in 2012

On Oct 1, 2012, BNY Mellon acquired the remaining 50% interest of the WestLB Mellon Asset Management joint venture for cash of $22 million. We later renamed the unit Meriten Investment Management GmbH (“Meriten”). We are obligated to pay, upon occurrence of certain events, contingent additional consideration of up to $13 million. Goodwill related to this acquisition, including the fair value of the contingent additional consideration, totaled $70 million and is included in our Investment Management business. This goodwill is not deductible for tax purposes. Customer relationship intangible assets related to this acquisition are included in our Investment Management business, with a life of eight years, and totaled $23 million.






72 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 4 - Securities

The following tables present the amortized cost, the gross unrealized gains and losses and the fair value of securities at June 30, 2013 and Dec. 31, 2012.

Securities at
June 30, 2013
Amortized
cost

Gross
unrealized
Fair
value

 
(in millions)
Gains

Losses

Available-for-sale:
 
 
 
 
 
U.S. Treasury
$
14,844

$
164

$
286

$
14,722

 
U.S. Government agencies
1,126

20

4

1,142

 
State and political subdivisions
6,475

54

95

6,434

 
Agency RMBS
37,146

383

401

37,128

 
Alt-A RMBS
240

38

12

266

 
Prime RMBS
575

4

15

564

 
Subprime RMBS
457

6

40

423

 
Other RMBS
2,418

46

83

2,381

 
Commercial MBS
2,711

73

39

2,745

 
Agency commercial MBS
1,137

1

16

1,122

 
Asset-backed CLOs
1,439

11

4

1,446

 
Other asset-backed securities
2,028

4

14

2,018

 
Foreign covered bonds
3,195

27

11

3,211

 
Corporate bonds
1,512

34

19

1,527

 
Other debt securities
12,497

147

13

12,631

(a) 
Equity securities
5

7


12

 
Money market funds
918



918

 
Alt-A RMBS (b)
1,459

390

2

1,847

 
Prime RMBS (b)
748

152

1

899

 
Subprime RMBS (b)
113

21


134

 
Total securities available-for-sale
91,043

1,582

1,055

91,570

 
Held-to-maturity:
 
 
 
 
 
U.S. Treasury
3,324

36

52

3,308

 
U.S. Government agencies
419


13

406

 
State and political subdivisions
47

1


48

 
Agency RMBS
8,469

20

153

8,336

 
Alt-A RMBS
96

10

2

104

 
Prime RMBS
86

1

2

85

 
Subprime RMBS
28


1

27

 
Other RMBS
617

20

48

589

 
Commercial MBS
20


1

19

 
Other securities
679


5

674

 
Total securities held-to-maturity
13,785

88

277

13,596

 
Total securities
$
104,828

$
1,670

$
1,332

$
105,166

 
(a)
Includes $10.4 billion, at fair value, of government-sponsored and guaranteed entities, and sovereign debt.
(b)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.


 
Securities at
Dec. 31, 2012
Amortized
cost

Gross
unrealized
Fair
value

 
(in millions)
Gains

Losses

Available-for-sale:
 
 
 
 
 
U.S. Treasury
$
17,539

$
467

$
3

$
18,003

 
U.S. Government agencies
1,044

30


1,074

 
State and political subdivisions
6,039

112

29

6,122

 
Agency RMBS
33,355

846

8

34,193

 
Alt-A RMBS
255

40

16

279

 
Prime RMBS
728

9

9

728

 
Subprime RMBS
508

6

62

452

 
Other RMBS
2,850

53

109

2,794

 
Commercial MBS
3,031

153

45

3,139

 
Asset-backed CLOs
1,285

7

10

1,282

 
Other asset-backed securities
2,123

11

3

2,131

 
Foreign covered bonds
3,596

122


3,718

 
Corporate bonds
1,525

63

3

1,585

 
Other debt securities
11,516

276


11,792

(a) 
Equity securities
23

4


27

 
Money market funds
2,190



2,190

 
Alt-A RMBS (b)
1,574

400

4

1,970

 
Prime RMBS (b)
833

177


1,010

 
Subprime RMBS (b)
113

17


130

 
Total securities available-for-sale
90,127

2,793

301

92,619

 
Held-to-maturity:
 
 
 
 
 
U.S. Treasury
1,011

59


1,070

 
State and political subdivisions
67

2


69

 
Agency RMBS
5,879

139

1

6,017

 
Alt-A RMBS
111

9

6

114

 
Prime RMBS
97

1

1

97

 
Subprime RMBS
28


1

27

 
Other RMBS
983

36

52

967

 
Commercial MBS
26


1

25

 
Other securities
3



3

 
Total securities held-to-maturity
8,205

246

62

8,389

 
Total securities
$
98,332

$
3,039

$
363

$
101,008

 
(a)
Includes $9.4 billion, at fair value, of government-sponsored and guaranteed entities, and sovereign debt.
(b)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.


Net securities gains (losses)
 
 
 
 
(in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

Realized gross gains
$
51

$
57

$
122

$
108

$
184

Realized gross losses
(1
)
(5
)
(5
)
(6
)
(5
)
Recognized gross impairments
(18
)
(4
)
(67
)
(22
)
(89
)
Total net securities gains (losses)
$
32

$
48

$
50

$
80

$
90






BNY Mellon 73

Notes to Consolidated Financial Statements (continued)
 

Temporarily impaired securities

At June 30, 2013, substantially all of the unrealized losses on the investment securities portfolio were attributable to interest rate movements and credit spreads widening since purchase. We do not intend to sell these securities and it is not more likely than not that we will have to sell.
 


The following tables show the aggregate related fair value of investments with a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or more.



Temporarily impaired securities at June 30, 2013
Less than 12 months
 
12 months or more
 
Total
(in millions)
Fair
value

 
Unrealized
losses

 
Fair
value

 
Unrealized
losses

 
Fair
value

 
Unrealized
losses

Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
6,269

 
$
286

 
$

 
$

 
$
6,269

 
$
286

U.S. Government agencies
97

 
4

 

 

 
97

 
4

State and political subdivisions
3,414

 
73

 
287

 
22

 
3,701

 
95

Agency RMBS
18,007

 
401

 
84

 

 
18,091

 
401

Alt-A RMBS
17

 
4

 
35

 
8

 
52

 
12

Prime RMBS
227

 
4

 
200

 
11

 
427

 
15

Subprime RMBS

 

 
398

 
40

 
398

 
40

Other RMBS
219

 
2

 
621

 
81

 
840

 
83

Commercial MBS
484

 
23

 
204

 
16

 
688

 
39

Agency commercial MBS
584

 
16

 

 

 
584

 
16

Asset-backed CLOs
275

 
1

 
110

 
3

 
385

 
4

Other asset-backed securities
1,584

 
13

 
6

 
1

 
1,590

 
14

Foreign covered bonds
1,620

 
11

 

 

 
1,620

 
11

Corporate bonds
299

 
19

 

 

 
299

 
19

Other debt securities
2,681

 
13

 

 

 
2,681

 
13

Alt-A RMBS (a)
25

 
1

 
26

 
1

 
51

 
2

Prime RMBS (a)
21

 
1

 
6

 

 
27

 
1

Total securities available-for-sale
$
35,823

 
$
872

 
$
1,977

 
$
183

 
$
37,800

 
$
1,055

Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
2,410

 
$
52

 
$

 
$

 
2,410

 
52

U.S. Government agencies
406

 
13

 

 

 
406

 
13

Agency RMBS
7,861

 
153

 

 

 
7,861

 
153

Alt-A RMBS
2

 

 
23

 
2

 
25

 
2

Prime RMBS
5

 

 
52

 
2

 
57

 
2

Subprime RMBS

 

 
24

 
1

 
24

 
1

Other RMBS

 

 
418

 
48

 
418

 
48

Commercial MBS

 

 
20

 
1

 
20

 
1

Other securities
606

 
5

 

 

 
606

 
5

Total securities held-to-maturity
$
11,290

 
$
223

 
$
537

 
$
54

 
$
11,827

 
$
277

Total temporarily impaired securities
$
47,113

 
$
1,095

 
$
2,514

 
$
237

 
$
49,627

 
$
1,332

(a)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.




74 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Temporarily impaired securities at Dec. 31, 2012
Less than 12 months
 
12 months or more
 
Total
(in millions)
Fair
value

 
Unrealized
losses

 
Fair
value

 
Unrealized
losses

 
Fair
value

 
Unrealized
losses

Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
956

 
$
3

 
$

 
$

 
$
956

 
$
3

State and political subdivisions
1,139

 
7

 
173

 
22

 
1,312

 
29

Agency RMBS
1,336

 
8

 
96

 

 
1,432

 
8

Alt-A RMBS
31

 
13

 
39

 
3

 
70

 
16

Prime RMBS
110

 
2

 
253

 
7

 
363

 
9

Subprime RMBS
13

 
3

 
397

 
59

 
410

 
62

Other RMBS
64

 
19

 
670

 
90

 
734

 
109

Commercial MBS
131

 
1

 
310

 
44

 
441

 
45

Asset-backed CLOs
314

 
1

 
321

 
9

 
635

 
10

Other asset-backed securities
779

 
2

 
7

 
1

 
786

 
3

Corporate bonds
178

 
3

 

 

 
178

 
3

Alt-A RMBS (a)
22

 

 
30

 
4

 
52

 
4

Total securities available-for-sale
$
5,073

 
$
62

 
$
2,296

 
$
239

 
$
7,369

 
$
301

Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
$
234

 
$
1

 
$

 
$

 
$
234

 
$
1

Alt-A RMBS
38

 

 
24

 
6

 
62

 
6

Prime RMBS

 

 
56

 
1

 
56

 
1

Subprime RMBS

 

 
24

 
1

 
24

 
1

Other RMBS
413

 

 
373

 
52

 
786

 
52

Commercial MBS

 

 
25

 
1

 
25

 
1

Total securities held-to-maturity
$
685

 
$
1

 
$
502

 
$
61

 
$
1,187

 
$
62

Total temporarily impaired securities
$
5,758

 
$
63

 
$
2,798

 
$
300

 
$
8,556

 
$
363

(a)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.


The following table shows the maturity distribution by carrying amount and yield (on a tax equivalent basis) of our investment securities portfolio at June 30, 2013.

Maturity distribution and yield on investment securities at June 30, 2013
U.S.
Treasury
 
U.S.
Government
agencies
 
State and
political
subdivisions
 
Other bonds,
notes and
debentures
 
Mortgage/
asset-backed and
equity
securities
 
 
(dollars in millions)
Amount

Yield (a)

 
Amount

Yield (a)

 
Amount

Yield (a)

 
Amount

Yield (a)

 
Amount

Yield (a)

 
Total

Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year or less
$
4,685

0.69
%
 
$
327

1.14
%
 
$
327

0.93
%
 
$
3,840

1.20
%
 
$

%
 
$
9,179

Over 1 through 5 years
4,770

1.18

 
672

1.85

 
3,094

1.79

 
11,115

1.11

 


 
19,651

Over 5 through 10 years
1,338

2.86

 
143

1.67

 
2,706

3.09

 
2,403

2.56

 


 
6,590

Over 10 years
3,929

3.12

 


 
307

2.74

 
11


 


 
4,247

Mortgage-backed securities


 


 


 


 
47,509

2.56

 
47,509

Asset-backed securities


 


 


 


 
3,464

1.26

 
3,464

Equity securities (b)


 


 


 


 
930


 
930

Total
$
14,722

1.69
%
 
$
1,142

1.62
%
 
$
6,434

2.34
%
 
$
17,369

1.33
%
 
$
51,903

2.43
%
 
$
91,570

Securities held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year or less
$

%
 
$

%
 
$

%
 
$
3

0.14
%
 
$

%
 
$
3

Over 1 through 5 years
2,328

1.19

 
308

1.20
%
 


 
676

0.54

 


 
3,312

Over 5 through 10 years
996

2.22

 
111

1.61
%
 
36

6.76

 


 


 
1,143

Over 10 years


 

%
 
11

5.22

 


 


 
11

Mortgage-backed securities


 


 


 


 
9,316

2.74
%
 
9,316

Total
$
3,324

1.50
%
 
$
419

1.31
%
 
$
47

6.41
%
 
$
679

0.54
%
 
$
9,316

2.74
%
 
$
13,785

(a)
Yields are based upon the amortized cost of securities.
(b)
Includes money market funds.




BNY Mellon 75

Notes to Consolidated Financial Statements (continued)
 

Other-than-temporary impairment

We routinely conduct periodic reviews of all securities using economic models to identify and evaluate each investment security to determine whether OTTI has occurred. Various inputs to the economic models are used to determine if an unrealized loss on securities is other-than-temporary. For example, the most significant inputs related to non-agency RMBS are:

Default rate - the number of mortgage loans expected to go into default over the life of the transaction, which is driven by the roll rate of loans in each performance bucket that will ultimately migrate to default; and
Severity - the loss expected to be realized when a loan defaults.

To determine if an unrealized loss is other-than-temporary, we project total estimated defaults of the underlying assets (mortgages) and multiply that calculated amount by an estimate of realizable value upon sale of these assets in the marketplace (severity) in order to determine the projected collateral loss. In determining estimated default rate and severity assumptions, we review the performance of the underlying securities, industry studies, market forecasts, as well as our view of the economic outlook affecting collateral. We also evaluate the current credit enhancement underlying the bond to determine the impact on cash flows. If we determine that a given security will be subject to a write-down or loss, we record the expected credit loss as a charge to earnings.

The table below shows the projected weighted-average default rates and loss severities for the 2007, 2006 and late 2005 non-agency RMBS and the securities previously held in the Grantor Trust we established in connection with the restructuring of our investment securities portfolio in 2009, at June 30, 2013 and Dec. 31, 2012.

Projected weighted-average default rates and loss severities
 
June 30, 2013
 
Dec. 31, 2012
 
Default rate

 
Severity

 
Default rate

 
Severity

Alt-A
41
%
 
57
%
 
43
%
 
57
%
Subprime
59
%
 
72
%
 
61
%
 
72
%
Prime
23
%
 
43
%
 
24
%
 
43
%

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

Net securities gains (losses)
 
 
(in millions)
2Q13

1Q13

2Q12

YTD13

YTD12

U.S. Treasury
$
31

$
(4
)
$
44

$
27

$
82

Commercial MBS
7

8


15


Foreign covered bonds

8


8


Non-agency RMBS
(3
)
4

(27
)
1

(41
)
Sovereign debt

1

61

1

68

European floating rate notes
(10
)
4

(22
)
(6
)
(23
)
Other
7

27

(6
)
34

4

Total net securities gains
$
32

$
48

$
50

$
80

$
90



The following table reflects investment securities credit losses recorded in earnings. The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods. The additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred. The deductions represent credit losses on securities that have been sold, are required to be sold, or for which it is our intention to sell.

Debt securities credit loss roll forward
 
 
(in millions)
2Q13

2Q12

Beginning balance as of March 31
$
174

$
266

Add: Initial OTTI credit losses
16

38

Subsequent OTTI credit losses
3

29

Less: Realized losses for securities sold
29


Ending balance as of June 30
$
164

$
333



Debt securities credit loss roll forward
Year-to-date
(in millions)
2013

2012

Beginning balance as of Jan. 1
$
288

$
253

Add: Initial OTTI credit losses
16

49

Subsequent OTTI credit losses
7

39

Less: Realized losses for securities sold
147

8

Ending balance as of June 30
$
164

$
333







76 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 5—Loans and asset quality

Loans

The table below provides the details of our loan distribution and industry concentrations of credit risk at June 30, 2013 and Dec. 31, 2012.

Loans
June 30, 2013

 
Dec. 31, 2012

(in millions)
 
Domestic:
 
 
 
Financial institutions
$
3,946

 
$
5,455

Commercial
1,511

 
1,306

Wealth management loans and mortgages
9,190

 
8,796

Commercial real estate
2,075

 
1,677

Lease financings (a)
1,282

 
1,329

Other residential mortgages
1,505

 
1,632

Overdrafts
1,762

 
2,228

Other
657

 
639

Margin loans
14,434

 
13,397

Total domestic
36,362

 
36,459

Foreign:
 
 
 
Financial institutions
8,990

 
5,833

Commercial
136

 
111

Wealth management loans and mortgages
74

 
68

Commercial real estate
18

 
63

Lease financings (a)
963

 
1,025

Other (primarily overdrafts)
3,764

 
3,070

Total foreign
13,945

 
10,170

Total loans
$
50,307

 
$
46,629

(a)
Net of unearned income on domestic and foreign lease financings of $1,063 million at June 30, 2013 and $1,135 million at Dec. 31, 2012.

 

Our loan portfolio is comprised of three portfolio segments: commercial, lease financings and mortgages. We manage our portfolio at the class level which is comprised of six classes of financing receivables: commercial, commercial real estate, financial institutions, lease financings, wealth management loans and mortgages and other residential mortgages. The following tables are presented for each class of financing receivable, and provide additional information about our credit risks and the adequacy of our allowance for credit losses.




BNY Mellon 77

Notes to Consolidated Financial Statements (continued)
 

Allowance for credit losses

Transactions in the allowance for credit losses are summarized as follows:

Allowance for credit losses activity for the quarter ended June 30, 2013
Wealth
management
loans and
mortgages

Other residential mortgages

 
 
 
 
(in millions)
Commercial

Commercial
real estate

Financial
institutions

Lease
financings

All
Other

 
Foreign

Total

Beginning balance
$
97

$
31

$
33

$
39

$
29

$
81

$
2

 
$
46

$
358

Charge-offs





(3
)

 

(3
)
Recoveries





1


 

1

Net (charge-offs)





(2
)

 

(2
)
Provision
(4
)
(1
)
1

2

(10
)
(4
)
(2
)
 
(1
)
(19
)
Ending balance
$
93

$
30

$
34

$
41

$
19

$
75

$

 
$
45

$
337

Allowance for:
 
 
 
 
 
 
 
 
 
 
Loans losses
$
19

$
18

$
7

$
41

$
15

$
75

$

 
$
37

$
212

Unfunded commitments
74

12

27


4



 
8

125

Individually evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
54

$
15

$
2

$

$
14

$

$

 
$
9

$
94

Allowance for loan losses
3

1



3



 
4

11

Collectively evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
1,457

$
2,060

$
3,944

$
1,282

$
9,176

$
1,505

$
16,853

(a)
$
13,936

$
50,213

Allowance for loan losses
16

17

7

41

12

75


 
33

201

(a)
Includes $1,762 million of domestic overdrafts, $14,434 million of margin loans and $657 million of other loans at June 30, 2013.


Allowance for credit losses for quarter ended March 31, 2013
Wealth
management
loans and
mortgages

Other residential mortgages

 
 
 
 
(in millions)
Commercial

Commercial
real estate

Financial
institutions

Lease
financings

All
Other

 
Foreign

Total

Beginning balance
$
104

$
30

$
36

$
49

$
30

$
88

$
2


$
48

$
387

Charge-offs
(2
)




(3
)



(5
)
Recoveries










Net (charge-offs)
(2
)




(3
)



(5
)
Provision
(5
)
1

(3
)
(10
)
(1
)
(4
)

 
(2
)
(24
)
Ending balance
$
97

$
31

$
33

$
39

$
29

$
81

$
2


$
46

$
358

Allowance for:
 
 
 
 
 
 
 
 
 
 
Loans losses
$
22

$
19

$
11

$
39

$
25

$
81

$
2


$
38

$
237

Unfunded commitments
75

12

22


4




8

121

Individually evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
54

$
16

$
3

$

$
31

$

$


$
9

$
113

Allowance for loan losses
7

1



7




5

20

Collectively evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
1,297

$
1,806

$
4,917

$
1,295

$
8,888

$
1,570

$
16,658

(a)
$
12,680

$
49,111

Allowance for loan losses
15

18

11

39

18

81

2


33

217

(a)
Includes $2,772 million of domestic overdrafts, $13,242 million of margin loans and $644 million of other loans at March 31, 2013.




78 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Allowance for credit losses activity for the quarter ended June 30, 2012
Wealth
management
loans and
mortgages

Other
residential
mortgages

All
Other

 
Foreign

Total

(in millions)
Commercial

Commercial
real estate

Financial
institutions

Lease
financings

 
Beginning balance
$
97

$
33

$
53

$
62

$
34

$
165

$


$
50

$
494

Charge-offs


(4
)


(7
)



(11
)
Recoveries
1





2




3

Net (charge-offs)
1


(4
)


(5
)



(8
)
Provision
5


(10
)
(6
)
(8
)
(7
)


7

(19
)
Ending balance
$
103

$
33

$
39

$
56

$
26

$
153

$


$
57

$
467

Allowance for:
 
 
 
 
 
 
 
 
 
 
Loans losses
$
42

$
23

$
18

$
56

$
21

$
153

$


$
49

$
362

Unfunded commitments
61

10

21


5




8

105

Individually evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
62

$
29

$
3

$

$
31

$

$


$
9

$
134

Allowance for loan losses
16

6



7




5

34

Collectively evaluated for impairment:
 
 
 
 
 
 
 
 
 
 
Loan balance
$
752

$
1,566

$
4,832

$
1,505

$
7,885

$
1,773

$
16,811

(a)
$
10,173

$
45,297

Allowance for loan losses
26

17

18

56

14

153



44

328

(a)
Includes $2,750 million of domestic overdrafts, $13,462 million of margin loans and $599 million of other loans at June 30, 2012.


