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(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ X ]
Smaller reporting company [ ]
Accelerated filer [ ]
Emerging growth company [ ]
Non-accelerated
filer [ ] (Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
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.
Items 2. and 3. Management’s Discussion and Analysis of Financial Condition and Results of Operations; Quantitative and Qualitative Disclosures about Market Risk:
BNY Mellon shareholders’ equity to total assets ratio – GAAP
11.6
11.6
10.3
BNY
Mellon common shareholders’ equity to total assets ratio – GAAP
10.5
10.6
9.6
Selected regulatory capital ratios – fully phased-in – Non-GAAP: (j)
Estimated
CET1 ratio:
Standardized Approach
11.5
%
11.3
%
11.0
%
Advanced Approach
10.0
9.7
9.8
Estimated
SLR
5.9
5.6
5.1
(a)
See “Supplemental information – Explanation of GAAP and Non-GAAP financial measures” beginning on page 47 for a reconciliation of Non-GAAP measures.
(b)
Non-GAAP
information for all periods presented excludes the amortization of intangible assets and M&I, litigation and restructuring charges. Pre-tax operating margin (Non-GAAP) also excludes the net income (loss) attributable to noncontrolling interests of consolidated investment management funds.
(c)
Tangible book value per common share – Non-GAAP and tangible common equity exclude goodwill and intangible assets, net of deferred tax liabilities. See “Supplemental information – Explanation of GAAP and Non-GAAP financial measures” beginning on page 47 for the reconciliation of Non-GAAP measures.
(d)
See
“Average balances and interest rates” on page 10 for a reconciliation of Non-GAAP measures.
(e)
Excludes securities lending cash management assets and assets managed in the Investment Services business.
(f)
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 March 31,
2017 and Dec. 31, 2016 and $1.1 trillion at March 31, 2016.
(g)
Represents the total amount of securities on loan in our agency securities lending program managed by the Investment Services business. Excludes securities for which BNY Mellon acts as an agent on behalf of CIBC Mellon clients, which totaled $65 billion at March 31, 2017, $63
billion at Dec. 31, 2016 and $56 billion at March 31, 2016.
(h)
For additional information on our LCR, see “Liquidity and dividends” beginning on page 30.
(i)
For our CET1, Tier 1 capital and Total capital ratios,
our effective capital ratios under U.S. capital rules are the lower of the ratios as calculated under the Standardized and Advanced Approaches. The leverage capital ratio is based on Tier I capital, as phased-in, and quarterly average total assets. The SLR is based on Tier 1 capital, as phased-in, and average quarterly assets and certain off-balance sheet exposures. For additional information on our capital ratios, see “Capital” beginning on page 35.
(j)
The estimated fully phased-in CET1 and SLR ratios (Non-GAAP) are based on our interpretation of the U.S. capital rules, which are being gradually phased-in over a multi-year period. For additional information on these Non-GAAP ratios,
see “Capital” beginning on page 35.
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, 2016 (“2016 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, certain measures, which are noted as “Non-GAAP financial measures,” exclude certain items or otherwise include components that differ from U.S. generally accepted accounting principles
(“GAAP”). 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 or because they provide additional information about our ability to meet fully phased-in capital requirements. See “Supplemental information - Explanation of GAAP and Non-GAAP financial measures” beginning on page 47 for a reconciliation of financial measures presented in accordance with GAAP to adjusted Non-GAAP financial measures. See “Net interest revenue,” including the “Average balances and interest rates” beginning on page 9 for information on measures presented on a fully taxable equivalent basis. Also see “Capital” beginning on page 35
for information on our fully phased-in capital requirements.
Overview
The Bank of New York Mellon Corporation was the first company listed on the New York Stock Exchange (NYSE symbol: BK). With a rich history
of maintaining our financial strength and stability through all business cycles, BNY Mellon is a global investments company dedicated to improving lives through investing.
We manage and service assets for financial institutions, corporations and individual
investors in 35 countries and more than 100 markets. As of March 31, 2017, BNY Mellon had $30.6 trillion in assets under custody and/or administration (“AUC/A”), and $1.7 trillion in assets under management (“AUM”).
BNY Mellon is focused on enhancing our clients’ experience by leveraging our scale and expertise to deliver innovative and strategic solutions for our clients, and building trusted relationships that drive value. We hold a unique position in the global financial services industry. We service both the buy-side and sell-side, providing us with distinctive marketplace insights that enable us to support our clients’ success.
BNY Mellon’s businesses benefit from global growth in financial assets, the globalization of the investment process, changes in demographics and the continued evolution of the regulatory landscape—each providing us with opportunities to advise and service clients.
Key first quarter 2017 and subsequent events
Established intermediate holding company
In connection with our single point of entry resolution strategy, we have established BNY Mellon IHC, LLC,
a wholly-owned direct subsidiary of the Parent, (the “IHC”), to facilitate the provision of capital and liquidity resources to certain key subsidiaries in the event of material financial distress or failure. In the second quarter of 2017, we entered into a binding support agreement that requires the IHC to provide that support. See “Liquidity and dividends” beginning on page 30 for additional information.
Highlights of first quarter 2017 results
We reported net income applicable to common shareholders of $880 million,
or $0.83 per diluted common share, in the first quarter of 2017. Net
4 BNY Mellon
income applicable to common shareholders was $804 million, or $0.73 per diluted common share, in the first quarter of 2016 and $822 million, or $0.77 per diluted common share, in the fourth quarter of 2016.
Highlights
of the first quarter of 2017 include:
•
AUC/A totaled a record $30.6 trillion at March 31, 2017 compared with $29.1 trillion at March 31, 2016. The 5% increase primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar. (See “Investment Services business” beginning on page 17.)
•
AUM
totaled $1.73 trillion at March 31, 2017 compared with $1.64 trillion at March 31, 2016. The 5% increase primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar (principally versus the British pound). AUM excludes securities lending cash management assets and assets managed in the Investment Services business. (See “Investment Management business” beginning on page 14.)
•
Investment
services fees totaled $1.83 billion, an increase of 4% compared with $1.77 billion in the first quarter of 2016. The increase primarily reflects higher money market fees, net new business and higher equity market values, partially offset by the unfavorable impact of a stronger U.S. dollar and the impact of downsizing the retail UK transfer agency business. (See “Investment Services business” beginning on page 17.)
•
Investment management and performance fees totaled $842 million,
an increase of 4% compared with $812 million in the first quarter of 2016. The increase primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar and the impact of outflows of assets under management in the prior year. (See “Investment Management business” beginning on page 14.)
•
Foreign exchange and other trading revenue totaled $164 million compared with $175 million in the first quarter
of 2016. Foreign exchange revenue totaled $154 million, a decrease of 10% compared with $171 million in the first quarter of 2016, primarily reflecting lower volatility and the migration to lower margin products. (See “Fee and other revenue” beginning on page 6.)
•
Investment and other income totaled $77 million compared with $105 million in the first
quarter of 2016. The decrease primarily reflects lower lease-related gains and other income, partially offset by a net gain related to an equity investment. (See “Fee and other revenue” beginning on page 6.)
•
Net interest revenue totaled $792 million compared with $766 million in the first quarter of 2016. The increase was primarily driven by higher interest rates and the impact of interest rate hedging activities, partially offset by lower average interest-earning assets and higher average long-term debt. Net interest margin was
1.13% in the first quarter of 2017 compared with 0.99% in the first quarter of 2016 and net interest margin (FTE) (Non-GAAP) was 1.14% in the first quarter of 2017 compared with 1.01% in the first quarter of 2016. (See “Net interest revenue” beginning on page 9.)
•
The provision for credit losses was a credit of $5
million in the first quarter of 2017 and a provision of $10 million in the first quarter of 2016. (See “Asset quality and allowance for credit losses” beginning on page 27.)
•
Noninterest expense totaled $2.64 billion compared with $2.63 billion in the first quarter of 2016. The increase reflects higher consulting expenses primarily driven by regulatory and compliance costs, and higher staff expense,
partially offset by the favorable impact of a stronger U.S. dollar and lower other expense. (See “Noninterest expense” beginning on page 11.)
•
The provision for income taxes was $269 million and the effective rate was 22.3% in the first quarter of 2017 compared with an income tax provision of $283 million and an effective tax rate of 25.9% in the first quarter of 2016. The effective tax rate in the first quarter of 2017
reflects an approximate 3% benefit related to applying the new accounting guidance required in ASU 2016-09, Compensation – Stock Compensation. (See “Income taxes” on page 12.)
•
The net unrealized pre-tax loss on the total investment securities portfolio was $23 million at March 31, 2017 compared with $221 million at Dec. 31, 2016. The
improvement in the net unrealized pre-tax loss was primarily driven by a decrease in market interest rates. (See “Investment securities” beginning on page 23.)
BNY Mellon 5
•
Our CET1 ratio under the Advanced Approach was 10.4% at March 31, 2017 and 10.6% at
Dec. 31, 2016. Our CET1 ratio under the Standardized Approach was 12.0% at March 31, 2017 and 12.3% at Dec. 31, 2016. The decreases reflect the additional phase-in requirements under the U.S. capital rules that became effective Jan. 1, 2017. (See “Capital” beginning on page 35.)
•
Our
estimated CET1 ratio (Non-GAAP) calculated under the Advanced Approach on a
fully phased-in basis was 10.0% at March 31, 2017 and 9.7% at Dec. 31, 2016. Our estimated CET1 ratio (Non-GAAP) calculated under the Standardized Approach on a fully phased-in basis was 11.5% at March 31, 2017 and 11.3% at Dec. 31, 2016. The
increases reflect CET1 generation and lower risk-weighted assets. (See “Capital” beginning on page 35.)
Fee and other revenue
Fee and other revenue
1Q17
vs.
(dollars in millions, unless otherwise noted)
1Q17
4Q16
1Q16
4Q16
1Q16
Investment services fees:
Asset
servicing (a)
$
1,063
$
1,068
$
1,040
—
%
2
%
Clearing
services
376
355
350
6
7
Issuer services
251
211
244
19
3
Treasury
services
139
140
131
(1
)
6
Total investment services fees
1,829
1,774
1,765
3
4
Investment
management and performance fees
842
848
812
(1
)
4
Foreign exchange and other trading revenue
164
161
175
2
(6
)
Financing-related
fees
55
50
54
10
2
Distribution and servicing
41
41
39
—
5
Investment
and other income
77
70
105
N/M
N/M
Total fee revenue
3,008
2,944
2,950
2
2
Net
securities gains
10
10
20
N/M
N/M
Total fee and other revenue
$
3,018
$
2,954
$
2,970
2
%
2
%
Fee
revenue as a percentage of total revenue
78
%
78
%
79
%
AUM
at period end (in billions) (b)
$
1,727
$
1,648
$
1,639
5
%
5
%
AUC/A
at period end (in trillions) (c)
$
30.6
$
29.9
$
29.1
2
%
5
%
(a)
Asset
servicing fees include securities lending revenue of $49 million in the first quarter of 2017, $54 million in the fourth quarter of 2016 and $50 million in the first quarter of 2016.
(b)
Excludes securities lending cash management assets and assets managed in the Investment Services business.
Fee and other revenue increased 2% compared with the first quarter of 2016 and 2% (unannualized)
compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher investment management and performance fees, clearing services and asset servicing fees, partially offset by lower investment and other income. The increase compared with the fourth quarter of 2016 was primarily driven by higher issuer services and clearing services fees.
Investment services fees
Investment services fees were impacted by the following compared with the first quarter of 2016 and the fourth quarter of 2016:
•
Asset
servicing fees increased 2% compared with the first quarter of 2016 and decreased slightly compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects net new business, including growth of collateral optimization solutions, and higher equity market values, partially offset by the unfavorable impact of a stronger U.S. dollar
6 BNY Mellon
and the impact of downsizing the retail UK transfer agency business.
•
Clearing
services fees increased 7% compared with the first quarter of 2016 and 6% (unannualized) compared with the fourth quarter of 2016. Both increases were primarily driven by higher money market and mutual fund fees.
•
Issuer services fees increased 3% compared with the first quarter of 2016 and 19% (unannualized) compared with the fourth quarter of 2016. Both
increases reflect higher fees in Depositary Receipts, partially offset by lower fees in Corporate Trust.
•
Treasury services fees increased 6% compared with the first quarter of 2016 and decreased 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher payment volumes, partially offset by higher compensating balance credits provided to clients, which reduces fee revenue and increases net interest revenue.
See
the “Investment Services business” in “Review of businesses” for additional details.
Investment management and performance fees
Investment management and performance fees increased 4% compared with the first quarter of 2016 and decreased 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar (principally versus the British pound) and the impact of outflows of assets under management in the prior year. On
a constant currency basis, investment management and performance fees increased 8% (Non-GAAP) compared with the first quarter of 2016. The decrease compared with the fourth quarter of 2016 was primarily driven by seasonally lower performance fees and fewer days in the first quarter of 2017, partially offset by higher market values. Performance fees were $12 million in the first quarter of 2017, $32 million in the fourth quarter of 2016 and $11 million in the first quarter of 2016.
Total AUM for the Investment Management business increased
5% compared with both March 31, 2016 and Dec. 31, 2016. The increase compared with the first quarter of 2016 primarily reflects higher market
values, partially offset by the unfavorable impact of a stronger U.S. dollar (principally versus the British pound). The increase compared with the fourth quarter of 2016 primarily reflects higher market values and inflows of AUM. Net long-term inflows of $14 billion in the first quarter of 2017 reflect inflows of liability-driven investments and other active strategies, partially offset by outflows of active equity
investments. Net short-term inflows of $13 billion in the first quarter of 2017 were a result of increased distribution through our liquidity portals.
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
(in millions)
1Q17
4Q16
1Q16
Foreign exchange
$
154
$
175
$
171
Other
trading revenue (loss)
10
(14
)
4
Total foreign exchange and other trading revenue
$
164
$
161
$
175
Foreign
exchange and other trading revenue decreased 6%, compared with the first quarter of 2016 and increased 2% (unannualized) compared with the fourth quarter of 2016.
Foreign exchange revenue is primarily driven by the volume of client transactions and the spread realized on these transactions, both of which are impacted by market volatility, and the impact of foreign currency hedging activities. Foreign exchange revenue decreased 10% compared with the first quarter of 2016 and 12% (unannualized) compared with the fourth quarter of 2016. Both
decreases primarily reflect lower volatility. The decrease compared with the first quarter of 2016 also reflects the migration to lower margin products. Foreign exchange revenue is primarily reported in the Investment Services business and, to a lesser extent, the Investment Management business and the Other segment.
Our custody clients may enter into foreign exchange transactions in a number of ways, including through our standing instruction programs. While the shift of custody clients from our standing instruction programs to other trading options has recently abated, our foreign exchange revenue continues to be impacted by changes in volume and volatility. For
BNY Mellon 7
the quarter ended March 31, 2017, our total revenue for all types of foreign exchange trading transactions was $154 million, or 4% of our total revenue, and approximately 25% of our foreign exchange revenue was generated by transactions in our standing instruction programs.
The increase in other trading revenue compared with the fourth quarter of 2016 primarily reflects the impact of interest rate hedging activities (offset in net interest revenue) recorded in the fourth quarter of 2016 and higher fixed income trading revenue. Other trading revenue is reported in all three
business segments.
Financing-related fees
Financing-related fees, which are primarily reported in the Investment Services business and the Other segment, include capital markets fees, loan commitment fees and credit-related fees. The increase in financing-related fees compared with the fourth quarter of 2016 primarily reflects higher underwriting fees.
Distribution and servicing fees
The increase in distribution and servicing fees compared with the first quarter of 2016 primarily reflects higher money market fees, partially offset by fees paid to introducing brokers.
Investment
and other income
Investment and other income
(in millions)
1Q17
4Q16
1Q16
Corporate/bank-owned
life insurance
$
30
$
53
$
31
Equity investment income (loss)
26
(2
)
(3
)
Expense
reimbursements from joint venture
14
15
17
Seed capital gains (a)
9
6
11
Asset-related
gains
3
1
—
Lease-related gains (loss)
1
(6
)
44
Other
(loss) income
(6
)
3
5
Total investment and other income
$
77
$
70
$
105
(a)
Does
not include the gain on seed capital investments in consolidated investment management funds which are reflected in operations of consolidated investment management funds, net of noncontrolling interests. The gain on seed capital investments in consolidated investment management funds was $15 million in the first quarter of 2017 and $1 million in both the fourth quarter of 2016 and first quarter of 2016.
The changes in investment and other income compared with both the first quarter of 2016 and the fourth quarter of 2016 primarily reflect the net gain related to an equity investment
and decreases in other income due to our increased investments in renewable energy. The decrease compared with the first quarter of 2016 also reflects lower lease-related gains. The increase compared with the fourth quarter of 2016 was partially offset by lower income from corporate/bank-owned life insurance.
8 BNY Mellon
Net interest revenue
Net
interest revenue
1Q17 vs.
(dollars in millions)
1Q17
4Q16
1Q16
4Q16
1Q16
Net
interest revenue
$
792
$
831
$
766
(5)%
3%
Tax equivalent
adjustment
12
12
14
N/M
N/M
Net interest revenue (FTE) – Non-GAAP (a)
$
804
$
843
$
780
(5)%
3%
Average
interest-earning assets
$
283,421
$
287,947
$
310,678
(2)%
(9)%
Net
interest margin
1.13
%
1.16
%
0.99
%
(3
) bps
14
bps
Net interest margin (FTE) – Non-GAAP (a)
1.14
%
1.17
%
1.01
%
(3
)
bps
13
bps
(a)
Net interest revenue (FTE) – Non-GAAP and net interest margin (FTE) – Non-GAAP include the tax equivalent adjustments on tax-exempt income which allows for comparisons 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.
FTE - fully taxable equivalent.
N/M - Not meaningful.
bps - basis points.
The
increase in net interest revenue compared with the first quarter of 2016 primarily reflects higher interest rates and the impact of interest rate hedging activities (which negatively impacted the first quarter of 2017 less than the first quarter of 2016), partially offset by lower average interest-earning assets and higher average long-term debt. The decrease in net interest revenue compared with the fourth quarter of 2016 primarily reflects the impact of interest rate hedging activities and the fourth quarter of 2016 premium amortization adjustment which combined reduced net interest revenue by approximately $43 million, or 6 basis points to the net interest margin. Substantially all of the impact of interest rate hedging activities in the fourth quarter of 2016 was offset in foreign exchange and other trading revenue.
The
increase in the net interest margin compared with the first quarter of 2016 was primarily driven by an increase in rates. The decrease in the net interest margin compared with the fourth quarter of 2016 was primarily driven by the factors listed above.
Average non-U.S. dollar deposits comprised approximately 20% of our average total deposits in the first quarter of 2017. Approximately 40% of the average non-U.S. dollar deposits in the first quarter of 2017 were euro-denominated.
(dollar amounts in millions, presented on an FTE basis)
Average
balance
Interest
Average
rates
Average
balance
Interest
Average
rates
Average
balance
Interest
Average rates
Assets
Interest-earning
assets:
Interest-bearing deposits with banks (primarily foreign banks)
$
14,714
$
22
0.60
%
$
15,447
$
28
0.71
%
$
14,909
$
26
0.69
%
Interest-bearing
deposits held at the Federal Reserve and other central banks
66,043
57
0.35
61,672
28
0.18
89,092
61
0.28
Federal
funds sold and securities purchased under resale agreements
25,312
67
1.07
27,233
66
0.97
23,623
49
0.84
Margin
loans
15,753
75
1.94
17,547
71
1.61
18,907
63
1.34
Non-margin
loans:
Domestic offices
30,963
188
2.44
32,730
183
2.23
28,506
157
2.21
Foreign
offices
13,596
57
1.71
13,370
53
1.58
13,783
48
1.39
Total
non-margin loans
44,559
245
2.22
46,100
236
2.04
42,289
205
1.95
Securities:
U.S.
Government obligations
26,239
104
1.60
25,953
101
1.54
24,479
92
1.50
U.S.
Government agency obligations
56,857
271
1.90
57,049
259
1.82
55,966
251
1.79
State
and political subdivisions – tax-exempt
3,373
26
3.11
3,461
27
3.08
3,979
29
2.89
Other
securities
28,317
88
1.25
31,197
106
1.36
34,114
103
1.22
Trading
securities
2,254
17
3.12
2,288
18
3.17
3,320
18
2.16
Total
securities
117,040
506
1.74
119,948
511
1.70
121,858
493
1.62
Total
interest-earning assets (a)
$
283,421
$
972
1.38
%
$
287,947
$
940
1.30
%
$
310,678
$
897
1.16
%
Allowance
for loan losses
(169
)
(148
)
(157
)
Cash
and due from banks
5,097
5,017
3,879
Other
assets
46,731
50,322
48,845
Assets
of consolidated investment management funds
1,120
1,004
1,309
Total
assets
$
336,200
$
344,142
$
364,554
Liabilities
Interest-bearing
liabilities:
Interest-bearing deposits:
Money
market rate accounts
$
7,510
$
1
0.05
%
$
9,102
$
1
0.04
%
$
7,385
$
1
0.06
%
Savings
1,094
2
0.61
1,152
1
0.42
1,235
1
0.27
Demand
deposits
5,371
1
0.12
4,719
2
0.15
864
1
0.50
Time
deposits
35,429
11
0.12
37,766
7
0.07
42,678
4
0.04
Foreign
offices
90,416
(6
)
(0.03
)
92,942
(16
)
(0.07
)
109,855
8
0.03
Total
interest-bearing deposits
139,820
9
0.03
145,681
(5
)
(0.01
)
162,017
15
0.04
Federal
funds purchased and securities sold under repurchase agreements
18,995
24
0.51
11,567
8
0.30
18,689
9
0.20
Trading
liabilities
908
2
0.89
892
1
0.54
551
2
1.43
Other
borrowed funds
822
2
0.98
903
3
0.95
759
2
0.97
Commercial
paper
2,164
5
0.88
383
—
0.34
22
—
0.33
Payables
to customers and broker-dealers
18,961
7
0.16
17,091
3
0.07
16,801
4
0.09
Long-term
debt
25,882
119
1.85
24,986
87
1.36
21,556
85
1.57
Total
interest-bearing liabilities
$
207,552
$
168
0.33
%
$
201,503
$
97
0.19
%
$
220,395
$
117
0.21
%
Total
noninterest-bearing deposits
73,555
82,267
82,944
Other
liabilities
15,600
20,760
22,300
Liabilities
and obligations of consolidated investment management funds
244
229
259
Total
liabilities
296,951
304,759
325,898
Temporary
equity
Redeemable noncontrolling interests
161
177
190
Permanent
equity
Total BNY Mellon shareholders’ equity
38,507
38,713
37,804
Noncontrolling
interests
581
493
662
Total
permanent equity
39,088
39,206
38,466
Total
liabilities, temporary equity and permanent equity
$
336,200
$
344,142
$
364,554
Net
interest revenue (FTE) – Non-GAAP
$
804
$
843
$
780
Net
interest margin (FTE) – Non-GAAP
1.14
%
1.17
%
1.01
%
Less: Tax
equivalent adjustment (b)
12
12
14
Net
interest revenue – GAAP
$
792
$
831
$
766
Net
interest margin – GAAP
1.13
%
1.16
%
0.99
%
Note:
Interest
and average rates were calculated on a taxable equivalent basis using dollar amounts in thousands and actual number of days in the year.
(a)
Interest income and average yield are presented on an FTE basis (Non-GAAP).
(b)
Based on the applicable tax rate of 35%.
10 BNY Mellon
Noninterest
expense
Noninterest expense
1Q17 vs.
(dollars in millions)
1Q17
4Q16
1Q16
4Q16
1Q16
Staff
$
1,472
$
1,395
$
1,459
6
%
1
%
Professional,
legal and other purchased services
312
325
278
(4
)
12
Software
166
177
154
(6
)
8
Net
occupancy
136
153
142
(11
)
(4
)
Distribution and servicing
100
98
100
2
—
Sub-custodian
64
57
59
12
8
Furniture
and equipment
57
60
65
(5
)
(12
)
Bank assessment charges (a)
57
53
53
8
8
Business
development
51
71
57
(28
)
(11
)
Other (a)
167
175
188
(5
)
(11
)
Amortization
of intangible assets
52
60
57
(13
)
(9
)
M&I, litigation and restructuring charges
8
7
17
N/M
N/M
Total
noninterest expense – GAAP
$
2,642
$
2,631
$
2,629
—
%
—
%
Staff
expense as a percentage of total revenue
38
%
37
%
39
%
Full-time
employees at period end
52,600
52,000
52,100
1
%
1
%
Memo:
Adjusted
total noninterest expense excluding amortization of intangible assets and M&I, litigation and restructuring charges – Non-GAAP
$
2,582
$
2,564
$
2,555
1
%
1
%
(a)
In
the first quarter of 2017, we began disclosing bank assessment charges on a quarterly basis. The bank assessment charges were previously included in other expense. All prior periods were reclassified.
N/M - Not meaningful.
Total noninterest expense increased less than 1% compared with the first quarter of 2016 and the fourth quarter of 2016 (unannualized). The increase compared with the first quarter of 2016 primarily reflects increases in consulting and staff expenses, partially offset by lower other expense and the favorable impact of the stronger U.S. dollar. The
increase compared with the fourth quarter of 2016 primarily reflects higher staff expense, partially offset by lower business development, net occupancy, professional, legal and other purchased services and software expenses. Excluding amortization of intangible assets and M&I, litigation and restructuring charges, noninterest expense, as adjusted (Non-GAAP), increased 1% compared with the first quarter of 2016 and the fourth quarter of 2016 (unannualized).
