10-K 1 d10k.htm ANNUAL REPORT Annual Report
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Table of Contents

THE BANK OF NEW YORK COMPANY, INC.

FINANCIAL REVIEW

TABLE OF CONTENTS

 

Selected Financial Data

   1

Management’s Discussion and Analysis of the Company’s Financial Condition and
Results of Operations

  

—Overview

   2

—Financial Highlights

   6

—Consolidated Income Statement Review

   7

—Business Segment Review

   13

—Critical Accounting Policies

   28

—Consolidated Balance Sheet Review

   31

—Liquidity

   45

—Commitments and Obligations

   47

—Off-Balance Sheet Arrangements

   48

—Capital Resources

   48

—Capital Framework

   52

—Risk Management

   53

—Statistical Information

   61

—Supplemental Information

   64

—Unaudited Quarterly Data

   67

—Comparisons of Total Shareholder Return

   69

—Other 2004 Developments

   71

—Glossary

   73

Consolidated Financial Statements

  

—Consolidated Balance Sheets December 31, 2006 and 2005

   76

—Consolidated Statements of Income For The Years Ended December 31, 2006, 2005 and 2004

   77

—Consolidated Statement of Changes In Shareholders’ Equity
    For The Years Ended December 31, 2006, 2005 and 2004

   79

—Consolidated Statements of Cash Flows For the Years
    Ended December 31, 2006, 2005 and 2004

   80

—Notes to Consolidated Financial Statements

   81

—Report of Independent Registered Public Accounting Firm

   125

Form 10-K

  

—Cover

   126

—Cross-Reference Index

   127

—Certain Regulatory Considerations

   128

—Submission of Matters to a Vote of Security Holders

   132

—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   132

—Properties

   133

—Legal and Regulatory Proceedings

   133

—Executive Officers

   134

—Mellon Transaction

   135

—Forward Looking Statements and Risk Factors

   136

—Website Information

   147

—Code of Ethics

   147

—Controls and Procedures

   148

—Auditor’s Attestation Report

   150

—Signatures

   151

—Exhibits and Financial Statement Schedules

   153

 


Table of Contents

SELECTED FINANCIAL DATA

 

(Dollars in millions, except per share amounts and unless otherwise noted)

   2006(1)     2005     2004     2003(3)     2002  

Net Interest Income

   $ 1,499     $ 1,340     $ 1,157     $ 1,143     $ 1,159  

Noninterest Income

     5,322       4,698       4,377       3,723       2,875  
                                        

Revenue

     6,821       6,038       5,534       4,866       4,034  

Provision for Credit Losses

     (20 )     (7 )     (4 )     132       634  

Noninterest Expense

     4,671       4,067       3,698       3,304       2,367  
                                        

Income from Continuing Operations Before Income Taxes

     2,170       1,978       1,840       1,430       1,033  

Income Taxes

     694       635       587       458       320  
                                        

Income from Continuing Operations

     1,476       1,343       1,253       972       713  

Income from Discontinued Operations, Net of Taxes

     1,535       228       187       185       189  
                                        

Net Income

   $ 3,011     $ 1,571     $ 1,440     $ 1,157     $ 902  
                                        

Basic EPS:

          

Income from Continuing Operations

   $ 1.95     $ 1.75     $ 1.63     $ 1.29     $ 0.99  

Net Income

     3.98       2.05       1.87       1.54       1.25  

Diluted EPS:

          

Income from Continuing Operations

     1.93       1.74       1.61       1.28       0.98  

Net Income(2)

     3.93       2.03       1.85       1.52       1.24  

Cash Dividends Per Share

     0.86       0.82       0.79       0.76       0.76  

At December 31

          

Securities

   $ 21,106     $ 27,218     $ 23,770     $ 22,780     $ 18,233  

Loans

     37,793       32,927       28,375       28,414       24,743  

Total Assets

     103,370       102,118       94,529       92,397       77,740  

Deposits

     62,146       49,787       43,052       40,753       40,828  

Long-Term Debt

     8,773       7,817       6,121       6,121       5,440  

Common Shareholders’ Equity

     11,593       9,876       9,290       8,428       6,684  

Market Capitalization (In billions)

     29.8       24.6       26.0       25.7       17.4  

Common Shares Outstanding (In millions)

     755.861       771.129       778.121       775.192       725.971  

Employees (Continuing Operations)

     22,961       19,944       19,646       18,747       15,188  

Ratios

          

Performance Ratios

          

Return on Average Common Shareholders’ Equity

     29.14 %     16.59 %     16.37 %     15.12 %     13.96 %

Return on Average Tangible Common Shareholders’ Equity

     59.25       31.13       31.46       31.90       23.20  

Return on Average Assets

     2.82       1.55       1.45       1.27       1.13  

Return on Average Tangible Assets

     3.01       1.65       1.54       1.34       1.17  

Net Interest Margin (Continuing Operations)

     2.01       2.02       1.79       1.97       2.34  

Pre-Tax Operating Margin (Continuing Operations)

     32       33       33       29       26  

Common Equity to Assets Ratio

     11.21       9.67       9.83       9.12       8.60  

Common Dividend Payout Ratio

     21.78       41.00       42.22       48.83       60.78  

Dividend Yield

     2.2       2.6       2.4       2.3       3.2  

Capital Ratios

          

Tier 1 Capital Ratio

     8.19 %     8.38 %     8.31 %     7.44 %     7.58 %

Total Capital Ratio

     12.49       12.48       12.21       11.49       11.96  

Leverage Ratio

     6.67       6.60       6.41       5.82       6.48  

Tangible Common Equity Ratio

     5.13       5.57       5.56       4.91       5.47  

Other Data

          

Assets Under Custody (In trillions)—Estimated

          

Total Assets Under Custody

   $ 13.0     $ 10.9     $ 9.7     $ 8.3     $ 6.8  

Equity Securities

     33 %     32 %     35 %     34 %     26 %

Fixed Income Securities

     67       68       65       66       74  

Cross-Border Assets Under Custody

   $ 4.7     $ 3.4     $ 2.7     $ 2.3     $ 1.9  

Assets Under Management (In billions)—Estimated

          

Asset Management Sector

          

Equity Securities

   $ 39     $ 37     $ 36     $ 30     $ 22  

Fixed Income Securities

     21       20       22       19       19  

Alternative Investments

     33       15       15       9       6  

Liquid Assets

     38       33       29       31       29  
                                        

Total Asset Management Sector

     131       105       102       89       76  

Foreign Exchange Overlay

     11       10       9       6       4  

Securities Lending Short-Term Investment Funds

     48       40       26       17       —    
                                        

Total Assets Under Management

   $ 190     $ 155     $ 137     $ 112     $ 80  
                                        

(1) The Company’s Retail Business, sold to JPMorgan Chase & Co. on October 1, 2006, has been accounted for as discontinued operations.
(2) Excluding the $2,159 million of pre-tax gain on the sale of the Retail Business and $151 million of pre-tax merger and integration costs, diluted earnings per share would have been $2.26 in 2006.
(3) The 2003 results reflect $96 million of pre-tax merger and integration costs associated with the Pershing acquisition as well as a $78 million pre-tax expense related to the settlement of a claim by General Motors Acceptance Corporation (“GMAC”) related to the 1999 sale of BNY Financial Corporation (“BNYFC”).

 

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MA NAGEMENT’S DISCUSSION AND ANALYSIS OF THE COMPANY’S FINANCIAL CONDITION AND RESULTS OF OPERATIONS (“MD&A”)

The Bank of New York Company, Inc.’s (the “Company”) 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,” “think,” “continue,” “seek,” “believe,” “plan,” “goal,” “could,” “should,” “may,” “will,” “strategy,” “highly attractive,” “extraordinarily strong and rapidly growing competitor,” “synergies,” “opportunities,” “superior returns,” “well-positioned,” “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 Glossary.

OVERVIEW

The Company’s Businesses

The Bank of New York Company, Inc. (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. The Company has a long tradition of collaborating with clients to deliver innovative solutions through its core competencies: securities servicing, treasury management, private banking, and asset management. The Company’s extensive global client base includes a broad range of leading financial institutions, corporations, government entities, endowments and foundations. Its 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.

The Company’s strategy over the past decade has been to focus on highly scalable, fee-based securities servicing and fiduciary businesses, and it has achieved top three market share in most of its major product lines. The Company distinguishes itself 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;

 

   

clearance and settlement capabilities and trade and foreign exchange execution;

 

   

sophisticated risk and performance measurement tools for analyzing portfolios; and

 

   

services for issuers of both equity and debt securities.

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

The Company’s long-term financial objectives include:

 

   

achieving positive operating leverage over an economic cycle; and

 

   

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

To achieve its long-term objectives, the Company has grown both through internal reinvestment as well as execution of strategic acquisitions to expand product offerings and increase market share in its scale businesses. Internal reinvestment occurs through increased technology spending, staffing levels, marketing/branding initiatives, quality programs, and product development. The Company consistently invests in technology to improve the breadth and quality of its product offerings, and to increase economies of scale. The Company has acquired over 90 businesses over the past ten years, almost exclusively in its securities servicing and asset management areas.

 

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Actions taken in the year 2006 significantly transformed the Company. During 2006 the Company:

 

   

Agreed to merge with Mellon Financial Corporation (“Mellon”), a global leader in asset management and securities servicing

 

   

Sold its 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

On December 3, 2006, the Company and Mellon entered into a definitive agreement to merge, creating the world’s largest securities servicing and asset management firm. The new company, which will be called The Bank of New York Mellon Corporation, will be the world’s leading asset servicer with assets under custody expected to exceed $17 trillion, the world’s leading corporate trustee with assets under trusteeship expected to exceed $8 trillion, and will rank among the top 10 global asset managers with assets under management expected to exceed $1.1 trillion.

Under the terms of the agreement, the Company’s shareholders will receive 0.9434 shares in the new company for each share of the Company that they own and Mellon shareholders will receive one share in the new company for each Mellon share they own. The Company and Mellon have entered into reciprocal stock option agreements for 19.9% of each other’s outstanding common stock.

The transaction has been unanimously approved by each company’s board of directors and is expected to be completed early in the third quarter of 2007, subject to regulatory and shareholder approvals. Assuming the achievement of planned synergies, on a GAAP basis the transaction is expected to be 1.0% dilutive to the Company’s operating earnings in 2007, and 1.4% accretive in 2008; is expected to be 1.0% accretive to Mellon’s operating earnings in 2007, and 5.7% accretive in 2008. On a cash basis, which excludes the impact of non-cash items such as the amortization of intangibles, the transaction is expected to be 1.1% accretive to the Company’s earnings in 2007, and 5.3% accretive in 2008; is expected to be 4.5% accretive to Mellon’s earnings in 2007, and 11.9% accretive in 2008.

The combined company is expected to have annual revenues of more than $12 billion, with approximately 28% derived from asset servicing, 38% from issuer services, clearing services and treasury services, and 29% from asset management and private wealth management. It will be well positioned to capitalize on global growth trends, including the evolution of emerging markets, the growth of hedge funds and alternative asset classes, 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 quarter of combined revenue will be derived internationally.

The companies expect to reduce annual pre-tax costs by approximately $700 million per year by 2010, or approximately 8.5% of the estimated 2006 combined expense base. The integration will be undertaken by a dedicated and experienced group of senior executives in a thoughtful and deliberate manner over a three-year period following the close of the transaction. The transaction will involve restructuring charges of approximately $1.3 billion.

The companies’ combined employee base of 40,000 is expected to be reduced by approximately 3,900 over a three-year period following the transaction. The companies expect to reduce headcount through normal attrition wherever possible and will provide extensive support to employees impacted by the merger.

On October 1, 2006, the Company purchased the Acquired Corporate Trust Business from, and sold the Company’s Retail Business to, JPMorgan Chase. In 2006, the Company adopted discontinued operations accounting for its Retail Business. Therefore, the results from continuing operations through September 30, 2006 exclude the results of the Company’s Retail Business but do not include the operations of the Acquired Corporate Trust Business, since the transaction did not close until October 1, 2006. Adjusted financial statements combining continuing and discontinued operations are presented in “Supplemental Information.”

 

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The addition of the Acquired Corporate Trust Business to the Company’s existing franchise allows the Company to capitalize on the faster growing international and structured finance debt markets, as well as to strengthen its leadership in the municipal and corporate debt markets. The transaction diversifies the corporate trust revenue base by both geography and product. JPMorgan Chase’s corporate trust business comprised issues representing $5 trillion in total debt outstanding. It had 2,400 employees in more than 40 locations globally. Prior to the acquisition, the Company’s corporate trust business comprised issues representing $3 trillion in total debt outstanding and had 1,300 employees in 25 locations globally.

On October 2, 2006, the Company completed the transaction that resulted in the formation of BNY ConvergEx Group, LLC. The Company joined forces with Eze Castle Software, LLC and GTCR Golder Rauner, LLC, a private equity firm, to form BNY ConvergEx Group, in which the Company retains a 35% interest. BNY ConvergEx Group brings together the Company’s trade execution, commission management, independent research and transition management businesses with Eze Castle Software, a leading provider of trade order management and related investment technologies. BNY ConvergEx Group’s comprehensive suite of services, advanced technology offerings and breadth of distribution channels enable its customers to manage all aspects of the investment cycle, including idea generation, research, trade analysis, execution and wholesale clearing, risk management, commission management, transition management, compliance and portfolio management. With approximately 635 employees worldwide, BNY ConvergEx Group has a global presence in New York, Boston, San Francisco, Chicago, Dallas, Stamford, London, Bermuda, Tokyo, Hong Kong, and Sydney.

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

The Company’s 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 the Company 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 the Company prices its services. In addition, international markets offer excellent growth opportunities.

Current Business Trends

In 2006 the operating environment was more favorable than in 2005. The equity markets were up and volumes were strong. The fixed income markets remained stable. Cross-border investment and trading activity increased. Volatility in foreign exchange markets was lower than expected, particularly in the second half of 2006. The Federal Reserve stopped raising interest rates in July 2006 and the yield curve became inverted. Because of its diversified business model, the Company achieved strong growth in many of its key business lines.

Noninterest income rose 13% in 2006. Revenue in the fourth quarter from the Acquired Corporate Trust Business was partly offset by the impact of the BNY ConvergEx transaction. The Company achieved solid growth in depositary receipts (“DR”), corporate trust, and investor and broker-dealer services. Private banking and asset management fees were up 26%, driven by strong growth in performance fees and acquisitions. Foreign exchange and other trading also performed well. These strong results offset lower fees from the global payments business and corporate lending activities.

 

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Net interest income was up 12% in 2006 from 2005. Strong liquidity generated from the securities servicing businesses, higher interest rates and the Acquired Corporate Trust Business all contributed to this strong performance.

Expense control was effective, enabling the Company to bring as much of its revenue growth as possible to the bottom line. This reflects the Company’s continued progress on reengineering for labor efficiencies. The Company continued to relocate staff to lower cost locations. Excluding merger and integration costs, expense growth overall was up 12% in 2006 from 2005, reflecting increases related to acquisitions, particularly the Acquired Corporate Trust Business, partially offset by the disposition of certain execution businesses in the BNY ConvergEx transaction. New business, increased volumes in existing business and higher pension costs also led to higher expenses.

For 2007, the Company based its budget planning process on expectations of moderate global economic growth with continued momentum in the capital markets. The Company expects U.S. equity markets to rise 6-8%. U.S. non-program equity volumes are forecasted to be up 4-6% with equity capital raising holding steady. Strong growth in merger and acquisition volumes is expected. The Company assumes a slight decrease in short-term interest rates. GDP growth is expected to be approximately 2.5% to 3%. The Company projects fixed income activity should be reasonably strong.