Allowance for credit losses activity for the six months ended June 30, 2013
Wealth
management
loans and
mortgages

Other
residential
mortgages

All
Other

 
Foreign

Total

(in millions)
Commercial

Commercial
real estate

Financial
institutions

Lease
financings

 
Beginning balance
$
104

$
30

$
36

$
49

$
30

$
88

$
2

 
$
48

$
387

Charge-offs
(2
)




(6
)

 

(8
)
Recoveries





1


 

1

Net (charge-offs)
(2
)




(5
)

 

(7
)
Provision
(9
)

(2
)
(8
)
(11
)
(8
)
(2
)
 
(3
)
(43
)
Ending balance
$
93

$
30

$
34

$
41

$
19

$
75

$

 
$
45

$
337



Allowance for credit losses activity for the six months ended June 30, 2012
Wealth
management
loans and
mortgages

Other
residential
mortgages

All
Other

 
Foreign

Total

(in millions)
Commercial

Commercial
real estate

Financial
institutions

Lease
financings

 
Beginning balance
$
91

$
34

$
63

$
66

$
29

$
156

$

 
$
58

$
497

Charge-offs


(4
)


(16
)

 

(20
)
Recoveries
1





3


 

4

Net (charge-offs)
1


(4
)


(13
)

 

(16
)
Provision
11

(1
)
(20
)
(10
)
(3
)
10


 
(1
)
(14
)
Ending balance
$
103

$
33

$
39

$
56

$
26

$
153

$

 
$
57

$
467




BNY Mellon 79

Notes to Consolidated Financial Statements (continued)
 

Nonperforming assets

The table below presents the distribution of our nonperforming assets. 

Nonperforming assets
June 30,
2013

 
Dec. 31, 2012

(in millions)
 
Nonperforming loans:
 
 
 
Other residential mortgages
$
135

 
$
158

Commercial
24

 
27

Commercial real estate
18

 
18

Wealth management loans and mortgages
13

 
30

Foreign loans
9

 
9

Financial institutions
2

 
3

Total nonperforming loans
201

 
245

Other assets owned
3

 
4

Total nonperforming assets (a)
$
204

 
$
249

(a)
Loans of consolidated investment management funds are not part of BNY Mellon’s loan portfolio. Included in these loans are nonperforming loans of $44 million at June 30, 2013 and $174 million at Dec. 31, 2012. These loans are recorded at fair value and therefore do not impact the provision for credit losses and allowance for loan losses, and accordingly are excluded from the nonperforming assets table above.
 
At June 30, 2013, undrawn commitments to borrowers whose loans were classified as nonaccrual or reduced rate were not material.

Lost interest

Lost interest
2Q13

1Q13

2Q12

YTD13

YTD12

(in millions)
Amount by which interest income recognized on nonperforming loans exceeded reversals
$
1

$
1

$
1

$
2

$
2

Amount by which interest income would have increased if nonperforming loans at period-end had been performing for the entire period
$
3

$
3

$
5

$
5

$
10






Impaired loans

The table below sets forth information about our impaired loans. We use the discounted cash flow method as the primary method for valuing impaired loans. 

Impaired loans
Quarter ended
 
June 30, 2013
 
March 31, 2013
 
June 30, 2012
(in millions)
Average
recorded
investment

 
Interest
income
recognized

 
Average
recorded
investment

 
Interest
income
recognized

 
Average
recorded
investment

 
Interest
income
recognized

Impaired loans with an allowance:
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
50

 
$
1

 
$
56

 
$
1

 
$
64

 
$
1

Commercial real estate
2

 

 
9

 

 
31

 

Financial institutions
1

 

 
1

 

 
6

 

Wealth management loans and mortgages
19

 

 
27

 

 
28

 

Foreign
9

 

 
9

 

 
10

 

Total impaired loans with an allowance
81

 
1

 
102

 
1

 
139

 
1

Impaired loans without an allowance:
 
 
 
 
 
 
 
 
 
 
 
Commercial
4

 

 

 

 

 

Commercial real estate
13

 

 
8

 

 
3

 

Financial institutions
2

 

 
1

 

 
2

 

Wealth management loans and mortgages
4

 

 
4

 

 
3

 

Total impaired loans without an allowance (a)
23

 

 
13

 

 
8

 

Total impaired loans
$
104

 
$
1

 
$
115

 
$
1

 
$
147

 
$
1

(a)
When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.




80 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Impaired loans
Year-to-date
 
June 30, 2013
 
June 30, 2012
(in millions)
Average
recorded
investment

 
Interest
income
recognized

 
Average
recorded
investment

 
Interest
income
recognized

Impaired loans with an allowance:
 
 
 
 
 
 
 
Commercial
$
52

 
$
2

 
$
51

 
$
2

Commercial real estate
7

 

 
32

 

Financial institutions
1

 

 
11

 

Wealth management loans and mortgages
21

 

 
28

 

Foreign
9

 

 
10

 

Total impaired loans with an allowance
90

 
2

 
132

 
2

Impaired loans without an allowance:
 
 
 
 
 
 
 
Commcercial
3

 

 

 

Commercial real estate
9

 

 
3

 

Financial institutions
2

 

 
2

 

Wealth management loans and mortgages
4

 

 
3

 

Total impaired loans without an allowance (a)
18

 

 
8

 

Total impaired loans
$
108

 
$
2

 
$
140

 
$
2

(a)
When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.


Impaired loans
June 30, 2013
 
Dec. 31, 2012
(in millions)
Recorded
investment

 
Unpaid
principal
balance

 
Related
allowance (a)

 
Recorded
investment

 
Unpaid
principal
balance

 
Related
allowance (a)

Impaired loans with an allowance:
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
45

 
$
49

 
$
3

 
$
57

 
$
61

 
$
12

Commercial real estate
2

 
3

 
1

 
15

 
16

 
1

Financial institutions

 

 

 
1

 
1

 

Wealth management loans and mortgages
10

 
10

 
3

 
28

 
28

 
7

Foreign
9

 
17

 
4

 
9

 
17

 
4

Total impaired loans with an allowance
66

 
79

 
11

 
110

 
123

 
24

Impaired loans without an allowance:
 
 
 
 
 
 
 
 
 
 
 
Commercial
9

 
9

 
N/A

 

 

 
N/A

Commercial real estate
13

 
13

 
N/A

 
2

 
2

 
N/A

Financial institutions
2

 
9

 
N/A

 
1

 
8

 
N/A

Wealth management loans and mortgages
4

 
5

 
N/A

 
4

 
4

 
N/A

Total impaired loans without an allowance (b)
28

 
36

 
N/A

 
7

 
14

 
N/A

Total impaired loans (c)
$
94

 
$
115

 
$
11

 
$
117

 
$
137

 
$
24

(a)
The allowance for impaired loans is included in the allowance for loan losses.
(b)
When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under the accounting standard related to impaired loans.
(c)
Excludes an aggregate of $1 million and $2 million of impaired loans in amounts individually less than $1 million at June 30, 2013 and Dec. 31, 2012, respectively. The allowance for loan loss associated with these loans totaled less than $1 million at both June 30, 2013 and Dec. 31, 2012.




BNY Mellon 81

Notes to Consolidated Financial Statements (continued)
 

Past due loans

The table below sets forth information about our past due loans. 

Past due loans and still accruing interest
June 30, 2013
 
Dec. 31, 2012
 
Days past due
 
Total
past due

 
Days past due
 
Total
past due

(in millions)
30-59

 
60-89

 
>90

 
30-59

 
60-89

 
>90

 
Domestic:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
30

 
$
8

 
$

 
$
38

 
$
44

 
$

 
$

 
$
44

Wealth management loans and mortgages
55

 
13

 

 
68

 
33

 
7

 
1

 
41

Commercial

 

 

 

 

 
60

 

 
60

Other residential mortgages
32

 
7

 
6

 
45

 
50

 
9

 
5

 
64

Total domestic
117

 
28

 
6

 
151

 
127

 
76

 
6

 
209

Foreign

 

 

 

 

 

 

 

Total past due loans
$
117

 
$
28

 
$
6

 
$
151

 
$
127

 
$
76

 
$
6

 
$
209

 


Troubled debt restructurings (“TDRs”)

A modified loan is considered a TDR if the debtor is experiencing financial difficulties and the creditor grants a concession to the debtor that would not
 


otherwise be considered. A TDR may include a transfer of real estate or other assets from the debtor to the creditor, or a modification of the term of the loan. Not all modified loans are considered TDRs.



The following table presents TDRs that occurred in the second quarter of 2013, first quarter of 2013 and the second quarter of 2012.


TDRs
2Q13
 
1Q13
 
2Q12
 

Outstanding
recorded investment
 
 
Outstanding
recorded investment
 

Outstanding
recorded investment
(dollars in millions)
Number of contracts

Pre-modification

Post-modification

 
Number of contracts

Pre-modification

Post-modification

 
Number of contracts

Pre-modification

Post-modification

Other residential mortgages
28

$
5

$
7

 
31

$
5

$
6

 
52

$
15

$
16

Commercial



 



 
1

4

4

Total TDRs
28

$
5

$
7

 
31

$
5

$
6

 
53

$
19

$
20



Other residential mortgages

The modifications of the other residential mortgage loans in the second quarter of 2013, first quarter of 2013 and second quarter of 2012 consisted of reducing the stated interest rates, and in certain cases, a forbearance of default and extending the maturity dates. The value of modified loans is based on the fair value of the collateral. Probable loss factors are applied to the value of the modified loans to determine the allowance for credit losses.

Commercial

The modification of the commercial exposure in the second quarter of 2012 consisted of changing the
 
maturity date of the loan. The difference between the book value of the loan and net cash flow discounted at the original loan’s rate, if no observable market price exists, is included in the allowance for credit losses.

TDRs that subsequently defaulted

There were 2 residential mortgage loans that had been restructured in a TDR during the previous 12 months and have subsequently defaulted in the second quarter of 2013. The total recorded investment of these loans was $1 million.




82 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Credit quality indicators

Our credit strategy is to focus on investment grade names to support cross-selling opportunities and avoid single name/industry concentrations. Each customer is assigned an internal credit rating which is
 
mapped to an external rating agency grade equivalent based upon a number of dimensions which are continually evaluated and may change over time.

The following tables set forth information about credit quality indicators.


Commercial loan portfolio

Commercial loan portfolio – Credit risk profile by creditworthiness category
 
Commercial
 
Commercial real estate
 
Financial institutions
(in millions)
June 30,
2013

 
Dec. 31, 2012

 
June 30,
2013

 
Dec. 31, 2012

 
June 30,
2013

 
Dec 31,
2012

Investment grade
$
1,280

 
$
1,064

 
$
1,596

 
$
1,289

 
$
11,367

 
$
9,935

Noninvestment grade
367

 
353

 
497

 
451

 
1,569

 
1,353

Total
$
1,647

 
$
1,417

 
$
2,093

 
$
1,740

 
$
12,936

 
$
11,288



The commercial loan portfolio is divided into investment grade and non-investment grade categories based on rating criteria largely consistent with those of the public rating agencies. Each customer in the portfolio is assigned an internal credit rating. These internal credit ratings are generally consistent with the ratings categories of the public rating agencies. Customers with ratings consistent with BBB- (S&P)/Baa3 (Moody’s) or better are considered to be investment grade. Those clients with ratings lower than this threshold are considered to be non-investment grade.

Wealth management loans and mortgages

Wealth management loans and mortgages – Credit risk
profile by internally assigned grade
(in millions)
June 30,
2013

 
Dec. 31, 2012

Wealth management loans:
 
 
 
Investment grade
$
4,701

 
$
4,597

Noninvestment grade
66

 
125

Wealth management mortgages
4,497

 
4,142

Total
$
9,264

 
$
8,864



Wealth management non-mortgage loans are not typically rated by external rating agencies. A majority of the wealth management loans are secured by the customers’ investment management accounts or custody accounts. Eligible assets pledged for these loans are typically investment-grade, fixed-income securities, equities and/or mutual funds. Internal ratings for this portion of the wealth management portfolio, therefore, would equate to investment-grade external ratings. Wealth management loans are provided to select customers based on the pledge of
 
other types of assets, including business assets, fixed assets or a modest amount of commercial real estate. For the loans collateralized by other assets, the credit quality of the obligor is carefully analyzed, but we do not consider this portfolio of loans to be investment grade.

Credit quality indicators for wealth management mortgages are not correlated to external ratings. Wealth management mortgages are typically loans to high-net-worth individuals, which are secured primarily by residential property. These loans are primarily interest-only adjustable rate mortgages with an average loan-to-value ratio of 64% at origination. In the wealth management portfolio, less than 1% of the mortgages were past due at June 30, 2013.

At June 30, 2013, the private wealth mortgage portfolio was comprised of the following geographic concentrations: New York - 21%; California - 20%; Massachusetts - 16%; Florida - 8%; and other - 35%.

Other residential mortgages

The other residential mortgage portfolio primarily consists of 1-4 family residential mortgage loans and totaled $1,505 million at June 30, 2013 and $1,632 million at Dec. 31, 2012. These loans are not typically correlated to external ratings. Included in this portfolio at June 30, 2013 are $461 million of mortgage loans purchased in 2005, 2006 and the first quarter of 2007 that are predominantly prime mortgage loans, with a small portion of Alt-A loans. As of June 30, 2013, the purchased loans in this portfolio had a weighted-average loan-to-value ratio of 75% at origination and 25% of these loans were at



BNY Mellon 83

Notes to Consolidated Financial Statements (continued)
 

least 60 days delinquent. The properties securing the prime and Alt-A mortgage loans were located (in order of concentration) in California, Florida, Virginia, the tri-state area (New York, New Jersey and Connecticut) and Maryland.

Overdrafts

Overdrafts primarily relate to custody and securities clearance clients and totaled $5,526 million at June 30, 2013 and $5,298 million at Dec. 31, 2012. Overdrafts occur on a daily basis in the custody and securities clearance business and are generally repaid within two business days.

Margin loans

We had $14,434 million of secured margin loans on our balance sheet at June 30, 2013 compared with $13,397 million at Dec. 31, 2012. Margin loans are collateralized with marketable securities and borrowers are required to maintain a daily collateral margin in excess of 100% of the value of the loan. We have rarely suffered a loss on these types of loans and do not allocate any of our allowance for credit losses to margin loans.

Other loans

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

 
Reverse repurchase agreements

Reverse repurchase agreements are transactions fully collateralized with high-quality liquid securities. These transactions carry minimal credit risk and therefore are not allocated an allowance for credit losses.

Note 6 - Goodwill and intangible assets

Impairment testing

Goodwill impairment testing is performed at least annually at the reporting unit level. Intangible assets not subject to amortization are tested annually for impairment or more often if events or circumstances indicate they may be impaired.

BNY Mellon’s three business segments include seven reporting units for which goodwill impairment testing is performed on an annual basis. In the second quarter of 2013, BNY Mellon conducted an annual goodwill impairment test on all seven reporting units. The estimated fair value of the seven reporting units exceeded the carrying value and no goodwill impairment was recognized.

Goodwill

The tables below provide a breakdown of goodwill by business.


Goodwill by business
(in millions)
Investment
Management

 
Investment
Services


Other


Consolidated

Balance at Dec. 31, 2012
$
9,508

 
$
8,517

 
$
50

 
$
18,075

Foreign exchange translation
(124
)
 
(49
)
 

 
(173
)
Other (a)
17

 

 

 
17

Balance at June 30, 2013
$
9,401

 
$
8,468

 
$
50

 
$
17,919

(a)
Other changes in goodwill include purchase price adjustments and certain other reclassifications.


Goodwill by business
(in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

Balance at Dec. 31, 2011
$
9,373

 
$
8,491

 
$
40

 
$
17,904

Foreign exchange translation
13

 
(7
)
 

 
6

Other (a)

 
(11
)
 
10

 
(1
)
Balance at June 30, 2012
$
9,386

 
$
8,473

 
$
50

 
$
17,909

(a)
Other changes in goodwill include purchase price adjustments and certain other reclassifications




84 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Intangible assets

The tables below provide a breakdown of intangible assets by business. In the second quarter of 2013, we recorded an $8 million impairment charge related to the write-down of the value of a customer contract intangible in the Investment Services business to its fair value.

Intangible assets – net carrying amount by business
(in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

Balance at Dec. 31, 2012
$
2,228

 
$
1,732

 
$
849

 
$
4,809

Disposition

 
(1
)
 

 
(1
)
Amortization
(77
)
 
(102
)
(a)

 
(179
)
Foreign exchange translation
(24
)
 
(3
)
 

 
(27
)
Other (b)
(14
)
 

 

 
(14
)
Balance at June 30, 2013
$
2,113

 
$
1,626

 
$
849

 
$
4,588

(a)
Includes an $8 million intangible asset impairment recorded in the second quarter of 2013.
(b)
Other changes in intangible assets include purchase price adjustments and certain other reclassifications.


Intangible assets – net carrying amount by business
(in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

Balance at Dec. 31, 2011
$
2,382

 
$
1,922

 
$
848

 
$
5,152

Amortization
(96
)
 
(97
)
 

 
(193
)
Foreign exchange translation
4

 
(1
)
 

 
3

Other (a)

 
(1
)
 
1

 

Balance at June 30, 2012
$
2,290

 
$
1,823

 
$
849

 
$
4,962

(a)
Other changes in intangible assets include purchase price adjustments and certain other reclassifications.


The table below provides a breakdown of intangible assets by type.

Intangible assets
June 30, 2013
 
Dec. 31, 2012
(in millions)
Gross
carrying
amount

 
Accumulated
amortization

 
Net
carrying
amount

 
Remaining
weighted
average
amortization
period
 
Net
carrying
amount

Subject to amortization:
 
 
 
 
 
 
 
 
 
Customer relationships—Investment Management
$
2,040

 
$
(1,384
)
 
$
656

 
12 years
 
$
761

Customer contracts—Investment Services
2,362

 
(1,125
)
 
1,237

 
12 years
 
1,335

Other
123

 
(103
)
 
20

 
5 years
 
25

Total subject to amortization
4,525

 
(2,612
)
 
1,913

 
12 years
 
2,121

Not subject to amortization: (a)
 
 
 
 
 
 
 
 
 
Trade name
1,365

 
N/A

 
1,365

 
N/A
 
1,368

Customer relationships
1,310

 
N/A

 
1,310

 
N/A
 
1,320

Total not subject to amortization
2,675

 
N/A

 
2,675

 
N/A
 
2,688

Total intangible assets
$
7,200

 
$
(2,612
)
 
$
4,588

 
N/A
 
$
4,809

(a)
Intangible assets not subject to amortization have an indefinite life.
N/A - Not applicable.


Estimated annual amortization expense for current intangibles for the next five years is as follows:

For the year ended
Dec. 31,
Estimated amortization expense
(in millions)
 
2013
 
$
348

2014
 
302

2015
 
269

2016
 
240

2017
 
216

 




BNY Mellon 85

Notes to Consolidated Financial Statements (continued)
 

Note 7—Other assets 

Other assets
June 30,

 
Dec. 31,

(in millions)
2013

 
2012

Accounts receivable
$
4,478

 
$
4,255

Corporate/bank owned life insurance
4,397

 
4,360

Income taxes receivable
2,986

 
3,099

Equity in joint ventures and other investments (a)
2,958

 
2,664

Fails to deliver
1,587

 
1,148

Fair value of hedging derivatives
1,234

 
989

Software
1,168

 
1,117

Prepaid expenses
501

 
508

Prepaid pension assets
453

 
419

Due from customers on acceptances
320

 
376

Other
1,665

 
1,533

Total other assets
$
21,747

 
$
20,468

(a)
Includes Federal Reserve Bank stock of $439 million and $436 million, respectively, at cost.

 
Seed capital and private equity investments valued using net asset value per share

In our Investment Management business, we manage investment assets, including equities, fixed income, money market and alternative investment funds for institutions and other investors. As part of that activity we make seed capital investments in certain funds. BNY Mellon also holds private equity investments, which consist of investments in private equity funds, mezzanine financings and direct equity investments. Seed capital and private equity investments are included in other assets. Consistent with our policy to focus on our core activities, we continue to reduce our exposure to private equity investments.

The fair value of these investments has been estimated using the net asset value (“NAV”) per share of BNY Mellon’s ownership interest in the funds. The table below presents information about BNY Mellon’s investments in seed capital and private equity investments.



Seed capital and private equity investments valued using NAV
 
June 30, 2013
 
Dec. 31, 2012
(dollar amounts in millions)
Fair
value

Unfunded 
commitments

Redemption 
frequency
Redemption 
notice period
 
Fair
value

Unfunded
commitments

Redemption 
frequency
Redemption 
notice period
Private equity funds (a)
$
94

$
12

N/A
N/A
 
$
99

$
13

N/A
N/A
Other funds (b)
190

25

Monthly-yearly
3-45 days
 
153

31

Monthly-yearly
3-45 days
Total
$
284

$
37

 
 
 
$
252

$
44

 
 
(a)
Private equity funds primarily include numerous venture capital funds that invest in various sectors of the economy. Private equity funds do not have redemption rights. Distributions from such funds will be received as the underlying investments in the funds are liquidated.
(b)
Other funds include various market neutral, leveraged loans, hedge funds, real estate and structured credit funds. Redemption notice periods vary by fund.
N/A - Not applicable.




86 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 8 - Net interest revenue

The following table provides the components of net interest revenue presented on the consolidated income statement.

