Fitch Affirms U.S. Trust and Processing Bank Ratings Following Industry Peer Review

CHICAGO--()--Fitch Ratings has affirmed the ratings of the U.S. Trust and Processing Banks (referred to as Trust Banks) following a peer review committee. The four Fitch rated banks included in this peer review are Bank of New York Mellon Corporation (BK, rated 'AA-/F1+'), State Street Corporation (STT, rated 'A+/F1+'), Northern Trust Corporation (NTRS, rated 'AA-/F1+'), and Brown Brothers Harriman (BBH, rated 'A+/F1'). The Rating Outlook for BK, NTRS, and BBH is Stable and the Rating Outlook for STT has been revised to Positive from Stable. A complete list of ratings is included at the end of this rating action commentary.

RATING ACTION AND RATIONALE

Today's rating affirmations are reflective of strong franchises in asset custody and asset management, barriers to entry in the business model due to scale, sound capital levels, strong funding and liquidity positions, and good asset quality metrics. These strengths are counterbalanced by an elevated level of operational risk inherent in the business model and earnings performance that while satisfactory remains below historical levels given still uncertain markets and the protracted low interest rate environment.

The Trust Bank business model is characterized by significant economies of scale and sticky relationships that have created barriers to entry in the business which helps support the Trust Banks' relatively high ratings. Combined, these four institutions provide custody and administration services for nearly $60 trillion in assets globally and asset management services for over $4 trillion in assets. These operations are supported by strong capital ratios that are comparatively higher than more traditional banks, relatively low-risk balance sheets, and ample liquidity that is inherent in the large trust bank business model.

While the industry, on average, has had reasonably good fee growth from the core asset servicing and asset management businesses, its more market-based revenues in areas such as net interest income (NII), foreign exchange trading, and securities lending activities have been more challenging. In particular, NII, one of the largest sources of revenue has felt the impact of net interest margin compression amid declining interest rates, and Fitch expects this to continue over at least an intermediate-term time horizon. As a result, the industry has been focused on expense management through the use of more technology as well as some headcount reductions.

Nevertheless Fitch has stressed revenue and expenses for each of the trust banks under several scenarios that include equity markets declining 40%, fixed income markets declining 5%, and interest rates remaining flat at today's currently low levels, and Fitch believes that each institutions annual earnings should remain around break-even absent any large charges or operational losses. Fitch notes that this adds some support to current ratings.

That said, Fitch does acknowledge that the main threat to the individual Trust Banks' business model and ratings could result from a technological or operational loss that is particular to an individual company that results in reputational damage that could cause clients to flee a particular firm. While Fitch believes these risks to be well-controlled and monitored, these types of risks are inherently difficult to predict and quantify, but a large occurrence at any one firm would likely prompt Fitch to review ratings to determine if a negative action was appropriate. An industrywide event that affects each firm equally may still impact ratings, but may allow each firm to better maintain its client base.

KEY RATING DRIVERS - IDRs, Viability Ratings (VRs), and Senior Debt:

Bank of New York Corporation

BK's rating affirmation is underpinned by the bank's strong franchise in global custody and asset servicing, solid risk-adjusted capital, and robust liquidity. These strengths are balanced by BK's earnings pressures, litigation issues, and operational risks inherent in the business.

BK has one of the strongest franchises in global custody and asset servicing, with over $26 trillion in assets under custody (AUC) making it the largest global custodian. Moreover, BK has shown demonstrated ability to generate new business. The bank has historically maintained solid risk-adjusted capital levels. Based on estimated Basel III implementation, BK would have a Tier 1 Common ratio (following recent charge) of 9.3%, which is comfortably above the minimum requirement, inclusive of the additional buffer. Fitch expects that BK will continue to hold capital comfortably above minimum requirements.

Fitch also regards BK's ample liquidity as a key rating consideration. The bank has generally benefitted from market distress as deposits increase.

As with most banks, BK faces earnings headwinds from the low rate environment coupled with volatility in financial markets. The low rate environment has depressed net interest income, while volatile financial markets affect AUM on a quarterly basis. Fitch expects that BK will seek to mitigate these issues through greater focus on expense reductions throughout the organization.

State Street Corporation

The affirmation of STT's ratings is reflective of strong franchise in global asset servicing and investment management, low-risk balance sheet, ample liquidity, and strong capital position. Offsetting these positives are continued earnings pressure, some regulatory uncertainty, and operational risk inherent to STT's business.

