UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended May 31, 2004
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ___________
Commission file number 1-8989
------
The Bear Stearns Companies Inc.
(Exact name of registrant as specified in its charter)
Delaware 13-3286161
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
383 Madison Avenue, New York, New York 10179
(Address of Principal Executive Offices) (Zip Code)
(212) 272-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of July 12, 2004, the latest practicable date, there were 103,068,727
shares of Common Stock, $1 par value, outstanding.
TABLE OF CONTENTS
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Page
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Available Information 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income (Unaudited)
for the three months and six months ended May 31, 2004 and
May 31, 2003 4
Condensed Consolidated Statements of Financial Condition
as of May 31, 2004 (Unaudited) and November 30, 2003 (Audited) 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the six months ended May 31, 2004 and May 31, 2003 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
Report of Independent Registered Public Accounting Firm 26
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 27
Item 3. Quantitative and Qualitative Disclosures about Market Risk 50
Item 4. Controls and Procedures 55
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 56
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of
Equity Securities 57
Item 4. Submission of Matters to a Vote of Security Holders 58
Item 5. Other Information 59
Item 6. Exhibits and Reports on Form 8-K 60
Signature 62
2
AVAILABLE INFORMATION
The Bear Stearns Companies Inc. and its subsidiaries ("Company") files current,
annual and quarterly reports, proxy statements and other information required by
the Securities Exchange Act of 1934, as amended, with the Securities and
Exchange Commission ("SEC"). You may read and copy any document the Company
files at the SEC's public reference room located at 450 Fifth Street, N.W.,
Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference room. The Company's SEC filings are also
available to the public from the SEC's internet site at http://www.sec.gov.
Copies of these reports, proxy statements and other information can also be
inspected at the offices of the New York Stock Exchange, Inc., 20 Broad Street,
New York, New York 10005, U.S.A.
The Company's public internet site is http://www.bearstearns.com. The Company
makes available free of charge through its internet site, via a link to the
SEC's internet site at http://www.sec.gov, its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements
and Forms 3, 4 and 5 filed on behalf of directors and executive officers and any
amendments to those reports filed or furnished pursuant to the Securities
Exchange Act of 1934, as amended, as soon as reasonably practicable after it
electronically files such material with, or furnishes it to, the SEC.
In addition, the Company currently makes available on http://www.bearstearns.com
its most recent annual report on Form 10-K, its quarterly reports on Form 10-Q
for the current fiscal year and its most recent proxy statement, although in
some cases these documents are not available on that site as soon as they are
available on the SEC's internet site. Also posted on the Company's website, and
available in print upon request of any stockholder to the Investor Relations
Department, are charters for the Company's Audit Committee, Compensation
Committee, Corporate Governance Committee, Nominating Committee and Qualified
Legal Compliance Committee. Copies of the Corporate Governance Guidelines and
the Code of Business Conduct and Ethics (the "Code") governing our directors,
officers and employees are also posted on the Company's website within the
"Corporate Governance" section under the heading "About Bear Stearns." You will
need to have on your computer the Adobe Acrobat Reader software to view these
documents, which are in the .PDF format.