This presents an overall backdrop that remains favorable to the Company’s operating model. Given these factors and the momentum carried into the year, the Company expects to show particular strength in investor services, as this business continues to benefit from the globalization of the financial markets and asset flows. The strong secular trend in heightened cross-border investing should continue to produce good results in the depositary receipts business as well. The Company also expects foreign exchange and other trading results to benefit, given these cross-border investment flows, although these businesses could be adversely impacted if foreign currency volatility does not rise from what were 10-year lows in the fourth quarter of 2006. The fixed income-linked businesses, corporate trust and broker-dealer services, are both poised to benefit from continued vibrancy in the fixed income markets, as global and structured products are expected to lead the way with increased activity. Private banking and asset management are also expected to perform well, as the Company enters the year with momentum and anticipates asset growth at its alternative assets complex, featuring Ivy Asset Management Corp. (“Ivy”), Alcentra Group Limited (“Alcentra”) and Urdang Capital Management, Inc. (“Urdang”). In terms of net interest income, the Acquired Corporate Trust Business has added an attractive deposit base to the Company’s balance sheet. The Company currently anticipates only modest average earning asset growth in 2007. The net interest margin should be reasonably steady, in spite of the inverted yield curve that the Company expects to persist for much of 2007. Credit costs are expected to be well below the through-the-cycle mean in 2007, although they will likely be positive for the year.

In 2006, comparisons of operating leverage with prior year periods will not be meaningful given the strategic transactions that closed in 2006. Excluding any additional impact of the planned merger with Mellon, the Company intends to migrate an additional 660 staff in 2007 to lower-cost locations such as Manchester, Orlando and India. Data center consolidation and decommissioning will continue and the Company expects to realize additional synergies of the Acquired Corporate Trust Business as conversions are completed.

The 2007 tax rate should be slightly higher than 2006 in the 32-33% range.

The Company has no significant share repurchases planned for 2007 as it rebuilds its tangible common equity, in light of the purchase of the Acquired Corporate Trust Business and the proposed merger with Mellon. The Company expects diluted weighted average shares outstanding for 2007 to increase by approximately 10 million shares from 766 million shares in 2006. The increase relates to employee stock option exercises and the impact of a higher share price on the computation of shares issuable upon conversion of employee stock options.

 

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FINANCIAL HIGHLIGHTS

2006

In 2006, the Company reported net income of $3,011 million and diluted earnings per share (“EPS”) of $3.93 compared with net income of $1,571 million and diluted earnings per share of $2.03 in 2005, and net income of $1,440 million and diluted earnings per share of $1.85 in 2004. On an adjusted basis, excluding merger and integration costs and the gain on the sale of the Retail Business, full-year 2006 diluted earnings per share was $2.26, an increase of 11% over $2.03 in 2005 and net income was $1,731 million, compared with $1,571 million in 2005.

Income from continuing operations in 2006 was $1,476 million, or $1.93 of diluted earnings per share, compared with $1,343 million, or $1.74 of diluted earnings per share in 2005 and $1,253 million or $1.61 of diluted earnings per share in 2004.

Performance highlights for 2006 include:

 

   

Securities servicing fees were up 13% from 2005;

 

   

Net interest income was up 12% from 2005;

 

   

Foreign exchange and other trading activities were up 12% from 2005; and

 

   

Private banking and asset management fees were up 26% from 2005.

The following table shows the impact of the gain on the sale of the Company’s Retail Business and merger and integration costs on diluted earnings per share for the full year ended December 31, 2006:

 

     Diluted Earnings Per Share  

(In dollars)

   Continuing
Operations
   Discontinued
Operations
    Adjusted(1)  

As Reported

   $ 1.93    $ 2.00     $ 3.93  

Merger & Integration Costs(2)

     0.09      0.04       0.13  

Gain on Sale of Retail Business(3)

     —        (1.80 )     (1.80 )
                       

Operating(4)

   $ 2.02    $ 0.24     $ 2.26  
                       

(1) Adjusted results combine continuing and discontinued operations to provide continuity with historical results.
(2) Merger and integration costs include investment portfolio restructuring costs, employee-related costs, and other transaction-related expenses totaling $101 million after-tax.
(3) The Company recorded an after-tax gain on the sale of the Retail Business of $1,381 million ($2,159 million pre-tax).
(4) Operating excludes merger & integration costs and the gain on the sale of the Retail Business.

2005

In 2005, the Company reported net income of $1,571 million and diluted earnings per share of $2.03. Income from continuing operations was $1,343 million, or $1.74 of diluted earnings per share.

Securities servicing fees were up 10% from 2004. Net interest income was up versus 2004. Private banking and asset management fees and foreign exchange and other trading revenues also rose from the prior year. The Company’s capital management was active, as the Company repurchased 5 million net shares.

The Company’s 2005 earnings reflected significant progress toward its key objectives. New business wins and revenues from new and innovative products drove double-digit revenue growth in many of the Company’s key business lines. In 2005, the Company focused on generating positive operating leverage and began to deliver on that objective as well. A number of regulatory issues were resolved. The Company launched its branding initiative in January 2005 and continued to expand it throughout the year.

 

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During 2005, the Company formed strategic alliances to penetrate faster-growing markets in France, Germany, the Nordic and Baltic region, Japan, Australia, and India. The Company also continued to expand its market presence in high-growth areas such as hedge fund servicing and collateral management, while extending its capabilities in the rapidly growing area of alternative investments.

2004

In 2004, the Company reported net income of $1,440 million and diluted earnings per share of $1.85. Income from continuing operations was $1,253 million or $1.61 of diluted earnings per share. In 2004, the Company recorded several gains and charges that in the aggregate reduced reported earnings by 3 cents per share. These items are detailed in “Other 2004 Developments.”

In 2004, the growth in earnings was paced by securities servicing and core net interest income growth, strong credit performance, and higher than expected securities gains. Performance was strong across nearly all the Company’s securities servicing businesses. Investor and issuer services increased by 11% and 12%, respectively. The growth in investor services was driven largely by new business wins and improvements year-over-year in asset values and volumes. Issuer services benefited from increased cross-border activity in depositary receipts and improving market share in global products within corporate trust. Broker-dealer services were up 17% primarily due to strong growth in collateral management.

The Company’s asset management business continued to perform well, responding to growing institutional investor interest in alternative investments. Private banking and asset management fees increased primarily due to exceptional growth at Ivy, the Company’s fund of funds manager. In addition, foreign exchange results benefited from currency volatility and increased cross-border investing.

This strength in revenue was partially offset by upward pressure on the Company’s expense base. Higher employee stock option and pension expenses, business continuity spending, costs associated with legal and regulatory matters, and costs associated with converting new business opportunities in investor services all contributed to higher expense levels.

CONSOLIDATED INCOME STATEMENT REVIEW

Noninterest Income (Continuing Operations)

 

(In millions)

   2006    2005    2004    Percent Inc/(Dec)  
            2006 vs. 2005     2005 vs. 2004  

Securities Servicing Fees

             

Execution and Clearing Services

   $ 1,245    $ 1,222    $ 1,141    2 %   7 %

Investor Services

     1,138      1,056      924    8     14  

Issuer Services

     895      639      583    40     10  

Broker-Dealer Services

     259      227      205    14     11  
                         

Securities Servicing Fees

     3,537      3,144      2,853    13     10  

Global Payment Services Fees

     252      260      277    (3 )   (6 )

Private Banking and Asset Management Fees

     569      452      406    26     11  

Service Charges and Fees

     207      228      223    (9 )   2  

Foreign Exchange and Other Trading Activities

     425      379      353    12     7  

Securities Gains

     88      68      78    29     (13 )

Net Economic Value Payments

     23      —        —      NM     NM  

Other

     221      167      187    32     (11 )
                         

Total Noninterest Income

   $ 5,322    $ 4,698    $ 4,377    13     7  
                         

NM—not meaningful

 

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Noninterest income is provided by a wide range of securities servicing, global payment services, private banking and asset management, trading activities, and other fee-based services. Revenues from these activities were $5,322 million in 2006, compared with $4,698 million in 2005 and $4,377 million in 2004. As a percentage of revenues, total noninterest income was 78% in 2006, essentially unchanged from 2005 and 2004. The increase in revenue in 2006 primarily reflects stronger performance in securities servicing and private banking and asset management fees, foreign exchange and other trading revenues as well as a higher level of securities gains and other income.

The increase in 2005 primarily reflected broadly stronger performance in securities servicing, private banking and asset management fees, and foreign exchange and other trading revenue.

Securities servicing fee growth over 2005 reflected the Acquired Corporate Trust Business and strong organic growth in issuer services, investor services, and broker-dealer services. Growth in these areas was partly offset by disposition of certain execution businesses in the BNY ConvergEx transaction and weaker results in the Company’s clearing and remaining domestic execution business. In 2005, the increase in securities servicing fees from 2004 reflected solid growth across all businesses. For additional details on Securities Servicing Fees, see “Institutional Services Segment” in “Business Segment Review”.

Global payment services fees, principally funds transfer, cash management, and trade services declined compared with 2005 and 2004. While the payments business continues to grow in 2006, as evidenced by the funds transfer volume and net new business, the level of fees has been impacted by customers paying with a higher value of compensatory balances in lieu of fees. On an invoiced services basis, total revenue was up 6% over 2005. The 2005 decline in global payment services fees from 2004 is attributable to customers choosing to pay with higher compensatory balances, which benefited net interest income.

Private banking and asset management fees increased over 2005 reflecting acquisitions and improved performance fees at Ivy. In 2005, the increase in fees reflected strong growth in asset management fees as well as higher fees in private banking.

The decline in service charges and fees from 2005 to 2006 was due to lower capital market fees. The increase in 2005 versus 2004 was due to higher capital market fees.

Foreign exchange and other trading revenues were up significantly from 2005 and 2004. Foreign exchange trading revenues grew strongly in 2006 reflecting higher customer volumes driven by cross-border investment flows, greater business from existing clients, and favorable market conditions in the first half of the year. Foreign currency volatility declined in the second half of 2006 reaching a ten-year low at the end of 2006. Other trading revenues grew in 2006 reflecting higher fixed income activities partially offset by lower trading revenue at Pershing. The increase in foreign exchange and other trading in 2005 from 2004 resulted from increased volume due to new business wins, greater business from existing clients, and higher interest rate and equity derivatives trading partially offset by a decline in trading revenue at Pershing. Pershing contributed $42 million to foreign exchange and other trading revenue in 2006, compared with $44 million in 2005 and $51 million in 2004.

Securities gains were higher in 2006 compared with 2005 and 2004. The securities gains in 2006 were primarily attributable to favorable market conditions and liquidity in the private equity markets. In 2006, the Company sold one of its sponsor fund investments to a third party for a realized gain of $11 million. The securities gains in 2005 were primarily attributable to the Company’s private equity portfolio.

Net economic value payments are amounts received from JPMorgan Chase for the economic value of certain deposits related to the Acquired Corporate Trust Business that have not yet transitioned to the Company’s balance sheet. The transition is expected to occur during the second quarter of 2007.

Other noninterest income is attributable to asset-related gains, equity investments, and other transactions. Asset-related gains include gains on lease residuals, as well as loan and real estate dispositions. Equity investment income primarily reflects the Company’s proportionate share of the income from its investment in

 

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BNY ConvergEx, Wing Hang Bank Limited (“Wing Hang”), RBSI Securities Services (Holdings) Limited, and AIB/BNY Securities Services (Ireland) Limited (“AIB/BNY”) through December 19, 2006, when the Company acquired the remaining 50% of the business it did not own. Other income primarily includes income or loss from insurance contracts, low income housing and other investments, as well as various miscellaneous revenues. The breakdown among these three categories is shown below:

Other Noninterest Income

 

(In millions)

       2006            2005            2004    

Asset-Related Gains

   $ 111    $ 88    $ 80

Equity Investment Income

     50      42      43

Other

     60      37      64
                    

Total Other Noninterest Income

   $ 221    $ 167    $ 187
                    

Other noninterest income increased versus 2005 and 2004 due to higher asset-related gains and higher income from other investments. In 2006, asset-related gains included a pre-tax gain of $35 million related to the conversion of the Company’s New York Stock Exchange (“NYSE”) seats into cash and shares of NYSE Group, Inc. common stock, some of which were sold. Asset-related gains in 2005 included a $17 million gain on the sale of the Company’s interest in Financial Models Companies, Inc. (“FMC”), a $12 million gain on the sale of certain Community Reinvestment Act (“CRA”) investments, a $12 million gain on sale of eight NYSE seats, and a $10 million gain on the sale of a building. Asset-related gains in 2004 included a pre-tax gain of $48 million from the sale of a portion of the Company’s investment in Wing Hang. The higher level of asset-related gains in 2005 and 2004 helped to offset higher legal and regulatory costs and the impact of the SFAS No. 13, “Accounting for Leases” (“SFAS 13”), lease income adjustment in 2004. The decline in income from other investments from 2004 to 2005 reflected fewer government grants and lower insurance-related income.

Net Interest Income (Continuing Operations)

 

(Dollars in millions)

   2006     2005     2004     Percent Inc/(Dec)  
         2006 vs. 2005     2005 vs. 2004  

Net Interest Income

   $ 1,499     $ 1,340     $ 1,157     12 %   16 %

Tax Equivalent Adjustment(1)

     22       27       26      
                            

Net Interest Income on a Tax Equivalent Basis

   $ 1,521     $ 1,367     $ 1,183     11     16  
                            

Net Interest Margin

     2.01 %     2.02 %     1.79 %    

(1) A number of amounts related to net interest income are presented on a “tax equivalent basis” for better comparability. To calculate the tax equivalent revenues and profit or loss, the Company adjusts 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 percent. The Company believes that this presentation provides comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry standards.

Net interest income on a continuing operations basis increased in 2006 from 2005 reflecting the higher deposit balances associated with the Acquired Corporate Trust Business, higher amounts of interest-earning assets and interest-free balances as well as the higher value of interest-free balances in a rising rate environment. In 2005, the increase in net interest income reflected the Company’s sound interest rate positioning for a rising rate environment, continued expansion of deposit spreads, and increased liquidity generated by servicing activities.

In 2006 and 2005, the Company also benefited from customers’ greater use of compensating balances in a rising rate environment.

Average interest-earning assets were $75.6 billion in 2006, compared with $67.7 billion in 2005 and $66.1 billion in 2004. The increase in 2006 from 2005 mainly reflects the investment of deposits from the Acquired

 

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Corporate Trust Business. Average loans were $33.6 billion in 2006, compared with $32.1 billion in 2005 and $30.6 billion in 2004. Average securities were $25.9 billion in 2006, up from $24.3 billion in 2005 and $20.1 billion in 2004.

The net interest margin was 2.01% in 2006, compared with 2.02% in 2005 and 1.79% in 2004. In 2004, excluding three cumulative leasing adjustments triggered by SFAS 13 of $66 million, the net interest margin would have been approximately eight basis points higher. See “Other 2004 Developments.”

Net interest income does not reflect the impact of certain deposits of the Acquired Corporate Trust Business which are expected to be transitioned to the Company in the second quarter of 2007. The payment for the economic value on these deposits was $23 million for the fourth quarter of 2006.

Noninterest Expense (Continuing Operations)

 

(In millions)

   2006     2005    2004    Percent Inc/(Dec)  
           2006 vs. 2005     2005 vs. 2004  

Salaries and Employee Benefits

   $ 2,640     $ 2,310    $ 2,094    14 %   10 %

Net Occupancy

     279       250      236    12     6  

Furniture and Equipment

     190       199      195    (5 )   2  

Clearing

     183       187      176    (2 )   6  

Sub-custodian Expenses

     134       96      87    40     10  

Software

     220       214      191    3     12  

Communications

     97       91      89    7     2  

Amortization of Intangibles

     76       40      34    90     18  

Merger and Integration Costs

     106       —        —      NM     NM  

Other

     746       680      596    10     14  
                          

Total Noninterest Expense Including
Merger and Integration Costs

     4,671       4,067      3,698    15     10  

Merger and Integration Costs

     (106 )     —        —      NM     NM  
                          

Total Noninterest Expense Excluding
Merger and Integration Costs

   $ 4,565     $ 4,067    $ 3,698    12     10  
                          

NM—not meaningful

Noninterest expense in 2006, excluding merger and integration costs, rose reflecting increased costs associated with new business, acquisitions, and higher pension costs.