STT's VR of 'a+' is supported by a low-risk balance sheet and strong capital position. STT's investment portfolio quality is good with issues rated 'AAA' or 'AA' comprising approximately 89% of total holdings as of Dec. 31, 2012. Similarly, STT's loan credit quality is sound. Fitch further notes that the balance sheet also sports ample liquidity, as STT's core businesses provide stable sources of funding. Fitch notes that these stable funding sources as well as the highly liquid nature of STT's assets compared to similarly rated entities also support the company's short-term rating of 'F1+'.

Fitch notes that STT's capital levels continue to be above the company's historical range with the company's Tier 1 common ratio under Basel 1 rules at a solid 17.1% as of Dec. 31, 2012. STT estimates that under current Basel 3 proposals, STT's Tier 1 common ratio would have been 10.8%, which is well above STT's regulatory minimums and any likely buffer that will be applied to institutions such as STT that are deemed to be systemically important financial institutions.

While the factors noted above support STT's strong credit profile, the company's earnings growth continues to be challenging, which Fitch notes serves as a constraint to ratings. Volatile markets and the low interest rate environment continue to be strong headwinds for meaningful revenue growth.

STT's fee revenue has been essentially flat as strength in asset servicing and management has been offset by weakness in foreign exchange trading and securities lending. Additionally, the low interest rate environment continues to pressure the company's net interest margin (NIM), which as of Dec. 31, 2012, declined to 1.36%. Fitch expects continued NIM compression over a near-to-intermediate term time horizon.

To help support the company's earnings amid the challenging environment noted above, management has engaged in a business transformation program which includes some explicit cost savings, process improvements, and significant information technology (IT) enhancements and initiatives.

Northern Trust Corporation

A long history of conservative management, strong capital ratios, and a low-risk balance sheet support NTRS's high credit ratings and Stable Rating Outlook. Moreover, the ratings incorporate NTRS's solid franchise in personal trust, private banking, institutional custody, and asset management. Fitch notes that the company's conservative operating philosophy has allowed NTRS to remain profitable throughout the credit crisis.

Fitch notes that NTRS's capital ratios compare reasonably well with other custodial banks as well as U.S. commercial banks. Though NTRS's Tier 1 capital ratio is modestly below the median ratio of similar institutions, Fitch believes the company's low-risk balance sheet compensates for this. At the end of 2012, NTRS's Tier 1 ratio was 12.8%, essentially flat from the year-ago period. Under current Basel III proposals, NTRS's estimated Tier 1 ratio was 13.1% as of year-end 2012, which Fitch notes compares favorably with peer institutions.

NTRS's balance sheet is highly liquid with a consistently low loan-to-deposit ratio. Additionally, the balance sheet sports $18.8 billion of interest bearing deposits with banks and an additional $7.6bn on deposit with the central bank. Credit quality of the loan portfolio is good and losses are very manageable which is in part reflective of NTRS's affluent client base, in Fitch's opinion.

The $31.5 billion investment portfolio at YE2012, representing nearly 34% of assets, is also highly liquid with the majority of investment securities re-pricing or maturing within one year. Moreover, Fitch views credit risk in the investment portfolio as low given that the majority of the portfolio is invested in highly rated agency securities or agency collateralized mortgage obligations.

Fitch views funding as solid, given that NTRS is primarily deposit funded with total deposits amounting to $81.4 billion at year-end 2012..

Fitch expects NTRS's earnings growth to remain challenging. The low interest rate environment is continuing to pressure the NIM, which dropped to 1.17% at Q412 and is also causing the company to continue to incur money market mutual fund fee waivers. Similar to others in the industry, NTRS has had weakness in market-based revenue such as foreign exchange trading income and securities lending income. Fitch believes there is also likely some increased pricing competition in the company's institutional asset management and custody businesses.

To try and shelter earnings, NTRS has optimized its fee structure in its personal trust and private banking business, and also engaged in some efficiency initiatives. Fitch views this strategy positively, and though Fitch believes that overall earnings growth may still be challenging, there should be some modest benefits from these initiatives.

Brown Brothers Harriman

BBH's ratings are underpinned by its long history of conservative management, consistent operating track record, low-risk balance sheet, and solid capital and liquidity position. Ratings also reflect BBH's solid franchise in global custody, focusing on financial institutions and asset managers as custody clients.

Fitch believes that BBH's partnership structure is the linchpin of its conservative risk culture, which has allowed BBH to remain profitable throughout the credit crisis. Each partner is jointly and severally liable for the firm's obligations, which motivates partners to take actions that preserve the long-term value of the firm.

The balance sheet is highly liquid, with cash/investment securities comprising 49.7% of total assets at Dec. 31, 2012. BBH does not use any financial leverage, which provides it with significant financial flexibility. The firm depends on client deposits (a majority of which are non-interest bearing) for all its funding needs, which accounted for 87.6% of total liabilities.