We continue to invest in our risk management, regulatory compliance and other control functions to improve our safety and soundness and in light of increasing global regulatory requirements. We
expect a modest decrease in the run rate of the expenses relating to these functions beginning in the second half of 2017 after we submit our 2017 resolution plan.
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 first quarter of 2017, 55% in the first quarter of 2016 and 53% in the fourth quarter of 2016.
Staff
expense increased 1% compared with the first quarter of 2016 and 6% (unannualized) compared with the fourth quarter of 2016. The increase in staff expense compared with the first quarter of 2016 primarily reflects higher incentive expense, partially offset by the favorable impact of the stronger U.S. dollar. The increase in staff expense compared to the fourth quarter of 2016 primarily reflects higher incentives due to the impact of vesting of long-term stock awards for retirement eligible employees, partially offset by lower severance expense.
Non-staff expense
Non-staff
expense includes certain expenses that vary with the levels of business activity and levels of expensed business investments, fixed infrastructure costs and expenses associated with corporate activities related to technology, compliance, legal, productivity initiatives and business development.
BNY Mellon 11
Non-staff expense totaled $1.2 billion in the first quarter of 2017, flat compared with the first quarter of 2016 and a decrease of 5% (unannualized) compared with the fourth
quarter of 2016. Year-over-year, consulting expenses increased primarily due to higher regulatory and compliance costs, which were offset by lower other expense. The decrease compared with the fourth quarter of 2016 primarily reflects lower business development, net occupancy, professional, legal and other purchased services and software expenses. Adjusted non-staff expense, excluding amortization of intangible assets and M&I, litigation and restructuring charges (Non-GAAP), totaled $1.1 billion in the first quarter of 2017, an increase of 1% compared with the first quarter of 2016 and a decrease of 5% (unannualized) compared with the fourth quarter
of 2016.
We continue to benefit from the savings generated by the business improvement process, including improved efficiencies by changing the way we work, the continued impact from location strategy and vendor renegotiations, and optimizing our physical footprint.
Income taxes
BNY Mellon recorded an income tax provision of $269 million (22.3% effective tax rate) in the first quarter of 2017. The effective tax in the first quarter of
2017 reflects an approximate 3% benefit related to applying the new accounting guidance required in ASU 2016-09, Compensation – Stock Compensation, to the annual vesting of stock awards and our stock price appreciating above the awards’ original grant price.
The adoption of ASU 2016-09 results in increased volatility to the Company’s income tax expense. The income tax volatility is dependent on the Company’s stock price at the dates on which restricted stock units vest, which primarily occur in the first quarter of each year, and when employees choose to exercise stock options.
The
income tax provision was $283 million (25.9% effective tax rate) in the first quarter of 2016 and $280 million (24.3% effective tax rate) in the fourth quarter of 2016. For additional information, see Note 10 of the Notes to Consolidated Financial Statements.
We expect the effective tax rate to be approximately 25-26% in 2017 based on current income tax rates.
Any legislation affecting income tax rates could have an impact on our future effective tax rate, the significance of which would depend on the timing, nature
and scope of any such legislation, as well as the level and composition of our earnings.
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 18 of the Notes to Consolidated Financial Statements.
Business results are subject to reclassification when organizational changes are made or when improvements are made in the measurement principles.
The results of our businesses may be influenced by client and other activities that vary by quarter. In the first quarter, incentive expense typically increases reflecting the vesting of long-term stock awards for retirement eligible employees. In
the third quarter, Depositary Receipts revenue is typically higher due to an increased level of client dividend payments. Also in the third quarter, volume-related fees may decline due to reduced client activity. In the fourth quarter, we typically incur higher business development and marketing expenses. 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 results of our businesses may also be impacted by the translation of financial results denominated in foreign currencies to the U.S. dollar. We are primarily impacted by activities denominated in the
12
BNY Mellon
British pound and the euro. On a consolidated basis and in our Investment Services business, we typically have more foreign currency denominated expenses than revenues. However, our Investment Management business typically has more foreign currency denominated revenues than expenses.
Overall, currency fluctuations impact the year-over-year growth rate in the Investment Management business more than the Investment Services business. However, currency fluctuations, in isolation, are not expected to significantly impact net income on a consolidated basis.
The following table presents key market metrics at period end and on an average basis.
Key
market metrics
1Q17 vs.
1Q17
4Q16
3Q16
2Q16
1Q16
4Q16
1Q16
Standard
& Poor’s (“S&P”) 500 Index (a)
2363
2239
2168
2099
2060
6 %
15
%
S&P 500 Index – daily average
2326
2185
2162
2075
1951
6
19
FTSE
100 Index (a)
7323
7143
6899
6504
6175
3
19
FTSE
100 Index – daily average
7274
6923
6765
6204
5988
5
21
MSCI
EAFE (a)
1793
1684
1702
1608
1652
6
9
MSCI
EAFE – daily average
1749
1660
1677
1648
1593
5
10
Barclays
Capital Global Aggregate BondSM Index (a)(b)
459
451
486
482
468
2
(2
)
NYSE
and NASDAQ share volume (in billions)
186
189
186
203
218
(2
)
(15
)
JPMorgan
G7 Volatility Index – daily average (c)
10.10
10.24
10.19
11.12
10.60
(1
)
(5
)
Average
interest on excess reserves paid by the Federal Reserve
0.79
%
0.55
%
0.50
%
0.50
%
0.50
%
24 bps
29
bps
Foreign exchange rates vs. U.S. dollar:
British pound (a)
$
1.25
$
1.23
$
1.30
$
1.34
$
1.44
2
%
(13) %
British pound – average rate
1.24
1.24
1.31
1.43
1.43
—
(13
)
Euro
(a)
1.07
1.05
1.12
1.11
1.14
2
(6
)
Euro
– average rate
1.07
1.08
1.12
1.13
1.10
(1
)
(3
)
(a)
Period
end.
(b)
Unhedged in U.S. dollar terms.
(c)
The JPMorgan G7 Volatility Index is based on the implied volatility in 3-month currency options.
bps - basis points.
Fee revenue in Investment Management, and to a lesser extent in Investment Services, is impacted by the
value of market indices. At March 31, 2017, we estimate that a 5% change in global equity markets, 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.
Fee waivers are highly sensitive to changes in the interest on excess reserves paid by the Federal Reserve. Since 2014, the interest on excess reserves paid by the Federal Reserve increased 75 basis points. As a result of the increases, we recovered nearly all of the pre-tax income related to interest rate sensitive fee waivers.
See Note 18 of the Notes to Consolidated Financial Statements for
the consolidating schedules which show the contribution of our businesses to our overall profitability.
BNY Mellon 13
Investment Management business
1Q17
vs.
(dollar amounts in millions)
1Q17
4Q16
3Q16
2Q16
1Q16
4Q16
1Q16
Revenue:
Investment
management fees:
Mutual funds
$
299
$
297
$
309
$
304
$
300
1
%
—
%
Institutional
clients
348
340
362
344
334
2
4
Wealth
management
167
164
166
160
152
2
10
Investment
management fees (a)
814
801
837
808
786
2
4
Performance
fees
12
32
8
9
11
N/M
9
Investment
management and performance fees
826
833
845
817
797
(1
)
4
Distribution
and servicing
52
48
49
49
46
8
13
Other
(a)
(1
)
(1
)
(18
)
(10
)
(31
)
N/M
N/M
Total
fee and other revenue (a)
877
880
876
856
812
—
8
Net
interest revenue
86
80
82
82
83
8
4
Total
revenue
963
960
958
938
895
—
8
Provision
for credit losses
3
6
—
1
(1
)
N/M
N/M
Noninterest
expense (ex. amortization of intangible assets)
668
672
680
684
660
(1
)
1
Amortization
of intangible assets
15
22
22
19
19
(32
)
(21
)
Total
noninterest expense
683
694
702
703
679
(2
)
1
Income
before taxes
$
277
$
260
$
256
$
234
$
217
7
%
28
%
Income
before taxes (ex. amortization of intangible assets) – Non-GAAP
$
292
$
282
$
278
$
253
$
236
4
%
24
%
Pre-tax
operating margin
29
%
27
%
27
%
25
%
24
%
Adjusted pre-tax operating
margin – Non-GAAP (b)
34
%
33
%
33
%
30
%
30
%
Average
balances:
Average loans
$
16,153
$
15,673
$
15,308
$
14,795
$
14,275
3
%
13
%
Average
deposits
$
15,781
$
15,511
$
15,600
$
15,518
$
15,971
2
%
(1
)%
(a)
Total
fee and other revenue includes the impact of the consolidated investment management funds, net of noncontrolling interests. See page 50 for a breakdown of the revenue line items in the Investment Management business impacted by the consolidated investment management funds. Additionally, other revenue includes asset servicing, treasury services, foreign exchange and other trading revenue and investment and other income.
(b)
Excludes amortization of intangible assets, provision for credit losses and distribution and servicing expense. See “Supplemental information – Explanation of GAAP and Non-GAAP financial measures” beginning
on page 47 for the reconciliation of this Non-GAAP measure.
N/M - Not meaningful.
14 BNY Mellon
AUM
trends (a)(b)
1Q17 vs.
(dollar amounts in billions)
1Q17
4Q16
3Q16
2Q16
1Q16
4Q16
1Q16
AUM
at period end, by product type: (b)
Equity
$
158
$
153
$
156
$
152
$
151
3
%
5
%
Fixed
income
191
186
194
192
194
3
(2
)
Index
330
312
302
296
310
6
6
Liability-driven
investments (c)
584
554
607
573
542
5
8
Multi-asset
and alternative investments
188
181
189
183
177
4
6
Cash
276
262
267
268
265
5
4
Total
AUM
$
1,727
$
1,648
$
1,715
$
1,664
$
1,639
5
%
5
%
AUM
at period end, by client type:
Institutional
$
1,243
$
1,182
$
1,234
$
1,182
$
1,155
5
%
8
%
Mutual
funds
397
381
396
398
405
4
(2
)
Private
client
87
85
85
84
79
2
10
Total
AUM
$
1,727
$
1,648
$
1,715
$
1,664
$
1,639
5
%
5
%
Changes
in AUM: (b)
Beginning balance of AUM
$
1,648
$
1,715
$
1,664
$
1,639
$
1,625
Net
inflows (outflows):
Long-term strategies:
Equity
(4
)
(5
)
(6
)
(2
)
(2
)
Fixed
income
2
(1
)
(1
)
(3
)
—
Liability-driven investments (c)
14
(7
)
4
15
14
Multi-asset
and alternative investments
2
3
7
2
—
Total
long-term active strategies inflows (outflows)
14
(10
)
4
12
12
Index
—
(1
)
(3
)
(17
)
(11
)
Total
long-term strategies inflows (outflows)
14
(11
)
1
(5
)
1
Short
term strategies:
Cash
13
(3
)
(1
)
4
(9
)
Total
net inflows (outflows)
27
(14
)
—
(1
)
(8
)
Net market impact/other
41
(11
)
80
71
41
Net
currency impact
11
(42
)
(29
)
(47
)
(19
)
Acquisition
—
—
—
2
—
Ending
balance of AUM
$
1,727
$
1,648
$
1,715
$
1,664
$
1,639
5
%
5
%
(a)
Excludes
securities lending cash management assets and assets managed in the Investment Services business.
(b)
In the first quarter of 2017, the AUM in our Wealth Management business and our multi-asset strategies has been reclassified into multi-asset and alternative investments. This reclassification does not change total AUM. All prior periods have been restated.
(c)
Includes currency overlay AUM.
Business
description
Our Investment Management business consists of our affiliated investment management boutiques, Wealth Management business and global distribution companies. See pages 19 and 20 of our 2016 Annual Report for additional information on our Investment Management business.
Review of financial results
AUM increased 5% compared with March 31, 2016 primarily reflecting higher market values, partially offset by the unfavorable impact of the stronger U.S. dollar (principally versus the British pound). The increase compared with
the fourth quarter of 2016 primarily reflects higher market values and inflows of AUM.
Net long-term inflows in the first quarter of 2017 reflect inflows of liability-driven investments and other active strategies, partially offset by outflows of active equity investments. Net short-term inflows in the first quarter of 2017 were a result of increased distribution through our liquidity portals. Market and regulatory trends are driving investable assets toward investments in lower fee asset management products, which are negatively impacting our investment management fees. However, at the same time, these trends are also providing growth opportunities
as clients are also investing in high value active solutions.
Total revenue increased 8% compared with the first quarter of 2016 and increased slightly compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher market values, higher seed capital gains and losses on
BNY Mellon 15
hedging activity recorded in the first quarter
of 2016, partially offset by the impact of a stronger U.S. dollar and net outflows of assets under management in the prior year.
Revenue generated in the Investment Management business included 40% from non-U.S. sources in the first quarter of 2017, compared with 40% in the first quarter of 2016 and 42% in the fourth quarter of 2016.
Investment management fees in the Investment Management business increased 4% compared with the first quarter of
2016 and 2% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar (principally versus the British pound) and the impact of outflows of assets under management in the prior year. On a constant currency basis, investment management fees increased 7% (Non-GAAP) compared with the first quarter of 2016. The increase compared with the fourth quarter of 2016 was primarily driven by higher market values, partially offset by fewer days in the first quarter of 2017.
Performance
fees decreased compared with the fourth quarter of 2016 primarily reflecting seasonality.
Both increases in distribution and servicing fees were primarily driven by higher money market fees.
The improvement in other revenue compared with the first quarter of 2016 reflects higher seed capital gains and losses on hedging activity recorded in the first quarter of 2016, partially offset by payments to Investment Services related to higher money market fees.
Both increases in net interest revenue primarily reflect higher rates on deposits. Average
loans increased 13% compared with the first quarter of 2016 and 3% compared with the fourth quarter of 2016, while average deposits decreased 1% compared with the first quarter of 2016 and increased 2% compared with the fourth quarter of 2016. Record average loans were driven by extending banking solutions to high net worth clients.
Noninterest expense, excluding amortization of intangible assets, increased 1% compared with the first quarter of
2016 and decreased 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 was primarily driven by higher incentive expense, partially offset by the favorable impact of a stronger U.S. dollar (principally versus the British pound). The decrease compared with the fourth quarter of 2016 primarily reflects lower business development expense.
16 BNY Mellon
Investment
Services business
1Q17
vs.
(dollar amounts in millions, unless otherwise noted)
1Q17
4Q16
3Q16
2Q16
1Q16
4Q16
1Q16
Revenue:
Investment
services fees:
Asset servicing
$
1,038
$
1,043
$
1,039
$
1,043
$
1,016
—
%
2
%
Clearing
services
375
354
347
350
348
6
8
Issuer
services
250
211
336
233
244
18
2
Treasury
services
139
139
136
137
129
—
8
Total
investment services fees
1,802
1,747
1,858
1,763
1,737
3
4
Foreign
exchange and other trading revenue
153
157
177
161
168
(3
)
(9
)
Other
(a)
129
128
148
130
125
1
3
Total
fee and other revenue
2,084
2,032
2,183
2,054
2,030
3
3
Net
interest revenue
707
713
715
690
679
(1
)
4
Total
revenue
2,791
2,745
2,898
2,744
2,709
2
3
Provision
for credit losses
—
—
1
(7
)
14
N/M
N/M
Noninterest
expense (ex. amortization of intangible assets)
1,812
1,786
1,812
1,819
1,770
1
2
Amortization
of intangible assets
37
38
39
40
38
(3
)
(3
)
Total
noninterest expense
1,849
1,824
1,851
1,859
1,808
1
2
Income
before taxes
$
942
$
921
$
1,046
$
892
$
887
2
%
6
%
Income
before taxes (ex. amortization of intangible assets) – Non-GAAP
$
979
$
959
$
1,085
$
932
$
925
2
%
6
%
Pre-tax
operating margin
34
%
34
%
36
%
33
%
33
%
Adjusted pre-tax
operating margin (ex. provision for credit losses and amortization of intangible assets) – Non-GAAP
35
%
35
%
37
%
34
%
35
%
Investment
services fees as a percentage of noninterest
expense (ex. amortization of intangible assets)
99
%
98
%
103
%
97
%
98
%
Securities
lending revenue
$
40
$
44
$
42
$
42
$
42
(9
)%
(5
)%
Metrics:
Average
loans
$
42,818
$
45,832
$
44,329
$
43,786
$
45,004
(7
)%
(5
)%
Average
deposits
$
197,690
$
213,531
$
220,316
$
221,998
$
215,707
(7
)%
(8
)%
AUC/A
at period end (in trillions) (b)
$
30.6
$
29.9
$
30.5
$
29.5
$
29.1
2
%
5
%
Market
value of securities on loan at period end (in billions) (c)
$
314
$
296
$
288
$
278
$
300
6
%
5
%
Asset
servicing:
Estimated new business wins (AUC/A) (in billions)
$
109
$
141
$
150
$
167
$
40
Depositary
Receipts:
Number of sponsored programs
1,050
1,062
1,094
1,112
1,131
(1
)%
(7
)%
Clearing
services:
Average active clearing accounts (U.S. platform) (in thousands)
6,058
5,960
5,942
5,946
5,947
2
%
2
%
Average
long-term mutual fund assets (U.S. platform)
$
460,977
$
438,460
$
443,112
$
431,150
$
415,025
5
%
11
%
Average
investor margin loans (U.S. platform)
$
10,740
$
10,562
$
10,834
$
10,633
$
11,063
2
%
(3
)%
Broker-Dealer:
Average
tri-party repo balances (in billions)
$
2,373
$
2,307
$
2,212
$
2,108
$
2,104
3
%
13
%
(a)
Other
revenue includes investment management fees, financing-related fees, distribution and servicing revenue and investment and other income.
Represents the total amount of securities on loan in our agency securities lending program managed by the Investment Services business. Excludes securities for which BNY Mellon acts as agent on behalf of CIBC Mellon clients, which totaled $65 billion at March 31, 2017, $63 billion at Dec. 31, 2016, $64 billion
at Sept. 30, 2016 and $56 billion at June 30, 2016 and March 31, 2016.
N/M - Not meaningful.
BNY Mellon 17
Business description
We are one of the leading global investment services providers with $30.6
trillion of AUC/A at March 31, 2017.
•
We are a leader in both global and U.S. government securities clearance, settling securities transactions in over 100 markets.
•
We are a leader in servicing tri-party repo collateral with approximately $2.4 trillion serviced globally.
•
We
service approximately $1.6 trillion, or approximately 87%, of the $1.8 trillion tri-party repo market in the U.S.
•
Our agency securities lending program is one of the largest lenders of U.S. and non-U.S. securities, servicing a lendable asset pool of approximately $3.1 trillion in 33 separate markets.
•
We serve as trustee and/or paying agent on more than 50,000 debt-related issuances globally.
•
As
one of the largest providers of depositary receipts services in the world, we served as depositary for 1,050 sponsored American and global depositary receipt programs at March 31, 2017, acting in partnership with leading companies from 62 countries.
BNY Mellon Investment Services provides business and technology solutions across the investments process to financial institutions, corporations, foundations and endowments, public funds and government agencies.
With NEXEN®, our next generation digital technology ecosystem, we are leading the
digital transformation of BNY Mellon and the services we provide to our clients. NEXEN® provides us with many competitive advantages. It is creating internal efficiencies while reducing costs and increasing speed of delivery, enhancing our clients’ experience and driving revenue opportunities as we continue to onboard clients to our new digital platform. We are collaborating with clients and leading financial technology startups, or fintechs, to develop and integrate new solutions and services, and attracting top information technology talent through our Innovation Centers worldwide.
We offer asset servicing, clearing services, issuer services and treasury services to our clients. BNY Mellon’s comprehensive suite of asset servicing solutions includes: global custody,
foreign exchange, global fund services, securities finance, investment manager outsourcing, performance and risk analytics, alternative investment services, broker-dealer services, and collateral and liquidity services.
As one of the largest fund accounting providers and a trusted partner, we offer services to ensure the safekeeping of assets in capital markets globally. These services include financial reporting, tax reporting services, calculating and reporting net asset values (“NAV”), computing yields, maintaining brokerage account records, and providing administrative support for U.S. Securities and Exchange Commission and other compliance requirements.
Our alternative investment services and structured products business provides a full range of solutions for alternative
investment managers, including prime custody, fund accounting, client and regulatory reporting services. We also support exchange-traded funds and unit investment trusts, providing fund administration, custody, basket creation and dissemination, authorized participant interaction and order processing, among other services.
Securities finance delivers solutions on both an agency and principal basis. The principal finance program supports a diverse group of client segments, including hedge and liquid alternative funds and other institutional clients.
In liquidity services, our market leading portal enables cash investments for institutional clients via money market funds, deposit products, and direct investments in money market securities, and includes fund research and analytics.
Our
broker-dealer services business clears and settles equity and fixed-income transactions globally and manages more than $2 trillion in collateral, including tri-party repo collateral, worldwide. As a leader in the U.S. tri-party repo market, BNY Mellon led the way in reducing systemic risk through operational and technology enhancements.
Clearing services, primarily Pershing LLC, an indirect subsidiary of BNY Mellon (“Pershing”) and its affiliates, provides business and technology
18 BNY Mellon
solutions to financial organizations
globally, delivering dependable operational support, robust trading services, flexible technology, an expansive array of investment and retirement solutions, practice management support and service excellence.
Our collateral services include collateral management, administration and segregation. We offer innovative solutions, like new collateral types and transaction structures, automation and efficiency, access to global markets, and industry expertise, to help financial institutions and institutional investors mine opportunities from liquidity, financing, risk and balance sheet challenges.
We are a leading provider to the debt capital markets, providing customized and market-driven solutions to investors, bondholders and lenders. Our corporate trust business delivers a full range
of issuer and related investor services, including trustee, paying agency, fiduciary, escrow and other financial services.
Our treasury services include customizable solutions and innovative technology that deliver high-quality cash management, payment and trade support for corporate and institutional global treasury needs.
We also provide credit facilities and solutions to support our clients globally.
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.
BNY Mellon also has been named as a defendant in legal actions brought by MBS investors alleging that the trustee has expansive duties under the governing agreements, including to investigate and pursue claims against other parties to the MBS transaction. For additional information on our legal proceedings related to this matter, see Note 17 of the Notes to Consolidated Financial Statements.
Review of financial results
AUC/A increased 5% compared with March 31,
2016 to a record $30.6 trillion. The increase primarily reflects higher market values, partially offset by the unfavorable impact of a stronger U.S. dollar. AUC/A consisted of 37% equity securities and 63% fixed income securities at March 31, 2017 compared with 34% equity securities and 66% fixed income securities at March 31, 2016.
Investment services fees increased 4% compared with the first quarter of 2016 and 3% (unannualized) compared
with the fourth quarter of 2016, reflecting the following factors:
•
Asset servicing fees (custody, fund services, broker-dealer services, securities finance, collateral and liquidity services) increased 2% compared with the first quarter of 2016 and decreased less than 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects net new business, including growth of collateral optimization solutions,
and higher equity market values, partially offset by the unfavorable impact of a stronger U.S. dollar and the impact of downsizing the retail UK transfer agency business.
•
Clearing services fees increased 8% compared with the first quarter of 2016 and 6% (unannualized) compared with the fourth quarter of 2016. Both increases primarily reflect higher money market and mutual fund fees.
•
Issuer
services fees (Depositary Receipts and Corporate Trust) increased 2% compared with the first quarter of 2016 and 18% (unannualized) compared with the fourth quarter of 2016. Both increases primarily reflect higher fees in
BNY Mellon 19
Depositary Receipts, partially offset by lower fees in Corporate Trust.
•
Treasury
services fees (global payments, trade finance and cash management) increased 8% compared with the first quarter of 2016 and were flat compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher payment volumes, partially offset by higher compensating balance credits provided to clients, which reduces fee revenue and increases net interest revenue.
Market and regulatory trends are driving investable assets toward investments in lower fee asset management products at reduced margins for our clients. These dynamics are also negatively impacting our investment services fees. However, at the same
time, these trends are also providing additional outsourcing opportunities as clients and other market participants seek to comply with new regulations and reduce their operating costs.
Foreign exchange and other trading revenue decreased 9% compared with the first quarter of 2016 and 3% (unannualized) compared with the fourth quarter of 2016. Both decreases primarily reflect lower volatility. The decrease compared with the first quarter of 2016 also reflects the migration to lower margin products.
Other revenue increased 3%
compared with the first quarter of 2016 and 1% compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher payments from Investment Management related to higher money market fees, and higher financing-related fees, partially offset by certain fees paid to introducing brokers.
Net interest revenue increased 4% compared with the first quarter of 2016 and decreased 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first
quarter of 2016 primarily reflects the impact of the higher interest rates, partially offset by lower deposits. The decrease compared with the fourth quarter of 2016 primarily reflects lower deposits and loans as well as fewer days in the first quarter of 2017, partially offset by higher short-term rates.
Noninterest expense, excluding amortization of intangible assets, increased 2% compared with the first quarter of 2016 and 1% (unannualized) compared with the fourth quarter of 2016. The increase compared with the first quarter of 2016 primarily reflects higher expense from regulatory
and compliance costs, additional technology investments and higher staff expenses, offset by lower litigation expense and the favorable impact of a stronger U.S. dollar. The increase compared with the fourth quarter of 2016 primarily reflects higher incentive expense, partially offset by lower severance and other general expenses.
