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| BK > SEC Filings for BK > Form 10-Q on 7-Nov-2008 | All Recent SEC Filings |
7-Nov-2008
Quarterly Report
General
In this Quarterly Report on Form 10-Q, references to "our," "we," "us," the "Company," and similar terms for periods prior to July 1, 2007 refer to The Bank of New York Company, Inc. and references to "our," "we," "us," the "Company," and similar terms for periods on or after July 1, 2007 refer to The Bank of New York Mellon Corporation.
Certain business terms used in this document are defined in the glossary included in our 2007 Annual Report on Form 10-K.
The following should be read in conjunction with the Consolidated Financial Statements included in this report. Investors should also read the sections entitled "Forward-looking Statements" and "Risk Factors".
How we reported results
All information in this Quarterly Report on Form 10-Q is reported on a continuing operations basis, unless otherwise noted. For a description of discontinued operations, see Note 4 in the Notes to Consolidated Financial Statements.
Throughout this Form 10-Q, certain measures, which are noted, exclude certain items. We believe the presentation of this information enhances investors' understanding of period-to-period results. In addition, these measures reflect the principal basis on which our management monitors financial performance. See Supplemental information - explanation of non-GAAP financial measures.
Certain amounts are presented on a fully taxable equivalent (FTE) basis. We believe that this presentation allows for comparison of amounts arising from both taxable and tax-exempt sources and is consistent with industry practice. The adjustment to an FTE basis has no impact on net income. In addition, results for 2008 reflect The Bank of New York Mellon Corporation. Results for nine months ended Sept. 30, 2007 include six months of legacy The Bank of New York Company, Inc. and three months of The Bank of New York Mellon Corporation.
In the first quarter of 2008, we adopted Statement of Financial Accounting Standards ("SFAS") No. 157 Fair Value Measurements ("SFAS 157") and SFAS No. 159 Fair Value Option ("SFAS 159"). For a discussion of SFAS 157 and SFAS 159, see Note 12 and Note 13 in the Notes to Consolidated Financial Statements.
Overview
The Bank of New York Mellon Corporation (NYSE symbol: 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 strive to be the global provider of choice for asset management and securities servicing and be recognized for our broad and deep capabilities, superior service and consistent outperformance versus peers. 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.
The Company's businesses benefit from the global growth in financial assets. We seek to deploy capital effectively to our businesses, to accelerate their long-term growth and deliver top-tier returns to our shareholders. Our long-term financial goals are focused on achieving superior total returns to shareholders by generating first quartile earnings per share growth over time relative to a group of peer companies.
Key components of this strategy include: providing superior 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.
4 The Bank of New York Mellon Corporation
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 to measurements of efficiency, over time we expect to increase both our level of fee revenue per employee and maintain competitive 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, relative to traditional banks, generally do not require as much capital for growth.
We pursue our long-term financial goals by focusing on organic revenue growth, expense management, superior client service, successful integration of acquisitions and disciplined capital management.
We are a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset and wealth management, asset servicing, issuer services, clearing services and treasury services through a worldwide client-focused team. At Sept. 30, 2008, we had $22.4 trillion in assets under custody and administration, approximately $1.1 trillion in assets under management and service approximately $12 trillion in outstanding debt.
Strategic actions impacting third quarter 2008 and year-to-date 2008 financial results
• In the second quarter of 2008, we sold Mellon 1st Business Bank, N. A. ("M1BB"). This sale reduced loan and deposit levels by $1.1 billion and $2.8 billion, respectively.
• In the first quarter of 2008, we acquired ARX Capital Management ("ARX"), a leading Brazilian asset management business. We also sold the B-Trade and G-Trade execution businesses. These businesses have historically contributed approximately $50-60 million of revenue and $10-15 million of pre-tax income on a quarterly basis.
• In the fourth quarter of 2007, we completed the acquisition of the remaining 50% interest in ABN AMRO Mellon Global Securities Services B.V. (now known as BNY Mellon Asset Servicing, B.V.) and we consolidated the assets of our bank-sponsored conduit, Three Rivers Funding Corporation ("TRFC").
