Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

[ ü ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2007

or

[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 000-52710

THE BANK OF NEW YORK MELLON CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   13-2614959

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

One Wall Street

New York, New York 10286

(Address of principal executive offices)(Zip Code)

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

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

Yes   ü     No      

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

Large accelerated filer    [ ü ]                                    Accelerated filer    [    ]                                     Non-accelerated filer    [    ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes          No   ü 

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

 

Class

 

Outstanding as of

Sept. 30, 2007

Common Stock, $.01 par value   1,138,681,554

 



Table of Contents

THE BANK OF NEW YORK MELLON CORPORATION

THIRD QUARTER 2007 FORM 10-Q

TABLE OF CONTENTS

 


 

     Page No.

Introduction

   2

Consolidated Financial Highlights (unaudited)

   3
Part I – Financial Information   

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

  

5

Overview

   5

Third quarter 2007 highlights

   6

Revenue overview

   7

Segment overview

   8

Fee and other revenue

   9

Net interest revenue

   12

Average balances and interest yields/rates

   13

Noninterest expense

   15

Income taxes

   17

Credit loss provision and net charge-offs

   18

Business segments

   18

Critical accounting estimates

   38

Consolidated balance sheet review

   43

Liquidity and dividends

   49

Capital

   52

Trading activities

   54

Asset/liability management

   55

Contractual obligations

   56

The Bank of New York historical earnings per share

   57

Supplemental information

   58

Recent accounting developments

   58

Government monetary policies and Competition

   60

Website information

   60

Item 1. Financial Statements:

   61

Consolidated Income Statement (unaudited)

   61

Consolidated Balance Sheet (unaudited)

   62

Consolidated Statement of Cash Flows (unaudited)

   63

Consolidated Statement of Changes in Shareholders’ Equity (unaudited)

   64

Notes to Consolidated Financial Statements

   65

Item 4. Controls and Procedures.

   83

Forward-Looking Statements and Risk Factors

   84
Part II – Other Information   

Item 1. Legal and Regulatory Proceedings.

   86

Item 1A. Risk Factors.

   87

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

   87

Item 6. Exhibits.

   87

Signature

   89

Index to Exhibits

   90

 


Table of Contents

Introduction


 

On July 1, 2007, The Bank of New York Company, Inc. (“The Bank of New York”) and Mellon Financial Corporation (“Mellon”) merged into The Bank of New York Mellon Corporation (“The Bank of New York Mellon” or “BNY Mellon”), with BNY Mellon being the surviving entity. The merger was accounted for as a purchase of Mellon for accounting and financial reporting purposes. As a result, the financial results for the third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the first half of 2007 and all periods in 2006 include legacy The Bank of New York only. In this Quarterly Report on Form 10-Q, references to “our,” “we,” “us,” the “company,” the “Company,” the “Corporation” and similar terms for periods prior to July 1, 2007 refer to The Bank of New York, and references to “our,” “we,” “us,” the “Company,” the “Corporation” and similar terms for periods on or after July 1, 2007 refer to BNY Mellon.

The Bank of New York Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset management and wealth management, asset servicing, issuer services, clearing and execution services and treasury services through a worldwide client-focused team. We have more than $20 trillion in assets under custody and administration, more than $1.1 trillion in assets under management and service $11 trillion in outstanding debt.

 

The merger transaction resulted in The Bank of New York shareholders receiving .9434 shares of The Bank of New York Mellon common stock for each share of The Bank of New York common stock outstanding on the closing date of the merger. All legacy The Bank of New York earnings per share and common share outstanding amounts, in this Form 10-Q, have been restated to reflect this exchange ratio. See page 57 for additional information.

Throughout this Quarterly Report on Form 10-Q, certain measures, which are noted, exclude certain items. We believe the presentation enhances investor understanding of period to period results. We believe they reflect the principal basis on which our management monitors financial performance.


 

2     The Bank of New York Mellon Corporation


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited)

 

The Bank of New York Mellon Corporation                                   
         

Legacy The   

Bank of New York only  

        
      Quarter ended        Nine months ended (a)

(dollar amounts in millions, except per share

 amounts and unless otherwise noted)

   Sept. 30,
2007
   June 30,
2007
   Sept. 30,
2006
        Sept. 30,
2007
   Sept. 30,
2006
Reported results                 

Net income

   $ 640    $ 445    $ 352      $ 1,519    $ 1,222

Basic EPS (b)

     0.57      0.63      0.49        1.79      1.71

Diluted EPS (b)

     0.56      0.62      0.49        1.76      1.69
Continuing operations                 

Fee and other revenue

   $ 2,931    $ 1,580    $ 1,263      $ 5,986    $ 3,898

Net interest revenue

     669      452      351        1,548      1,048
                                      

Total revenue

   $ 3,600    $ 2,032    $ 1,614      $ 7,534    $ 4,946

Income from continuing operations

   $ 642    $ 448    $ 298      $ 1,527    $ 1,049

EPS from continuing operations (b):

                

Basic

   $ 0.57    $ 0.63    $ 0.42      $ 1.80    $ 1.47

Diluted

     0.56      0.62      0.41        1.77      1.45

Diluted excluding merger and integration expense (c)

     0.67      0.66      0.50        1.96      1.53

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

     0.74      0.69      0.51        2.10      1.57

Return on average tangible common equity

     46.01%      37.27%      21.44%        41.20%      26.15%

Return on average tangible common equity excluding merger and integration expense (c)

     54.02         39.81         25.94           45.43         27.71   

Return on average common equity

     8.89         15.54         11.61           11.85         14.03   

Return on average common equity excluding merger and integration expense (c)

     10.64         16.65         14.05           13.16         14.87   

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

     81%      78%      78%        79%      78%

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

   $ 290    $ 274    $ 248      $ 278    $ 260

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

     30%      32%      29%        31%      30%

Pre-tax operating margin (FTE)

     25%      32%      26%        29%      32%

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

     35%      36%      33%        36%      34%

Net interest margin (FTE)

     2.02%      2.01%      1.89%        2.05%      1.93%

Net interest revenue (FTE)

   $ 674    $ 454    $ 358      $ 1,557    $ 1,069

Assets under custody and administration (in trillions)

   $ 20.8    $ 14.9    $ 12.2      $ 20.8    $ 12.2

Equity securities

     36%      32%      31%        36%      31%

Fixed income securities

     64         68         69           64         69   

Cross-border assets (in trillions)

   $ 8.3    $ 6.2    $ 4.2      $ 8.3    $ 4.2

Assets under management (in billions) :

                

Equity securities

   $ 456    $ 43    $ 36      $ 456    $ 36

Fixed income securities

     215      22      20        215      20

Overlay and alternative investments

     160      47      41        160      41

Money market

     275      41      34        275      34
                                      

Total assets under management

   $ 1,106    $ 153    $ 131      $ 1,106    $ 131

Securities lending cash collateral assets (in billions)

   $ 575    $ 365    $ 368      $ 575    $ 368

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

                

Basic

     1,125,165      709,783      713,946        849,259      715,405

Diluted

     1,140,797      722,661      723,272        862,669      724,249

 

The Bank of New York Mellon Corporation     3


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited) (continued)

 

The Bank of New York Mellon Corporation                                          
          

Legacy The              

Bank of New York only              

            
      Quarter ended          Nine months ended (a)  

(dollar amounts in millions, except per share

 amounts and unless otherwise noted)

               Sept. 30,
2007
                June 30,
2007
                Sept. 30,
2006
          Sept. 30,
2007
    Sept. 30,
2006
 

Capital ratios

             

Tier I capital ratio (d)

     9.12%       8.09%       8.17%          9.12%       8.17%  

Total (Tier I plus Tier II capital ratio) (d)

     13.05           12.07           12.32              13.05           12.32      

Adjusted tangible shareholders’ equity to assets ratio (d)(e)

     5.31           4.53           5.58              5.31           5.58      

Return on average assets

     1.39%       1.57%       1.19%          1.53%       1.41%  

Return on average assets excluding merger and integration costs (c)

     1.66           1.68           1.44              1.70           1.49      

Return on average tangible assets

     1.78           1.74           1.25              1.81           1.48      

Return on average tangible assets excluding merger and integration costs (c)

     2.10           1.86           1.51              1.99           1.57      

Selected average balances

             

Interest-earning assets

   $ 133,534     $ 90,557     $ 76,088        $ 101,256     $ 74,238  

Total assets

     183,828       114,323       108,864          133,699       108,472  

Interest-bearing deposits

     80,870       53,610       43,905          59,582       42,738  

Noninterest-bearing deposits

     26,466       15,334       10,687          18,944       10,561  

Shareholders’ equity

     28,669       11,566       10,262          17,234       10,012  

Credit loss provision and net charge-offs

             

Total provision

   $ -     $ (15 )   $ (4 )      $ (30 )   $ (5 )

Total net (charge-offs) recoveries

     (35 )     5       -          (27 )     10  

Loans

             

Allowance for loan losses as a percent of total loans

     0.65%       0.73%       1.00%          0.65%       1.00%  

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

     0.72           0.85           1.16              0.72           1.16      

Total allowance for credit losses as a percent of total loans

     1.00           1.08           1.40              1.00           1.40      

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

     1.11           1.25           1.63              1.11           1.63      

Nonperforming assets

             

Total nonperforming assets

   $ 37     $ 27     $ 38        $ 37     $ 38  

Nonperforming assets ratio

     0.1%       0.1%       0.1%          0.1%       0.1%  

Other

             

Employees

     40,600       23,200       20,500          40,600       20,500  

Book value per common share (b)

   $ 25.43     $ 16.50     $ 14.52        $ 25.43     $ 14.52  

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

     1,138,682       717,000       720,751          1,138,682       720,751  

Dividends per share (b)

   $ 0.24     $ 0.23     $ 0.23        $ 0.71     $ 0.68  

Dividend yield

     2.17%       2.12%       2.46%          2.17%       2.46%  

Closing common stock price per share (b)

   $ 44.14     $ 43.93     $ 37.38        $ 44.14     $ 37.38  

Market capitalization at period-end

     50,266       31,495       26,938            50,266       26,938  
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results while the results for the second quarter 2007 and all periods in 2006 include legacy The Bank of New York only.
(b) Legacy The Bank of New York earnings per share and all other share-related data are presented in post-merger share count terms. See page 57 for additional information. Also see page 58 for a reconciliation of reported net income and diluted earnings per share to non-GAAP net income and diluted earnings per share.
(c) Calculated excluding pre-tax charges associated with merger and integration expenses ($218 million in the third quarter of 2007, $47 million in the second quarter of 2007 and $89 million in the third quarter of 2006, $280 million in the first nine months of 2007 and $89 million in the first nine months of 2006).
(d) Includes discontinued operations.
(e) Includes deferred tax liabilities of $1.947 billion for the third quarter and first nine months of 2007, and $149 million for the second quarter of 2007, related to non-tax deductible identifiable intangible assets. There were no deferred tax liabilities in the third quarter and first nine months of 2006.