Other segment
(in
millions)
1Q17
4Q16
3Q16
2Q16
1Q16
Revenue:
Fee
and other revenue
$
72
$
42
$
100
$
95
$
129
Net
interest (expense) revenue
(1
)
38
(23
)
(5
)
4
Total revenue
71
80
77
90
133
Provision
for credit losses
(8
)
1
(20
)
(3
)
(3
)
Noninterest expense (ex. M&I and restructuring charges (recoveries))
106
108
88
53
141
M&I
and restructuring charges (recoveries)
1
2
—
3
(1
)
Total noninterest expense
107
110
88
56
140
(Loss)
income before taxes
$
(28
)
$
(31
)
$
9
$
37
$
(4
)
(Loss)
income before taxes (ex. M&I and restructuring charges (recoveries)) – Non-GAAP
$
(27
)
$
(29
)
$
9
$
40
$
(5
)
Average
loans and leases
$
1,341
$
2,142
$
1,941
$
1,703
$
1,917
20 BNY Mellon
See page 26 of our 2016 Annual Report for additional information on the Other segment.
Review of financial results
Total fee and other revenue decreased $57 million compared with the first quarter of 2016 and increased $30 million compared with the fourth quarter of 2016. Both comparisons primarily reflect the net gain related to an
equity investment, the impact of interest rate hedging activities and lower other income due to increased investments in renewable energy. The decrease compared with the first quarter of 2016 also reflects lower lease-related gains. The increase compared with the fourth quarter of 2016 was partially offset by lower income from corporate/bank-owned life insurance.
Net interest revenue decreased $5 million compared with the first quarter of 2016 and $39 million compared with the fourth quarter
of 2016. The decrease compared with the first quarter of 2016 was primarily driven by the impact of interest rate hedging activities. The decrease compared with the fourth quarter of 2016 reflects the impact of interest rate hedging activities and the premium amortization adjustment recorded in the fourth quarter of 2016 which combined reduced net interest revenue by approximately $43 million.
Noninterest expense, excluding M&I and restructuring charges (recoveries), decreased $35 million compared with the first
quarter of 2016 and decreased $2 million compared with the fourth quarter of 2016. The decrease compared with the first quarter of 2016 primarily reflects lower incentive expense.
Critical accounting estimates
Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements in our 2016 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
2016 Annual Report, pages 29 - 31.
Fair value of financial instruments and derivatives
2016
Annual Report, pages 31 - 32.
OTTI
2016 Annual Report, page 33.
Goodwill and other intangibles
2016 Annual Report, pages 33 - 34.
Pension accounting
2016 Annual Report, pages 34 - 36.
Consolidated balance sheet review
One of our
key risk management objectives is to maintain a balance sheet that remains strong throughout market cycles to meet the expectations of our major stakeholders, including our shareholders, clients, creditors and regulators.
We also seek to ensure that the overall liquidity risk, including intra-day liquidity risk, that we undertake stays within our risk appetite. In managing the balance sheet, appropriate consideration is given to balancing the competing needs to maintain sufficient levels of liquidity and complying with applicable regulations and supervisory expectations while optimizing profitability. The objective of our balance sheet management strategy is to maintain a balance sheet that is characterized by strong liquidity and asset quality, ready access to external funding sources at competitive rates and a strong capital structure that supports
our risk-taking activities and that is adequate to absorb potential losses.
At March 31, 2017, total assets were $338 billion compared with $333 billion at Dec. 31, 2016. The increase in total assets was primarily driven by higher interest-bearing deposits with the Federal Reserve and other central banks, partially offset by lower loans. Deposits totaled $221 billion at both March 31, 2017 and Dec.
31, 2016. At March 31, 2017, total interest-bearing deposits were 50% of total interest-earning assets, compared with 51% at Dec. 31, 2016.
At March 31, 2017, we had $40 billion of liquid funds (which include interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements) and $71 billion of cash (including $65 billion of overnight deposits with the Federal Reserve and other central banks)
for a total of
BNY Mellon 21
$111 billion of available funds. This compares with available funds of $104 billion at Dec. 31, 2016. Total available funds as a percentage of total assets were 33% at March 31, 2017 compared with 31% at Dec. 31, 2016. For additional information on our
liquid funds and available funds, see “Liquidity and dividends.”
Investment securities were $115.8 billion, or 34% of total assets, at March 31, 2017, compared with $114.7 billion, or 34% of total assets, at Dec. 31, 2016. For additional information on our investment securities portfolio, see “Investment securities” and Note 4 of the Notes to Consolidated Financial Statements.
Loans were $60.9
billion, or 18% of total assets, at March 31, 2017, compared with $64.5 billion, or 19% of total assets, at Dec. 31, 2016. For additional information on our loan portfolio, see “Loans” and Note 5 of the Notes to Consolidated Financial Statements.
Long-term debt totaled $26.3 billion at March 31, 2017 and $24.5 billion
at Dec. 31, 2016. For additional information on long-term debt, see “Liquidity and dividends.”
The Bank of New York Mellon Corporation total shareholders’ equity increased to $39.1 billion from $38.8 billion at Dec. 31, 2016. For additional information on our capital, see “Capital.”
Country risk exposure
We have exposure to
certain countries and territories with higher risk profiles. Exposure described below reflects the country of operations and risk of the immediate counterparty. We continue to monitor our exposure to these and other countries as part of our Risk Management process. See “Risk management” in our 2016 Annual Report for additional information on how our exposures are managed.
BNY Mellon has a limited economic interest in the performance of assets of consolidated investment management funds, and therefore they are excluded from this disclosure.
Italy, Spain, Portugal and Greece
Over the past several years, there have been concerns about European sovereign debt and its impact on the European
banking system, as a number of European
countries, including Italy, Spain, Portugal and Greece, experienced credit deterioration. We had net exposure of $1.2 billion to Italy and $1.9 billion to Spain at March 31, 2017. We had net exposure of $1.2 billion to Italy and $2.0 billion to Spain at Dec. 31, 2016. At both March 31, 2017 and Dec. 31, 2016, exposure to Italy and Spain primarily consisted of investment grade sovereign debt. Investment securities exposure totaled $1.2 billion in Italy and $1.8
billion in Spain at March 31, 2017 and $1.1 billion in Italy and $1.8 billion in Spain at Dec. 31, 2016. At March 31, 2017 and Dec. 31, 2016, we had exposure to Portugal of $4 million and $2 million, respectively. At both March 31, 2017 and Dec. 31, 2016, BNY Mellon had exposure of less than $1 million to Greece.
Brazil
Current conditions in Brazil have resulted in increased focus on its economic and political stability. We have operations in Brazil providing investment services and investment management services. In addition, at March 31, 2017 and Dec. 31, 2016, we had total net exposure to Brazil of $1.4 billion and $1.3 billion, respectively. This included $1.3 billion at both periods, in loans, which are primarily short-term trade finance loans extended to large financial institutions. At March 31, 2017
and Dec. 31, 2016, we held $140 million and $73 million, respectively, of noninvestment grade sovereign debt.
Other countries and territories
Events in recent years have resulted in increased focus on exposures to Turkey, Russia and Puerto Rico. Related to Turkey, we mainly provide treasury and issuer services, as well as foreign exchange products primarily to the top-10 largest financial institutions in the country. As of March 31, 2017 and Dec. 31, 2016,
our exposure totaled $735 million and $713 million, respectively, consisting primarily of syndicated credit facilities and trade finance loans. At March 31, 2017 and Dec. 31, 2016, our exposure to Russia was $54 million and $79 million, respectively. Related to Puerto Rico, BNY Mellon had $23 million of securities held in the trading account measured at fair value at March 31, 2017 as well as margin loan exposure that was collateralized with a concentration of Puerto Rican securities. The margin loan exposure was approximately $30 million and $45 million, at March 31,
2017 and Dec. 31, 2016, respectively.
22 BNY Mellon
Investment securities
In the discussion of our investment securities portfolio, we have included certain credit ratings information because the information can indicate the degree of credit risk to which we are exposed.
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 shows the distribution of our total investment securities portfolio.
Primarily consists of exposure to UK, France, Germany, Spain and the Netherlands.
(c)
These RMBS were included in the former Grantor Trust and were marked-to-market in 2009. We believe these RMBS would receive higher credit ratings if these ratings incorporated, as additional credit enhancements, the difference between the written-down amortized cost and the current face amount of each of these securities.
(d)
Includes
RMBS and commercial MBS. Primarily consists of exposure to UK and the Netherlands.
(e)
Primarily consists of exposure to Canada, Norway, the Netherlands and UK.
(f)
Includes commercial paper with a fair value of $401 million and $701 million and money market funds with a fair value of $842 million and $853 million at Dec.
31, 2016 and March 31, 2017, respectively.
(g)
Includes net unrealized losses on derivatives hedging securities available-for-sale of $211 million at Dec. 31, 2016 and $134 million at March 31, 2017.
(h)
Unrealized
gains of $165 million at March 31, 2017 related to available-for-sale securities, net of hedges.
The fair value of our total investment securities portfolio was $115.5 billion at March 31, 2017, compared with $114.3 billion at Dec. 31, 2016. The higher level of securities primarily reflects increases in U.S. Treasury and commercial MBS
securities, partially offset by a decrease in sovereign debt/ sovereign guaranteed.
At March 31, 2017, the total investment securities portfolio had a net unrealized pre-tax loss of $23 million compared with $221 million at Dec. 31, 2016, including the impact of related hedges. The improvement in the net unrealized pre-tax loss was primarily driven by a decrease in market interest rates.
The unrealized gain net of tax on our available-for-sale investment securities portfolio included in accumulated other comprehensive income was $131
million at March 31, 2017, compared with $45 million at Dec. 31, 2016.
At March 31, 2017, 92% of the securities in our portfolio were rated AAA/AA- compared with 93% at Dec. 31, 2016.
We routinely test our investment securities for OTTI. See “Critical
accounting estimates” for additional information regarding OTTI.
BNY Mellon 23
The following table presents the amortizable purchase premium (net of discount) related to the investment securities portfolio and accretable discount related to the 2009 restructuring of the investment securities portfolio.
Net
premium amortization and discount accretion of investment securities (a)
(dollars in millions)
1Q17
4Q16
3Q16
2Q16
1Q16
Amortizable
purchase premium (net of discount) relating to investment securities:
Balance at period end
$
2,058
$
2,188
$
2,267
$
2,251
$
2,233
Estimated
average life remaining at period end (in years)
4.9
4.9
4.5
4.4
4.5
Amortization
$
138
$
146
$
163
$
169
$
163
Accretable
discount related to the prior restructuring of the investment securities portfolio:
Balance at period end
$
299
$
315
$
331
$
342
$
325
Estimated
average life remaining at period end (in years)
6.2
6.2
5.9
5.9
6.0
Accretion
$
25
$
25
$
24
$
26
$
27
(a)
Amortization
of purchase premium decreases net interest revenue while accretion of discount increases net interest revenue. Both were recorded on a level yield basis.
The following table presents pre-tax net securities gains by type.
Net securities gains (losses)
(in
millions)
1Q17
4Q16
1Q16
Agency RMBS
$
1
$
—
$
8
Non-agency
RMBS
(1
)
7
(2
)
Other
10
3
14
Total
net securities gains
$
10
$
10
$
20
On a quarterly basis, we perform our impairment analysis using several factors, including projected loss severities and default rates. In the first quarter of
2017, this analysis resulted in other-than-temporary credit losses of $1 million primarily in our non-agency RMBS portfolio. At March 31, 2017, if we were to increase or decrease each of our projected loss severity and default rates by 100 basis points on each of the positions in our non-agency RMBS portfolio, including the securities previously held by the Grantor Trust, credit-related impairment charges on these securities would have increased or decreased by less than $1 million (pre-tax). See Note 4 of the
Notes to Consolidated Financial Statements for the projected weighted-average default rates and loss severities.
The following table shows the fair value of the
European floating rate notes by geographical location at March 31, 2017. The unrealized loss on these securities was $8 million at March 31, 2017, compared with $11 million at Dec. 31, 2016.
At
March 31, 2017, total exposures were $116.4 billion, a decrease of 3% compared with Dec. 31, 2016. The decrease in total exposure primarily reflects lower exposure to financial institutions and lower margin loans, partially offset by higher unfunded commitments in the commercial real estate portfolio.
Our financial institutions and commercial portfolios comprise our largest concentrated risk. These portfolios comprised 57% of our total exposure at both March 31,
2017 and Dec. 31, 2016. Additionally, a substantial portion of our overdrafts relate to financial institutions.
Financial institutions
The financial institutions portfolio is shown below.
The
financial institutions portfolio exposure was $46.7 billion at March 31, 2017, compared with $48.4 billion at Dec. 31, 2016. The decrease primarily reflects lower exposure in the banks, securities industry and insurance portfolios.
Financial institution exposures are high-quality, with 93% of the exposures meeting the investment grade equivalent criteria of our internal credit rating classification at March 31, 2017. 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, 85% expire within one year and 22% expire within 90 days. In addition, 80% of the financial institutions exposure is secured. For example, securities industry clients and asset managers often borrow against marketable securities held in custody.
For ratings of non-U.S. counterparties, 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
BNY Mellon 25
rating assigned to the counterparty or the underlying collateral.
At March 31, 2017, the secured intraday credit provided to dealers in connection with their tri-party repo activity totaled $18.7 billion and was primarily included in the securities industry portfolio. Dealers secure the outstanding intraday credit with high-quality liquid collateral having a market value in excess of the amount
of the outstanding credit.
Our bank exposure primarily relates to our global trade finance. These exposures are short-term in nature, with 95% due in less than one year. The investment grade percentage of our bank exposure was 70% at March 31, 2017, compared with 69% at Dec. 31, 2016.
The asset manager portfolio exposures are high-quality with 99% of the exposures meeting our investment grade equivalent ratings criteria as of March 31, 2017. These exposures are generally short-term liquidity facilities,
with the vast majority to regulated mutual funds.
The
commercial portfolio exposure increased slightly to $20.2 billion at March 31, 2017, from $20.1 billion at Dec. 31, 2016, primarily reflecting an increase in total exposure in the manufacturing portfolio, partially offset by a decrease in exposure to the energy and utilities portfolio.
Utilities-related exposure represents approximately three-quarters of the energy and utilities portfolio. The remaining exposure in the energy and utilities portfolio, which includes exposure to refining, integrated companies, exploration and production companies and pipelines, was 76% investment grade at both March 31,
2017 and Dec. 31, 2016.
The following table summarizes the percentage of the financial institutions and commercial portfolio exposures that are investment grade.
Percentage of the portfolios that are investment grade
Our
credit strategy is to focus on investment grade clients that are active users of our non-credit services. The execution of our strategy has resulted in 93% of our financial institutions portfolio and 95% of our commercial portfolio rated as investment grade at March 31, 2017.
Wealth management loans and mortgages
Our wealth management exposure was $17.2 billion at March 31, 2017, compared with $16.9 billion at Dec.
31, 2016. Wealth management loans and mortgages primarily consist 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 a weighted-average loan-to-value ratio of 61% at origination. In the wealth management portfolio, less than 1% of the mortgages were past due at March 31, 2017.
At March 31, 2017, the wealth management mortgage portfolio consisted of the following geographic concentrations: California - 24%;
New York - 19%; Massachusetts - 12%; Florida - 7%; and other - 38%.
26 BNY Mellon
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 $8.3 billion at March 31, 2017, compared with $7.9 billion at Dec. 31, 2016.
At March 31, 2017, 58%
of our commercial real estate portfolio was secured. The secured portfolio is diverse by project type, with 48% secured by residential buildings, 34% secured by office buildings, 12% secured by retail properties and 6% secured by other categories. Approximately 94% of the unsecured portfolio consists of real estate investment trusts (“REITs”) and real estate operating companies, which are both predominantly investment grade.
At March 31, 2017, our commercial real estate portfolio consists of the following concentrations: New York metro - 41%;
REITs and real estate operating companies - 40%; and other - 19%.
Lease financings
The leasing portfolio exposure totaled $1.6 billion at March 31, 2017, compared with $1.7 billion at Dec. 31, 2016. At March 31, 2017, approximately 93% of the leasing portfolio exposure was investment
grade, or investment grade equivalent.
At March 31, 2017, the lease financing portfolio consisted of exposures backed by well-diversified assets, primarily large-ticket transportation equipment.
Other residential mortgages
The other residential mortgages portfolio primarily consists of 1-4 family residential mortgage loans and totaled $817 million at March 31, 2017 and $854 million at Dec.
31, 2016. Included in this portfolio at March 31, 2017 are $208 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 March 31, 2017, the purchased loans in this portfolio had a weighted-average loan-to-value ratio of 76% at origination and 14% of the serviced loan balance was 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).
Overdrafts
Overdrafts primarily relate to custody and securities clearance clients. Overdrafts occur on a daily basis in the custody and securities clearance business and are generally repaid within two business days.
Other loans
Other
loans primarily include loans to consumers that are fully collateralized with equities, mutual funds and fixed income securities.
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 include $5.3 billion at March 31, 2017 and $6.3 billion at Dec. 31, 2016 related to a term loan program that offers fully collateralized loans to broker-dealers.
Asset
quality and allowance for credit losses
Over the past several years, we have improved our risk profile through greater focus on clients who are active users of our non-credit services. Our primary exposure to the credit risk of a customer consists of funded loans, unfunded contractual commitments to lend, standby letters of credit and overdrafts associated with our custody and securities clearance businesses.
Allowance for loan losses as a percentage of total loans
0.27
%
0.26
%
0.26
%
Allowance
for loan losses as a percentage of non-margin loans
0.37
0.36
0.38
Total allowance for credit losses as a percentage of total loans
0.45
0.44
0.47
Total
allowance for credit losses as a percentage of non-margin loans
0.62
0.60
0.68
There were no net charge-offs in the first quarter of 2017 or fourth quarter of 2016. Net recoveries were $2 million in the first
quarter of 2016.
The provision for credit losses was a credit of $5 million in the first quarter of 2017, a provision of $7 million in the fourth quarter of 2016 and a provision of $10 million in the first quarter of 2016.
We had $16.1 billion of secured margin loans on our balance sheet at March 31, 2017 compared with $17.6 billion at Dec. 31, 2016 and $18.8
billion at March 31, 2016. 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 process is subject to numerous estimates and judgments. For
additional information on this process, see “Critical accounting estimates” in our 2016 Annual Report.
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” and Note 1 of the Notes to Consolidated Financial Statements, both in our 2016 Annual Report, we have allocated our allowance for credit losses as follows.
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 each credit were rated one grade better, the allowance would have decreased by $66 million, while if each credit were rated one grade worse, the allowance would have increased by $108 million. Similarly, if the loss given default were one rating worse, the
28 BNY Mellon
allowance would have increased by $44 million, while if the loss given default were one rating better, the allowance would have decreased by $29 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 less than $1 million, respectively.
Nonperforming assets
The following table shows the distribution of nonperforming assets.
The
nonperforming assets ratio was 0.18% at March 31, 2017 and 0.17% at Dec. 31, 2016. The ratio of the allowance for loan losses to nonperforming loans was 167.3% at March 31, 2017 and 164.1% at Dec. 31, 2016. The ratio of the total allowance for credit losses to nonperforming loans was 281.6% at March 31,
2017 and 272.8% at Dec. 31, 2016.
Deposits
Total deposits were $221.3 billion at March 31, 2017, a decrease of less than 1% compared with $221.5 billion at Dec. 31, 2016. The decrease in deposits primarily reflects lower interest-bearing deposits in U.S. and Non-U.S.
offices, partially offset by higher noninterest-bearing deposits.
Noninterest-bearing deposits were $79.8 billion at March 31, 2017 compared with $78.3 billion at Dec. 31, 2016. Interest-bearing deposits were $141.5 billion at March 31, 2017 compared with $143.2 billion at Dec. 31, 2016.
Short-term
borrowings
We fund ourselves primarily through deposits and, to a lesser extent, other short-term borrowings and long-term debt. Short-term borrowings consist of federal funds purchased and securities sold under repurchase agreements, payables to customers and broker-dealers, commercial paper and other borrowed funds. Certain other borrowings, for example, securities sold under repurchase agreements, require the delivery of securities as collateral.
See “Liquidity and dividends” 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.
Fluctuations of federal funds purchased and securities sold under repurchase agreements between periods resulted from changes in overnight borrowing opportunities. The increase in the weighted-average rates, compared with prior periods, primarily reflects increases in the Fed Funds effective rate.
BNY
Mellon 29
Information related to payables to customers and broker-dealers is presented below.
The
weighted-average rate is calculated based on, and is applied to, the average interest-bearing payables to customers and broker-dealers, which were $18,961 million in the first quarter of 2017, $17,091 million in the fourth quarter of 2016 and $16,801 million in the first quarter of 2016.
Payables to customers and broker-dealers represent funds awaiting re-investment and short sale proceeds payable on demand. Payables to customers and broker-dealers are driven by customer trading activity levels and market volatility.
Information
related to commercial paper is presented below.
The
Bank of New York Mellon, our largest bank subsidiary, issues commercial paper that matures within 364 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment. Increases in the balances of commercial paper between periods resulted from increased issuances as we manage our overall liquidity. The increase in the weighted-average rates, compared with prior periods, primarily reflects increases in the Fed Funds effective rate and the issuance of higher-yielding term commercial paper.
Information related to other borrowed funds is presented below.
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. Fluctuations in other borrowed funds balances primarily reflect changes in 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, or to rollover or issue new debt, especially during periods of market stress and in order to meet its short-term (up to one year) obligations. 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 our financial condition. Liquidity risk can arise from cash flow mismatches, market constraints from the inability to convert assets to cash, the inability to raise cash in the markets, deposit run-off or contingent liquidity events. We also manage liquidity risks on an intra-day basis, in a manner designed to ensure that we can access required funds during the business day to make payments or settle immediate obligations, often in real time. Changes in economic conditions or exposure to credit, market, operational, legal and reputational risks also can affect BNY Mellon’s liquidity
risk profile and are considered in our liquidity risk framework.
The Parent’s liquidity policy is to have sufficient unencumbered cash and cash equivalents on hand at each quarter-end to cover forecasted debt
30 BNY Mellon
redemptions, net interest payments and net tax payments for the following 18-month period, and to provide sufficient collateral to satisfy transactions subject to Section 23A of the Federal Reserve Act. As of March 31, 2017, the Parent was in compliance with this policy. For
additional information on our liquidity policy, see “Risk Management - Liquidity risk” in our 2016 Annual Report. Our overall approach to liquidity management is further described in “Liquidity and dividends” in our 2016 Annual Report.
We define available funds for internal liquidity management purposes 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 following table presents our total available funds including liquid funds at period end and on an average basis.
Federal
funds sold and securities purchased under resale agreements
25,776
25,801
25,312
27,233
23,623
Total liquid funds
40,330
40,887
40,026
42,680
38,532
Cash
and due from banks
5,366
4,822
5,097
5,017
3,879
Interest-bearing deposits with the Federal Reserve and other central banks
65,086
58,041
66,043
61,672
89,092
Total
available funds
$
110,782
$
103,750
$
111,166
$
109,369
$
131,503
Total
available funds as a percentage of total assets
33
%
31
%
33
%
32
%
36
%
At
March 31, 2017, we had $40 billion of liquid funds, compared with $41 billion at Dec. 31, 2016. Of the $40 billion in liquid funds held at March 31, 2017, $15 billion was placed in interest-bearing deposits with large, highly-rated global financial institutions with a weighted-average life to maturity of approximately 25 days. Of the $15 billion, $3 billion was placed with banks in the Eurozone.
Total
available funds totaled $111 billion at March 31, 2017, compared with $104 billion at Dec. 31, 2016. The increase was primarily due to an increase in interest-bearing deposits with the Federal Reserve and other central banks.
On an average basis for the three months ended March 31, 2017 and the three months ended March 31, 2016, non-core sources of funds, such as money market rate accounts, federal funds purchased
and securities sold under repurchase agreements, trading liabilities, commercial paper and other borrowings, were $30.4 billion and $27.4 billion, respectively. The increase primarily reflects an increase in commercial paper.
Average foreign deposits, primarily from our European-based Investment Services business, were $90.4 billion for the three months ended March 31, 2017, compared with $109.9 billion for the three
months ended March 31, 2016. Domestic
savings, interest-bearing demand and time deposits averaged $41.9 billion for the three months ended March 31, 2017 and $44.8 billion for the three months ended March 31, 2016. The decrease primarily reflects a decrease in time deposits, partially offset by an increase in demand deposits.
Average payables to customers and broker-dealers were $19.0 billion for the three months ended March 31, 2017 and $16.8 billion
for the three months ended March 31, 2016. Payables to customers and broker-dealers are driven by customer trading activity and market volatility.
Long-term debt averaged $25.9 billion for the three months ended March 31, 2017 and $21.6 billion for the three months ended March 31, 2016.
Average noninterest-bearing deposits decreased to $73.6 billion for the three
months ended March 31, 2017 from $82.9 billion for the three months ended March 31, 2016, reflecting a decrease in client deposits.
A significant reduction in our Investment Services business would reduce our access to deposits. See “Asset/liability management” for additional factors that could impact our deposit balances.