Net interest revenue
Quarter ended
 
Year-to-date
(in millions)
June 30, 2013

March 31, 2013

June 30, 2012

 
June 30, 2013

June 30, 2012

Interest revenue
 
 
 
 
 
 
Non-margin loans
$
171

$
165

$
169

 
$
336

$
338

Margin loans
40

38

42

 
78

84

Securities:
 
 
 
 
 
 
Taxable
453

441

484

 
894

987

Exempt from federal income taxes
23

24

20

 
47

35

Total securities
476

465

504

 
941

1,022

Deposits in banks
68

71

93

 
139

207

Deposits with the Federal Reserve and other central banks
31

31

39

 
62

82

Federal funds sold and securities purchased under resale agreements
10

10

9

 
20

18

Trading assets
40

35

19

 
75

36

Total interest revenue
836

815

875

 
1,651

1,787

Interest expense
 
 
 
 
 
 
Deposits
27

30

43

 
57

86

Federal funds purchased and securities sold under repurchase agreements
(6
)
(3
)

 
(9
)

Trading liabilities
11

9

6

 
20

10

Other borrowed funds
1

2

6

 
3

11

Customer payables
2

2

2

 
4

4

Long-term debt
44

56

84

 
100

177

Total interest expense
79

96

141

 
175

288

Net interest revenue
$
757

$
719

$
734

 
$
1,476

$
1,499

 
 
 
 
 


 


Note 9 - Employee benefit plans

The components of net periodic benefit cost are as follows.

Net periodic benefit cost (credit)
 
 
 
Quarter ended
 
 
 
 
 
June 30, 2013
 
March 31, 2013
 
June 30, 2012
(in millions)
Domestic pension benefits

Foreign pension benefits

Health care benefits

 
Domestic pension benefits

Foreign pension benefits

Health care benefits

 
Domestic pension benefits

Foreign pension benefits

Health care benefits

Service cost
$
16

$
9

$
1

 
$
16

$
9

$
1

 
$
15

$
8

$
1

Interest cost
43

10

2

 
43

10

2

 
42

9

3

Expected return on assets
(73
)
(12
)
(2
)
 
(73
)
(12
)
(2
)
 
(68
)
(12
)
(2
)
Other
46

4

1

 
47

4

1

 
38

3

3

Net periodic benefit cost
$
32

$
11

$
2

 
$
33

$
11

$
2

 
$
27

$
8

$
5


Net periodic benefit cost (credit)
Year-to-date
 
June 30, 2013
 
June 30, 2012
(in millions)
Domestic pension benefits

Foreign pension benefits

Health care benefits

 
Domestic pension benefits

Foreign pension benefits

Health care benefits

Service cost
$
32

$
18

$
2

 
$
30

$
16

$
2

Interest cost
86

20

4

 
84

18

6

Expected return on assets
(146
)
(24
)
(4
)
 
(136
)
(24
)
(4
)
Other
93

8

2

 
76

6

6

Net periodic benefit cost
$
65

$
22

$
4

 
$
54

$
16

$
10



BNY Mellon 87

Notes to Consolidated Financial Statements (continued)
 

Note 10 - Restructuring charges

The aggregate restructuring charge is included in the merger and integration, litigation and restructuring charges expense category on the income statement and reported in the Other segment as restructuring charges are corporate initiatives and not directly related to the operating performance of the businesses. Severance payments are primarily paid over the salary continuance period in accordance with the separation plan.

Operational excellence initiatives

In 2011, we announced our operational excellence initiatives which include an expense reduction initiative impacting approximately 1,500 positions, as well as additional initiatives to transform operations, technology and corporate services that will increase productivity and reduce the growth rate of expenses. We recorded a pre-tax restructuring charge of $107 million related to the operational excellence initiatives in 2011. In the second quarter of 2013, we recorded a net charge of $2 million reflecting additional severance charges. The following table presents the activity in the restructuring reserve related to the operational excellence initiatives through June 30, 2013.

Operational excellence initiatives 2011 – restructuring reserve activity
(in millions)
Severance

Other

Total

Original restructuring charge
$
78

$
29

$
107

Net additional charges (net recovery/gain)
60

(57
)
3

Utilization
(54
)
28

(26
)
Balance at March 31, 2013
$
84

$

$
84

Net additional charges
2


2

Utilization
(16
)

(16
)
Balance at June 30, 2013
$
70

$

$
70



The table below presents the restructuring charge if it had been allocated by business.

Operational excellence initiatives 2011 – restructuring charge (recovery) by business


Total charges since inception

(in millions)
2Q13

1Q13

Investment Management
$
(1
)
$
1

$
48

Investment Services
4


64

Other segment (including Business Partners)
(1
)
4


Total restructuring charge
$
2

$
5

$
112

 
 
Note 11—Income taxes

The statutory federal income tax rate is reconciled to our effective income tax rate below:

Effective tax rate
Six months ended
  
June 30,
2013

June 30,
2012

Federal rate
35.0
 %
35.0
 %
State and local income taxes, net of federal income tax benefit
2.8

2.4

Tax-exempt income
(2.8
)
(3.3
)
Foreign operations
(4.2
)
(5.3
)
Tax credits
(3.1
)
(5.6
)
Tax litigation
42.4


Other - net
(2.3
)
0.3

Effective rate
67.8
 %
23.5
 %
 


As previously disclosed, on Nov. 10, 2009 BNY Mellon filed a petition with the U.S. Tax Court challenging the IRS’ disallowance of certain foreign tax credits claimed for the 2001 and 2002 tax years. Trial was held from April 16 to May 17, 2012. On Feb. 11, 2013, BNY Mellon received an adverse decision from the U.S. Tax Court.  We continue to believe the tax treatment of the transaction was correct and will appeal the Court’s decision. As a result of the ruling and in accordance with the accounting for uncertain tax positions under ASC 740, BNY Mellon recorded a tax charge of $854 million in the first quarter of 2013.

Our total tax reserves as of June 30, 2013 were $1,060 million compared with $1,050 million at March 31, 2013. If these tax reserves were unnecessary, $1,060 million would affect the effective tax rate in future periods. We recognize accrued interest and penalties, if applicable, related to income taxes in income tax expense. Included in the balance sheet at June 30, 2013 is accrued interest, where applicable, of $289 million. The additional tax expense related to interest for the six months ended June 30, 2013 was $291 million compared with $8 million for the six months ended June 30, 2012.

It is reasonably possible the total reserve for uncertain tax positions could decrease within the next 12 months by an amount up to $50 million as a result of adjustments related to tax years that are still subject to examination.

Our federal income tax returns are closed to examination for all periods through 2002. The years



88 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

2003 through 2006 remain open to examination. The years 2007 and 2008 are closed for further examination; however, one matter is before the Internal Revenue Service (“IRS”) appeals. Our New York State and New York City income tax returns are closed to examination through 2010. Our UK income tax returns are closed to examination through 2008.

Note 12 - Securitizations and variable interest entities

BNY Mellon’s VIEs generally include retail, institutional and alternative investment funds offered to its retail and institutional customers in which it acts as the fund’s investment manager. BNY Mellon earns management fees on these funds as well as performance fees in certain funds. It may also provide start-up capital in its new funds. These VIEs are included in the scope of ASU 2010-10 and are reviewed for consolidation based on the guidance in ASC 810, “Consolidation”.

BNY Mellon has other VIEs, including securitization trusts, which are no longer considered qualifying special purpose entities, and CLOs, in which BNY Mellon serves as the investment manager. In addition, we provide trust and custody services for a fee to entities sponsored by other corporations in which we have no other interest. These VIEs are evaluated under the guidance included in ASU 2009-17. BNY Mellon has two securitizations and several CLOs, which are assessed for consolidation in accordance with ASU 2009-17.

The following tables present the incremental assets and liabilities included in BNY Mellon’s consolidated financial statements, after applying intercompany eliminations, as of June 30, 2013 and Dec. 31, 2012, based on the assessments performed in accordance with ASC 810 and ASU 2009-17. The net assets of any consolidated VIE are solely available to settle the liabilities of the VIE and to settle any investors’ ownership liquidation requests, including any seed capital invested in the VIE by BNY Mellon.

 
Investments consolidated under ASC 810 and ASU 2009-17
at June 30, 2013
(in millions)
Investment
Management
funds

Securitizations

Total
consolidated
investments

Available-for-sale
$

$
501

$
501

Trading assets
10,766


10,766

Other assets
705


705

Total assets
$
11,471

$
501

$
11,972

Trading liabilities
10,110


10,110

Other liabilities
32

440

472

Total liabilities
$
10,142

$
440

$
10,582

Non-redeemable noncontrolling interests
$
860

$

$
860

 

Investments consolidated under ASC 810 and ASU 2009-17
at Dec. 31, 2012
(in millions)
Investment
Management
funds

Securitizations

Total
consolidated
investments

Available-for-sale
$

$
499

$
499

Trading assets
10,961


10,961

Other assets
520


520

Total assets
$
11,481

$
499

$
11,980

Trading liabilities
10,152


10,152

Other liabilities
29

461

490

Total liabilities
$
10,181

$
461

$
10,642

Non-redeemable noncontrolling interests
$
833

$

$
833



BNY Mellon is not contractually required to provide financial or any other support to any of our VIEs. Additionally, creditors of any consolidated VIEs do not have any recourse to the general credit of BNY Mellon.

Non-consolidated VIEs

As of June 30, 2013 and Dec. 31, 2012, the following assets related to the VIEs, where BNY Mellon is not the primary beneficiary, are included in our consolidated financial statements.

Non-consolidated VIEs at June 30, 2013
Maximum loss exposure

(in millions)
Assets

Liabilities

Other
$
118

$

$
118


Non-consolidated VIEs at Dec. 31, 2012
Maximum loss exposure

(in millions)
Assets

Liabilities

Other
$
100

$

$
100

 

The maximum loss exposure indicated in the above tables relates solely to BNY Mellon’s seed capital or residual interests invested in the VIEs.



BNY Mellon 89

Notes to Consolidated Financial Statements (continued)
 

Note 13 - Preferred Stock

BNY Mellon has 100 million authorized shares of preferred stock with a par value of $0.01. The table below presents a summary of BNY Mellon’s preferred stock issued and outstanding at June 30, 2013 and Dec. 31, 2012.


Preferred stock summary
Liquidation
preference
per share
(in dollars)
 
Total shares issued and outstanding
 
 
 

 
 
 
Carrying value (a)
(dollars in millions, unless
otherwise noted)
Per annum dividend rate
 
June 30, 2013

Dec. 31, 2012

June 30, 2013

Dec. 31,
2012

Series A
Noncumulative Perpetual Preferred Stock
Greater of (i) three-month LIBOR plus 0.565% for the related distribution period; or (ii) 4.000%

$
100,000

 
5,001

5,001

 
$
500

$
500

Series C
Noncumulative Perpetual Preferred Stock
5.2
%
$
100,000

 
5,825

5,825

 
$
568

$
568

Series D
Noncumulative Perpetual Preferred Stock
4.50% commencing Dec. 20, 2013 to but excluding June 20, 2023, then a floating rate equal to the three-month LIBOR plus 2.46%

$
100,000

 
5,000


 
$
494

$

Total
 
 
 
15,826

10,826

 
$
1,562

$
1,068

(a)
The carrying value of the Series C and Series D preferred stock is recorded net of issuance costs.


On May 17, 2013, BNY Mellon issued 500,000 Series D depository shares, each representing a 1/100th interest in a share of BNY Mellon’s Series D preferred stock. BNY Mellon will pay dividends on the Series D preferred stock, if declared by our board of directors, at an annual rate of 4.5% on each June 20 and December 20, to but excluding June 20, 2023; and a floating rate equal to three-month LIBOR plus 2.46% on each March 20, June 20, September 20 and December 20, from and including June 20, 2023. Holders of both the Series A and Series C preferred stock are entitled to receive dividends on each dividend payment date (March 20, June 20, September 20 and December 20 of each year), if declared by BNY Mellon’s Board of Directors. BNY Mellon’s ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our common stock or any of our shares that rank junior to the preferred stock as to the payment of dividends
 
and/or the distribution of any assets on any liquidation, dissolution or winding-up of BNY Mellon will be prohibited, subject to certain restrictions, in the event that we do not declare and pay in full preferred dividends for the then current dividend period of the Series A preferred stock or the last preceding dividend period of the Series C and Series D preferred stock.

All of the outstanding shares of the Series A preferred stock are owned by Mellon Capital IV, which will pass through any dividend on the Series A preferred stock to the holders of its Normal Preferred Capital Securities. All of the outstanding shares of the Series C and Series D preferred stock are held by the depositary of the depositary shares, which will pass through the applicable portion of any dividend on the Series C and Series D preferred stock to the holders of record of their respective depositary shares.




90 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

The following table presents a summary of the preferred stock dividends.


Preferred stock dividends (a)
 
 
 
Approximate dividend paid per share (in dollars)
 
Declaration date
Record date
Payment date
Series A (b)
July 17, 2013
Sept. 5, 2013
Sept. 20, 2013
 
$
10.2222

 
April 9, 2013
June 5, 2013
June 20, 2013
 
$
10.2222

 
Jan. 16, 2013
March 5, 2013
March 20, 2013
 
$
10.0000

 
Oct. 17, 2012
Dec. 5, 2012
Dec. 20, 2012
 
$
10.1111

Series C (c)
July 17, 2013
Sept. 5, 2013
Sept. 20, 2013
 
$
0.3250

 
April 9, 2013
June 5, 2013
June 20, 2013
 
$
0.3250

 
Jan. 16, 2013
March 5, 2013
March 20, 2013
 
$
0.3250

 
Oct. 17, 2012
Dec. 5, 2012
Dec. 20, 2012
 
$
0.3286

Series D (d)
N/A
N/A
N/A
 
N/A

(a)
Dividends are noncumulative.
(b)
Dividend per Normal Preferred Capital Security of Mellon Capital IV, each representing 1/100th interest in a share of Series A preferred stock.
(c)
Dividend per depositary share, each representing a 1/4,000th interest in a share of Series C preferred stock.
(d)
The Series D noncumulative perpetual preferred stock was issued on May 17, 2013. If declared by BNY Mellon’s Board of Directors, the first dividend payment date would be Dec. 20, 2013.


The preferred stock is not subject to the operation of a sinking fund and is not convertible into, or exchangeable for, shares of our common stock or any other class or series of our other securities. Subject to the restrictions in BNY Mellon’s 2007 replacement capital covenant, subsequently amended on May 8 and Sept. 11, 2012, we may redeem the Series A preferred stock, in whole or in part, at our option. We may also, at our option, redeem the shares of the Series C preferred stock in whole or in part, on or after the dividend payment date in September 2017 and the Series D preferred stock in whole or in part, on or after the dividend payment date in June 2023.
 
Both of the Series C or Series D preferred stock can be redeemed in whole but not in part at any time within 90 days following a regulatory capital treatment event (as defined in the Certificate of Designations of the Series C preferred stock and the Certificate of Designations of the Series D preferred stock).

The terms of the Series A preferred stock, Series C preferred stock, and Series D preferred stock are more fully described in each of their Certificate of Designations, each of which is filed as an Exhibit to this Form 10-Q.




91 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 14 - Other comprehensive income (loss)

Components of other comprehensive income (loss)
 
Quarter ended
 
June 30, 2013
 
March 31, 2013
 
June 30, 2012
(in millions)
Pre-tax
amount

Tax
(expense)
benefit

After-tax
amount

 
Pre-tax
amount

Tax
(expense)
benefit

After-tax
amount

 
Pre-tax
amount

Tax
(expense)
benefit

After-tax
amount

Foreign currency translation adjustments arising during the period
$
(9
)
$
14

$
5

 
$
(229
)
$
(80
)
$
(309
)
 
$
(223
)
$
(42
)
$
(265
)
Unrealized gain (loss) on assets available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) arising during the period
(1,215
)
479

(736
)
 
(9
)
3

(6
)
 
318

(121
)
197

Reclassification adjustment (a)
(32
)
15

(17
)
 
(48
)
18

(30
)
 
(50
)
15

(35
)
Net unrealized gain (loss) on assets available-for-sale
(1,247
)
494

(753
)
 
(57
)
21

(36
)
 
268

(106
)
162

Defined benefit plans:
 
 
 
 
 
 
 
 
 
 
 
Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost (a)
51

(20
)
31

 
68

(25
)
43

 
42

(18
)
24

Total defined benefit plans
51

(20
)
31

 
68

(25
)
43

 
42

(18
)
24

Unrealized gain (loss) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
Unrealized hedge gain (loss) arising during period
13

(6
)
7

 
171

(70
)
101

 
(329
)
137

(192
)
Reclassification adjustment (a)
(27
)
11

(16
)
 
(170
)
70

(100
)
 
328

(136
)
192

Net unrealized gain (loss) on cash flow hedges
(14
)
5

(9
)
 
1


1

 
(1
)
1


Total other comprehensive income (loss)
$
(1,219
)
$
493

$
(726
)
 
$
(217
)
$
(84
)
$
(301
)
 
$
86

$
(165
)
$
(79
)
(a)
The reclassification adjustment related to the unrealized gain (loss) on assets available-for-sale is recorded as net securities gains on the Consolidated Income Statement. The amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost is recorded as staff expense on the Consolidated Income Statement. See Note 17 for the location of the reclassification adjustment related to cash flow hedges on the Consolidated Income Statement.


Components of other comprehensive income (loss)
 
Year-to-date
 
June 30, 2013
 
June 30, 2012
(in millions)
Pre-tax
amount

Tax
(expense)
benefit

After-tax
amount

 
Pre-tax
amount

Tax
(expense)
benefit

After-tax
amount

Foreign currency translation adjustments arising during the period
$
(238
)
$
(66
)
$
(304
)
 
$
(94
)
$
1

$
(93
)
Unrealized gain (loss) on assets available-for-sale:
 
 
 
 
 
 
 
Unrealized gain (loss) arising during the period
(1,224
)
482

(742
)
 
696

(262
)
434

Reclassification adjustment (a)
(80
)
33

(47
)
 
(90
)
31

(59
)
Net unrealized gain (loss) on assets available-for-sale
(1,304
)
515

(789
)
 
606

(231
)
375

Defined benefit plans:
 
 
 
 
 
 
 
Amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost (a)
119

(45
)
74

 
86

(35
)
51

Total defined benefit plans
119

(45
)
74

 
86

(35
)
51

Unrealized gain (loss) on cash flow hedges:
 
 
 
 
 
 
 
Unrealized hedge gain (loss) arising during period
184

(76
)
108

 
13

(5
)
8

Reclassification adjustment (a)
(197
)
81

(116
)
 
(8
)
3

(5
)
Net unrealized gain (loss) on cash flow hedges
(13
)
5

(8
)
 
5

(2
)
3

Total other comprehensive income (loss)
$
(1,436
)
$
409

$
(1,027
)
 
$
603

$
(267
)
$
336

(a)
The reclassification adjustment related to the unrealized gain (loss) on assets available-for-sale is recorded as net securities gains on the Consolidated Income Statement. The amortization of prior service credit, net loss and initial obligation included in net periodic benefit cost is recorded as staff expense on the Consolidated Income Statement. See Note 17 for the location of the reclassification adjustment related to cash flow hedges on the Consolidated Income Statement.




92 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 15 - Fair value measurement

The guidance related to “Fair Value Measurement” included in ASC 820 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date and establishes a framework for measuring fair value. It establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and expands the disclosures about instruments measured at fair value. ASC 820 requires consideration of a company’s own creditworthiness when valuing liabilities.

The standard provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The objective is to determine from weighted indicators of fair value a reasonable point within the range that is most representative of fair value under current market conditions.

Determination of fair value

Following is a description of our valuation methodologies for assets and liabilities measured at fair value. We have established processes for determining fair values. Fair value is based upon quoted market prices in active markets, where available. For financial instruments where quotes from recent exchange transactions are not available, we determine fair value based on discounted cash flow analysis, comparison to similar instruments, and the use of financial models. Discounted cash flow analysis is dependent upon estimated future cash flows and the level of interest rates. Model-based pricing uses inputs of observable prices, where available, for interest rates, foreign exchange rates, option volatilities and other factors. Models are benchmarked and validated by an independent internal risk management function. Our valuation
 
process takes into consideration factors such as counterparty credit quality, liquidity, concentration concerns, and observability of model parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.

Most derivative contracts are valued using internally developed models which are calibrated to observable market data and employ standard market pricing theory for their valuations. An initial “risk-neutral” valuation is performed on each position assuming time-discounting based on a AA credit curve. Then, to arrive at a fair value that incorporates counter-party credit risk, a credit adjustment is made to these results by discounting each trade’s expected exposures to the counterparty using the counterparty’s credit spreads, as implied by the credit default swap market. We also adjust expected liabilities to the counterparty using BNY Mellon’s own credit spreads, as implied by the credit default swap market. Accordingly, the valuation of our derivative position is sensitive to the current changes in our own credit spreads as well as those of our counterparties.

In certain cases, recent prices may not be observable for instruments that trade in inactive or less active markets. Upon evaluating the uncertainty in valuing financial instruments subject to liquidity issues, we make an adjustment to their value. The determination of the liquidity adjustment includes the availability of external quotes, the time since the latest available quote and the price volatility of the instrument.

Certain parameters in some financial models are not directly observable and, therefore, are based on management’s estimates and judgments. These financial instruments are normally traded less actively. We apply valuation adjustments to mitigate the possibility of error and revision in the model based estimate value. Examples include products where parameters such as correlation and recovery rates are unobservable.

The methods described above for instruments that trade in inactive or less active markets may produce a current fair value calculation that may not be indicative of net realizable value or reflective of future fair values. We believe our methods of determining fair value are appropriate and consistent with other market participants. However, the use of different methodologies or different assumptions to value certain financial instruments could result in a different estimate of fair value.