• On July 1, 2007, The Bank of New York Company, Inc. ("The Bank of New York") and Mellon Financial Corporation ("Mellon Financial") merged into The Bank of New York Mellon Corporation (together with its consolidated subsidiaries, the "Company"), with the Company being the surviving entity.
Highlights of third quarter 2008 results
We reported third quarter net income of $303 million, and diluted earnings per share of $0.26, and income from continuing operations of $305 million and diluted earnings per share of $0.26. This compares to net income of $640 million, or $0.56 per share, and income from continuing operations of $642 million, or $0.56 per share, in the third quarter of 2007 and net income of $309 million, or $0.27 per share, and income from continuing operations of $302 million, or $0.26 per share, in the second quarter of 2008. The third quarter of 2008 included: a charge relating to support agreements (described below) of $726 million (pre-tax), or $0.37 per share; a charge relating to certain structured lease transactions ("SILOs/LILOs") of $112 million (pre-tax) as well as the settlement of several audit cycles, with a combined impact of $0.03 per share; and M&I expenses of $111 million (pre-tax), or $0.06 per share. The third quarter of 2007 included M&I expenses of $218 million (pre-tax), or $0.11 per share. The second quarter of 2008 included a charge relating to SILOs of $377 million (pre-tax), or $0.33 per share, as well as M&I expenses of $149 million (pre-tax), or $0.08 per share. Excluding these amounts, earnings per share from continuing operations were $0.72 in the third quarter of 2008, $0.67 in the third quarter of 2007 and $0.67 in the second quarter of 2008.
Adjusting for the impact of the charge for the support agreements, the SILO/LILO/tax settlement, M&I expenses and intangible amortization ($120 million pre-tax), diluted earnings per share for the third quarter of 2008 were $0.79, which compares to $0.75 a year ago and $0.74 sequentially. See Supplemental information - Explanation of non-GAAP financial measures.
The results for the third quarter of 2008 included net pre-tax costs associated with the write-down of certain investments in our securities portfolio of $162 million compared with write-downs of $9 million in the third quarter of 2007 and $152 million in the second quarter of 2008.
Performance highlights for the third quarter of 2008 included:
• Assets under management totaled $1.07 trillion at Sept. 30, 2008 compared with $1.11 trillion at Sept. 30, 2007. The decrease resulted from market depreciation and the impact of a stronger U.S. dollar, partially offset by net positive flows. Assets under custody and administration totaled $22.4 trillion at Sept. 30, 2008 compared with $22.7 trillion at Sept. 30, 2007 as the benefit of new business conversions was offset by weaker market values and the impact of a stronger U.S. dollar.
• Asset and wealth management fees totaled $792 million in the third quarter of 2008 compared with $854 million in the third quarter of 2007. The decrease reflects global weakness in market values and net long-term outflows, partially offset by inflows of money market assets.
• Asset servicing revenue totaled $803 million in the third quarter of 2008 compared with $720 million in the third quarter of 2007. The increase was primarily due to higher securities lending revenue, net new business and the fourth quarter 2007 acquisition of the remaining 50% interest in BNY Mellon Asset Servicing, B.V.
• Issuer services revenue totaled $477 million in the third quarter of 2008 compared with $436 million in the third quarter of 2007. The increase primarily reflects growth in Depositary Receipts, Corporate Trust and Shareowner Services fees.
• Clearing and execution services fees totaled $262 million compared with $304 million in the third quarter of 2007. The decrease primarily reflects the sale of the B-Trade and
G-Trade execution businesses in the first quarter of 2008, partially offset by growth in trading activity along with continued growth in money market mutual fund fees.
• Foreign exchange and other trading activities revenue totaled a record $385 million in the third quarter of 2008 compared with $238 million in the third quarter of 2007. The increase primarily reflects the benefit of increased market volatility and higher client volumes.
• Securities losses totaled $162 million in the third quarter of 2008 compared with a loss of $9 million in the third quarter of 2007. The loss in the third quarter of 2008 included a $29 million loss related to Alt-A securities, a $42 million loss related to asset-backed securities ("ABS") collateralized debt obligations ("CDOs"), a $12 million loss related to prime mortgage securities, a $12 million loss related to subprime mortgage securities, a $10 million loss related to securities backed by home equity lines of credit ("HELOC") and $57 million of losses related to structured investment vehicles ("SIVs") and other securities.