BNY Mellon 31
Sources of liquidity
In
connection with our single point of entry resolution strategy, we have established the IHC to facilitate the provision of capital and liquidity resources to certain key subsidiaries in the event of material financial distress or failure. In the second quarter of 2017, we entered into a binding support agreement that required the IHC to provide that support. The support agreement required the Parent to transfer its intercompany loans and most of its cash to the IHC, and requires the Parent to continue to transfer cash and other liquid financial assets to the IHC, subject to certain amounts retained by the Parent to meet its near-term cash needs. The Parent’s and the IHC’s obligations under the support agreement are secured. In connection with the initial transfer, the IHC issued unsecured subordinated funding notes to the Parent. The IHC has also provided the Parent with a
committed line of credit that allows the Parent to draw funds necessary to service near-term obligations. As a result, during business-as-usual circumstances, the Parent is expected to continue to have access to the funds necessary to pay dividends, repurchase common stock, service its debt, and satisfy its other obligations. If our projected liquidity resources deteriorate so severely that resolution of the
Parent becomes imminent, the committed line of credit will automatically terminate, with all amounts outstanding becoming due and payable, and the support agreement will require the Parent to transfer most of its remaining assets (other than stock in subsidiaries and a cash reserve to fund bankruptcy expenses) to the IHC. As a result, during a period of severe financial stress the
Parent might commence bankruptcy proceedings at an earlier time than it otherwise would if the support agreement had not been implemented. See “Supervision and Regulation - Recovery and Resolution” in our 2016 Annual Report and “Risk Factors” in this Form 10-Q for additional information.
The Parent’s three major sources of liquidity are cash on hand and cash otherwise made readily available to the Parent through a committed credit facility with the IHC, access to the debt and equity markets and dividends from its subsidiaries.
The Parent had cash of $9.1 billion at March 31,
2017, compared with $8.7 billion at Dec. 31, 2016, an increase of $337 million primarily reflecting the issuance of long-term debt, partially offset by common stock repurchases, the redemption of the trust preferred securities and dividends paid.
Our ability to access the capital markets on favorable terms, or at all, is partially dependent on our credit ratings, which are as follows:
Long-term debt totaled $26.3 billion at March 31, 2017 and $24.5 billion at Dec. 31, 2016. The increase reflects issuances of $2.25 billion, partially offset by the redemption of the trust preferred securities. The Parent has $750 million of long-term debt that will mature in the remainder of 2017.
All
outstanding trust preferred securities issued by Mellon Capital III were redeemed on March 20, 2017. The redemption price for the trust preferred securities was equal to the par value plus interest accrued up to and excluding the redemption date. For additional information on our trust preferred securities, see Note 11 of the Notes to Consolidated Financial Statements in our 2016 Annual Report.
The Bank of New York Mellon, our largest bank subsidiary, issues commercial paper that matures within 364 days from date of issue and is not redeemable prior to maturity or subject to voluntary prepayment. The average commercial paper borrowings were $2.2 billion in the first quarter of 2017 and $22
million in the first quarter of 2016. Commercial paper outstanding was $2.5 billion at March 31, 2017. There was no commercial paper outstanding at Dec. 31, 2016.
Subsequent to March 31, 2017, our U.S. bank subsidiaries could declare dividends to the Parent of approximately $5.1 billion, without the
need for a regulatory waiver. The Bank of New York Mellon, our primary subsidiary, may choose to resume paying regular dividends to the Parent as early as the second quarter of 2017. In addition, at March 31, 2017, non-bank subsidiaries of the Parent had liquid assets of approximately $1.3 billion. Restrictions on our ability to obtain funds from our subsidiaries are discussed in more detail in “Supervision and Regulation - Capital Planning and Stress Testing - Payment of Dividends, Stock Repurchases and Other Capital Distributions” and in Note 17 of the Notes to Consolidated Financial Statements in our 2016 Annual
Report.
Pershing has uncommitted lines of credit in place for liquidity purposes which are guaranteed by the Parent. Pershing has eight separate uncommitted lines of credit amounting to $1.5 billion in aggregate. There were no borrowings under these lines in the first quarter of 2017. Pershing Limited, an indirect UK-based subsidiary of BNY Mellon, has two separate uncommitted lines of credit amounting to $250 million in aggregate in place for liquidity purposes, which are guaranteed by the Parent.
Average borrowings under these lines were $2 million, in aggregate, in the first quarter of 2017.
The double
leverage ratio is the ratio of our equity investment in subsidiaries divided by our consolidated parent company equity, which includes our noncumulative perpetual preferred stock. In short, the double leverage ratio measures the extent to which equity in subsidiaries is financed by Parent company debt. As the double leverage ratio increases, this can reflect greater demands on a company’s cash flows in order to service interest payments and debt maturities. BNY Mellon’s double leverage ratio is managed in a range considering the high level of unencumbered available liquid assets held in its principal subsidiaries (such as central bank deposits and government securities), the
Company’s cash generating fee-based business model, with fees representing approximately 80% of revenue, and the dividend capacity of our banking subsidiaries. Our double leverage ratio was 121.7% at March 31, 2017 and 119.1% at Dec. 31, 2016, and within the range targeted by management.
Uses of funds
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, and loans to, its subsidiaries.
In February 2017, a quarterly cash dividend was paid to common shareholders of $0.19 per common share. Our common stock dividend payout ratio was 23% for the first three months of 2017. The Federal Reserve’s instructions for the 2017 Comprehensive Capital Analysis and Review (“CCAR”) provided that, for large bank holding companies like us, dividend payout ratios exceeding 30% of after-tax net income would receive particularly close scrutiny.
In the first quarter of 2017,
we repurchased 19 million common shares at an average price of $45.90 per common share for a total cost of $879 million.
Liquidity coverage ratio
U.S. regulators have established an LCR that requires certain banking organizations, including BNY Mellon, to maintain a minimum amount of unencumbered high quality liquid assets (“HQLA”) sufficient to withstand the net cash outflow under a
BNY Mellon 33
hypothetical
standardized acute liquidity stress scenario for a 30-day time horizon.
The following table presents the consolidated HQLA at March 31, 2017 and the average for the first quarter of 2017, and the average LCR for the first quarter of 2017.
Primarily includes U.S. Treasury, U.S. agency, sovereign securities, securities of U.S. government-sponsored enterprises, investment-grade corporate debt and publicly traded common equity.
(b)
Primarily
includes cash on deposit with central banks.
(c)
Consolidated HQLA presented before adjustments. After haircuts and the impact of trapped liquidity, consolidated HQLA totaled $130 billion at March 31, 2017 and averaged $124 billion for the first quarter of 2017.
The U.S. LCR rules became fully phased-in on Jan. 1, 2017 and require BNY Mellon and our affected
domestic bank subsidiaries to meet an LCR of at least 100%. The LCR for BNY Mellon and our domestic bank subsidiaries was compliant with the fully phased-in requirements of the U.S. LCR as of March 31, 2017.
For additional information on the LCR, see “Supervision and Regulation - Liquidity Standards - Basel III and U.S. Rules and Proposals” in our 2016 Annual Report.
We also perform liquidity stress tests to evaluate whether the
Company maintains sufficient liquidity resources under multiple stress scenarios. Stress tests are based on scenarios that measure liquidity risks under unlikely but plausible conditions. We perform 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.
Beginning on Jan. 1, 2015, Bank Holding Companies (“BHCs”) with total consolidated assets of $50 billion or more
were subject to the Federal Reserve’s
Enhanced Prudential Standards, which include liquidity standards, described under “Supervision and Regulation - Enhanced Prudential Standards and Large Exposures” in our 2016 Annual Report. BNY Mellon has taken actions to comply with these standards, including the adoption of various liquidity risk management standards and maintenance of a liquidity buffer of unencumbered highly liquid assets based on the results of internal liquidity stress testing.
Statement of cash flows
The following summarizes the activity reflected on the statement of cash flows. While this information may be helpful to highlight certain macro trends and business strategies, the
cash flow analysis may not be as relevant when analyzing changes in our net earnings and net assets. We believe that in addition to the traditional cash flow analysis, the discussion related to liquidity and dividends and asset/liability management herein may provide more useful context in evaluating our liquidity position and related activity.
Cash used for operating activities was $1.2 billion in the three months ended March 31, 2017, compared with cash provided by operating activities of $1.8 billion in the three months ended March 31, 2016. In the three months ended March
31, 2017, cash flows for operations were principally the result of changes in accruals and other and changes in trading activities, partially offset by earnings. In the three months ended March 31, 2016, cash flows from operations were principally the result of changes in trading activities and earnings, partially offset by changes in accruals and other balances.
Cash used for investing activities was $2.3 billion in the three months ended March 31, 2017, compared with cash provided by investing activities of $20.1 billion in the three months ended
March 31, 2016. In the three months ended March 31, 2017, an increase in interest-bearing deposits with the Federal Reserve and other central banks was a significant use of funds, partially offset by net changes in loans. In the three months ended March 31, 2016, a decrease in interest-bearing deposits with the Federal Reserve and other central banks, sales, paydowns and maturities of securities and net changes in loans were significant sources of funds, partially offset by purchases of securities and an increase in federal funds sold and securities purchased under resale agreements.
34 BNY Mellon
Cash provided by financing activities was $4.0 billion in the three months ended March 31, 2017, compared with cash used for financing activities of $24.5 billion in the three months ended March 31, 2016. In the three months ended March 31, 2017, changes in commercial paper and net proceeds from the issuance
of long-term debt
were significant sources of funds, partially offset by changes in deposits. In the three months ended March 31, 2016, a decrease in deposits, the repayment of long-term debt and common stock repurchases were significant uses of funds, partially offset by the issuance of long-term debt.
Capital
Capital
data
(dollar amounts in millions except per share amounts; common shares in thousands)
BNY Mellon shareholders’ equity to total assets ratio
11.6
%
11.6
%
BNY Mellon common shareholders’ equity to total assets ratio
10.5
%
10.6
%
Total
BNY Mellon shareholders’ equity
$
39,138
$
38,811
Total BNY Mellon common shareholders’ equity
$
35,596
$
35,269
BNY
Mellon tangible common shareholders’ equity – Non-GAAP (a)
$
17,310
$
16,957
Book value per common share (a)
$
34.23
$
33.67
Tangible
book value per common share – Non-GAAP (a)
$
16.65
$
16.19
Closing stock price per common share
$
47.23
$
47.38
Market
capitalization
$
49,113
$
49,630
Common shares outstanding
1,039,877
1,047,488
Cash
dividends per common share
$
0.19
$
0.19
Common dividend payout ratio
23
%
25
%
Common dividend yield
1.6
%
1.6
%
(a)
See
“Supplemental information – Explanation of GAAP and Non-GAAP financial measures” beginning on page 47 for a reconciliation of GAAP to Non-GAAP.
The Bank of New York Mellon Corporation total shareholders’ equity increased to $39.1 billion at March 31, 2017 from $38.8 billion at Dec. 31, 2016. The increase primarily reflects earnings, approximately $290 million resulting from stock awards, the exercise of stock options and stock
issued for employee benefit plans, foreign currency translation adjustments and the unrealized gain in our investment securities portfolio, partially offset by share repurchases and dividends.
The unrealized gain, net of tax, on our investment securities portfolio recorded in accumulated other comprehensive income was $131 million at March 31, 2017, compared with $45 million at Dec. 31, 2016. The increase in the unrealized gain, net of tax, was primarily driven by a decrease in market interest rates.
In
the first quarter of 2017, we repurchased 19 million common shares at an average price of $45.90 per common share for a total cost of $879 million.
On April 20, 2017, The Bank of New York Mellon Corporation declared a quarterly cash dividend on common stock of $0.19 per share. This cash dividend is payable on May 12, 2017 to shareholders of record as of the close of business on May 2, 2017.
We submitted our 2017
capital plan in connection with the CCAR on April 5, 2017. The Federal Reserve has indicated that it expects to publish its objection or non-objection to the capital plan and proposed capital actions, such as dividend payments and share repurchases, in June 2017.
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 U.S. bank subsidiaries
and BNY Mellon must, among other things, qualify as “well capitalized.”
Failure to satisfy regulatory standards, including “well
capitalized” status or capital adequacy rules more generally, could result in limitations on our activities and adversely affect our financial condition. See the discussion of these matters in “Supervision and Regulation - Regulated Entities of BNY Mellon and Ancillary Regulatory Requirements” and “Risk Factors - Operational Risk - Failure to satisfy regulatory standards, including “well capitalized” and “well managed” status or capital adequacy and liquidity rules more generally, could result in limitations on our activities and adversely affect our business and financial condition” in our 2016 Annual Report.
The “well capitalized” and other capital categories (where applicable), as established by applicable regulations for bank holding companies and depository institutions, have been established by those regulations solely for purposes of implementing
their respective requirements (for example, eligibility for financial holding company status in the case of bank holding companies and prompt corrective action
measures in the case of depository institutions). A bank holding company’s or depository institution’s qualification for a capital category may not constitute an accurate representation of the entity’s overall financial condition or prospects.
The U.S. banking agencies’ capital rules have been based on the framework adopted by the Basel Committee on Banking Supervision, as amended from time to time. For additional information on these capital requirements, see “Supervision and Regulation” in our 2016 Annual Report. BNY Mellon is subject to the U.S. capital rules, which are being gradually phased-in
over a multi-year period through 2018.
Our estimated CET1 and SLR ratios on a fully phased-in basis are based on our current interpretation of the U.S. capital rules. Our risk-based capital adequacy is determined using the higher of risk-weighted assets (“RWAs”) determined using the Advanced Approach and Standardized Approach.
The transitional capital ratios for March 31, 2017 included in the following table were negatively impacted by the additional phase-in requirements that became effective on Jan. 1, 2017.
36
BNY Mellon
Consolidated and largest bank subsidiary regulatory capital ratios
Selected
regulatory capital ratios – fully phased-in – Non-GAAP: (c)
Estimated CET1 ratio:
Standardized
Approach
8.5
%
(e)
6.5
%
11.5
%
11.3
%
Advanced Approach
8.5
(e)
6.5
10.0
9.7
Estimated
SLR (d)
5
(e)
3
5.9
5.6
The
Bank of New York Mellon regulatory capital ratios: (b)
Advanced:
CET1
ratio
6.5
%
5.75
%
13.9
%
13.6
%
Tier 1 capital ratio
8
7.25
14.2
13.9
Total
(Tier 1 plus Tier 2) capital ratio
10
9.25
14.6
14.2
Leverage capital ratio
5
4
7.6
7.2
SLR
(d)
6
3
6.9
6.5
Selected
regulatory capital ratios – fully phased-in – Non-GAAP:
Estimated SLR (d)
6
%
3
%
6.6
%
6.1
%
(a)
Minimum
requirements for March 31, 2017 include Basel III minimum thresholds plus currently applicable buffers.
(b)
For our CET1, Tier 1 capital and Total capital ratios, our effective capital ratios under U.S. capital rules are the lower of the ratios as calculated under the Standardized and Advanced Approaches. The leverage capital ratio is based on Tier 1 capital, as phased-in and quarterly average total assets.
(c)
The Federal Reserve’s regulations do not establish well
capitalized thresholds for these measures for bank holding companies.
(d)
The SLR does not become a binding measure until the first quarter of 2018. The SLR is based on Tier 1 capital, as phased-in, and average quarterly assets and certain off-balance sheet exposures.
(e)
Fully phased-in Basel III minimum with expected buffers. See page 39 for the capital ratios with the phase-in of the capital conservation buffer and the U.S. G-SIB surcharge, as well as the introduction
of the SLR buffer.
Our CET1 ratio determined under the Advanced Approach was 10.4% at March 31, 2017 and 10.6% at Dec. 31, 2016. The decrease reflects the additional phase-in requirements under the U.S. capital rules that became effective Jan. 1, 2017, partially offset by increased capital and lower RWAs.
Our estimated
CET1 ratio (Non-GAAP) calculated under the Advanced Approach on a fully phased-in basis was 10.0% at March 31, 2017 and 9.7% at Dec. 31, 2016. Our estimated CET1 ratio (Non-GAAP) calculated under the Standardized Approach on a fully phased-in basis was 11.5% at March 31, 2017 and 11.3% at Dec. 31, 2016.
The estimated
fully phased-in SLR (Non-GAAP) of 5.9% at March 31, 2017 and 5.6% at Dec. 31, 2016 was based on our interpretation of the U.S. capital
rules, as supplemented by the Federal Reserve’s final rules on the SLR. BNY Mellon will be subjected to an enhanced SLR, which will require a buffer in excess of 2% over the minimum SLR of 3%. The insured depository institution subsidiaries of the U.S. G-SIBs, including those of BNY Mellon, must maintain a 6%
SLR to be considered “well capitalized.”
For additional information on the U.S. capital rules, see “Supervision and Regulation - Capital Requirements - Generally” in our 2016 Annual Report.
The Advanced Approach capital ratios are significantly impacted by RWAs for operational risk. Our operational loss risk model is informed by external losses, including fines and penalties levied
BNY Mellon 37
against institutions in the financial services industry, particularly those that relate
to businesses in which we operate, and as a result external losses have impacted and could in the future impact the amount of capital that we are required to hold.
Management views the estimated fully phased-in CET1 and other risk-based capital ratios and SLR as key measures in monitoring BNY Mellon’s capital position and progress against future regulatory capital standards. Additionally, the presentation of the estimated fully phased-in CET1 and other risk-based capital ratios and SLR are intended to allow investors to compare these ratios with estimates presented by other companies.
Our capital ratios are necessarily subject to, among other things, anticipated compliance with all necessary enhancements to model calibration, approval by regulators of certain models used as part of
RWA calculations, further implementation guidance from regulators, market practices and standards and any changes BNY Mellon may make to its businesses. As a consequence of these factors, our capital ratios may materially change, and may be volatile over time and from period to period.
Minimum capital ratios and capital buffers
The U.S. capital rules include a series of buffers and surcharges over required minimums that apply to bank holding companies, including BNY Mellon, which are being phased-in over time. Banking organizations with a risk-based ratio or SLR above the minimum required level, but with a risk-based ratio or SLR below the minimum level with buffers will face constraints on dividends, equity repurchases and discretionary executive compensation based on the amount of
the shortfall. Different regulatory capital minimums, buffers and surcharges apply to our banking subsidiaries.
The U.S. capital rules introduced a capital conservation buffer and countercyclical capital buffer that add to the minimum regulatory capital ratios. The capital conservation buffer–1.25% for 2017 and 2.5% when fully phased-in on Jan. 1, 2019–is designed to absorb losses during periods of economic stress and applies to all banking organizations. During periods of excessive growth, the capital conservation buffer may be expanded through the imposition of a countercyclical capital buffer that may be as high as an additional 2.5%. The
countercyclical capital buffer, when applicable, applies only to Advanced Approach banking organizations. The countercyclical capital buffer is currently set to zero with respect to U.S. exposures, but it could increase if the banking agencies determine that systemic vulnerabilities are meaningfully above normal.
BNY Mellon is subject to an additional G-SIB surcharge, which is implemented as an extension of the capital conservation buffer and must be satisfied with CET1 capital. For 2017, the G-SIB surcharge applicable to BNY Mellon is 0.75%, and, when fully phased-in on Jan. 1, 2019, as calculated, applying metrics as currently applicable to BNY Mellon, would be 1.5%.
The following table presents the principal minimum capital ratio
requirements with buffers and surcharges, as phased-in, applicable to the Parent and The Bank of New York Mellon. This table does not include the imposition of a countercyclical capital buffer. The U.S. capital rules also provide for transitional arrangements for qualifying instruments, deductions, and adjustments, which are not reflected in this table. Buffers and surcharges are not applicable to the leverage capital ratio. These buffers, other than the SLR buffer, and surcharge began to phase-in on Jan. 1, 2016 and will be fully implemented on Jan. 1, 2019.
Net income applicable to common shareholders of The Bank of New York Mellon Corporation
880
880
Goodwill
and intangible assets, net of related deferred tax liabilities
(482
)
26
Gross CET1 generated
398
906
Capital deployed:
Common
stock dividends
(201
)
(201
)
Common stock repurchased
(879
)
(879
)
Total capital deployed
(1,080
)
(1,080
)
Other
comprehensive income (loss):
Foreign currency translation
124
123
Unrealized loss on assets available-for-sale
77
88
Defined
benefit plans
(254
)
20
Unrealized gain on cash flow hedges
10
10
Total other comprehensive income (loss)
(43
)
241
Additional
paid-in capital (c)
286
286
Other additions (deductions):
Net pension fund assets
(17
)
—
Deferred
tax assets
(8
)
(2
)
Embedded goodwill
(13
)
3
Other
(10
)
(9
)
Total
other deductions
(48
)
(8
)
Net CET1 (used) generated
(487
)
345
CET1 – End of period
$
17,606
$
16,835
(a)
Reflects
transitional adjustments to CET1 required under the U.S. capital rules.
(b)
Estimated.
(c)
Primarily related to stock awards, the exercise of stock options and stock issued for employee benefit plans.
BNY Mellon 39
The
following table presents the components of our transitional and fully phased-in CET1, Tier 1 and Tier 2 capital, the RWAs determined under both the Standardized and Advanced Approaches, the average assets used for leverage capital purposes and the total leverage exposure for estimated SLR purposes.
Reflects
transitional adjustments to CET1, Tier 1 capital and Tier 2 capital required in 2017 and 2016 under the U.S. capital rules.
(b)
Estimated.
40 BNY Mellon
The following table presents the amount of capital by which BNY Mellon and our largest bank subsidiary, The Bank of New York Mellon, exceeded the capital thresholds determined under the transitional rules
at March 31, 2017.
Based
on minimum required standards, with applicable buffers.
(b)
Based on well capitalized standards.
The following table shows the impact on the consolidated capital ratios at March 31, 2017 of a $100 million increase or decrease in common equity, or a $1 billion increase or decrease in RWA, quarterly average assets or total leverage exposure.
Sensitivity
of consolidated capital ratios at March 31, 2017
Increase or decrease of
(in basis points)
$100 million
in common
equity
$1 billion in
RWA, quarterly
average assets or total leverage exposure
CET1:
Standardized
Approach
7
bps
8
bps
Advanced Approach
6
6
Tier
1 capital:
Standardized Approach
7
10
Advanced Approach
6
7
Total
capital:
Standardized Approach
7
10
Advanced Approach
6
8
Leverage
capital
3
2
SLR
3
2
Estimated
CET1 ratio, fully phased-in – Non-GAAP:
Standardized Approach
7
8
Advanced Approach
6
6
Estimated
SLR, fully phased-in – Non-GAAP
3
2
In the first quarter 2017, all outstanding trust preferred securities issued by Mellon Capital III were redeemed. Prior to the redemption, a portion of the trust preferred securities were eligible for inclusion in Tier 2 capital.
Capital ratios vary depending on the size of the balance sheet at quarter-end and the levels and types of investments in assets. 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.
Supplementary Leverage Ratio
BNY Mellon has presented its consolidated and largest bank subsidiary’s estimated fully phased-in SLRs based on its interpretation of the U.S. capital rules, which are being gradually phased-in over a multi-year period and on the application of such rules to BNY Mellon’s businesses as currently conducted.
BNY
Mellon 41
The following table presents the components of our SLR on both the transitional and fully phased-in basis.
Potential future exposure for derivatives contracts (plus certain other items)
5,898
5,898
6,021
6,021
Repo-style
transaction exposures
536
536
533
533
Credit-equivalent amount of other off-balance sheet exposures (less SLR exclusions)
22,901
22,901
23,274
23,274
Total
off-balance sheet exposures
29,335
29,335
29,828
29,828
Total leverage exposure
$
347,519
$
346,772
$
356,637
$
355,083
SLR
- Consolidated
6.1
%
5.9
%
6.0
%
5.6
%
The
Bank of New York Mellon, our largest bank subsidiary:
Tier 1 capital
$
19,320
$
18,523
$
19,011
$
17,708
Total
leverage exposure
$
281,114
$
280,741
$
291,022
$
290,230
SLR
- The Bank of New York Mellon
6.9
%
6.6
%
6.5
%
6.1
%
(a)
Estimated.
Trading
activities and risk management
Our trading activities are focused on acting as a market-maker for our customers, facilitating customer trades and risk mitigating hedging in compliance with the Volcker Rule. The risk from market-making activities for customers is managed by our traders and limited in total exposure through a system of position limits, value-at-risk (“VaR”) methodology and other market sensitivity measures. VaR is the potential loss in value due to adverse market movements over a defined time horizon with a specified confidence level. The calculation of our VaR used by management and presented below assumes a one-day holding period, utilizes a 99% confidence level, and incorporates non-linear product characteristics. VaR facilitates comparisons across portfolios of different risk characteristics. VaR also captures the diversification of aggregated risk
at the firm wide level.
VaR represents a key risk management measure and it is important to note the inherent limitations to VaR, which include:
•
VaR does not estimate potential losses over longer time horizons where moves may be extreme;
•
VaR does not take account of potential variability of market liquidity; and
•
Previous
moves in market risk factors may not produce accurate predictions of all future market moves.
See Note 16 of the Notes to Consolidated Financial Statements for additional information on the VaR methodology.
In an effort to improve our enterprise level risk management capabilities, we have changed our VaR model from Monte Carlo simulation to historical simulation for both management and RWA calculations. This change was effective as of Jan. 1, 2017. In addition to this model enhancement, the impact of credit valuation adjustment (“CVA”) is now included.
The following table indicates the calculated
VaR amounts for the trading portfolio for the designated period using the newly implemented historical simulation VaR model. The impact of changes in methodology is not material. For the first quarter of 2017, the average overall portfolio VaR using the newly implemented historical simulation model is $4.1 million. This represents a decrease of $1.3
42 BNY Mellon
million or 23% when compared to $5.4 million VaR for the comparable period using the former Monte Carlo model.
Beginning Jan. 1, 2017, the VaR figures reflect the impact
of the CVA and hedges as per the guidance included in ASC 820, Fair Value Measurement. 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 minimum and maximum portfolio diversification effect.