 

4     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

BNY Mellon’s actual results of future operations may differ from those estimated or anticipated in certain forward-looking statements contained herein for reasons which are discussed below and under the heading “Forward-Looking Statements and Risk Factors.” When used in this report, words such as “estimate,” “forecast,” “project,” “anticipate,” “confident,” “target,” “expect,” “intend,” “continue,” “seek,” “believe,” “plan,” “goal,” “could,” “should,” “may,” “will,” “strategy,” “synergies,” “opportunities,” “trends” and words of similar meaning, signify forward-looking statements in addition to statements specifically identified as forward-looking statements. In addition, certain business terms used in this document are defined in The Bank of New York’s 2006 Annual Report on Form 10-K.

Overview

Our businesses

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

BNY Mellon’s businesses benefit from the global growth in financial assets. Our success is based on continuing to provide superior client service, strong investment performance and the highest fiduciary standards. Our goal is to deploy capital effectively to our businesses to accelerate their long-term growth and deliver top-tier returns to our shareholders.

 

Our long-term financial goal is focused on achieving superior total returns for shareholders by generating first quartile earnings per share growth over time relative to a group of 12 peer companies. Key components of this strategy include: providing the best client service versus peers (as measured through independent surveys); strong investment performance (relative to investment benchmarks); above median revenue growth (relative to peer companies for each of our businesses); competitive margins; and positive operating leverage.

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

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

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

 

  ·  

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

  ·  

Many of our products complement one another.

  ·  

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

  ·  

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

  ·  

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

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

In 2007, we established a Tier I capital target of 8% as our principal capital measure. We also revised our secondary targeted capital ratio from 5% of tangible common equity to 5% of adjusted tangible common equity. The change from “tangible common equity” to “adjusted tangible common equity” reflects the


 

The Bank of New York Mellon Corporation     5


Table of Contents

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

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


 

impact of the merger with Mellon and associated goodwill, intangibles and related deferred tax liability. The goodwill and intangibles created in the merger have no economic impact, but reduce tangible equity.

How we reported results

All information in this Quarterly Report on Form 10-Q is reported on a continuing operations basis, unless otherwise noted. For a description of discontinued operations, see Note 5 of Notes to Consolidated Financial Statements.

Certain amounts are presented on a fully taxable equivalent (FTE) basis. We believe that this presentation allows for comparison of amounts arising from both taxable and tax-exempt sources and is consistent with industry practice. The adjustment to an FTE basis has no impact on net income. In addition, third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the first half of 2007 and all periods in 2006 include legacy The Bank of New York only.

Third quarter 2007 highlights

We reported third quarter net income of $640 million and diluted earnings per share of 56 cents, and income from continuing operations of $642 million and diluted earnings per share of 56 cents. This compares to net income of $352 million, or 49 cents of diluted earnings per share, and income from continuing operations of $298 million, or 41 cents of diluted earnings per share, in the third quarter of 2006. The third quarter of 2007 included merger and integration expenses of $218 million (pre-tax), which is approximately 11 cents per share. Excluding this amount, diluted earnings per share from continuing operations in the third quarter of 2007 was 67 cents per share. The third quarter of 2006 included merger and integration expenses of $89 million (pre-tax), which is approximately 9 cents per share. Excluding this amount, diluted earnings per share from continuing operation in the third quarter of 2006 was 50 cents per share.

Third quarter 2007 results include:

The net pre-tax benefit of $27 million from a negotiated settlement received for early termination

of a contract that occurred in 2005 associated with the clearing business, as well as the pre-tax write-offs of the value of the remaining interest in a hedge fund manager that was disposed of in 2006 ($32 million) and internally developed software ($6 million). In addition, the impact of the merger in the third quarter on the New York state marginal tax rate required a recalculation of the yield on our leverage lease portfolio. The effect was a $22 million reduction in net interest revenue, together with a $45 million tax benefit recorded as a reduction to taxes. The net impact of all of these items increased earnings per share by approximately 1 cent.

Year-to-date net income was $1.519 billion, or $1.76 of diluted earnings per share, compared to $1.222 billion, or $1.69 of diluted earnings per share for the same period in 2006. Year-to-date income from continuing operations was $1.527 billion, or $1.77 of diluted earnings per share compared with $1.049 billion, or $1.45 of diluted earnings per share in 2006.

Performance highlights for the third quarter of 2007 include:

 

  ·  

Assets under management, excluding securities lending assets, amounted to $1.106 trillion at Sept. 30, 2007 compared to $153 billion at June 30, 2007. Assets under custody and administration amounted to $20.8 trillion at Sept. 30, 2007 compared with $14.9 trillion at June 30, 2007. Both increases primarily resulted from the merger with Mellon;

  ·  

Asset and wealth management fees totaled $854 million in the third quarter of 2007 compared with $133 million in the third quarter of 2006. The increase was primarily due to the merger with Mellon as well as net new business and higher equity market levels;

  ·  

Asset servicing revenue was $720 million in the third quarter of 2007 compared with $346 million in the third quarter of 2006. The increase was primarily due to the merger with Mellon, as well as a record level of securities lending revenue and increased client activity related to market volatility and net new business;

  ·  

Issuer services revenue was $436 million in the third quarter of 2007 compared with

 


6     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

 

$194 million in the third quarter of 2006. The increase was primarily due to the Acquired Corporate Trust Business and also reflects a strong quarter in both depositary receipts and global products within Corporate Trust, and to a lesser extent the merger with Mellon;

  ·  

Performance fees were a negative $3 million reflecting the impact of market volatility during the third quarter of 2007 on certain alternative and quantitative strategies as well as weaker relative performance compared to prior quarters;

  ·  

Net interest revenue of $669 million increased in the third quarter of 2007 compared with $351 million in the third quarter of 2006. The increase was primarily due to the merger with Mellon, as well as growth in client deposits and wider spreads on investment securities;

  ·  

Noninterest expense was $2.706 billion in the third quarter of 2007 compared with $1.196 billion in the third quarter of 2006. The increase resulted from the merger with Mellon as well as $218 million of merger and integration expense and $131 million of intangible amortization expense recorded in the third quarter of 2007. The current quarter also included $79 million of merger related synergies ($62 million net of open positions eliminated); and

  ·  

Asset quality remained strong.

Revenue overview

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

 

Fee and other revenue. In the third quarter of 2007, fee and other revenue represented 81% of total revenue, on a fully taxable equivalent basis, compared with 78% in the third quarter of 2006.

Since fee and other revenue constitutes the majority of our total revenue, we discuss it in greater detail by type of fee in the following sections, as well as in the business segments section beginning on page 18.

There we note the more specific drivers of such revenue and the factors that caused the various types of fee and other revenue to be higher or lower in the third quarter of 2007 compared with the third quarter of 2006. The business segments discussion combines, for each business sector, all types of fee and other revenue generated directly by that sector as well as fee and other revenue transferred between sectors under revenue transfer agreements, with net interest revenue generated directly by or allocated to that sector. The discussion of revenue by business segment is fundamental to an understanding of BNY Mellon’s results as it represents a principal measure by which management reviews the performance of our businesses compared with performance in prior periods, with the operating plan and with the performance of our competitors.

Net interest revenue comprised 19% of total revenue, on an FTE basis, in the third quarter of 2007 compared with 22% in the third quarter of 2006. Net interest revenue is generated from a combination of loans, investment securities, interest-bearing deposits with banks and federal funds sold and securities purchased under resale agreements. For more information, see page 12.


 

The Bank of New York Mellon Corporation     7


Table of Contents

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

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


 

Segment overview

 

Segment/Sector    Primary Types of Fee Revenue

Asset & Wealth Management Segment

    Asset Management Sector

  

·      Asset and wealth management fees from:

Institutional clients

Mutual funds

Private clients

·      Performance fees

·      Distribution and servicing fees

    Wealth Management Sector

  

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

Institutional Services Segment

    Asset Servicing Sector

  

·      Asset servicing fees, including:

Institutional trust and custody fees

Broker-dealer services

Securities lending

·      Foreign exchange and other trading activities

    Issuer Services Sector

  

·      Issuer services fees, including:

Corporate Trust

Depositary receipts

Shareowner services

    Clearing & Execution Services Sector

  

·      Clearing and execution services, including:

Broker Dealer and Registered Investment Advisor services

Electronic trading services

    Treasury Services Sector

  

·      Treasury services fees, including:

Global payment services

Working capital solutions

Global markets and institutional banking services

·      Financing-related fees

Other Segment

  

·      Business exits

·      Corporate Treasury activities

·      Merger and integration charges

 

8     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

Fee and other revenue

 

Fee and other revenue    3Q07   

Legacy The Bank

      of New York only      

  

3Q07

vs.
2Q07

   3Q07
vs.
3Q06
   Year-to-date (a)   

YTD07

vs.