3
Part I - Financial Information
Item 1. Financial Statements
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Income
(Unaudited)
------------------------------------------------------------------
Three Months Ended Six Months Ended
------------------------------------------------------------------
May 31, May 31, May 31, May 31,
(in thousands, except share and per share data) 2004 2003 2004 2003
==========================================================================================================================
REVENUES
Commissions $ 307,150 $ 267,682 $ 615,253 $ 509,597
Principal transactions 915,469 809,915 1,862,331 1,778,379
Investment banking 261,564 212,550 521,974 380,133
Interest and dividends 498,469 522,565 1,018,933 956,724
Other income 81,146 37,500 126,752 63,294
------------------------------------------------------------------
Total revenues 2,063,798 1,850,212 4,145,243 3,688,127
Interest expense 340,260 387,492 695,782 709,973
------------------------------------------------------------------
Revenues, net of interest expense 1,723,538 1,462,720 3,449,461 2,978,154
------------------------------------------------------------------
NON-INTEREST EXPENSES
Employee compensation and benefits 860,053 692,181 1,709,201 1,450,070
Floor brokerage, exchange and clearance fees 59,647 47,540 116,547 92,220
Communications and technology 88,321 90,744 182,149 183,484
Occupancy 34,768 33,088 68,383 68,031
Advertising and market development 29,315 27,507 55,216 52,717
Professional fees 42,370 28,995 84,170 57,448
Other expenses 97,588 114,535 191,341 220,855
------------------------------------------------------------------
Total non-interest expenses 1,212,062 1,034,590 2,407,007 2,124,825
------------------------------------------------------------------
Income before provision for income taxes 511,476 428,130 1,042,454 853,329
Provision for income taxes 163,673 147,719 333,586 298,665
------------------------------------------------------------------
Net income $ 347,803 $ 280,411 $ 708,868 $ 554,664
==================================================================
Net income applicable to common shares $ 340,609 $ 272,616 $ 694,255 $ 538,878
==================================================================
Basic earnings per share $ 2.77 $ 2.27 $ 5.65 $ 4.48
Diluted earnings per share $ 2.49 $ 2.05 $ 5.07 $ 4.05
==================================================================
Weighted average common shares outstanding:
Basic 129,071,295 128,711,363 129,029,761 129,240,413
Diluted 146,921,897 146,062,838 146,945,015 146,608,993
==================================================================
Cash dividends declared per common share $ 0.20 $ 0.17 $ 0.40 $ 0.34
==================================================================
See Notes to Condensed Consolidated Financial Statements.
4
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Financial Condition
(Unaudited)
May 31, November 30,
(in thousands, except share data) 2004 2003
===========================================================================================================================
ASSETS
Cash and cash equivalents $ 1,960,342 $ 3,837,570
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations 12,018,874 8,657,065
Securities purchased under agreements to resell 45,900,404 33,822,695
Securities received as collateral 7,443,895 5,496,832
Securities borrowed 70,099,534 73,317,962
Receivables:
Customers 23,333,556 19,646,879
Brokers, dealers and others 4,614,121 3,730,306
Interest and dividends 312,007 268,054
Financial instruments owned, at fair value
Pledged as collateral 31,383,523 32,349,781
Not pledged as collateral 39,231,019 26,882,877
Assets of variable interest entities 1,124,580 --
Property, equipment and leasehold improvements, net of accumulated depreciation
and amortization of $780,059 and $816,646 in 2004 and 2003, respectively 366,682 381,262
Other assets 3,806,236 3,776,827
------------------------------------
Total Assets $ 241,594,773 $ 212,168,110
====================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 11,951,756 $ 13,387,662
Securities sold under agreements to repurchase 54,487,569 47,464,156
Obligation to return securities received as collateral 7,443,895 5,496,832
Securities loaned 6,754,679 6,648,165
Payables:
Customers 78,835,358 68,666,893
Brokers, dealers and others 5,565,519 2,676,351
Interest and dividends 572,170 567,575
Financial instruments sold, but not yet purchased, at fair value 32,125,093 27,109,147
Liabilities of variable interest entities 1,124,580 --
Accrued employee compensation and benefits 1,307,722 1,376,215
Other liabilities and accrued expenses 1,453,019 1,312,061
------------------------------------
201,621,360 174,705,057
------------------------------------
Commitments and contingencies (Note 4)
Long-term borrowings 31,966,579 29,430,465
------------------------------------
Guaranteed Preferred Beneficial Interests in Company Subordinated Debt Securities -- 562,500
------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 489,373 538,415
Common stock, $1.00 par value; 500,000,000 shares authorized and
184,805,848 shares issued as of both May 31, 2004 and November 30, 2003 184,806 184,806
Paid-in capital 3,331,698 3,245,380
Retained earnings 5,603,087 4,954,508
Employee stock compensation plans 2,205,703 2,299,170
Unearned compensation (159,792) (188,952)
Treasury stock, at cost:
Common stock: 81,579,985 and 82,233,811 shares
as of May 31, 2004 and November 30, 2003,
respectively (3,648,041) (3,563,239)
------------------------------------
Total Stockholders' Equity 8,006,834 7,470,088
------------------------------------
Total Liabilities and Stockholders' Equity $ 241,594,773 $ 212,168,110
====================================
See Notes to Condensed Consolidated Financial Statements.
