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 June 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

July 31, 2007

    
      Common Stock, $.01 par value   1,137,850,691  

 

Table of Contents

THE BANK OF NEW YORK MELLON CORPORATION

SECOND 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.

  

Overview

     5

Second quarter 2007 highlights

     6

Fee and other revenue

     7

Net interest revenue

   10

Noninterest expense

   11

Income taxes

   12

Credit loss provision and net charge-offs

   13

Business segments

   13

Critical accounting policies

   32

Consolidated balance sheet review

   36

Liquidity and dividends

   42

Capital

   45

Trading activities

    47

Asset/liability management

    50

Statistical information

    52

Supplemental information - Merger with Mellon

    54

Supplemental information - Sale of Retail Business and purchase of Acquired Corporate Trust Business

    66

The Bank of New York historical earnings per share and average shares outstanding

   69

Government monetary policies and Competition

   70

Website Information

   70
Item 1. Financial Statements:   

Consolidated Income Statement (unaudited)

    71

Consolidated Balance Sheet (unaudited)

    72

Consolidated Statement of Cash Flows (unaudited)

    73

Consolidated Statement of Changes in Shareholders’ Equity (unaudited)

    74

Notes to Consolidated Financial Statements

   75

Item 4. Controls and Procedures.

   91

Forward-looking Statements and Risk Factors

   92
Part II - Other Information   

Item 1. Legal and Regulatory Proceedings.

   94

Item 1A. Risk Factors.

    94

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

    94

Item 4. Submission of Matters to a Vote of Security Holders

    95

Item 6. Exhibits.

    96

Signature

   98

Index to Exhibits

   99

 

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 historical financial statements of the combined company presented in this Form 10-Q are the historical financial statements of The Bank of New York. In this document, 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 “Company,” the “Corporation” and similar terms for periods on and after July 1, 2007 refer to BNY Mellon.

The combined company 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 world wide client focused team. It has more than $20 trillion in assets under custody and administration and more than $1 trillion in assets under management, and it services $10 trillion in outstanding debt.

The combined company has annual revenues of more than $13 billion, with approximately 30% derived from asset servicing, 40% from issuer services, clearing and execution services and treasury services, and 30% from asset and wealth management. By the end of 2008, BNY Mellon is expected to generate over $1 billion of tangible capital per quarter. We will be well positioned to capitalize on global growth trends, including the evolution of emerging markets, the increasing need for more complex financial products and services, and the increasingly global need for people to save and invest for retirement. Almost a third of our combined revenue is derived internationally.

Financial results for Mellon are included in the “Merger with Mellon” section of this report. See pages 54 to 65. In addition, The Bank of New York Mellon Corporation will file a Form 8-K/A, which will include Mellon’s financial statements and notes for the six month periods ended June 30, 2007 and 2006, and a pro forma combined balance sheet for The Bank of New York Mellon as of June 30, 2007 and pro forma combined income statements for The Bank of New York Mellon for the six months ended June 30, 2007 and for the full year 2006. The combined financial statements for The Bank of New York Mellon will include the pro forma impact of purchase accounting adjustments resulting from the merger.

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 earnings per share and common share outstanding amounts, in this Form 10-Q, have been restated to reflect this exchange ratio. See page 69 for additional information.

 

2     The Bank of New York Mellon Corporation

Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited)

The Bank of New York Mellon Corporation

(dollar amounts in millions, except per share amounts

and unless otherwise noted)

    Quarter ended           Six months ended  
   June 30,
2007		     March 31,
2007		     June 30,
2006		           June 30,
2007		     June 30,
2006		  

Reported results

              

Net income

    $ 445     $ 434     $ 448        $ 879     $ 870  

Basic EPS (a)

      0.63       0.61       0.63          1.24       1.21  

Diluted EPS (a)

      0.62       0.60       0.62          1.22       1.20  

Continuing operations

              

Fee and other revenue

    $ 1,580     $ 1,475     $ 1,370        $ 3,055     $ 2,635  

Net interest revenue

      452       427       358            879       697  

Total revenue

    $ 2,032     $ 1,902     $ 1,728        $ 3,934     $ 3,332  

EPS from continuing operations (a):

              

Basic

    $ 0.63     $ 0.62     $ 0.55        $ 1.25     $ 1.05  

Diluted

      0.62       0.61       0.54          1.23       1.03  

Diluted excluding merger and integration costs (b)

      0.66       0.62       0.54          1.28       1.03  

Return on average tangible common equity

      37.27 %     39.20 %     30.76 %        38.20 %     29.35 %

Return on average tangible common equity excluding merger and integration costs (b)

      39.81       40.09       30.76          39.95       29.35  

Return on average common equity

      15.54       15.70       15.85          15.62       15.30  

Return on average common equity excluding merger and integration costs (b)

      16.65       16.06       15.85          16.36       15.30  

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

      78 %     77 %     79 %        78 %     79 %

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

    $ 274     $ 259     $ 275        $ 267     $ 266  

Non-U.S.:

              

Percent of revenue (FTE)

      32 %     30 %     30 %        31 %     32 %

Percent of pre-tax income (FTE) excluding merger and integrations costs (b)

      30       24       32          27       25  

Pre-tax operating margin (FTE)

      32 %     34 %     34 %        33 %     34 %

Pre-tax operating margin (FTE) excluding merger and integration costs (b)

      36 %     36 %     35 %        36 %     34 %

Net interest margin (FTE)

      2.01 %     2.18 %     1.95 %        2.10 %     1.95 %

Net interest revenue (FTE)

    $ 454     $ 429     $ 365        $ 883     $ 711  

Net income – from continuing operations

      448       437       391          885       751  

Assets under custody and administration (in trillions)

    $ 14.9     $ 13.8     $ 12.0        $ 14.9     $ 12.0  

Equity securities

      32 %     32 %     32 %        32 %     32 %

Fixed income securities

      68       68       68          68       68  

Cross-border assets (in trillions)

    $ 6.2     $ 5.0     $ 4.1        $ 6.2     $ 4.1  

Assets under management (in billions):

              

Equity securities

    $ 43     $ 41     $ 36        $ 43     $ 36  

Fixed income securities

      22       22       21          22       21  

Alternative investments

      36       33       28          36       28  

Liquid assets

      41       34       31          41       31  

Foreign exchange overlay

      11       12       11            11       11  

Total assets under management

    $ 153     $ 142     $ 127        $ 153     $ 127  

Securities lending cash collateral assets (in billions)