Access to additional liquidity is provided by off-balance-sheet sweep deposits totaling $29.7 billion at Dec. 31, 2012. Capital base is strong, with a Tier 1 capital ratio of 17.4% and tangible equity capital ratio of 10.9% at Dec. 31, 2012, which compares favorably to larger custody banks.

Credit quality of BBH's commercial loan portfolio has been solid throughout this crisis. Non-performing loans (NPLs) measured 0.14% of net loans outstanding at Dec. 31, 2012. Reserves as a percentage of net loans measured 0.39%, offering solid coverage of 2.71x 2012 NPLs.

Operating performance in 2012 slight improved from 2011. Still, consistent with other trust banks, BBH is facing increased headwinds from the continued low interest rate environment which is affecting NIM, weaker foreign exchange trading income from lower trading volume, and increased pricing pressure in the institutional custody business. To combat these headwinds, BBH has heightened focus on expense discipline. The firm is also focused on growing revenues from its investment management and wealth management businesses, which currently lack scale compared to some of its peers.

Assets under custody (AUC) declined to $3.3 trillion in 2012 from $2.8 trillion in 2011 buoyed by favorable equity markets in 2H'12. Total AUM increased to $52.9 billion in 2012, from $45.3 billion in 2011, as management has increased its focus on generating scale through organic growth initiatives. Pretax margins continue to compare favorably to larger trust banks.

Fitch expects net interest revenues and asset servicing fees will continue to be affected by the low interest rates and competitive pressures, but believes that adding scale to the investment/wealth management business and expense reduction efforts will hold BBH's pre-tax margins steady in 2013.

RATING SENSITIVITIES - IDRs, VRs, and Senior Debt:

Bank of New York Corporation

BK's Rating Outlook is Stable given the strength of the business model.

Risks to BK's ratings include litigation risks, most notably related to foreign exchanges fees. BK did announce an $850 million charge to 1Q'13 earnings based on tax issue (STARS). Fitch does not regard this as a rating issue, given the company's capital levels and no spillover effect on client activity.

As a global trust and processing bank, Fitch considers operational risk is a key rating issue for BK. The bank measures and monitors operational losses, and benchmarks itself to industry standards. Nonetheless, BK could still be exposed to large operational losses if not properly managed.

State Street Corporation

Fitch has revised the Rating Outlook to Positive, as Fitch notes that STT's IT investments have improved the company's risk management functions from the perspective of data collection and security as well as analyzing and assessing enterprise-wide risks. Fitch believes there is, over time, the potential for upside to STT's ratings, which would likely be predicated on further establishing a track record of favorable risk management.

Fitch does believe that STT's risk management processes, procedures, and infrastructure have been significantly enhanced in the wake of its past risk management issues during the financial crisis. However, given their relatively new implementation, some are still untested in various market environments.

Fitch views the biggest downside risks to STT's business and ratings could result from a technological or operational loss particular to STT, resulting in reputational damage that causes clients to flee the firm. Other risks to STT's business and ratings include litigation risks, the potential for significant losses in foreign exchange trading, or potential contagion impacts from European market and economic issues.

Northern Trust Corporation

NTRS' Rating Outlook is Stable owing to the strength of the business model and conservative operating culture.

Risks to NTRS's ratings include any large and unexpected loan or securities losses. The larger risk to NTRS's business and ratings is the potential for operational errors that produce a combination of either financial losses or cause clients to leave the firm.

While operational risks are inherently difficult to predict and quantify, a large occurrence would likely prompt Fitch to review ratings to determine if a negative action was appropriate. Fitch would note, however, that the level of NTRS's operational losses has historically been very moderate, and that the most significant recent losses represent support provided to clients during the 2008-2009 market collapse.

Brown Brothers Harriman

BBH's Stable Rating Outlook reflects Fitch's expectation for consistent operating performance, continued conservative risk management practices, and maintenance of solid capital and liquidity positions.

BBH ratings are constrained by its relatively lesser scale and revenue diversity compared to some of the larger custody banks. Ratings could be lowered if BBH were to incur higher than expected losses in the underlying loans and investment portfolio, and/or if material losses from operational errors or litigation were to occur.

While BBH's 'Statement of Condition' is audited by a CPA firm, due to its partnership status the company is not required to obtain audited income statements. Fitch notes this as a limiting factor in its financial analysis. However, BBH supplies Fitch with a substantial level of non-public information on earnings, and Fitch has factored this information into its ratings.