YTD06

(in millions unless otherwise noted)       2Q07    3Q06          2007    2006   

Securities servicing fees:

                       

Asset servicing

   $ 720    $ 427    $ 346    69%    108%    $ 1,540    $ 1,046    47%

Issuer services

     436      367      194    19       125         1,122      555    102   

Clearing and execution services

     304      291      302    4       1         877      981    (11)   

Total securities servicing fees

     1,460      1,085      842    35       73         3,539      2,582    37   

Asset and wealth management fees

     854      168      133    408       542         1,173      393    198   

Performance fees

     (3)      21      3    N/M       N/M         32      17    88   

Foreign exchange and other trading activities

     238      117      83    103       187         482      322    50   

Treasury services

     122      55      55    122       122         227      158    44   

Distribution and servicing

     95      2      2    N/M       N/M         99      4    N/M   

Financing-related fees

     51      61      62    (16)      (18)        164      189    (13)  

Investment income

     22      39      34    (44)      (35)        97      108    (10)  

Securities gains (losses)

     (9)      (2)      1    N/M       N/M         (9)      -    N/M   

Other (b)

     101      34      48    197       110         182      125    46   

Total fee and other revenue

   $ 2,931    $ 1,580    $ 1,263    86%    132%    $ 5,986    $ 3,898    54%

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

     81%      78%      78%            79%      78%   

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

   $ 1,106    $ 153    $ 131    623%    744%    $ 1,106    $ 131    744%

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

   $ 20.8    $ 14.9    $ 12.2    40%    70%    $ 20.8    $ 12.2    70%
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results, while second quarter 2007 and the results for all periods in 2006 include legacy The Bank of New York only.
(b) Includes net economic value payments of $3 million and $13 million for the third and second quarters of 2007 and $41 million for the nine months ended Sept. 30, 2007.
N/M - Not meaningful.

 

Fee and other revenue

The results of many of our businesses are influenced by client activities that vary by quarter. For instance, we experience seasonal increases in securities lending and depositary receipts reflecting European dividend distribution during the second quarter of the year, and to a lesser extent, in the fourth quarter of the year. Also, consistent with an overall decline in securities industry activity in the summer, we typically experience a seasonal decline in the third quarter. However, the market volatility in the third quarter of 2007 resulted in higher than normal growth in foreign exchange and other trading revenue, securities lending revenue, depositary receipts and clearing and execution fees.

The increase in fee and other revenue versus the prior year quarter primarily reflects the merger with Mellon. In addition, growth in securities servicing

fees reflects higher revenue from the Acquired Corporate Trust Business, a record level of securities lending revenue and a strong quarter in depositary receipts. The increase in foreign exchange and other trading fees resulted primarily from a significant increase in currency volatility. The sequential-quarter increase in fee and other revenue primarily reflects the merger with Mellon, growth in securities servicing and higher foreign exchange and other trading activities.

Securities servicing fees

The increase in securities servicing fees compared to the third quarter of 2006 reflects the merger with Mellon, the Acquired Corporate Trust Business, as well as strong growth in Issuer services and Asset servicing fees, partially offset by the BNY ConvergEx transaction. Securities servicing fees were up sequentially, reflecting the merger with


 

The Bank of New York Mellon Corporation     9


Table of Contents

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

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


 

Mellon and growth in Issuer services, Asset servicing and Clearing and execution services. See the “Institutional Services Segment” in “Business Segments” for additional details.

Asset and wealth management fees

Asset and wealth management fees increased from both the third quarter of 2006 and second quarter of 2007 primarily due to the merger with Mellon, net new business and improved equity markets.

 

Asset and wealth management revenue - by business sector
(in millions)   3Q07   3Q06 (a)   3Q07
vs.
3Q06

Asset Management:

     

Mutual funds

  $ 307   $ 2   N/M%

Institutional clients

    331     64   417   

Private clients

    46     12   283   
             

Total

    684     78   777   

Wealth Management

    152     46   230   

Clearing and execution services

    12     9   33   

Other

    6     -   N/M   

Total asset and wealth management fee revenue

  $ 854   $ 133   542%
(a) Legacy The Bank of New York only.

Total assets under management for the Asset and Wealth management segment were $1.106 trillion at Sept. 30, 2007, up from $131 billion at Sept. 30, 2006 and $153 billion at June 30, 2007. The increases from Sept. 30, 2006 and June 30, 2007 resulted from the merger with Mellon, net new business and improved markets. Net asset flows totaled $29 billion in the third quarter of 2007 resulting from $27 billion of money market inflows and $2 billion of long-term inflows.

A large category of Asset and Wealth management fees are from managed mutual funds generated in the Asset Management sector. These fees are based on the daily average net assets of each fund and the basis point management fee paid by that fund. Managed mutual fund revenue was $307 million compared with $2 million in the third quarter of 2006. The increase resulted from the merger with Mellon.

Performance fees

Performance fees are generally calculated as a percentage of a portfolio’s performance in excess of a benchmark index or a peer group’s performance. There is an increase/decrease in incentive expense with a related change in performance fees.

Performance fees were a negative $3 million in the third quarter of 2007, a decrease of $6 million compared with the third quarter of 2006 and a decrease of $24 million compared with the second quarter of 2007, reflecting the impact of market volatility during the third quarter of 2007 on certain alternative and quantitative strategies as well as weaker relative performance.

Foreign exchange and other trading activities

Foreign exchange and other trading activities revenue, which is primarily reported in the Asset Servicing sector, increased by $155 million, or 187%, to $238 million compared with the third quarter of 2006 and increased $121 million compared with the second quarter of 2007. The increase compared to both the third quarter of 2006 and second quarter of 2007 was due to the merger with Mellon, higher client volumes, the favorable impact that resulted from increased currency volatility, and a higher valuation of the credit derivative portfolio caused by the widening of credit spreads.

Treasury services

Treasury services includes fees related to funds transfer, cash management, and liquidity management. Treasury services fees increased $67 million from both the second quarter of 2007 and third quarter of 2006 reflecting the merger with Mellon.

Distribution and servicing fees

Distribution and servicing fees earned from mutual funds are primarily based on average assets in the funds and the sales of funds managed or administered by BNY Mellon and are primarily reported in the Asset Management sector. These fees, which include 12b-1 fees, fluctuate with the overall level of net sales, the relative mix of sales between share classes and the funds’ market values. The $93 million increase in distribution and servicing fee revenue in the third quarter of 2007 compared with both the third quarter of 2006 and second quarter of 2007 primarily reflects the merger with Mellon, as well as higher sales volumes and higher market values of mutual funds. The impact of these fees on income in any one period can be more than offset by distribution and servicing expense


 

10     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

paid to other financial intermediaries to cover their costs for distribution and servicing of mutual funds. Distribution and servicing expense is recorded as noninterest expense on the income statement.

Financing-related fees

Financing-related fees, which are primarily reported in the Treasury Services sector, include capital markets and investment banking fees, loan commitment fees and credit-related trade fees. Financing-related fees decreased from the third quarter 2006 and second quarter 2007 reflecting a lower level of credit-related activities consistent with our strategic direction.

Investment income

Investment income, which is primarily reported in the Other segment and the Asset Management sector, includes the gains and losses on private equity investments and seed capital investments, income from insurance contracts, and lease residual gains and losses. The decline compared to prior periods principally reflects the lower market value of seed capital investments due to the market environment. Venture capital income was $17 million in the third quarter of 2007, down from $18 million in the second

quarter of 2007 and down from $23 million in the third quarter of 2006. On a year-to-date basis, venture capital income was $53 million, down from $68 million a year ago.

Securities gains (losses)

The $9 million securities loss for the quarter reflects a $13 million loss on CDO exposure.

Other revenue

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


 

Other revenue           

Legacy The Bank

of New York only

         
     Quarter ended      Nine months ended (a)  
(in millions)    Sept. 30,
2007
     June 30,
2007
   Sept. 30,
2006
     Sept. 30,
2007
   Sept. 30,
2006
 

Expense reimbursements from joint ventures

   $ 31      $ -    $ -      $ 31    $ -  

Merchant card fees

     15        -      -        15      -  

Asset-related gains (losses)

     (5 )      5      40        4      92  

Equity investment income

     13        12      11        38      36  

Net economic value payments

     3        13      -        41      -  

Other

     44        4      (3 )      53      (3 )

Other revenue

   $ 101      $ 34    $ 48      $ 182    $ 125  
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the second quarter 2007 and all periods in 2006 include legacy The Bank of New York only.

 

Other revenue increased sequentially reflecting the merger with Mellon and a settlement received for early termination of a contract that occurred in 2005 associated with the clearing business ($28 million), partially offset by lower net economic value payments. The third quarter of 2007 included $3 million and the second quarter of 2007 included $13 million of net economic value payments primarily from European, Asian, and Latin American Corporate Trust clients’ net revenue that has not yet transferred. Upon conversion, revenue from Corporate Trust clients is reflected in Issuer Services fees and net interest revenue.