The following tables indicate the calculated VaR amounts for the trading portfolio for the designated periods as previously reported under the former Monte Carlo simulation VaR model.
VaR figures do not reflect the impact of the CVA guidance in ASC 820, Fair Value Measurement. 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 minimum and maximum 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: sovereign debt, 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, exchange-traded futures and options, and other currency derivative products.
The equity component of VaR consists 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, preferred stock, listed equity options (puts and calls), over-the-counter (“OTC”) equity options, equity
total return swaps, equity index futures and other equity derivative products.
The credit component of VaR represents instruments whose values predominantly vary with the credit worthiness of counterparties. These instruments include, but are not limited to, credit derivatives (credit default swaps and exchange-traded credit index instruments) and exposures from corporate credit spreads, and mortgage prepayments. Credit derivatives are used to hedge various credit exposures.
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 first
quarter of 2017, interest rate risk generated 43% of average gross VaR, foreign exchange risk generated 40% of average gross VaR, equity risk accounted for 2% of average gross VaR and credit risk generated 15% of average gross VaR. During the first quarter of 2017, our daily trading loss did not exceed our calculated VaR amount of the overall portfolio.
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.
Trading
revenue (loss) includes realized and unrealized gains and losses primarily related to spot and forward foreign exchange transactions, derivatives, and securities trades for our customers and excludes any associated commissions, underwriting fees and net interest revenue.
Trading assets include debt and equity instruments and derivative assets, primarily interest rate and foreign exchange contracts, not designated as hedging instruments. Trading assets were $5 billion at March 31, 2017 and $6 billion at
Dec. 31, 2016.
Trading liabilities include debt and equity instruments and derivative liabilities, primarily interest rate and foreign exchange contracts, not designated as hedging instruments. Trading liabilities were $3 billion at March 31, 2017 and $4 billion at Dec. 31, 2016.
Under our fair
value 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.
We reflect external credit ratings as well as observable credit default swap spreads for both ourselves and 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.
At March 31,
2017, our OTC derivative assets of $2.9 billion included a CVA deduction of $33 million. Our OTC derivative liabilities of $2.4 billion included a debit valuation adjustment (“DVA”) of $2 million related to our own credit spread. Net of hedges, the CVA decreased by $2 million and the DVA was unchanged in the first quarter of 2017. The net impact of these adjustments increased foreign exchange and other trading revenue by $2 million in the first quarter of 2017.
In the fourth quarter of 2016, net of hedges, the CVA and the DVA were unchanged. As a result, foreign exchange
and other trading revenue was not impacted.
In the first quarter of 2016, net of hedges, the CVA decreased by $5 million and the DVA decreased $1 million. The net impact of these adjustments increased foreign exchange and other trading revenue by $4 million in the first quarter of 2016.
The table below summarizes the risk ratings for our foreign exchange and interest rate derivative counterparty credit exposure during the past five quarters. 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.
Foreign
exchange and other trading counterparty risk
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
44 BNY Mellon
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.
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. Generally, there has been an inverse relationship between interest rates and client deposit levels. 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. The interest rate ramp scenarios are reviewed to examine the impact of large interest rate movements. In each scenario, all currencies interest rates are shifted higher or lower. 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)
In
the parallel rate ramp, both short-term and long-term rates move in four equal quarterly increments.
(b)
Long-term is equal to or greater than one year.
The sequential decline in the interest rate sensitivity was primarily driven by an increase in the expected baseline scenario, resulting from the recent short-term interest rate increases. The baseline scenario used for the calculations in the estimated changes in net interest revenue table above as of March 31, 2017 and Dec.
31, 2016 are based on our quarter-end balance sheet and the spot yield curve. The baseline scenarios used for periods prior to Dec. 31, 2016 were based on implied forward yield curves. We revised the methodology as of Dec. 31, 2016 as we believe using the spot yield curve for the baseline scenario provides a more accurate reflection of net interest revenue sensitivity given the recent increase in short-term interest rates and the implied forward rates. Because interest rates and the implied forward yield curves were lower in prior periods, the impact of using a flat yield curve versus an implied forward yield curve was not as significant. The 100 basis point ramp scenario assumes rates increase 25 basis points above the yield curve 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 and the potential change to implementation of monetary policy, the impact of depositor behavior is highly uncertain. The lower sensitivity in the ramp up 200 basis point scenario compared with the 100 basis point scenario is driven by the assumption of increased deposit runoff and forecasted changes in the deposit pricing.
Growth or contraction of deposits could also be affected by the following factors:
•
Monetary
policy;
•
Global economic uncertainty;
•
Our ratings relative to other financial institutions’ ratings; and
•
Regulatory 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.
BNY Mellon 45
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 (“VIEs”). 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 17 of the Notes to Consolidated Financial Statements for a further discussion of our off-balance sheet arrangements.
46 BNY Mellon
Supplemental information - Explanation of GAAP and Non-GAAP financial measures
BNY Mellon has included in this Form 10-Q certain Non-GAAP financial measures
based on fully phased-in CET1 and other risk-based capital ratios, the fully phased-in SLR and tangible common shareholders’ equity. BNY Mellon believes that the CET1 and other risk-based capital ratios, on a fully phased-in basis, and the SLR on a fully phased-in basis are measures of capital strength that provide additional useful information to investors, supplementing the capital ratios which are, or were, required by regulatory authorities. The tangible common shareholders’ equity ratio, which excludes goodwill and intangible assets, net of deferred tax liabilities, includes 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. BNY Mellon believes that the return on tangible common equity measure is a useful additional measure for investors because it presents a measure of those assets that can generate income. BNY Mellon has provided
a measure of tangible book value per common share, which it believes provides additional useful information as to the level of tangible assets in relation to shares of common stock outstanding.
BNY Mellon has presented revenue measures, which exclude the effect of noncontrolling interests related to consolidated investment management funds, and expense measures, which exclude amortization of intangible assets, M&I, litigation and restructuring charges.
Return on equity, operating leverage and operating margin measures, which exclude some or all of these items, are also presented. Operating margin measures may also exclude the provision for credit losses and distribution and servicing expense. 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. M&I expenses primarily relate to acquisitions and generally continue for approximately three years after the transaction. 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 streamlining actions and Operational Excellence Initiatives. Excluding the charges mentioned above permits investors to view expenses on a basis consistent with how management views the business.
The presentation of revenue growth on a constant currency basis permits investors to assess
the significance of changes in foreign currency exchange rates. Growth rates on a constant currency basis were determined by applying the current period foreign currency exchange rates to the prior period revenue. BNY Mellon believes that this presentation, as a supplement to GAAP information, gives investors a clearer picture of the related revenue results without the variability caused by fluctuations in foreign currency exchange rates.
The presentation of income (loss) from consolidated investment management funds, net of net income (loss) attributable to noncontrolling interests related to the 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.
Each of these measures as described above is used by management to monitor financial performance, both on a company-wide and on a business-level basis.
BNY Mellon 47
The following table presents the reconciliation of the pre-tax operating margin ratio.
Reconciliation
of income before income taxes – pre-tax operating margin
1Q17
4Q16
1Q16
(dollars in millions)
Income before income taxes – GAAP
$
1,206
$
1,152
$
1,091
Less: Net
income (loss) attributable to noncontrolling interests of consolidated investment management funds
18
4
(7
)
Add: Amortization of intangible assets
52
60
57
M&I,
litigation and restructuring charges
8
7
17
Income before income taxes, as adjusted – Non-GAAP (a)
$
1,248
$
1,215
$
1,172
Fee
and other revenue – GAAP
$
3,018
$
2,954
$
2,970
Income (loss) from consolidated investment management funds – GAAP
33
5
(6
)
Net
interest revenue – GAAP
792
831
766
Total revenue – GAAP
3,843
3,790
3,730
Less: Net
income (loss) attributable to noncontrolling interests of consolidated investment management funds
Non-GAAP
information for all periods presented excludes the net income (loss) attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges.
(b)
Income before taxes divided by total revenue.
(c)
Our GAAP earnings include tax-advantaged investments such as low income housing, renewable energy, bank-owned life insurance and tax-exempt securities. The benefits of these investments are primarily reflected in tax expense. If
reported on a tax-equivalent basis, these investments would increase revenue and income before taxes by $101 million for the first quarter of 2017, $92 million for the fourth quarter of 2016 and $77 million for the first quarter of 2016, and would increase our pre-tax operating margin by approximately 1.8% for the first quarter of 2017, 1.7% for the fourth quarter of 2016 and 1.4% for the first quarter of 2016.
The following table presents the reconciliation of operating leverage.
Operating
leverage
1Q17
4Q16
1Q16
1Q17 vs.
(dollars in millions)
4Q16
1Q16
Total
revenue – GAAP
$
3,843
$
3,790
$
3,730
1.40%
3.03%
Less: Net
income (loss) attributable to noncontrolling interests of consolidated investment management funds
18
4
(7
)
Total revenue, as adjusted – Non-GAAP
$
3,825
$
3,786
$
3,737
1.03%
2.35%
Total
noninterest expense – GAAP
$
2,642
$
2,631
$
2,629
0.42%
0.49%
Less: Amortization
of intangible assets
52
60
57
M&I, litigation and restructuring charges
8
7
17
Total
noninterest expense, as adjusted – Non-GAAP
$
2,582
$
2,564
$
2,555
0.70%
1.06%
Operating
leverage – GAAP (a)
98
bps
254
bps
Adjusted operating leverage – Non-GAAP (a)(b)
33
bps
129
bps
(a)
Operating
leverage is the rate of increase (decrease) in total revenue less the rate of increase (decrease) in total noninterest expense.
(b)
Non-GAAP operating leverage for all periods presented excludes the net income (loss) attributable to noncontrolling interests of consolidated investment management funds, amortization of intangible assets and M&I, litigation and restructuring charges.
bps - basis points.
48 BNY Mellon
The
following table presents the reconciliation of the returns on common equity and tangible common equity.
Return on common equity and tangible common equity
1Q17
4Q16
1Q16
(dollars
in millions)
Net income applicable to common shareholders of The Bank of New York Mellon Corporation – GAAP
$
880
$
822
$
804
Add: Amortization of intangible assets
52
60
57
Less:
Tax impact of amortization of intangible assets
18
19
20
Adjusted net income applicable to common shareholders of The Bank of New York Mellon Corporation excluding amortization of intangible assets – Non-GAAP
914
863
841
Add: M&I,
litigation and restructuring charges
8
7
17
Less: Tax impact of M&I, litigation and restructuring charges
2
3
6
Adjusted
net income applicable to common shareholders of The Bank of New York Mellon Corporation, as adjusted – Non-GAAP (a)
BNY Mellon tangible common shareholders’ equity at period end – Non-GAAP
$
17,310
$
16,957
$
17,090
Period-end
common shares outstanding (in thousands)
1,039,877
1,047,488
1,077,083
Book value per common share – GAAP
$
34.23
$
33.67
$
33.34
Tangible
book value per common share – Non-GAAP
$
16.65
$
16.19
$
15.87
(a)
Deferred tax liabilities are based on fully phased-in Basel III rules.
BNY
Mellon 49
The following table presents the impact of changes in foreign currency exchange rates on our consolidated investment management and performance fees.
Investment management and performance fees – Consolidated
1Q17
vs.
(dollars in millions)
1Q17
1Q16
1Q16
Investment management and performance fees – GAAP
$
842
$
812
4
%
Impact
of changes in foreign currency exchange rates
—
(30
)
Investment management and performance fees, as adjusted – Non-GAAP
$
842
$
782
8
%
The
following table presents income from consolidated investment management funds, net of noncontrolling interests.
Income (loss) from consolidated investment management funds, net of noncontrolling interests
(in millions)
1Q17
4Q16
1Q16
Income
(loss) from consolidated investment management funds
$
33
$
5
$
(6
)
Less: Net income (loss) attributable to noncontrolling interests of consolidated investment
management funds
18
4
(7
)
Income
from consolidated investment management funds, net of noncontrolling interests
$
15
$
1
$
1
The following table presents the impact of changes
in foreign currency exchange rates on investment management fees reported in the Investment Management segment.
Investment management fees - Investment Management business
1Q17 vs.
(dollars in millions)
1Q17
1Q16
1Q16
Investment
management fees – GAAP
$
814
$
786
4
%
Impact of changes in foreign currency exchange rates
—
(28
)
Investment
management fees, as adjusted – Non-GAAP
$
814
$
758
7
%
The following table presents the revenue line items in the Investment Management business impacted by the consolidated investment management funds.
Income
(loss) from consolidated investment management funds, net of noncontrolling interests - Investment Management business
(in millions)
1Q17
4Q16
3Q16
2Q16
1Q16
Investment
management fees
$
2
$
4
$
2
$
3
$
2
Other
(Investment income (loss))
13
(3
)
6
3
(1
)
Income from consolidated investment management funds, net of noncontrolling interests
$
15
$
1
$
8
$
6
$
1
50 BNY Mellon
The following table presents the reconciliation of the pre-tax operating margin for the Investment Management business.
Pre-tax operating margin - Investment Management business
(dollars
in millions)
1Q17
4Q16
3Q16
2Q16
1Q16
Income before income taxes – GAAP
$
277
$
260
$
256
$
234
$
217
Add: Amortization
of intangible assets
15
22
22
19
19
Provision for credit losses
3
6
—
1
(1
)
Adjusted
income before income taxes excluding amortization of intangible assets and provision for credit losses – Non-GAAP
$
295
$
288
$
278
$
254
$
235
Total
revenue – GAAP
$
963
$
960
$
958
$
938
$
895
Less: Distribution
and servicing expense
101
98
104
102
100
Adjusted total revenue net of distribution and servicing expense – Non-GAAP
$
862
$
862
$
854
$
836
$
795
Pre-tax
operating margin – GAAP (a)
29
%
27
%
27
%
25
%
24
%
Adjusted pre-tax operating margin, excluding amortization of intangible assets, provision for credit losses and distribution and servicing expense
– Non-GAAP (a)
34
%
33
%
33
%
30
%
30
%
(a)
Income
before taxes divided by total revenue.
Recent accounting and regulatory developments
Recently issued accounting standards
The following Accounting Standards Updates (“ASUs”) issued by the Financial Accounting Standards Board (“FASB”) have not yet been adopted.
ASU 2017-07, Compensation-Retirement Benefits - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
In
March 2017, the FASB issued an ASU, Compensation-Retirement Benefits - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The ASU requires the disaggregation of the service cost component from the other components of the net benefit cost in the income statement. The ASU also permits only the service cost component of net benefit cost to be eligible for capitalization. The ASU is effective for the first quarter of 2018, with early adoption permitted. The guidance in this ASU should be applied retrospectively for the presentation of the service cost component and the other components in the income statement, and prospectively for the capitalization of the service cost component in assets. BNY Mellon is assessing the impacts of the new standard. For information on the components of our pension and post-retirement health plan costs, see Note 9 of the Notes to Consolidated
Financial Statements in this Form 10-Q and Note 16 of the
Notes to Consolidated Financial Statements in our 2016 Annual Report. To the extent that our recent trend of having a net credit for pension and other post-retirement costs continues, the standard will result in an increase to staff expense and a reduction in other expense.
ASU 2017-04, Simplifying the Test for Goodwill Impairment
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. This ASU simplifies the annual goodwill impairment test by eliminating Step 2. The Step 2 calculation estimated the implied goodwill using the fair values
of all assets, including previously unrecorded intangibles, and liabilities at the date of the test, and was required if the first step of the annual test indicated that the fair value of a reporting unit is less than its carrying value. After adopting this ASU, the amount of any goodwill impairment would be determined by the excess of the carrying value of a reporting unit over its fair value. To date, the Company has not been required to prepare a Step 2 computation for any of its reporting units. The Company will early adopt this standard in 2017.
ASU 2016-18, Statement of Cash Flows – Restricted Cash
In
November 2016, the FASB issued an ASU, Statement of Cash Flows – Restricted Cash. This ASU provides guidance on the presentation of restricted cash or restricted cash equivalents in the
BNY Mellon 51
statement of cash flows and is effective for the first quarter of 2018. Earlier application is permitted. BNY Mellon is assessing the impacts of the new standard, but would expect to include restricted cash (which totaled $3 billion as of March 31, 2017) with cash and due from banks when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash
flows.
ASU 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued an ASU, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on eight specific cash flow presentation issues and is effective for the first quarter of 2018. Earlier application is permitted, however all of the amendments must be adopted in the same period. BNY Mellon is assessing the impacts of the new standard, but would not expect this ASU to materially affect the results of operations or financial condition.
In June 2016, the FASB issued an ASU, Financial Instruments – Credit Losses. This ASU introduces a new current expected credit losses model, which will apply to financial assets subject to credit losses and measured at amortized cost, including held-to-maturity securities and certain off-balance sheet credit exposures. The guidance will also change current practice for the impairment model for available-for-sale debt securities. The available-for-sale debt securities model will require the use of an allowance to record estimated credit losses and subsequent recoveries. This ASU is effective for the first quarter of 2020. Earlier application is
permitted beginning with the first quarter of 2019. BNY Mellon has begun its implementation efforts and is currently identifying key interpretive issues, and will assess existing credit loss forecasting models and processes against the new guidance to determine what modifications may be required. The extent of the impact to our financial statements upon adoption depends on several factors including the remaining expected life of financial instruments at the time of adoption, the establishment of an allowance for expected credit loss on held to maturity securities, and the macroeconomic conditions and forecasts that exist at that date.
ASU 2014-09, Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides guidance on the recognition of revenue related to the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the guidance in determining revenue recognition as principal versus agent. In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing,
which provides guidance in accounting for immaterial performance obligations and shipping and handling. In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, which provides clarification on assessing the collectability criterion, presentation of sales taxes, measurement date for non-cash consideration and completed contracts at transition, and provides a practical expedient for contract modifications. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers which provides amended guidance
on narrow aspects of ASU 2014-09. The new standards are effective for the first quarter of 2018, with early adoption permitted no earlier than the first quarter of 2017. The standards permit the use of either the retrospective or cumulative effect transition method upon transition.
The Company has substantially completed its evaluation of the potential impact of this guidance on our accounting policies, and based on that evaluation, we expect the timing of most of our revenue recognition to remain the same and the impacts to not be material. To date, the impacts we have identified primarily relate to deferring and amortizing certain sales commission costs related to obtaining customer contracts
and the timing of recognizing the contra revenue related to certain payments made to customers. The Company is considering using the retrospective method of adoption, but has not yet finalized its decision as we are still evaluating the related costs and benefits, including disclosure requirements in the year of adoption if the retrospective method is not used.
52 BNY Mellon
ASU 2016-02, Leases
In February 2016, the FASB issued
ASU 2016-02, Leases. The primary objective of this ASU is to increase transparency and comparability by recognizing lease assets and liabilities on the balance sheet and expand related disclosures. ASU 2016-02 requires a “right-of-use” asset and a payment obligation liability on the balance sheet for most leases and subleases. Additionally, depending on the lease classification under the standard, it may result in different expense recognition patterns and classification than under existing accounting principles. For leases classified as finance leases, it will result in higher expense recognition in the earlier periods and lower expense in the later periods of the lease.
The standard is effective for the first quarter of 2019, with early adoption permitted. The standard requires that a modified
retrospective transition approach be used by lessees and lessors to recognize and measure leases at the beginning of the earliest period presented. This modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. We are currently evaluating the potential impact of the leasing standard on our consolidated financial statements and evaluating the practical expedients that may be elected. Upon adoption, the implementation of the leasing standard is expected to result in an immaterial increase in both assets and liabilities.
ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and
Financial Liabilities. The ASU requires investments in equity securities that do not result in consolidation and are not accounted for under the equity method to be measured at fair value with changes in the fair value recognized through net income, unless one of two available exceptions apply. The first exception, a scope exception, allows Federal Reserve Bank Stock, Federal Home Loan Bank stock and other exchange memberships held by broker dealers to remain accounted for at cost, less impairment. The second exception, a practicability exception, will be available for equity investments that do not have readily determinable fair values and do not qualify for the practical expedient to estimate fair value under ASC 820, Fair Value Measurement.
To the extent the practicability exception applies, such investments
will be accounted for at cost adjusted for impairment, if any, plus or minus changes from observable price changes.
The amendments also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from the entity’s “own credit risk” when the entity has elected to measure the liability at fair value. The amendments also eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair values of financial instruments measured at amortized cost that are on the balance sheet.
This ASU is effective for the first quarter of 2018. If certain requirements are met, early adoption of the “own credit risk” provision is permitted; early adoption of the other provisions
is not permitted. The FASB requires a modified retrospective method of adoption. BNY Mellon does not expect the adoption of this ASU to have a material impact.
Recent regulatory developments
For a summary of additional regulatory matters relevant to our operations, see Supervision and Regulation in our 2016 Annual Report.
Department of Labor Fiduciary Rule Suspension
The U.S. Department of Labor issued a 60-day delay with respect to the applicability of its recent final rule regarding the conduct standards of certain service providers to employee benefit plans and individual
retirement accounts. The rule, among other things, expands the definition of who is designated a “fiduciary” of an employee benefit plan or individual retirement account, and provides certain prohibited transaction exemptions. The delay changed the prior applicability date of April 10, 2017 to the new applicability date of June 9, 2017, and also delayed the applicability of certain restrictive conditions of the rule’s prohibited transaction exemptions until Jan. 1, 2018. BNY Mellon businesses that are impacted by this rule have remained focused on conforming their business practices to address changes required by the rule. For more information regarding this rule, see “Supervision and Regulation” in our 2016 Annual Report.
BNY
Mellon 53
Liquidity coverage ratio
The U.S. LCR rules became fully phased-in on Jan. 1, 2017 and require BNY Mellon and our affected domestic bank subsidiaries to meet an LCR of 100%. The LCR for BNY Mellon and our domestic bank subsidiaries was compliant with the fully phased-in requirements of the U.S. LCR as of March 31, 2017. On Dec. 19, 2016, the Federal
Reserve issued a final rule requiring that large banking organizations, including BNY Mellon, publicly disclose certain quantitative liquidity metrics, including their consolidated average LCR each quarter and consolidated average HQLA amounts, broken down by HQLA category along with a qualitative discussion of material drivers of the ratio and related changes. BNY Mellon will commence this disclosure for the second quarter of 2017. For additional information on the LCR, see “Supervision and Regulation - Liquidity Standards - Basel III and U.S. Rules and Proposals” in our 2016 Annual Report.
Swap Margin Requirements
The U.S. prudential regulators have adopted joint final rules establishing minimum margin requirements for the uncleared swap transactions engaged in by those dealers
subject to their jurisdiction (each, a “Covered Swap Entity”) with compliance requirements which began to apply in September 2016. From that point forward, variation margin requirements (the “VM Regulations”) were phased in over a six-month period while initial margin requirements are being phased in over a four-year period. In each instance, the higher a Covered Swap Entity’s derivatives exposure, the earlier in the phase-in period it is required to comply. In addition, the rules require the initial margin posted to or by a Covered Swap Entity be segregated at a third-party custodian. While BNY Mellon does not expect to be impacted by the initial margin component of these new rules in 2017, we did expect to become fully subject to the substantial, new, VM Regulations effective March 1, 2017. If the VM Regulations had been fully implemented on March 1, 2017,
there would have been a risk that a number of BNY Mellon’s OTC derivatives trading relationships would have been temporarily interrupted. However, on Feb. 23, 2017, the U.S. prudential regulators released joint interagency guidance providing that with respect to counterparties of Covered Swap Entities that present significant credit and market risk exposures, compliance with VM Regulations is expected to be in
place on March 1, 2017. For other counterparties that do not present significant credit and market risk exposure, Covered Swap Entities are expected to make good faith efforts to comply with the VM Regulations as soon as possible, and in no case later than Sept. 1, 2017. Based in part on such guidance, no material interruptions
occurred in BNY Mellon OTC derivatives trading relationships.
BCBS Proposed Revisions to G-SIB Surcharge
On March 30, 2017, the Basel Committee on Banking Supervision (“BCBS”) proposed several changes to the framework for assessing and designating G-SIBs and determining their respective surcharges. The proposed changes would maintain the current assessment categories (cross-jurisdictional activity, size, interconnectedness, substitutability and complexity), but would revise indicators relating to certain categories.
The most significant proposed changes include:
•
Removal
of the cap on the substitutability category, which includes payments, underwriting, and custody activities;
•
Modification of the weights in the substitutability category and introduction of a trading volume indicator; and
•
Potential inclusion of a short-term wholesale funding indicator in the interconnectedness category.
If adopted by the BCBS and implemented in the U.S., these revisions may increase the
G-SIB surcharges on U.S banks that focus on providing investment services on an absolute basis and relative to other G-SIBs that do not focus on providing investment services.
BCBS Proposal on Step-in Risk
On March 15, 2017, the BCBS re-proposed guidelines that define and seek to manage the step-in risk that is potentially embedded in banks’ relationships with unconsolidated entities such as sponsored investment funds. Step-in risk is the risk that a bank might support entities beyond its contractual obligations in order to protect itself from any adverse reputational risk stemming from its connection to the entities. The guidelines propose criteria for identification of step-in risk that cover the risk characteristics of the entities
based on, and in
54 BNY Mellon
some cases, in addition to banks’ relationships with them. The proposed framework entails no automatic capital or liquidity charge additional to the existing standards. Rather, the guidelines propose a framework in which banks would determine the appropriate response to significant step-in risk, subject to supervisory review.