5
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Cash Flows
(Unaudited)
Six Months Ended
-----------------------------------
May 31, May 31,
(in thousands) 2004 2003
===================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 708,868 $ 554,664
Adjustments to reconcile net income to cash used in operating activities:
Noncash items included in net income:
Depreciation and amortization 65,675 71,754
Deferred income taxes (30,502) (13,142)
Employee stock compensation plans 20,854 29,559
Other 4,306 6,265
Changes in operating assets and liabilities:
Cash and securities deposited with clearing organizations or segregated
in compliance with federal regulations (3,361,809) 1,794,532
Securities purchased under agreements to resell (12,077,709) (6,823,455)
Securities borrowed 3,218,428 (1,951,362)
Receivables from customers (3,686,677) (4,636,094)
Receivables from brokers, dealers and others (883,815) (555,513)
Financial instruments owned (10,555,006) (9,999,293)
Other assets 23,128 102,055
Securities sold under agreements to repurchase 7,023,413 983,683
Securities loaned 106,514 2,331,678
Payables to customers 10,168,465 6,891,623
Payables to brokers, dealers and others 2,789,833 537,002
Financial instruments sold, but not yet purchased 5,015,946 4,863,120
Accrued employee compensation and benefits (67,500) (52,762)
Other liabilities and accrued expenses 194,625 46,981
----------------------------------
Cash used in operating activities (1,322,963) (5,818,705)
----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (51,095) (16,405)
Purchases of investment securities and other assets (184,228) (49,492)
Proceeds from sales of investment securities and other assets 142,513 35,303
----------------------------------
Cash used in investing activities (92,810) (30,594)
----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments for) proceeds from short-term borrowings (1,435,906) 2,944,326
Net proceeds from issuance of long-term borrowings 5,443,454 6,014,576
Proceeds from issuances of derivatives with a financing element, net 99,335 --
Redemption of preferred stock issued by a subsidiary (300,000) --
Issuance of common stock 135,793 56,463
Redemption of preferred stock (49,043) (27,660)
Payments for retirement of long-term borrowings (4,026,012) (4,649,758)
Treasury stock purchases - common stock (272,403) (244,945)
Cash dividends paid (56,673) (49,798)
----------------------------------
Cash (used in) provided by financing activities (461,455) 4,043,204
----------------------------------
Net decrease in cash and cash equivalents (1,877,228) (1,806,095)
Cash and cash equivalents, beginning of year 3,837,570 5,520,285
----------------------------------
Cash and cash equivalents, end of period $ 1,960,342 $ 3,714,190
==================================
See Notes to Condensed Consolidated Financial Statements.
6
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Bear Stearns Companies Inc. is a holding company that, through its
broker-dealer and international bank subsidiaries, principally Bear,
Stearns & Co. Inc. ("Bear Stearns"), Bear, Stearns Securities Corp.
("BSSC"), Bear, Stearns International Limited ("BSIL") and Bear Stearns
Bank plc ("BSB"), is primarily engaged in business as a securities
broker-dealer and operates in three principal segments: Capital Markets,
Global Clearing Services and Wealth Management. Capital Markets is
comprised of the institutional equities, fixed income and investment
banking areas. Global Clearing Services provides clearance related
services for prime brokerage clients and clearance on a fully-disclosed
basis for introducing broker dealers. Wealth Management is comprised of
the Private Client Services ("PCS") and asset management areas. See Note
8, "Segment Data," in the Notes to Condensed Consolidated Financial
Statements. The Company also conducts significant activities through other
wholly owned subsidiaries including: Bear Stearns Global Lending Limited,
Custodial Trust Company, Bear Stearns Financial Products Inc., Bear
Stearns Capital Markets Inc., EMC Mortgage Corporation, Bear Stearns
Commercial Mortgage Inc., Bear Stearns Credit Products Inc. and Bear
Stearns Forex Inc.