 

Year-to-date 2007 compared with year-to-date 2006

Fee and other revenue for the first nine months of 2007 increased $2,088 million, or 54%, compared with the first nine months of 2006. This increase primarily reflects the merger with Mellon, higher issuer services revenue including the impact of the Acquired Corporate Trust Business, and higher asset servicing revenue driven by custody, fund services, and broker dealer services, as well as higher foreign exchange and other trading activities, partially offset by the BNY ConvergEx transaction.


 

The Bank of New York Mellon Corporation     11


Table of Contents

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

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


 

Net interest revenue

 


Net interest revenue        

Legacy The Bank

of New York only

   3Q07
vs.
2Q07
   3Q07
vs.
3Q06
        YTD07
vs.
YTD06
               Year-to-date (a)   
(dollar amounts in millions)    3Q07    2Q07    3Q06          2007    2006   

Net interest revenue

   $ 669    $ 452    $ 351    48%    91%    $ 1,548    $ 1,048    48%  

Tax equivalent adjustment

     5      2      7    N/M        N/M          9      21    N/M     

Net interest revenue (FTE)

   $ 674    $ 454    $ 358    48%    88%      $ 1,557    $ 1,069    46%  

Net interest margin (b)

     2.02%      2.01%      1.89%    1 bp    13 bp      2.05%      1.93%    12 bp

(a)

Third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the second quarter 2007 and all periods in 2006 include legacy The Bank of New York only.

(b)

Calculated on a continuing operations basis even though the balance sheet, in accordance with GAAP, is not restated for discontinued operations.

N/M - Not meaningful.

bp - basis points.

 

Net interest revenue on an FTE basis totaled $674 million in the third quarter of 2007, compared with $358 million in the third quarter of 2006 and $454 million in the second quarter of 2007. The net interest margin was 2.02% in the third quarter of 2007, compared with 1.89% in the third quarter of 2006 and 2.01% in the second quarter of 2007.

The increase in net interest revenue from both prior periods principally reflects the merger with Mellon as well as a higher level of average interest-earning assets driven by growth in client deposits, wider spreads on investment securities, lower bond premium amortization due to slowing prepayments and a positive day variance relative to the sequential quarter. This growth was partially offset by the required recalculation of the yield on leverage leases under

SFAS 13, for changes to New York state tax rates resulting from the merger with Mellon ($22 million). The increase in interest-earning assets reflects the impact of higher deposits related to the Acquired Corporate Trust Business of $14 billion in the third quarter of 2007 compared with $9 billion in the second quarter of 2007, as well as higher client activity across our businesses which drove higher deposits.

For the nine months ended Sept. 30, 2007, net interest revenue on an FTE basis was $1.557 billion compared with $1.069 billion in 2006, while the net interest margin was 2.05% in the first nine months of 2007 and 1.93% in the first nine months of 2006. The increase in net interest revenue resulted from the factors mentioned above.


 

12     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

The Bank of New York Mellon Corporation

 

AVERAGE BALANCES AND INTEREST YIELDS/RATES (a)
                   

Legacy The Bank

of New York only

     Quarter ended
     Sept. 30, 2007    June 30, 2007    Sept. 30, 2006
(dollar amounts in millions)    Average
balance
     Average
yields/rates
   Average
balance
     Average
yields/rates
   Average
balance
     Average
yields/rates

Assets

                 

Interest-earning assets:

                 

Interest-bearing deposits with banks (primarily foreign)

   $ 34,461      4.83%    $ 20,558      4.54%    $ 16,033      4.11%

Federal funds sold and securities under resale agreements

     5,504      5.26          5,846      5.25         1,907      4.63   

Margin loans

     5,293      6.29          5,563      6.31         5,158      6.54   

Non-margin loans:

                 

Domestic offices

     27,044      5.17          19,170      5.04         18,184      4.78   

Foreign offices

     13,180      5.50          12,584      5.70         10,210      5.80   
                                   

Total non-margin loans

     40,224      5.28          31,754      5.30         28,394      5.14   

Securities

                 

U.S. government obligations

     401      4.59          87      4.90         198      4.24   

U.S. government agency obligations

     11,671      5.56          2,775      5.20         3,427      4.95   

Obligations of states and political subdivisions

     734      6.55          77      8.65         99      8.67   

Other securities

     33,361      5.69          22,572      5.22         18,395      5.48   

Trading securities

     1,885      3.93          1,325      4.27         2,477      4.69   
                                   

Total securities

     48,052      5.60          26,836      5.17         24,596      5.33   
                                   

Total interest-earning assets

     133,534      5.32          90,557      5.15         76,088      5.07   

Allowance for credit losses

     (303 )         (290 )         (346 )   

Cash and due from banks

     5,013           2,631           2,226     

Other assets

     45,541           21,380           17,611     

Assets of discontinued operations

     43             45             13,285       

Total assets

   $ 183,828           $ 114,323           $ 108,864       

Liabilities and shareholders’ equity

                 

Interest-bearing liabilities:

                 

Money market rate accounts

   $ 17,204      3.38%    $ 6,406      2.87%    $ 5,117      2.83%

Savings

     793      3.09          423      1.92         460      0.74   

Certificates of deposit of $100,000 & over

     3,025      5.37          2,679      5.23         4,310      5.42   

Other time deposits

     1,392      6.32          684      5.36         294      5.03   

Foreign offices

     58,456      3.78          43,418      3.64         33,724      3.43   
                                   

Total interest-bearing deposits

     80,870      3.79          53,610      3.64         43,905      3.54   

Federal funds purchased and securities under repurchase agreements

     4,655      4.29          1,377      4.79         2,728      5.02   

Other funds borrowed

     2,790      4.90          2,321      4.22         1,834      5.99   

Payables to customers and broker-dealers

     5,316      3.54          5,154      3.63         4,657      3.62   

Long-term debt

     14,767      5.47          10,042      5.38         8,339      5.37   
                                   

Total interest-bearing liabilities

     108,398      4.06          72,504      3.92         61,463      3.93   

Total noninterest-bearing deposits

     26,466           15,334           10,687     

Other liabilities

     20,252           14,874           13,167     

Liabilities of discontinued operations

     43             45             13,285       

Total liabilities

     155,159             102,757             98,602       

Shareholders’ equity

     28,669             11,566             10,262       

Total liabilities and shareholders’ equity

   $ 183,828           $ 114,323           $ 108,864       

Net interest margin:

                 

Taxable equivalent basis

            2.02%             2.01%             1.89%
(a) Average balances and rates have been impacted by allocations made to match assets of discontinued operations with liabilities of discontinued operations.

Note:  Interest and average yields/rates were calculated on a taxable equivalent basis, at tax rates approximating 35%, using dollar amounts in thousands and actual number of days in the years, and are before the effect of reserve requirements.

 

The Bank of New York Mellon Corporation     13


Table of Contents

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

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


 

The Bank of New York Mellon Corporation

 

AVERAGE BALANCES AND INTEREST YIELDS/RATES (a)                    
                

Legacy The Bank

of New York only

     Nine months ended
     Sept. 30, 2007 (b)    Sept. 30, 2006
(dollar amounts in millions)    Average
balance
     Average
yields/rates
   Average
balance
     Average
yields/rates

Assets

           

Interest-earning assets:

           

Interest-bearing deposits with banks (primarily foreign)

   $ 22,932      4.65%    $ 12,720      3.91%

Federal funds sold and securities under resale agreements

     5,266      5.24          1,775      3.99   

Margin loans

     5,418      6.31          5,438      6.08   

Non-margin loans:

           

Domestic offices

     21,844      5.12          17,543      4.68   

Foreign offices

     12,368      5.67          10,050      5.49   
                       

Total non-margin loans

     34,212      5.32          27,593      4.97   

Securities

           

U.S. government obligations

     193      4.69          213      4.23   

U.S. government agency obligations

     5,816      5.39          3,795      4.65   

Obligations of states and political subdivisions

     301      6.88          109      8.42   

Other securities

     25,133      5.44          18,717      5.19   

Trading securities

     1,985      4.49          3,878      4.55   
                       

Total securities

     33,428      5.38          26,712      5.03   
                       

Total interest-earning assets

     101,256      5.24          74,238      4.87   

Allowance for credit losses

     (293 )         (341 )   

Cash and due from banks

     3,365           3,187     

Other assets

     29,313           17,532     

Assets of discontinued operations

     58             13,856       

Total assets

   $ 133,699           $ 108,472       

Liabilities and shareholders’ equity

           

Interest-bearing liabilities:

           

Money market rate accounts

   $ 9,967      3.18%    $ 5,251      2.57%

Savings

     545      2.47          461      1.29   

Certificates of deposit of $100,000 & over

     2,945      5.35          4,221      5.03   
           

Other time deposits

     890      5.83          629      4.67   

Foreign offices

     45,235      3.71          32,176      3.12   
                       

Total interest-bearing deposits

     59,582      3.72          42,738      3.25   

Federal funds purchased and securities under repurchase agreements

     2,531      4.52          2,532      4.65   

Other funds borrowed

     2,331      4.14          2,045      4.54   

Payables to customers and broker-dealers

     5,074      3.59          4,972      3.34   

Long-term debt

     11,254      5.46          8,167      5.13   
                       

Total interest-bearing liabilities

     80,772      3.99          60,454      3.61   

Total noninterest-bearing deposits

     18,944           10,561     

Other liabilities

     16,691           13,589     

Liabilities of discontinued operations

     58             13,856       

Total liabilities

     116,465             98,460       

Shareholders’ equity

     17,234             10,012       

Total liabilities and shareholders’ equity

   $ 133,699           $ 108,472       

Net interest margin:

           

Taxable equivalent basis

            2.05%             1.93%
(a) Average balances and rates have been impacted by allocations made to match assets of discontinued operations with liabilities of discontinued operations.
(b) Average balances and rates for nine months ended 2007 include three months of the combined company’s results and six months of legacy The Bank of New York.