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 by us in connection with the solicitation of proxies;
•
Financial statements and footnotes prepared using eXtensible Business Reporting Language (“XBRL”);
•
Our earnings materials and selected management conference calls and presentations;
•
Other
regulatory disclosures, including: Pillar 3 Disclosures (and Market Risk Disclosure contained therein); 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, Amended and Restated By-laws, Directors Code of Conduct and the Charters of the Audit, Finance, Corporate Governance and Nominating, Corporate Social Responsibility, Human Resources and Compensation, Risk and Technology
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.
BNY Mellon 55
Item
1. Financial Statements
The Bank of New York Mellon Corporation (and its subsidiaries)
Net
securities gains — including other-than-temporary impairment
10
12
19
Noncredit-related portion of other-than-temporary impairment
(recognized in other comprehensive income)
—
2
(1
)
Net
securities gains
10
10
20
Total fee and other revenue
3,018
2,954
2,970
Operations
of consolidated investment management funds
Investment income (loss)
37
8
(3
)
Interest of investment management fund note holders
4
3
3
Income
(loss) from consolidated investment management funds
33
5
(6
)
Net interest revenue
Interest revenue
960
928
883
Interest
expense
168
97
117
Net interest revenue
792
831
766
Total
revenue
3,843
3,790
3,730
Provision for credit losses
(5
)
7
10
Noninterest
expense
Staff
1,472
1,395
1,459
Professional, legal and other purchased services
312
325
278
Software
166
177
154
Net
occupancy
136
153
142
Distribution and servicing
100
98
100
Sub-custodian
64
57
59
Furniture
and equipment
57
60
65
Bank assessment charges (a)
57
53
53
Business
development
51
71
57
Other (a)
167
175
188
Amortization
of intangible assets
52
60
57
Merger and integration, litigation and restructuring charges
8
7
17
Total
noninterest expense
2,642
2,631
2,629
Income
Income before income taxes
1,206
1,152
1,091
Provision
for income taxes
269
280
283
Net income
937
872
808
Net
(income) loss attributable to noncontrolling interests (includes $(18), $(4) and $7 related to consolidated investment management funds, respectively)
(15
)
(2
)
9
Net income applicable to shareholders of The Bank of New York Mellon Corporation
922
870
817
Preferred
stock dividends
(42
)
(48
)
(13
)
Net income applicable to common shareholders of The Bank of New York Mellon Corporation
$
880
$
822
$
804
(a)
In
the first quarter of 2017, we began disclosing bank assessment charges on a quarterly basis. The bank assessment charges were previously included in other expense. All prior periods were reclassified.
56 BNY Mellon
The Bank of New York Mellon Corporation (and its subsidiaries)
Consolidated Income Statement
(unaudited) (continued)
Net income applicable to common shareholders of The Bank of New York Mellon Corporation used for the earnings per share calculation
Net income applicable to common shareholders of The Bank of New York Mellon Corporation
$
880
$
822
$
804
Less:
Earnings allocated to participating securities
14
13
11
Net income applicable to the common shareholders of The Bank of New York Mellon Corporation after required adjustment for the calculation of basic and diluted earnings per common share
$
866
$
809
$
793
Average
common shares and equivalents outstanding of The Bank of New York Mellon Corporation
Represents stock options, restricted stock, restricted stock units and participating securities outstanding but not included in the computation of diluted average common shares because their effect would be anti-dilutive.
(b)
Basic and diluted earnings per share under the two-class method are determined on the net income applicable to common shareholders of The Bank of New York Mellon Corporation reported on the income statement less earnings allocated to participating securities.
See accompanying Notes to Consolidated Financial
Statements.
BNY Mellon 57
The Bank of New York Mellon Corporation (and its subsidiaries)
Consolidated Comprehensive Income Statement (unaudited)
Unrealized gain (loss) on assets available-for-sale:
Unrealized
gain (loss) arising during the period
94
(469
)
163
Reclassification adjustment
(6
)
(6
)
(15
)
Total
unrealized gain (loss) on assets available-for-sale
88
(475
)
148
Defined benefit plans:
Net gain (loss) arising during the period
2
(110
)
2
Amortization
of prior service credit, net loss and initial obligation included in net periodic benefit cost
18
14
15
Total defined benefit plans
20
(96
)
17
Net
unrealized gain on cash flow hedges
10
—
3
Total other comprehensive income (loss), net of tax (a)
243
(988
)
205
Total
comprehensive income (loss)
1,180
(116
)
1,013
Net (income) loss attributable to noncontrolling interests
(15
)
(2
)
9
Other
comprehensive (income) loss attributable to noncontrolling interests
(2
)
8
5
Comprehensive income (loss) applicable to the shareholders of The Bank of New York Mellon Corporation
$
1,163
$
(110
)
$
1,027
(a)
Other
comprehensive income (loss) attributable to The Bank of New York Mellon Corporation shareholders was $241 million for the quarter ended March 31, 2017, $(980) million for the quarter ended Dec. 31, 2016 and $210 million for the quarter ended March 31, 2016.
See
accompanying Notes to Consolidated Financial Statements.
58 BNY Mellon
The Bank of New York Mellon Corporation (and its subsidiaries)
Includes
total The Bank of New York Mellon Corporation common shareholders’ equity of $35,269 million at Dec. 31, 2016 and $35,596 million at March 31, 2017.
See accompanying Notes to Consolidated Financial Statements.
BNY Mellon 61
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 presented 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, 2016. 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 derivatives, other-than-temporary impairment, goodwill and other intangibles 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 change and new accounting guidance
ASU 2016-09, Compensation – Stock Compensation
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation. This ASU simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The adoption of this ASU results in increased volatility to the Company’s income tax expense. The income tax volatility is dependent
on the Company’s stock price at dates restricted stock units vest, which occur on award vesting dates primarily in the first quarter of each year, and when employees choose to exercise stock options. The Company adopted this ASU effective Jan. 1, 2017.
As a result of applying this ASU, in the first quarter of 2017, we recorded an income tax benefit of approximately $32 million, or $0.03 per common share, related to the annual vesting of stock awards and our stock price appreciating above the awards’ original grant price. Our effective tax rate
in the first quarter of 2017 also benefited by approximately 3%.
We also determined that we will continue applying the accounting policy election to estimate forfeitures.
Additionally, we are reporting excess tax benefits as operating activities on the statement of cash flows on a prospective basis and the employee taxes paid will continue to be reported as financing activities.
62 BNY Mellon
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. There were no contingent payments in the first quarter of 2017.
At March 31, 2017, we are potentially
obligated to pay additional consideration which, using reasonable assumptions, could range from $0 million to $18 million over the next two years, but could be higher as certain of the arrangements do not contain a contractual maximum. The acquisition described below did not have a material impact on BNY Mellon’s results of operations.
Acquisition in 2016
On April 1, 2016, BNY Mellon acquired
the assets of Atherton Lane Advisers, LLC, a U.S.-based investment manager with approximately $2.45 billion in AUM and servicer for approximately 700 high net worth clients, for cash of $38 million, plus contingent payments measured at $22 million. Goodwill related to this acquisition totaled $29 million and is included in the Investment Management business. The customer relationship intangible asset related to this acquisition is included in the Investment Management business, with an estimated life of 14 years, and totaled $30 million at acquisition.
Note
4 - Securities
The following tables present the amortized cost, the gross unrealized gains and losses and the fair value of securities at March 31, 2017 and Dec. 31, 2016.
Previously
included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(b)
Includes gross unrealized gains of $59 million and gross unrealized losses of $179 million recorded in accumulated other comprehensive income related to investment securities that were transferred from available-for-sale to held-to-maturity. The unrealized gains and losses are primarily related to Agency RMBS and will be amortized into net interest revenue over the contractual lives of the securities.
BNY Mellon 63
Notes to Consolidated Financial Statements (continued)
Previously
included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(b)
Includes gross unrealized gains of $62 million and gross unrealized losses of $190 million recorded in accumulated other comprehensive income related to investment securities that were transferred from available-for-sale to held-to-maturity. The unrealized gains and losses are primarily related to Agency RMBS and will be amortized into net interest revenue over the contractual lives of the securities.
The following table presents the gross securities gains, losses
and impairments.
Net securities gains (losses)
(in millions)
1Q17
4Q16
1Q16
Realized
gross gains
$
11
$
15
$
22
Realized gross losses
—
(3
)
—
Recognized
gross impairments
(1
)
(2
)
(2
)
Total net securities gains
$
10
$
10
$
20
Temporarily
impaired securities
At March 31, 2017, the unrealized losses on the investment securities portfolio were primarily attributable to an increase in interest rates from date of purchase, and for certain securities that were transferred from available-for-sale to held-to-maturity, an increase in interest rates through the date they were transferred. Specifically, $179 million of the unrealized losses at March 31, 2017 and $190 million at Dec. 31, 2016 reflected in the available-for-sale sections of the tables
below relate to certain securities (primarily Agency RMBS) that were transferred in prior periods from available-for-sale to held-to-maturity. The unrealized losses will be amortized into net interest revenue over the contractual lives of the securities. The transfer created a new cost basis for the securities. As a result, if these securities have experienced unrealized losses since the date of transfer, the corresponding fair value and unrealized losses would be reflected in the held-to-maturity sections of the following tables. We do not intend to sell these securities and it is not more likely than not that we will have to sell these securities.
64 BNY Mellon
Notes
to Consolidated Financial Statements (continued)
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 at March 31, 2017 and Dec. 31, 2016.
Previously
included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(b)
Gross unrealized losses for 12 months or more of $179 million were recorded in accumulated other comprehensive income and related to investment securities that were transferred from available-for-sale to held-to-maturity. The unrealized losses are primarily related to Agency RMBS and will be amortized into net interest revenue over the contractual lives of the securities. There were no gross unrealized losses for less than 12 months.
BNY Mellon 65
Notes to Consolidated Financial Statements (continued)
Previously
included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
(b)
Includes gross unrealized losses for 12 months or more of $190 million recorded in accumulated other comprehensive income related to investment securities that were transferred from available-for-sale to held-to-maturity. The unrealized losses are primarily related to Agency RMBS and will be amortized into net interest revenue over the contractual lives of the securities. There were no gross unrealized losses for less than 12 months.
The
following table shows the maturity distribution by carrying amount and yield (on a tax equivalent basis) of our investment securities portfolio at March 31, 2017.
Maturity
distribution and yield on investment securities at March 31, 2017
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
$
2,934
0.98
%
$
—
—
%
$
276
2.55
%
$
3,580
0.94
%
$
—
—
%
$
6,790
Over
1 through 5 years
5,057
1.51
114
1.30
1,732
2.98
12,348
1.02
—
—
19,251
Over
5 through 10 years
4,302
1.88
237
2.35
1,085
3.52
2,177
1.09
—
—
7,801
Over
10 years
3,374
3.11
—
—
212
2.04
168
1.67
—
—
3,754
Mortgage-backed
securities
—
—
—
—
—
—
—
—
33,102
2.75
33,102
Asset-backed
securities
—
—
—
—
—
—
—
—
4,026
2.10
4,026
Equity
securities (b)
—
—
—
—
—
—
—
—
856
—
856
Total
$
15,667
1.86
%
$
351
2.01
%
$
3,305
3.06
%
$
18,273
1.02
%
$
37,984
2.62
%
$
75,580
Securities
held-to-maturity:
One
year or less
$
3,999
0.89
%
$
475
0.91
%
$
—
—
%
$
438
0.62
%
$
—
—
%
$
4,912
Over
1 through 5 years
5,092
1.47
1,089
1.23
1
7.06
752
0.62
—
—
6,934
Over
5 through 10 years
1,505
1.94
50
2.02
3
6.71
661
0.71
—
—
2,219
Over
10 years
—
—
—
—
14
5.34
—
—
—
—
14
Mortgage-backed
securities
—
—
—
—
—
—
—
—
26,175
2.75
26,175
Total
$
10,596
1.32
%
$
1,614
1.16
%
$
18
5.69
%
$
1,851
0.65
%
$
26,175
2.75
%
$
40,254
(a)
Yields
are based upon the amortized cost of securities.
(b)
Includes money market funds.
66 BNY Mellon
Notes to Consolidated Financial Statements (continued)
Other-than-temporary
impairment
We routinely conduct periodic reviews of all securities to determine whether OTTI has occurred. Such reviews may incorporate the use of economic models. 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 that we established in connection with the restructuring of our investment securities portfolio in 2009, at March 31, 2017 and Dec. 31, 2016.
Projected weighted-average
default rates and loss severities
The
following table presents pre-tax net securities gains (losses) by type.
Net securities gains (losses)
(in millions)
1Q17
4Q16
1Q16
Agency
RMBS
$
1
$
—
$
8
Non-agency RMBS
(1
)
7
(2
)
Other
10
3
14
Total
net securities gains
$
10
$
10
$
20
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)
1Q17
1Q16
Beginning
balance as of Jan.1
$
88
$
91
Add: Initial OTTI credit losses
—
—
Subsequent OTTI credit losses
1
2
Less:
Realized losses for securities sold
—
—
Ending balance as of March 31
$
89
$
93
Pledged
assets
At March 31, 2017, BNY Mellon had pledged assets of $100 billion, including $84 billion pledged as collateral for potential borrowings at the Federal Reserve Discount Window. The components of the assets pledged at March 31, 2017 included $85 billion of securities, $8 billion of loans, $5 billion of interest-bearing deposits with banks and $2 billion of trading assets.
If
there has been no borrowing at the Federal Reserve Discount Window, the Federal Reserve generally allows banks to freely move assets in and out of their pledged assets account to sell or repledge the assets for other purposes. BNY Mellon regularly moves assets in and out of its pledged assets account at the Federal Reserve.
BNY Mellon 67
Notes to Consolidated Financial Statements (continued)
At
Dec. 31, 2016, BNY Mellon had pledged assets of $102 billion, including $84 billion pledged as collateral for potential borrowing at the Federal Reserve Discount Window. The components of the assets pledged at Dec. 31, 2016 included $87 billion of securities, $8 billion of loans, $4 billion of interest-bearing deposits with banks and $3 billion of trading assets.
At March 31,
2017 and Dec. 31, 2016, pledged assets included $5 billion and $6 billion, respectively, for which the recipients were permitted to sell or repledge the assets delivered.
We also obtain securities as collateral, including receipts under resale agreements, securities borrowed, derivative contracts and custody agreements on terms which permit us to sell or repledge the securities to others. At March 31, 2017 and Dec.
31, 2016, the market value of the securities received that can be sold or repledged was $50 billion and $50 billion, respectively. We routinely sell or repledge these securities through delivery to third parties. As of March 31, 2017 and Dec. 31, 2016, the market value of securities collateral sold or repledged was $23 billion and $20 billion, respectively.
Restricted cash and securities
Cash
and securities may also be segregated under federal and other regulations or requirements. At March 31, 2017 and Dec. 31, 2016, cash segregated under federal and other regulations or requirements was $3 billion and $3 billion, respectively. Restricted cash is included in interest-bearing deposits with banks on the consolidated balance sheet. Securities segregated for these purposes were $2 billion at March 31, 2017 and $2 billion at Dec.
31, 2016. Restricted securities were sourced from securities purchased under resale agreements at March 31, 2017 and Dec. 31, 2016 and are included in federal funds sold and securities purchased under resale agreements on the consolidated balance sheet.
Note 5 - Loans and asset quality
Loans
The table below provides the details of our loan portfolio and industry
concentrations of credit risk at March 31, 2017 and Dec. 31, 2016.
Net
of unearned income of $511 million at March 31, 2017 and $527 million at Dec. 31, 2016 primarily on domestic and foreign lease financings.
Our loan portfolio consists of three portfolio segments: commercial, lease financings and mortgages. We manage our portfolio at the class level which consists 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.
68 BNY Mellon
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 March 31, 2017
Wealth management loans and mortgages
Other
residential
mortgages
(in millions)
Commercial
Commercial
real
estate
Financial
institutions
Lease
financings
All
Other
Foreign
Total
Beginning
balance
$
82
$
73
$
26
$
13
$
23
$
28
$
—
$
36
$
281
Charge-offs
—
—
—
—
—
(1
)
—
—
(1
)
Recoveries
—
—
—
—
—
1
—
—
1
Net
recoveries
—
—
—
—
—
—
—
—
—
Provision
—
—
(3
)
(3
)
3
(3
)
—
1
(5
)
Ending
balance
$
82
$
73
$
23
$
10
$
26
$
25
$
—
$
37
$
276
Allowance
for:
Loan losses
$
24
$
54
$
5
$
10
$
22
$
25
$
—
$
24
$
164
Lending-related
commitments
58
19
18
—
4
—
—
13
112
Individually
evaluated for impairment:
Loan balance
$
—
$
—
$
—
$
—
$
5
$
—
$
—
$
—
$
5
Allowance
for loan losses
—
—
—
—
3
—
—
—
3
Collectively
evaluated for impairment:
Loan balance
$
2,543
$
4,698
$
5,387
$
846
$
15,904
$
817
$
17,873
(a)
$
12,795
$
60,863
Allowance
for loan losses
24
54
5
10
19
25
—
24
161
(a)
Includes
$673 million of domestic overdrafts, $16,081 million of margin loans and $1,119 million of other loans at March 31, 2017.
Allowance
for credit losses activity for the quarter ended Dec. 31, 2016
Wealth management loans and mortgages
Other
residential
mortgages
(in millions)
Commercial
Commercial
real
estate
Financial
institutions
Lease
financings
All
Other
Foreign
Total
Beginning
balance
$
91
$
63
$
29
$
14
$
18
$
28
$
—
$
31
$
274
Charge-offs
—
—
—
—
—
(1
)
—
—
(1
)
Recoveries
—
—
—
—
—
1
—
—
1
Net
recoveries
—
—
—
—
—
—
—
—
—
Provision
(9
)
10
(3
)
(1
)
5
—
—
5
7
Ending
balance
$
82
$
73
$
26
$
13
$
23
$
28
$
—
$
36
$
281
Allowance
for:
Loan losses
$
25
$
52
$
8
$
13
$
19
$
28
$
—
$
24
$
169
Lending-related
commitments
57
21
18
—
4
—
—
12
112
Individually
evaluated for impairment:
Loan balance
$
—
$
—
$
—
$
4
$
5
$
—
$
—
$
—
$
9
Allowance
for loan losses
—
—
—
2
3
—
—
—
5
Collectively
evaluated for impairment:
Loan balance
$
2,286
$
4,639
$
6,342
$
985
$
15,550
$
854
$
19,760
(a)
$
14,033
$
64,449
Allowance
for loan losses
25
52
8
11
16
28
—
24
164
(a)
Includes
$1,055 million of domestic overdrafts, $17,503 million of margin loans and $1,202 million of other loans at Dec. 31, 2016.
BNY Mellon 69
Notes to Consolidated Financial Statements (continued)
Allowance
for credit losses activity for the quarter ended March 31, 2016
Wealth management loans and mortgages
Other
residential
mortgages
All
Other
Foreign
Total
(in
millions)
Commercial
Commercial
real estate
Financial
institutions
Lease
financings
Beginning balance
$
82
$
59
$
31
$
15
$
19
$
34
$
—
$
35
$
275
Charge-offs
—
—
—
—
—
—
—
—
—
Recoveries
—
—
—
—
—
2
—
—
2
Net
recoveries
—
—
—
—
—
2
—
—
2
Provision
6
3
1
1
(1
)
(4
)
—
4
10
Ending
balance
$
88
$
62
$
32
$
16
$
18
$
32
$
—
$
39
$
287
Allowance
for:
Loan losses
$
25
$
40
$
11
$
16
$
15
$
32
$
—
$
23
$
162
Lending-related
commitments
63
22
21
—
3
—
—
16
125
Individually
evaluated for impairment:
Loan balance
$
—
$
2
$
171
$
5
$
8
$
—
$
—
$
—
$
186
Allowance
for loan losses
—
1
—
2
1
—
—
—
4
Collectively
evaluated for impairment:
Loan balance
$
2,130
$
3,927
$
5,415
$
973
$
13,874
$
993
$
20,697
(a)
$
13,044
$
61,053
Allowance
for loan losses
25
39
11
14
14
32
—
23
158
(a)
Includes
$917 million of domestic overdrafts, $18,674 million of margin loans and $1,106 million of other loans at March 31, 2016.
Nonperforming assets
The table below presents the distribution of our nonperforming assets.
At
March 31, 2017, undrawn commitments to borrowers whose loans were classified as nonaccrual or reduced rate were not material.
Lost interest
The table below presents the amount of lost interest income.
Lost
interest
(in millions)
1Q17
4Q16
1Q16
Amount by which interest income recognized on nonperforming loans exceeded reversals
$
—
$
—
$
—
Amount
by which interest income would have increased if nonperforming loans at period end had been performing for the entire period
$
1
$
1
$
1
70 BNY Mellon
Notes to Consolidated Financial Statements (continued)
Impaired loans
The tables below provide information about our impaired loans. We use the discounted cash flow method as the primary method for valuing impaired loans.
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.
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 less than $1 million of impaired loans in amounts individually less than $1 million at both March 31,
2017 and Dec. 31, 2016, respectively. The allowance for loan loss associated with these loans totaled less than $1 million at both March 31, 2017 and Dec. 31, 2016, respectively.
Past due loans
The table below sets forth information about our past due loans.
Notes to Consolidated Financial Statements (continued)
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 first quarter of 2017, fourth quarter of 2016 and first quarter of 2016.
The modifications of the other residential mortgage loans in the first quarter of 2017, fourth quarter of 2016 and first quarter of 2016 consisted of reducing the stated interest rates and, in certain cases, a forbearance of default and extending the maturity dates. The modified loans are primarily collateral dependent for which the value is based on the fair value of the collateral.
TDRs that subsequently defaulted
There were seven residential mortgage loans and one
wealth management loan and mortgage that had been
restructured in a TDR during the previous 12 months and have subsequently defaulted in the first quarter of 2017. The total recorded investment of these loans was $2 million.
Credit quality indicators
Our credit strategy is to focus on investment grade clients that are active users of our non-credit services. Each customer is assigned an internal credit rating, which is mapped to an external rating agency grade equivalent, if possible, 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.
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.
72 BNY Mellon
Notes
to Consolidated Financial Statements (continued)
Wealth management loans and mortgages
Wealth management loans and mortgages – Credit risk
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 a weighted-average loan-to-value ratio of 61% at origination. In the wealth management portfolio, less than 1% of the mortgages were past due at March 31, 2017.
At March 31, 2017, the wealth management mortgage portfolio consisted of the following geographic concentrations: California - 24%; New York - 19%;
Massachusetts - 12%; Florida - 7%; and other - 38%.
Other residential mortgages
The other residential mortgage portfolio primarily consists of 1-4 family residential mortgage loans and
totaled $817 million at March 31, 2017 and $854 million at Dec. 31, 2016. These loans are not typically
correlated to external ratings. Included in this portfolio at March 31, 2017 are $208 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 March 31, 2017, the purchased loans in this portfolio had a weighted-average loan-to-value ratio of 76% at origination and 14% of the serviced loan balance was 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.
Overdrafts
Overdrafts
primarily relate to custody and securities clearance clients and totaled $4.2 billion at March 31, 2017 and $5.5 billion at Dec. 31, 2016. Overdrafts occur on a daily basis in the custody and securities clearance business and are generally repaid within two business days.
Other loans
Other loans primarily include loans to consumers that are fully collateralized with equities, mutual funds and fixed income securities.
Margin
loans
We had $16.1 billion of secured margin loans on our balance sheet at March 31, 2017 compared with $17.6 billion at Dec. 31, 2016. 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.
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.
BNY Mellon 73
Notes to Consolidated Financial Statements (continued)
Note
6 - Goodwill and intangible assets
Goodwill
The tables below provide a breakdown of goodwill by business.
Intangible assets not subject to amortization have an indefinite life.
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)
2017
$
208
2018
178
2019
108
2020
98
2021
75
Impairment
testing
The goodwill impairment test is performed at least annually at the reporting unit level. Intangible assets not subject to amortization are tested for impairment annually or more often if events or circumstances indicate they may be impaired.
Note 7 - Other assets
The following table provides the components of other assets presented on the balance sheet.
Certain 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
BNY Mellon 75
Notes to Consolidated Financial Statements (continued)
funds. BNY Mellon also holds private equity investments, specifically in small business investment companies (“SBICs”), which are compliant with the Volcker Rule. Seed capital and private equity investments are
included in other assets.
The fair value of certain of these investments has been estimated using the 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 that have been valued using NAV.
Seed
capital and private equity investments valued using NAV
Other
funds include various leveraged loans, hedge funds and structured credit funds. Redemption notice periods vary by fund.
(b)
Private equity investments primarily include Volcker Rule-compliant investments in SBICs that invest in various sectors of the economy. Private equity investments do not have redemption rights. Distributions from such investments will be received as the underlying investments in the private equity investments are liquidated.
Qualified affordable housing project investments
We
invest in affordable housing projects primarily to satisfy the Company’s requirements under the Community Reinvestment Act. Our total investment in qualified affordable housing projects totaled $900 million at March 31, 2017 and $914 million at Dec. 31, 2016. Commitments to fund future investments in qualified affordable housing projects totaled $355 million at March 31, 2017 and $369 million at Dec.
31, 2016. A summary of the commitments to fund future investments is as follows: 2017 – $126 million; 2018 – $132 million; 2019 – $81 million; 2020 – $2
million; 2021 – $1 million; and 2022 and thereafter – $13 million.
Tax
credits and other tax benefits recognized were $38 million in the first quarter 2017, $38 million in the first quarter of 2016 and $40 million in the fourth quarter of 2016.