The 2005 increase in expenses primarily reflected increased staffing and clearing costs associated with new business and acquisitions, higher stock option and pension expense, and expanded occupancy costs associated with business continuity, as well as higher technology and legal costs.

Salaries and employee benefits are comprised of:

 

   

compensation expense, which includes

 

   

base salary expense, primarily driven by headcount,

 

   

the cost of temporary help and overtime, and

 

   

severance expense;

 

   

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

 

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stock option expense; and

 

   

employee benefit expense, primarily medical benefits, payroll taxes, pension and other retirement benefits.

Salaries and employee benefits were up in 2006 compared with 2005, reflecting higher staff levels tied to new businesses, acquisitions, higher incentive compensation and increased temporary help, partially offset by the BNY ConvergEx transaction. In 2005, the increase in salaries reflected tight headcount control and reengineering and relocation projects partially offset the impact of business wins, acquisitions and additional legal and compliance personnel. Benefits expenses were up compared with 2005, reflecting acquisitions and higher expenses for incentive payments and pensions. In 2005, benefit expense increased significantly reflecting higher expenses for pensions, stock options, medical benefits, and incentive payments. The Acquired Corporate Trust Business and the conversion of AIB/BNY to a wholly-owned subsidiary resulted in an increase in the number of employees at December 31, 2006, to 22,961, up from 19,944 and 19,646, in 2005 and 2004, respectively.

The reduction in clearing expenses in 2006 reflects the BNY ConvergEx transaction. The increase in 2005 reflected higher expenses associated with acquisitions within the execution business.

The higher level of sub-custodian expenses in 2006 reflects increased asset values and transaction volumes of assets under custody, and increased activity in depositary receipts. In 2005, the increase in sub-custodian expenses was associated with higher levels of business activity.

Software expenses increased in 2006 and 2005, reflecting the Company’s continued investment in technology capabilities supporting its servicing activities as well as spending and development to support business growth.

Amortization of intangibles increased in 2006 primarily reflecting the Acquired Corporate Trust Business and the Alcentra and Urdang acquisitions.

Merger and integration costs primarily included a loss in connection with the restructuring of the Company’s investment portfolio and employee-related costs such as severance. The swap of the Acquired Corporate Trust Business for the Retail Business resulted in a more liability-sensitive balance sheet because corporate trust liabilities reprice more quickly than retail deposits. The Company sold $5.5 billion of investment portfolio securities in the third quarter of 2006 to adjust interest rate sensitivity going forward.

Other noninterest expense consists of vendor services, business development, legal expenses, settlements and claims, and other expenses. Vendor services include professional fees, computer services, market data, courier, and other services. Business development includes advertising, charitable contributions, travel, and entertainment expenses. The breakdown among these four categories is shown below:

Other Noninterest Expense

 

(In millions)

   2006    2005    2004

Vendor Services

   $ 368    $ 293    $ 268

Business Development

     108      97      82

Legal Fees, Settlements and Claims

     66      120      65

Other

     204      170      181
                    

Total Other Noninterest Expense

   $ 746    $ 680    $ 596
                    

In 2006, other expenses increased reflecting increases in vendor services, business development and other partially offset by a decline in legal fees and settlements. The increase in vendor services in 2006 primarily reflects higher expenses due to the acquisition of the Acquired Corporate Trust Business. Growth in business development expenses during 2006 reflects higher travel and entertainment, and advertising related to the Company’s branding initiatives. The decline in legal fees, settlements and claims in 2006 reflects the settlement of certain legal and regulatory matters involving the Company. Legal fees, settlements and claims in 2005 included $24 million associated with the Russian Funds transfer matter and other regulatory matters.

 

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The Company continues to increase its investment in technology, focusing on key items such as delivering positive operating leverage, driving product innovation and enhancing the client experience. Software development has been an increasing component of technology expense in 2006, 2005, and 2004. The rate of infrastructure investment is slowing. In the fourth quarter of 2005, the Company’s new data center in the mid-south region of the U.S. became operational. The new data center improved the geographic diversification and resilience of the Company’s operations and supports the processing needs of the Company’s customers. Print center consolidation was completed in 2005. Core investor services applications were recently developed and engineered with technologies that should be durable over time.

In January 2004, the Company began a three-year effort to move 1,500 positions to lower cost areas. In 2006, the Company moved 575 positions out of higher-cost locations, up from 516 in 2005 and 419 in 2004. As a result of the moves, the Company incurred higher expense in 2006 for severance and lease termination, but will achieve net benefits in 2007 and 2008. In 2007, excluding any additional impact of the planned merger with Mellon, the Company anticipates moving an additional 660 positions.

Income Taxes

On a continuing operations basis, the Company’s consolidated effective tax rates for 2006, 2005, and 2004 were 32.0%, 32.1%, and 31.9%, respectively. The slight decrease in the effective tax rate in 2006 primarily reflects the increased benefit from foreign operations offset by lower tax-exempt income and lower credits from low-income housing. The increase in the effective tax rate in 2005 from 2004 primarily reflected higher state and local taxes.

The Company makes synthetic fuel and low income housing (Sections 29 and 42 of the Internal Revenue Code, respectively) investments that generate tax credits, which have the effect of permanently reducing the Company’s tax expense. The Company also invests in leveraged leases which, through accelerated depreciation, postpone the payment of taxes to future years. For financial statement purposes, deferred taxes are recorded as a liability for future payment.

The Company’s effective tax rate in 2007 is expected to be impacted by the price of oil, which determines the amount of synthetic fuel tax credits it will receive. These credits relate to investments that produce alternative fuel from coal by-products.

To manage its exposure in 2007 to the risk of an increase in oil prices that could reduce synthetic fuel tax credits, the Company 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 the Company’s 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 will be recorded currently in trading income. The Company may enter into further option contracts to protect against fluctuations in oil prices.

The Company is assuming a $69.50 average price per barrel in 2007 to estimate the 2007 benefit from synthetic fuel credits. To the extent the average oil price differs from this assumption, the table below shows the estimated effect on EPS for 2007.

 

 

Avg. Price
Per Barrel
in 2007

   Phase-
out %
    Net Benefit
(In millions)
   Option Contract
Benefit/ (Cost)
(In millions)
    EPS
Effect
 

$64.00

   0.0 %   $ 60.2    $ (1.5 )   $ 0.03  

65.50

   12.6       52.6      (1.5 )     0.02  

67.50

   26.3       44.4      (0.7 )     0.01  

69.50

   40.0       36.1      2.3       —   (1)

71.50

   53.8       27.8      5.3       (0.01 )

73.50

   67.5       19.6      8.3       (0.01 )

78.00

   100.0       0.0      12.1       (0.03 )

(1) Assumption used to compute effective tax rate of between 32% and 33% for 2007.

If the 2007 average price per barrel of oil were to go below $64 or above $78, there would be no additional EPS effect.

 

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BUSINESS SEGMENT REVIEW

Segment Data

The Company has an internal information system that produces performance data for its three business segments along product and service lines.

Business Segments Accounting Principles

The Company’s segment data has been determined on an internal management basis of accounting, rather than U.S. 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.

In 2005, the Company determined that it was appropriate to modify its segment presentation to provide more transparency into its results of operations and to better reflect modifications in the management structure that the Company implemented during the fourth quarter of 2005. All prior periods have been restated to reflect this realignment.

On October 1, 2006, the Company sold substantially all of the assets of its Retail Business. The business segment information is reported on a continuing operations basis for all periods presented, but only includes the operations of the Acquired Corporate Trust Business, from October 1, 2006, the date on which it was acquired. The corporate trust business acquired is included in Issuer Services Business in the Institutional Services Segment. Information related to the Company’s Retail Business is no longer included in the segment data. See “Discontinued Operations” in the Notes to the Consolidated Financial Statements for a discussion of discontinued operations. Results in the Execution and Clearing Services Business in 2006 were impacted by the disposition of certain execution businesses in the BNY ConvergEx transaction.

The Company currently reports results for three segments, with the Institutional Services Segment being further subdivided into four business groupings. These segments are shown below:

 

   

Institutional Services Segment

 

   

Investor & Broker-Dealer Services Business

 

   

Execution & Clearing Services Business

 

   

Issuer Services Business

 

   

Treasury Services Business

 

   

Private Bank & BNY Asset Management Segment

 

   

Corporate and Other Segment

Other specific segment accounting principles employed include:

 

   

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 allocated to each segment is based on management’s judgment as to average credit losses that will be incurred in the operations of the segment over a credit cycle of a period of years. Management’s judgment includes the following factors among others: historical charge-off experience and the volume, composition, and size of the credit portfolio. This method is different from that required under U.S. generally accepted accounting principles as it anticipates future losses which are not yet probable and therefore not recognizable under U.S. generally accepted accounting principles.

 

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Balance sheet assets and liabilities and their related income or expense are specifically assigned to each segment.

 

   

Net interest income is allocated to segments based on the yields on the assets and liabilities generated by each segment. Assets and liabilities generated by credit-related activities are allocated to businesses based on borrower usage of those businesses’ products or services. Credit-only relationships and borrowers using both credit and payment services remain in the Treasury Services Business. Segments with a net liability position are allocated assets primarily from the securities portfolio.

 

   

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 Investor & Broker-Dealer Services Business (which includes the Company’s custody operations.)

 

   

Noninterest income associated with Treasury-related services (global payment services for corporate customers, as well as lending and credit-related services) is similarly allocated back to the other Institutional Services businesses.

 

   

Support and other indirect expenses are allocated to segments based on internally-developed methodologies.

Description of Business Segments

The activities within each business segment are described below.

Institutional Services Segment

Investor & Broker-Dealer Services Business

Investor & Broker-Dealer Services includes global custody, global fund services, securities lending, global liquidity services, outsourcing, government securities clearance, collateral management, credit-related services, and other linked revenues, principally foreign exchange and execution and clearing revenues.

In Investor Services, the Company is one of the leading custodians with $13.0 trillion of assets under custody at December 31, 2006. The Company is one of the largest mutual fund custodians for U.S. funds and one of the largest providers of fund services in the world with over $2.0 trillion in total assets. The Company also services more than 40% of the exchange-traded funds in the United States, and is a leading U.K. custodian. In securities lending, the Company is the largest lender of U.S. Treasury securities and depositary receipts with a lending pool of approximately $1.8 trillion in 27 markets around the world.

The Company’s Broker-Dealer Services business clears approximately 50% of U.S. Government securities transactions. The Company is a leader in global clearance, clearing equity and fixed income transactions in 101 markets. With over $1.3 trillion in tri-party balances worldwide, the Company is the world’s largest collateral management agent.

Execution & Clearing Services Business

As a result of the BNY ConvergEx transaction, beginning in the fourth quarter of 2006, the Company’s Execution and Clearing Services business consists of its Pershing clearing business, its 35% equity interest in BNY ConvergEx Group and the Company’s B-Trade and G-Trade businesses which are expected to become part of the BNY ConvergEx Group in 2008. The BNY ConvergEx transaction changed the accounting from a line by line consolidation to a 35% equity interest recorded in other income.

The Company’s Pershing subsidiary provides clearing, execution, financing, and custody for introducing broker-dealers and registered investment advisors. Pershing services more than 1,100 retail and institutional financial organizations and independent investment advisors with over 5.6 million active accounts.

 

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Issuer Services Business

Issuer Services includes corporate trust, depositary receipts, employee investment plan services, stock transfer, and credit-related services.

In Issuer Services, the Company is depositary for more than 1,271 American and global depositary receipt programs, with a 64% market share, servicing leading companies from 62 countries. As a trustee, the Company provides diverse services for corporate, municipal, structured, and international debt securities. The Company serves as trustee for some 90,000 clients with more than $8 trillion in outstanding debt securities. The Company is the third largest stock transfer agent in the United States, servicing more than 17 million shareowners. Employee Investment Plan Services has 120 clients with 650,000 employees in over 54 countries.

Treasury Services Business

Treasury Services includes global payment services for corporate customers as well as lending and credit-related services.

Corporate Global Payment Services offers leading-edge technology, innovative products, and industry expertise to help its clients optimize cash flow, manage liquidity, and make payments around the world in more than 90 different countries. The Company maintains a global network of branches, representative offices and correspondent banks to provide comprehensive payment services including funds transfer, cash management, trade services and liquidity management. The Company is one of the largest funds transfer banks in the U.S. transferring over $1.1 trillion daily via more than 150,000 wire transfers.

The Company provides lending and credit-related services to large public and private corporations nationwide. Special industry groups focus on industry segments such as media, telecommunications, cable, energy, real estate, retailing, and healthcare. Credit-related revenues are allocated to businesses other than Treasury Services to the extent the borrower uses that businesses’ products or services. Credit-only relationships and borrowers using both credit and payment services remain in Treasury Services. Through BNY Capital Markets, Inc., the Company provides a broad range of capital markets services including syndicated loans, bond underwriting, and private placements of corporate debt and equity securities. The Company is a lead arranger or agent of syndicated financings for clients in the U.S., having completed 106 transactions totaling in excess of $63 billion during 2006.

For its credit services business overall, the Company’s corporate lending strategy is to focus on those clients and industries that are major users of securities servicing and global payment services.

Private Bank & BNY Asset Management Segment

The Private Bank & BNY Asset Management Segment includes traditional banking and trust services for wealthy clients and investment management services for institutional and high-net-worth clients. In private banking, the Company offers a full array of wealth 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, brokerage and investment solutions.

BNY Asset Management provides investment solutions for some of the wealthiest individuals, largest corporations and most prestigious organizations around the world applying a broad spectrum of investment strategies and wealth management solutions. BNY Asset Management’s alternative strategies have expanded to include funds of hedge funds, private equity, alternative fixed income, and real estate.

The Company’s asset management subsidiaries include:

 

   

Ivy Asset Management Corporation, a leading fund of hedge funds firm, offers a comprehensive range of multi-manager hedge fund products and customized portfolio solutions.

 

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Alcentra 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 REITs.

 

   

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

 

   

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

The Company also provides investment management services directly to institutions and manages the “Hamilton” family of mutual funds.

Corporate and Other Segment

The Corporate and Other Segment primarily includes the Company’s leasing operations and corporate overhead. Net interest income in this segment primarily reflects the funding cost of goodwill and intangibles. The tax equivalent adjustment on net interest income is eliminated in this segment. Provision for credit losses reflects the difference between the aggregate of the credit provision over a credit cycle for the other two reportable segments and the Company’s recorded provision. The Company’s approach to acquisitions is highly centralized and controlled by senior management. Accordingly, the resulting goodwill and other intangible assets are included in this segment’s assets. Noninterest expense includes the related amortization. Noninterest income primarily reflects leasing, securities gains, and income from the sale of other corporate assets. Noninterest expenses include direct expenses supporting the leasing activities as well as certain corporate overhead not directly attributable to the operations of the other segments.

In addition, this segment includes the difference between amounts previously reported in the Company’s Retail and Middle Market Banking Segment and the discontinued operations of the Company’s retail and regional middle market banking businesses.