Note:  Interest and average yields/rates were calculated on a taxable equivalent basis, at tax rates approximating 35%, using dollar amounts in thousands and actual number of days in the years, and are before the effect of reserve requirements.

 

14     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

Noninterest expense

 

Noninterest expense          Legacy The Bank
of New York Only
   3Q07
vs.
2Q07
   3Q07
vs.
3Q06
   Year-to-date (a)    YTD07
vs.
YTD06
(in millions)    3Q07    2Q07    3Q06          2007    2006   

Staff:

                       

Compensation

   $ 764    $ 472    $ 404    62%    89%    $ 1,695    $ 1,182    43%

Incentives

     347      171      141    103       146         665      422    58   

Employee benefits

     169      109      99    55       71         392      300    31   

Total staff

     1,280      752      644    70       99         2,752      1,904    45   

Professional, legal and other purchased services

     241      132      89    83       171         503      256    96   

Net occupancy

     144      81      70    78       106         304      206    48   

Distribution and servicing

     127      4      4    N/M       N/M         135      12    N/M   

Software

     91      57      53    60       72         202      161    25   

Furniture and equipment

     80      54      46    48       74         184      145    27   

Sub-custodian

     58      42      31    38       87         134      101    33   

Business development

     56      37      27    51       107         123      78    58   

Clearing and execution

     52      44      52    18       -         133      161    (17)  

Communications

     33      23      26    43       27         75      74    1   

Other

     195      87      51    124       282         354      174    103   

Subtotal

     2,357      1,313      1,093    80       116         4,899      3,272    50   

Merger and integration expense:

                       

The Bank of New York Mellon

     205      35      -    N/M       N/M         244      -    N/M   

Acquired Corporate Trust Business

     13      12      89    N/M       N/M         36      89    N/M   

Amortization of intangible assets

     131      29      14    N/M       N/M         188      42    N/M   

Total noninterest expense

   $ 2,706    $ 1,389    $ 1,196    95%    126%    $ 5,367    $ 3,403    58%

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

     35%      37%      40%            36%      38%   

Employees at period-end

     40,600      23,200      20,500    75%    98%      40,600      20,500    98%
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the second quarter 2007 and all periods in 2006 include legacy The Bank of New York only.

N/M - Not meaningful

 

Total noninterest expense increased compared with the third quarter of 2006 and second quarter of 2007. The merger with Mellon, the purchase of the Acquired Corporate Trust Business and the disposition of certain execution businesses in the BNY ConvergEx transaction, significantly impacted comparisons of the third quarter of 2007 to the third quarter of 2006. The net impact of these transactions increased nearly all expense categories. The results also reflect the write-off of the remaining interest in a hedge fund manager that was disposed of in 2006 ($32 million) and the write-off of internally developed software ($6 million), partially offset by $79 million in expense synergies ($62 million net of open positions eliminated), in the third quarter of 2007. The sequential quarter increase reflects the merger with Mellon and the write-off of the interest in the hedge fund manager partially offset by the expense synergies. The increase in merger and

integration expense and intangible amortization expense compared to both prior periods resulted from the merger with Mellon.

Staff expense

Given the company’s mix of fee-based businesses, which are staffed primarily with high quality professionals, staff expense comprised approximately 54% of total noninterest expense excluding merger and integration and intangible amortization in the third quarter of 2007.

Staff expense is comprised of:

  ·  

compensation expense, which includes;

  ·  

base salary expense, primarily driven by headcount;

  ·  

the cost of temporary help and overtime; and

  ·  

severance expense;


The Bank of New York Mellon Corporation      15



Table of Contents

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

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


 

  ·  

incentive expense, which includes:

  ·  

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

  ·  

stock-based compensation expense; and

  ·  

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

The increase in staff expense reflects a net increase in headcount associated with the Mellon merger and the Acquired Corporate Trust Business, the consolidation of AIB/BNY, higher incentive expense, and organic business growth, partially offset by the BNY ConvergEx transaction.

Non-staff expense

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

Non-staff expense, excluding merger and integration expense and intangible amortization expense, totaled $1.077 billion in the third quarter of 2007 compared with $449 million in the third quarter of 2006. Non-staff expense was impacted by the merger with Mellon, the Acquired Corporate Trust Business, the consolidation of AIB/BNY, and the BNY ConvergEX transaction, and included the following activity:

 

  ·  

A $123 million increase in distribution and servicing expense related to the merger with Mellon. Distribution and servicing expense represents amounts paid to other financial intermediaries to cover their costs for distribution (marketing support, administration and record keeping) and servicing of mutual funds. Generally, increases in distribution and servicing expense reflect higher net sales. Distribution and servicing expense in any one year is not fully recovered by higher distribution and service revenue; rather it contributes to future growth in mutual fund

 

management revenue reflecting the growth in mutual fund assets generated through certain distribution channels;

  ·  

The increase in professional, legal and other purchased services, business development and equipment expense reflect business growth and strategic initiatives;

  ·  

Software expense increased reflecting business growth, strategic initiatives and the write-off of internally developed software ($6 million);

  ·  

The increase in subcustodian expenses reflects increased asset values, higher transaction volumes and increased depositary receipts activity; and

  ·  

Other expense increased reflecting the write-off of the remaining interest in a hedge fund manager and organic business growth.

In the third quarter of 2007 we incurred $205 million of merger and integration expenses related to the merger with Mellon. Merger and integration expenses are comprised of the following:

 

  ·  

Personnel related—includes severance, retention, relocation expenses, stock option and restricted stock expense ($73 million)

  ·  

Transaction costs—includes investment banker and legal fees, and foundation funding ($65 million)

  ·  

Integration/conversion costs—including consulting, system conversions and staff ($52 million)

  ·  

One-time costs—includes facilities related costs, asset write-offs, vendor contract modifications, reloading and net gain (loss) on disposals ($15 million)

We also incurred $13 million of merger and integration expense associated with the Acquired Corporate Trust Business in the third quarter of 2007.

Amortization of intangible assets increased to $131 million in the third quarter of 2007 compared with $14 million in the third quarter of 2006, reflecting the merger with Mellon.

SFAS No. 123 (Revised 2004)

On Jan. 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (Revised 2004) (“SFAS 123(R)”), “Share-Based Payment”, which is


 

16     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” We adopted SFAS 123(R) using the “modified prospective” method. Under this method, compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. As of Jan. 1, 2006, we were amortizing all of our unvested stock option grants. Certain of our stock compensation grants vest when the employee retires. SFAS 123(R) requires the completion of expensing of new grants with this feature by the first date the employee is eligible to retire. For grants prior to Jan. 1, 2006, we will continue to expense them over their stated vesting period. As a result of the early retirement provisions, the adoption of SFAS 123(R) increased pre-tax expense in 2006 by $12 million.

During the nine months ended Sept. 30, 2007, approximately 8 million options were granted. In the third quarter of both 2007 and 2006, we recorded $20 million and $11 million of stock option expense, respectively. The SFAS 123(R) impact related to early retirement, stemming from stock-based compensation grants, was $4 million for the third quarter of 2007 and $17 million in the first nine months of 2007.

The fair value of options granted in 2007 and 2006 were estimated at the grant date using the following weighted average assumptions:

 

Assumptions (a)   Quarter ended    Nine months ended
     Sept. 30,
2007
  Sept. 30,
2006 (b)
   Sept. 30,
2007
  Sept. 30,
2006

Dividend yield

  2.22%   -%    2.42%   2.77%

Expected volatility

  22.39      -       22.94      22.43   

Risk free interest rates

  4.76      -       4.46      4.72   

Expected options lives (in years)

  6      -       6      6   
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results while the results for the third quarter and year-to-date 2006 include legacy The Bank of New York only.
(b) There were no stock options granted in the third quarter of 2006.

 

Year-to-date 2007 compared with year-to-date 2006

Total noninterest expense was $5.367 billion in the first nine months of 2007, compared with $3.403 billion in the first nine months of 2006. The increase primarily reflects the same factors impacting the quarterly results.

Income taxes

The effective tax rate for the third quarter of 2007 was 28.2%, compared to 29.4% in the third quarter of 2006 and 31.9% in the second quarter of 2007. The lower effective tax rate in the third quarter of 2007 compared with the third quarter of 2006 reflects the impact of the recalculation of the yield on the leverage lease portfolio under SFAS 13. Excluding this adjustment, the effective tax rate was 32.4%. On a year-to-date basis, the effective tax rate was 30.5% compared with 32.2% in the first nine months of 2006.

The projected effective tax rate for the fourth quarter of 2007 ranges between 33.5% and 34.0%. The anticipated increase in the effective tax rate is primarily attributable to the adverse effect of the merger in 2007 on New York state and local income taxes, and an increase in foreign taxes.

Our effective tax rate benefits from the amount of synthetic fuel tax credits (Section 29 of the Internal Revenue Code) we receive. These credits relate to investments that produce alternative fuel from coal byproducts and are impacted by the price of oil.

To manage our exposure in 2007 to the risk of an increase in oil prices that could reduce synthetic fuel tax credits, we entered into an option contract covering a specified number of barrels of oil that settles at the end of 2007. The option contract economically hedges a portion of our projected 2007 synthetic fuel tax credit benefit. The contract does not qualify for hedge accounting and, as a result, changes in the fair value of the option are recorded in trading income.