Amortization expense included in the provision for income taxes was $27 million in the first quarter 2017, $28 million in the first quarter of 2016 and $29 million in the fourth quarter
of 2016.
76 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.
BNY Mellon recorded an income tax provision of $269 million (22.3% effective tax rate) in the first quarter of 2017 and $283 million (25.9% effective tax rate) in the first quarter of 2016. The effective tax rate for the first quarter of 2017 reflects an approximate 3% benefit primarily driven by applying
the new accounting guidance included in ASU 2016-09, Compensation –
Stock Compensation, to the annual vesting of stock awards and our stock price appreciating above the awards’ original grant price.
Our total tax reserves as of March 31, 2017 were $150 million compared with $146 million at Dec. 31, 2016. If these tax reserves were unnecessary, $150
BNY Mellon 77
Notes
to Consolidated Financial Statements (continued)
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 March 31, 2017 is accrued interest, where applicable, of $21 million. The additional tax expense related to interest for the three months ended March 31, 2017 was $2 million,
compared with $2 million for the three months ended March 31, 2016.
It is reasonably possible the total reserve for uncertain tax positions could decrease within the next 12 months by approximately $13 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 through 2013. Our New York State, New York City and UK income tax returns are closed to examination through 2012.
Note
11 - Securitizations and variable interest entities
BNY Mellon has variable interests in VIEs, which include investments in retail, institutional and alternative investment funds, including collateralized loan obligation (“CLO”) structures in which we provide asset management services, some of which are consolidated. The investment funds are offered to our retail and institutional clients to provide them with access to investment vehicles with specific investment objectives and strategies that address the client’s investment needs.
BNY Mellon earns management fees from these funds as well as performance fees in certain funds and may also provide start-up capital for its new funds. The funds are primarily financed
by our customers’ investments in the funds’ equity or debt.
Additionally, BNY Mellon invests in qualified affordable housing and renewable energy projects, which are designed to generate a return primarily through the realization of tax credits by the Company. The projects, which are structured as limited partnerships and LLCs, are also VIEs, but are not consolidated.
The VIEs discussed above are included in the scope of ASU 2015-02, which was adopted effective Jan. 1, 2015, and are reviewed for consolidation based on the guidance in ASC 810, Consolidation.
We reconsider and reassess whether or not we are the primary beneficiary of a VIE when governing documents or contractual arrangements are changed that would reallocate the obligation to absorb expected losses or receive expected residual returns between BNY Mellon and the other investors. This could occur when BNY Mellon disposes of its variable interests in the fund, when additional variable interests are issued to other investors or when we acquire additional variable interests in the VIE.
The following tables present the incremental assets and liabilities included in BNY Mellon’s consolidated financial statements, after applying intercompany eliminations, as of March 31,
2017 and Dec. 31, 2016. 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.
Includes
voting model entities (“VMEs”) with assets of $85 million, liabilities of $1 million and nonredeemable noncontrolling interests of $14 million.
78 BNY Mellon
Notes to Consolidated Financial Statements (continued)
Includes VMEs with assets
of $114 million, liabilities of $3 million and nonredeemable noncontrolling interests of $25 million.
BNY Mellon has not provided financial or other support that was not otherwise contractually required to be provided to 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 March 31,
2017 and Dec. 31, 2016, the following assets and liabilities related to the VIEs where BNY Mellon is not the primary beneficiary are included in our consolidated financial statements.
The
maximum loss exposure indicated in the above tables relates solely to BNY Mellon’s investments in, and unfunded commitments to, the VIEs.
Note 12 - Preferred stock
BNY Mellon has 100 million authorized shares of preferred stock with a par value of $0.01 per share. The following table summarizes BNY Mellon’s preferred stock issued and outstanding at March 31, 2017 and Dec. 31, 2016.
Greater of (i) three-month LIBOR plus 0.565% for the related distribution period; or (ii) 4.000%
5,001
5,001
$
500
$
500
Series
C
5.2%
5,825
5,825
568
568
Series D
4.50% to but excluding June 20, 2023, then a floating rate equal to the three-month
LIBOR plus 2.46%
5,000
5,000
494
494
Series E
4.95% to and including June 20, 2020, then a floating rate equal to the three-month LIBOR plus 3.42%
10,000
10,000
990
990
Series
F
4.625% to and including Sept. 20, 2026, then a floating rate equal to the three-month LIBOR plus 3.131%
10,000
10,000
990
990
Total
35,826
35,826
$
3,542
$
3,542
(a)
All
outstanding preferred stock is noncumulative perpetual preferred stock with a liquidation preference of $100,000 per share.
(b)
The carrying value of the Series C, Series D, Series E and Series F preferred stock is recorded net of issuance costs.
On March 20, 2017, The Bank of New York Mellon Corporation paid the following dividends for the noncumulative perpetual preferred stock for the dividend period ending in March 2017 to holders of record as of the close of business on March
5, 2017:
•
$1,000.00 per share on the Series A Preferred Stock (equivalent to $10.0000 per Normal
Preferred Capital Security of Mellon Capital IV, each representing a 1/100th interest in a share of the Series A Preferred Stock);
•
$1,300.00 per share on the Series C Preferred Stock (equivalent to $0.3250
per depositary share, each representing a 1/4,000th interest in a share of the Series C Preferred Stock); and
BNY Mellon 79
Notes to Consolidated Financial Statements (continued)
•
$2,942.01
per share on the Series F Preferred Stock (equivalent to $29.4201 per depositary share, each representing a 1/100th interest in a share of the Series F Preferred Stock).
For additional information on the preferred stock, see Note 13 of the Notes to Consolidated Financial Statements in our 2016 Annual Report.
Terms of the Series A, Series C, Series D, Series E and Series F preferred stock are more fully described in each of their Certificates of Designations, each of which is filed as an Exhibit to this Form 10-Q.
Foreign currency translation adjustments arising during the period (a)
$
96
$
29
$
125
$
(295
)
$
(122
)
$
(417
)
$
45
$
(8
)
$
37
Total
foreign currency translation
96
29
125
(295
)
(122
)
(417
)
45
(8
)
37
Unrealized
gain (loss) on assets available-for-sale:
Unrealized gain (loss) arising during period
164
(70
)
94
(726
)
257
(469
)
243
(80
)
163
Reclassification
adjustment (b)
(10
)
4
(6
)
(10
)
4
(6
)
(20
)
5
(15
)
Net
unrealized gain (loss) on assets available-for-sale
154
(66
)
88
(736
)
261
(475
)
223
(75
)
148
Defined
benefit plans:
Net gain (loss) arising during the period
3
(1
)
2
(154
)
44
(110
)
3
(1
)
2
Foreign
exchange adjustment
—
—
—
(1
)
1
—
—
—
—
Amortization
of prior service credit, net loss and initial obligation included in net periodic benefit cost (b)
25
(7
)
18
23
(9
)
14
22
(7
)
15
Total
defined benefit plans
28
(8
)
20
(132
)
36
(96
)
25
(8
)
17
Unrealized
gain (loss) on cash flow hedges:
Unrealized hedge gain (loss) arising during period
14
(5
)
9
63
(20
)
43
(81
)
27
(54
)
Reclassification
adjustment (b)
1
—
1
(65
)
22
(43
)
86
(29
)
57
Net
unrealized gain (loss) on cash flow hedges
15
(5
)
10
(2
)
2
—
5
(2
)
3
Total
other comprehensive income (loss)
$
293
$
(50
)
$
243
$
(1,165
)
$
177
$
(988
)
$
298
$
(93
)
$
205
(a)
Includes
the impact of hedges of net investments in foreign subsidiaries. See Note 16 for additional information.
(b)
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 16 of the Notes to Consolidated Financial Statements for the location of the reclassification adjustment related to cash flow hedges on the Consolidated Income Statement.
Note
14 - Fair value measurement
Fair value is defined 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. A three-level hierarchy for fair value measurements is utilized based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. BNY Mellon’s own creditworthiness is considered when valuing liabilities. See Note 18 of the Notes to Consolidated Financial Statements in our 2016 Annual Report for information on how we determine fair value and the fair value hierarchy.
The following tables present the financial instruments carried at fair value at March 31, 2017 and Dec.
31, 2016, by caption on the consolidated balance sheet and by the three-level valuation hierarchy. 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 first quarter of 2017.
80 BNY Mellon
Notes to Consolidated
Financial Statements (continued)
Assets measured at fair value on a recurring basis at March 31, 2017
Total
derivative liabilities not designated as hedging
2
10,075
—
(8,228
)
1,849
Total trading liabilities
779
10,265
—
(8,228
)
2,816
Long-term
debt (b)
—
364
—
—
364
Other liabilities – derivative liabilities designated as hedging:
Interest
rate
—
467
—
—
467
Foreign exchange
—
88
—
—
88
Total
other liabilities – derivative liabilities designated as hedging
—
555
—
—
555
Subtotal liabilities of operations at fair value
779
11,184
—
(8,228
)
3,735
Percentage
of liabilities prior to netting
7
%
93
%
—
%
Liabilities of consolidated investment management funds
1
208
—
—
209
Total
liabilities
$
780
$
11,392
$
—
$
(8,228
)
$
3,944
Percentage
of liabilities prior to netting
6
%
94
%
—
%
(a)
ASC 815, Derivatives and Hedging, 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 and seed capital.
82 BNY Mellon
Notes to Consolidated Financial Statements (continued)
Assets
measured at fair value on a recurring basis at Dec. 31, 2016
Total
derivative liabilities not designated as hedging
4
13,847
—
(10,047
)
3,804
Total trading liabilities
353
14,083
—
(10,047
)
4,389
Long-term
debt (b)
—
363
—
—
363
Other liabilities – derivative liabilities designated as hedging:
Interest
rate
—
545
—
—
545
Foreign exchange
—
52
—
—
52
Total
other liabilities – derivative liabilities designated as hedging
—
597
—
—
597
Subtotal liabilities of operations at fair value
353
15,043
—
(10,047
)
5,349
Percentage
of liabilities prior to netting
2
%
98
%
—
%
Liabilities of consolidated investment management funds
3
312
—
—
315
Total
liabilities
$
356
$
15,355
$
—
$
(10,047
)
$
5,664
Percentage
of liabilities prior to netting
2
%
98
%
—
%
(a)
ASC 815, Derivatives and Hedging, 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 and seed capital.
84 BNY Mellon
Notes to Consolidated Financial Statements (continued)
European
floating rate notes - available-for-sale:
United
Kingdom
$
321
88
%
12
%
—
%
—
%
$
379
90
%
10
%
—
%
—
%
Netherlands
121
100
—
—
—
125
100
—
—
—
Ireland
58
—
—
100
—
58
—
—
100
—
Total
European floating rate notes - available-for-sale
$
500
81
%
7
%
12
%
—
%
$
562
83
%
7
%
10
%
—
%
Sovereign
debt/sovereign guaranteed:
United
Kingdom
$
2,816
100
%
—
%
—
%
—
%
$
3,209
100
%
—
%
—
%
—
%
France
2,005
100
—
—
—
1,998
100
—
—
—
Spain
1,774
—
—
100
—
1,749
—
—
100
—
Germany
1,394
100
—
—
—
1,347
100
—
—
—
Italy
1,138
—
—
100
—
1,130
—
—
100
—
Netherlands
1,019
100
—
—
—
1,061
100
—
—
—
Belgium
958
100
—
—
—
1,005
100
—
—
—
Ireland
735
—
100
—
—
736
—
100
—
—
Other
(b)
332
58
—
—
42
254
71
—
—
29
Total
sovereign debt/sovereign guaranteed
$
12,171
69
%
6
%
24
%
1
%
$
12,489
70
%
6
%
23
%
1
%
Non-agency
RMBS (c), originated in:
2007
$
376
—
%
—
%
—
%
100
%
$
387
—
%
—
%
—
%
100
%
2006
373
—
—
—
100
391
—
—
—
100
2005
414
—
2
1
97
437
—
2
1
97
2004
and earlier
135
2
2
17
79
142
2
2
17
79
Total
non-agency RMBS (c)
$
1,298
—
%
1
%
2
%
97
%
$
1,357
—
%
1
%
2
%
97
%
(a)
At
March 31, 2017 and Dec. 31, 2016, foreign covered bonds and sovereign debt 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)
Included noninvestment grade sovereign debt related to Brazil of $140 million at March 31, 2017 and $73 million at Dec.
31, 2016.
(c)
Previously included in the Grantor Trust. The Grantor Trust was dissolved in 2011.
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 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.
BNY
Mellon 85
Notes to Consolidated Financial Statements (continued)
The table below includes a roll forward of the balance sheet amount for the quarter ended March 31, 2016 (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 quarter ended March 31, 2016
Change in unrealized gains or (losses) for the period included in earnings for assets held at the end of the reporting period
$
2
(a)
Reported
in investment and other income.
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 tables present the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy as of March 31, 2017
and Dec. 31, 2016, for which a nonrecurring change in fair value has been recorded during the quarters ended March 31, 2017 and Dec. 31, 2016.
Assets measured at fair value on a nonrecurring
basis at March 31, 2017
Total carrying
value
(in millions)
Level 1
Level 2
Level 3
Loans (a)
$
—
$
83
$
3
$
86
Other
assets (b)
—
5
35
40
Total assets at fair value on a nonrecurring basis
$
—
$
88
$
38
$
126
Assets
measured at fair value on a nonrecurring basis at Dec. 31, 2016
Total carrying
value
(in millions)
Level 1
Level 2
Level 3
Loans (a)
$
—
$
84
$
7
$
91
Other
assets (b)
—
4
—
4
Total assets at fair value on a nonrecurring basis
$
—
$
88
$
7
$
95
(a)
During
the quarters ended March 31, 2017 and Dec. 31, 2016, the fair value of these loans decreased less than $1 million and $1 million, respectively, based on the fair value of the underlying collateral based on guidance in ASC 310, Receivables, with an offset to the allowance for credit losses.
(b)
Includes other assets received in satisfaction of debt.
Estimated
fair value of financial instruments
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 March 31, 2017 and Dec. 31, 2016, by caption on the consolidated balance sheet and by the valuation
hierarchy. See Note 18 of the Notes to Consolidated Financial Statements in our 2016 Annual Report for additional information regarding the financial instruments within the scope of this disclosure, and the methods and significant assumptions used to estimate their fair value.
86 BNY Mellon
Notes to Consolidated Financial Statements (continued)
Interest-bearing
deposits with the Federal Reserve and other central banks
$
—
$
58,041
$
—
$
58,041
$
58,041
Interest-bearing
deposits with banks
—
15,091
—
15,091
15,086
Federal funds sold and securities purchased under resale agreements
—
25,801
—
25,801
25,801
Securities
held-to-maturity
11,173
29,496
—
40,669
40,905
Loans (a)
—
62,829
—
62,829
62,564
Other
financial assets
4,822
1,112
—
5,934
5,934
Total
$
15,995
$
192,370
$
—
$
208,365
$
208,331
Liabilities:
Noninterest-bearing
deposits
$
—
$
78,342
$
—
$
78,342
$
78,342
Interest-bearing
deposits
—
141,418
—
141,418
143,148
Federal funds purchased and securities sold under repurchase agreements
—
9,989
—
9,989
9,989
Payables
to customers and broker-dealers
—
20,987
—
20,987
20,987
Borrowings
—
960
—
960
960
Long-term
debt
—
24,184
—
24,184
24,100
Total
$
—
$
275,880
$
—
$
275,880
$
277,526
(a)
Does
not include the leasing portfolio.
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.
Assets of consolidated investment management funds:
Trading
assets
$
883
$
979
Other assets
144
252
Total assets of consolidated investment management funds
$
1,027
$
1,231
Liabilities
of consolidated investment management funds:
Trading liabilities
$
—
$
282
Other liabilities
209
33
Total
liabilities of consolidated investment management funds
$
209
$
315
BNY Mellon values the assets and liabilities of its consolidated asset management funds using quoted prices for identical assets or liabilities in active markets or observable inputs such as quoted prices for similar assets or liabilities. Quoted prices for either identical or similar assets or liabilities in inactive markets may also be used. Accordingly,
fair value best reflects the interests BNY Mellon holds in the economic performance of the consolidated asset management funds. Changes in the value of the assets and liabilities are recorded in the income statement as investment income of consolidated investment management funds and in the interest of investment management fund note holders, respectively.
We have elected the fair value option on $240 million of long-term debt. The fair value of this long-term debt was $364 million at March 31, 2017 and $363 million at Dec. 31, 2016. The long-term
debt is valued using observable market inputs and is included in Level 2 of the valuation hierarchy.
The following table presents the changes in fair value of long-term debt and certain loans for which we elected the fair value option that we previously held in 2016, and the location of the changes in the consolidated income statement.
Impact of changes in fair value in the income statement (a)
The changes in fair value of the loans and long-term debt are approximately offset by economic
hedges included in foreign exchange and other trading revenue.
Note 16 - 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 compliance with the Volcker Rule.
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 and collateral arrangements 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 recorded in the first quarter of 2017 or the first quarter of 2016.
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 eliminate fair value variability by converting fixed rate interest payments to LIBOR.
88 BNY Mellon
Notes
to Consolidated Financial Statements (continued)
The available-for-sale investment securities hedged consist of U.S. Treasury bonds, agency commercial mortgage-backed securities, sovereign debt and covered bonds 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 March 31, 2017, $10.5 billion face amount of
securities were hedged with interest rate swaps that had notional values of $10.5 billion.
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 “receive fixed rate, pay variable rate” swaps with similar maturity, repricing and fixed rate coupon. Callable debt is hedged with callable swaps where the call dates of the swaps exactly match the call dates of the debt. At March 31, 2017, $22.2 billion par value of debt was hedged with interest rate swaps that had
notional values of $22.2 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 Indian rupee, British pound, Hong Kong dollar, Singapore dollar, euro and Canadian 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 March 31, 2017, the hedged forecasted foreign currency transactions and designated forward foreign exchange contract
hedges were $341 million (notional), with a pre-tax loss of $8 million recorded in accumulated other comprehensive income. This loss will be reclassified to income or expense over the next nine 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 foreign currency translation adjustments in shareholders’ equity, net of tax. At March 31, 2017, forward foreign exchange contracts with notional amounts totaling $7.3 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 March 31, 2017, had a combined U.S. dollar equivalent value of $163 million.
Ineffectiveness
related to derivatives and hedging relationships was recorded in income as follows:
Total
derivatives not designated as hedging instruments
$
10,058
$
13,737
$
10,077
$
13,851
Total
derivatives fair value (c)
$
10,540
$
14,521
$
10,632
$
14,448
Effect
of master netting agreements (d)
(7,595
)
(10,257
)
(8,228
)
(10,047
)
Fair
value after effect of master netting agreements
$
2,945
$
4,264
$
2,404
$
4,401
(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, Derivatives and Hedging.
(d)
Effect
of master netting agreements includes cash collateral received and paid of $752 million and $1,385 million, respectively, at March 31, 2017, and $1,119 million and $909 million, respectively, at Dec. 31, 2016.
The following tables present the impact of derivative instruments used in fair value, cash flow and net investment hedging relationships on the income statement.
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
We manage trading risk through a system of position limits, a VaR methodology based on historical simulation and other market sensitivity measures. Risk is monitored and reported to senior management by a separate unit, independent from trading, 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,
utilizes a 99% confidence level and incorporates non-linear product characteristics. 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 historical market events are also performed. Stress tests may incorporate the impact of reduced market liquidity and the breakdown of historically observed correlations and extreme scenarios. VaR and other statistical measures, stress testing and sensitivity analysis
are incorporated in other risk management materials.
Revenue from foreign exchange and other trading included the following:
Foreign exchange and other trading revenue
(in millions)
1Q17
4Q16
1Q16
Foreign
exchange
$
154
$
175
$
171
Other trading revenue (loss)
10
(14
)
4
Total
foreign exchange and other trading revenue
$
164
$
161
$
175
Foreign exchange includes income from purchasing and selling foreign currencies and currency forwards, futures and options. Other trading revenue reflects
results from futures and forward contracts, interest rate swaps, structured foreign currency swaps, options, equity derivatives and fixed income and equity securities.
Counterparty credit risk and collateral
We assess credit risk of our counterparties through regular examination of their financial statements, confidential communication with the management of those counterparties and regular monitoring of publicly available credit rating information. This and other information is used to develop proprietary credit rating metrics used to assess credit quality.
Collateral
requirements are determined after a comprehensive review of the credit quality of each counterparty. Collateral is generally held or pledged in the form of cash or highly liquid government securities. Collateral requirements are monitored and adjusted daily.
Additional disclosures concerning derivative financial instruments are provided in Note 14 of the Notes to Consolidated Financial Statements.
Disclosure of contingent features in 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 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.
BNY Mellon 91
Notes to Consolidated Financial Statements (continued)
The following table shows the fair value of contracts
falling under early termination provisions that were in net liability positions as of March 31, 2017 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-
$
26
million
Baa2/BBB
$
540
million
Ba1/BB+
$
1,483
million
(a)
The
amounts represent potential total close-out values if The Bank of New York Mellon’s rating were to immediately drop to the indicated levels.
The aggregated fair value of contracts impacting potential trade close-out amounts and collateral obligations can fluctuate from quarter to quarter due to changes in market conditions, changes in the composition of counterparty trades, new business or changes to the agreement definitions establishing close-out or collateral obligations.
Additionally, if The Bank of New York Mellon’s debt rating had fallen below investment grade on March 31, 2017, existing
collateral arrangements would have required us to post an additional $116 million of collateral.
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 legally enforceable netting agreement for which we are not currently netting.
Offsetting
of derivative assets and financial assets at March 31, 2017
Total
derivatives not subject to netting arrangements
1,128
—
1,128
—
—
1,128
Total
derivatives
10,540
7,595
2,945
350
—
2,595
Reverse
repurchase agreements
16,730
502
(b)
16,228
16,228
—
—
Securities
borrowing
9,548
—
9,548
9,267
—
281
Total
$
36,818
$
8,097
$
28,721
$
25,845
$
—
$
2,876
(a)
Includes
the effect of netting agreements and net cash collateral received. The offset related to the OTC 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.
92 BNY Mellon
Notes
to Consolidated Financial Statements (continued)
Offsetting of derivative assets and financial assets at Dec. 31, 2016
Total
derivatives not subject to netting arrangements
2,007
—
2,007
—
—
2,007
Total
derivatives
14,521
10,257
4,264
523
—
3,741
Reverse
repurchase agreements
17,588
481
(b)
17,107
17,104
—
3
Securities
borrowing
8,694
—
8,694
8,425
—
269
Total
$
40,803
$
10,738
$
30,065
$
26,052
$
—
$
4,013
(a)
Includes
the effect of netting agreements and net cash collateral received. The offset related to the OTC 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 derivative liabilities and financial liabilities at March 31, 2017
Total
derivatives not subject to netting arrangements
632
—
632
—
—
632
Total
derivatives
10,632
8,228
2,404
735
—
1,669
Repurchase
agreements
9,777
502
(b)
9,275
9,275
—
—
Securities
lending
1,501
—
1,501
1,417
—
84
Total
$
21,910
$
8,730
$
13,180
$
11,427
$
—
$
1,753
(a)
Includes
the effect of netting agreements and net cash collateral paid. The offset related to the OTC 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.
Offsetting
of derivative liabilities and financial liabilities at Dec. 31, 2016
Total
derivatives not subject to netting arrangements
1,271
—
1,271
—
—
1,271
Total
derivatives
14,448
10,047
4,401
1,675
—
2,726
Repurchase
agreements
8,703
481
(b)
8,222
8,222
—
—
Securities
lending
1,615
—
1,615
1,522
—
93
Total
$
24,766
$
10,528
$
14,238
$
11,419
$
—
$
2,819
(a)
Includes
the effect of netting agreements and net cash collateral paid. The offset related to the OTC 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.
BNY Mellon 93
Notes
to Consolidated Financial Statements (continued)
Secured borrowings
The following tables present the contract value of repurchase agreements and securities lending transactions accounted for as secured borrowings by the type of collateral provided to counterparties.
Repurchase
agreements and securities lending transactions accounted for as secured borrowings at March 31, 2017
Remaining contractual maturity of the agreements
(in millions)
Overnight and continuous
Up to 30 days
30 days or more
Total
Repurchase
agreements:
U.S. Treasury
$
3,014
$
13
$
—
$
3,027
U.S.
government agencies
523
64
—
587
Agency RMBS
2,551
348
—
2,899
Corporate
bonds
428
—
1,138
1,566
Other debt securities
616
—
390
1,006
Equity
securities
435
—
257
692
Total
$
7,567
$
425
$
1,785
$
9,777
Securities
lending:
U.S. government agencies
$
45
$
—
$
—
$
45
Other
debt securities
389
—
—
389
Equity securities
1,067
—
—
1,067
Total
$
1,501
$
—
$
—
$
1,501
Total borrowings
$
9,068
$
425
$
1,785
$
11,278
Repurchase
agreements and securities lending transactions accounted for as secured borrowings at Dec. 31, 2016
Remaining contractual maturity of the agreements
(in millions)
Overnight and continuous
Up to 30 days
30 days or more
Total
Repurchase
agreements:
U.S. Treasury
$
2,488
$
4
$
—
$
2,492
U.S.
government agencies
396
10
—
406
Agency RMBS
3,294
386
—
3,680
Corporate
bonds
304
—
694
998
Other debt securities
146
—
563
709
Equity
securities
375
—
43
418
Total
$
7,003
$
400
$
1,300
$
8,703
Securities
lending:
U.S. government agencies
$
39
$
—
$
—
$
39
Other
debt securities
477
—
—
477
Equity securities
1,099
—
—
1,099
Total
$
1,615
$
—
$
—
$
1,615
Total borrowings
$
8,618
$
400
$
1,300
$
10,318
BNY
Mellon’s repurchase agreements and securities lending transactions primarily encounter risk associated with liquidity. We are required to pledge collateral based on predetermined terms within the agreements. If we were to experience a decline in the fair value of the collateral pledged for these transactions, we could be required to provide
additional collateral to the counterparty, therefore decreasing the amount of assets available for other liquidity needs that may arise. BNY Mellon also offers tri-party collateral agency services in the tri-party repo market where we are exposed to credit risk. In order to mitigate this risk, we require dealers to fully secure intraday credit.