BNY Mellon 93

Notes to Consolidated Financial Statements (continued)
 

Valuation hierarchy

ASC 820 established a three-level valuation hierarchy for disclosure of fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are described below.

Level 1: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 assets and liabilities include debt and equity securities and derivative financial instruments actively traded on exchanges and U.S. Treasury securities that are actively traded in highly liquid over-the-counter markets.

Level 2: Observable inputs other than Level 1 prices, for example, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs that are observable or can be corroborated, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 assets and liabilities include debt instruments that are traded less frequently than exchange-traded securities and derivative instruments whose model inputs are observable in the market or can be corroborated by market-observable data. Examples in this category are agency and non-agency mortgage-backed securities, corporate debt securities and over-the-counter derivative contracts.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Examples in this category include certain private equity investments, derivative contracts that are highly structured or long-dated, and interests in certain securitized financial assets.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities

Where quoted prices are available in an active market, we classify the securities within Level 1 of
 
the valuation hierarchy. Securities include both long and short positions. Level 1 securities include highly liquid government bonds, money market mutual funds, foreign covered bonds and exchange-traded equities.

If quoted market prices are not available, we estimate fair values using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include agency and non-agency mortgage-backed securities, commercial mortgage-backed securities, sovereign debt, corporate bonds and foreign covered bonds.

For securities where quotes from recent transactions are not available for identical securities, we determine fair value primarily based on pricing sources with reasonable levels of price transparency that employ financial models or obtain comparison to similar instruments to arrive at “consensus” prices.

Specifically, the pricing sources obtain recent transactions for similar types of securities (e.g., vintage, position in the securitization structure) and ascertain variables such as discount rate and speed of prepayment for the types of transaction and apply such variables to similar types of bonds. We view these as observable transactions in the current marketplace and classify such securities as Level 2. Pricing sources discontinue pricing any specific security whenever they determine there is insufficient observable data to provide a good faith opinion on price.

In addition, we have significant investments in more actively traded agency RMBS and other types of securities such as sovereign debt. The pricing sources derive the prices for these securities largely from quotes they obtain from three major inter-dealer brokers. The pricing sources receive their daily observed trade price and other information feeds from the inter-dealer brokers.

For securities with bond insurance, the financial strength of the insurance provider is analyzed and that information is included in the fair value assessment for such securities.

In certain cases where there is limited activity or less transparency around inputs to the valuation, we classify those securities in Level 3 of the valuation



94 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

hierarchy. Securities classified within Level 3 primarily include securities of state and political subdivisions and distressed debt securities.

At June 30, 2013, more than 99% of our securities were valued by pricing sources with reasonable levels of price transparency. Less than 1% of our securities were priced based on economic models and non-binding dealer quotes, and are included in Level 3 of the ASC 820 hierarchy.

Consolidated collateralized loan obligations

BNY Mellon values assets in consolidated CLOs using observable market prices observed from the secondary loan market. The returns to the note holders are solely dependent on the assets and accordingly equal the value of those assets. Based on the structure of the CLOs, the valuation of the assets is attributable to the senior note holders. Changes in the values of assets and liabilities are reflected in the income statement as investment income and interest of investment management fund note holders, respectively.

Derivatives

We classify exchange-traded derivatives valued using quoted prices in Level 1 of the valuation hierarchy. Examples include exchanged-traded equity and foreign exchange options. Since few other classes of derivative contracts are listed on an exchange, most of our derivative positions are valued using internally developed models that use as their basis readily observable market parameters, and we classify them in Level 2 of the valuation hierarchy. Such derivatives include basic swaps and options and credit default swaps.

Derivatives valued using models with significant unobservable market parameters in markets that lack two-way flow are classified in Level 3 of the valuation hierarchy. Examples include long-dated interest rate or currency swaps and options, where parameters may be unobservable for longer maturities; and certain products, where correlation risk is unobservable. The fair value of these derivatives compose approximately 1% of our derivative financial instruments. Additional disclosures of derivative instruments are provided in Note 17 of the Notes to Consolidated Financial Statements.

 
Loans and unfunded lending-related commitments

Where quoted market prices are not available, we generally base the fair value of loans and unfunded lending-related commitments on observable market prices of similar instruments, including bonds, credit derivatives and loans with similar characteristics. If observable market prices are not available, we base the fair value on estimated cash flows adjusted for credit risk which are discounted using an interest rate appropriate for the maturity of the applicable loans or the unfunded lending-related commitments.

Unrealized gains and losses, if any, on unfunded lending-related commitments carried at fair value are classified in Other assets and Other liabilities, respectively. Loans and unfunded lending-related commitments carried at fair value are generally classified within Level 2 of the valuation hierarchy.

Seed capital

In our Investment Management business, we manage investment assets, including equities, fixed income, money market and alternative investment funds for institutions and other investors. As part of that activity, we make seed capital investments in certain funds. Seed capital is included in other assets. When applicable, we value seed capital based on the published NAV of the fund. We include funds in which ownership interests in the fund are publicly traded in an active market and institutional funds in which investors trade in and out daily in Level 1 of the valuation hierarchy. We include open-end funds where investors are allowed to sell their ownership interest back to the fund less frequently than daily and where our interest in the fund contains no other rights or obligations in Level 2 of the valuation hierarchy. However, we generally include investments in funds that allow investors to sell their ownership interest back to the fund less frequently than monthly in Level 3, unless actual redemption prices are observable.

For other types of investments in funds, we consider all of the rights and obligations inherent in our ownership interest, including the reported NAV as well as other factors that affect the fair value of our interest in the fund. To the extent the NAV measurements reported for the investments are based on unobservable inputs or include other rights and obligations (e.g., obligation to meet cash calls), we



BNY Mellon 95

Notes to Consolidated Financial Statements (continued)
 

generally classify them in Level 3 of the valuation hierarchy.

Certain interests in securitizations

For certain interests in securitizations that are classified in securities available-for-sale, trading assets and long-term debt, we use discounted cash flow models, which generally include assumptions of projected finance charges related to the securitized assets, estimated net credit losses, prepayment assumptions and estimates of payments to third-party investors. When available, we compare our fair value estimates and assumptions to market activity and to the actual results of the securitized portfolio.

Private equity investments

Our Other segment includes holdings of nonpublic private equity investment through funds managed by third-party investment managers. We value private equity investments initially based upon the transaction price, which we subsequently adjust to reflect expected exit values as evidenced by financing and sale transactions with third parties or through ongoing reviews by the investment managers.

 
Private equity investments also include publicly held equity investments, generally obtained through the initial public offering of privately held equity investments. These equity investments are often held in a partnership structure. Publicly held investments are marked-to-market at the quoted public value less adjustments for regulatory or contractual sales restrictions or adjustments to reflect the difficulty in selling a partnership interest.

Discounts for restrictions are quantified by analyzing the length of the restriction period and the volatility of the equity security. Publicly held private equity investments are primarily classified in Level 2 of the valuation hierarchy.

The following tables present the financial instruments carried at fair value at June 30, 2013 and Dec. 31 2012, by caption on the consolidated balance sheet and by ASC 820 valuation hierarchy (as described above). We have included credit ratings information in certain of the tables because the information indicates the degree of credit risk to which we are exposed, and significant changes in ratings classifications could result in increased risk for us. There were no material transfers between Level 1 and Level 2 during the second quarter of 2013.




96 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Assets measured at fair value on a recurring basis at June 30, 2013
(dollar amounts in millions)
Level 1

 
Level 2

 
Level 3

 
Netting (a)

 
Total carrying
value

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
14,722

 
$

 
$

 
$

  
$
14,722

U.S. Government agencies

 
1,142

 

 

  
1,142

Sovereign debt
79

 
10,345

 

 

  
10,424

State and political subdivisions (b)

 
6,382

 
52

 

  
6,434

Agency RMBS

 
37,128

 

 

  
37,128

Alt-A RMBS

 
266

 

 

  
266

Prime RMBS

 
564

 

 

  
564

Subprime RMBS

 
423

 

 

  
423

Other RMBS

 
2,381

 

 

  
2,381

Commercial MBS

 
2,745

 

 

  
2,745

Agency commercial MBS

 
1,122

 

 

 
1,122

Asset-backed CLOs

 
1,446

 

 

  
1,446

Other asset-backed securities

 
2,018

 

 

  
2,018

Equity securities
12

 

 

 

  
12

Money market funds (b)
918

 

 

 

  
918

Corporate bonds

 
1,527

 

 

 
1,527

Other debt securities

 
2,207

 

 

  
2,207

Foreign covered bonds
2,550

 
661

 

 

  
3,211

Alt-A RMBS (c)

 
1,847

 

 

  
1,847

Prime RMBS (c)

 
899

 

 

  
899

Subprime RMBS (c)

 
134

 

 

  
134

Total available-for-sale
18,281

 
73,237

 
52

 

  
91,570

Trading assets:
 
 
 
 
 
 
 
 
 
Debt and equity instruments (b)
2,697

 
4,191

 
2

 

  
6,890

Derivative assets not designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
16,824

 
10

 
(15,307
)
  
1,527

Foreign exchange
3,920

 
254

 
1

 
(2,025
)
  
2,150

Equity
198

 
258

 
31

 
(146
)
  
341

Total derivative assets not designated as hedging
4,118

 
17,336

 
42

 
(17,478
)
 
4,018

Total trading assets
6,815

 
21,527

 
44

 
(17,478
)
 
10,908

Other assets:
 
 
 
 
 
 
 
 
 
Derivative assets designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
986

 

 

 
986

Foreign exchange
248

 

 

 

 
248

Total other assets - derivative assets
248

 
986

 

 

 
1,234

Other assets (d)
129

 
149

 
113

 

 
391

Total other assets
377

 
1,135

 
113

 

 
1,625

Subtotal assets of operations at fair value
25,473

 
95,899

 
209

 
(17,478
)
 
104,103

Percentage of assets prior to netting
21
%
 
79
%
 
%
 
 
 
 
Assets of consolidated investment management funds:
 
 
 
 
 
 
 
 
 
Trading assets
18

 
10,704

 
44

 

 
10,766

Other assets
570

 
135

 

 

 
705

Total assets of consolidated investment management funds
588

 
10,839

 
44

 

 
11,471

Total assets
$
26,061

 
$
106,738

 
$
253

 
$
(17,478
)
 
$
115,574

Percentage of assets prior to netting
20
%
 
80
%
 
%
 
 
 
 



BNY Mellon 97

Notes to Consolidated Financial Statements (continued)
 

Liabilities measured at fair value on a recurring basis at June 30, 2013
(dollar amounts in millions)
Level 1

 
Level 2

 
Level 3

 
Netting (a)

 
Total carrying
value

Trading liabilities:
 
 
 
 
 
 
 
 
 
Debt and equity instruments
$
1,442

 
$
772

 
$

 
$

  
$
2,214

Derivative liabilities not designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
17,343

 
65

 
(14,478
)
  
2,930

Foreign exchange
4,054

 
182

 

 
(1,821
)
  
2,415

Equity and other contracts
80

 
469

 
52

 
(146
)
  
455

Total derivative liabilities not designated as hedging
4,134

 
17,994

 
117

 
(16,445
)
 
5,800

Total trading liabilities
5,576

 
18,766

 
117

 
(16,445
)
 
8,014

Long-term debt (b)

 
324

 

 

  
324

Other liabilities - derivative liabilities designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
179

 

 

 
179

Foreign exchange
37

 

 

 

 
37

Total other liabilities - derivative liabilities
37

 
179

 

 

 
216

Subtotal liabilities at fair value
5,613

 
19,269

 
117

 
(16,445
)
 
8,554

Percentage of liabilities prior to netting
23
%
 
77
%
 
%
 
 
 
 
Liabilities of consolidated investment management funds:
 
 
 
 
 
 
 
 
 
Trading liabilities

 
10,110

 

 

  
10,110

Other liabilities

 
32

 

 

  
32

Total liabilities of consolidated investment management funds

 
10,142

 

 

  
10,142

Total liabilities
$
5,613

 
$
29,411

 
$
117

 
$
(16,445
)
 
$
18,696

Percentage of liabilities prior to netting
16
%
 
84
%
 
%
 
 
 
 
a)
ASC 815 permits the netting of derivative receivables and derivative payables under legally enforceable master netting agreements and permits the netting of cash collateral. Netting is applicable to derivatives not designated as hedging instruments included in trading assets or trading liabilities, and derivatives designated as hedging instruments included in other assets or other liabilities. Netting is allocated to the derivative products based on the net fair value of each product.
(b)
Includes certain interests in securitizations.
(c)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(d)
Includes private equity investments, seed capital and a brokerage account.



98 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Assets measured at fair value on a recurring basis at Dec. 31, 2012
(dollar amounts in millions)
Level 1

 
Level 2

 
Level 3

 
Netting (a)

 
Total carrying
value

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
18,003

 
$

 
$

 
$

  
$
18,003

U.S. Government agencies

 
1,074

 

 

  
1,074

Sovereign debt
41

 
9,383

 

 

  
9,424

State and political subdivisions (b)

 
6,077

 
45

 

  
6,122

Agency RMBS

 
34,193

 

 

  
34,193

Alt-A RMBS

 
279

 

 

  
279

Prime RMBS

 
728

 

 

  
728

Subprime RMBS

 
452

 

 

  
452

Other RMBS

 
2,794

 

 

  
2,794

Commercial MBS

 
3,139

 

 

  
3,139

Asset-backed CLOs

 
1,282

 

 

  
1,282

Other asset-backed securities

 
2,131

 

 

  
2,131

Equity securities
27

 

 

 

  
27

Money market funds (b)
2,190

 

 

 

  
2,190

Corporate bonds

 
1,585

 

 

 
1,585

Other debt securities

 
2,368

 

 

  
2,368

Foreign covered bonds
2,995

 
723

 

 

  
3,718

Alt-A RMBS (c)

 
1,970

 

 

  
1,970

Prime RMBS (c)

 
1,010

 

 

  
1,010

Subprime RMBS (c)

 
130

 

 

  
130

Total available-for-sale
23,256

 
69,318

 
45

 

  
92,619

Trading assets:
 
 
 
 
 
 
 
 
 
Debt and equity instruments (b)
912

 
4,116

 
48

 

  
5,076

Derivative assets not designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate
36

 
22,734

 
19

 
(20,042
)
  
2,747

Foreign exchange
3,364

 
148

 
1

 
(2,171
)
  
1,342

Equity
121

 
152

 
38

 
(98
)
  
213

Total derivative assets not designated as hedging
3,521

 
23,034

 
58

 
(22,311
)
 
4,302

Total trading assets
4,433

 
27,150

 
106

 
(22,311
)
 
9,378

Other assets:
 
 
 
 
 
 
 
 
 
Derivative assets designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
928

 

 

 
928

Foreign exchange
61

 

 

 

 
61

Total derivative assets
61

 
928

 

 

 
989

Other assets (d)
96

 
116

 
120

 

 
332

Total other assets
157

 
1,044

 
120

 

 
1,321

Subtotal assets of operations at fair value
27,846

 
97,512

 
271

 
(22,311
)
 
103,318

Percentage of assets prior to netting
22
%
 
78
%
 
%
 
 
 
 
Assets of consolidated investment management funds:
 
 
 
 
 
 
 
 
 
Trading assets
182

 
10,735

 
44

 

 
10,961

Other assets
390

 
130

 

 

 
520

Total assets of consolidated investment management funds
572

 
10,865

 
44

 

 
11,481

Total assets
$
28,418

 
$
108,377

 
$
315

 
$
(22,311
)
 
$
114,799

Percentage of assets prior to netting
21
%
 
79
%
 
%
 
 
 
 




BNY Mellon 99

Notes to Consolidated Financial Statements (continued)
 

Liabilities measured at fair value on a recurring basis at Dec. 31, 2012
(dollar amounts in millions)
Level 1

 
Level 2

 
Level 3

 
Netting (a)

 
Total carrying
value

Trading liabilities:
 
 
 
 
 
 
 
 
 
Debt and equity instruments
$
1,121

 
$
659

 
$

 
$

  
$
1,780

Derivative liabilities not designated as hedging:
 
 
 
 
 
 
 
 
 
Interest rate

 
23,173

 
168

 
(19,069
)
  
4,272

Foreign exchange
3,535

 
97

 

 
(1,823
)
  
1,809

Equity
91

 
266

 
56

 
(98
)
  
315

Total derivative liabilities not designated as hedging
3,626

 
23,536

 
224

 
(20,990
)
 
6,396

Total trading liabilities
4,747

 
24,195

 
224

 
(20,990
)
 
8,176

Long-term debt (b)

 
345

 

 

  
345

Other liabilities - derivative liabilities designated as hedging:
 
 
 
 
 
 
 
 
 
      Interest rate

 
343

 

 

 
343

      Foreign exchange
361

 

 

 

 
361

             Total other liabilities - derivative liabilities
361

 
343

 

 

 
704

Subtotal liabilities at fair value
5,108

 
24,883

 
224

 
(20,990
)
 
9,225

Percentage of liabilities prior to netting
17
%
 
82
%
 
1
%
 
 
 
 
Liabilities of consolidated investment management funds:
 
 
 
 
 
 
 
 
 
Trading liabilities

 
10,152

 

 

  
10,152

Other liabilities

 
29

 

 

  
29

Total liabilities of consolidated investment management funds

 
10,181

 

 

  
10,181

Total liabilities
$
5,108

 
$
35,064

 
$
224

 
$
(20,990
)
 
$
19,406

Percentage of liabilities prior to netting
13
%
 
87
%
 
%
 
 
 
 
(a)
ASC 815 permits the netting of derivative receivables and derivative payables under legally enforceable master netting agreements and permits the netting of cash collateral. Netting is applicable to derivatives not designated as hedging instruments included in trading assets or trading liabilities, and derivatives designated as hedging instruments included in other assets or other liabilities. Netting is allocated to the derivative products based on the net fair value of each product.
(b)
Includes certain interests in securitizations.
(c)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(d)
Includes private equity investments, seed capital and a brokerage account.




100 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Details of certain items measured at fair value
 on a recurring basis
June 30, 2013
 
Dec. 31, 2012
Total
carrying
value (a)

 
Ratings
 
Total
carrying value (a)

 
Ratings
AAA/
AA-

A+/
A-

BBB+/
BBB-

BB+ and
lower

 
 
AAA/
AA-

A+/
A-

BBB+/
BBB-

BB+ and
lower

(dollar amounts in millions)
 
Alt-A RMBS, originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2006-2007
$
107

 
%
%
%
100
%
 
$
111

 
%
%
%
100
%
2005
104

 



100

 
107

 



100

2004 and earlier
55

 
1

9

25

65

 
61

 
4

9

25

62

Total Alt-A RMBS
$
266

 
%
2
%
5
%
93
%
 
$
279

 
1
%
2
%
6
%
91
%
Prime RMBS, originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2007
$
96

 
%
%
46
%
54
%
 
$
106

 
%
%
45
%
55
%
2006
59

 



100

 
70

 



100

2005
145

 

43


57

 
215

 

33

7

60

2004 and earlier
264

 
9

41

12

38

 
337

 
16

42

7

35

Total prime RMBS
$
564

 
4
%
31
%
13
%
52
%
 
$
728

 
7
%
29
%
12
%
52
%
Subprime RMBS, originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2005
$
111

 
%
8
%
46
%
46
%
 
$
108

 
4
%
8
%
34
%
54
%
2004 and earlier
312

 
2

4

7

87

 
344

 
3

4

6

87

Total subprime RMBS
$
423

 
1
%
6
%
17
%
76
%
 
$
452

 
3
%
5
%
13
%
79
%
Commercial MBS - Domestic, originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2009-2012
$
364

 
83
%
17
%
%
%
 
$
283

 
97
%
3
%
%
%
2008
23

 
60

40



 
24

 
59

41



2007
553

 
73

19

8


 
707

 
78

16

6


2006
786

 
86

14



 
900

 
85

14

1


2005
570

 
99


1


 
640

 
98

1

1


2004 and earlier
256

 
96

4



 
285

 
100




Total commercial MBS - Domestic
$
2,552

 
86
%
12
%
2
%
%
 
$
2,839

 
89
%
9
%
2
%
%
Foreign covered bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
Canada
$
860

 
100
%
%
%
%
 
$
925

 
100
%
%
%
%
United Kingdom
735

 
100




 
756

 
100




Germany
654

 
98

2



 
866

 
98

2



Netherlands
281

 
100




 
360

 
100




Other
681

 
100




 
811

 
100




Total foreign covered bonds
$
3,211

 
100
%
%
%
%
 
$
3,718

 
100
%
%
%
%
European floating rate notes - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
United Kingdom
$
1,631

 
85
%
12
%
3
%
%
 
$
1,873

 
79
%
19
%
2
%
%
Netherlands
598

 
100




 
841

 
100




Ireland
158

 
14



86

 
161

 
15



85

Italy
110

 

100



 
125

 

100



Australia
65

 
95

5



 
77

 
94

6



Germany
61

 

3


97

 
68

 

9


91

Total European floating rate notes - available-for-sale
$
2,623

 
79
%
12
%
2
%
7
%
 
$
3,145

 
77
%
15
%
2
%
6
%
Sovereign debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
United Kingdom
$
4,399

 
100
%
%
%
%
 
$
4,771

 
100
%
%
%
%
Germany
2,212

 
100




 
1,646

 
100




Netherlands
2,005

 
100




 
2,054

 
100




France
1,429

 
100




 
897

 
100




Other
379

 
100




 
56

 
100




Total sovereign debt
$
10,424

 
100
%
%
%
%
 
$
9,424

 
100
%
%
%
%
Alt-A RMBS (b), originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2006-2007
$
1,070

 
%
%
%
100
%
 
$
1,128

 
%
%
%
100
%
2005
573

 

4

1

95

 
622

 
4


1

95

2004 and earlier
204

 


13

87

 
220

 

2

12

86

Total Alt-A RMBS (b)
$
1,847

 
%
1
%
2
%
97
%
 
$
1,970

 
1
%
%
2
%
97
%
Prime RMBS (b), originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2006-2007
$
536

 
%
%
%
100
%
 
$
601

 
%
%
%
100
%
2005
336

 


1

99

 
378

 

1

2

97

2004 and earlier
27

 

8

22

70

 
31

 

8

24

68

Total prime RMBS (b)
$
899

 
%
%
1
%
99
%
 
$
1,010

 
%
1
%
1
%
98
%
Subprime RMBS (b), originated in:
 
 
 
 
 
 
 
 
 
 
 
 
 
2005-2007
$
98

 
%
%
%
100
%
 
$
94

 
%
%
%
100
%
2004 and earlier
36

 
1

5

36

58

 
36

 
5


36

59

Total subprime RMBS (b)
$
134

 
%
1
%
10
%
89
%
 
$
130

 
2
%
%
10
%
88
%
(a)
At June 30, 2013 and Dec. 31, 2012, foreign covered bonds were included in Level 1 and Level 2 in the valuation hierarchy. All other assets in the table are Level 2 assets in the valuation hierarchy.
(b)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.