• In the third quarter of 2008, we settled several prior tax audit cycles. As part of the tax settlements, we also accepted the Internal Revenue Service ("IRS") uniform SILO/LILO settlement offer announced on Aug. 6, 2008, resulting in a pre-tax charge of $112 million. The combined after-tax charge of these settlements was $30 million. In the second quarter of 2008, we recorded a $380 million after-tax charge related to the SILO transactions covered by this settlement.
• Net interest revenue totaled $703 million in the third quarter of 2008 compared with $669 million in the third quarter of 2007. The increase was primarily due to wider spreads on investment securities and a higher level of average interest-earning assets, partially offset by the SILO/LILO charges recorded in the third quarter of 2008.
• Noninterest expense totaled $3.3 billion in the third quarter of 2008 compared with $2.7 billion in the third quarter of 2007. The increase resulted from the support agreement charges described below ($726 million), the acquisition of the remaining 50% interest in BNY Mellon Asset Servicing, B.V., and higher professional, legal and other purchased services. These increases were partially offset by lower M&I expenses, the benefit of merger-related expense
6 The Bank of New York Mellon Corporation
• The unrealized net of tax loss on our securities portfolio was $2.8 billion at Sept. 30, 2008 compared with $1.8 billion at June 30, 2008. The increase primarily resulted from wider credit spreads.
• The Tier I capital ratio at Sept. 30, 2008 was 9.34% compared with 9.32% at Dec. 31, 2007. The Company had total assets of $268 billion at Sept. 30, 2008 compared with $198 billion at Dec. 31, 2007. The increase in total assets reflects the record level of client deposits generated by the market turmoil that began in mid-September 2008. Noninterest-bearing deposits were $82 billion at Sept. 30, 2008 compared with $32 billion at Dec. 31, 2007. At Sept. 30, 2008, we maintained a highly liquid balance sheet by placing an increased level of deposits with the Federal Reserve and in overnight deposits with large global banks.
Impact of the market disruption on our business
The recent events in the global markets could have a significant impact on our results of operation. The following discusses the areas of our business that are likely to be impacted by the current market environment, as well as recent events that impact the Company.
Impact on our business
Recent market volatility associated with the performance of global equity indices and the disruption in the fixed income securities market, continue to impact our Asset and Wealth Management and Securities Servicing businesses.
Our Asset and Wealth Management businesses have been negatively impacted by global weakness in market values. Over the twelve-month period ended Sept. 30, 2008, the S&P 500 and the MSCI EAFE indices declined 24% and 32%, respectively, resulting in lower performance fees, a decline in investment income related to seed capital investments as well as lower asset and wealth management fee revenue as lower market values offset the impact of new business wins.
In contrast, current market conditions have favorably impacted our processing and capital markets related fees in our Securities Servicing businesses, as well as our net interest revenue. Market volatility has resulted in an increased volume of activity impacting foreign exchange and clearing and has led to a widening of spreads associated with securities lending, foreign exchange and net interest revenue. A lower risk appetite by investors and our institutional clients has led to an increase in deposit levels. It is uncertain how long we will continue to benefit from increased volatility, volumes and deposit levels.
The ongoing disruption in the fixed income securities market has resulted in additional impairment charges, as well as an increase in unrealized securities losses. In addition, market conditions have resulted in a reduction in the volume in new fixed income securities issuances, which has impacted the level of new business in our Corporate Trust business. However, the disruption has also resulted in new product opportunities.
Support Agreements
During the third quarter of 2008, the Company elected to support its clients invested in money market mutual funds, cash sweep funds and similar collective funds, managed by our affiliates, impacted by the Lehman Brothers Holdings, Inc. ("Lehman") bankruptcy. The support agreements relate to five commingled cash funds used primarily for overnight custody cash sweeps, four Dreyfus money market funds and various securities lending customers.
These voluntary agreements are in addition to agreements that existed at June 30, 2008 covering SIV exposure in two short-term net asset value funds and the support agreements covering securities related to Whistle Jacket Capital/White Pine Financial, LLC to a commingled short-term net asset value fund. During the third quarter of 2008, we also offered to support certain clients holding auction rate securities in the Wealth Management and Treasury Services segments. These actions resulted in a $726 million pre-tax, or $0.37 per share, charge recorded in the third quarter of 2008. See page 53 for further information on support agreements.