Although oil prices have increased during the first few weeks of the fourth quarter of 2007, any phase-out above our assumptions will not have a material effect on our 2007 earnings. The synthetic fuel program terminates at the end of 2007.


 

The Bank of New York Mellon Corporation     17


Table of Contents

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

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


 

Credit loss provision and net charge-offs

 

Credit loss provision and net charge-offs         

Legacy The Bank

of New York Only

           
     Quarter ended    Nine months ended (a)
(in millions)    Sept. 30,
2007
   June 30,
2007
   Sept. 30,
2006
   Sept. 30,
2007
   Sept. 30,
2006

Provision for credit losses

   $    $ (15)    $ (4)    $ (30)    $ (5)

Net (charge-offs)/recoveries:

              

Commercial

   $    $    $    $ (5)    $

Leases

     (35)                (22)     

Foreign

                        

Other

                        

Total net (charge-offs)/recoveries

   $ (35)    $    $    $ (27)    $ 10 
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results, while the results for the second quarter 2007 and all periods in 2006 include legacy The Bank of New York only.

 

There was no provision for credit losses for the third quarter of 2007, compared with a credit of $4 million in the third quarter of 2006 and a credit of $15 million in the second quarter of 2007, reflecting continued strong credit quality. We recorded a net charge-off of $35 million in the third quarter of 2007, compared with a net recovery of $5 million in the second quarter of 2007. Net charge-offs in the third quarter of 2007 include $36 million of charge-offs related to leased aircraft. The second quarter of 2007 includes $5 million of recoveries related to leased aircraft that were sold. For the nine months ended Sept. 30, 2007, the provision for credit losses was a credit of $30 million compared with a credit of $5 million in the first nine months of 2006. We recorded a net charge-off of $27 million for the nine months ended Sept. 30, 2007 compared with a net recovery of $10 million in the first nine months of 2006.

Business segments

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

Business Segments Accounting Principles

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

 

The accounting policies of the business segments are the same as those described in Note 1 of The Bank of New York’s 2006 Annual Report except segment results are subject to restatement whenever improvements are made in the measurement principles or when organizational changes are made. Net interest revenue differs from the amounts shown in the Consolidated Income Statement because amounts presented in the Business Segments are on a fully taxable equivalent basis (FTE). In the first, second and third quarters of 2007, in connection with the merger with Mellon, business segment reporting was realigned to reflect the new business structure of the combined company. In addition, several allocation methodologies were also revised to achieve greater harmonization with Mellon’s methodologies. All prior periods have been restated to reflect these revisions. It is anticipated that remaining allocation methodologies will be harmonized during the first half of 2008.

The operations of acquired businesses are integrated with the existing business segments soon after most acquisitions are completed. As a result of the integration of staff support functions, management of customer relationships, operating processes and the financial impact of funding the acquisitions, we cannot precisely determine the impact of acquisitions on income before taxes and therefore do not report it.

We now provide segment data for three segments with the Asset and Wealth Management Segment and Institutional Services Segment being further


 

18     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

divided into sector groupings. These segments are shown below:

 

  ·  

Asset and Wealth Management Segment

  ·  

Asset Management sector

  ·  

Wealth Management sector

  ·  

Institutional Services Segment

  ·  

Asset Servicing sector

  ·  

Issuer Services sector

  ·  

Clearing and Execution Services sector

  ·  

Treasury Services sector

  ·  

Other Segment

The business segment information is reported on a continuing operations basis for all periods presented. See Note 5 of this report for a discussion of discontinued operations.

On July 1, 2007, we merged with Mellon Financial Corporation and on Oct. 1, 2006, we sold substantially all of the assets of our Retail Business.

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

 

  ·  

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

  ·  

Revenues and expenses associated with specific client bases are included in those segments. For example, foreign exchange activity associated with clients using custody products is allocated to the Asset Servicing sector within the Institutional Services Segment (which includes our custody operations).

  ·  

Balance sheet assets and liabilities and their related income or expense are specifically assigned to each segment. Segments with a net liability position have also been allocated assets from the securities portfolio.

  ·  

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

  ·  

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

  ·  

The provision for credit losses is allocated to segments based on changes in each segment’s credit risk during the period. Previously, the provision for credit losses was based on management’s judgment as to average credit losses that would have been incurred in the operations of the segment over a credit cycle of a period of years.

  ·  

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

  ·  

Goodwill and intangibles are reflected within individual business segments.

  ·  

The operations of the Acquired Corporate Trust Business are included only from Oct. 1, 2006, the date on which it was acquired.

  ·  

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


 

The Bank of New York Mellon Corporation     19


Table of Contents

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

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


 

Market indexes   

3Q06

  

4Q06

  

1Q07

  

2Q07

  

3Q07

   3Q07
vs.
2Q07
    Year-to-date   

YTD07
vs.

YTD06

 
                    2007    2006   

S&P 500 Index (a)

   1,336    1,418    1,421    1,503    1,527    2 %   1,527    1,336    14 %

FTSE 100 Index (a)

   5,961    6,221    6,308    6,608    6,467    (2 )   6,467    5,961    8  

NASDAQ Composite Index (a)

   2,258    2,415    2,422    2,603    2,702    4     2,702    2,258    20  

Lehman Brothers Aggregate Bondsm Index (a)

   220.0    226.6    230.8    227.9    246.2    8     246.2    220.0    12  

MSCI EAFE® Index (a)

   1,885.3    2,074.5    2,147.5    2,262.2    2,300.3    2     2,300.3    1,885.3    22  

NYSE Volume (in billions)

   108.8    114.4    123.8    127.7    145.5    14     397.0    344.1    15  

NASDAQ Volume (in billions)

   114.6    121.5    131.4    134.0    137.0    2     402.3    379.6    6  
(a) Period end.

 

The results of many of our sectors are influenced by client activities that vary by quarter. For instance, we experience seasonal increases in securities lending and depositary receipts reflecting the European dividend distribution season during the second quarter of the year, and to a lesser extent, in the fourth quarter of the year. Also, consistent with an overall decline in securities industry activity in the summer, we typically experience a seasonal decline in the third quarter.

The volatile market environment in the third quarter of 2007 resulted in an unseasonably strong quarter in securities lending revenue, foreign exchange and other trading revenue and clearing and execution fees. Depositary receipts were also strong in the third quarter, reflecting business growth and dividend distributions. Non-program equity trading volumes were up 11% sequentially and up 25% year-over-year. In addition, average daily U.S. fixed-income trading volume was up 9% sequentially and 21% year-over-year. Total debt issuance decreased 47% sequentially and decreased 27% year-over-year. The issuance of global collateralized debt obligations was down 55% versus the third quarter of 2006.

 

As of Sept. 30, 2007, our assets under custody and administration rose to $20.8 trillion, from $12.2 trillion at Sept. 30, 2006 and $14.9 trillion at June 30, 2007. The increase in assets under custody and administration from Sept. 30, 2006 primarily reflects the merger with Mellon, rising asset prices, growth in the custody business and the impact of the Acquired Corporate Trust Business. The increase compared with June 30, 2007, primarily resulted from the merger with Mellon. Equity securities comprised 36% and fixed-income securities were 64% of the assets under custody and administration at Sept. 30, 2007, compared with 31% equity securities and 69% fixed-income securities at Sept. 30, 2006. Assets under custody and administration at Sept. 30, 2007 consisted of assets related to the custody, mutual funds, and corporate trust businesses of $16.1 trillion, broker-dealer services assets of $2.5 trillion, and all other assets of $2.2 trillion.

The consolidating schedules on the following pages show the contribution of the company’s sectors to its overall profitability.


 

20     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

For the quarter ended
Sept. 30, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 746     $ 162   $ 908   $ 907   $ 460   $ 372   $ 221     $ 1,960     $ 72     $ 2,940  

Net interest revenue

    (5 )     85     80     206     159     77     131       573       21       674  

Total revenue

    741       247     988     1,113     619     449     352       2,533       93       3,614  

Provision for credit losses

    -       -     -     -     -     -     -       -       -       -  

Noninterest expense

    609       183     792     761     311     324     202       1,598       316       2,706  

Income before taxes

  $ 132     $ 64   $ 196   $ 352   $ 308   $ 125   $ 150     $ 935     $ (223 )   $ 908  

Pre-tax operating margin (a)

    18%       26%     20%     32%     50%     28%     43%       37%       N/M       25%  

Average assets

  $ 12,771     $ 13,754   $ 26,525   $ 25,129   $ 7,590   $ 15,897   $ 23,726     $ 72,342     $ 84,918     $ 183,785 (b)

Excluding intangible amortization:

                   

Noninterest expense

  $ 539     $ 162   $ 701   $ 755   $ 291   $ 318   $ 195     $ 1,559     $ 315     $ 2,575  

Income before taxes

    202       85     287     358     328     131     157       974       (222 )     1,039  

Pre-tax operating margin (a)

    27%       34%     29%     32%     53%     29%     45%       38%       N/M       29%  
                   

Legacy The Bank of New York Only

 

For the quarter ended

June 30, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
    Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 122     $ 52   $ 174   $ 520   $ 390   $ 320   $ 145     $ 1,375     $ 31     $ 1,580  

Net interest revenue

    4       15     19     155     128     63     93       439       (4 )     454  

Total revenue

    126       67     193     675     518     383     238       1,814       27       2,034  

Provision for credit losses

    -       -     -     -     -     -     (7 )     (7 )     (8 )     (15 )

Noninterest expense

    72       56     128     473     253     299     129       1,154       107       1,389  

Income before taxes

  $ 54     $ 11   $ 65   $ 202   $ 265   $ 84   $ 116     $ 667     $ (72 )   $ 660  