BNY Mellon 101

Notes to Consolidated Financial Statements (continued)
 

Changes in Level 3 fair value measurements

Our classification of a financial instrument in Level 3 of the valuation hierarchy is based on the significance of the unobservable factors to the overall fair value measurement. However, these instruments generally include other observable components that are actively quoted or validated to third-party sources; accordingly, the gains and losses in the table below include changes in fair value due to observable parameters as well as the unobservable parameters in our valuation methodologies. We also frequently manage the risks of Level 3 financial instruments using securities and derivatives positions that are Level 1 or 2 instruments which are not included in the
 
table; accordingly, the gains or losses below do not reflect the effect of our risk management activities related to the Level 3 instruments.

The Company has a Level 3 Pricing Committee which evaluates the valuation techniques used in determining the fair value of Level 3 assets and liabilities.

The tables below include a roll forward of the balance sheet amounts for the quarter ended June 30, 2013 and 2012 (including the change in fair value), for financial instruments classified in Level 3 of the valuation hierarchy.


Fair value measurements for assets using significant unobservable inputs for the three months ended June 30, 2013
 
Available-for-sale securities

 
Trading assets
 
 
 
 
Assets of consolidated management funds

 
(in millions)
State and  political
subdivisions

 
Debt and equity
instruments

 
Derivative
assets

(a)
Other
assets

 
Total assets of operations

 
Fair value at March 31, 2013
$
44

 
$
11

 
$
42

 
$
112

 
$
209

44

 
Total gains or (losses) for the period:
 
 
 
 
 
 
 
 
 
 
 
Included in earnings (or changes in net assets)
8

(b)

(c) 

(c) 
5

(d) 
13


(e) 
Sales

 
(9
)
 

 
(4
)
 
(13
)

 
Fair value at June 30, 2013
$
52

 
$
2

 
$
42

 
$
113

 
$
209

$
44

 
Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period
 
 
$

 
$
1

 
$

 
$
1

$

 
(a)
Derivative assets are reported on a gross basis.
(b)
Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c)
Reported in foreign exchange and other trading revenue.
(d)
Reported in investment and other income.
(e)
Reported in income from consolidated investment management funds.


Fair value measurements for liabilities using significant unobservable inputs for the three months ended June 30, 2013
 
Trading liabilities

 
Total liabilities

(in millions)
Derivative liabilities

(a)
Fair value at March 31, 2013
$
170

 
$
170

Transfers out of Level 3
(4
)
 
(4
)
Total (gains) or losses for the period:
Included in earnings (or changes in net liabilities)
(49
)
(b)
(49
)
Fair value at June 30, 2013
$
117

 
$
117

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period
$
(23
)
 
$
(23
)
(a)
Derivative liabilities are reported on a gross basis.
(b)
Reported in foreign exchange and other trading revenue.



102 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Fair value measurements for assets using significant unobservable inputs for the three months ended June 30, 2012
 
Available-for-sale securities
 
Trading assets
 
 
 
 
(in millions)
State and  political subdivisions

 
Debt and equity
instruments

 
Derivative
assets

(a)
Other
assets

 
Total
assets
Fair value at March 31, 2012
$
43

 
$
58

 
$
72

 
$
151

 
$
324

Total gains or (losses) for the period:
 
 
 
 
 
 
 
 
 
Included in earnings (or changes in net assets)

(b)
3

(c)
1

(c)
(2
)
(d)
2

Purchases, sales and settlements:
 
 
 
 
 
 
 
 
 
Purchases

 

 

 
2

 
2

Sales

 
(1
)
 

 
(13
)
 
(14
)
Settlements
(1
)
 

 

 

 
(1
)
Fair value at June 30, 2012
$
42

 
$
60

 
$
73

 
$
138

 
$
313

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period
 
 
$
2

 
$
4

 
$

 
$
6

(a)
Derivative assets are reported on a gross basis.
(b)
Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c)
Reported in foreign exchange and other trading revenue.
(d)
Reported in investment and other income.


Fair value measurements for liabilities using significant unobservable inputs for the three months ended June 30, 2012
 
Trading liabilities

 
Total liabilities

(in millions)
Derivative liabilities

(a)
Fair value at March 31, 2012
$
246

 
$
246

Total (gains) or losses for the period:
 
 
 
Included in earnings (or changes in net liabilities)
56

(b)
56

Fair value at June 30, 2012
$
302

 
$
302

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period
$
66

 
$
66

(a)
Derivative liabilities are reported on a gross basis.
(b)
Reported in foreign exchange and other trading revenue.


Fair value measurements for assets using significant unobservable inputs for the six months ended June 30, 2013
 
 
 
Available-for-sale securities

 
Trading assets
 
 
 
Total
assets of
operations

Assets of
consolidated
management
funds

 
(in millions)
State and 
political
subdivisions

 
Debt and
equity
instruments

 
Derivative
assets

(a)
Other
assets

 
 
Fair value at Dec. 31, 2012
$
45

 
$
48

 
$
58

 
$
120

 
$
271

$
44

 
Transfers out of Level 3

 

 
(5
)
 

 
(5
)

 
Total gains or (losses) for the period:
 
 
 
 
 
 
 
 
 
 
 
Included in earnings (or changes in net assets)
7

(b)
3

(c)
(11
)
(c)

(d)
(1
)

(e)
Purchases and sales:
 
 
 
 
 
 
 
 
 
 
 
Purchases

 

 

 
3

 
3


 
Sales

 
(49
)
 

 
(10
)
 
(59
)

 
Fair value at June 30, 2013
$
52

 
$
2

 
$
42

 
$
113

 
$
209

$
44

 
Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period
$

 
$

 
$
(10
)
 
$

 
$
(10
)
$

 
(a)
Derivative assets are reported on a gross basis.
(b)
Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c)
Reported in foreign exchange and other trading revenue.
(d)
Reported in investment and other income.
(e)
Reported in income from consolidated investment management funds.


BNY Mellon 103

Notes to Consolidated Financial Statements (continued)
 

Fair value measurements for liabilities using significant unobservable inputs for the six months ended June 30, 2013
 
Trading liabilities

 
Total liabilities

(in millions)
Derivative liabilities

(a)
Fair value at Dec. 31, 2012
$
224

 
$
224

Transfers out of Level 3
(4
)
 
(4
)
Total (gains) or losses for the period:
 
 
 
Included in earnings (or changes in net liabilities)
(105
)
(b)
(105
)
Settlements
2

 
2

Fair value at June 30, 2013
$
117

 
$
117

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period
$
(38
)
 
$
(38
)
(a)
Derivative liabilities are reported on a gross basis.
(b)
Reported in foreign exchange and other trading revenue.


Fair value measurements for assets using significant unobservable inputs for the six months ended June 30, 2012
 
Available-for-sale securities
 
Trading assets
 
 
 
 
(in millions)
State and  political
subdivisions

 
Other debt securities

 
Debt and  equity
instruments

 
Derivative
assets

(a)
Other
assets

 
Total
assets

Fair value at Dec. 31, 2011
$
45

 
$
3

 
$
63

 
$
97

 
$
157

 
$
365

Total gains or (losses) for the period:
 
 
 
 
 
 
 
 
 
 
 
Included in earnings (or changes in net assets)

(b)
(3
)
(b)

(c)
(24
)
(c)
1

(d)
(26
)
Purchases, sales and settlements:
 
 
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 
5

 
5

Sales

 

 
(3
)
 

 
(17
)
 
(20
)
Settlements
(3
)
 

 

 

 
(8
)
 
(11
)
Fair value at June 30, 2012
$
42

 
$

 
$
60

 
$
73

 
$
138

 
$
313

Change in unrealized gains or (losses) for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period
 
 
 
 
$

 
$
(7
)
 
$

 
$
(7
)
(a)
Derivative assets are reported on a gross basis.
(b)
Realized gains (losses) are reported in securities gains (losses). Unrealized gains (losses) are reported in accumulated other comprehensive income (loss) except for the credit portion of OTTI losses which are recorded in securities gains (losses).
(c)
Reported in foreign exchange and other trading revenue.
(d)
Reported in investment and other income.

Fair value measurements for liabilities using significant unobservable inputs for the six months ended June 30, 2012
 
Trading liabilities

 
Total liabilities

(in millions)
Derivative liabilities

(a)
Fair value at Dec. 31, 2011
$
314

 
$
314

Total (gains) or losses for the period:
 
 
 
Included in earnings (or changes in net liabilities)
(12
)
(b)
(12
)
Fair value at June 30, 2012
$
302

 
$
302

Change in unrealized (gains) or losses for the period included in earnings (or changes in net assets) for liabilities held at the end of the reporting period
$
(8
)
 
$
(8
)
(a)
Derivative liabilities are reported on a gross basis.
(b)
Reported in foreign exchange and other trading revenue.


Assets and liabilities measured at fair value on a nonrecurring basis

Under certain circumstances, we make adjustments to fair value our assets, liabilities and unfunded lending-related commitments although they are not measured at fair value on an ongoing basis. An example would be the recording of an impairment of an asset.
 


The following table presents the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy as of June 30, 2013 and Dec. 31, 2012, for which a nonrecurring change in fair value has been recorded during the quarters ended June 30, 2013 and Dec. 31, 2012. 




104 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Assets measured at fair value on a nonrecurring basis at June 30, 2013
 
Total carrying
value

(in millions)
Level 1

 
Level 2

 
Level 3

 
Loans (a)
$

 
$
176

 
$
21

 
$
197

Other assets (b)

 
40

 

 
40

Total assets at fair value on a nonrecurring basis
$

 
$
216

 
$
21

 
$
237

 


Assets measured at fair value on a nonrecurring basis at Dec. 31, 2012
 
Total carrying
value

(in millions)
Level 1

 
Level 2

 
Level 3

 
Loans (a)
$

 
$
183

 
$
23

 
$
206

Other assets (b)

 
79

 

 
79

Total assets at fair value on a nonrecurring basis
$

 
$
262

 
$
23

 
$
285

(a)
During the quarters ended June 30, 2013 and Dec. 31, 2012, the fair value of these loans was reduced $2 million and $2 million, respectively, based on the fair value of the underlying collateral as allowed by ASC 310, Accounting by Creditors for Impairment of a loan, with an offset to the allowance for credit losses.
(b)
Includes other assets received in satisfaction of debt and loans held for sale. Loans held for sale are carried on the balance sheet at the lower of cost or market value.


Level 3 unobservable inputs

The following tables present the unobservable inputs used in valuation of assets and liabilities classified as Level 3 within the fair value hierarchy.
 
Quantitative information about Level 3 fair value measurements of assets
(dollars in millions)
Fair value at
June 30, 2013

Valuation techniques
Unobservable input
 
Range
Measured on a recurring basis:
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
State and political subdivisions
$
52

Discounted cash flow
Expected credit loss
 
6%-22%
Trading assets:
 
 
 
 
 
Debt and equity instruments:
 
 
 
 
 
Distressed debt
$
2

Discounted cash flow
Expected maturity
 
1 - 10 years
 
 
 
Credit spreads
 
200-880 bp
Derivative assets:
 
 
 
 
 
Interest rate:
 
 
 
 
 
Structured foreign exchange swaptions
$
10

Option pricing model (a)
Correlation risk
 
0%-25%
 
 
 
Long-term foreign exchange volatility
 
14%-17%
Foreign exchange contracts:
 
 
 
 
 
Long-term foreign exchange options
$
1

Option pricing model (a)
Long-term foreign exchange volatility
 
18%
Equity:
 
 
 
 
 
Equity options
$
31

Option pricing model (a)
Long-term equity volatility
 
16%-29%
Measured on a nonrecurring basis:
 
 
 
 
 
Loans
$
21

Discounted cash flows
Timing of sale
 
0-12 months
 
 
 
Cap rate
 
8%
 
 
 
Cost to complete/sell
 
0%-30%

Quantitative information about Level 3 fair value measurements of liabilities
(dollars in millions)
Fair value at
June 30, 2013

Valuation techniques
Unobservable input
 
Range
Measured on a recurring basis:
 
 
 
 
 
Trading liabilities:
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
Interest rate:
 
 
 
 
 
Structured foreign exchange swaptions
$
65

Option pricing model (a)
Correlation risk
 
0%-25%
 
 
 
Long-term foreign exchange volatility
 
14%-17%
Equity:
 
 
 
 
 
Equity options
$
52

Option pricing model (a)
Long-term equity volatility
 
16%-29%
(a)
The option pricing model uses market inputs such as foreign currency exchange rates, interest rates and volatility to calculate the fair value of the option.


BNY Mellon 105

Notes to Consolidated Financial Statements (continued)
 

Estimated fair value of financial instruments

The carrying amounts of our financial instruments (i.e., monetary assets and liabilities) are determined under different accounting methods - see Note 1 of the Notes to Consolidated Financial Statements in our 2012 Annual Report. The following disclosure discusses these instruments on a uniform fair value basis. However, active markets do not exist for a significant portion of these instruments. For financial instruments where quoted prices from identical assets and liabilities in active markets do not exist, we determine fair value based on discounted cash flow analysis and comparison to similar instruments. Discounted cash flow analysis is dependent upon estimated future cash flows and the level of interest rates. Other judgments would result in different fair values. The assumptions we used at June 30, 2013 and Dec. 31, 2012 include discount rates ranging principally from 0.21% to 4.72%. The fair value information supplements the basic financial statements and other traditional financial data presented throughout this report.

A summary of the practices used for determining fair value and the respective level in the valuation hierarchy for financial assets and liabilities not recorded at fair value follows.

Interest-bearing deposits with the Federal Reserve and other central banks and interest-bearing deposits with banks

The estimated fair value of interest-bearing deposits with the Federal Reserve and other central banks is equal to the book value as these interest-bearing deposits are generally considered cash equivalents. These instruments are classified as Level 2 within the valuation hierarchy. The estimated fair value of interest-bearing deposits with banks is generally determined using discounted cash flows and duration of the instrument to maturity. The primary inputs used to value these transactions are interest rates based on current LIBOR market rates and time to maturity. Interest-bearing deposits with banks are classified as Level 2 within the valuation hierarchy.

Federal funds sold and securities purchased under resale agreements

The estimated fair value of federal funds sold and securities purchased under resale agreements is based on inputs such as interest rates and tenors. Federal
 
funds sold and securities purchased under resale agreements are classified as Level 2 within the valuation hierarchy.

Securities held-to-maturity

Where quoted prices are available in an active market for identical assets and liabilities, we classify the securities as Level 1 within the valuation hierarchy. Securities are defined as both long and short positions. Level 1 securities include U.S. Treasury securities.

If quoted market prices are not available for identical assets and liabilities, we estimate fair value using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of such instruments, which would generally be classified as Level 2 within the valuation hierarchy, include certain agency and non-agency mortgage-backed securities, commercial mortgage-backed securities and state and political subdivision securities. For securities where quotes from active markets are not available for identical securities, we determine fair value primarily based on pricing sources with reasonable levels of price transparency that employ financial models or obtain comparison to similar instruments to arrive at “consensus” prices.

Specifically, the pricing sources obtain active market prices for similar types of securities (e.g., vintage, position in the securitization structure) and ascertain variables such as discount rate and speed of prepayment for the types of transaction and apply such variables to similar types of bonds. We view these as observable transactions in the current marketplace and classify such securities as Level 2 within the valuation hierarchy.

Loans

For residential mortgage loans, fair value is estimated using discounted cash flow analysis, adjusting where appropriate for prepayment estimates, using interest rates currently being offered for loans with similar terms and maturities to borrowers. The estimated fair value of margin loans and overdrafts is equal to the book value due to the short-term nature of these assets. The estimated fair value of other types of loans is determined using discounted cash flows. Inputs include current LIBOR market rates adjusted for credit spreads. These loans are generally classified as Level 2 within the valuation hierarchy.



106 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Other financial assets

Other financial assets include cash, the Federal Reserve Bank stock and accrued interest receivable. Cash is classified as Level 1 within the valuation hierarchy. The Federal Reserve Bank stock is not redeemable or transferable. The estimated fair value of the Federal Reserve Bank stock is based on the issue price and is classified as Level 2 within the valuation hierarchy. Accrued interest receivable is generally short-term. As a result, book value is considered to equal fair value. Accrued interest receivable is included as Level 2 within the valuation hierarchy.

Noninterest-bearing and interest-bearing deposits

Interest-bearing deposits are comprised of money market rate and demand deposits, savings deposits and time deposits. Except for time deposits, book value is considered to equal fair value for these deposits due to their short duration to maturity or payable on demand feature. The fair value of interest-bearing time deposits is determined using discounted cash flow analysis. Inputs primarily consist of current LIBOR market rates and time to maturity. For all noninterest-bearing deposits, book value is considered to equal fair value as a result of the short duration of the deposit. Interest-bearing and noninterest-bearing deposits are classified as Level 2 within the valuation hierarchy.

Federal funds purchased and securities sold under repurchase agreements

The estimated fair value of federal funds purchased and securities sold under repurchase agreements is based on inputs such as interest rates and tenors. Federal funds purchased and securities sold under repurchase agreements are classified as Level 2 within the valuation hierarchy.

 
Payables to customers and broker-dealers

The estimated fair value of payables to customers and broker-dealers is equal to the book value, due to the demand feature of the payables to customers and broker-dealers, and are classified as Level 2 within the valuation hierarchy.

Borrowings

Borrowings primarily consist of overdrafts of subcustodian account balances in our Investment Services businesses, commercial paper and accrued interest payable. The estimated fair value of overdrafts of subcustodian account balances in our Investment Services businesses is considered to equal book value as a result of the short duration of the overdrafts. Overdrafts are typically repaid within two days. The estimated fair value of our commercial paper is based on discount and duration of the commercial paper. Our commercial paper matures within 397 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment. Our commercial paper is included in Level 2 of the valuation hierarchy. Accrued interest payable is generally short-term. As a result, book value is considered to equal fair value. Accrued interest payable is included as Level 2 within the valuation hierarchy.

Long-term debt

The estimated fair value of long-term debt is based on current rates for instruments of the same remaining maturity or quoted market prices for the same or similar issues. Long-term debt is classified as Level 2 within the valuation hierarchy.

The following tables present the estimated fair value and the carrying amount of financial instruments not carried at fair value on the consolidated balance sheet at June 30, 2013 and Dec. 31, 2012, by caption on the consolidated balance sheet and by ASC 820 valuation hierarchy (as described above).



BNY Mellon 107

Notes to Consolidated Financial Statements (continued)
 

Summary of financial instruments
June 30, 2013
(in millions)
Level 1

Level 2

Level 3

 
Total
estimated
fair value

 
Carrying
amount

Assets:
 
 
 
 
 
 
 
Interest-bearing deposits with the Federal Reserve and other central banks
$

$
77,150

$

 
$
77,150

 
$
77,150

Interest-bearing deposits with banks

42,170


 
42,170

 
42,145

Federal funds sold and securities purchased under resale agreements

9,978


 
9,978

 
9,978

Securities held-to-maturity
3,308

10,288


 
13,596

 
13,785

Loans

47,902


 
47,902

 
47,850

Other financial assets
6,940

1,123


 
8,063

 
8,063

Total
$
10,248

$
188,611

$

 
$
198,859

 
$
198,971

Liabilities:
 
 
 
 
 
 
 
Noninterest-bearing deposits
$

$
82,948

$

 
$
82,948

 
$
82,948

Interest-bearing deposits

161,877


 
161,877

 
161,934

Federal funds purchased and securities sold under repurchase agreements

12,600


 
12,600

 
12,600

Payables to customers and broker-dealers

15,267


 
15,267

 
15,267

Borrowings

1,332


 
1,332

 
1,332

Long-term debt

18,654


 
18,654

 
18,157

Total
$

$
292,678

$

 
$
292,678

 
$
292,238



Summary of financial instruments
Dec. 31, 2012
(in millions)
Level 1

Level 2

Level 3

 
Total estimated
fair value

 
Carrying
amount

Assets:
 
 
 
 
 
 
 
Interest-bearing deposits with the Federal Reserve and other central banks
$

$
90,110

$

 
$
90,110

 
$
90,110

Interest-bearing deposits with banks

43,936


 
43,936

 
43,910

Federal funds sold and securities purchased under resale agreements

6,593


 
6,593

 
6,593

Securities held-to-maturity
1,070

7,319


 
8,389

 
8,205

Loans

44,031


 
44,031

 
44,010

Other financial assets
4,727

1,115


 
5,842

 
5,842

Total
$
5,797

$
193,104

$

 
$
198,901

 
$
198,670

Liabilities:
 
 
 
 
 
 
 
Noninterest-bearing deposits
$

$
93,019

$

 
$
93,019

 
$
93,019

Interest-bearing deposits

153,030


 
153,030

 
153,076

Federal funds purchased and securities sold under repurchase agreements

7,427


 
7,427

 
7,427

Payables to customers and broker-dealers

16,095


 
16,095

 
16,095

Borrowings

1,883


 
1,883

 
1,883

Long-term debt

19,397


 
19,397

 
18,530

Total
$

$
290,851

$

 
$
290,851

 
$
290,030



The table below summarizes the carrying amount of the hedged financial instruments, the notional amount of the hedge and the unrealized gain (loss) (estimated fair value) of the derivatives.