Asset-backed commercial paper liquidity facility program
In September 2008, the Federal Reserve announced an Asset Backed Commercial Paper ("ABCP") Money Market Mutual Fund ("MMMF") Liquidity Facility program (the "ABCP Program").
Eligible borrowers under the ABCP Program include all U.S. depository institutions, U.S. bank holding companies, U.S. branches and agencies of foreign banks and broker-dealers. Eligible borrowers may borrow funds under the ABCP Program in order to fund the purchase of eligible ABCP from an MMMF. The MMMF must be a fund that qualifies as a money market mutual fund under Rule 2a-7 of The Investment Company Act of 1940, as amended (the "'40 Act"). ABCP used for collateral in the ABCP Program must be rated no lower than A1, F1 or P1, U.S. dollar denominated and from a U.S. issuer. The ABCP Program, which began on Sept. 19, 2008, is currently scheduled to run through Jan. 30, 2009.
Borrowings under the ABCP Program are non-recourse. Further, the ABCP pledged under the ABCP Program receives a 0% risk weight for risk-based capital purposes and is excluded from average total consolidated assets for leverage capital purposes.
Subsidiaries of the Company purchased ABCP under the ABCP Program from MMMFs managed by the Company's subsidiaries, as well as funds managed by third parties. At Sept. 30, 2008, we held $10.9 billion of assets and liabilities under the ABCP Program. The ABCP Program increased average assets by $1.0 billion in the third quarter of 2008. These assets are recorded on the balance sheet as other short-term investments - U.S. government-backed commercial paper. The liabilities are recorded as Borrowings from Federal Reserve related to asset-backed commercial paper.
Temporary Guarantee Program for Money Market Mutual Funds
In late September 2008, the U.S. Treasury Department opened its Temporary Guarantee Program for Money Market Mutual Funds (the "Temporary Guarantee Program"). The U.S. Treasury will guarantee the share price of any publicly-offered eligible money market fund that applies for and pays a fee to participate in the Temporary Guarantee Program. All money market funds that are structured within the confines of Rule 2a-7 of the '40 Act, maintain a stable share price of $1.00, are
publicly offered and are registered with the Securities and Exchange Commission are eligible to participate in the Temporary Guarantee Program.
The Temporary Guarantee Program provides coverage to shareholders for amounts that they held in participating money market funds at the close of business on Sept. 19, 2008. The guarantee will be triggered if the market value of assets held in a participating fund falls below $0.995, the fund's sponsor chooses not to maintain the $1.00 share price, and the fund's board determines to liquidate the fund. The Temporary Guarantee Program is designed to address temporary dislocations in credit markets and will run through Dec. 18, 2008, after which the Secretary of the Treasury will review the need and terms for extending the Temporary Guarantee Program. If extended, it may be extended only up to Sept. 18, 2009, and continued insurance protection is contingent upon funds renewing their coverage and paying any additional required fee.
Each Dreyfus and BNY Mellon Funds Trust money market fund has entered into a Guarantee Agreement with the Department of the Treasury, which permits these funds to participate in the Treasury's Temporary Guarantee Program for Money Market Mutual Funds.
U.S. Treasury program - investment in U.S. financial institutions
On Oct. 14, 2008, the U.S. government announced the Troubled Asset Relief Program ("TARP") Capital Purchase Program ("CPP") authorized under the Emergency Economic Stabilization Act ("EESA"). The intention of this program is to encourage U.S. financial institutions to build capital, to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. Initially, nine large financial institutions agreed to participate in the program. On Oct. 14, 2008, the Company announced that it would be part of the initial group of nine institutions in which the U.S. Treasury would purchase an equity stake. The Company agreed to issue and sell to the U.S. Treasury preferred stock and a warrant to purchase shares of common stock in accordance with the terms of the CPP for an aggregate purchase price of $3 billion. As a result, on Oct. 28, 2008, we issued $3 billion of Fixed Rate Cumulative Perpetual Preferred Stock, Series B, and a warrant, as described below, to the U.S. Treasury. The Series B preferred stock will pay cumulative dividends at a rate
8 The Bank of New York Mellon Corporation
of 5% per annum until the fifth anniversary of the date of the investment and thereafter at a rate of 9% per annum. Dividends will be payable quarterly in arrears on March 20, June 20, Sept. 20 and Dec. 20 of each year. The Series B preferred stock can only be redeemed within the first three years with the proceeds of at least $750 million from one or more qualified equity offerings. After Dec. 20, 2011, the Series B preferred stock may be redeemed, in whole or in part, at any time at our option, at a price equal to 100% of the issue price plus any accrued and unpaid interest. Redemption of the Series B preferred stock at any time will be subject to the prior approval of the Federal Reserve.
