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, as of the dates indicated:



(In millions)	December 31, 2016			December 31, 2015
Domestic:
Commercial and financial:
Loans to investment funds	$	11,734		$	11,915
Senior secured bank loans	3,256			2,929
Loans to municipalities	1,352			962
Other	70			93
Commercial real estate	27			28
Lease financing	338			337
Total domestic	16,777			16,264
Non-U.S.:
Commercial and financial:
Loans to investment funds	2,224			1,752
Senior secured bank loans	252			205
Lease financing	504			578
Total non-U.S.	2,980			2,535
Total loans and leases	19,757			18,799
Allowance for loan and lease losses	(53		)	(46		)
Loans and leases, net of allowance	$	19,704		$	18,753

We segregate our loans and leases into three segments: commercial and financial loans, commercial real estate loans, and lease financing. We further classify commercial and financial loans as loans to investment funds, senior secured bank loans, loans to municipalities, and other. These classifications reflect their risk characteristics, their initial measurement attributes and the methods we use to monitor and assess credit risk.

The commercial and financial segment is composed of primarily floating-rate loans to mutual fund clients, purchased senior secured bank loans, and loans to municipalities. Investment fund lending is composed of short-duration revolving credit lines providing liquidity to fund clients in support of their transaction flows associated with securities' settlement activities.

Certain loans are pledged as collateral for access to the Federal Reserve's discount window. As of December 31, 2016 and December 31, 2015, the loans pledged as collateral totaled $1.5 billion and $2.5 billion, respectively.

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



(In millions)	2016			2015
Net rental income receivable	$	1,039		$	1,159
Estimated residual values	89			89
Unearned income	(286		)	(333		)
Investment in leveraged lease financing	842			915
Less: related deferred income tax liabilities	(313		)	(334		)
Net investment in leveraged lease financing	$	529		$	581

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



December 31, 2016	Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases
(In millions)	Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases
Investment grade⁽¹⁾	$	14,889	$	27	$	842	$	15,758
Speculative⁽²⁾	3,984		—		—		3,984
Substandard⁽⁴⁾	15		—		—		15
Total	$	18,888	$	27	$	842	$	19,757



December 31, 2015	Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases
(In millions)	Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases
Investment grade⁽¹⁾	$	14,288	$	28	$	888	$	15,204
Speculative⁽²⁾	3,537		—		27		3,564
Special mention⁽³⁾	31		—		—		31
Total	$	17,856	$	28	$	915	$	18,799

⁽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.

⁽⁴⁾ Substandard loans and leases consist of counterparties with well-defined weakness that jeopardizes repayment with the possibility we will sustain some loss.

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 source 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, 2016.

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



	December 31, 2016								December 31, 2015
(In millions)	Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases		Commercial and Financial		Commercial Real Estate		Lease Financing		Total Loans and Leases
Loans and leases⁽¹⁾:
Individually evaluated for impairment	$	15	$	—	$	—	$	15	$	—	$	—	$	—	$	—
Collectively evaluated for impairment	18,873		27		842		19,742		17,856		28		915		18,799
Total	$	18,888	$	27	$	842	$	19,757	$	17,856	$	28	$	915	$	18,799

⁽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, 2016, $195 thousand of the allowance for loan and lease loss related to commercial and financial loans individually evaluated for impairment, and the remainder of the allowance related to commercial and financial loans collectively evaluated for impairment. As of December 31, 2015, all of the allowance for loan and lease loss related to commercial and financial loans collectively evaluated for impairment.

The following table presents information related to our recorded investment in impaired loans and leases for the dates or periods indicated. As of December 31, 2015, we had no impaired loans and leases.



	As of December 31, 2016						Year Ended December 31, 2016
(In millions)	Recorded Investment		Unpaid Principal Balance⁽¹⁾		Related Allowance⁽²⁾		Average Recorded Investment		Interest Revenue Recognized
Commercial and financial⁽¹⁾	$	15	$	15	$	—	$	15	$	—
Total	$	15	$	15	$	—	$	15	$	—

⁽¹⁾ As of December 31, 2016, the related allowance for loan loss was approximately $195 thousand. This relates to one loan, which was on non-accrual status.

⁽²⁾As of December 31, 2016 and December 31, 2015, with exception of the aforementioned specific allowance, all of the allowance for loan and lease losses of $53 million and $46 million, respectively, related to loans that were not impaired.

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, 2016 and December 31, 2015.

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, 2016, there was one commercial and financial loan on non-accrual status, no CRE loans or leases were on non-accrual status, and no loans and leases were 90 days or more contractually past due. As of December 31, 2015, no loans or leases were on non-accrual status or 90 days or more contractually past due.

Allowance for loan and lease losses

The allowance for loan and lease 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 each segment 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 and leases are charged off to the allowance for loan and lease losses in the reporting period in which either an event occurs that confirms the existence of a loss on a loan or lease or a portion of a loan or lease is determined to be uncollectible. In addition, any impaired loan or lease 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 or lease 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 following table presents activity in the allowance for loan and lease losses for the periods indicated:



	Years Ended December 31,
	2016			2015			2014
(In millions)	Total Loans and Leases			Total Loans and Leases			Total Loans and Leases
Allowance for loan and lease losses⁽¹⁾:
Beginning balance	$	46		$	38		$	28
Provision for loan and lease losses	10			12			10
Charge-offs	(3		)	(4		)	—
Ending balance	$	53		$	46		$	38

⁽¹⁾The provisions and charge-offs for loans and leases were attributable to exposure to senior secured loans to non-investment grade borrowers, purchased in connection with our participation in syndicated loans.

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

Off-balance sheet credit exposures

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 and lease 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.