Hedged financial instruments
Carrying amount

 
Notional amount of hedge

 
Unrealized
(in millions)
Gain

 
(Loss)

At June 30, 2013:
 
 
 
 
 
 
 
Interest-bearing deposits with banks
$
2,600

 
$
2,600

 
$
69

 
$
(9
)
Securities available-for-sale
5,821

 
6,183

 
406

 
(137
)
Deposits
10

 
10

 

 

Long-term debt
14,156

 
13,748

 
580

 
(42
)
At Dec. 31, 2012:
 
 
 
 
 
 
 
Interest-bearing deposits with banks
$
11,328

 
$
11,328

 
$
38

 
$
(224
)
Securities available-for-sale
5,597

 
5,355

 
12

 
(339
)
Deposits
10

 
10

 
1

 

Long-term debt
15,100

 
14,314

 
911

 
(4
)



108 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 16—Fair value option

ASC 825 provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments and written loan commitments.

The following table presents the assets and liabilities, by type, of consolidated investment management funds recorded at fair value. 

Assets and liabilities of consolidated investment management funds, at fair value
(in millions)
June 30, 2013

Dec. 31, 2012

Assets of consolidated investment management funds:
 
 
Trading assets
$
10,766

$
10,961

Other assets
705

520

Total assets of consolidated investment management funds
$
11,471

$
11,481

Liabilities of consolidated investment management funds:
 
 
Trading liabilities
$
10,110

$
10,152

Other liabilities
32

29

Total liabilities of consolidated investment management funds
$
10,142

$
10,181



BNY Mellon values assets in consolidated CLOs using observable market prices observed from the secondary loan market. The returns to the note holders are solely dependent on the assets and accordingly equal the value of those assets. Mark-to-market valuation best reflects the limited interest BNY Mellon has in the economic performance of the consolidated CLOs. Changes in the values of assets and liabilities are reflected in the income statement as investment income of consolidated investment management funds.

We have elected the fair value option on $240 million of long-term debt in connection with ASC 810. At June 30, 2013, the fair value of this long-term debt was $324 million. The long-term debt is valued using observable market inputs and is included in Level 2 of the ASC 820 hierarchy.

The following table presents the changes in fair value of the long-term debt included in foreign exchange and other trading revenue in the consolidated income statement.

 
Foreign exchange and other trading revenue
 
 
 
 
 
Quarter ended
 
Year-to-date
(in millions)
June 30, 2013

June 30, 2012

 
June 30, 2013

June 30, 2012

Changes in the fair value of long-term debt (a)
$
17

$
(19
)
 
$
21

$
(13
)
(a)
The change in fair value of the long-term debt is approximately offset by an economic hedge included in trading.

Note 17 - Derivative instruments

We use derivatives to manage exposure to market risk including interest rate risk, equity price risk and foreign currency risk, as well as credit risk. Our trading activities are focused on acting as a market-maker for our customers and facilitating customer trades. In addition, we periodically manage positions for our own account. Positions managed for our own account are immaterial to our foreign exchange and other trading revenue and to our overall results of operations.

The notional amounts for derivative financial instruments express the dollar volume of the transactions; however, credit risk is much smaller. We perform credit reviews and enter into netting agreements to minimize the credit risk of derivative financial instruments. We enter into offsetting positions to reduce exposure to foreign currency, interest rate and equity price risk.

Use of derivative financial instruments involves reliance on counterparties. Failure of a counterparty to honor its obligation under a derivative contract is a risk we assume whenever we engage in a derivative contract. There were no counterparty default losses in the second quarter of 2013 or 2012.

Hedging derivatives

We utilize interest rate swap agreements to manage our exposure to interest rate fluctuations. For hedges of available-for-sale investment securities, deposits and long-term debt, the hedge documentation specifies the terms of the hedged items and the interest rate swaps and indicates that the derivative is hedging a fixed rate item and is a fair value hedge, that the hedge exposure is to the changes in the fair value of the hedged item due to changes in benchmark interest rates, and that the strategy is to



BNY Mellon 109

Notes to Consolidated Financial Statements (continued)
 

eliminate fair value variability by converting fixed-rate interest payments to LIBOR.

The available-for-sale investment securities hedged consist of sovereign debt, U.S. Treasury bonds and agency commercial mortgage-backed securities that had original maturities of 30 years or less at initial purchase. The swaps on all of these investment securities are not callable. All of these securities are hedged with “pay fixed rate, receive variable rate” swaps of similar maturity, repricing and fixed rate coupon. At June 30, 2013, $6.0 billion face amount of securities were hedged with interest rate swaps that had notional values of $6.2 billion.

The hedged fixed rate deposits have original maturities of approximately ten years and are not callable. These deposits are hedged with “receive fixed rate, pay variable” rate swaps of similar maturity, repricing and fixed rate coupon. The swaps are not callable. At June 30, 2013, $10 million face amount of deposits were hedged with interest rate swaps that had notional values of $10 million.

The fixed rate long-term debt instruments hedged generally have original maturities of five to 30 years. We issue both callable and non-callable debt. The non-callable debt is hedged with simple interest rate swaps similar to those described for deposits. Callable debt is hedged with callable swaps where the call dates of the swaps exactly match the call dates of the debt. At June 30, 2013, $13.7 billion par value of debt was hedged with interest rate swaps that had notional values of $13.7 billion.

In addition, we enter into foreign exchange hedges. We use forward foreign exchange contracts with maturities of nine months or less to hedge our British Pound, Euro, Hong Kong Dollar, Indian Rupee and Singapore Dollar foreign exchange exposure with respect to foreign currency forecasted revenue and expense transactions in entities that have the U.S. dollar as their functional currency. As of June 30, 2013, the hedged forecasted foreign currency transactions and designated forward foreign exchange contract hedges were $181 million (notional), with a pre-tax loss of $6 million recorded in accumulated other comprehensive income. This loss will be reclassified to income or expense over the next six months.

 
We use forward foreign exchange contracts with remaining maturities of nine months or less as hedges against our foreign exchange exposure to Australian Dollar, Euro, Swedish Krona, British Pound, Danish Krone, Norwegian Krone and Japanese Yen with respect to interest-bearing deposits with banks and their associated forecasted interest revenue. These hedges are designated as cash flow hedges. These hedges are effected such that their maturities and notional values match those of the deposits with banks. As of June 30, 2013, the hedged interest-bearing deposits with banks and their designated forward foreign exchange contract hedges were $2.8 billion (notional), with a pre-tax loss of $8 million recorded in accumulated other comprehensive income. This loss will be reclassified to net interest revenue over the next six months.

Forward foreign exchange contracts are also used to hedge the value of our net investments in foreign subsidiaries. These forward foreign exchange contracts have maturities of less than two years. The derivatives employed are designated as hedges of changes in value of our foreign investments due to exchange rates. Changes in the value of the forward foreign exchange contracts offset the changes in value of the foreign investments due to changes in foreign exchange rates. The change in fair market value of these forward foreign exchange contracts is deferred and reported within accumulated translation adjustments in shareholders’ equity, net of tax. At June 30, 2013, forward foreign exchange contracts with notional amounts totaling $5.4 billion were designated as hedges.

In addition to forward foreign exchange contracts, we also designate non-derivative financial instruments as hedges of our net investments in foreign subsidiaries. Those non-derivative financial instruments designated as hedges of our net investments in foreign subsidiaries were all long-term liabilities of BNY Mellon in various currencies, and, at June 30, 2013, had a combined U.S. dollar equivalent value of $502 million.

Ineffectiveness related to derivatives and hedging relationships was recorded in income as follows:




110 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Ineffectiveness
Six months ended
(in millions)
June 30,
2013

June 30,
2012

Fair value hedges of securities
7.8

0.7

Fair value hedges of deposits and long-term debt
(0.5
)
(1.4
)
Cash flow hedges
0.1

0.1

Other (a)
0.1

(0.1
)
Total
$
7.5

$
(0.7
)
(a)
Includes ineffectiveness recorded on foreign exchange hedges.



The following table summarizes the notional amount and credit exposure of our total derivative portfolio at June 30, 2013 and Dec. 31, 2012.

Impact of derivative instruments on the balance sheet
Notional value
 
Asset derivatives
fair value
 
Liability derivatives
fair value
(in millions)
June 30, 2013

Dec. 31, 2012

 
June 30, 2013

Dec. 31, 2012

 
June 30, 2013

Dec. 31, 2012

Derivatives designated as hedging instruments (a):
 
 
 
 
 
 
 
 
Interest rate contracts
$
19,941

$
19,679

 
$
986

$
928

 
$
179

$
343

Foreign exchange contracts
8,373

16,805

 
248

61

 
37

361

Total derivatives designated as hedging instruments
 
 
 
$
1,234

$
989

 
$
216

$
704

Derivatives not designated as hedging instruments (b):
 
 
 
 
 
 
 
 
Interest rate contracts
$
817,201

$
796,155

 
$
16,834

$
22,789

 
$
17,408

$
23,341

Foreign exchange contracts
439,109

359,204

 
4,175

3,513

 
4,236

3,632

Equity contracts
20,572

11,375

 
487

311

 
601

413

Credit contracts
141

166

 


 


Total derivatives not designated as hedging instruments
 
 
 
$
21,496

$
26,613

 
$
22,245

$
27,386

Total derivatives fair value (c)
 
 
 
$
22,730

$
27,602

 
$
22,461

$
28,090

Effect of master netting agreements (d)
 
 
 
(17,478
)
(22,311
)
 
(16,445
)
(20,990
)
Fair value after effect of master netting agreements
 
 
 
$
5,252

$
5,291

 
$
6,016

$
7,100

(a)
The fair value of asset derivatives and liability derivatives designated as hedging instruments is recorded as other assets and other liabilities, respectively, on the balance sheet.
(b)
The fair value of asset derivatives and liability derivatives not designated as hedging instruments is recorded as trading assets and trading liabilities, respectively, on the balance sheet.
(c)
Fair values are on a gross basis, before consideration of master netting agreements, as required by ASC 815.
(d)
Master netting agreements are reported net of cash collateral received and paid of $1,189 million and $156 million, respectively, at June 30, 2013, and $1,452 million and $131 million, respectively, at Dec. 31, 2012.


At June 30, 2013, $477 billion (notional) of interest rate contracts will mature within one year, $181 billion between one and five years, and $179 billion after five years. At June 30, 2013, $433 billion (notional) of foreign exchange contracts will mature within one year, $6 billion between one and five years, and $8 billion after five years.


Impact of derivative instruments on the income statement
(in millions)
 
  
Derivatives in fair value hedging relationships
Location of gain or
(loss) recognized in income on derivatives
 
Gain or (loss) recognized
in income on derivatives
 
Location of gain or(loss) recognized in income on hedged item
 
Gain or (loss) recognized 
in hedged item
2Q13

 
1Q13

 
2Q12

 
2Q13

 
1Q13

 
2Q12

Interest rate contracts
Net interest  revenue
 
$
169

 
$
75

 
$
(249
)
 
Net interest  revenue
 
$
(167
)
 
$
(71
)
 
$
248



BNY Mellon 111

Notes to Consolidated Financial Statements (continued)
 

Derivatives in cash flow hedging
relationships
Gain or (loss) recognized
in accumulated
OCI on derivatives(effective portion)
 
Location of gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Gain or (loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Location of gain or
(loss) recognized in
income on derivatives
(ineffective portion and
amount excluded from
effectiveness testing)
 
Gain or (loss) recognized in income on derivatives 
(ineffectiveness portion and amount excluded from effectiveness testing)
2Q13

1Q13

2Q12

 
 
2Q13

1Q13

2Q12

 
 
2Q13

1Q13

2Q12

FX contracts
$
(15
)
$
(12
)
$
9

 
Net interest revenue
 
$
(6
)
$
(13
)
$
9

 
Net interest revenue
 
$

$

$

FX contracts
(1
)
2

(1
)
 
Other revenue
 



 
Other revenue
 

0.1


FX contracts
34

183

(338
)
 
Trading revenue
 
34

183

(338
)
 
Trading revenue
 



FX contracts
(5
)
(2
)
1

 
Salary expense
 
(1
)

1

 
Salary expense
 



Total
$
13

$
171

$
(329
)
 
 
 
$
27

$
170

$
(328
)
 
 
 
$

$
0.1

$



Derivatives in net
investment hedging
relationships
Gain or (loss) recognized in accumulated OCI
on derivatives
(effective portion)
 
Location of gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Gain or (loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Location of gain or
(loss) recognized in
income on derivative
(ineffective portion and
amount excluded from
effectiveness testing)
 
Gain or (loss) recognized in income on
derivatives 
(ineffectiveness
portion and amount
excluded from
effectiveness testing)
2Q13

1Q13

2Q12

 
 
2Q13

1Q13

2Q12

 
 
2Q13

1Q13

2Q12

FX contracts
$
38

$
167

$
110

 
Net interest revenue
 
$

$

$

 
Other revenue
 
$
0.2

$
(0.1
)
$



Impact of derivative instruments on the income statement
(in millions)
 
  
Derivatives in fair value hedging relationships
Location of gain or
(loss) recognized in income on derivatives
 
Gain or (loss) recognized
in income on derivatives
Six months ended
 
Location of gain or(loss) recognized in income on hedged item
 
Gain or (loss) recognized 
in hedged item
Six months ended
June 30,
2013

 
June 30,
2012

 
June 30,
2013

 
June 30,
2012

Interest rate contracts
Net interest  revenue
 
$
245

 
$
(122
)
 
Net interest  revenue
 
$
(237
)
 
$
121



Derivatives in cash flow hedging
relationships
Gain or (loss) recognized
in accumulated
OCI on derivatives(effective portion)
Six months ended
 
Location of gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Gain or (loss) reclassified
from accumulated
OCI into income
(effective portion)
Six months ended
 
Location of gain or
(loss) recognized in
income on derivatives
(ineffective portion and
amount excluded from
effectiveness testing)
 
Gain or (loss) recognized in income on derivatives 
(ineffectiveness portion and amount excluded from effectiveness testing)
Six months ended
June 30,
2013

 
June 30,
2012

 
 
June 30,
2013

 
June 30,
2012

 
 
June 30,
2013

 
June 30,
2012

FX contracts
$
(27
)
 
$
7

 
Net interest revenue
 
$
(19
)
 
$
4

 
Net interest revenue
 
$

 
$

FX contracts
1

 
2

 
Other revenue
 

 
1

 
Other revenue
 
0.1

 
0.1

FX contracts
217

 
4

 
Trading revenue
 
217

 
4

 
Trading revenue
 

 

FX contracts
(7
)
 

 
Salary expense
 
(1
)
 
(1
)
 
Salary expense
 

 

Total
$
184

 
$
13

 
 
 
$
197

 
$
8

 
 
 
$
0.1

 
$
0.1



Derivatives in net
investment hedging
relationships
Gain or (loss) recognized in accumulated OCI
on derivatives
(effective portion)
Six months ended
 
Location of gain or
(loss) reclassified
from accumulated
OCI into income
(effective portion)
 
Gain or (loss) reclassified
from accumulated
OCI into income
(effective portion)
Six months ended
 
Location of gain or
(loss) recognized in
income on derivative
(ineffective portion and
amount excluded from
effectiveness testing)
 
Gain or (loss) recognized in income on
derivatives 
(ineffectiveness
portion and amount
excluded from
effectiveness testing)
Six months ended
June 30,
2013

 
June 30,
2012

 
 
June 30,
2013

 
June 30,
2012

 
 
June 30,
2013

 
June 30,
2012

FX contracts
$
205

 
$
(29
)
 
Net interest revenue
 
$

 
$

 
Other revenue
 
$
0.1

 
$
(0.1
)



112 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Trading activities (including trading derivatives)

We manage trading risk through a system of position limits, a VaR methodology based on Monte Carlo simulations, stop loss advisory triggers, and other market sensitivity measures. Risk is monitored and reported to senior management by a separate unit on a daily basis. Based on certain assumptions, the VaR methodology is designed to capture the potential overnight pre-tax dollar loss from adverse changes in fair values of all trading positions. The calculation assumes a one-day holding period for most instruments, utilizes a 99% confidence level, and incorporates the non-linear characteristics of options. The VaR model is one of several statistical models used to develop economic capital results, which is allocated to lines of business for computing risk-adjusted performance.

As the VaR methodology does not evaluate risk attributable to extraordinary financial, economic or other occurrences, the risk assessment process includes a number of stress scenarios based upon the risk factors in the portfolio and management’s assessment of market conditions. Additional stress scenarios based upon historic market events are also performed. Stress tests, by their design, incorporate the impact of reduced liquidity and the breakdown of observed correlations. The results of these stress tests are reviewed weekly with senior management.

Revenue from foreign exchange and other trading included the following:

Foreign exchange and other trading revenue
 
 
 
 
 
Year-to-date
(in millions)
2Q13
1Q13
2Q12

2013

2012

Foreign exchange
$
179

$
149

$
157

$
328

$
293

Other trading revenue:
 
 
 
 
 
Fixed income
12

8

16

20

63

Equity/other
16

4

7

20

15

Total other trading revenue
28

12

23

40

78

Total
$
207

$
161

$
180

$
368

$
371



Foreign exchange includes income from purchasing and selling foreign currencies and currency forwards, futures and options. Fixed income reflects results from futures and forward contracts, interest rate swaps, structured foreign currency swaps, options, and fixed income securities. Equity/Other primarily includes revenue from equity securities and equity derivatives.
 
Counterparty credit risk and collateral

We assess credit risk of our counterparties through regular examination of their financial statements, confidential communication with the management of those counterparties and regular monitoring of publicly available credit rating information. This and other information is used to develop proprietary credit rating metrics used to assess credit quality.

Collateral requirements are determined after a comprehensive review of the credit quality of each counterparty. Collateral is generally held or pledged in the form of cash or highly liquid government securities. Collateral requirements are monitored and adjusted daily.

Additional disclosures concerning derivative financial instruments are provided in Note 15 of the Notes to Consolidated Financial Statements.

Disclosure of contingent features in over-the-counter (“OTC”) derivative instruments

Certain OTC derivative contracts and/or collateral agreements of The Bank of New York Mellon, our largest banking subsidiary and the subsidiary through which BNY Mellon enters into the substantial majority of all of its OTC derivative contracts and/or collateral agreements, contain provisions that may require us to take certain actions if The Bank of New York Mellon’s public debt rating fell to a certain level. Early termination provisions, or “close-out” agreements, in those contracts could trigger immediate payment of outstanding contracts that are in net liability positions. Certain collateral agreements would require The Bank of New York Mellon to immediately post additional collateral to cover some or all of The Bank of New York Mellon’s liabilities to a counterparty.

The following table shows the fair value of contracts falling under early termination provisions that were in net liability positions as of June 30, 2013 for three key ratings triggers:
If The Bank of New York Mellon’s rating was changed to (Moody’s/S&P)
Potential close-out
exposures (fair value)  (a)
 
A3/A-
 
$
682
 million
Baa2/BBB
 
$
847
 million
Bal/BB+
 
$
1,615
 million
(a)
The change between rating categories is incremental, not cumulative.





BNY Mellon 113

Notes to Consolidated Financial Statements (continued)
 

Additionally, if The Bank of New York Mellon’s debt rating had fallen below investment grade on June 30, 2013, existing collateral arrangements would have required us to have posted an additional $485 million of collateral.


 
Offsetting assets and liabilities

The following tables present derivative instruments and financial instruments that are either subject to an enforceable netting agreement or offset by collateral arrangements. There were no derivative instruments or financial instruments subject to a netting agreement for which we are not currently netting.