Pre-tax operating margin (a)

    43%       16%     34%     30%     51%     22%     49%       37%       N/M       32%  

Average assets

  $ 1,387     $ 1,487   $ 2,874   $ 12,146   $ 5,104   $ 16,267   $ 16,966     $ 50,483     $ 60,921     $ 114,278  (b)

Excluding intangible amortization:

                   

Noninterest expense

  $ 68     $ 56   $ 124   $ 471   $ 236   $ 293   $ 129     $ 1,129     $ 107     $ 1,360  

Income before taxes

    58       11     69     204     282     90     116       692       (72 )     689  

Pre-tax operating margin (a)

    46%       16%     36%     30%     54%     23%     49%       38%       N/M       34%  

 

Legacy The Bank of New York Only

 

For the quarter ended

March 31, 2007

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 101   $ 51   $ 152   $ 476   $ 356   $ 308   $ 132     $ 1,272     $ 51     $ 1,475  

Net interest revenue

    6     16     22     132     110     61     97       400       7       429  

Total revenue

    107     67     174     608     466     369     229       1,672       58       1,904  

Provision for credit losses

    -     -     -     -     -     -     (3 )     (3 )     (12 )     (15 )

Noninterest expense

    67     55     122     442     251     276     130       1,099       51       1,272  

Income before taxes

  $ 40   $ 12   $ 52   $ 166   $ 215   $ 93   $ 102     $ 576     $ 19     $ 647  

Pre-tax operating margin (a)

    37%     18%     30%     27%     46%     25%     45%       34%       N/M       34%  

Average assets

  $ 1,387   $ 1,448   $ 2,835   $ 10,610   $ 4,235   $ 16,363   $ 17,003     $ 48,211     $ 50,929     $ 101,975  (b)

Excluding intangible amortization:

                   

Noninterest expense

  $ 63   $ 55   $ 118   $ 441   $ 234   $ 270   $ 130     $ 1,075     $ 51     $ 1,244  

Income before taxes

    44     12     56     167     232     99     102       600       19       675  

Pre-tax operating margin (a)

    41%     18%     32%     27%     50%     27%     45%       36%       N/M       35%  

 

The Bank of New York Mellon Corporation     21


Table of Contents

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

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


 

Legacy The Bank of New York Only

 

For the quarter ended

Dec. 31, 2006

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 109   $ 49   $ 158   $ 414   $ 371     $ 296   $ 134     $ 1,215     $ 68     $ 1,441  

Net interest revenue

    7     15     22     137     107       76     101       421       9       452  

Total revenue

    116     64     180     551     478       372     235       1,636       77       1,893  

Provision for credit losses

    -     -     -     -     (1 )     2     (7 )     (6 )     (9 )     (15 )

Noninterest expense

    74     53     127     421     246       262     129       1,058       100       1,285  

Income before taxes

  $ 42   $ 11   $ 53   $ 130   $ 233     $ 108   $ 113     $ 584     $ (14 )   $ 623  

Pre-tax operating margin (a)

    36%     17%     29%     24%     49%       29%     48%       36%       N/M       33%  

Average assets

  $ 1,226   $ 1,481   $ 2,707   $ 9,453   $ 3,988     $ 14,825   $ 16,615     $ 44,881     $ 54,499     $  102,087  (b)

Excluding intangible amortization:

                   

Noninterest expense

  $ 70   $ 53   $ 123   $ 413   $ 230     $ 256   $ 129     $ 1,028     $ 100     $ 1,251  

Income before taxes

    46     11     57     138     249       114     113       614       (14 )     657  

Pre-tax operating margin (a)

    40%     17%     32%     25%     52%       31%     48%       38%       N/M       35%  

 

Legacy The Bank of New York Only

 

For the quarter ended

Sept. 30, 2006

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 84   $ 47   $ 131   $ 437   $ 205   $ 328   $ 143     $ 1,113     $ 19     $ 1,263  

Net interest revenue

    3     16     19     119     49     70     98       336       3       358  

Total revenue

    87     63     150     556     254     398     241       1,449       22       1,621  

Provision for credit losses

    -     -     -     -     1     -     (3 )     (2 )     (2 )     (4 )

Noninterest expense

    58     52     110     414     127     309     126       976       110       1,196  

Income before taxes

  $ 29   $ 11   $ 40   $ 142   $ 126   $ 89   $ 118     $ 475     $ (86 )   $ 429  

Pre-tax operating margin (a)

    33%     17%     27%     26%     50%     22%     49%       33%       N/M       26%  

Average assets

  $ 1,082   $ 1,503   $ 2,585   $ 8,641   $ 1,359   $ 16,363   $ 16,680     $ 43,043     $ 49,951     $ 95,579  (b)

Excluding intangible amortization:

                   

Noninterest expense

  $ 54   $ 52   $ 106   $ 413   $ 126   $ 301   $ 126     $ 966     $ 110     $ 1,182  

Income before taxes

    33     11     44     143     127     97     118       485       (86 )     443  

Pre-tax operating margin (a)

    38%     17%     29%     26%     50%     24%     49%       33%       N/M       27%  
(a) Income before taxes divided by total revenue.
(b) Including average assets of discontinued operations of $43 million, $45 million, $66 million, $51 million and $13,285 million for quarters ended Sept. 30, 2007, June 30, 2007, March 31, 2007, Dec. 31, 2006 and Sept. 30, 2006, consolidated average assets were $183,828 million for the third quarter of 2007, $114,323 million for the second quarter of 2007, $102,041 million for the first quarter of 2007, $102,138 million for the fourth quarter of 2006 and $108,864 million for the third quarter of 2006.

N/M - Not meaningful.

 

22     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

For the nine months ended

Sept. 30, 2007 (a)

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
 

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 969   $ 265   $ 1,234   $ 1,903   $ 1,206   $ 1,000   $ 498     $ 4,607     $ 154     $ 5,995  

Net interest revenue

    5     116     121     493     397     201     321       1,412       24       1,557  

Total revenue

    974     381     1,355     2,396     1,603     1,201     819       6,019       178       7,552  

Provision for credit losses

    -     -     -     -     -     -     (10 )     (10 )     (20 )     (30 )

Noninterest expense

    748     294     1,042     1,676     815     899     461       3,851       474       5,367  

Income before taxes

  $ 226   $ 87   $ 313   $ 720   $ 788   $ 302   $ 368     $ 2,178     $ (276 )   $ 2,215  

Pre-tax operating margin (b)

    23%     23%     23%     30%     49%     25%     45%       36%       N/M       29%  

Average assets

  $ 5,223   $ 5,608   $ 10,831   $ 16,015   $ 5,655   $ 16,174   $ 19,256     $ 57,100     $ 65,710     $ 133,641  (d)

Excluding intangible amortization:

                   

Noninterest expense

  $ 670   $ 273   $ 943   $ 1,667   $ 761   $ 881   $ 454     $ 3,763     $ 473     $ 5,179  

Income before taxes

    304     108     412     729     842     320     375       2,266       (275 )     2,403  

Pre-tax operating margin (b)

    31%     28%     30%     30%     53%     27%     46%       38%       N/M       32%  

 

Legacy The Bank of New York Only

 

For the nine months ended

Sept. 30, 2006 (c)

(in millions,

presented on

an FTE basis)

  Asset
Management
  Wealth
Management
   

Total

Asset &
Wealth
Management
Segment

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

Fee and other revenue

  $ 248   $ 149     $ 397     $ 1,298   $ 590   $ 1,063     $ 436   $ 3,387   $ 114     $ 3,898  

Net interest revenue

    8     45       53       339     151     202       291     983     33       1,069  

Total revenue

    256     194       450       1,637     741     1,265       727     4,370     147       4,967  

Provision for credit losses

    -     (2 )     (2 )     -     1     (6 )     12     7     (10 )     (5 )

Noninterest expense

    163     157       320       1,209     369     928       381     2,887     196       3,403  

Income before taxes

  $ 93   $ 39     $ 132     $ 428   $ 371   $ 343     $ 334   $ 1,476   $ (39 )   $ 1,569  

Pre-tax operating margin (b)

    36%     20%       29%       26%     50%     27%       46%     34%     N/M       32%  

Average assets

  $ 1,021   $ 1,491     $ 2,512     $ 8,315   $ 1,342   $ 16,969     $ 16,165   $ 42,791   $ 49,313     $ 94,616  (d)

Excluding intangible amortization:

                   

Noninterest expense

  $ 152   $ 157     $ 309     $ 1,204   $ 367   $ 904     $ 381   $ 2,856   $ 196     $ 3,361  

Income before taxes

    104     39       143       433     373     367       334     1,507     (39 )     1,611  

Pre-tax operating margin (b)

    41%     20%       32%       26%     50%     29%       46%     34%     N/M       32%  
(a) Nine months ended 2007 include three months of the combined company’s results and six months of legacy The Bank of New York only.
(b) Income before taxes divided by total revenue.
(c) Legacy The Bank of New York only.
(d) Including average assets of discontinued operations of $58 million for first nine months of 2007 and $13,856 million for the first nine months of 2006, consolidated average assets were $133,699 million for the first nine months of 2007 and $108,472 million for the first nine months of 2006.

N/M - Not meaningful.

 

The Bank of New York Mellon Corporation     23


Table of Contents

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

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


 

Asset and Wealth Management Segment

Asset and Wealth Management fee revenue is dependent on the overall level and mix of assets under management (“AUM”) and the management fees charged for managing those assets. Assets under management were $1,106 billion at Sept. 30, 2007, compared with $131 billion at Sept. 30, 2006, and $153 billion at June 30, 2007. The year-over-year increase in AUM primarily reflects the merger with Mellon and continued growth across asset classes and strategies. The increase from June 30, 2007 reflects the merger with Mellon.