    $ 365     $ 375     $ 356        $ 365     $ 356  

Average common shares and equivalents outstanding (in thousands) (a)

              

Basic

      709,783       708,245       713,451          709,019       717,014  

Diluted

      722,661       719,893       721,430          721,285       725,613  

 

The Bank of New York Mellon Corporation    3

Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS (unaudited) (continued)

The Bank of New York Mellon Corporation

(dollar amounts in millions, except per share amounts and

unless otherwise noted)

    Quarter ended           Six months ended  
   June 30,
2007		     March 31,
2007		     June 30,
2006		           June 30,
2007		     June 30,
2006		  

Capital ratios

              

Tier I capital ratio (e)

      8.09 %     8.43 %     7.96 %        8.09 %     7.96 %

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

      12.07       12.81       12.06          12.07       12.06  

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

      4.53       5.47       5.19          4.53       5.19  

Return on average assets

      1.57 %     1.73 %     1.54 %        1.65 %     1.52 %

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

      1.68       1.78       1.54          1.73       1.52  

Return on average tangible assets

      1.74       1.93       1.66          1.83       1.63  

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

      1.86       1.98       1.66          1.91       1.63  

Selected average balances

              

Interest-earning assets

    $ 90,557     $ 79,075     $ 75,380        $ 84,847     $ 73,219  

Total assets

      114,278       101,975       96,395          108,217       94,124  

Interest-bearing deposits

      53,610       43,862       43,015          48,763       42,144  

Noninterest-bearing deposits

      15,334       14,903       10,869          15,120       10,496  

Shareholders’ equity

      11,566       11,277       9,882          11,422       9,885  

Credit loss provision and net charge-offs

              

Total provisions

    $ (15 )   $ (15 )   $ (1 )      $ (30 )   $ (1 )

Total net recoveries

      5       3       7          8       10  

Loans

              

Allowance for loan losses as a percent of total loans

      0.73 %     0.76 %     0.95 %        0.73 %     0.95 %

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

      0.85       0.87       1.10          0.85       1.10  

Total allowance for credit losses as a percent of total loans

      1.08       1.11       1.35          1.08       1.35  

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

      1.25       1.28       1.57          1.25       1.57  

Nonperforming assets

              

Total nonperforming assets

    $ 27     $ 29     $ 32        $ 27     $ 32  

Nonperforming assets ratio

      0.1 %     0.1 %     0.1 %        0.1 %     0.1 %

Other

              

Employees

      23,200       23,100       20,000          23,200       20,000  

Book value per common share (a)

    $ 16.50     $ 16.11     $ 13.97        $ 16.50     $ 13.97  

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

      717,000       715,403       719,607          717,000       719,607  

Dividends per share (a)

    $ 0.23     $ 0.23     $ 0.22        $ 0.47     $ 0.45  

Dividend yield

      2.12 %     2.17 %     2.61 %        2.12 %     2.61 %

Closing common stock price per share (a)

   $ 43.93     $ 42.98     $ 34.13        $ 43.93     $ 34.13  

Market capitalization (in billions)

      31.5       30.8       24.6            31.5       24.6  
(a) Earnings per share and all other share-related data has been recalculated in post-merger share terms. See page 69 for additional information.
(b) Calculated excluding pre-tax charges associated with merger and integration expenses ($47 million in the second quarter of 2007 and $15 million in the first quarter of 2007). The pre-tax operating margin for all periods presented also excludes intangible amortization.
(c) Amounts have been reclassified. See discussion on page 20.
(d) Includes deferred tax liabilities of $149 million for the second quarter of 2007, $154 million for the first quarter of 2007, $20 million for the second quarter of 2006, $149 million for the first six months of 2007 and $20 million for the first six months of 2006 related to non-tax deductible identifiable intangible assets.
(e) Includes discontinued operations.

 

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,” “rapidly evolving financial markets,” “synergies,” “opportunities,” “well-positioned,” “trends,” “pro forma” 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 move and manage 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: securities servicing, asset management, wealth management, and treasury management. Our extensive global client base includes a broad range of leading financial institutions, corporations, government entities, endowments and foundations. Our principal subsidiary, The Bank of New York (the “Bank”), founded in 1784, is the oldest bank in the United States and has consistently played a prominent role in the evolution of financial markets worldwide.

Our strategy over the past decade has been to focus on highly scalable, fee-based securities servicing and fiduciary businesses, and we have achieved top three market share in most of our major product lines. We distinguish ourselves competitively by offering one of the industry’s broadest array of products and services around the investment lifecycle. These include:

 

  •  

advisory and asset management services to support the investment decision;

 

  •  

custody, securities lending, accounting, and administrative services for investment portfolios;

 

  •  

sophisticated risk and performance measurement tools for analyzing portfolios;

 

  •  

clearance and settlement capabilities and trade and foreign exchange execution; and

 

  •  

services for issuers of both equity and debt securities.

By providing integrated solutions for clients’ needs, we strive to be the preferred partner in helping our clients succeed in the world’s rapidly evolving financial markets.

Our long-term financial objectives include:

 

  •  

sustaining top-line growth by expanding client relationships and winning new ones; and

 

  •  

achieving positive operating leverage over an economic cycle.

To achieve our long-term objectives, we have grown both through internal reinvestment as well as execution of strategic acquisitions to expand product offerings and increase market share in our scale businesses. Internal reinvestment occurs through increased technology spending, staffing levels, marketing/branding initiatives, quality programs, and product development. We consistently invest in technology to improve the breadth and quality of our product offerings, and to increase economies of scale. Our acquisitions over the past ten years have been almost exclusively in our securities servicing and asset management areas.

We have taken recent strategic actions that have significantly transformed us.

 

  •  

In July 2007 we:

 

  •  

Completed the merger of The Bank of New York and Mellon, a global leader in asset management and securities servicing.

 

  •  

Announced an agreement to buy out the remaining 50% interest in the ABN AMRO Mellon joint venture. This

 

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)

 

transaction is expected to close in late third quarter or early fourth quarter of 2007.

