Loans and Leases

Loans are generally recorded at their principal amount outstanding, net of the allowance for loan losses, unearned income, and any net unamortized deferred loan origination fees. Acquired loans have been initially recorded at fair value based on management’s expectation with respect to future principal and interest collection as of the date of acquisition. Acquired loans are held for investment, and as such their initial fair value is not adjusted subsequent to acquisition. Loans that are classified as held-for-sale are measured at lower of cost or fair value on an individual basis.

Interest revenue related to loans is recognized in our consolidated statement of income using the interest method, or on a basis approximating a level rate of return over the term of the loan. Fees received for providing loan commitments and letters of credit that we anticipate will result in loans typically are deferred and amortized to interest revenue over the term of the related loan, beginning with the initial borrowing. Fees on commitments and letters of credit are amortized to processing fees and other revenue over the commitment period when funding is not known or expected.

Leveraged-lease investments are reported at the aggregate of lease payments receivable and estimated residual values, net of non-recourse debt and unearned income. Lease residual values are reviewed regularly for other-than-temporary impairment, with valuation adjustments recorded against processing fees and other revenue. Unearned income is recognized to yield a level rate of return on the net investment in the leases. Gains and losses on residual values of leased equipment sold are recorded in processing fees and other revenue.

The following table presents our recorded investment in loans and leases, by segment and class, as of the dates indicated:



(In millions)	December 31, 2015			December 31, 2014
Institutional:
Investment funds:
U.S.	$	11,136		$	11,388
Non-U.S.	1,678			2,333
Commercial and financial:
U.S.	4,671			3,061
Non-U.S.	278			256
Purchased receivables:
U.S.	93			124
Non-U.S.	—			6
Lease financing:
U.S.	337			335
Non-U.S.	578			668
Total institutional	18,771			18,171
Commercial real estate:
U.S.	28			28
Total loans and leases	18,799			18,199
Allowance for loan losses	(46		)	(38		)
Loans and leases, net of allowance for loan losses	$	18,753		$	18,161

The components of our net investment in leveraged lease financing, included in the institutional segment in the preceding table, were as follows as of December 31:



(In millions)	2015			2014
Net rental income receivable	$	1,159		$	1,284
Estimated residual values	89			89
Unearned income	(333		)	(370		)
Investment in leveraged lease financing	915			1,003
Less: related deferred income tax liabilities	(334		)	(326		)
Net investment in leveraged lease financing	$	581		$	677

We segregate our loans and leases into two segments: institutional and CRE. Within the institutional and CRE segments, we further segregate the receivables into classes based on their risk characteristics, their initial measurement attributes and the methods we use to monitor and assess credit risk.

The institutional segment is composed of the following classes: investment funds, commercial-and- financial, purchased receivables and lease financing. The investment funds class includes lending to mutual and other collective investment funds. The commercial-and-financial class includes lending to corporate borrowers, including broker/dealers, as well as purchased senior secured bank loans. These senior secured bank loans, which are more fully described below, are carried in connection with our participation in loan syndications in the non-investment-grade lending market. The purchased receivables class represents undivided interests in securitized pools of underlying third-party receivables added in connection with the commercial paper conduit consolidation in 2009. The lease financing class includes our investment in leveraged lease financing.

Short-duration advances to our clients included in the institutional segment were $2.62 billion and $3.54 billion as of December 31, 2015 and December 31, 2014, respectively. These short-duration advances provide liquidity to fund clients in support of their transaction flows associated with securities settlement activities.

The commercial-and-financial class in the institutional segment presented in the preceding table included approximately $3.14 billion and $2.07 billion of senior secured bank loans as of December 31, 2015 and 2014, respectively. These senior secured bank loans are included in the “speculative” category in the credit-quality-indicator tables presented below. As of December 31, 2015 and December 31, 2014, our allowance for loan losses included approximately $35 million and $26 million, respectively, related to these loans.

The CRE segment comprises the loans acquired in 2008 pursuant to indemnified repurchase agreements with an affiliate of Lehman as a result of the Lehman Brothers bankruptcy. The CRE loans, primarily collateralized by direct and indirect interests in commercial real estate, were recorded at their then-current fair value based on management’s expectations with respect to future cash flows from the loans using appropriate market discount rates as of the date of acquisition. These cash flow estimates are updated quarterly to reflect changes in management’s expectations, which consider market conditions and other factors.