Segment Analysis

Institutional Services Segment

 

(In millions)

  

2006

  

2005

  

2004

   Inc/(Dec)
            2006 vs. 2005    2005 vs. 2004

Net Interest Income

   $ 1,403    $ 1,193    $ 1,064    $ 210    $ 129

Noninterest Income

     4,639      4,180      3,830      459      350

Total Revenue

     6,042      5,373      4,894      669      479

Provision for Credit Losses

     65      59      59      6      —  

Noninterest Expense

     3,774      3,444      3,140      330      304

Income Before Taxes

     2,203      1,870      1,695      333      175

Average Assets

     83,045      75,682      72,286      7,363      3,396

Average Deposits

     52,743      45,475      43,811      7,268      1,664

The Company’s Institutional Services business is conducted in four business groupings: Investor & Broker-Dealer Services, Execution & Clearing Services, Issuer Services, and Treasury Services. Income before taxes was up 18% to $2,203 million in 2006 from $1,870 million in 2005, which was up 10% versus $1,695 million in 2004.

As of December 31, 2006, assets under custody rose to $13.0 trillion, from $10.9 trillion at December 31, 2005. The increase in assets under custody primarily reflects rising asset values and growth in cross-border assets. Cross-border assets were up 38% to $4.7 billion from $3.4 billion. Equity securities composed 33% of the

 

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assets under custody at December 31, 2006 compared with 32% at December 31, 2005, while fixed income securities were 67% compared with 68% last year. Assets under custody in 2006 consisted of assets related to the custody and mutual funds businesses of $9.0 trillion, broker-dealer services assets of $2.3 trillion, and all other assets of $1.7 trillion.

The Institutional Services Segment had a strong year in 2006. Almost all business lines reported significant growth with depositary receipts, corporate trust and broker-dealers services particularly strong. The Institutional Services Segment’s 2006 results were impacted by the purchase of the Acquired Corporate Trust Business and the BNY ConvergEx transactions, both of which occurred at the start of the fourth quarter. Non-program equity trading volumes were up 5% from 2005. Foreign exchange volatility was at a ten-year low at year-end. Average daily U.S. fixed income trading volume was up 1% during the year. Total global debt issuance increased 3% from 2005. In 2006, asset prices rose, with the S&P 500 Index up 14% and the MSCI EAFE® Index up 23%. During the year, depositary receipts trading exceeded $1.9 trillion, up over 58% from 2005. The issuance of global collateralized debt obligations is up 96% versus 2005.

Market Data

 

     2006    2005    2004    Percent Inc/ (Dec)  
            2006 vs. 2005     2005 vs. 2004  

S&P 500 Index(1)

   1,418    1,248    1,212    14 %   3 %

NASDAQ Composite Index(1)

   2,415    2,205    2,175    10     1  

Lehman Brothers

             

Aggregate Bondsm Index(1)

   226.6    206.2    220.6    10     (7 )

MSCI EAFE® Index(1)

   2,074.5    1,680.1    1,515.5    23     11  

NYSE Volume (In billions)

   458.5    415.1    369.6    10     12  

NASDAQ Volume (In billions)

   502.6    449.2    453.9    12     (1 )

(1) Period end

The results of many of the Company’s businesses are influenced by customer activities that vary by quarter. For instance, consistent with an overall decline in securities industry activity in the summer, the Company typically experiences a seasonal decline in the third quarter. The Company also experiences 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. The results for the businesses in the Institutional Service segment are discussed below.

Investor & Broker-Dealer Services Business

 

     2006    2005    2004    Inc/ (Dec)  

(In millions)

            2006 vs. 2005    2005 vs. 2004  

Net Interest Income

   $ 624    $ 569    $ 518    $ 55    $ 51  

Noninterest Income

     1,971      1,826      1,627      145      199  

Total Revenue

     2,595      2,395      2,145      200      250  

Provision for Credit Losses

     10      7      7      3      —    

Noninterest Expense

     1,797      1,636      1,441      161      195  

Income Before Taxes

     788      752      697      36      55  

Average Assets

     40,293      36,233      35,225      4,060      1,008  

Average Deposits

     33,059      28,416      27,199      4,643      1,217  

Nonperforming Assets

     6      4      26      2      (22 )

Net Charge-offs/(Recoveries)

     —        —        4      —        (4 )

 

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Table of Contents

In 2006, income before taxes in the Investor & Broker-Dealer Services business increased to $788 million from $752 million in 2005 and $697 million in 2004. The increase in 2006 reflects strong revenue growth in both investor services fees and broker-dealer services fees.

Noninterest income was $1,971 million in 2006, compared with $1,826 million in 2005 and $1,627 million in 2004. The increase in noninterest income in 2006 is attributable to growth in both investor and broker-dealer services fees. Revenues from foreign exchange trading were also up significantly reflecting higher customer volumes driven by cross-border investment flows, greater business from existing clients, and favorable market conditions in the first half of the year.

Investor services fees depend on:

 

   

the volume of transactions in clients’ accounts, as well as the number of accounts;

 

   

the level of assets under custody; and

 

   

securities lending revenue.

Investor services fees were up in 2006 compared with 2005 and 2004. The increase over 2005 reflects strong cross-border flows which drove double-digit growth in global fund services and global custody. The continued growth of hedge funds drove growth in alternative investment services up over 40% while the Company’s UIT and exchange-traded fund businesses grew over 20%. Securities lending fees showed good growth in 2006 as strong growth in average loan volumes was partly offset by lower spreads. Securities lending spreads were impacted by lower demand for treasury borrowing and a narrowing of the interest rate differential between federal funds and repurchase transactions. In 2005, investor services fee growth resulted from strength in global and domestic fund services and custody, as well as new business wins and strong organic growth.

Broker-dealer services fees depend on:

 

   

level of activity in the fixed income market; and

 

   

financing needs of customers, which are typically higher when the equity and fixed-income markets are active.

Broker-dealer services fees were up compared with 2005 and 2004. The increase in 2006 was primarily driven by growth in domestic and global collateral management. Higher volumes led to increased fees in domestic and global clearance. The Company now handles approximately $1.3 trillion of financing for the Company’s broker-dealer clients daily through tri-party collateralized financing agreements, up 20% from a year ago. In 2005, increased broker-dealer services fees reflected higher volumes due to new business wins in the collateral management business and greater volumes in government securities clearance.

Net interest income in the Investor & Broker-Dealer Services business was $624 million in 2006, compared with $569 million in 2005 and $518 million in 2004. Net interest income growth in 2006 and 2005 reflected increased deposit flows from customers in both businesses. Average deposits generated by the Investor & Broker-Dealer Services business were $33.1 billion in 2006, compared with $28.4 billion in 2005 and $27.2 billion in 2004. Average assets in the business were $40.3 billion in 2006, compared with $36.2 billion in 2005 and $35.2 billion in 2004.

Noninterest expense was $1,797 million in 2006, compared with $1,636 million in 2005 and $1,441 million in 2004. The increase in noninterest expense in 2006 and 2005 was due to higher salaries, employee benefits, technology costs, and sub-custody expenses tied to business growth, and higher pension expenses. Costs associated with moves to lower cost areas also drove expenses higher in 2006. Stock option and business continuity expense also drove expenses higher in 2005.

Net charge-offs were zero in 2006 and 2005, compared with $4 million in 2004. Nonperforming assets were $6 million at December 31, 2006, compared with $4 million at December 31, 2005, and $26 million at December 31, 2004.

 

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Table of Contents

Execution & Clearing Services Business

 

     2006     2005    2004    Inc/ (Dec)  

(In millions)

           2006 vs. 2005     2005 vs. 2004  

Net Interest Income

   $ 268     $ 211    $ 170    $ 57     $ 41  

Noninterest Income

     1,394       1,325      1,242      69       83  

Total Revenue

     1,662       1,536      1,412      126       124  

Provision for Credit Losses

     2       1      1      1       —    

Noninterest Expense

     1,150       1,151      1,087      (1 )     64  

Income Before Taxes

     510       384      324      126       60  

Average Assets

     14,866       15,478      15,122      (612 )     356  

Average Payables to Customers and Broker-Dealers

     4,899       6,014      6,361      (1,115 )     (347 )

Nonperforming Assets

     —         —        2      —         (2 )

Net Charge-offs/(Recoveries)

     (4 )     8      10      (12 )     (2 )

In 2006, income before taxes in the Execution & Clearing Services Business increased to $510 million from $384 million and $324 million in 2005 and 2004. The increase in 2006 reflects improved results at Pershing, both from ongoing activities and the $35 million gain related to the conversion of the Company’s New York Stock Exchange seats into cash and shares of the NYSE Group, Inc. common stock, some of which were sold.

Noninterest income was $1,394 million in 2006, compared with $1,325 million in 2005 and $1,242 million in 2004. The execution business in 2006 was impacted by the BNY ConvergEx transaction. Income from the Company’s 35% equity interest in BNY ConvergEx in the fourth quarter of 2006 was not significant.

Pershing noninterest income depends on:

 

   

trading volumes, particularly those related to retail customers;

 

   

overall market levels; and

 

   

the amount of assets under administration.

Pershing’s 2006 noninterest income rose, reflecting good internal growth in asset-driven fees and retirement products and the $35 million gain related to the conversion of the Company’s New York Stock Exchange seats into cash and shares of NYSE Group, Inc. common stock, some of which were sold. The majority of Pershing’s revenues are generated from non-transactional activities, such as asset gathering, administration and other services. Pershing’s 2005 noninterest income was up reflecting organic growth from value-added fees, partially offset by business lost through client consolidation. Pershing’s assets under administration were $890 billion at year-end 2006, compared with $749 billion at December 31, 2005. Pershing trading revenue was $42 million in 2006, compared with $44 million in 2005 and $51 million in 2004.

Execution and clearing service fees were $1,245 million in 2006, compared with $1,222 million in 2005 and $1,141 million in 2004. The increase in execution and clearing fees reflects good growth at Pershing and the international execution business partly offset by the disposition of certain execution businesses in the BNY ConvergEx transaction. Also impacting fees in 2006 was the previously disclosed loss of a significant customer at Pershing. Execution and clearing fees of the businesses contributed to BNY ConvergEx were $233 million for the first nine months of 2006 and $259 million and $193 million for the year 2005 and 2004. The execution business benefited in 2005 from increased client activity, strong growth in transition management and incremental revenues from the acquisition of Lynch, Jones & Ryan, Inc. (“LJR”). These factors offset the relatively weak market environment, in which non-program trading volumes were down 1%.

Net interest income in the Execution and Clearing Services business was $268 million in 2006, compared with $211 million in 2005 and $170 million in 2004. Net interest income growth in 2006 reflects rising interest rates and the internalization of Pershing’s stock loan activities partly offset by lower balances. In 2005 net interest income reflected the benefit of rising interest rates on spreads at Pershing.

 

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Table of Contents

Average assets in the business were $14.9 billion in 2006, compared with $15.5 billion in 2005 and $15.1 billion in 2004. At year-end 2006, margin loans decreased to $5.2 billion from $6.1 billion reflecting the previously disclosed loss of a significant customer. Average payables to customers and broker-dealers were $4.9 billion, compared with $6.0 billion in 2005 and $6.4 billion in 2004.

Noninterest expense was $1,150 million in 2006, compared with $1,151 million in 2005 and $1,087 million in 2004. In 2006, noninterest expense was flat as higher activity-driven expenses at Pershing were mostly offset by the impact of the BNY ConvergEx transaction. The rise in noninterest expense in 2005 was attributable to higher salaries, benefits and clearing expenses tied to both higher business activity overall as well as the LJR acquisition.

Net charge-offs were recoveries of $4 million in 2006, compared with charge-offs of $8 million and $10 million in 2005 and 2004. Nonperforming assets were zero at December 31, 2006 and December 31, 2005, and $2 million at December 31, 2004.

Issuer Services Business

 

    

2006

  

2005

  

2004

   Inc/ (Dec)  

(In millions)

            2006 vs. 2005    2005 vs. 2004  

Net Interest Income

   $ 341    $ 239    $ 214    $ 102    $ 25  

Noninterest Income

     1,030      757      696      273      61  

Total Revenue

     1,371      996      910      375      86  

Provision for Credit Losses

     16      11      11      5      —    

Noninterest Expense

     628      458      426      170      32  

Income Before Taxes

     727      527      473      200      54  

Average Assets

     15,906      13,349      11,776      2,557      1,573  

Average Deposits

     10,247      8,457      7,669      1,790      788  

Nonperforming Assets

     7      4      28      3      (24 )

Net Charge-offs/(Recoveries)

     —        —        4      —        (4 )

In 2006, income before taxes in the Issuer Services Business increased to $727 million from $527 million in 2005 and $473 million in 2004. The increase in 2006 reflects continued growth in both the depositary receipts and corporate trust businesses.

Noninterest income was $1,030 million in 2006, compared with $757 million in 2005 and $696 million in 2004. In 2006, the increase reflects strong growth in depositary receipts and corporate trust as well as the results of the Acquired Corporate Trust Business. Included in noninterest income in 2006 was a $23 million net economic value payment from JPMorgan Chase for deposits of the Acquired Corporate Trust Business that have not yet transitioned to the Company. In 2005, the increase reflected higher levels of trading activity and greater corporate actions in depositary receipts, as well as continued strength in international issuance and structured products in corporate trust. Foreign exchange revenue was up in 2006 compared with 2005 and 2004.

Issuer services fees depend on:

 

   

depositary receipts issuance and cancellation volume;

 

   

corporate actions impacting depositary receipts; and

 

   

volume of issuance of fixed-income securities, particularly more complex securities such as collateralized debt obligations and asset- and mortgage-backed securities.

The overall environment for depositary receipts has improved steadily from 2004 to 2006. The continued globalization of the world’s equity portfolios drove extraordinary levels of DR trading and investment in both U.S. and non-U.S. markets. Nearly $1.9 trillion of DRs traded on U.S. and non-U.S. markets and exchanges during 2006, an increase of 58% year-on-year. Issuers from 25 countries—the majority from emerging markets—

 

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completed 129 primary and follow-on DR offerings, raising a record $44.5 billion. Industry-wide, a record 1,985 sponsored DR programs from 76 countries with a market value exceeding $1.2 trillion are now available to investors. The year 2006 was a record year in depositary receipts for the Company.

The Company has long been a leader in corporate trust in the U.S. The Acquired Corporate Trust Business transformed the Company into a global leader in corporate trust. The Company’s corporate trust product line includes structured, corporate, municipal, collateralized debt obligations, and global securities. Strong organic growth plus the Acquired Corporate Trust Business drove corporate trust fees to a record level in 2006. Corporate trust also had a solid performance in 2005 and 2004. The principal organic growth drivers have been global trust and structured finance products where the markets are growing rapidly.

Net interest income in the Issuer Services business was $341 million in 2006, compared with $239 million in 2005 and $214 million in 2004. Net interest income growth in 2006 and 2005 reflects the positive impact of rising rates on spreads and increased deposit levels generated by growth in the corporate trust business. Growth in net interest income in 2006 was also impacted by the deposits of the Acquired Corporate Trust Business. Average deposits generated by the Issuer Services business were $10.2 billion in 2006, compared with $8.5 billion in 2005 and $7.7 billion in 2004. Average assets in the business were $15.9 billion in 2006, compared with $13.3 billion in 2005 and $11.8 billion in 2004.

Noninterest expense was $628 million in 2006, compared with $458 million in 2005 and $426 million in 2004. Noninterest expense in 2006 reflects the impact of the Acquired Corporate Trust Business and expenses associated with revenue growth in depositary receipts and corporate trust. Growth in depositary receipts drove sub-custodian expense higher. Included in 2006 expense was $22 million of transition services expense associated with the Acquired Corporate Trust Business. The rise in noninterest expense in 2005 was attributable to increased client activity as well as higher technology, stock option and pension expenses.

Net charge-offs were zero in 2006 and 2005, compared with $4 million in 2004. Nonperforming assets were $7 million at December 31, 2006, compared with $4 million at December 31, 2005, and $28 million at December 31, 2004.