KEY RATING DRIVERS - Support Ratings and Support Floor Ratings:

The Trust Banks' Long-term IDR is equalized with their VR's, which for STT and BK remains above their Support Rating Floor of 'A' and Support Rating '1'. Support Rating Floors factor in government support in the event of need for BK and STT and other U.S. G-SIFIs. Both NTRS and BBH are not considered G-SIFIs and as such have Support Ratings of '5'.

RATING SENSITIVITIES - Support Ratings and Support Floor Ratings:

While Fitch believes the broad policy goal is to no longer provide full support to systemically important banks, this is progressing at an uneven pace globally. Fitch could reassess its support ratings for U.S. G-SIFIs if global market conditions normalize and resolution regimes become more harmonized across international jurisdictions. At BK and STT's current VR, the firm's Long-term IDR would not be affected by a change in support rating floor.

KEY RATING DRIVERS - Subordinated Debt and Other Hybrid Securities:

Subordinated debt and other hybrid capital issued by the trust banks and by various issuing vehicles are all notched down from the holding company or its bank subsidiaries' VRs in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles. The Trust Banks's subordinated debt has been affirmed due to the affirmation of the Trust Bank's VRs.

RATING SENSITIVITIES - Subordinated Debt and Other Hybrid Securities:

Ratings are primarily sensitive to any change in the VRs, where the notching would be realigned in conjunction with any change in the VR.

KEY RATING DRIVERS - Subsidiary and Affiliated Company Rating:

The IDRs and VRs of the trust banks' bank subsidiaries are core to each company's business and therefore IDRs and VRs are equalized across the group.

RATING SENSITIVITIES - Subsidiary and Affiliated Company Rating:

Ratings are primarily sensitive to any change in the VRs of the associated bank subsidiaries

The rating actions are as follows:

Fitch has affirmed the following ratings:

Bank of New York Mellon Corporation (The)

--Long-term IDR at 'AA-'; Outlook Stable;

--Long-term senior at 'AA-';

--Long-term subordinated at 'A+';

--Short-term IDR at 'F1+';

--Commercial Paper at `F1+';

--Viability Rating at 'aa-';

--Support Rating at '1';

--Support Rating Floor at 'A'.

The Bank of New York Mellon reg

--Long-term deposits at 'AA';

--Long-term IDR at 'AA-'; Outlook Stable;

--Long-term senior at 'AA-';

--Short-term deposits at 'F1+';

--Short-term IDR at 'F1+';

--Viability Rating at 'aa-';

--Support Rating at `1';

--Support Rating Floor at `A'.

BNY Mellon National Association

--Long-term IDR at 'AA-'; Outlook Stable;

--Long-term deposits at 'AA';

--Long-term subordinated debt at 'A+';

--Short-term IDR at 'F1+';

--Short-term deposits at 'F1+';

--Viability Rating at 'aa-';

--Support Rating at `1';

--Support Rating Floor at `A'.

BNY Mellon Trust Delaware

--Long-term deposits at 'AA';

--Long-term IDR at 'AA-'; Outlook Stable;

--Short-term deposits at 'F1+';

--Short-term IDR at 'F1+';

--Viability Rating at 'aa-';

--Support Rating at `1';

--Support Rating Floor at `A';.

The Bank of New York Mellon Trust Company, National Association

--Long-term deposits at 'AA';

--Long-term IDR at 'AA-'; Outlook Stable;

--Short-term deposits at 'F1+';

--Short-term IDR at 'F1+';

--Viability Rating at 'aa-';

--Support Rating at `1';

--Support Rating Floor at `A'.

Mellon Funding Corporation

--Long-term IDR at 'AA-'; Outlook Stable

--Long-term senior at 'AA-';

--Long-term subordinated debt at 'A+';

--Short-term IDR at 'F1+';

--Short-term debt at 'F1+';

--Support Rating at '5';

--Support Rating Floor at 'NF.

The Bank of New York Mellon (International) Ltd

--Long-term IDR at 'AA-'; Outlook Stable;

--Short-term IDR at 'F1+';

--Support at '1.

The Bank of New York (Luxembourg) S.A.

The Bank of New York (Luxembourg) S.A. - Italian Branch

--Long-term IDR at 'AA-'; Outlook Stable.

--Short-term IDR at 'F1+';

--Support at '1';

--Rating Outlook Stable.

The Bank of New York Mellon S.A./N.V.

--Long-term IDR at 'AA-'; Outlook Stable

--Short-term IDR at 'F1+';

--Support at '1';

--Rating Outlook Stable.

BNY Institutional Capital Trust A;

Mellon Capital III

--Trust Preferred Securities at `BBB+'.