 

  •  

In 2006 we:

 

  •  

Sold our retail and regional middle market banking businesses (“Retail Business”)

 

  •  

Purchased the corporate trust business (the “Acquired Corporate Trust Business”) of JPMorgan Chase & Co. (“JPMorgan Chase”)

 

  •  

Formed a joint venture known as BNY ConvergEx Group, LLC, a trade execution and investment technology firm (“BNY ConvergEx”)

As part of the transformation to a leading securities servicing provider, we have also de-emphasized or exited several of our slower growth traditional banking businesses over the past decade. Our more significant actions include selling our credit card business in 1997 and our factoring business in 1999, significantly reducing non-financial corporate credit exposures, and most recently, the sale of our Retail Business. To the extent these actions generated capital, the capital has been reallocated to our higher-growth businesses or used to repurchase shares.

Our business model is well positioned to benefit from a number of long-term secular trends. These include:

 

  •  

growth of worldwide financial assets,

 

  •  

globalization of investment activity,

 

  •  

structural market changes, and

 

  •  

increased outsourcing.

These trends benefit us by driving higher levels of financial asset trading volume and other transactional activity, as well as higher asset price levels and growth in client assets, all factors by which we price our services. In addition, international markets offer excellent growth opportunities.

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.

Second quarter 2007 highlights

We reported second quarter net income of $445 million and diluted earnings per share of 62 cents, and income from continuing operations of $448 million and diluted earnings per share of 62 cents. This compares to net income of $448 million, or 62 cents of diluted earnings per share, and income from continuing operations of $391 million, or 54 cents of diluted earnings per share, in the second quarter of 2006. The second quarter of 2007 included merger and integration expenses ($47 million) that amounted to approximately four cents per share. Excluding this amount, diluted earnings per share from continuing operations in the second quarter of 2007 was 66 cents per share.

Year-to-date net income was $879 million, or $1.22 of diluted earnings per share, compared to $870 million, or $1.20 of diluted earnings per share for the same period in 2006. Year-to-date income from continuing operations was $885 million, or $1.23 of diluted earnings per share compared with $751 million, or $1.03 of diluted earnings per share in 2006.

Performance highlights for the quarter include:

 

  •  

Asset servicing revenue grew 17% over the second quarter of 2006, a record quarterly level reflecting increased transaction volumes and organic growth across all business products;

 

  •  

Issuer services results were strong on a sequential quarter basis reflecting seasonal factors;

 

  •  

Asset and wealth management fees were up 25% over the second quarter of 2006 reflecting organic growth;

 

  •  

Performance fees were up driven by Ivy Asset Management (“Ivy”) and Alcentra;

 

  •  

Good expense discipline drove positive operating leverage (excluding merger and integration expense); and

 

  •  

Asset quality remained excellent.

 

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)

 

In the second quarter of 2007, we continued our strong momentum in asset management and securities servicing. The results in these businesses demonstrate our success in maintaining focus on our clients while successfully closing the merger with Mellon. We are now executing the disciplined, thoughtful integration plan that will support our goals for new business development and merger synergies.

Fee and other revenue

 

Fee and other revenue

 

(in millions unless otherwise noted)

   

 

2Q07

           1Q07            2Q06          2Q07

vs.

1Q07

  

 

 

        2Q07

vs.

2Q06

  

 

 

          Year-to-date          YTD07

vs.

YTD06

  

 

 

                                         2007            2006         

Securities servicing fees:

                                       

Asset servicing

    $ 427       $ 393        $ 365        9 %      17 %      $ 820        $ 700        17 %

Issuer services

      367         319          207        15        77          686          361        90  

Clearing and execution services

      291         282          337        3        (14 )        573          679        (16 )

Total securities servicing fees

      1,085         994          909        9        19          2,079          1,740        19  

Asset and wealth management fees

      168         151          134        11        25          319          260        23  

Performance fees

      21         14          7        50        200          35          14        150  

Foreign exchange and other trading activities

      117         127          128        (8 )      (9 )        244          239        2  

Financing-related fees

      61         52          64        17        (5 )        113          127        (11 )

Treasury services

      55         50          52        10        6          105          103        2  

Distribution and servicing

      2         2          1        —          100          4          2        100  

Investment income

      39         36          38        8        3          75          74        1  

Securities gains (losses)

      (2)         2          3        N/M        N/M          —            (1 )      N/M  

Other (a)

      34         47          34        (28 )      —            81          77        5  

Total fee and other revenue

    $ 1,580       $ 1,475        $ 1,370        7 %      15 %      $ 3,055        $ 2,635        16 %

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

      78%         77 %        79 %      1 %      (1 )%        78 %        79 %      (1 )%

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

    $ 153       $ 142        $ 127        8 %      20 %      $ 153        $ 127        20 %

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

    $ 14.9         $ 13.8          $ 12.0          8 %        24 %        $ 14.9          $ 12.0          24 %
(a) Includes net economic value payments of $13 million and $25 million for the second and first quarters of 2007 and $38 million for the six months ended June 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.

The increase in fee and other revenue versus the year-ago quarter primarily reflects growth in securities servicing, asset and wealth management

 

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)

 

and performance fees. The first and second quarters of 2007 reflect our new business mix including higher revenue from the Acquired Corporate Trust Business partially offset by the BNY ConvergEx transaction. The sequential-quarter increase in fee and other revenue primarily reflects growth in securities servicing fees, asset and wealth management fees, performance fees and financing-related fees.

Securities servicing fees

Securities servicing fees increased over the second quarter of 2006 reflecting strong growth in asset servicing and issuer services, partially offset by a decrease in clearing and execution services fees. Securities servicing fees were up sequentially reflecting growth in issuer services, asset servicing and clearing and execution services. See “Institutional Services Segment” in “Business Segments” for additional details.

Asset and wealth management fees

Asset and wealth management fees increased from the second quarter of 2006 primarily due to strong performance in alternative investments, the introduction of a new fund at Urdang, as well as solid performance at Alcentra driven by new product introductions. Total assets under management for asset and wealth management were $153 billion at June 30, 2007, up from $127 billion at June 30, 2006 and $142 billion at March 31, 2007.

Performance fees

Performance fees were up from a year-ago quarter and sequential quarter reflecting organic growth and strong results at our alternative asset management subsidiaries, Ivy, Alcentra and Urdang.