Offsetting of financial assets and derivative assets
 
 
 
 
 
 
 
June 30, 2013
 
Dec. 31, 2012
(in millions)
Gross assets recognized

Offset in the balance sheet

(a)
Net assets recognized

 
Gross assets recognized

Offset in the balance sheet

(a)
Net assets recognized

Derivatives subject to netting arrangements:
 
 
 
 
 
 
 
 
 
Interest rate contracts
$
16,653

$
15,307

 
$
1,346

 
$
22,234

$
20,042

 
$
2,192

Foreign exchange contracts
3,440

2,025

 
1,415

 
3,255

2,171

 
1,084

Equity and other contracts
389

146

 
243

 
264

98

 
166

Total derivatives subject to netting arrangements
20,482

17,478

 
3,004

 
25,753

22,311

 
3,442

Total derivatives not subject to netting arrangements
2,248


 
2,248

 
1,849


 
1,849

Total derivatives
22,730

17,478

 
5,252

 
27,602

22,311

 
5,291

Reverse repurchase agreements
9,860


(b)
9,860

 
6,718

137

(b)
6,581

Total
$
32,590

$
17,478

 
$
15,112

 
$
34,320

$
22,448

 
$
11,872

(a)
Includes the effect of netting agreements and net cash collateral paid. The offset related to the over-the-counter derivatives was allocated to the various types of derivatives based on the net positions.
(b)
Offsetting of reverse repurchase agreements relates to our involvement in the Fixed Income Clearing Corporation, where we settle government securities transactions on a net basis for payment and delivery through the Fedwire system.


Offsetting of financial liabilities and derivative liabilities
 
 
 
 
 
 
 
June 30, 2013
 
Dec. 31, 2012
(in millions)
Gross liabilities recognized

Offset in the balance sheet

(a)
Net liabilities recognized

 
Gross liabilities recognized

Offset in the balance sheet

(a)
Net liabilities recognized

Derivatives subject to netting arrangements:
 
 
 
 
 
 
 
 
 
Interest rate contracts
$
17,178

$
14,478

 
$
2,700

 
$
23,274

$
19,069

 
$
4,205

Foreign exchange contracts
2,784

1,821

 
963

 
3,423

1,823

 
1,600

Equity and other contracts
440

146

 
294

 
310

98

 
212

Total derivatives subject to netting arrangements
20,402

16,445

 
3,957

 
27,007

20,990

 
6,017

Total derivatives not subject to netting arrangements
2,059


 
2,059

 
1,083


 
1,083

Total derivatives
22,461

16,445

 
6,016

 
28,090

20,990

 
7,100

Repurchase agreements
12,449


(b)
12,449

 
7,153

137

(b)
7,016

Total
$
34,910

$
16,445

 
$
18,465

 
$
35,243

$
21,127

 
$
14,116

(a)
Includes the effect of netting agreements and net cash collateral received. The offset related to the over-the-counter derivatives was allocated to the various types of derivatives based on the net positions.
(b)
Offsetting of repurchase agreements relates to our involvement in the Fixed Income Clearing Corporation, where we settle government securities transactions on a net basis for payment and delivery through the Fedwire system.




114 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Note 18 - Commitments and contingent liabilities

In the normal course of business, various commitments and contingent liabilities are outstanding that are not reflected in the accompanying consolidated balance sheets.

Our significant trading and off-balance sheet risks are securities, foreign currency and interest rate risk management products, commercial lending commitments, letters of credit and securities lending indemnifications. We assume these risks to reduce interest rate and foreign currency risks, to provide customers with the ability to meet credit and liquidity needs and to hedge foreign currency and interest rate risks. These items involve, to varying degrees, credit, foreign currency and interest rate risk not recognized in the balance sheet. Our off-balance sheet risks are managed and monitored in manners similar to those used for on-balance sheet risks. Significant industry concentrations related to credit exposure at June 30, 2013 are disclosed in the financial institutions portfolio exposure table and the commercial portfolio exposure table below.

Financial institutions
portfolio exposure
(in billions)
June 30, 2013
Loans

Unfunded
commitments

Total
exposure

Banks
$
9.0

$
2.0

$
11.0

Asset managers
1.2

3.6

4.8

Securities industry
2.5

1.7

4.2

Insurance
0.1

4.1

4.2

Government

3.0

3.0

Other
0.1

1.1

1.2

Total
$
12.9

$
15.5

$
28.4

 


Commercial portfolio
exposure
(in billions)
June 30, 2013
Loans

Unfunded
commitments

Total
exposure

Services and other
$
0.6

$
6.0

$
6.6

Energy and utilities
0.7

6.0

6.7

Manufacturing
0.2

5.7

5.9

Media and telecom
0.1

1.6

1.7

Total
$
1.6

$
19.3

$
20.9



Major concentrations in securities lending are primarily to broker-dealers and are generally collateralized with cash. Securities lending transactions are discussed below.

 
The following table presents a summary of our off-balance sheet credit risks, net of participations.

Off-balance sheet credit risks
June 30,

 
Dec. 31,

(in millions)
2013

 
2012

Lending commitments (a)
$
31,754

 
$
31,265

Standby letters of credit (b)
7,087

 
7,167

Commercial letters of credit
376

 
219

Securities lending indemnifications
264,746

 
245,717

(a)
Net of participations totaling $324 million at June 30, 2013 and $350 million at Dec. 31, 2012.
(b)
Net of participations totaling $876 million at June 30, 2013 and $1.0 billion at Dec. 31, 2012.


Included in lending commitments are facilities that provide liquidity for variable rate tax-exempt securities wrapped by monoline insurers. The credit approval for these facilities is based on an assessment of the underlying tax-exempt issuer and considers factors other than the financial strength of the monoline insurer.

The total potential loss on undrawn lending commitments, standby and commercial letters of credit, and securities lending indemnifications is equal to the total notional amount if drawn upon, which does not consider the value of any collateral.

Since many of the commitments are expected to expire without being drawn upon, the total amount does not necessarily represent future cash requirements. A summary of lending commitment maturities is as follows: $8.3 billion in less than one year, $23.4 billion in one to five years and $0.1 billion over five years.

Standby letters of credit (“SBLC”) principally support corporate obligations. As shown in the off-balance sheet credit risks table, the maximum potential exposure of SBLCs was $7.1 billion at June 30, 2013 and $7.2 billion at Dec. 31, 2012, and includes $448 million and $781 million that were collateralized with cash and securities at June 30, 2013 and Dec. 31, 2012, respectively. At June 30, 2013, $3.7 billion of the SBLCs will expire within one year and $3.4 billion in one to five years.

We must recognize, at the inception of standby letters of credit and foreign and other guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. As required by ASC 460 - “Guarantees”, the fair value of the liability, which was recorded with a corresponding asset in other



BNY Mellon 115

Notes to Consolidated Financial Statements (continued)
 

assets, was estimated as the present value of contractual customer fees.

The estimated liability for losses related to these commitments and SBLCs, if any, is included in the allowance for lending-related commitments. The allowance for lending-related commitments was $125 million at June 30, 2013 and $121 million at Dec. 31, 2012.

Payment/performance risk of SBLCs is monitored using both historical performance and internal ratings criteria. BNY Mellon’s historical experience is that SBLCs typically expire without being funded. SBLCs below investment grade are monitored closely for payment/performance risk. The table below shows SBLCs by investment grade:

Standby letters of credit
June 30,

 
Dec. 31,

  
2013

 
2012

Investment grade
90
%
 
93
%
Noninvestment grade
10
%
 
7
%


A commercial letter of credit is normally a short-term instrument used to finance a commercial contract for the shipment of goods from a seller to a buyer. Although the commercial letter of credit is contingent upon the satisfaction of specified conditions, it represents a credit exposure if the buyer defaults on the underlying transaction. As a result, the total contractual amounts do not necessarily represent future cash requirements. Commercial letters of credit totaled $376 million at June 30, 2013 compared with $219 million at Dec. 31, 2012.

A securities lending transaction is a fully collateralized transaction in which the owner of a security agrees to lend the security (typically through an agent, in our case, The Bank of New York Mellon), to a borrower, usually a broker-dealer or bank, on an open, overnight or term basis, under the terms of a prearranged contract, which normally matures in less than 90 days.

We typically lend securities with indemnification against borrower default. We generally require the borrower to provide collateral with a minimum value of 102% of the fair value of the securities borrowed, which is monitored on a daily basis, thus reducing credit risk. Market risk can also arise in securities lending transactions. These risks are controlled through policies limiting the level of risk that can be
 
undertaken. Securities lending transactions are generally entered into only with highly rated counterparties. Securities lending indemnifications were secured by collateral of $273 billion at June 30, 2013 and $253 billion at Dec. 31, 2012.

We expect many of these guarantees to expire without the need to advance any cash. The revenue associated with guarantees frequently depends on the credit rating of the obligor and the structure of the transaction, including collateral, if any.

Exposure for certain administrative errors

In connection with certain funds that we manage, we may be liable to the funds for certain administrative errors. The errors relate to questions about the resident status of certain offshore tax exempt funds, potentially exposing the Company to a tax liability related to the funds’ earnings. The Company is in discussions with tax authorities regarding the funds. In addition to amounts accrued, we believe it is reasonably possible that we could have a potential additional exposure of approximately $100 million.

Indemnification Arrangements

We have provided standard representations for underwriting agreements, acquisition and divestiture agreements, sales of loans and commitments, and other similar types of arrangements and customary indemnification for claims and legal proceedings related to providing financial services that are not otherwise included above. Insurance has been purchased to mitigate certain of these risks. Generally, there are no stated or notional amounts included in these indemnifications and the contingencies triggering the obligation for indemnification are not expected to occur. Furthermore, often counterparties to these transactions provide us with comparable indemnifications. We are unable to develop an estimate of the maximum payout under these indemnifications for several reasons. In addition to the lack of a stated or notional amount in a majority of such indemnifications, we are unable to predict the nature of events that would trigger indemnification or the level of indemnification for a certain event. We believe, however, that the possibility that we will have to make any material payments for these indemnifications is remote. At June 30, 2013 and Dec. 31, 2012, we had no material liabilities under these arrangements.



116 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

Clearing and Settlement Exchanges

We are a minority equity investor in, and member of, several industry clearing or settlement exchanges through which foreign exchange, securities, or other transactions settle. Certain of these industry clearing and settlement exchanges require their members to guarantee their obligations and liabilities or to provide financial support in the event other members do not honor their obligations. We believe the likelihood that a clearing or settlement exchange (of which we are a member) would become insolvent is remote. Additionally, certain settlement exchanges have implemented loss allocation policies that enable the exchange to allocate settlement losses to the members of the exchange. It is not possible to quantify such mark-to-market loss until the loss occurs. In addition, any ancillary costs that occur as a result of any mark-to-market loss cannot be quantified. At June 30, 2013 and Dec. 31, 2012, we have not recorded any material liabilities under these arrangements.

Legal proceedings

In the ordinary course of business, BNY Mellon and its subsidiaries are routinely named as defendants in or made parties to pending and potential legal actions and regulatory matters. Claims for significant monetary damages are often asserted in many of these legal actions, while claims for disgorgement, penalties and/or other remedial sanctions may be sought in regulatory matters. It is inherently difficult to predict the eventual outcomes of such matters given their complexity and the particular facts and circumstances at issue in each of these matters. However, on the basis of our current knowledge and understanding, we do not believe that judgments or settlements, if any, arising from these matters (either individually or in the aggregate, after giving effect to applicable reserves and insurance coverage) will have a material adverse effect on the consolidated financial position or liquidity of BNY Mellon, although they could have a material effect on net income in a given period.

In view of the inherent unpredictability of outcomes in litigation and regulatory matters, particularly where (i) the damages sought are substantial or indeterminate, (ii) the proceedings are in the early stages, or (iii) the matters involve novel legal theories or a large number of parties, as a matter of course there is considerable uncertainty surrounding the
 
timing or ultimate resolution of litigation and regulatory matters, including a possible eventual loss, fine, penalty or business impact, if any, associated with each such matter. In accordance with applicable accounting guidance, BNY Mellon establishes accruals for litigation and regulatory matters when those matters proceed to a stage where they present loss contingencies that are both probable and reasonably estimable. In such cases, there may be a possible exposure to loss in excess of any amounts accrued. BNY Mellon will continue to monitor such matters for developments that could affect the amount of the accrual, and will adjust the accrual amount as appropriate. If the loss contingency in question is not both probable and reasonably estimable, BNY Mellon does not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. BNY Mellon believes that its accruals for legal proceedings are appropriate and, in the aggregate, are not material to the consolidated financial position of BNY Mellon, although future accruals could have a material effect on net income in a given period.

For certain of those matters described herein for which a loss contingency may, in the future, be reasonably possible (whether in excess of a related accrued liability or where there is no accrued liability), BNY Mellon is currently unable to estimate a range of reasonably possible loss. For those matters where BNY Mellon is able to estimate a reasonably possible loss, the aggregate range of such reasonably possible loss is up to $715 million in excess of the accrued liability (if any) related to those matters.

The following describes certain judicial, regulatory and arbitration proceedings involving BNY Mellon:

Sentinel Matters
As previously disclosed, on Jan. 18, 2008, The Bank of New York Mellon filed a proof of claim in the Chapter 11 bankruptcy proceeding of Sentinel Management Group, Inc. (“Sentinel”) pending in federal court in the Northern District of Illinois, seeking to recover approximately $312 million loaned to Sentinel and secured by securities and cash in an account maintained by Sentinel at The Bank of New York Mellon. On March 3, 2008, the bankruptcy trustee filed an adversary complaint against The Bank of New York Mellon seeking to disallow The Bank of New York Mellon’s claim and seeking damages for allegedly aiding and abetting Sentinel insiders in



BNY Mellon 117

Notes to Consolidated Financial Statements (continued)
 

misappropriating customer assets and improperly using those assets as collateral for the loan. In a decision dated Nov. 3, 2010, the court found for The Bank of New York Mellon and against the bankruptcy trustee, holding that The Bank of New York Mellon’s loan to Sentinel is valid, fully secured and not subject to equitable subordination. The bankruptcy trustee appealed this decision, and on Aug. 9, 2012, the United States Court of Appeals for the Seventh Circuit issued a decision affirming the trial court’s judgment. On Sept. 7, 2012, the bankruptcy trustee filed a petition for rehearing on the fraudulent transfer portion of the opinion and, on Nov. 30, 2012, the Court of Appeals withdrew its opinion and vacated its judgment. The appeal remains under consideration.

As previously disclosed, in November 2009, the Division of Enforcement of the U.S. Commodities Futures Trading Commission (“CFTC”) indicated that it is considering a recommendation to the CFTC that it file a civil enforcement action against The Bank of New York Mellon for possible violations of the Commodity Exchange Act and CFTC regulations in connection with its relationship to Sentinel. The Bank of New York Mellon responded in writing to the CFTC on Jan. 29, 2010 and provided an explanation as to why an enforcement action is unwarranted.

Securities Lending Matters
As previously disclosed, BNY Mellon or its affiliates have been named as defendants in a number of lawsuits initiated by participants in BNY Mellon’s securities lending program, which is a part of BNY Mellon’s Investment Services business. The lawsuits were filed on various dates from 2009 to 2013, and are currently pending in courts in New York, North Carolina and Illinois and in commercial court in London. The complaints assert contractual, statutory, and common law claims, including claims for negligence and breach of fiduciary duty. The plaintiffs allege losses in connection with the investment of securities lending collateral, including losses related to investments in Sigma Finance Inc. (“Sigma”), Lehman Brothers Holdings, Inc. and certain asset-backed securities, and seek damages as to those losses.

Matters Relating To Bernard L. Madoff
As previously disclosed, on May 11, 2010, the New York State Attorney General commenced a civil lawsuit against Ivy Asset Management LLC (“Ivy”), a subsidiary of BNY Mellon that manages primarily funds-of-hedge-funds, and two of its former officers
 
in New York state court. The lawsuit alleged that Ivy, in connection with its role as sub-advisor to investment managers whose clients invested with Madoff, did not disclose certain material facts about Madoff. The complaint sought an accounting of compensation received from January 1997 to the present by the Ivy defendants in connection with the Madoff investments, and unspecified damages, including restitution, disgorgement, costs and attorneys’ fees.

As previously disclosed, on Oct. 21, 2010, the U.S. Department of Labor commenced a civil lawsuit against Ivy, two of its former officers, and others in federal court in the Southern District of New York. The lawsuit alleged that Ivy violated the Employee Retirement Income Security Act (“ERISA”) by failing to disclose certain material facts about Madoff to investment managers subadvised by Ivy whose clients included employee benefit plan investors. The complaint sought disgorgement and damages.

As previously disclosed, Ivy or its affiliates were named in a number of civil lawsuits filed beginning Jan. 27, 2009 relating to certain investment funds that allege losses due to the Madoff investments. Ivy acted as a sub-advisor to the investment managers of some of those funds. Plaintiffs asserted various causes of action including securities and common-law fraud. Certain of the cases were certified as class actions and/or assert derivative claims on behalf of the funds. Most of the cases were consolidated in two actions in federal court in the Southern District of New York, with certain cases filed in New York State Supreme Court for New York and Nassau counties.

On Nov. 13, 2012, Ivy entered into a settlement agreement with the New York State Attorney General, the U.S. Department of Labor, and the civil lawsuit plaintiffs that would settle all claims for $210 million. Final approval of the settlement was granted on May 9, 2013.

Medical Capital Litigations
As previously disclosed, The Bank of New York Mellon was named as a defendant in a number of class actions and non-class actions brought by numerous plaintiffs in connection with its role as indenture trustee for debt issued by affiliates of Medical Capital Corporation. The actions, filed in late 2009 and consolidated in federal court in the Central District of California, alleged that The Bank of New York Mellon breached its fiduciary and



118 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

contractual obligations to the holders of the underlying securities, and sought unspecified damages.

On Dec. 21, 2012, The Bank of New York Mellon entered into a settlement agreement with the plaintiffs and the Federal Equity Receiver for Medical Capital Corporation and its affiliates. Under the terms of the settlement, The Bank of New York Mellon made a payment of $114 million in exchange for a complete release of claims. Final court approval of the settlement was granted on June 24, 2013.

Foreign Exchange Matters
As previously disclosed, beginning in December 2009, government authorities have been conducting inquiries seeking information relating primarily to standing instruction foreign exchange transactions in connection with custody services BNY Mellon provides to public pension plans and certain other custody clients. BNY Mellon is cooperating with these inquiries.

In addition, in early 2011, as previously disclosed, the Virginia Attorney General’s Office and the Florida Attorney General’s Office each intervened in a qui tam lawsuit pending in its jurisdiction, and, on Aug. 11, 2011, filed superseding complaints. On Nov. 9, 2012, the Virginia court, which had previously dismissed all of the claims against BNY Mellon, dismissed the lawsuit with prejudice by agreement of the parties. On Oct. 4, 2011, the New York Attorney General’s Office, the New York City Comptroller and various city pension and benefit funds filed a lawsuit asserting, claims under the Martin Act and state and city false claims acts. On Aug. 5, 2013, the court dismissed the false claims act claims. Also, on Oct. 4, 2011, the United States Department of Justice (“DOJ”) filed a civil lawsuit seeking civil penalties under 12 U.S.C. Section 1833a and injunctive relief under 18 U.S.C. Section 1345 based on alleged ongoing violations of 18 U.S.C. Sections 1341 and 1343 (mail and wire fraud). On Jan. 17, 2012, the court approved a partial settlement resolving the DOJ’s claim for injunctive relief. In October 2011, several political subdivisions of the state of California intervened in a qui tam lawsuit that was removed to federal district court in California. On March 30, 2012, the court dismissed certain of plaintiffs’ claims, including all claims under the California False Claims Act. Certain plaintiffs have since filed an amended complaint. Several plaintiffs also had their claims dismissed for improper venue and one refiled on
 
Sept. 5, 2012 in a different California federal district court. On Oct. 26, 2011, the Massachusetts Securities Division filed an Administrative Complaint against BNY Mellon.

BNY Mellon has also been named as a defendant in several putative class action federal lawsuits filed on various dates in 2011 and 2012. The complaints, which assert claims including breach of contract and ERISA and securities laws violations, all allege that the prices BNY Mellon charged for standing instruction foreign exchange transactions executed in connection with custody services provided by BNY Mellon were improper. In addition, BNY Mellon has been named as a nominal defendant in several derivative lawsuits filed in 2011 and 2012 in state and federal court in New York. On July 2, 2013, the court in the consolidated federal derivative action dismissed all of plaintiffs’ claims. BNY Mellon has also been named in a qui tam lawsuit filed on May 22, 2012 in Massachusetts state court. To the extent these lawsuits are pending in federal court, they have been consolidated for pre-trial purposes in federal court in New York.

Lyondell Litigation
As previously disclosed, in an action filed in New York State Supreme Court for New York County, on Sept. 14, 2010, plaintiffs as holders of debt issued by Basell AF in 2005 allege that The Bank of New York Mellon, as indenture trustee, breached its contractual and fiduciary obligations by executing an intercreditor agreement in 2007 in connection with Basell’s acquisition of Lyondell Chemical Company. Plaintiffs are seeking damages for their alleged losses resulting from the execution of the 2007 intercreditor agreement that allowed the company to increase the amount of its senior debt. After its motion to dismiss was denied in part, BNY Mellon appealed the denial. On May 21, 2013, the appellate court found in our favor and held that BNY Mellon had been released from liability. Plaintiffs have sought leave to reargue or, in the alternative, to pursue an appeal to the New York Court of Appeals.

Tax Litigation
As previously disclosed, on Aug. 17, 2009, BNY Mellon received a Statutory Notice of Deficiency disallowing tax benefits for the 2001 and 2002 tax years in connection with a 2001 transaction that involved the payment of UK corporate income taxes that were credited against BNY Mellon’s U.S. corporate income tax liability. On Nov. 10, 2009,



BNY Mellon 119

Notes to Consolidated Financial Statements (continued)
 

BNY Mellon filed a petition with the U.S. Tax Court contesting the disallowance of the benefits. Trial was held from April 16 to May 17, 2012. On Feb. 11, 2013, the Tax Court upheld the IRS’s Notice of Deficiency and disallowed BNY Mellon’s tax credits and associated transaction costs.  BNY Mellon will appeal the Tax Court’s ruling once a formal decision is entered, which awaits the Tax Court’s computation of the amounts owed. See Note 11 of the Notes to Consolidated Financial Statements for additional information.