Issuance of the Series B preferred shares places restrictions on our common
stock dividend and repurchases of common stock. Prior to the the earlier of
(i) the third anniversary of the closing date or (ii) the date on which the
Series B preferred stock is redeemed in whole or the U.S. Treasury has
transferred all of the Series B preferred stock to unaffiliated third parties,
the consent of the U.S. Treasury is required to:
• Pay any dividend on our common stock other than regular quarterly dividends of not more than our current quarterly dividend of $0.24 per share; or
• Redeem, purchase or acquire any shares of common stock or other capital stock or other equity securities of any kind of the Company or any trust preferred securities issued by the Company or any affiliate except in connection with (i) any benefit plan in the ordinary course of business consistent with past practice; (ii) market-making, stabilization or customer facilitation transactions in the ordinary course or; (iii) acquisitions by the Company as trustees or custodians.
In addition, until such time as the U.S. Treasury ceases to own any debt or
equity securities of the Company acquired pursuant to the Oct. 28, 2008 closing
or exercise of the warrant described below, the Company must ensure that its
compensation, bonus, incentive and other benefit plans, arrangements and
agreements (including so-called golden parachute, severance and employment
agreements (collectively, "Benefit Plans") with respect to its senior executive
officers (as defined in the EESA and regulations thereunder) comply with
Section 111(b) of the EESA as implemented by any guidance and regulations issued
and in effect on Oct. 28, 2008.
The Series B preferred stock qualifies as Tier I capital. Including the Series B preferred stock, the Tier I capital ratio at Sept. 30, 2008 would have been approximately 12%.
In connection with the issuance of the Series B preferred stock, we issued a warrant to purchase 14,516,129 shares of our common stock to the U.S. Treasury. The warrant has a 10-year term and an exercise price of $31.00 per share. The warrant is immediately exercisable, in whole or in part. Exercise must be on a cashless basis unless the Company agrees to a cash exercise. However, the U.S. Treasury has agreed that it will not transfer or exercise the warrant for more than 50% of the shares covered until the earlier of (i) the date on which we receive aggregate gross proceeds of not less than $3 billion from one or more qualified equity offerings, and (ii) Dec. 31, 2009. If the Company completes one or more qualified equity offerings on or prior to Dec. 31, 2009 that results in the Company receiving aggregate gross proceeds of not less than $3 billion, the number of shares of common stock originally covered by the warrant will be reduced by one-half. The U.S. Treasury will not exercise voting power associated with any shares underlying the warrant. The warrant will be classified as permanent equity under GAAP.
The issuance of the Series B preferred stock is expected to reduce fully diluted earnings per share by approximately $0.02 in the fourth quarter of 2008 and approximately $0.10 in 2009.
FDIC Temporary Liquidity Guarantee Program
On Oct. 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program. This new program will:
• Guarantee certain types of senior unsecured debt issued by most U.S. bank
holding companies, U.S. savings and loan holding companies and FDIC-insured
depositary institutions between Oct. 14, 2008 and the earlier of
(i) June 30, 2009 and (if applicable) (ii) the date the FDIC-insured bank
elects not to participate in the program - a decision that must be made no
later than Dec. 5, 2008, including promissory notes, commercial paper and
any unsecured portion of secured debt. Prepayment of debt not guaranteed by
the FDIC and replacement with FDIC-guaranteed debt will not be allowed. The
amount of debt covered by the guarantee may not exceed 125 percent of the
par value of the issuing entity's senior unsecured
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