Foreign exchange and other trading activities

Foreign exchange and other trading activities declined by $11 million, or 9%, to $117 million, and decreased 8% (unannualized) compared with the first quarter of 2007. The decline compared to both the second quarter of 2006 and first quarter of 2007 was due to lower other trading revenue reflecting the recognition of hedging costs associated with synthetic fuel tax credit investments and losses on swaps that no longer qualify as hedges. Foreign exchange results were down from the second quarter of 2006 reflecting lower market volatility. Foreign exchange revenue increased on a sequential quarter basis consistent with higher market volatility and volumes.

Financing-related fees

Financing-related fees decreased from a year-ago quarter reflecting a lower level of credit-related activities consistent with our strategic direction. Finance-related fees include capital markets and investment banking fees, loan commitment fees and credit-related trade fees. On a sequential quarter basis, financing-related fees increased reflecting higher underwriting fees.

Treasury services

Treasury services fees increased from the first quarter of 2007 and second quarter of 2006 reflecting higher client volume and net new business in the global payment business. Treasury services includes fees related to funds transfer, cash management, and liquidity management.

Investment income

Investment income in the quarter reflected continued strong returns on investments in the sponsor fund portfolio. Venture capital income was $18 million in the second quarter of 2007, up from $17 million in the first quarter of 2007 and down from $23 million in the second quarter of 2006. On a year-to-date basis, venture capital income was $36 million, down from $46 million a year ago. Investment income includes the gains and losses on private equity investments, income from insurance contracts, and lease residual gains and losses.

Securities gains (losses)

The $2 million securities loss for the quarter reflects a loss on the call of $117 million of Philippine Bonds.

 

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)

 

Other revenue

Other revenue is comprised of asset-related gains, equity investment income, net economic value payments, and other transactions. Asset-related gains 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 four categories is shown in the following table:

 

Other revenue    Quarter ended          Six months ended
(in millions)    June 30,
2007		    March 31,
2007		    June 30,
2006		          June 30,
2007		    June 30,
2006

Asset-related gains

    $ 5    $ 4    $ 18       $ 9    $ 52

Equity investment income

      12      13      14         25      25

Net economic value payments

      13      25      —         38      —

Other

      4      5      2           9      —

Other revenue

    $ 34    $ 47    $ 34         $ 81    $ 77

Other revenue decreased sequentially reflecting lower net economic value payments. The second quarter and first quarter of 2007 included $13 million and $25 million, respectively, of net economic value payments primarily for European, Middle Eastern and Asian Corporate Trust deposits that did not transfer to our balance sheet until May 21, 2007.

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

Fee and other revenue for the first six months of 2007 increased $420 million, or 16%, compared with the first six months of 2006. This increase primarily reflects the Acquired Corporate Trust Business, higher asset servicing revenue driven by custody, fund services, and broker dealer services, as well as higher wealth management fees reflecting organic growth, partially offset by the BNY ConvergEx transaction.

 

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)

 

Net interest revenue

 

Net interest revenue

 

 

(dollar amounts in millions)

                                          

 

2Q07

          

 

2Q07

           Year-to-date          

 

YTD07

  
   2Q07           1Q07           2Q06          

vs.

1Q07

          

vs.

2Q06

        2007           2006          

vs.

YTD06

  

Net interest revenue

    $ 452        $ 427        $ 358        6 %      26 %      $ 879        $ 697        26 %

Tax equivalent adjustment (a)

      2            2            7          N/M          N/M            4            14          N/M  

Net interest revenue (FTE)

    $ 454        $ 429        $ 365        6 %      24 %      $ 883        $ 711        24 %

Net interest margin

      2.01 %          2.18 %          1.95 %        (17 )bp        6 bp          2.10 %          1.95 %        15  bp
(a) Selected items included in net interest revenue have been adjusted to a fully tax equivalent (“FTE”) basis. To calculate the tax equivalent revenues and profit or loss, we adjust tax-exempt revenues and the income or loss from such tax-exempt revenues to show these items as if they were taxable, applying an assumed tax rate of 35%. We believe that this presentation provides comparability of net interest revenue arising from both taxable and tax-exempt sources and is consistent with industry standards.

N/M - Not meaningful.

bp - basis points.

Net interest revenue on an FTE basis totaled $454 million in the second quarter of 2007, an increase of $89 million from the second quarter of 2006 and $25 million from the first quarter of 2007. Net interest margin was 2.01% in the second quarter of 2007, compared with 1.95% in the second quarter of 2006 and 2.18% in the first quarter of 2007.

The majority of the increase in net interest revenue from both prior periods reflects new business and higher client volumes. In addition, net interest revenue, in the second quarter of 2007, benefited by approximately $11 million from the May 21, 2007 conversion of the European operations of the Acquired Corporate Trust Business, which added approximately $10 billion in non-U.S. deposits. We received net economic value payments on these deposits, which are recorded in Other Revenue, of $13 million for the second quarter of 2007 and $25 million for the first quarter of 2007. On a pro forma basis, including these deposits for the full quarter and the associated net economic value payments, the net interest margin would have been approximately 1.95%.

For the six months ended June 30, 2007, net interest revenue on an FTE basis was $883 million compared with $711 million in 2006, while the net interest margin was 2.10% in the first half of 2007 and 1.95% in the first half of 2006. The increase in the first six months of 2007 compared with the first six months of 2006 resulted from the factors mentioned above, as well as higher deposit balances associated with the Acquired Corporate Trust Business.

 

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)

 

Noninterest expense

 

Noninterest expense                        

2Q07

vs.

    

2Q07

vs.

                  

YTD07

vs.

  
            

 

Year-to-date

 

  
(in millions)    2Q07     1Q07     2Q06     1Q07     2Q06     2007     2006     YTD06  

Staff:

                 

Compensation

    $ 472     $ 459     $ 394     3 %   20 %   $ 931     $ 779     20 %

Incentives

      171       147       162     16     6       318       281     13  

Employee benefits

      109       114       100     (4 )   9       223       200     12  

Total staff

      752       720       656     4     15       1,472       1,260     17  

Professional, legal and other purchased services

      132       130       85     2     55       262       167     57  

Distribution and servicing

      4       4       4     —     —       8       8     —  

Net occupancy

      81       79       68     3     19       160       136     18  

Furniture and equipment

      54       50       48     8     13       104       99     5  

Software

      57       54       53     6     8       111       108     3  

Business development

      37       30       28     23     32       67       51     31  

Sub-custodian expenses

      42       34       36     24     17       76       70     9  

Clearing and execution

      44       37       59     19     (25 )     81       109     (26 )

Communications

      23       19       22     21     5       42       48     (13 )

Other

      87       72       64     21     36       159       123     29  

Subtotal

      1,313       1,229       1,123     7     17       2,542       2,179     17  

Amortization of intangible assets

      29       28       15     4     93       57       28     N/M  

Merger and integration expense:

                 

The Bank of New York Mellon

      35       4       —     N/M     N/M       39       —     N/M  

Acquired Corporate Trust Business

      12       11       —     N/M     N/M       23       —     N/M  

Total noninterest expense

    $ 1,389     $ 1,272     $ 1,138     9 %   22 %   $ 2,661     $ 2,207     21 %

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

      37 %     38 %     38 %         37 %     38 %  

Employees at period-end

      23,200       23,100       20,000     — %   16 %     23,200       20,000     16 %

N/M - Not meaningful.