The condensed consolidated financial statements include the accounts of
The Bear Stearns Companies Inc. and its subsidiaries ("Company"). All
material intercompany transactions and balances have been eliminated in
consolidation. Certain prior period amounts have been reclassified to
conform to the current period's presentation. The Condensed Consolidated
Statement of Financial Condition as of May 31, 2004, the Condensed
Consolidated Statements of Income for the three and six months ended May
31, 2004 and May 31, 2003 and the Condensed Consolidated Statements of
Cash Flows for the six months ended May 31, 2004 and May 31, 2003 are
unaudited. The November 30, 2003 Condensed Consolidated Statement of
Financial Condition and related information was derived from the audited
financial statements.
The condensed consolidated financial statements are prepared in accordance
with the rules and regulations of the Securities and Exchange Commission
("SEC") with respect to the Form 10-Q and reflect all adjustments which in
the opinion of management are normal and recurring, which are necessary
for a fair statement of the results for the interim periods presented. In
accordance with such rules and regulations, certain disclosures that are
normally included in annual financial statements have been omitted. These
financial statements should be read in conjunction with the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 2003
filed by the Company under the Securities Exchange Act of 1934.
The condensed consolidated financial statements include the accounts of
the Company, its wholly owned subsidiaries and other entities in which the
Company has a controlling financial interest. The Company's policy is to
consolidate all entities in which it owns more than 50% of the outstanding
voting stock unless it does not control the entity. In accordance with
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN No. 46"), or FIN No.
46, as revised ("FIN No. 46 (R)") issued in December 2003, the Company
also consolidates any variable interest entities ("VIEs") for which it is
the primary beneficiary. The assets and related liabilities of such
variable interest entities have been shown in the Condensed Consolidated
Statement of Financial Condition in the captions "Assets of variable
interest entities" and "Liabilities of variable interest entities." See
Note 10, "Consolidation of Variable Interest Entities," in the Notes to
Condensed Consolidated Financial Statements.
The Company participates, through a majority-owned joint venture, in
specialist activities on the NYSE, AMEX and International Securities
Exchange. Due to the occurrence of a Control Event triggered in December
2003, the Company began consolidating this entity beginning in the first
quarter of fiscal 2004. Included in the Condensed Consolidated Statements
of Financial Condition at May 31, 2004 are total assets of $1.8 billion,
including approximately $360 million of goodwill and identifiable
intangible assets.
7
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The condensed consolidated financial statements are prepared in conformity
with accounting principles generally accepted in the United States of
America. These principles require management to make certain estimates and
assumptions, including those regarding inventory valuations, stock
compensation, certain accrued liabilities and the potential outcome of
litigation, which may affect the amounts reported in the condensed
consolidated financial statements and accompanying notes. Actual results
could differ materially from these estimates. The nature of the Company's
business is such that the results of any interim period may not be
indicative of the results to be expected for an entire fiscal year.
Financial Instruments
Proprietary securities, futures and other derivatives transactions are
recorded on a trade date basis. Financial instruments owned and financial
instruments sold, but not yet purchased, including contractual commitments
arising pursuant to futures, forward and option contracts, interest rate
swaps and other derivative contracts, are recorded at fair value with the
resulting net unrealized gains and losses reflected in "Principal
Transactions" revenues in the Condensed Consolidated Statements of Income.
Fair value is generally based on quoted market prices. If quoted market
prices are not available, or if liquidating the Company's position is
reasonably expected to affect market prices, fair value is determined
based on other relevant factors, including dealer price quotations, price
activity for equivalent instruments and valuation pricing models.
Valuation pricing models consider time value, yield curve and volatility
factors, prepayment speeds, default rates, loss severity, current market
and contractual prices for the underlying financial instruments, as well
as other economic measurements.
