Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2008, for The Bank of New York Mellon Corporation (BNY Mellon). The Company is a global leader in asset and wealth management, asset servicing, issuer services, clearing services, and treasury services. Financial results reflect the combined operations of The Bank of New York and Mellon Financial following their July 1, 2007 merger. During the quarter, the Company completed the consolidation of its principal U.S. bank subsidiaries into two entities: The Bank of New York Mellon and BNY Mellon, National Association.
Key Financial Metrics
| Metric | Q2 2008 | Q2 2007 (Legacy BNY) | YTD 2008 | YTD 2007 (Legacy BNY) |
|---|---|---|---|---|
| Net Income | $309 million | $445 million | $1,055 million | $879 million |
| Diluted EPS | $0.27 | $0.62 | $0.92 | $1.22 |
| Total Revenue | $3,397 million | $2,032 million | $7,142 million | $3,934 million |
| Fee and Other Revenue | $2,986 million | $1,580 million | $5,964 million | $3,055 million |
| Net Interest Revenue | $411 million | $452 million | $1,178 million | $879 million |
| Noninterest Expense | $2,758 million | $1,389 million | $5,377 million | $2,661 million |
| Provision for Credit Losses | $25 million | ($15 million) credit | $41 million | ($30 million) credit |
| Assets Under Management (AUM) | $1.113 trillion | $153 billion | $1.113 trillion | $153 billion |
| Assets Under Custody | $23.0 trillion | $16.7 trillion | $23.0 trillion | $16.7 trillion |
| Tier I Capital Ratio | 9.33% | 8.09% | 9.33% | 8.09% |
| Return on Tangible Common Equity | 26.7% | 37.3% | 38.8% | 38.2% |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 67% year-over-year and 9% sequentially, primarily driven by the inclusion of Mellon Financial's results, higher foreign exchange trading revenue, and growth in securities servicing fees.
- Profitability Decline: Net income decreased 31% year-over-year. This decline is largely attributable to significant non-recurring charges: a $380 million pre-tax charge related to Sale-in, Lease-out (SILO) transactions and a $152 million pre-tax securities loss due to other-than-temporary impairments (OTTI) on Alt-A, ABS CDO, and HELOC securities.
- Expense Increases: Noninterest expenses rose 99% year-over-year due to the merger, annual merit salary increases, and higher intangible amortization ($124 million in Q2 2008 vs. $29 million in Q2 2007).
- Net Interest Margin: The net interest margin (FTE) dropped to 1.16% from 2.01% in the prior year, heavily impacted by the SILO charge. Excluding the SILO charge, the margin was 2.21%.
Guidance, Outlook, and Risks
- Merger Synergies: Management revised its targets, now expecting annual merger-related expense synergies of $850 million by 2010 and revenue synergies of $325-425 million by 2011. Total merger and integration expenses are now estimated at $1.475 billion.
- SILO Tax Contingency: The Company recorded a $380 million charge related to SILO transactions following adverse court rulings. The Company expects to deposit funds with the IRS in Q3 2008 to offset interest accruals. An IRS settlement program was announced in August 2008, but the financial impact of any offer remains uncertain.
- Securities Portfolio: The Company recorded $152 million in OTTI losses. Management continues to monitor the portfolio, which includes significant exposure to Alt-A and CDO securities. Unrealized losses on the available-for-sale portfolio totaled $1.8 billion (net of tax), reducing tangible equity.
- Legal Proceedings: Significant ongoing matters include a $22.5 billion claim by the Russian Federation regarding funds transfers, an SEC investigation into Pershing Trading Company, and a bankruptcy adversary proceeding involving Sentinel Management Group.
- Capital Outlook: The Company maintains a Tier I capital target of 8% and an adjusted tangible common equity target of 5%. While the Tier I ratio (9.33%) exceeds the target, the adjusted tangible common equity ratio (4.31%) is below the 5% target due to unrealized securities losses.
Investor Verification Checklist
- SILO Resolution: Verify the terms and financial impact of the IRS settlement offer for SILO transactions, as the outcome could materially affect future earnings and tax reserves.
- Securities Impairments: Monitor the valuation of the Alt-A, CDO, and HELOC portfolios for further other-than-temporary impairment charges, given the volatility in the housing market.
- Merger Integration Costs: Track actual merger and integration expenses against the revised $1.475 billion total estimate to assess the timeline for realizing synergies.
- Legal Exposure: Review updates on the Russian Federation claim and the Sentinel Management Group bankruptcy, as these represent significant contingent liabilities.
- Capital Ratios: Assess the Company's ability to maintain capital ratios above regulatory minimums and internal targets amidst unrealized losses in the securities portfolio.