Noninterest expense was up compared with the second quarter of 2006 and first quarter of 2007. The purchase of the Acquired Corporate Trust Business and the remaining 50% of the AIB/BNY Securities Servicing (Ireland) Ltd. (“AIB/BNY”) joint venture, along with the disposition of certain execution businesses in the BNY ConvergEx transaction, significantly impacted comparisons of the second quarter of 2007 to the second quarter of 2006. The net impact of these transactions was to increase staff expense, net occupancy, business development, professional, legal and other purchased services, amortization of intangibles, and other expense. The BNY ConvergEx transaction also resulted in lower clearing expenses. The sequential-quarter increase reflects higher salaries, incentive compensation, as well as merger and integration expenses related to the merger transaction 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 in the second 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    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)

 

 

  •  

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 versus goals; and

 

  •  

stock option 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 Acquired Corporate Trust Business and the consolidation of AIB/BNY, partially offset by the BNY ConvergEx transaction.

Non-staff expense

Non-staff expenses include 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 expenses increased $155 million, or 32%, compared with the second quarter of 2006 reflecting:

 

  •  

Higher professional, legal and other purchased services expenses resulting from higher legal expense and consulting fees.

 

  •  

An increase in net occupancy primarily resulting from the conversion of AIB/BNY to a wholly-owned subsidiary.

 

  •  

Transition services expense and other costs related to the Acquired Corporate Trust Business of $11 million in the current quarter and $21 million in the first quarter of 2007, recorded in other expense.

 

  •  

Merger and integration expense in the second quarter of 2007 included $12 million related to the Acquired Corporate Trust Business and $35 million related to the merger with Mellon. The merger and integration expenses associated with the Mellon merger include amounts for personnel-related ($17 million), integration/conversion ($15 million), and one-time costs ($3 million).

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

Noninterest expense in the first six months of 2007 increased $454 million, or 21%, compared with the first six months of 2006. The increase primarily reflects the same factors impacting the quarterly results.

Income taxes

The effective tax rate for the second quarter of 2007 was 31.9%, compared to 33.8% in the second quarter of 2006 and 32.2% in the first quarter of 2007. The lower effective rate in the second quarter of 2007 compared to the prior year was attributable to higher foreign tax credit benefits in the second quarter of 2007. On a year-to-date basis, the effective tax rate was 32.1% compared with 33.3% in the first six months of 2006.

The projected effective tax rate for the second half of 2007 ranges between 33.8% and 34.2%. The 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.

Our effective tax rate benefits by the amount of synthetic fuel tax credits (Section 29 of the Internal Revenue Code) we will 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.

 

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)

 

At June 30, 2007, we assumed a $70 average price per barrel after June 30, 2007 to estimate the remainder of 2007 benefit from synthetic fuel credits. We believe our assumption for the second half of 2007 is reasonable given the historic seasonal patterns for oil prices. To the extent the average oil price differs from this assumption, we do not expect a material effect on earnings in the third and fourth quarters of 2007.

Credit loss provision and net charge-offs

 

      Quarter ended           Six months ended  
(in millions)    June 30,
2007		     March 31,
2007		     June 30,
2006		           June 30,
2007		     June 30,
2006		  

Provision

    $ (15 )   $ (15 )   $ (1 )      $ (30 )   $ (1 )

Net (charge-offs)/recoveries:

              

Commercial

    $ 5     $ 3     $ 2        $ 8     $ 3  

Foreign

      —       —       4          —       6  

Other

      —       —       1            —       1  

Total net (charge-offs)/recoveries

    $ 5     $ 3     $ 7          $ 8     $ 10  

The provision for credit losses for the second quarter of 2007 was a credit of $15 million, compared with a credit of $1 million in the second quarter of 2006 and a credit of $15 million in the first quarter of 2007, reflecting the favorable disposition of an aircraft lease and continuing excellent credit quality. We recorded a net recovery of $5 million in the second quarter of 2007, compared with a net recovery of $7 million in the second quarter of 2006 and a net recovery of $3 million in the first quarter of 2007. The second quarter and first quarter of 2007 include $5 million and $7 million, respectively, of recoveries related to leased aircraft that were sold. For the six months ended June 30, 2007, the provision for credit losses was a credit of $30 million compared with a credit of $1 million in the first half of 2006. We recorded a net recovery of $8 million for the six months ended June 30, 2007 compared with a net recovery of $10 million in the first six 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. 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).

 

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)

 

We continuously update segment information for changes that occur in the management of our businesses. In the first and second quarters of 2007, in connection with the merger with Mellon, business segment reporting was realigned to reflect the planned 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 third quarter of 2007.

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

 

  •  

Clearing and Execution Services sector

 

  •  

Issuer Services sector

 

  •  

Treasury Services sector

 

  •  

Other Segment

On Oct. 1, 2006, we sold substantially all of the assets of our Retail Business.

Specific segment accounting principles employed include:

 

  •  

Revenue amounts reflect fee revenue generated by each segment.

 

  •  

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. Previously, segments with a net liability position would 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 a tax equivalent 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 business segment information is reported on a continuing operations basis for all periods presented.

 

  •  

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

 

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)

 

 

Market indexes                                                               

2Q07

vs.

                                  

YTD07

vs.