Treasury Services Business

 

      2006     2005    2004    Inc/(Dec)  

(In millions)

           2006 vs. 2005     2005 vs. 2004  

Net Interest Income

   $ 170     $ 174    $ 162    $ (4 )   $ 12  

Noninterest Income

     244       272      265      (28 )     7  

Total Revenue

     414       446      427      (32 )     19  

Provision for Credit Losses

     37       40      40      (3 )     —    

Noninterest Expense

     199       199      186      —         13  

Income Before Taxes

     178       207      201      (29 )     6  

Average Assets

     11,980       10,622      10,163      1,358       459  

Average Deposits

     9,214       8,379      8,793      835       (414 )

Nonperforming Assets

     22       12      87      10       (75 )

Net Charge-offs/(Recoveries)

     (1 )     2      15      (3 )     (13 )

In 2006, income before taxes in the Treasury Services Business was $178 million, compared with $207 million in 2005 and $201 million in 2004. The decline in this segment reflects lower noninterest income and net interest income. The results in all periods reflected the continued strong credit environment.

The decrease in noninterest income to $244 million in 2006 from $272 million in 2005 was due to lower levels of asset-related gains and capital market fees. The increase in 2005 versus 2004 reflected higher capital market fees associated with clients in this segment partly offset by lower fees from global payment services as more clients used compensatory balances to pay for services. Global payment services fees declined in 2006 from 2005 and 2004 reflecting customers paying with a higher level of compensatory balances in lieu of fees. This was partly offset by growth in invoiced services.

 

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Table of Contents

The Treasury Services business’s net interest income was $170 million in 2006, compared with $174 million in 2005 and $162 million in 2004. The decrease in 2006 reflects lower credit spreads. Average assets for 2006 were $12.0 billion, compared with $10.6 billion in 2005 and $10.2 billion in 2004. Average deposits were $9.2 billion versus $8.4 billion in 2005 and $8.8 billion in 2004.

The provision for credit losses, which is assessed on a long-term credit cycle basis (see “Business Segment Accounting Principles”), was $37 million in 2006 compared with $40 million in 2005 and 2004. The decrease in 2006 compared to 2005 principally reflects the benefits of the Company’s corporate credit risk reduction program. Over the past several years, the Company has been seeking to improve its overall risk profile by reducing its credit exposures through elimination of non-strategic exposures, cutting back large individual exposures and avoiding outsized industry concentrations.

Net charge-offs in the Treasury Services business were a recovery of $1 million in 2006, compared with charge-offs of $2 million and $15 million in 2005 and 2004. The charge-offs in 2005 primarily relate to loans to media, corporate, and foreign borrowers. Nonperforming assets were $22 million at December 31, 2006, compared with $12 million at December 31, 2005, and $87 million at December 31, 2004. The decrease in nonperforming assets in 2005 from 2004 primarily reflected loan sales, paydowns and charge-offs of commercial loans.

Noninterest expense was $199 million in 2006 and 2005, compared with $186 million in 2004. In 2006, noninterest expense remained flat. The increase in noninterest expense in 2005 was due in part to a higher pension expense, stock option expensing, and an increase in incentive compensation tied to revenue growth.

Private Bank and BNY Asset Management Segment

 

    

2006

   

2005

  

2004

   Inc/(Dec)  

(In millions)

           2006 vs. 2005     2005 vs. 2004  

Net Interest Income

   $ 67     $ 66    $ 61    $ 1     $ 5  

Noninterest Income

     562       456      416      106       40  

Total Revenue

     629       522      477      107       45  

Provision for Credit Losses

     —         3      3      (3 )     —    

Noninterest Expense

     400       320      288      80       32  

Income Before Taxes

     229       199      186      30       13  

Average Assets

     2,539       2,205      2,144      334       61  

Average Deposits

     2,010       1,673      1,616      337       57  

Nonperforming Assets

     —         1      1      (1 )     —    

Net Charge-offs/(Recoveries)

     (1 )     —        5      (1 )     (5 )

In 2006, income before taxes in the Private Bank and BNY Asset Management Segment was $229 million, compared with $199 million in 2005 and $186 million in 2004. The improvement in 2006 over 2005 is primarily attributable to strong revenue growth at Ivy, the acquisitions of Alcentra and Urdang, and higher fee levels in Private Banking. The increase in 2005 versus 2004 is primarily attributable to strong revenue growth at Ivy.

Noninterest income was $562 million in 2006, compared with $456 million in 2005 and $416 million in 2004. Private bank and asset management revenues in 2006 were up compared with 2005 and 2004. The increase in 2006 reflects a rise in equity market values and higher performance fees. The Company’s asset managers earn performance fees when the investment performance of their products exceeds various benchmarks and satisfies other criteria. The S&P 500® Index was up 14% for the year, with average daily price levels up 9% from 2005. Performance for the NASDAQ Composite Index was up 10% for the year, with average daily prices up by 8%. In 2005, the increase reflected strong growth at Ivy, higher fees in Private Banking, and higher equity price levels.

 

22


Table of Contents

Assets Under Management—Asset Management Sector

 

(In billions)—Estimated

   2006    2005    2004

Equity Securities

   $ 39    $ 37    $ 36

Fixed Income Securities

     21      20      22

Alternative Investments

     33      15      15

Liquid Assets

     38      33      29
                    

Total Assets Under Management

   $ 131    $ 105    $ 102
                    

Assets under management (“AUM”) were $131 billion at December 31, 2006, compared with $105 billion at December 31, 2005 and $102 billion at December 31, 2004. The increase in assets under management for 2006 primarily reflects the acquisitions of Alcentra and Urdang. At December 31, 2006, AUM was invested 30% in equities, 16% in fixed income, and 25% in alternative investments, with the remaining amount in liquid assets. Institutional clients represented 75% of AUM while individual clients were 25%.

Net interest income in the Private Bank and BNY Asset Management segment was $67 million in 2006, compared with $66 million in 2005 and $61 million in 2004. Net interest income growth in 2006 and 2005 reflects wider spreads given higher interest rates. Average deposits generated by the Private Bank and BNY Asset Management segment were $2.0 billion in 2006, compared with $1.7 billion in 2005 and $1.6 billion in 2004. Average assets in the segment were $2.5 billion in 2006, compared with $2.2 billion in 2005 and $2.1 billion in 2004.

Noninterest expense was $400 million in 2006, compared with $320 million in 2005 and $288 million in 2004. In 2006, the increase in noninterest expense reflects the acquisitions of Alcentra and Urdang as well as higher staff costs, incentive compensation, and technology costs. The rise in noninterest expense in 2005 was attributable to higher salaries, employee benefits, and technology costs.

Net charge-offs were a recovery of $1 million, compared with zero in 2005 and charge-offs of $5 million in 2004. Nonperforming assets were zero at December 31, 2006, compared with $1 million at December 31, 2005 and 2004.

Corporate and Other Segment

 

                       Inc/(Dec)  

(In millions)

   2006     2005     2004     2006 vs. 2005     2005 vs. 2004  

Net Interest Income

   $ 29     $ 81     $ 32     $ (52 )   $ 49  

Noninterest Income

     121       62       131       59       (69 )

Total Revenue

     150       143       163       7       (20 )

Provision for Credit Losses

     (85 )     (69 )     (66 )     (16 )     (3 )

Noninterest Expense

     497       303       270       194       33  

Income Before Taxes

     (262 )     (91 )     (41 )     (171 )     (50 )

Average Assets

     10,894       8,432       9,222       2,462       (790 )

Nonperforming Assets

     3       18       7       (15 )     11  

Net Charge-offs/(Recoveries)

     19       140       14       (121 )     126  

In 2006, income before taxes in the Corporate and Other Segment was a loss of $262 million, compared with losses of $91 million and $41 million in 2005 and 2004. The larger loss in 2006 reflects $106 million of merger and integration costs associated with the Acquired Corporate Trust Business and the impact of certain expenses previously allocated to the Retail and Middle Market Banking Segment that were not included in the Retail Business sold to JPMorgan Chase.

Net interest income in the Corporate and Other Segment was $29 million in 2006, compared with $81 million in 2005 and $32 million in 2004. In 2006, the decrease in net interest income reflects the impact of

 

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Table of Contents

accounting for the Retail Business as discontinued operations offset by higher leasing income. Net interest income in 2004 included the SFAS 13 cumulative adjustments to the leasing portfolio, which reduced net interest income by $66 million.

Noninterest income was $121 million in 2006, compared with $62 million in 2005 and $131 million in 2004. In 2006, the increase in noninterest income reflects higher securities, investment, and asset gains. In 2005, the decline in noninterest income was attributable to both lower securities gains and lower gains from corporate asset sales, given the $48 million gain on the sale of 5% of the Company’s stake in Wing Hang in 2004. Securities gains were $88 million in 2006, compared to $68 million in 2005 and $78 million in 2004.

Provision for credit losses was a credit of $85 million in 2006, compared with a $69 million credit in 2005 and a credit of $66 million in 2004. The provision for credit losses reflects the difference between the aggregate of the credit provision over a credit cycle assigned to the other segments and the Company’s recorded provision. The SFAS 13 aircraft adjustments lowered the provision by $7 million in 2004.

Noninterest expense includes unallocated corporate overhead, amortization of intangibles, nonrecurring items, and certain expenses previously allocated to the Retail and Middle Market Banking Segment that are not included in the businesses sold to JPMorgan Chase. Noninterest expense was $497 million in 2006, compared with $303 million in 2005 and $270 million in 2004. The increase in noninterest expense in 2006 versus 2005 was primarily due to merger and integration expenses associated with the Acquired Corporate Trust Business and higher intangibles amortization. The Company expects certain costs that were previously allocated to the Retail and Middle Market Banking Segment and are now included in the Corporate and Other Segment will be absorbed by the Institutional Services Segment in 2007 as a result of the acquisition of the Acquired Corporate Trust Business. Noninterest expense in 2006 also included $12 million associated with the adoption of SFAS 123(R).

Net charge-offs were $19 million for 2006, compared to $140 million for 2005 and $14 million for 2004. The charge-offs in 2006 and 2005 are primarily attributable to the Company’s airline leasing portfolio. Nonperforming assets were $3 million at December 31, 2006, compared with $18 million at December 31, 2005, and $7 million at December 31, 2004.

Significant other items related to the Corporate and Other Segment for the past three years are presented in the following table.

 

(In millions)

   2006     2005     2004  

Items impacting net interest income:

      

Cost to Carry Goodwill

   $ (111 )   $ (99 )   $ (105 )

Tax Equivalent Adjustment

     (22 )     (27 )     (26 )

Items impacting noninterest income:

      

Gain on Sale of FMC

     —         17       —    

Gain on Sale of Wing Hang

     —         —         48  

Items impacting noninterest expense:

      

Intangibles Amortization

     76       40       34  

Other Regulatory Matters

     —         24       —    

SFAS 123(R)

     12       —         —    

Merger and Integration Costs

     106       —         —    

Other items—Acquisitions are the responsibility of corporate management. Accordingly, the funding cost of goodwill and amortization of intangibles are assigned to the Corporate and Other Segment. If the funding cost of goodwill was allocated to the other two segments, it would be assigned based on the goodwill attributable to each segment. Intangible amortization would be assigned based on the intangibles attributable to each segment.

The tax equivalent adjustment is eliminated in the Corporate and Other Segment. Certain revenue and expense items have been driven by corporate decisions and have been included in the Corporate and Other

 

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Table of Contents

Segment. In 2006, these included merger and integration costs of $106 million associated with the Acquired Corporate Trust Business and a charge of $12 million associated with the implementation of SFAS 123(R) related to the retirement provisions of equity compensation programs. In 2005, these include the $17 million gain on the sale of FMC and the $24 million charge for regulatory matters. In 2004, the $48 million gain on the sale of Wing Hang was included in the Corporate and Other Segment. Alternatively, these items could be allocated to the Institutional Services Segment.

Segment Financial Data

The consolidating schedule below shows the contribution of the Company’s businesses to its overall profitability.

 

(Dollars in millions)

For the Year Ended
December 31, 2006

  Investor &
Broker-Dealer
Services
    Execution
& Clearing
Services
    Issuer
Services
    Treasury
Services
    Sub-total
Institutional
Services
    Private
Bank &
BNY Asset
Management
    Corporate
and Other
    Total
Continuing
Operations
 

Net Interest Income

  $ 624     $ 268     $ 341     $ 170     $ 1,403     $ 67     $ 29     $ 1,499  

Noninterest Income

    1,971       1,394       1,030       244       4,639       562       121       5,322  
                                                               

Total Revenue

    2,595       1,662       1,371       414       6,042       629       150       6,821  

Provision for Credit Losses

    10       2       16       37       65       —         (85 )     (20 )

Noninterest Expense

    1,797       1,150       628       199       3,774       400       497       4,671  
                                                               

Income Before Taxes

  $ 788     $ 510     $ 727     $ 178     $ 2,203     $ 229     $ (262 )   $ 2,170  
                                                               

Contribution Percentage(1)

    32 %     21 %     30 %     7 %     90 %     10 %    

Average Assets

  $ 40,293     $ 14,866     $ 15,906     $ 11,980     $ 83,045     $ 2,539     $ 10,894     $ 96,478 (2)

(Dollars in millions)

For the Year Ended

December 31, 2005

  Investor &
Broker-Dealer
Services
    Execution
& Clearing
Services
    Issuer
Services
    Treasury
Services
    Sub-total
Institutional
Services
    Private
Bank &
BNY Asset
Management
    Corporate
and Other
    Total
Continuing
Operations
 

Net Interest Income

  $ 569     $ 211     $ 239     $ 174     $ 1,193     $ 66     $ 81     $ 1,340  

Noninterest Income

    1,826       1,325       757       272       4,180       456       62       4,698  
                                                               

Total Revenue

    2,395       1,536       996       446       5,373       522       143       6,038  

Provision for Credit Losses

    7       1       11       40       59       3       (69 )     (7 )

Noninterest Expense

    1,636       1,151       458       199       3,444       320       303       4,067  
                                                               

Income Before Taxes

  $ 752     $ 384     $ 527     $ 207     $ 1,870     $ 199     $ (91 )   $ 1,978  
                                                               

Contribution Percentage(1)

    36 %     19 %     25 %     10 %     90 %     10 %    

Average Assets

  $ 36,233     $ 15,478     $ 13,349     $ 10,622     $ 75,682     $ 2,205     $ 8,432     $ 86,319 (2)

(Dollars in millions)

For the Year Ended

December 31, 2004

  Investor &
Broker-Dealer
Services
    Execution
& Clearing
Services
    Issuer
Services
    Treasury
Services
    Sub-total
Institutional
Services
    Private
Bank &
BNY Asset
Management
    Corporate
and Other
    Total
Continuing
Operations
 

Net Interest Income

  $ 518     $ 170     $ 214     $ 162     $ 1,064     $ 61     $ 32     $ 1,157  

Noninterest Income

    1,627       1,242       696       265       3,830       416       131       4,377  
                                                               

Total Revenue

    2,145       1,412       910       427       4,894       477       163       5,534  

Provision for Credit Losses

    7       1       11       40       59       3       (66 )     (4 )

Noninterest Expense

    1,441       1,087       426       186       3,140       288       270       3,698  
                                                               

Income Before Taxes

  $ 697     $ 324     $ 473     $ 201     $ 1,695     $ 186     $ (41 )   $ 1,840  
                                                               

Contribution Percentage(1)

    37 %     17 %     25 %     11 %     90 %     10 %    

Average Assets

  $ 35,225     $ 15,122     $ 11,776     $ 10,163     $ 72,286     $ 2,144     $ 9,222     $ 83,652 (2)

(1) As a percent of total income before tax excluding Corporate and Other.
(2) Including average assets of discontinued operations of $10,364 million for 2006, $15,116 million for 2005, and $15,688 million for 2004, consolidated average assets were $106,842 million in 2006, $101,435 million in 2005, and $99,340 million in 2004.