The following tables present our recorded investment in each class of loans and leases by credit quality indicator as of the dates indicated:



	Institutional
December 31, 2015	Investment Funds		Commercial and Financial		Purchased Receivables		Lease Financing		Commercial Real Estate		Total Loans and Leases
(In millions)	Investment Funds		Commercial and Financial		Purchased Receivables		Lease Financing		Commercial Real Estate		Total Loans and Leases
Investment grade⁽¹⁾	$	12,415	$	1,780	$	93	$	888	$	28	$	15,204
Speculative⁽²⁾	399		3,138		—		27		—		3,564
Special mention⁽³⁾	—		31		—		—		—		31
Total	$	12,814	$	4,949	$	93	$	915	$	28	$	18,799



	Institutional
December 31, 2014	Investment Funds		Commercial and Financial		Purchased Receivables		Lease Financing		Commercial Real Estate		Total Loans and Leases
(In millions)	Investment Funds		Commercial and Financial		Purchased Receivables		Lease Financing		Commercial Real Estate		Total Loans and Leases
Investment grade⁽¹⁾	$	13,304	$	1,011	$	130	$	976	$	—	$	15,421
Speculative⁽²⁾	417		2,306		—		27		28		2,778
Total	$	13,721	$	3,317	$	130	$	1,003	$	28	$	18,199

⁽¹⁾Investment-grade loans and leases consist of counterparties with strong credit quality and low expected credit risk and probability of default. Ratings apply to counterparties with a strong capacity to support the timely repayment of any financial commitment.

⁽²⁾Speculative loans and leases consist of counterparties that face ongoing uncertainties or exposure to business, financial, or economic downturns. However, these counterparties may have financial flexibility or access to financial alternatives, which allow for financial commitments to be met.

⁽³⁾Special mention loans and leases consist of counterparties with potential weaknesses that, if uncorrected, may result in deterioration of repayment prospects.

We use an internal risk-rating system to assess our risk of credit loss for each loan or lease. This risk-rating process incorporates the use of risk-rating tools in conjunction with management judgment. Qualitative and quantitative inputs are captured in a systematic manner, and following a formal review and approval process, an internal credit rating based on our credit scale is assigned.

In assessing the risk rating assigned to each individual loan or lease, among the factors considered are the borrower's debt capacity, collateral coverage, payment history and delinquency experience, financial flexibility and earnings strength, the expected amounts and sources of repayment, the level and nature of contingencies, if any, and the industry and geography in which the borrower operates. These factors are based on an evaluation of historical and current information, and involve subjective assessment and interpretation. Credit counterparties are evaluated and risk-rated on an individual basis at least annually. Management considers the ratings to be current as of December 31, 2015.

The following table presents our recorded investment in loans and leases, disaggregated based on our impairment methodology, as of the dates indicated:



	December 31, 2015						December 31, 2014
(In millions)	Institutional		Commercial Real Estate		Total Loans and Leases		Institutional		Commercial Real Estate		Total Loans and Leases
Loans and leases:
Collectively evaluated for impairment⁽¹⁾	$	18,771	$	28	$	18,799	$	18,171	$	28	$	18,199
Total	$	18,771	$	28	$	18,799	$	18,171	$	28	$	18,199

⁽¹⁾For those portfolios where there are a small number of loans each with a large balance, we review each loan annually for indicators of impairment. For those loans where no such indicators are identified, the loans are collectively evaluated for impairment. As of December 31, 2015 and December 31, 2014, all of the allowance for loan losses of $46 million and $38 million, respectively, related to institutional loans collectively evaluated for impairment.

The following table presents information related to our recorded investment in impaired loans and leases as of the dates indicated:



	December 31, 2015				December 31, 2014
(In millions)	Recorded Investment		Unpaid Principal Balance⁽¹⁾		Recorded Investment		Unpaid Principal Balance⁽¹⁾
With no related allowance recorded:
CRE—property development—acquired credit-impaired	$	—	$	34	$	—	$	34
CRE—other—acquired credit-impaired	—		22		—		22
Total CRE	$	—	$	56	$	—	$	56

⁽¹⁾As of December 31, 2015 and December 31, 2014, all of the allowance for loan losses of $46 million and $38 million, respectively, related to institutional and CRE loans collectively evaluated for impairment.