YTD06

  
                                                            Year-to-date      
      2Q06          3Q06          4Q06          1Q07          2Q07          1Q07           2007          2006      

S&P 500 Index (a)

    1,270       1,336       1,418       1,421       1,503       6 %      1,503       1,270       18 %

NASDAQ Composite Index (a)

    2,172       2,258       2,415       2,422       2,603       7        2,603       2,172       20  

Lehman Brothers Aggregate Bondsm Index (a)

    213.2       220.0       226.6       230.8       227.9       (1 )      227.9       213.2       7  

MSCI EAFE® Index (a)

    1,822.9       1,885.3       2,074.5       2,147.5       2,262.2       5        2,262.2       1,822.9       24  

NYSE Volume (in billions)

    121.6       108.8       114.4       123.8       127.7       3        251.5       235.3       7  

NASDAQ Volume (in billions)

    134.2         114.6         121.5         131.4         134.0         2          265.4         265.0         —  
(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 second quarter of 2007 was impacted by a seasonal pick up in corporate actions that increased revenue related to depositary receipts and securities lending. Non-program equity trading volumes were down 6% sequentially and up 5% year-over-year. In addition, average daily U.S. fixed-income trading volume was up 3% sequentially and 10% year-over-year. Total debt issuance decreased 5% sequentially and increased 15% year-over-year. The issuance of global collateralized debt obligations was up 13% versus the second quarter of 2006.

As of June 30, 2007, assets under custody and administration rose to $14.9 trillion, from $12.0 trillion at June 30, 2006 and $13.8 trillion at March 31, 2007. The increase in assets under custody and administration from June 30, 2006 primarily reflects rising asset prices, growth in the custody business and the impact of the Acquired Corporate Trust Business. Equity securities comprised 32% of the assets under custody and administration at June 30, 2007, and fixed-income securities were 68%, both unchanged from June 30, 2006. Assets under custody and administration at June 30, 2007 consisted of assets related to the custody, mutual funds, and corporate trust businesses of $10.7 trillion, broker-dealer services assets of $2.4 trillion, and all other assets of $1.8 trillion.

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

 

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)

 

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 %
                   

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 %

 

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)

 

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     $ 424     $ 371     $ 296     $ 132     $ 1,223     $ 60     $ 1,441  

Net interest revenue

      7       15       22       136       107       63       101       407       23       452  

Total revenue

      116       64       180       560       478       359       233       1,630       83       1,893  

Provision for credit losses

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

Noninterest expense

      74       53       127       422       246       262       129       1,059       99       1,285  

Income before taxes

    $ 42     $ 11     $ 53     $ 138     $ 233     $ 95     $ 111     $ 577     $ (7 )   $ 623  

Pre-tax operating margin (a)

      36 %     17 %     29 %     25 %     49 %     26 %     48 %     35 %     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     $ 414     $ 230     $ 256     $ 129     $ 1,029     $ 99     $ 1,251  

Income before taxes

      46       11       57       146       249       101       111       607       (7 )     657  

Pre-tax operating margin (a)

      40 %     17 %     32 %     26 %     52 %     28 %     48 %     37 %     N/M       35 %
                    
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     $ 427     $ 205     $ 328     $ 141     $ 1,101     $ 31     $ 1,263  

Net interest revenue

      3       16       19       119       49       60       98       326       13       358  

Total revenue

      87       63       150       546       254       388       239       1,427       44       1,621  

Provision for credit losses

      —       —       —       —       1       —       (3 )     (2 )     (2 )     (4 )

Noninterest expense

      58       52       110       411       127       309       126       973       113       1,196  

Income before taxes

    $ 29     $ 11     $ 40     $ 135     $ 126     $ 79     $ 116     $ 456     $ (67 )   $ 429  

Pre-tax operating margin (a)

      33 %     17 %     27 %     25 %     50 %     20 %     49 %     32 %     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     $ 410     $ 126     $ 301     $ 126     $ 963     $ 113     $ 1,182  

Income before taxes

      33       11       44       136       127       87       116       466       (67 )     443  

Pre-tax operating margin (a)

      38 %     17 %     29 %     25 %     50 %     22 %     49 %     33 %     N/M       27 %

 

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)

 

For the quarter ended
June 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

    $ 85     $ 51     $ 136     $ 474     $ 220     $ 352     $ 156     $ 1,202     $ 32     $ 1,370  

Net interest revenue

      3       13       16       114       54       56       97       321       28       365  

Total revenue

      88       64       152       588       274       408       253       1,523       60       1,735  

Provision for credit losses

      —       (2 )     (2 )     —       —       (4 )     7       3       (2 )     (1 )

Noninterest expense

      55       52       107       410       128       312       131       981       50       1,138  

Income before taxes

    $ 33     $ 14     $ 47     $ 178     $ 146     $ 100     $ 115     $ 539     $ 12     $ 598  

Pre-tax operating margin (a)

      38 %     22 %     31 %     30 %     53 %     25 %     45 %     35 %     N/M       34 %

Average assets

    $ 1,055     $ 1,446     $ 2,501     $ 8,873     $ 1,316     $ 17,175     $ 16,280     $ 43,644     $ 50,250     $ 96,395 (b)

Excluding intangible amortization:

                     

Noninterest expense

    $ 51     $ 52     $ 103     $ 408     $ 127     $ 304     $ 131     $ 970     $ 50     $ 1,123  

Income before taxes

      37       14       51       180       147       108       115       550       12       613  

Pre-tax operating margin (a)

      42 %     22 %     34 %     31 %     54 %     26 %     45 %     36 %     N/M       35 %
(a) Income before taxes divided by total revenue.
(b) Including average assets of discontinued operations of $45 million, $66 million, $51 million, $13,285 million and $13,993 million for quarters ended June 30, 2007, March 31, 2007, Dec. 31, 2006, Sept. 30, 2006 and June 30, 2006, consolidated average assets were $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, $108,864 million for the third quarter of 2006 and $110,388 million for the second quarter of 2006.

N/M - Not meaningful.