94
BNY Mellon
Notes to Consolidated Financial Statements (continued)
Note 17 - 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 March 31, 2017 are disclosed in the financial institutions portfolio exposure and the commercial portfolio exposure tables below.
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.
Excludes the indemnification for securities for which BNY Mellon acts as an agent on behalf of CIBC Mellon clients, which totaled $64 billion at March 31, 2017 and $61
billion at Dec. 31, 2016.
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: $29.4 billion in less than one year, $21.5 billion
in one to five years and $411 million over five years.
Standby letters of credit (“SBLC”) principally support corporate obligations and were collateralized with cash and securities of $283 million at March 31, 2017 and $293 million at Dec. 31, 2016. At March 31, 2017, $2.4 billion of the SBLCs will expire within one year and $1.5 billion in one
to five years.
We must recognize, at the inception of an SBLC and foreign and other guarantees, a liability for the fair value of the obligation undertaken in issuing the guarantee. The fair value of the liability, which was recorded with a corresponding asset in other assets, was estimated as the present value of contractual customer fees. The estimated liability for losses related to these commitments and SBLCs, if any, is included in the allowance for lending-related commitments. The allowance for lending-related commitments was $112 million at March 31, 2017 and $112 million at Dec. 31, 2016.
Payment/performance
risk of SBLCs is monitored using both historical performance and internal ratings
BNY Mellon 95
Notes to Consolidated Financial Statements (continued)
criteria. BNY Mellon’s historical experience is that
96
BNY Mellon
Notes to Consolidated Financial Statements (continued)
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:
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 $286 million at March 31, 2017 and $339 million at Dec. 31, 2016.
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 $353 billion at March 31, 2017 and $331 billion at Dec. 31, 2016.
CIBC Mellon, a joint venture between BNY Mellon and the Canadian Imperial Bank of Commerce (“CIBC”), engages in securities lending activities. CIBC Mellon, BNY Mellon and CIBC jointly
and severally indemnify securities lenders against specific types of borrower default. At March 31, 2017 and
respectively, of borrowings at CIBC Mellon for which BNY Mellon acts as agent on behalf of CIBC Mellon clients, were secured by collateral of $67 billion and $64 billion, respectively. If, upon a default,
a borrower’s collateral was not sufficient to cover its related obligations, certain losses related to the indemnification could be covered by the indemnitors.
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 offshore tax-exempt funds that we manage, we may be liable to the funds for certain administrative errors. The errors relate to the resident status of such 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. With the charge recorded in 2014 for this matter, we believe we are appropriately accrued and the additional reasonably possible exposure is not significant.
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
BNY Mellon 97
Notes to Consolidated Financial Statements (continued)
have to make any material payments for these
98 BNY Mellon
Notes to Consolidated
Financial Statements (continued)
indemnifications is remote. At March 31, 2017 and Dec. 31, 2016, we have not recorded any material liabilities under these arrangements.
Clearing and settlement exchanges
We are a noncontrolling equity investor in, and/or member of, several industry clearing or settlement exchanges through which foreign exchange,
securities, derivatives or other transactions settle. Certain of these industry clearing and settlement exchanges require their members to guarantee their obligations and liabilities and/or to provide liquidity 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 March 31, 2017 and Dec. 31, 2016,
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. We also are subject to governmental and regulatory examinations, information-gathering requests, investigations and proceedings (both formal and informal). Claims for significant monetary damages are often asserted in many of these legal actions, while claims for disgorgement, restitution, penalties and/or other remedial actions or sanctions may be sought in governmental and 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, settlements or orders, 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 governmental 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 governmental 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 governmental 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 here 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 described here where BNY Mellon is able to estimate a reasonably possible loss, the aggregate range of such reasonably possible loss is up to $920 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:
Mortgage-Securitization Trusts Proceedings
The Bank of New York Mellon has been named as a defendant in a number of legal actions brought by MBS investors alleging that the trustee has expansive duties under the governing agreements, including the
BNY Mellon 99
Notes
to Consolidated Financial Statements (continued)
100 BNY Mellon
Notes to Consolidated Financial Statements (continued)
duty
to investigate and pursue breach of representation and warranty claims against other parties to the MBS transactions. These actions include a lawsuit brought in New York State court on June 18, 2014, and later re-filed in federal court, by a group of institutional investors who purport to sue on behalf of 253 MBS trusts.
Matters Related to R. Allen Stanford
In late December 2005, Pershing LLC (“Pershing”) became a clearing firm for Stanford Group Co. (“SGC”), a registered broker-dealer that was part of a group of entities ultimately controlled by R. Allen Stanford (“Stanford”). Stanford International Bank (“SIB”), also controlled by Stanford, issued certificates of deposit (“CDs”). Some investors allegedly
wired funds from their SGC accounts to purchase CDs. In 2009, the SEC charged Stanford with operating a Ponzi scheme in connection with the sale of CDs, and SGC was placed into receivership. Alleged purchasers of CDs have filed 15 lawsuits against Pershing that are pending in Texas, including two putative class actions. The purchasers allege that Pershing, as SGC’s clearing firm, assisted Stanford in a fraudulent scheme and assert contractual, statutory and common law claims. In addition, one FINRA arbitration matter brought by alleged purchasers remains pending.
Brazilian Postalis Litigation
BNY Mellon Servicos Financeiros DTVM S.A. (“DTVM”), a subsidiary that provides a number of asset
services in Brazil, acts as administrator for certain investment funds in which the exclusive investor is a public pension fund for postal workers called Postalis-Instituto de Seguridade Social dos Correios e Telégrafos (“Postalis”). On Aug. 22, 2014, Postalis sued DTVM in Rio de Janeiro, Brazil for losses related to a Postalis investment fund for which DTVM serves as fund administrator. Postalis alleges that DTVM failed to properly perform alleged duties, including duties to conduct due diligence of and exert control over the fund manager, Atlântica Administração de Recursos (“Atlântica”), and Atlântica’s investments. On March 12, 2015, Postalis filed a lawsuit in Rio de Janeiro against DTVM and BNY Mellon Administração de Ativos Ltda. (“Ativos”) alleging failure to properly perform alleged duties relating to another fund of which DTVM is administrator
and Ativos is investment manager. On Dec. 14, 2015, Associaceão Dos Profissionais Dos Correiros, a Brazilian postal workers association, filed a lawsuit in São Paulo
against DTVM and other defendants alleging that DTVM improperly contributed to investment losses in the Postalis portfolio. On March 20, 2017, the lawsuit was dismissed without prejudice. On Dec. 17, 2015, Postalis filed three additional lawsuits in Rio de Janeiro against DTVM and Ativos alleging failure to properly perform alleged duties and liabilities for losses with respect to investments in several other funds. On Feb.
4, 2016, Postalis filed another lawsuit in Brasilia against DTVM, Ativos and BNY Mellon Alocação de Patrimônio Ltda., an investment management subsidiary, alleging failure to properly perform duties and liability for losses with respect to investments in various other funds of which the defendants were administrator and/or manager. The lawsuit has been transferred to São Paulo.
Depositary Receipt Matters
Between late December 2015 and February 2016, four putative class action lawsuits were filed against BNY Mellon asserting claims relating to BNY Mellon’s foreign exchange pricing when converting dividends and other distributions from non-U.S. companies in its role as depositary bank to Depositary Receipt issuers. The claims are for breach of contract
and violations of ERISA. The lawsuits have been consolidated into two suits that are pending in federal court in the Southern District of New York.
Brazilian Silverado Litigation
DTVM acts as administrator for the Fundo de Investimento em Direitos Creditórios Multisetorial Silverado Maximum (“Silverado Maximum Fund”), which invests in commercial credit receivables. On June 2, 2016, the Silverado Maximum Fund sued DTVM in its capacity as administrator, along with Deutsche Bank S.A. - Banco Alemão in its capacity as custodian and Silverado Gestão e Investimentos Ltda. in its capacity as investment manager. The Fund alleges that each of the defendants failed to fulfill its respective duty, and caused losses to the Fund for which the
defendants are jointly and severally liable.
Note 18 - Lines of business
We have an internal information system that produces performance data along product and service lines for our two principal businesses and the Other segment.
BNY Mellon 101
Notes
to Consolidated Financial Statements (continued)
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 when organizational changes are made or when improvements are made
in the measurement principles.
The accounting policies of the businesses are the same as those described in Note 1 of the Notes to Consolidated Financial Statements in our 2016 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
• Investment management and performance fees from:
Mutual funds
Institutional clients
Private clients
High net worth individuals and families, endowments and foundations and related entities
• Distribution and servicing fees
• Other revenue from seed capital investments
Investment Services
• Asset servicing fees, including custody fees, fund services, broker-dealer services, securities finance and
collateral and liquidity services
• Issuer services fees, including Depositary Receipts and Corporate Trust
• Clearing services fees
• Treasury services fees, including global payments, trade finance and cash management
• Foreign exchange revenue
• Financing-related fees and net interest revenue from credit-related activities
Other segment
• Net interest revenue and lease-related gains (losses) from leasing operations
• Gain
(loss) on securities and net interest revenue from corporate treasury activity
• Other trading revenue from derivatives and other trading activity
• Results of business exits
The results of our businesses are presented and analyzed on an internal management reporting basis:
•
Revenue amounts reflect fee and other revenue generated by each business. Fee and other revenue transferred
between businesses under revenue transfer agreements is included within other revenue in each business.
•
Revenues and expenses associated with specific client bases are included in those businesses. For example, foreign exchange activity associated with clients using custody products is included in 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.
•
The provision for credit losses associated with the respective credit portfolios is reflected in each business segment.
•
Incentive expense related to restricted stock is allocated to the businesses.
•
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.
102 BNY Mellon
Notes to Consolidated
Financial Statements (continued)
We typically allocate all interest revenue to the businesses generating the deposits. Accordingly, accretion related to the portion of the investment securities portfolio restructured in 2009 has been included in the results of the businesses.
•
M&I expense is a corporate level item and is recorded in the Other segment.
•
Restructuring
charges relate to corporate-level initiatives and were 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.
Both
fee and other revenue and total revenue include the net income from consolidated investment management funds of $15 million representing $33 million of income and noncontrolling interests of $18 million. Income before taxes is net of noncontrolling interests of $18 million.
(b)
Noninterest expense includes a loss attributable to noncontrolling interest of $3 million related to other consolidated subsidiaries.
Both
fee and other revenue and total revenue include the net income from consolidated investment management funds of $1 million, representing $5 million of income and noncontrolling interests of $4 million. Income before taxes is net of noncontrolling interests of $4 million.
(b)
Noninterest expense includes a loss attributable to noncontrolling interest of $3 million related to other consolidated subsidiaries.
(c)
Income
before taxes divided by total revenue.
N/M - Not meaningful.
BNY Mellon 103
Notes to Consolidated Financial Statements (continued)
Both
fee and other revenue and total revenue include net income from consolidated investment management funds of $1 million, representing $6 million of losses and a loss attributable to noncontrolling interests of $7 million. Income (loss) before taxes is net of a loss attributable to noncontrolling interests of $7 million.
(b)
Noninterest expense includes a loss attributable to noncontrolling interest of $2 million related to other consolidated subsidiaries.
(c)
Income
before taxes divided by total revenue.
N/M - Not meaningful.
Note 19 - Supplemental information to the Consolidated Statement of Cash Flows
Noncash investing and financing transactions that, appropriately, are not reflected in the Consolidated Statement of Cash Flows are listed below.
Noncash
investing and financing transactions
Three months ended March 31,
(in millions)
2017
2016
Transfers from loans to other assets for other real estate owned (“OREO”)
$
1
$
1
Change
in assets of consolidated VIEs
204
101
Change in liabilities of consolidated VIEs
106
8
Change in nonredeemable noncontrolling interests
of consolidated investment management funds
84
81
Securities purchased not settled
580
86
Securities sales not settled
81
356
Premises
and equipment/capitalized software funded by capital lease obligations
1
2
104 BNY Mellon
Item 4. Controls and Procedures
Disclosure
controls and procedures
Our management, including the Chief Executive Officer and Chief Financial Officer, with participation by the members of the Disclosure Committee, has responsibility for ensuring that there is an adequate and effective process for establishing, maintaining, and evaluating disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in our SEC reports is timely recorded, processed, summarized and reported and that information required to be disclosed by BNY Mellon is accumulated and communicated to BNY Mellon’s management to allow timely decisions regarding the required disclosure. In addition, our ethics hotline can also be used by employees and others for the anonymous communication of concerns about financial controls or reporting matters. There are inherent limitations to the effectiveness of any system
of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
Changes
in internal control over financial reporting
In the ordinary course of business, we may routinely modify, upgrade or enhance our internal controls and procedures for financial reporting. There have not been any changes in our internal controls over financial reporting as defined in Rule 13a-15(f) of the Exchange Act during the first quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
105 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, our businesses, financial, liquidity and capital condition, results of operations, goals, strategies, outlook, objectives, expectations (including those regarding our performance results, regulatory, market, economic or accounting developments, legal proceedings and other contingencies), effective tax rate, estimates (including those regarding capital ratios), intentions (including those regarding our resolution strategy), targets, opportunities and initiatives.
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,”“likely,”“target,”“expect,”“intend,”“continue,”“seek,”“believe,”“plan,”“goal,”“could,”“should,”“would,”“may,”“might,”“will,”“strategy,”“synergies,”“opportunities,”“trends” and words of similar meaning, may signify forward-looking statements.
Actual results may differ materially from those expressed or implied as a result of a number of factors, including those discussed in the “Risk Factors” section of our 2016 Annual
Report and this Form 10-Q, such as: an information security event or technology disruption that results in a loss of information or impacts our ability to provide services to our clients and any material adverse effect on our business and results of operations; failure of our technology or that of a third party or vendor, or if we neglect to update our technology, develop and market new technology to meet clients’ needs or protect our intellectual property and any material adverse effect on our business; a determination that our resolution plan is not credible and any material negative impact on our business, reputation, results of operations and financial condition and the application of our Title I preferred resolution strategy or resolution under the Title II orderly liquidation authority and any adverse effects on our liquidity, financial condition and security holders; extensive government rulemaking regulation, and supervision, which have, and in the future may,
compel us to change how we manage our businesses, could have a material adverse effect on our business, financial condition and results of operations and have increased our compliance and operational risks and costs; failure to satisfy regulatory standards, including “well capitalized” and “well managed” status or capital adequacy and
liquidity rules, and any resulting limitations on our activities, or adverse effects on our business and financial condition; regulatory or enforcement actions or litigation and any material adverse effect on our results of operations or harm to our businesses or reputation; adverse events, publicity, government scrutiny or other reputational harm and any negative effect on our businesses; operational risk and any material adverse effect on our business; failure or circumvention of our controls and procedures and any material adverse
effect on our business, reputation, results of operations and financial condition; failure of our risk management framework to be effective in mitigating risk and reducing the potential for losses; change or uncertainty in monetary, tax and other governmental policies and the impact on our businesses, profitability and ability to compete; political, economic, legal, operational and other risks inherent in operating globally and any adverse effect on our business; acts of terrorism, natural disasters, pandemics and global conflicts and any negative impact on our business and operations; ongoing concerns about the financial stability of certain countries, the failure or instability of any of our significant global counterparties, new barriers to global trade or a breakup of the EU or Eurozone and any material adverse effect on our business and results of operations; the United Kingdom’s referendum decision to leave the EU and any negative effects on global economic conditions,
global financial markets, and our business and results of operations; weakness and volatility in financial markets and the economy generally and any material adverse effect on our business, results of operations and financial condition; changes in interest rates and any material adverse effect on our profitability; write-downs of securities that we own and other losses related to volatile and illiquid market conditions and any reduction in our earnings or impact on our financial condition; our dependence on fee-based business for a substantial majority of our revenue and the adverse effects of a slowing in market activity, weak financial markets, underperformance and/or negative trends in savings rates or in investment preferences; any adverse effect on our foreign exchange revenues from decreased market volatility or cross-border investment activity of our clients; the failure or perceived weakness of any of our significant counterparties, and our assumption of credit
and counterparty risk, which could expose us to loss and adversely affect our business; any material reduction in our credit ratings or the credit ratings of our principal bank subsidiaries, which could increase
BNY Mellon 106
Forward-looking Statements (continued)
the cost of funding
and borrowing to us and our rated subsidiaries and have a material adverse effect on our results of operations and financial condition and on the value of the securities we issue; any adverse effect on our business, financial condition and results of operations of not effectively managing our liquidity; the potential to incur losses if our allowance for credit losses is inadequate; the risks relating to new lines of business, new products and services or transformational or strategic project initiatives and the failure to implement these initiatives, which could affect our results of operations; the risks and uncertainties relating to our strategic transactions and any adverse effect on our business, results of operations and financial condition; competition in all aspects of our business and any negative effect on our ability to maintain or increase our profitability; failure
to attract and retain employees and any adverse effect on our business; tax law changes or challenges to our tax positions and any adverse effect on our net income, effective tax rate and overall results of operations and financial condition; changes in accounting standards and any material impact on our reported financial condition, results of operations,
cash flows and other financial data; risks associated with being a non-operating holding company, including our dependence on dividends from our subsidiaries to meet obligations, to provide funds for payment of dividends and for stock repurchases; and the impact of provisions of U.S. banking laws and regulations, including those governing capital and the approval of our capital plan, applicable provisions of Delaware law or failure to pay
full and timely dividends on our preferred stock, on our ability to return capital to shareholders.
Investors should consider all risk factors discussed in our 2016 Annual Report, this Form 10-Q 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 107
Part II - Other Information
Item 1. Legal Proceedings
The
information required by this Item is set forth in the “Legal proceedings” section in Note 17 of the Notes to Consolidated Financial Statements, which portion is incorporated herein by reference in response to this item.
Item 1A. Risk Factors
The following discussion supplements the discussion of risk factors that could affect our business, financial condition or results of operations set forth in Part I, Item 1A, Risk Factors, on pages 90 through 116 of our 2016 Annual Report. The discussion of Risk Factors, as so supplemented, sets forth our most significant risk factors that could affect our business, financial condition or
results of operations. However, other factors, besides that discussed below or in our 2016 Annual Report or other of our reports filed with or furnished to the SEC, also could adversely affect our business or results. We cannot assure you that the risk factors described below or elsewhere in this report and such other reports address all potential risks that we may face. These risk factors also serve to describe factors which may cause our results to differ materially from those described in forward-looking statements included herein or in other documents or statements that make reference to this Form 10-Q. See Forward-looking Statements.
If our resolution plan is determined not to be credible or not to facilitate an orderly resolution under the U.S. Bankruptcy Code, our business, reputation, results of operation and financial condition could be materially negatively impacted. The
application of our Title I preferred resolution strategy or resolution under the Title II orderly liquidation authority could adversely affect our liquidity and financial condition and our security holders.
Large BHCs must develop and submit to the Federal Reserve and the FDIC for review plans for their rapid and orderly resolution in the event of material financial distress or failure. BNY Mellon and The Bank of New York Mellon each file periodic complementary resolution plans. In April 2016, the Federal Reserve and the FDIC jointly determined that our 2015 resolution plan was not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code. The agencies issued a joint notice of deficiencies and shortcomings and the actions that
must be taken to address them,
which we responded to in an Oct. 1, 2016 submission. In December 2016, the agencies jointly determined that our Oct. 1, 2016 submission adequately remedied the identified deficiencies. If the agencies determine that our future submissions are not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code, and we fail to address the deficiencies in a timely manner, the agencies may jointly impose more stringent capital, leverage or liquidity requirements or restrictions on our growth, activities or operations. If we continue to fail to adequately remedy any deficiencies identified in future submissions, we could be required to divest assets or operations that the agencies determine necessary to facilitate our orderly resolution.
Following the receipt
of feedback from the Federal Reserve and the FDIC in April 2016 on our 2015 resolution plan, we determined that, in the event of our material financial distress or failure, our preferred resolution strategy under Title I of the Dodd-Frank Act is a single point of entry strategy.
In connection with our single point of entry resolution strategy, we have established the IHC to facilitate the provision of capital and liquidity resources to certain key subsidiaries in the event of material financial distress or failure. In the second quarter of 2017, we entered into a binding support agreement that required the IHC to provide that support. The support agreement required the Parent to transfer its intercompany loans and most of its cash to the IHC, and requires the Parent to continue to transfer
cash and other liquid financial assets to the IHC.
If our projected liquidity resources deteriorate so severely that resolution of the Parent becomes imminent, the committed line of credit will automatically terminate, with all amounts outstanding becoming due and payable, and the support agreement will require the Parent to transfer most of its remaining assets (other than stock in subsidiaries and a cash reserve to fund bankruptcy expenses) to the IHC. As a result, during a period of severe financial stress the Parent might commence bankruptcy proceedings at an earlier time than it otherwise would if the support agreement had not been implemented.
If the Parent were to become subject to a
bankruptcy proceeding and our single point of entry strategy is successful, creditors of some or all of our material
BNY Mellon 108
Part II - Other Information (continued)
entities would receive full recoveries on their claims, while Parent’s security holders, including unsecured debt holders, could face significant losses, potentially including the loss of their entire
investment. It is possible that the application of the single point of entry strategy – in which the Parent would be the only legal entity to enter resolution proceedings – could result in greater losses to holders of our unsecured debt securities than the losses that could result from the application of a different resolution strategy. Further, if the single point of entry strategy is not successful, our liquidity and financial condition would be adversely affected and our security holders may, as a consequence, be in a worse position than if the strategy had not been implemented.
In addition, Title II of the Dodd-Frank Act established an orderly liquidation process in the event of the failure of a large systemically important financial institution, such as BNY Mellon, in order to avoid or mitigate serious adverse effects on the U.S. financial system. Specifically, when a
U.S. G-SIB, such as BNY Mellon is in default or danger of default, and certain specified conditions are met, the FDIC may be appointed receiver under the orderly liquidation authority instead of the U.S. Bankruptcy Code.
U.S. supervisors have indicated that a single point of entry strategy may be a desirable strategy to resolve a large financial institution such as BNY Mellon under Title II in a manner that would, similar to our preferred strategy under our Title I resolution plan, impose losses on shareholders, unsecured debt holders and other unsecured creditors of the top-tier holding company (in our case, the Parent), while permitting the holding company’s subsidiaries to continue to operate and remain solvent. Under such a strategy, assuming
the Parent entered resolution proceedings and its subsidiaries remained solvent, losses at the subsidiary level could be transferred to the Parent and ultimately borne by the Parent’s security holders (including holders of the Parent’s unsecured debt securities), while third-party creditors of the Parent’s subsidiaries would receive full recoveries on their claims. Accordingly, the Parent’s security holders (including holders of unsecured debt securities and other unsecured creditors) could face losses in excess of what otherwise would have been the case.
BNY Mellon 109
Part II - Other Information (continued)
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c)
The following table discloses repurchases of our common stock made in the first
quarter of 2017. 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 - first quarter of 2017
Total shares repurchased as part of a publicly announced plan or program
Maximum approximate dollar value of shares that may yet be purchased under the publicly announced plans or programs at March 31, 2017
(dollars
in millions, except per share information; common shares in thousands)
Total shares repurchased
Average price per share
January 2017
10,933
$
45.47
10,933
$
896
February
2017
5,157
46.32
5,157
657
March 2017
3,062
46.73
3,062
514
First
quarter of 2017 (a)
19,152
$
45.90
19,152
$
514
(b)
(a)
Includes
2.9 million shares repurchased at a purchase price of $135 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 $45.68.
(b)
Represents the maximum value of the shares authorized to be repurchased through the second quarter of 2017, including employee benefit plan repurchases, in connection with the Federal Reserve’s non-objection to our 2016 capital plan.
On
June 29, 2016, in connection with the Federal Reserve’s non-objection to our 2016 capital plan, BNY Mellon announced a stock purchase program providing for the total repurchase of up to $2.7 billion of common stock. The 2016 capital plan began in the third quarter of 2016 and continues through the second quarter of 2017. Also, in connection with the 2016 capital plan, in August 2016, BNY Mellon issued $1 billion of noncumulative perpetual preferred stock.
Share repurchases may be executed through repurchase plans designed to comply with Rule 10b5-1 and through derivative, accelerated share repurchase and other structured transactions.
Item
6. Exhibits
Pursuant to the rules and regulations of the SEC, 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 to such agreements. 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.
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.
Certificate of Designations of The Bank of New York Mellon Corporation with respect to Series C Noncumulative Perpetual Preferred Stock, dated Sept. 13, 2012.
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.
Certificate of Designations of The Bank of New York Mellon Corporation with respect to the Series E Noncumulative Perpetual Preferred Stock, dated April 27, 2015.
Certificate of Designations of The Bank of New York Mellon Corporation with respect to the Series F Noncumulative Perpetual Preferred Stock, dated July 29, 2016.
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 March 31, 2017. The Company hereby agrees to furnish to the Commission, upon request, a copy of any such instrument.