In certain circumstances, we restructure troubled loans by granting concessions to borrowers experiencing financial difficulty. Once restructured, the loans are generally considered impaired until their maturity, regardless of whether the borrowers perform under the modified terms of the loans. No loans were modified in troubled debt restructurings during the years ended December 31, 2015 and 2014.

We generally place loans on non-accrual status once principal or interest payments are 60 days contractually past due, or earlier if management determines that full collection is not probable. Loans 60 days past due, but considered both well-secured and in the process of collection, may be excluded from non-accrual status. When we place a loan on non-accrual status, the accrual of interest is discontinued and previously recorded but unpaid interest is reversed and generally charged against interest revenue. For loans on non-accrual status, revenue is recognized on a cash basis after recovery of principal, if and when interest payments are received. Loans may be removed from non-accrual status when repayment is reasonably assured and performance under the terms of the loan has been demonstrated.

As of December 31, 2015 and December 31, 2014, no institutional loans or leases and no CRE loans were on non-accrual status or 90 days or more contractually past due.

The allowance for loan losses, recorded as a reduction of loans and leases in our consolidated statement of condition, represents management’s estimate of incurred credit losses in our loan-and-lease portfolio as of the balance sheet date. The allowance is evaluated on a regular basis by management. Factors considered in evaluating the appropriate level of the allowance for both the institutional and commercial real estate segments of our loan-and-lease portfolio include loss experience, the probability of default reflected in our internal risk rating of the counterparty's creditworthiness, current economic conditions and adverse situations that may affect the borrower’s ability to repay, the estimated value of the underlying collateral, if any, the performance of individual credits in relation to contract terms, and other relevant factors.

Loans are charged off to the allowance for loan losses in the reporting period in which either an event occurs that confirms the existence of a loss on a loan or a portion of a loan is determined to be uncollectible. In addition, any impaired loan that is determined to be collateral-dependent is reduced to an amount equal to the fair value of the collateral less costs to sell. A loan is identified as collateral-dependent when management determines that it is probable that the underlying collateral will be the sole source of repayment. Recoveries are recorded on a cash basis as adjustments to the allowance.

The reserve for off-balance sheet credit exposures, recorded in accrued expenses and other liabilities in our consolidated statement of condition, represents management’s estimate of probable credit losses in outstanding letters and lines of credit and other credit-enhancement facilities provided to our clients and outstanding as of the balance sheet date. The reserve is evaluated on a regular basis by management. Factors considered in evaluating the appropriate level of this reserve are similar to those considered with respect to the allowance for loan losses. Provisions to maintain the reserve at a level considered by us to be appropriate to absorb estimated incurred credit losses in outstanding facilities are recorded in other expenses in our consolidated statement of income.

The following table presents activity in the allowance for loan losses for the periods indicated:



	Years Ended December 31,
	2015			2014		2013
(In millions)	Total Loans and Leases			Total Loans and Leases		Total Loans and Leases
Allowance for loan losses⁽¹⁾⁽²⁾:
Beginning balance	$	38		$	28	$	22
Provision for loan losses	12			10		6
Charge-offs	(4		)	—		—
Ending balance	$	46		$	38	$	28

⁽¹⁾As of December 31, 2015, approximately $35 million of our allowance for loan losses was related to senior secured bank loans included in the institutional segment; the remaining $11 million was related to other commercial-and-financial loans in the institutional segment.

⁽²⁾ There were no recoveries in any of the years ended December 31, 2015, 2014 or 2013.

The provision of $12 million and the charge-offs of $4 million recorded in the year ended December 31, 2015 were a result of exposure to certain senior secured bank loans to non-investment grade borrowers, which we purchased in connection with our participation in loan syndications in the non-investment-grade lending market.

The provision of $10 million recorded in the year ended December 31, 2014 and $6 million recorded in the year ended December 31, 2013 primarily resulted from our estimate of credit losses incurred on our portfolio of senior secured bank loans.

Loans and leases are reviewed on a regular basis, and any provisions for loan losses that are recorded reflect management's estimate of the amount necessary to maintain the allowance for loan losses at a level considered appropriate to absorb estimated incurred losses in the loan-and-lease portfolio.