 

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Table of Contents

International Operations

The Company’s primary international activities consist of securities servicing and global payment services. Target customers include financial institutions, pension funds and securities issuers worldwide.

In Investor Services, the Company is a leading global custodian. In the United Kingdom, the Company provides a full range of both local and global services. In Continental Europe, a full global product set is provided with access to local markets through strategic partnerships. Off-shore mutual fund servicing capabilities for funds registered in Dublin, the Channel Islands, Luxembourg and Singapore are provided through operations in Luxembourg and Dublin.

In Issuer Services, the Company is a leader in the DR market, currently acting as the depositary receipts agent for 64% of all publicly sponsored listings by foreign companies. For debt issuance, the Company is one of the leading corporate trust providers for global debt issuance.

The Company’s international clearing business delivers clearing and financial services outsourcing solutions in 65 countries. In Execution, the Company provides institutional trade execution services in over 90 global markets, including 50 emerging markets.

In the Asia-Pacific region, the Company has over 50 years of experience providing trade and cash services to financial institutions and central banks. In addition, the Company offers a broad range of servicing and fiduciary products to financial institutions, corporations and central banks depending on the state of market development. In emerging markets, the Company leads with global payments and issuer services, introducing other products as the markets mature. For more established markets, the Company’s focus is on global, not local, investor services products and alternative investments.

The Company is also a leading provider and major market maker in the area of foreign exchange and interest-rate risk management services, dealing in over 100 currencies, and provides traditional trust and banking services to customers domiciled outside of the United States, principally in Europe and Asia. Ivy Asset Management (UK), Ltd. provides clients in Europe and the Middle East with hedge fund of funds investment advisory services. Alcentra in London offers sophisticated alternative credit investments, including leveraged loans and subordinated and distressed debt.

The Company conducts business through subsidiaries, branches, and representative offices in 33 countries. The Company has major operation centers based in Brussels, Dublin, Singapore and throughout the United Kingdom including London, Manchester, and Edinburgh.

The Company’s financial results, as well as its levels of assets under custody and management, are impacted by the translation of financial results denominated in foreign currencies to the U.S. Dollar. The Company is primarily impacted by activities denominated in the British Pound, and to a lesser extent, the Euro. If the U.S. Dollar depreciates against these currencies, the translation impact is a higher level of fee revenue, net interest revenue, operating expense and assets under management and custody. Conversely, if the U.S. Dollar appreciates, the translated levels of fee revenue, net interest revenue, operating expense and assets under management and custody will be lower.

Foreign currency exchange rates for one U.S. Dollar:

 

     Year
     2006    2005    2004

Spot rate (at December 31):

        

British Pound

   0.5107    0.5813    0.5192

Euro

   0.7580    0.8444    0.7331

Yearly average rate:

        

British Pound

   0.5435    0.5500    0.5460

Euro

   0.7970    0.8045    0.8051

 

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International clients accounted for 30% of revenue and 26% of net income in 2006. At December 31, 2006, the Company had 4,971 employees in Europe and 1,948 in Asia.

International Financial Data

Revenue, income before income taxes, net income and total assets from foreign operations on a continuing operations basis are shown in the table below.

 

     2006   2005   2004

(In millions)

Geographic Data

  Revenues   Income
Before
Income
Taxes
  Net
Income
  Total
Assets
  Revenues   Income
Before
Income
Taxes
  Net
Income
  Total
Assets
  Revenues   Income
Before
Income
Taxes
  Net
Income
  Total
Assets

Domestic

  $ 4,758   $ 1,605   $ 1,092   $ 71,217   $ 4,228   $ 1,475   $ 1,007   $ 67,031   $ 3,871   $ 1,350   $ 926   $ 66,044

Europe

    1,517     423     286     24,855     1,327     376     251     19,414     1,208     353     235     15,062

Asia

    338     104     72     4,204     279     85     56     4,828     292     118     79     3,759

Other

    208     38     26     3,076     204     42     29     2,037     163     19     13     1,365
                                                                       

Total

  $ 6,821   $ 2,170   $ 1,476   $ 103,352   $ 6,038   $ 1,978   $ 1,343   $ 93,310   $ 5,534   $ 1,840   $ 1,253   $ 86,230
                                                                       

In 2006, revenues from Europe were $1,517 million, compared with $1,327 million in 2005 and $1,208 million in 2004. Revenues from Europe were up 14% in 2006. The increase in 2006 reflects increased cross-border flows which drove revenue higher in global mutual funds, custody, corporate trust and depositary receipts. The increase in 2005 reflected strong growth in investor and issuer service revenues. Revenues from Asia were $338 million in 2006, compared with $279 million and $292 million in 2005 and 2004, respectively. The increase in Asia in 2006 was primarily due to increases in net interest income, securities lending, depositary receipts, and equity in the earnings of Wing Hang. The slight decrease in Asia in 2005 was primarily due to the large gain in 2004 related to Wing Hang. Net income from Europe was $286 million in 2006, compared with $251 million and $235 million in 2005 and 2004, respectively. Net income from Asia was $72 million in 2006, compared with $56 million and $79 million in 2005 and 2004, respectively. Net income from Europe and Asia were driven by the same factors affecting revenue. In addition, in 2006 and 2005, net income from Europe was adversely impacted by the strength of the Euro and Sterling versus the dollar.

Cross-Border Risk

Foreign assets are subject to general risks attendant to the conduct of business in each foreign country, including economic uncertainties and each foreign government’s regulations. In addition, the Company’s foreign assets may be affected by changes in demand or pricing resulting from fluctuations in currency exchange rates or other factors. Cross-border outstandings include loans, acceptances, interest-bearing deposits with other banks, other interest-bearing investments, and other monetary assets which are denominated in dollars or other non-local currency. Also included are local currency outstandings not hedged or funded by local borrowings.

The tables below show the Company’s cross-border outstandings for the last three years where cross-border exposure exceeds 1.00% of total assets (denoted with “*”) or 0.75% of total assets (denoted with “**”).

 

(In millions)

 

2006

   Germany*    France*    United
Kingdom*
   Netherlands*    Canada*    Italy**    Switzerland**

Banks and Other Financial Institutions

   $ 4,241    $ 2,197    $ 1,211    $ 653    $ 723    $ 992    $ 767

Public Sector

     200      341      38      —        197      —        —  

Commercial, Industrial and Other

     402      35      1,025      753      233      17      121
                                                

Total Cross-Border Outstandings

   $ 4,843    $ 2,573    $ 2,274    $ 1,406    $ 1,153    $ 1,009    $ 888
                                                
2005    Germany*    United
Kingdom*
   Netherlands*    France*    Belgium**    Switzerland**

Banks and Other Financial Institutions

   $ 2,216    $ 571    $ 1,010    $ 740    $ 634    $ 744

Public Sector

     185      —        —        169      49      —  

Commercial, Industrial and Other

     406      1,256      570      203      257      141
                                         

Total Cross-Border Outstandings

   $ 2,807    $ 1,827    $ 1,580    $ 1,112    $ 940    $ 885
                                         

 

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2004    Germany*    United
Kingdom*
   France*

Banks and Other Financial Institutions

   $ 2,586    $ 307    $ 850

Public Sector

     176      —        128

Commercial, Industrial and Other

     433      776      302
                    

Total Cross-Border Outstandings

   $ 3,195    $ 1,083    $ 1,280
                    

CRITICAL ACCOUNTING POLICIES

The Company’s significant accounting policies are described in the Notes to Consolidated Financial Statements under “Summary of Significant Accounting and Reporting Policies”. Four of the Company’s more critical accounting policies are those related to the allowance for credit losses, the valuation of derivatives and securities where quoted market prices are not available, goodwill and other intangibles, and pension accounting. In addition to “Summary of Significant Accounting and Reporting Policies” in the Notes to Consolidated Financial Statements, further information on policies related to the allowance for credit losses can be found under “Asset Quality and Allowance for Credit Losses” in the MD&A section. Further information on the valuation of derivatives and securities where quoted market prices are not available can be found under “Market Risk Management” and “Trading Activities and Risk Management” in the MD&A section and in “Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements. Further information on goodwill and intangible assets can be found in “Goodwill and Intangibles” in the Notes to Consolidated Financial Statements. Additional information on pensions can be found in “Employee Benefit Plans” in the Notes to the Consolidated Financial Statements.

Allowance for Credit Losses

The allowance for credit losses and allowance for lending-related commitments consist of four elements: (1) an allowance for impaired credits; (2) an allowance for higher risk rated loans and exposures; (3) an allowance for pass rated loans and exposures; and (4) an unallocated allowance based on general economic conditions and certain risk factors in the Company’s individual portfolio and markets. Further discussion on the four elements can be found under “Asset Quality and Allowance for Credit Losses” in the MD&A section.

The allowance for credit losses represents management’s estimate of probable losses inherent in the Company’s credit portfolio. This evaluation process is subject to numerous estimates and judgments. Probability of default ratings are assigned after analyzing the credit quality of each borrower/counterparty and the Company’s internal rating are generally consistent with external ratings agency’s default databases. Loss given default ratings are driven by the collateral, structure, and seniority of each individual asset and are consistent with external loss given default/recovery databases. The portion of the allowance related to impaired credits is based on the present value of future cash flows. Changes in the estimates of probability of default, risk ratings, loss given default/recovery rates, and cash flows could have a direct impact on the allocated allowance for loan losses.

To the extent actual results differ from forecasts or management’s judgment, the allowance for credit losses may be greater or less than future charge-offs.

The Company considers it difficult to quantify the impact of changes in forecast on its allowance for credit losses. Nevertheless, the Company believes the following discussion may enable investors to better understand the variables that drive the allowance for credit losses.

A key variable in determining the allowance is management’s judgment in determining the size of the unallocated allowance. At December 31, 2006, the unallocated allowance was 23% of the total allowance. If the unallocated allowance were five percent higher or lower, the allowance would have increased or decreased by $22 million, respectively.

 

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The credit rating assigned to each credit is another significant variable in determining the allowance. If each credit were rated one grade better, the allowance would have decreased by $74 million, while if each credit were rated one grade worse, the allowance would have increased by $133 million.

Similarly, if the loss given default were one rating worse, the allowance would have increased by $45 million, while if the loss given default were one rating better, the allowance would have decreased by $42 million.

For impaired credits, if the fair value of the loans were 10% higher or lower, the allowance would have increased or decreased by $3 million, respectively.

Valuation of Derivatives and Securities Where Quoted Market Prices Are Not Available

When quoted market prices are not available for derivatives and securities values, such values are determined at fair value, which is defined as the value at which positions could be closed out or sold in a transaction with a willing counterparty over a period of time consistent with the Company’s trading or investment strategy. Fair value for these instruments is determined based on discounted cash flow analysis, comparison to similar instruments, and the use of financial models. Financial models use as their basis independently-sourced market parameters including, for example, interest rate yield curves, option volatilities, and currency rates. Discounted cash flow analysis is dependent upon estimated future cash flows and the level of interest rates. Model-based pricing uses inputs of observable prices for interest rates, foreign exchange rates, option volatilities and other factors. Models are benchmarked and validated by independent parties. The Company’s valuation process takes into consideration factors such as counterparty credit quality, liquidity and concentration concerns. The Company applies judgment in the application of these factors. In addition, the Company must apply judgment when no external parameters exist. Finally, other factors can affect the Company’s estimate of fair value, including market dislocations, incorrect model assumptions, and unexpected correlations.

These valuation methods could expose the Company to materially different results should the models used or underlying assumptions be inaccurate. See “Use of Estimates” in “Summary of Significant Accounting and Reporting Policies” in the Notes to Consolidated Financial Statements.

To assist in assessing the impact of a change in valuation, at December 31, 2006, approximately $2.2 billion of the Company’s portfolio of securities and derivatives is not priced based on quoted market prices. A change of 2.5% in the valuation of these securities and derivatives would result in a change in pre-tax income of $54 million.

Goodwill and Other Intangibles

The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles, and other intangibles, at fair value as required by SFAS No. 141 (“SFAS 141”), “Business Combinations”. Goodwill ($5,172 million at December 31, 2006) and indefinite-lived intangible assets ($370 million at December 31, 2006) are not amortized but are subject to annual tests for impairment or more often if events or circumstances indicate they may be impaired. Other intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial recording of goodwill, indefinite-lived intangibles, and other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets. Goodwill is assigned to specific reporting units, which are generally one level below the segment level but can be combined when reporting units within the same segment have similar economic characteristics. The goodwill impairment test is performed in two phases. The first step of the goodwill impairment test compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, an additional procedure must be performed. That additional procedure compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. An

 

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impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. Indefinite-lived intangible assets are evaluated for impairment at least annually by comparing their fair value to their carrying value. Other intangible assets ($1,083 million at December 31, 2006) are evaluated for impairment if events and circumstances indicate a possible impairment. Such evaluation of other intangible assets is based on undiscounted cash flow projections. The Company recorded a $6 million impairment charge in 2006 related to the write-off of customer intangibles in Europe.

Fair value may be determined using: market prices, comparison to similar assets, market multiples, discounted cash flow analysis and other determinants. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates and specific industry or market sector conditions. Other key judgments in accounting for intangibles include useful life and classification between goodwill and indefinite-lived intangibles or other intangibles which require amortization. See “Goodwill and Intangibles” in the Notes to Consolidated Financial Statements for additional information regarding intangible assets.

To assist in assessing the impact of a goodwill, indefinite-lived intangibles, or other intangible asset impairment charge, at December 31, 2006, the Company has $6.6 billion of goodwill, indefinite-lived intangibles, and other intangible assets. The impact of a 5% impairment charge would result in a reduction in pre-tax income of approximately $331 million.

Pension Accounting

The Company has defined benefit pension plans covering approximately 14,200 U.S. employees and approximately 2,750 non-U.S. employees.

The Company has three defined benefit pension plans in the U.S. and six overseas. The U.S. plans account for 77% of the projected benefit obligation. Pension expense was $38 million in 2006, compared with $26 million in 2005 and a pension credit of $24 million in 2004. In addition to its pension plans, the Company also has an Employee Stock Ownership Plan (“ESOP”) which may provide additional benefits to certain employees. Upon retirement, covered employees are entitled to the higher of their benefit under the ESOP or the defined benefit plan. If the benefit is higher under the defined benefit plan, the employees’ ESOP account is contributed to the pension plan.

A number of key assumption and measurement date values determine pension expense. The key elements include the long-term rate of return on plan assets, the discount rate, the market-related value of plan assets, and for the primary U.S. plan the price used to value stock in the ESOP. Since 2004, these key elements have varied as follows:

 

(Dollars in millions, except per share amounts)

   2007     2006     2005     2004  

Domestic Plans:

        

Long-Term Rate of Return on Plan Assets

     8.00 %     7.88 %     8.25 %     8.75 %

Discount Rate

     6.00       5.88       6.00       6.25  

Market-Related Value of Plan Assets(1)

   $ 1,352     $ 1,324     $ 1,502     $ 1,523  

ESOP Stock Price(1)

     34.85       30.46       30.67       27.88  

Net U.S. Pension Credit/(Expense)

     $ (26 )   $ (17 )   $ 31  

All Other Pension Credit/(Expense)

       (12 )     (9 )     (7 )
                          

Total Pension Credit/(Expense)(2)

     $ (38 )   $ (26 )   $ 24  
                          

(1) Actuarially smoothed data. See “Summary of Significant Accounting and Reporting Policies” in Notes to the Consolidated Financial Statements.
(2) Pension benefits expense includes discontinued operations expense of $6 million in 2006, 2005, and 2004.