Assets under management at period-end, by
product type
    Legacy The Bank of New York Only          
(in billions)  

Sept. 30,

2006

    

Dec. 31,

2006

    

March 31,

2007

    

June 30,

2007

    

Sept. 30,

2007

Equity securities

  $ 36      $ 39      $ 41      $ 43      $ 456

Fixed income securities

    20        21        22        22        215

Overlay and alternative investments

    41        44        45        47        160

Money market

    34        38        34        41        275

Total assets under management

  $ 131      $ 142      $ 142      $ 153      $ 1,106

 

Assets under management at period-end, by
client type
  Legacy The Bank of New York Only        
(in billions)  

Sept. 30,

2006

    

Dec. 31,

2006

    

March 31,

2007

    

June 30,

2007

    

Sept. 30,

2007

Institutional

  $ 98      $ 105      $ 106      $ 113      $ 682

Mutual funds

    12        15        15        18        323

Private client

    21        22        21        22        101

Total market value of assets under management

  $ 131      $ 142      $ 142      $ 153      $ 1,106

 

Changes in market value of assets under management from June 30,
2007 to Sept. 30, 2007 - by business sector
(in billions)   Asset
Management
    Wealth
Management
  Total 

Market value of assets under management at June 30, 2007:

  

   

The Bank of New York

  $ 129     $ 24   $ 153 

Mellon Financial

    868       61     929 

Net inflows:

     

Long-term

    1       1    

Money market

    27       -     27 
                   

Total net inflows

    28       1     29 

Net market depreciation (a)

    (5 )     -     (5)

Market value of assets under management at Sept. 30, 2007

  $ 1,020     $ 86   $ 1,106 
(a) Includes the effect of changes in foreign exchange rates.

 

24     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

Asset Management sector

 

(dollar amounts in millions,

unless otherwise noted;

presented on an FTE basis)

   Legacy The Bank of New York Only           3Q07
vs.
3Q06
    Year-to-date (a)    YTD07
vs.
YTD06
 
   3Q06    4Q06    1Q07    2Q07    3Q07       2007     2006   

Revenue:

                       

Asset and wealth management:

                       

Mutual funds

   $ 2    $ 3    $ 3    $ 4    $ 307     N/M     $ 314     $ 7    N/M  

Institutional clients

     64      72      68      80      331     417 %     479       180    166 %

Private clients

     12      13      13      15      46     283       74       35    111  
                                                       

Total asset management revenue

     78      88      84      99      684     777       867       222    291  

Performance fees

     3      18      14      21      (3 )   (200 )     32       17    88  

Distribution and servicing

     -      -      -      -      89     -       89       -    -  

Other

     3      3      3      2      (24 )   (900 )     (19 )     9    (311 )
                                                       

Total fee and other revenue

     84      109      101      122      746     788       969       248    291  

Net interest revenue (expense)

     3      7      6      4      (5 )   N/M       5       8    (38 )
                                                       

Total revenue

     87      116      107      126      741     752       974       256    280  

Noninterest expense (excluding intangible amortization)

     54      70      63      68      539     898       670       152    341  
                                                       

Income before taxes (excluding intangible amortization)

     33      46      44      58      202     512       304       104    192  

Amortization of intangible assets

     4      4      4      4      70     N/M       78       11    N/M  
                                                       

Income before taxes

   $ 29    $ 42    $ 40    $ 54    $ 132     355 %   $ 226     $ 93    143 %
                                                       

Memo: Income before taxes (excluding intangible amortization and non-operating items) (b)

   $ 33    $ 46    $ 44    $ 58    $ 234     609 %   $ 336     $ 104    223 %

Pre-tax operating margin (excluding intangible amortization)

     38%      40%      41%      46%      27%         31%       41%   

Average assets

   $ 1,082    $ 1,226    $ 1,387    $ 1,387    $ 12,771     N/M     $ 5,223     $ 1,021    412 %
(a) Third quarter and year-to-date 2007 include three months of the combined company’s results, while results prior to July 1, 2007 include legacy The Bank of New York only.
(b) Third quarter 2007 excludes a pre-tax charge ($32 million) related to the write-off of the value of the remaining interest in a hedge fund manager that was disposed of in 2006.

N/M - Not meaningful.

 

Business description

Asset Management is comprised of BNY Mellon Institutional Asset Management, which consists of a number of asset management boutiques offering a broad range of equity, fixed income, hedge and liquidity management products; BNY Mellon Asset Managment International (formerly Mellon Global Investments), which distributes investment management products internationally; and all products and services associated with the Dreyfus Corporation complex of equity, fixed income and money market mutual funds, separate accounts and annuities.

We are a top 15 global asset manager; a top 10 U.S. asset manager; and the seventh largest asset manager in Europe. We are also a top five tax-exempt, institutional U.S. asset manager.

The results of the Asset Management sector are mainly driven by the period-end and average levels of

assets managed as well as the mix of those assets, as shown in the table on page 24. Managed equity assets typically generate higher percentage fees than money market and fixed-income assets. Also, actively managed assets typically generate higher management fees than indexed or passively managed assets of the same type. In addition, performance fees may be generated when the investment performance of products exceeds various benchmarks and satisfies other criteria. Results for this sector are also impacted by sales of fee-based products such as fixed and variable annuities and separately managed accounts. Expenses in this sector are mainly driven by staffing costs, incentives, distribution and servicing expense, and product distribution costs.

Review of financial results

Income before taxes was $132 million in the third quarter of 2007 compared with $29 million in the third


 

The Bank of New York Mellon Corporation     25


Table of Contents

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

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


 

quarter of 2006, and $54 million in the second quarter of 2007. Income before taxes (excluding intangible amortization) was $202 million in the third quarter of 2007 compared with $33 million in the third quarter of 2006 and $58 million in the second quarter of 2007. The third quarter of 2007 also included a $32 million charge related to the write-off of the value of the remaining interest in a hedge fund manager that was disposed of in 2006. Excluding this charge, income before taxes (excluding intangible amortization) was $234 million in the third quarter of 2007.

Fee and other revenue was $746 million in the third quarter of 2007 compared with $84 million in the third quarter of 2006 primarily reflecting the merger with Mellon, net new business and improved equity markets. Performance fees were negative $3 million in the third quarter of 2007 reflecting the impact of market volatility on certain alternative and quantitative strategies. Other fee revenue decreased, principally reflecting the lower market value of seed capital investments due to the market environment. Fee and other revenue increased on a sequential-quarter basis primarily reflecting the same factors affecting year-over-year results.

Noninterest expense (excluding intangible amortization) was $539 million in the third quarter of 2007 compared with $54 million in the third

quarter of 2006 primarily reflecting the merger with Mellon and higher incentive compensation, temporary labor, technology, legal expenses and the write-off of the remaining interest in a hedge fund manager. The sequential-quarter increase in noninterest expense primarily reflects the merger with Mellon and legal, technology and other compensation expenses, and the write-off of the interest in a hedge fund manager.

On a year-to-date basis, income before taxes was $226 million in the first nine months of 2007 compared with $93 million in the first nine months of 2006. Income before taxes (excluding intangible amortization) was $304 million in the first nine months of 2007 compared with $104 million in the first nine months of 2006. Income before taxes (excluding intangible amortization) was $336 million excluding the write-off of the interest in a hedge fund manager. Fee and other revenue increased $721 million, primarily due to the merger with Mellon and higher asset management fees from institutional clients. Noninterest expense (excluding intangible amortization) increased $518 million in the first nine months of 2007 compared with the first nine months of 2006 primarily due to the merger with Mellon and higher other compensation, salaries and temporary labor, technology, occupancy and legal expenses.


 

26     The Bank of New York Mellon Corporation


Table of Contents

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

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


 

Wealth Management sector

 

(dollar amounts in millions,
unless otherwise noted;

presented on an FTE basis)

   Legacy The Bank of New York Only   

3Q07

   3Q07
vs.
3Q06
    Year-to-date (a)     YTD07
vs.
YTD06
 
   3Q06    4Q06    1Q07    2Q07         2007    2006    

Revenue:

                        

Asset and wealth management

   $ 46    $ 48    $ 50    $ 50    $ 152    230 %   $ 252    $ 145     74 %

Other

     1      1      1      2      10    900       13      4     225  
                                                      

Total fee and other revenue

     47      49      51      52      162    245       265      149     78  

Net interest revenue

     16      15      16      15      85    431       116      45     158  
                                                      

Total revenue

     63      64      67      67      247    292       381      194     96  

Provision for credit losses

     -      -      -      -      -    -       -      (2 )   N/M  

Noninterest expense (excluding intangible amortization)

     52      53      55      56      162    212       273      157     74  
                                                      

Income before taxes (excluding intangible amortization)

     11      11      12      11      85    673       108      39     177  

Amortization of intangible assets

     -      -      -      -      21    -       21      -     -  
                                                      

Income before taxes

   $ 11    $ 11    $ 12    $ 11    $ 64    482     $ 87    $ 39     123  
                                                      

Pre-tax operating margin (excluding intangible amortization)

     17%      17%      18%      16%      34%        28%      20%    

Average loans

   $ 1,410    $ 1,373    $ 1,336    $ 1,341    $ 6,590    367     $ 3,109    $ 1,397     123  

Average assets

     1,503      1,481      1,448      1,487      13,754    815       5,608      1,491     276  

Average deposits

     1,116      1,090      1,119      1,065      11,289    912       4,528      1,122     304  

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