Mellon Capital IV

--Trust Preferred Securities at 'BBB'

The following ratings have been withdrawn, as the entity has been merged into The Bank of New York Mellon S.A./N.V.

The Bank of New York Mellon (Ireland) Limited

--Long-term deposits at 'AA-'; Outlook Stable;

--Long-term IDR at 'AA-';

--Short-term deposits at 'F1+';

--Short-term IDR at 'F1+';

--Support Rating at '1'.

The following ratings have been assigned:

The Bank of New York Mellon S.A./N.V.

--Long-term Deposits AA-

--Short-term Deposits F1+

Fitch has affirmed the following ratings:

State Street Corporation

--Long-term IDR at `A+'; Outlook Positive;

--Short-term IDR at 'F1+';

--Viability rating at `a+';

--Support at `1';

--Support Rating Floor at `A';

--Commercial paper at 'F1+';

--Junior subordinated debt at `BBB';

--Preferred stock at 'BBB-'

--Long-term senior debt at `A+'.

State Street Bank and Trust Company

--Long-term IDR at `A+'; Outlook Positive;

--Senior Debt at 'A+';

--Short-term IDR at 'F1+';

--Viability rating at `a+';

--Support at `1';

--Support Rating Floor at `A';

--Long-term deposits at `AA-';

--Short-term deposits at 'F1+';

--Long-term subordinated at `A'

State Street Capital I

State Street Capital IV

--Trust Preferred Securities at `BBB'.

Fitch has affirmed the following ratings:

Northern Trust Corporation

--Long-term IDR at 'AA-'; Outlook Stable;

--Long-Term Senior Unsecured at 'AA-';

--Short-term IDR at 'F1+';

--Short-term commercial paper at 'F1+';

--Viability at 'aa-';

--Support at '5';

--Support floor at 'NF'.

Northern Trust Company (The)

--Long-term IDR at 'AA-'; Outlook Stable;

--Short-term IDR at 'F1+';

--Short-term deposits at 'F1+';

--Long-term deposits at 'AA';

--Subordinated notes at 'A+'

--Viability at 'aa-';

--Support at '5';

--Support floor at 'NF'.

NTC Capital I and II

--Preferred stock at 'BBB+'.

Fitch has affirmed the following ratings:

Brown Brothers Harriman & Co.

--Long-term IDR at 'A+'; Outlook Stable

--Short-term IDR at 'F1';

--Viability Rating at 'a+';

--Support at '5';

--Support Floor at 'NF'.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the source(s) of information identified in Fitch's Master Criteria, these actions were additionally informed by information provided by the companies.

Applicable Criteria and Related Research:

--'Risk Radar' (Jan. 16, 2013);

--'U.S. Banks: Rationalizing the Branch Network (Witness the Incredible Shrinking Branch Network)' (Sept. 17, 2012);

--'U.S. Banks: Mortgage Representations and Warranties (Banks Increase Reserves; Uncertainty Remains)' (Aug. 20, 2012)

--'Global Financial Institutions Rating Criteria' (Aug. 15, 2012);

--'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012);

--'Treatment of Unrealized Losses in U.S. Bank Capital Rule Proposal (Pro-Cyclical Capital Policy to Create Greater Capital Volatility for Banks)' (Aug. 7, 2012);

--'Basel III: Return and Deleveraging Pressures' (May 17, 2012);

--'Assessing and Rating Bank Subordinated and Hybrid Securities' (Dec. 05, 2012).

Applicable Criteria and Related Research

Assessing and Rating Bank Subordinated and Hybrid Securities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695542

Basel III: Return and Deleveraging Pressures

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=678273

Treatment of Unrealized Losses in U.S. Bank Capital Rule Proposal (Pro-Cyclical Capital Policy to Create Greater Capital Volatility for Banks)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685638

Rating FI Subsidiaries and Holding Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686181

U.S. Banks: Mortgage Representations and Warranties (Banks Increase Reserves; Uncertainty Remains)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684038

U.S. Banks: Rationalizing the Branch Network (Witness the Incredible Shrinking Branch Network)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688330

Risk Radar Update

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=699014

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Contacts

Fitch Ratings
Primary Analyst
Justin Fuller, CFA (Primary Analyst for STT & NTRS), +1-312-268-2057
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60606
or
Christopher Wolfe (Primary Analyst for BK), +1-212-908-0771
Managing Director
or
Mohak Rao, CFA (Primary Analyst for BBH), +1-212-908-0559
Senior Director
or
Committee Chairperson
Joo-Yung Lee, +1-212-908-0560
Managing Director
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
Email: brian.bertsch@fitchratings.com