 

For the six months 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

   $ 223     $ 103     $ 326     $ 996     $ 746     $ 628     $ 277     $ 2,647     $ 82     $ 3,055  

Net interest revenue

     10       31       41       287       238       124       190       839       3       883  

Total revenue

     233       134       367       1,283       984       752       467       3,486       85       3,938  

Provision for credit losses

     —       —       —       —       —       —       (10 )     (10 )     (20 )     (30 )

Noninterest expense

     139       111       250       915       504       575       259       2,253       158       2,661  

Income before taxes

   $ 94     $ 23     $ 117     $ 368     $ 480     $ 177     $ 218     $ 1,243     $ (53 )   $ 1,307  

Pre-tax operating margin (a)

     40 %     17 %     32 %     29 %     49 %     24 %     47 %     36 %     N/M       33 %

Average assets

   $ 1,387     $ 1,468     $ 2,855     $ 11,382     $ 4,672     $ 16,315     $ 16,984     $ 49,353     $ 56,009     $ 108,217 (b)

Excluding intangible amortization:

                    

Noninterest expense

   $ 131     $ 111     $ 242     $ 912     $ 470     $ 563     $ 259     $ 2,204     $ 158     $ 2,604  

Income before taxes

     102       23       125       371       514       189       218       1,292       (53 )     1,364  

Pre-tax operating margin (a)

     44 %     17 %     34 %     29 %     52 %     25 %     47 %     37 %     N/M       35 %

 

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)

 

 

For the six months ended
June 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

    $ 164     $ 102     $ 266     $ 901     $ 385     $ 735     $ 291     $ 2,312     $ 57     $ 2,635  

Net interest revenue

      5       29       34       220       102       110       193       625       52       711  

Total revenue

      169       131       300       1,121       487       845       484       2,937       109       3,346  

Provision for credit losses

      —       (2 )     (2 )     —       —       (6 )     15       9       (8 )     (1 )

Noninterest expense

      105       105       210       804       242       619       255       1,920       77       2,207  

Income before taxes

    $ 64     $ 28     $ 92     $ 317     $ 245     $ 232     $ 214     $ 1,008     $ 40     $ 1,140  

Pre-tax operating
margin (a)

      38 %     21 %     31 %     28 %     50 %     27 %     44 %     34 %     N/M       34 %

Average assets

    $ 990     $ 1,485     $ 2,475     $ 8,150     $ 1,333     $ 17,277     $ 15,902     $ 42,662     $ 48,987     $ 94,124 (b)

Excluding intangible amortization:

                     

Noninterest expense

    $ 98     $ 105     $ 203     $ 800     $ 241     $ 603     $ 255     $ 1,899     $ 77     $ 2,179  

Income before taxes

      71       28       99       321       246       248       214       1,029       40       1,168  

Pre-tax operating margin (a)

      42 %     21 %     33 %     29 %     51 %     29 %     44 %     35 %     N/M       35 %
(a) Income before taxes divided by total revenue.
(b) Including average assets of discontinued operations of $55 million for first six months of 2007 and $14,147 million for the first six months of 2006, consolidated average assets were $108,272 million for the first six months of 2007 and $108,271 million for the first six months of 2006.

N/M - Not meaningful.

 

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)

 

Asset and Wealth Management Segment

Asset and Wealth Management fee revenue is dependent on the overall level and mix of assets under management and the management fees charged for managing those assets. Assets under management (“AUM”) were $153 billion at June 30, 2007, compared with $127 billion at June 30, 2006, and $142 billion at March 31, 2007. The year-over-year increase in AUM primarily reflects the continued good growth across asset classes and strategies. Institutional clients represent 77% of AUM while individual clients equal 23%.

 

Assets under management at period-end

(in billions)

    2Q06          3Q06          4Q06          1Q07          2Q07

Equity securities

    $ 36       $ 36       $ 39       $ 41       $ 43

Fixed-income securities

      21         20         21         22         22

Alternative investments

      28         30         33         33         36

Liquid assets

      31         34         38         34         41

Foreign exchange overlay

      11           11           11           12           11

Total assets under management

    $ 127         $ 131         $ 142         $ 142         $ 153

As part of the planning process for the integration of The Bank of New York and Mellon, we no longer include securities lending cash collateral assets in total assets under management. The following table provides a reconciliation of assets under management as originally reported to the current disclosure format.

 

Assets under management reconciliation

(in billions)

    2Q06           3Q06           4Q06           1Q07  

Originally reported

    $ 170        $ 179        $ 190        $ 196  

Securities lending adjustment

      (43 )          (48 )          (48 )          (54 )

Assets under management - revised

    $ 127          $ 131          $ 142          $ 142  

 

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)

 

Asset Management sector

 

(dollar amounts in millions,

unless otherwise noted;

      2Q06            3Q06            4Q06            1Q07            2Q07          2Q07

vs.

2Q06

  

 

 

          Year-to-date          YTD07

vs

YTD06

  

 

 

presented on an FTE basis)

                                                2007            2006         

Revenue:

                                           

Asset and wealth management:

                                           

Mutual funds

    $ 3        $ 2        $ 3        $ 3        $ 4        33 %      $ 7        $ 5        40 %

Institutional clients

      61          64          72          68          80        31          148          116        28  

Private clients

      12          12          13          13          15        25          28          23        22  

Total asset management revenue

      76          78          88          84          99        30          183          144        27  

Performance fees

      7          3          18          14          21        200          35          14        150  

Other

      2          3          3          3          2        —          5          6        (17 )

Total fee and other revenue

      85          84          109          101          122        44          223          164        36  

Net interest revenue

      3          3          7          6          4        N/M          10          5        100  

Total revenue

      88          87          116          107          126        43          233          169        38  

Noninterest expense (excluding intangible amortization)

      51          54          70          63          68        33          131          98        34  

Income before taxes (excluding intangible amortization)

      37          33          46          44          58        57          102          71        44  

Amortization of intangible assets

      4          4          4          4          4        —          8          7        14  

Income before taxes

    $ 33        $ 29        $ 42        $ 40        $ 54        64 %      $ 94        $ 64        47 %

Pre-tax operating margin (excluding intangible amortization)

      42 %        38 %        40 %        41 %        46 %             44 %        42 %     

Average assets

    $ 1,055          $ 1,082          $ 1,226          $ 1,387          $ 1,387          31 %        $ 1,387          $ 990          40 %

N/M - Not meaningful.

Business description

The Asset Management sector provides investment solutions predominantly to institutional investors around the world applying a broad spectrum of investment strategies. Asset Management’s alternative strategies have expanded to include funds of hedge funds, private equity, alternative fixed income, and real estate.

Our asset management subsidiaries include:

 

  •  

Ivy Asset Management Corporation, one of the country’s leading fund of hedge funds firms, offers a comprehensive range of multi- manager hedge fund products and customized portfolio solutions.