Mortgage-Securitization Trusts Proceeding
As previously disclosed, The Bank of New York Mellon as trustee is the petitioner in a legal proceeding filed in New York State Supreme Court, New York County on June 29, 2011, seeking approval of a proposed settlement involving Bank of America Corporation and bondholders in certain Countrywide residential mortgage-securitization trusts. The New York and Delaware Attorneys General have intervened in this proceeding. The trial in this matter began on June 3, 2013.


Note 19 - Lines of businesses

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

 
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.

Business results are subject to reclassification whenever improvements are made in the measurement principles or when organizational changes are made. Internal crediting rates for deposits are regularly updated to reflect the value of deposit balances and distribution of overall interest revenue. In the second quarter of 2013, lower internal crediting rates were applied to deposits in the Investment Management and Investment Services businesses. There was no impact to consolidated results.

The accounting policies of the businesses are the same as those described in Note 1 of the Notes to Consolidated Financial Statements in our 2012 Annual Report.


The primary types of revenue for our two principal businesses and the Other segment are presented below:

Business
Primary types of revenue
Investment Management
Ÿ   Investment management and performance fees from:
Mutual funds
Institutional clients
Private clients
High-net-worth individuals and families, endowments and foundations and related entities
Ÿ   Distribution and servicing fees
Investment Services
Ÿ   Asset servicing fees, including institutional trust and custody fees, broker-dealer services and securities lending
Ÿ   Issuer services fees, including Corporate Trust and Depositary Receipts
Ÿ   Clearing services fees, including broker-dealer services, registered investment advisor services and prime brokerage services
Ÿ   Treasury services fees, including global payment services and working capital solutions
Ÿ   Foreign exchange
Other segment
Ÿ   Credit-related activities
Ÿ   Leasing operations
Ÿ   Corporate treasury activities
Ÿ   Global markets and institutional banking services
Ÿ   Business exits



120 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

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

Revenue amounts reflect fee and other revenue generated by each business. Fee and other revenue transferred between businesses under revenue transfer agreements is included within other revenue in each business.
Revenues and expenses associated with specific client bases are included in those businesses. For example, foreign exchange activity associated with clients using custody products is allocated to Investment Services.
Net interest revenue is allocated to businesses based on the yields on the assets and liabilities generated by each business. We employ a funds transfer pricing system that matches funds with the specific assets and liabilities of each business based on their interest sensitivity and maturity characteristics.
Support and other indirect expenses are allocated to businesses based on internally-developed methodologies.
Recurring FDIC expense is allocated to the businesses based on average deposits generated within each business.
 
Litigation expense is generally recorded in the business in which the charge occurs.
Management of the investment securities portfolio is a shared service contained in the Other segment. As a result, gains and losses associated with the valuation of the securities portfolio are included in the Other segment.
Client deposits serve as the primary funding source for our investment securities portfolio. We typically allocate all interest revenue to the businesses generating the deposits. Accordingly, accretion related to the restructured investment securities portfolio has been included in the results of the businesses.
M&I expenses and restructuring charges are corporate level items and are therefore recorded in the Other segment.
Balance sheet assets and liabilities and their related income or expense are specifically assigned to each business. Businesses with a net liability position have been allocated assets.
Goodwill and intangible assets are reflected within individual businesses.


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

For the quarter ended June 30, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
922

 (a) 
$
1,972

 
$
319

 
$
3,213

 (a) 
Net interest revenue
63

 
633

 
61

 
757

 
Total revenue
985

 
2,605

 
380

 
3,970

 
Provision for credit losses

 

 
(19
)
 
(19
)
 
Noninterest expense
713

 
1,878

 
231

 
2,822

 
Income before taxes
$
272

 (a) 
$
727

 
$
168

 
$
1,167

 (a) 
Pre-tax operating margin (b)
28
%
 
28
%
 
N/M

 
29
%
 
Average assets
$
37,953

 
$
244,803

 
$
54,699

 
$
337,455

 
(a)
Total fee and other revenue includes income from consolidated investment management funds of $65 million, net of noncontrolling interests of $39 million, for a net impact of $26 million. Income before taxes includes noncontrolling interests of $39 million.
(b)
Income before taxes divided by total revenue.
N/M - Not meaningful.




BNY Mellon 121

Notes to Consolidated Financial Statements (continued)
 

For the quarter ended March 31, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
891

 (a) 
$
1,862

 
$
125

 
$
2,878

 (a) 
Net interest revenue
62

 
653

 
4

 
719

 
Total revenue
953

 
2,515

 
129

 
3,597

 
Provision for credit losses

 
1

 
(25
)
 
(24
)
 
Noninterest expense
743

 
1,843

 
242

 
2,828

 
Income (loss) before taxes
$
210

 (a) 
$
671

 
$
(88
)
 
$
793

 (a) 
Pre-tax operating margin (b)
22
%
 
27
%
 
N/M

 
22
%
 
Average assets
$
38,743

 
$
240,188

 
$
54,733

 
$
333,664

 
(a)
Total fee and other revenue includes income from consolidated investment management funds of $50 million, net of noncontrolling interests of $16 million, for a net impact of $34 million. Income before taxes includes noncontrolling interests of $16 million.
(b)
Income before taxes divided by total revenue.
N/M - Not meaningful.

For the quarter ended June 30, 2012
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
858

 (a) 
$
1,880

 
$
116

 
$
2,854

 (a) 
Net interest revenue
52

 
607

 
75

 
734

 
Total revenue
910

 
2,487

 
191

 
3,588

 
Provision for credit losses

 
(14
)
 
(5
)
 
(19
)
 
Noninterest expense
690

 
2,141

 
216

 
3,047

 
Income (loss) before taxes
$
220

 (a) 
$
360

 
$
(20
)
 
$
560

 (a) 
Pre-tax operating margin (b)
24
%
 
14
%
 
N/M

 
16
%
 
Average assets
$
35,603

 
$
210,064

 
$
59,335

 
$
305,002


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


For the six months ended June 30, 2013
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
1,813

 (a) 
$
3,834

 
$
444

 
$
6,091

 (a) 
Net interest revenue
125

 
1,286

 
65

 
1,476

 
Total revenue
1,938

 
5,120

 
509

 
7,567

 
Provision for credit losses

 
1

 
(44
)
 
(43
)
 
Noninterest expense
1,456

 
3,721

 
473

 
5,650

 
Income before taxes
$
482

 (a) 
$
1,398

 
$
80

 
$
1,960

 (a) 
Pre-tax operating margin (b)
25
%
 
27
%
 
N/M

 
26
%
 
Average assets
$
38,346

 
$
242,508

 
$
54,715

 
$
335,569


(a)
Total fee and other revenue includes income from consolidated investment management funds of $115 million, net of noncontrolling interests of $55 million, for a net impact of $60 million. Income before taxes includes noncontrolling interests of $55 million.
(b)
Income before taxes divided by total revenue.
N/M - Not meaningful.




122 BNY Mellon

Notes to Consolidated Financial Statements (continued)
 

For the six months ended June 30, 2012
(dollar amounts in millions)
Investment
Management

 
Investment
Services

 
Other

 
Consolidated

 
Fee and other revenue
$
1,707

 (a) 
$
3,730

 
$
287

 
$
5,724

 (a) 
Net interest revenue
107

 
1,249

 
143

 
1,499

 
Total revenue
1,814

 
4,979

 
430

 
7,223

 
Provision for credit losses

 
2

 
(16
)
 
(14
)
 
Noninterest expense
1,358

 
3,977

 
468

 
5,803

 
Income (loss) before taxes
$
456

 (a) 
$
1,000

 
$
(22
)
 
$
1,434

 (a) 
Pre-tax operating margin (b)
25
%
 
20
%
 
N/M

 
20
%
 
Average assets
$
35,857

 
$
212,328

 
$
54,987

 
$
303,172


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


Note 20 - Supplemental information to the Consolidated Statement of Cash Flows

Noncash investing and financing transactions that, appropriately, are not reflected in the Consolidated Statement of Cash Flows are listed below.

Noncash investing and financing transactions
Six months ended June 30,
(in millions)
2013

 
2012

Transfers from loans to other assets for OREO
$
2

 
$
6

Change in assets of consolidated VIEs
10

 
392

Change in liabilities of consolidated VIEs
39

 
295

Change in noncontrolling interests of consolidated VIEs
27

 
52

 



BNY Mellon 123

Item 4. Controls and Procedures
 


Disclosure controls and procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, with participation by the members of the Disclosure Committee, has responsibility for ensuring that there is an adequate and effective process for establishing, maintaining, and evaluating disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in our SEC reports is timely recorded, processed, summarized and reported and that information required to be disclosed by BNY Mellon is accumulated and communicated to BNY Mellon’s management to allow timely decisions regarding the required disclosure. In addition, our ethics hotline can also be used by employees and others for the anonymous communication of concerns about financial controls or reporting matters. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

As previously disclosed in our 2012 Annual Report, we are reviewing our process for the reporting of information included in our public filings and we have initiated plans to streamline and enhance the data collection processes and systems relating to AUC/A and other information in our public filings.  To date, the review has not resulted in any material changes to our publicly disclosed historical information.

 

Changes in internal control over financial reporting

In the ordinary course of business, we may routinely modify, upgrade or enhance our internal controls and procedures for financial reporting. There have not been any changes in our internal controls over financial reporting as defined in Rule 13a-15(f) of the Exchange Act during the second quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.





124 BNY Mellon

Forward-looking Statements
 


Some statements in this document are forward-looking. These include all statements about the usefulness of Non-GAAP measures; the future results of BNY Mellon and our long-term goals and strategies. In addition, these forward-looking statements relate to expectations regarding: Basel III and our estimated Basel III Tier 1 common equity ratio; the closing and impact of the Newton transaction; the potential impact of supplementary leverage ratio proposals; the impact of the continued run-off of structured debt securitizations on our total annual revenue; our foreign exchange revenue; elevated levels of legal and litigation costs; operational excellence initiatives, targeted savings by the end of 2013, actual operating expenses and program costs; our effective tax rate; the seasonality impact on our business; estimations of market value impact on fee revenue and earnings per share; estimated new business wins in assets under custody and/or administration; our tri-party repo business; overdraft exposure with respect to Irish-domiciled investment funds; the impact of significant changes in ratings classifications for our investment securities portfolio; assumptions with respect to residential mortgage-backed securities; effects of changes in projected loss severities and default rates on impairment charges; goals with respect to our commercial portfolio; statements on our credit strategies; our anticipated quarterly provision for credit losses in 2013; the effect of credit ratings on allowances; our liquidity cushion, liquidity ratios, liquid asset buffer, levels and sources of wholesale funds and potential uses of liquidity; the impact of money market fund reform on deposit volumes; a reduction in our Investment Services businesses; access to capital markets and our shelf registration statements; the impact of a change in rating agencies’ assumptions on ratings of the Parent, The Bank of New York Mellon and BNY Mellon, N.A.; capital, including anticipated redemptions or other actions with regard to outstanding securities; statements regarding the capitalization status of BNY Mellon and its bank subsidiaries; our share repurchase program; the effects of customer behavior and market volatility or stress on our balance sheet size and client deposit levels; the effects of changes in risk-weighted assets/quarterly average assets or changes in common equity levels on capital ratios; our foreign exchange and other trading counterparty risk rating profile; estimations and assumptions on net interest revenue and net interest rate sensitivities; our earnings simulation model; impact of certain events on the growth or contraction of deposits, our assumptions
 
about depositor behavior, our balance sheet and net interest revenue; the timing and effects of pending and proposed accounting standards, legislation and regulation including new risk-based and leverage regulatory capital rules, supplementary leverage ratio proposals, the Basel Committee large exposures framework, Money Market Fund Reform and EMEA regulations; BNY Mellon’s anticipated actions with respect to legal or regulatory proceedings; and future litigation costs, the expected outcome and the impact of judgments and settlements, if any, arising from pending or potential legal or regulatory proceedings and BNY Mellon’s expectations with respect to litigation accruals.

In this report, any other report, any press release or any written or oral statement that BNY Mellon or its executives may make, words, such as “estimate,” “forecast,” “project,” “anticipate,” “target,” “expect,” “intend,” “continue,” “seek,” “believe,” “plan,” “goal,” “could,” “should,” “may,” “will,” “strategy,” “synergies,” “opportunities,” “trends” and words of similar meaning, signify forward-looking statements.

Forward-looking statements, including discussions and projections of future results of operations and discussions of future plans contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations, are based on management’s current expectations and assumptions that involve risk and uncertainties and that are subject to change based on various important factors (some of which are beyond BNY Mellon’s control), including adverse changes in market conditions, and the timing of such changes, and the actions that management could take in response to these changes. Actual results may differ materially from those expressed or implied as a result of a number of factors, including those discussed in the “Risk Factors” section included in our 2012 Annual Report, such as: government regulation and supervision, and associated limitations on our ability to pay dividends or make other capital distributions; recent legislative and regulatory actions; adverse publicity, regulatory actions or litigation with respect to us, other well-known companies and the financial services industry generally; continued litigation and regulatory investigations and proceedings involving our foreign exchange standing instruction program; failure to satisfy regulatory standards; operational risk; failure or circumvention of our controls and procedures; disruption or breaches in security of our information systems that results in a loss of confidential client



125 BNY Mellon

Forward-looking Statements (continued)
 

information or impacts our ability to provide services to our clients; failure to update our technology; change or uncertainty in monetary, tax and other governmental policies; intense competition in all aspects of our business; the risks relating to new lines of business or new products and services, and the failure to grow our existing businesses; failure to attract and retain employees; political, economic, legal, operational and other risks inherent in operating globally; acts of terrorism, natural disasters, pandemics and global conflicts; failure to successfully integrate strategic acquisitions; the ongoing Eurozone crisis, the failure or instability of any of our significant counterparties in Europe, or a breakup of the European Monetary Union, continuing uncertainty in financial markets and weakness in the economy; low or volatile interest rates; continued market volatility; further writedowns of financial instruments that we own and other losses related to volatile and illiquid market conditions; dependence on our fee-based business for a substantial majority of our revenue; declines in capital markets on our fee-based businesses; the impact of a stable exchange-rate environment and declines in cross-border activity on our foreign exchange revenue; material reductions in our credit ratings or the credit ratings of certain of our subsidiaries; the failure or instability of any of our significant counterparties, and our assumption of credit and counterparty risk; credit, regulatory and reputation risks from our tri-party repo agent services; the impact of not effectively managing our liquidity; inadequate reserves for credit losses, including loan reserves; tax law changes or challenges to our tax positions; changes in accounting standards; risks associated with being a holding company, including our dependence on dividends from our subsidiary banks; the impact of provisions of Delaware law and the Federal Reserve on our ability to pay dividends and anti-takeover provisions in our certificate of incorporation and bylaws. Investors should consider all risks included in our 2012 Annual Report and any subsequent reports filed with the SEC by BNY Mellon pursuant to the Exchange Act.

All forward-looking statements speak only as of the date on which such statements are made, and BNY Mellon undertakes no obligation to update any statement to reflect events or circumstances after the date on which such forward-looking statement is made or to reflect the occurrence of unanticipated events. The contents of BNY Mellon’s website or
 
any other websites referenced herein are not part of this report.




BNY Mellon 126

Part II - Other Information
 



Item 1. Legal Proceedings

The information required by this Item is set forth in the “Legal proceedings” section in Note 18 of the Notes to Consolidated Financial Statements, which portion is incorporated herein by reference in response to this item.


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

(c)
The following table discloses repurchases of our common stock made in the second quarter of 2013. All of the Company’s preferred stock outstanding has preference over the Company’s common stock with respect to the payment of dividends.

Issuer purchases of equity securities

Share repurchases during second quarter of 2013
 
 
 
(dollars in millions, except per share information; common shares in thousands)
Total shares
repurchased

 
Average price
per share

 
Total shares repurchased as part of a publicly announced plan

Maximum approximate dollar value of shares that may yet be purchased under the Board authorized plans or programs at June 30, 2013
 
 
April 2013
9,016

 
$
27.58

 
9,000

 
$
1,101

 
May 2013
2,892

 
28.46

 
2,875

 
1,019

 
June 2013
8

 
29.86

 

 
1,019

(b)
Second quarter of 2013
11,916

(a) 
$
27.79

 
11,875

 
$
1,019

(b)
(a)
Includes 41 thousand shares repurchased at a purchase price of $1 million from employees, primarily in connection with the employees’ payment of taxes upon the vesting of restricted stock. The average price per share of open market purchases was $27.79.
(b)
On March 14, 2013, in connection with the Federal Reserve’s non-objection to our 2013 capital plan, the Board of Directors authorized a new stock purchase program providing for the repurchase of an aggregate of $1.35 billion of common stock beginning in the second quarter of 2013 and continuing through the first quarter of 2014. The share repurchase program may be executed through open market purchases or privately negotiated transactions at such prices, times and upon such other terms as may be determined from time to time.


Item 6. Exhibits

Pursuant to the rules and regulations of the Securities and Exchange Commission (“Commission”), BNY Mellon has filed certain agreements as exhibits to this Quarterly Report on Form 10-Q. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in BNY Mellon’s public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe our actual state of affairs at the date hereof and should not be relied upon.
 
The list of exhibits required to be filed as exhibits to this report appears on page 129 hereof, under “Index to Exhibits”, which is incorporated herein by reference.





127 BNY Mellon







SIGNATURE








Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.







    
    

 
THE BANK OF NEW YORK MELLON CORPORATION
 
(Registrant)

 
 
 
 
Date: August 8, 2013
By:
 
/s/ John A. Park
 
 
 
John A. Park
 
 
 
Corporate Controller
 
 
 
(Duly Authorized Officer and
 
 
 
Principal Accounting Officer of
 
 
 
the Registrant)
 
 
 
 
 
 
 
 
 
 
 
 




128 BNY Mellon

Index to Exhibits
 

Exhibit No.
 
Description
 
Method of Filing
2.1
 
Amended and Restated Agreement and Plan of Merger, dated as of Dec. 3, 2006, as amended and restated as of Feb. 23, 2007, and as further amended and restated as of March 30, 2007, between The Bank of New York Company, Inc., Mellon Financial Corporation and The Bank of New York Mellon Corporation (the “Company”).

 
Previously filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K (File Nos. 000-52710 and 001-06152) as filed with the Commission on July 2, 2007, and incorporated herein by reference.


2.2
 
Stock Purchase Agreement, dated as of Feb. 1, 2010, by and between The PNC Financial Services Group, Inc. and The Bank of New York Mellon Corporation.
 
Previously filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 000-52710) as filed with the Commission on Feb. 3, 2010, and incorporated herein by reference.
3.1
 
Restated Certificate of Incorporation of The Bank of New York Mellon Corporation.
 
Previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File Nos. 000-52710 and 001-06152) as filed with the Commission on July 2, 2007, and incorporated herein by reference.
3.2
 
Certificate of Designations of The Bank of New York Mellon Corporation with respect to Series A Noncumulative Preferred Stock dated June 15, 2007.
 
Previously filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 000-52710) as filed with the Commission on July 5, 2007, and incorporated herein by reference.
3.3
 
Certificate of Designations of The Bank of New York Mellon Corporation with respect to Series C Noncumulative Perpetual Preferred Stock dated Sept. 13, 2012.
 
Previously filed as Exhibit 3.2 to the Company’s Registration Statement on Form 8A12B (File No. 001-35651) as filed with the Commission on Sept. 14, 2012, and incorporated herein by reference.
3.4
 
Certificate of Designations of The Bank of New York Mellon Corporation with respect to the Series D Noncumulative Perpetual Preferred Stock, dated May 16, 2013.
 
Previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 001-35651) as filed with the Commission on May 16, 2013, and incorporated herein by reference.

3.5
 
Amended and Restated By-Laws of The Bank of New York Mellon Corporation, as amended and restated on Oct. 12, 2010.
 
Previously filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K (File No. 000-52710) for the year ended Dec. 31, 2010, as filed with the Commission on Feb. 28, 2011, and incorporated herein by reference.
3.6
 
Deposit Agreement, dated as of May 16, 2013, by and among The Bank of New York Mellon Corporation, Computershare Shareowner Services LLC, as depositary, and the holders from time to time of the depositary receipts described therein.

 
Previously filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 001-35651) as filed with the Commission on May 16, 2013, and incorporated herein by reference.


129 BNY Mellon

Index to Exhibits (continued)
 


Exhibit No.
 
Description
 
Method of Filing
4.1
 
None of the instruments defining the rights of holders of long-term debt of the Parent or any of its subsidiaries represented long-term debt in excess of 10% of the total assets of the Company as of June 30, 2013. The Company hereby agrees to furnish to the Commission, upon request, a copy of any such instrument.
 
N/A
10.1
 
Form of Performance Share Unit Agreement.
 
Filed herewith.
10.2
 
Form of Restricted Stock Unit Agreement.
 
Filed herewith.
12.1
 
Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend.
 
Filed herewith.
31.1
 
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith.
31.2
 
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith.
32.1
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Furnished herewith.
32.2
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Furnished herewith.
101.INS
 
XBRL Instance Document.
 
Filed herewith.
101.SCH
 
XBRL Taxonomy Extension Schema Document.
 
Filed herewith.
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
Filed herewith.
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
Filed herewith.
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
 
Filed herewith.
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
 
Filed herewith.




BNY Mellon 130