 

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The discount rate for U.S. pension plans was determined after reviewing a number of high quality long-term bond indices whose yields were adjusted to match the duration of the Company’s pension liability. The Company also reviewed the results of several models that matched bonds to the Company’s pension cash flows. The various indices and models produced discount rates ranging from 5.91% to 6.10%. After reviewing the various indices and models the Company selected a discount rate of 6.00%. The discount rates for foreign pension plans are based on high quality corporate bonds rates in countries that have an active corporate bond market. In those countries with no active corporate bond market, discount rates are based on local government bond rates plus a credit spread.

The Company’s expected long-term rate of return on plan assets is based on anticipated returns for each asset class. At September 30, 2006 and 2005, the assumptions for the long-term rates of return on plan assets were 8.00% and 7.88%, respectively. Anticipated returns are weighted for the target allocation for each asset class. Anticipated returns are based on forecasts for prospective returns in the equity and fixed income markets, which should track the long-term historical returns for these markets. The Company also considers the growth outlook for U.S. and global economies, as well as current and prospective interest rates.

The market-related value of plan assets also influences the level of pension expense. Differences between expected and actual returns are recognized over five years to compute an actuarially derived market-related value of plan assets. In 2006, the market-related value of plan assets declined as the extraordinary actual return in 2000 was replaced with a more modest return. The market-related value of plan assets grew slightly for 2007 as the pension fund earned more normal returns.

Unrecognized actuarial gains and losses are amortized over the future service period (11 years) of active employees if they exceed a threshold amount. The Company currently has unrecognized losses which are being amortized.

For 2006, U.S. pension expense increased by $9 million reflecting changes in assumptions, the amortization of unrecognized pension losses, and a decline in the market-related value of plan assets, partly offset by a switch to the computation of benefits from final average pay to career average pay. U.S. pension expense is expected to decline approximately $30 million in 2007 primarily due to employees working longer and the Pension Protection Act of 2006.

The annual impacts on the primary U.S. plan of hypothetical changes in the key elements on the pension expense are shown in the tables below.

 

(Dollars in millions, except per share amount)

  

Increase in

Pension Expense

    2007 Base    

Decrease in

Pension Expense

 

Long-Term Rate of Return on Plan Assets

     7.00 %     7.50 %     8.00 %     8.50 %     9.00 %

Change in Pension Expense

   $ 18.4     $ 9.2       N/A     $ 9.2     $ 18.4  

Discount Rate

     5.50 %     5.75 %     6.00 %     6.25 %     6.50 %

Change in Pension Expense

   $ 11.8     $ 5.8       N/A     $ 5.7     $ 11.2  

Market-Related Value of Plan Assets

     -20.00 %     -10.00 %   $ 1,352       +10.00 %     +20.00 %

Change in Pension Expense

   $ 50.6     $ 25.3       N/A     $ 25.2     $ 46.9  

ESOP Stock Price

   $ 24.85     $ 29.85     $ 34.85     $ 39.85     $ 44.85  

Change in Pension Expense

   $ 14.5     $ 7.0       N/A     $ 6.5     $ 12.5  

CONSOLIDATED BALANCE SHEET REVIEW

The Company’s assets were $103.4 billion at December 31, 2006, up from $102.1 billion in the prior year. The increase in 2006 from 2005 primarily reflects growth in the Company’s securities servicing businesses and the Acquired Corporate Trust Business, partly offset by the sale of the Retail Business. Investment securities as a

 

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percent of the Company’s year-end assets were 20% in 2006 and 27% in 2005. The decline in investment securities relates to the sale of $5.5 billion of securities as part of the portfolio restructuring entered into in connection with the sale of the Retail Business and the purchase of the Acquired Corporate Trust Business. Loans as a percent of assets was 37% and 32% in 2006 and 2005, respectively. The increase in loans was driven by the needs of the Company’s securities servicing customers. Total shareholders’ equity was $11.6 billion at December 31, 2006 compared with $9.9 billion in 2005. The major reason for the increase in shareholders’ equity was retention of earnings.

Investment Securities

The table below shows the distribution of the Company’s investment securities portfolio:

Investment Securities (at Fair Value)

 

(In millions)

   December 31,
2006
   December 31,
2005

Fixed Income Securities:

     

Mortgage-Backed Securities

   $ 17,785    $ 22,484

Asset-Backed Securities

     464      305

Corporate Debt

     256      1,034

Short-Term Money Market Instruments

     531      975

U.S. Treasury Securities

     86      226

U.S. Government Agencies

     673      620

State and Political Subdivisions

     88      116

Emerging Market Debt (Collateralized by U.S. Treasury
Zero Coupon Obligations)

     116      117

Other Foreign Debt

     10      363
             

Subtotal Fixed Income Securities

     20,009      26,240

Equity Securities:

     

Money Market or Fixed Income Funds

     1,032      922

Other

     46      31
             

Subtotal Equity Securities

     1,078      953
             

Total Securities

   $ 21,087    $ 27,193
             

Total investment securities were $21.1 billion in 2006, compared with $27.2 billion in 2005 and $23.7 billion in 2004. In 2006, the $5.5 billion portfolio restructuring sale is primarily responsible for the decline in investments. The increase in 2005 was primarily due to the addition of $3.1 billion of highly rated mortgage-backed securities. Average investment securities were $22.3 billion in 2006, compared with $20.7 billion in 2005 and $18.0 billion in 2004. At December 31, 2006, the fixed income portfolio composition was approximately 26% hybrid, 38% fixed rate, and 27% variable rate mortgage-backed securities while treasuries, government agencies, municipalities and short-term securities were 7% and other securities were 2%.

The Company’s portfolio of mortgage-backed securities is 87% rated AAA, 9% AA, and 4% A. The primary risk in these securities is interest rate sensitivity. The Company seeks to reduce interest rate risk by investing in securities that convert to floating within three to five years or by investing in traunches of mortgage-backed securities that have rapid repayment characteristics. See “Asset/Liability Management”. The Company has been adding either adjustable or short life classes of structured mortgage-backed securities, both of which have short durations. The Company has maintained an effective duration of approximately 1.6 years on its mortgage portfolio to best match its liabilities and to reduce the adverse impact from a rise in interest rates.

 

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Corporate debt securities declined in 2006. The primary risks in corporate debt securities are credit risk and interest rate risk. Almost all of the corporate securities are investment grade.

The short-term money market instruments and obligations of state and political subdivisions have a modest amount of credit risk. The U.S. Treasury and Agency securities and obligations of state and political subdivision are generally fixed–rate securities so they expose the Company to interest rate risk.

There was no unrealized net gain or loss on securities available-for-sale at December 31, 2006, compared with an unrealized net loss of $108 million at December 31, 2005. The decline in unrealized net loss reflects the portfolio restructuring and a decline in longer term interest rates.

The following table shows the maturity distribution by carrying amount and yield (not on a tax equivalent basis) of the Company’s securities portfolio at December 31, 2006.

 

(Dollars in millions)

 

U.S.

Government

   

U.S.

Government
Agency

    States and
Political
Subdivisions
    Other Bonds,
Notes and
Debentures
   

Mortgage/

Asset-Backed
and Equity
Securities

    Total
  Amount   Yield(1)     Amount   Yield(1)     Amount   Yield(1)     Amount   Yield(1)     Amount   Yield(1)    

Securities Held-to-Maturity

                     

One Year or Less

  $ —     —   %   $ 120   2.65 %   $ —     —   %   $ —     —   %   $ —     —   %   $ 120

Over 1 through 5 Years

    —     —         —     —         —     —         —     —         —     —         —  

Over 5 through 10 Years

    —     —         —     —         —     —         —     —         —     —         —  

Over 10 years

    —     —         —     —         —     —         117   6.33       —     —         117

Mortgage-Backed Securities

    —     —         —     —         —     —         —     —         1,492   4.68       1,492
                                             
  $ —     —   %   $ 120   2.65 %   $ —     —   %   $ 117   6.33 %   $ 1,492   4.68 %   $ 1,729
                                             

Securities Available-for-Sale

                     

One Year or Less

  $ 36   4.47 %   $ 463   4.91 %   $ 8   8.15 %   $ 274   5.25 %   $ —     —   %   $ 781

Over 1 through 5 Years

    50   4.53       91   5.47       36   8.69       3   5.78       —     —         180

Over 5 through 10 Years

    —     —         —     —         29   8.69       31   6.28       —     —         60

Over 10 years

    —     —         —     —         15   7.24       490   3.75       —     —         505

Mortgage-Backed Securities

    —     —         —     —         —     —         —     —         16,309   5.43       16,309

Asset-Backed Securities

    —     —         —     —         —     —         —     —         464   6.72       464

Equity Securities

    —     —         —     —         —     —         —     —         1,078   4.98       1,078
                                             
  $ 86   4.50 %   $ 554   5.00 %   $ 88   8.39 %   $ 798   4.37 %   $ 17,851   5.26 %   $ 19,377
                                             

(1) Yields are based upon the amortized cost of securities.

The Company also has equity investments categorized as other assets (bracketed amounts indicate carrying values). Included in other assets are strategic investments related to securities servicing ($86 million), venture capital investments ($281 million), an investment in Wing Hang ($241 million), tax advantaged low-income housing investments ($140 million), Federal Reserve Bank stock ($107 million), and other equity investments ($2 million).

The largest minority interest is Wing Hang with a fair value of $698 million (book value of $241 million) at December 31, 2006. An agreement with certain other shareholders of Wing Hang prohibits the sale of this interest without their permission. The Company received dividends from Wing Hang of $18 million, $16 million, and $12 million in 2006, 2005, and 2004, respectively. In 2004, the Company reduced its investment in Wing Hang from approximately 25% of Wing Hang’s outstanding shares to 20%.

Venture capital activities consist of investments in private equity funds, mezzanine financings, and direct equity investments. Consistent with the Company’s policy to focus on its core activities, it continues to reduce its

 

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exposure to venture capital activities. The carrying and fair value of the Company’s venture capital investments was $281 million at December 31, 2006, down $166 million from $447 million at December 31, 2002. Venture capital investments consist of investments in private equity funds of $231 million, direct equity of $21 million, mezzanine financings of $9 million, and leveraged bond funds of $20 million. Fair values for private equity funds are generally based upon information provided by fund sponsors and the Company’s knowledge of the underlying portfolio while mezzanine financing and direct equity investments are based upon Company models. At December 31, 2006, the Company had hedged approximately $7 million of its private equity fund investments. Hedge positions are recorded at fair value with resulting gains and losses reflected in securities gains.

In 2006, the Company had an average invested balance of $311 million in venture capital. Securities gains and interest income were $97 million, a pre-tax return of 31%. For 2007, the Company enters the year with a $281 million investment balance, and would expect returns to be lower than 2006.

At December 31, 2006, the Company had $55 million of unfunded investment commitments to private equity funds and partnerships. The timing of future cash requirements to fund such commitments is generally dependent on the investment cycle. This cycle, the period over which privately-held companies are funded by private equity investors and ultimately sold, merged, or taken public through an initial public offering, can vary based on overall market conditions as well as the nature and type of industry in which the companies operate. If unused, the commitments expire as follows:

 

(In millions)

   Commitments

2007

   $ 2

2008

     —  

2009 - 2011

     53
      

Total

   $ 55
      

Commitments to venture capital limited partnerships may extend beyond the expiration period shown above to cover certain follow-on investments, claims and liabilities, and organizational and partnership expenses.

Consistent with its objective to expand its asset management activities, the Company started the BNY Mezzanine Partners, L.P. in 2006 and committed $75 million to the fund. As of December 31, 2006, the fund had $194 million of assets under management. The Company expects the final close of BNY Mezzanine Partners, L.P. to be in April 2007, with a maximum size of $250 million.

In February 2006, the Company registered an investment fund company in Poland, called BNY National Trust TFI SA (“BNY National Trust”). BNY National Trust expects to receive a license to start operations in the Polish market in the second quarter 2007. BNY National Trust’s first fund will be a closed-end private equity investment fund offering a portfolio of private equity funds and direct investments in established privately-held companies. The fund will consist of 50% private equity fund of funds, 30% direct mezzanine investments and 20% direct equity co-investment. The Company’s expected commitment to BNY National Trust is 10% of the fund, up to $15 million.

From time to time, the Company may make other fund commitments consistent with its strategy to expand its asset management activities.

Loans

 

(In billions)

   December 31,    Annual Average
   Total    Non-Margin    Margin    Total    Non-Margin    Margin

2006

   $ 37.8    $ 32.7    $ 5.1    $ 33.6    $ 28.2    $ 5.4

2005

     32.9      26.8      6.1      32.1      25.7      6.4

2004

     28.4      22.3      6.1      30.6      24.3      6.3

 

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Total loans were $37.8 billion at December 31, 2006, compared with $32.9 billion in 2005. The increase in 2006 versus 2005 primarily reflects increased lending to securities servicing customers and higher mortgage loans partially offset by a decrease in margin loans reflecting the loss of a significant customer at Pershing. The Company continues to focus on its strategy of reducing non-strategic and outsized corporate loan exposures to improve its credit risk profile. Average total loans were $33.6 billion in 2006, compared with $32.1 billion in 2005. The increase in average loans in 2006 primarily results from the same factors impacting year-end loans outstanding.

The table below shows trends in the loans outstanding at year-end on a continuing operations basis over the last five years based on a product analysis.

 

(In millions)

   2006     2005     2004     2003     2002  

Domestic

          

Commercial and Industrial Loans

   $ 4,814     $ 3,676     $ 3,411     $ 4,221     $ 8,187  

Real Estate Loans:

          

Construction and Land Development

     284       324       284       304       480  

Other, Principally Commercial Mortgages

     422       554       863       1,375       1,450  

Collateralized by Residential Properties

     3,815       2,710       1,983       1,076       1,275  

Banks and Other Financial Institutions

     2,494       2,266       1,323       1,320       1,292  

Loans for Purchasing or Carrying Securities

     7,114       4,935       3,028       4,221       1,720  

Lease Financings

     3,032       3,262       3,595       3,727       3,529  

Less:

          

Unearned Income on Lease Financings

     (832 )     (938 )     (1,072 )     (1,063 )     (944 )

Consumer Loans

     266       378       431       573       608  

Margin loans

     5,167       6,089       6,059       5,712       352  

Other

     1,336       946       548       431       238  
                                        

Total Domestic

     27,912       24,202       20,453       21,897       18,187  
                                        

Foreign

          

Commercial and Industrial Loans

     1,111       1,184       793       1,305       1,780  

Banks and Other Financial Institutions

     5,350       4,196       3,939       2,045       1,624  

Lease Financings

     5,802       5,816       5,871       6,026       6,062  

Less:

          

Unearned Income on Lease Financings

     (2,504 )     (2,615 )     (2,731 )     (2,960 )     (3,124 )

Government and Official Institutions

     9       101       42       93       205  

Other

     113       43       8       8       9  
                                        

Total Foreign

     9,881       8,725       7,922       6,517       6,556  
                                        

Less: Allowance for Loan Losses

     (287 )     (326 )     (491 )     (558 )     (530 )
                                        

Net Loans

   $ 37,506     $ 32,601     $ 27,884     $ 27,856     $ 24,213  
                                        

Asset Quality and Allowance for Credit Losses

Over the past several years, the Company has improved its risk profile through greater focus on clients who are active users of the Company’s non-credit services, with a de-emphasis on broad-based loan growth. The Company’s primary exposure to credit risk of a customer consists of funded loans, unfunded formal contractual commitments to lend, counterparty risk associated with derivative transactions and overdrafts associated with clearing and settlement.