 

  •  

Alcentra, a company that offers sophisticated alternative credit investments, including leveraged loans and subordinated and distressed debt.

 

  •  

Urdang, a real estate investment firm, offers the opportunity to invest in real estate through separate accounts, a closed-end commingled fund that invests directly in properties, and a separate account that invests in publicly-traded real estate investment trusts.

 

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)

 

 

  •  

Estabrook Capital Management LLC, a company that offers value-oriented investment management strategies, including socially responsible investing.

 

  •  

Gannett, Welsh & Kotler, a company that specializes in tax-exempt securities management and equity portfolio strategies.

We also provide investment management services directly to institutions and manage the “Hamilton” family of mutual funds.

Review of financial results

Income before taxes increased 64% to $54 million in the second quarter of 2007 from $33 million in the second quarter of 2006, and increased 35% from $40 million in the first quarter of 2007.

Fee and other revenue increased $37 million, or 44%, in the second quarter of 2007 compared with the second quarter of 2006 reflecting higher asset management fees from institutional clients. Performance fees were up reflecting strong results at two of our alternative asset management subsidiaries, Ivy Asset Management and Alcentra. 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) increased $17 million, or 33%, in the second quarter of 2007 compared with the second quarter of 2006 reflecting higher incentive compensation, outside help, technology and legal expenses. The sequential-quarter increase in noninterest expense primarily reflects legal, technology and other compensation expenses.

On a year-to-date basis, income before taxes increased $30 million, or 47%, compared with the first six months of 2006. The pre-tax operating margin (excluding intangible amortization) was 44% in the first six months of 2007 reflecting a 2% increase. Fee and other revenue increased $59 million, or 36%, primarily due to higher asset management fees from institutional clients and higher performance fees at Ivy and Alcentra. Net interest revenue increased $5 million compared with the first half of 2006 reflecting higher interest-earning assets. Noninterest expense (excluding intangible amortization) increased $33 million, or 34%, in the first half of 2007 compared with the first half of 2006 primarily due to higher other compensation, salaries and outside help, technology, occupancy and legal expenses.

 

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)

 

Wealth Management sector

 

(dollar amounts in millions,

unless otherwise noted;

                                                                     2Q07

vs.

 

 

          Year-to-date          YTD07
vs.		  
 

presented on an FTE basis)

      2Q06            3Q06            4Q06            1Q07            2Q07          2Q06            2007            2006          YTD06  

Revenue:

                                           

Asset and wealth management

    $ 50        $ 46        $ 48        $ 50        $ 50        — %      $ 100        $ 99        1 %

Other

      1          1          1          1          2        N/M          3          3        —  

Total fee and other revenue

      51          47          49          51          52        2          103          102        1  

Net interest revenue

      13          16          15          16          15        15          31          29        7  

Total revenue

      64          63          64          67          67        5          134          131        2  

Provision for credit losses

      (2 )        —          —          —          —        N/M          —          (2 )      N/M  

Noninterest expense (excluding intangible amortization)

      52          52          53          55          56        8          111          105        6  

Income before taxes (excluding intangible amortization)

      14          11          11          12          11        (21 )        23          28        (18 )

Amortization of intangible assets

      —          —          —          —          —        —          —          —        —  

Income before taxes

    $ 14        $ 11        $ 11        $ 12        $ 11        (21 )      $ 23        $ 28        (18 )

Pre-tax operating margin (excluding intangible amortization)

      22 %        17 %        17 %        18 %        16 %             17 %        21 %     

Average loans

    $ 1,352        $ 1,410        $ 1,373        $ 1,336        $ 1,341        (1 )      $ 1,339        $ 1,391        (4 )

Average assets

      1,446          1,503          1,481          1,448          1,487        3          1,468          1,485        (1 )

Average deposits

      1,110          1,116          1,090          1,119          1,065        (4 )     

 

1,092

 

        1,125        (3 )

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

    $ 61          $ 59          $ 60          $ 59          $ 59          (3 )          59            61          (3 )

N/M - Not meaningful.

Business description

In the Wealth Management sector, we offer a full array of investment management, wealth management, and comprehensive financial management services to help individuals plan, invest, and arrange intergenerational wealth transition, which includes financial and estate planning, trust and fiduciary services, customized banking services, and brokerage and investment solutions. Clients include predominantly high-net-worth individuals, families, family offices, charitable gift programs, endowments, foundations, professionals, and entrepreneurs.

Review of financial results

Income before taxes was down 21% to $11 million for the second quarter of 2007 from $14 million in the second quarter of 2006, and down 8% from $12 million in the first quarter of 2007.

Total fee and other revenue increased $1 million, or 2%, in the second quarter of 2007 compared with the second quarter of 2006 primarily resulting from nonrecurring termination fees, new business and market performance.

Net interest revenue increased $2 million, or 15%, compared with the second quarter of 2006, reflecting growth in non-interest bearing deposits coupled with a higher spread earned. On a sequential-quarter basis, net interest revenue

 

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)

 

decreased reflecting a lower level of deposits and a challenging spread environment.

Noninterest expense (excluding intangible amortization) increased $4 million, or 8%, in the second quarter of 2007 compared with the second quarter of 2006 primarily reflecting higher salaries and outside help, occupancy and technology expense. The sequential-quarter increase primarily reflects higher technology expense.

On a year-to-date basis, income before taxes decreased $5 million, or 18%, compared with the first six months of 2006. The pre-tax operating margin (excluding intangible amortization) was 17% in the first six months of 2007 reflecting a 4% decrease. Fee and other revenue increased $1 million, or 1%. Net interest revenue increased reflecting growth in noninterest bearing deposits coupled with a higher spread earned. Noninterest expense (excluding intangible amortization) increased $6 million, or 6%, in the first half of 2007 compared with the first half of 2006 primarily driven by higher salaries and outside help, operations and occupancy expenses.

Institutional Services Segment

Asset Servicing sector

 

(dollar amounts in millions,

unless otherwise noted;

presented on an FTE
basis)

                                                                   

 

2Q07

           Year-to-date          

 

YTD07

  
   2Q06          

3Q06

          

4Q06

          

1Q07

          

2Q07

           vs.
2Q06		           2007           2006           vs.
YTD06		  

Revenue:

                                           

Securities servicing fees - Asset Servicing

    $ 364        $ 345        $ 353        $ 393        $ 426        17 %      $ 819        $