The role of credit has shifted to one that complements the Company’s other services instead of as a lead product. Credit solidifies customer relationships and, through a disciplined allocation of capital, can earn acceptable rates of return as part of an overall relationship. The Company’s credit risk management objectives

 

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are: (1) to eliminate non-strategic exposures; (2) to increase granularity in the portfolio by cutting back large individual borrower exposures; (3) to restructure the portfolio to avoid outsized industry concentrations; and (4) to limit exposures to non-investment grade counterparties. The goal of these objectives is to reduce volatility in the Company’s credit provisioning and earnings. The Company regularly culls its loan portfolio of credit exposures that no longer meet risk/return criteria, including an assessment of overall relationship profitability. In addition, the Company makes use of credit derivatives and other risk mitigants as economic hedges of portions of the credit risk in its portfolio. The effect of these transactions is to transfer credit risk to creditworthy, independent third parties.

The Company continues to make progress towards improving its credit risk profile.

 

   

At December 31, 2006, corporate exposure was $23.9 billion.

 

   

The Company brought industry concentrations in line with reduced targets in areas such as telecom, retailing, and automotive. The largest single corporate industry exposure is now energy at 6% of total exposures.

 

   

The Company continued to eliminate non-strategic exposures that do not meet yield or cross-sell criteria.

 

   

At December 31, 2006, the Company has used credit default swaps to reduce exposure on $1,688 million of loans and commitments.

At December 31, 2006, total exposures were $87.1 billion, up from $76.5 billion in 2005 reflecting increased lending to financial institutions.

The Company’s largest absolute risk is lending to financial institutions and corporates, which make up 79% of the total. The business unit components of the loan portfolio are detailed below.

Loan Portfolio

 

     12/31/06    12/31/05    12/31/04    12/31/03

(In billions)

   Loans    Exposure    Loans    Exposure    Loans    Exposure    Loans    Exposure

Financial Institutions

   $ 17.4    $ 44.9    $ 13.0    $ 35.4    $ 9.5    $ 31.1    $ 9.2    $ 31.0

Corporate

     4.1      23.9      3.7      23.3      3.6      23.0      4.0      24.5
                                                       
     21.5      68.8      16.7      58.7      13.1      54.1      13.2      55.5
                                                       

Consumer

     4.3      4.8      3.2      3.5      2.2      2.9      2.2      2.5

Lease Financings

     5.5      5.6      5.5      5.6      5.7      5.7      5.8      5.8

Commercial Real Estate

     1.4      2.8      1.4      2.6      1.3      2.3      1.5      2.1

Margin Loans

     5.1      5.1      6.1      6.1      6.1      6.0      5.7      5.7
                                                       

Total

   $ 37.8    $ 87.1    $ 32.9    $ 76.5    $ 28.4    $ 71.0    $ 28.4    $ 71.6
                                                       

Of the credits in the financial institutions and corporate segments with a rating equivalent to non-investment grade at December 31, 2006, 48% of these credits mature in less than one year.

Financial Institutions

The financial institutions portfolio exposure increased to $44.9 billion at year-ended 2006 from $31.1 billion in 2004 reflecting the expansion of the Company’s securities servicing business. The financial institutions exposure fluctuates day to day based on the financing needs of the Company’s broker-dealer customers and overdrafts relating to security settlements. These exposures are generally high quality, with 85% meeting the investment grade criteria of the Company’s rating system. The exposures are short-term with 77% expiring

 

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within one year, and are frequently secured. For example, mortgage banking, securities industry, and investment managers often borrow against marketable securities held in custody at the Company. The diversity of the portfolio is shown in the accompanying table.

 

(In billions)

Lending Division

  12/31/06         12/31/05   12/31/04
  Loans   Unfunded
Commitments
  Total
Exposures
  % Inv
Grade
    % due
<1 Yr
    Loans   Unfunded
Commitments
  Total
Exposures
  Loans   Unfunded
Commitments

Banks

  $ 5.7   $ 5.5   $ 11.2   69 %   84 %   $ 5.0   $ 3.8   $ 8.8   $ 4.2   $ 3.5

Securities Industry

    6.0     5.4     11.4   87     98       3.4     3.6     7.0     1.5     3.0

Insurance

    0.6     6.1     6.7   100     45       0.4     4.9     5.3     0.5     4.8

Government

    0.1     6.7     6.8   100     62       0.1     4.7     4.8     —       5.0

Asset Managers

    4.7     1.9     6.6   82     85       3.8     3.6     7.4     3.0     3.8

Mortgage Banks

    0.2     0.7     0.9   70     50       0.2     0.7     0.9     0.2     0.7

Endowments

    0.1     1.2     1.3   100     58       0.1     1.1     1.2     0.1     0.8
                                                           

Total

  $ 17.4   $ 27.5   $ 44.9   85 %   77 %   $ 13.0   $ 22.4   $ 35.4   $ 9.5   $ 21.6
                                                           

Corporate

The corporate portfolio exposure increased to $23.9 billion at December 31, 2006, from $23.0 billion at year-ended 2004. Approximately 75% of the portfolio is investment grade based on the Company’s rating system and 13% of the portfolio matures within one year.

 

(In billions)

Lending Division

  12/31/06         12/31/05   12/31/04
  Loans   Unfunded
Commitments
  Total
Exposures
  % Inv
Grade
    % due
<1 Yr
    Loans   Unfunded
Commitments
  Total
Exposures
  Loans   Unfunded
Commitments

Media

  $ 1.2   $ 2.0   $ 3.2   61 %   6 %   $ 1.0   $ 2.1   $ 3.1   $ 0.9   $ 2.2

Cable

    0.2     0.4     0.6   53     —         0.4     0.5     0.9     0.6     0.4

Telecom

    —       0.3     0.3   90     —         0.1     0.4     0.5     0.1     0.5
                                                   

Subtotal

    1.4     2.7     4.1   63     4       1.5     3.0     4.5     1.6     3.1

Energy

    0.6     5.0     5.6   83     10       0.4     4.9     5.3     0.4     4.4

Retailing

    0.1     2.3     2.4   81     19       0.1     2.1     2.2     0.1     2.1

Automotive(1)

    0.1     1.0     1.1   57     36       0.1     1.2     1.3     0.1     1.7

Healthcare

    0.5     1.8     2.3   79     10       0.3     1.7     2.0     0.3     1.5

Other(2)

    1.4     7.0     8.4   75     15       1.3     6.7     8.0     1.1     6.6
                                                           

Total

  $ 4.1   $ 19.8   $ 23.9   75 %   13 %   $ 3.7   $ 19.6   $ 23.3   $ 3.6   $ 19.4
                                                           

(1) In 2005, the Company reduced its automotive exposure, eliminated the Automotive division, and transferred the remaining customers to the other geographic lending divisions. The amounts in the table were reconstructed for comparison to prior years.
(2) Diversified portfolio of industries and geographies

Automotive Industry Exposures

The Company continues to seek to selectively reduce automotive exposures given ongoing weakness in the domestic automotive industry. Total exposure was $1.1 billion at December 31, 2006, down $180 million from December 31, 2005. At December 31, 2006, this broadly defined industry portfolio consisted of exposures of $180 million to Big Three automotive manufacturing companies, $166 million to finance subsidiaries, $378 million to highly rated asset-backed securitizations vehicles, $256 million to suppliers, and $141 million of other.

Consumer

The Company’s consumer loan exposure is primarily comprised of loans to private bank clients, employee loans, and purchased mortgage loans. The Company has been purchasing mortgage loans as an alternative to investing in mortgage-backed securities.

 

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Lease Financings

The Company utilizes the leasing portfolio as part of its tax cash flow management strategy. This portfolio generates attractive after-tax risk-adjusted returns. Counterparties in the leasing transactions are generally highly rated. The leasing portfolio consisted of non-airline exposures of $5.3 billion and $293 million of airline exposures at December 31, 2006.

The non-airline portion of the leasing portfolio consists of exposures backed by well-diversified assets, primarily large-ticket transportation equipment. The largest component is rail, consisting of both passenger and freight trains. Assets are both domestic and foreign-based, with primary concentrations in the United States and European countries. Excluding airline leasing, counterparty rating equivalents at December 31, 2006, are as follows: 43% of the counterparties are AA or better, 33% are single A, 17% are BBB, and only 7% are non-investment grade.

The Company’s exposure to the airline industry at December 31, 2006, consisted of a $293 million leasing portfolio, including a $17 million real estate lease exposure. Compared to 2005, the leasing portfolio was down by $44 million. In 2006, the airline leasing portfolio consisted of exposures of $90 million to major U.S. carriers, $140 million to foreign airlines, and $63 million to U.S. regionals. In 2006, the airline industry continued to face difficult operating conditions driven by persistently high fuel prices and the limited ability to implement meaningful fare increases. The industry’s excess capacity and higher oil prices continued to have a dampening effect on aircraft values in the secondary market. Because of these factors, the Company continues to maintain a sizable allowance for loan losses against these exposures and to closely monitor the portfolio. In 2006, the Company sold $38 million of leasing exposure to a domestic airline, resulting in a charge-off of $23 million. In 2005, the Company charged off $140 million of a $153 million exposure to two bankrupt domestic airlines.

Commercial Real Estate

The Company’s commercial real estate loan portfolio was approximately $2.8 billion of exposure at December 31, 2006. Over 60% of the portfolio is secured by mortgages on properties predominantly located in the Tri-State region. The secured portfolio is diverse by project type with approximately 47% secured by residential buildings, approximately 29% secured by office buildings, 6% secured by retail properties, and 18% by other categories. Approximately 85% of the unsecured portfolio is allocated to investment grade real estate investment trusts (REITs) under revolving credit agreements.

The Company avoids speculative development loans and concentrates its activities largely within the New York Metropolitan area. Real estate credit facilities are focused on experienced owners and are structured with moderate leverage based on existing cash flows.

International Loans

The Company is active in the international markets, particularly in areas associated with securities servicing and trade finance. Excluding lease financings, these activities result in outstanding international loans of $6.6 billion and $5.5 billion at December 31, 2006 and 2005, respectively.

At December 31, 2006, the Company’s emerging markets exposures consisted of $298 million in medium-term loans, $2,742 million in short-term loans, primarily trade related, and a $241 million investment in Wing Hang. In addition, the Company has $117 million of Philippine bonds whose principal payments are collateralized by U.S. Treasury zero coupon obligations and whose interest payments are partially collateralized. Emerging market countries where the Company has exposure include Argentina, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Czech Republic, Dominican Republic, Egypt, Honduras, Hungary, India, Indonesia, Israel, Jamaica, Jordan, Korea, Malaysia, Mexico, Morocco, Mozambique, Panama, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey, Uruguay, Venezuela, Vietnam, and Yemen.

Further details of the Company’s outstanding international loans are included under “Loans”.

 

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Counterparty Risk Ratings Profile

The table below summarizes the risk ratings of the Company’s foreign exchange and interest rate derivative counterparty credit exposure for the past year.

 

     For the Quarter Ended  

Rating(1)

   12/31/06     9/30/06     6/30/06     3/31/06     12/31/05  

AAA to AA-

   76 %   77 %   77 %   77 %   74 %

A+ to A-

   12     10     10     8     13  

BBB+ to BBB-

   6     7     6     9     9  

Noninvestment Grade

   6     6     7     6     4  
                              

Total

   100 %   100 %   100 %   100 %   100 %
                              

(1) Represents credit rating agency equivalent of internal credit ratings.

For derivative counterparty credit exposure, see “Commitments and Contingent Liabilities” in the Notes to the Consolidated Financial Statements.

Nonperforming Assets

Nonperforming assets decreased by $1 million to $38 million at December 31, 2006. The low-level of nonperforming assets at year-end 2006 and 2005 is primarily attributable to actions the Company has taken to reduce risk in the loan portfolio as well as continued strength in the economy. See “Loans” in the Notes to the Consolidated Financial Statements.

Activity in Nonperforming Assets

 

     Year Ended December 31,  

(In millions)

       2006             2005      

Balance at Beginning of Year

   $ 39     $ 151  

Additions

     41       29  

Charge-offs

     (2 )     (4 )

Paydowns/Sales

     (37 )     (137 )

Other

     (3 )     —    
                

Balance at End of Year

   $ 38     $ 39  
                

The following table shows the distribution of nonperforming assets at the end of each of the last five years:

 

(Dollars in millions)

   2006     2005     2004     2003     2002  

Category of Loans:

          

Domestic:

          

Commercial

   $ 28     $ 12     $ 121     $ 207     $ 306  

Other

     —         1       1       9       17  

Foreign

     9       13       28       80       84  
                                        

Total Nonperforming Loans

     37       26       150       296       407  

Other Assets Owned

     1       13       1       —         1  
                                        

Total Nonperforming Assets

   $ 38     $ 39     $ 151     $ 296     $ 408  
                                        

Nonperforming Asset Ratio

     0.1 %     0.1 %     0.7 %     1.3 %     1.7 %

Allowance for Loan Losses/Nonperforming Loans

     775.7       1,253.8       327.3       188.5       130.2  

Allowance for Loan Losses/Nonperforming Assets

     755.3       835.9       325.2       188.5       129.9  

Total Allowance for Credit Losses/Nonperforming Loans

     1,181.1       1,807.7       418.0       230.7       170.0  

Total Allowance for Credit Losses/Nonperforming Assets

     1,150.0       1,205.1       415.2       230.7       169.6  

 

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Significant nonperforming assets at December 31, 2006 include $19 million to a global supplier of mobile electronics and transportation systems, $6 million to an automotive supplier, $6 million of international exposures and $3 million of emerging markets exposure.

The following table shows loans past due 90 days or more and still accruing interest for the last five years:

 

(In millions)

   2006    2005    2004    2003    2002

Domestic:

              

Consumer

   $ 9    $ 2    $ 7    $ 9    $ 9

Commercial

     7      7      1      2      8
                                  
     16      9      8      11      17

Foreign:

              

Banks

     —        —        —        —        5
                                  
   $ 16    $ 9    $ 8    $ 11    $ 22
                                  

 

40


Table of Contents

Activity in Allowance for Credit Losses

The following table details changes in the Company’s allowance for credit losses for the last five years.

 

(Dollars in millions)

   2006     2005     2004     2003     2002  

Loans Outstanding, December 31,

   $ 37,793     $ 32,927     $ 28,375     $ 28,414     $ 24,743  

Average Loans Outstanding

     33,612       32,069       30,627       28,678       27,588  

Allowance for Credit Losses

          

Balance, January 1,

          

Domestic

   $ 363     $ 481     $ 500     $ 514     $ 359  

Foreign

     11       27       70       79       43  

Unallocated

     96       119       113       99       65  
                                        

Total, January 1,

     470       627       683       692       467  
                                        

Charge-Offs:

          

Commercial

     (27 )     (144 )     (24 )     (118 )     (396 )

Foreign

     (2 )     (10 )     (28 )     (26 )     (23 )

Other

     —         —         (5 )     (7 )     —    
                                        

Total Charge-offs

     (29 )     (154 )     (57 )     (151 )     (419 )

Recoveries:

          

Commercial

     7       1       2       9       8  

Foreign

     7       3       3       1       2  

Other

     2       —         —         —         —    
                                        

Total Recoveries

     16       4       5       10       10  
                                        

Net Charge-Offs

     (13 )     (150 )     (52 )     (141 )     (409 )
                                        

Provision

     (20 )     (7 )     (4 )     132       634  

Balance, December 31,

          

Domestic

     328       363       481       500       514  

Foreign

     7       11       27       70       79  

Unallocated

     102       96       119       113       99  
                                        

Total, December 31,

   $ 437     $ 470     $ 627     $ 683     $ 692  
                                        

Allowance for Loan Losses

   $ 287     $ 326     $ 491     $ 558     $ 530  

Allowance for Lending-Related Commitments

     150       144       136       125       162  

Ratios

          

Net Charge-Offs to Average Loans Outstanding

     0.04 %     0.47 %     0.17 %     0.49 %     1.48 %

Net Charge-Offs to Total Allowance for Credit Losses

     2.97       31.91       8.29       20.64       59.10  

Total Allowance for Credit Losses to
Year-End Loans Outstanding

     1.16       1.43       2.21