Equity securities acquired as a result of leveraged acquisition
transactions are reflected in the consolidated financial statements at
their initial costs until significant transactions or developments
indicate that a change in the carrying value of the securities is
appropriate. Generally, the carrying values of these securities will be
increased only in those instances where market values are readily
ascertainable by reference to substantial transactions occurring in the
marketplace or quoted market prices. Reductions to the carrying value of
these securities are made when the Company's estimate of net realizable
value has declined below the carrying value.
Customer Transactions
Customer securities transactions are recorded on a settlement date basis,
which is generally three business days after trade date, while the related
commission revenues and expenses are recorded on a trade date basis.
Receivables from and payables to customers include amounts related to both
cash and margin transactions. Securities owned by customers, including
those that collateralize margin or other similar transactions, are
generally not reflected in the Condensed Consolidated Statements of
Financial Condition.
Collateralized Securities Transactions
Transactions involving purchases of securities under agreements to resell
("reverse repurchase agreements") or sales of securities under agreements
to repurchase ("repurchase agreements") are treated as collateralized
financing transactions and are recorded at their contracted resale or
repurchase amounts plus accrued interest. Resulting interest income and
expense is generally included in "Principal Transactions" revenues in the
Condensed Consolidated Statements of Income. Reverse repurchase agreements
and repurchase agreements are presented in the Condensed Consolidated
Statements of Financial Condition on a net-by-counterparty basis, where
permitted by generally accepted accounting principles. It is the Company's
general policy to take possession of securities with a market value in
excess of the principal amount
8
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
loaned plus the accrued interest thereon, in order to collateralize
reverse repurchase agreements. Similarly, the Company is generally
required to provide securities to counterparties to collateralize
repurchase agreements.
The Company's agreements with counterparties generally contain contractual
provisions allowing for additional collateral to be obtained, or excess
collateral returned. It is the Company's policy to value collateral and to
obtain additional collateral, or to retrieve excess collateral from
counterparties, when deemed appropriate.
Securities borrowed and securities loaned are recorded based upon the
amount of cash collateral advanced or received. Securities borrowed
transactions facilitate the settlement process and require the Company to
deposit cash, letters of credit or other collateral with the lender. With
respect to securities loaned, the Company receives collateral in the form
of cash or other collateral. The amount of collateral required to be
deposited for securities borrowed, or received for securities loaned, is
an amount generally in excess of the market value of the applicable
securities borrowed or loaned. The Company monitors the market value of
securities borrowed and loaned, with additional collateral obtained, or
excess collateral retrieved, when deemed appropriate.
Fixed Assets
Depreciation of property and equipment is provided by the Company on a
straight-line basis over the estimated useful life of the asset.
Amortization of leasehold improvements is provided on a straight-line
basis over the lesser of the estimated useful life of the asset or the
remaining life of the lease.
Goodwill and Identifiable Intangible Assets
The Company accounts for goodwill and identifiable intangible assets under
the provisions of Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets." In accordance with this
guidance, the Company does not amortize goodwill, but amortizes
identifiable intangible assets over their useful lives. Goodwill is tested
at least annually for impairment and identifiable intangible assets are
tested for potential impairment whenever events or changes in
circumstances suggest that the carrying value of an asset or asset group
may not be fully recoverable in accordance with SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets."
Translation of Foreign Currencies
Assets and liabilities denominated in foreign currencies are translated at
period-end rates of exchange, while income statement items are translated
at daily average rates of exchange during the fiscal period. Gains or
losses resulting from foreign currency transactions are included in net
income.
Income Taxes
The Company and certain of its subsidiaries file a consolidated federal
income tax return. The Company accounts for income taxes under the
provisions of SFAS No. 109, "Accounting for Income Taxes." Under SFAS No.
109, deferred income taxes are based on the net tax effects of temporary
differences between the financial reporting and tax bases of assets and
liabilities. In addition, deferred income taxes are determined by the
enacted tax rates and laws expected to be in effect when the related
temporary differences are expected to be reversed.
9
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Earnings Per Share
Earnings per share ("EPS") is computed in accordance with SFAS No. 128,
"Earnings Per Share." Basic EPS is computed by dividing net income
applicable to common shares, adjusted for costs related to vested shares
under the Capital Accumulation Plan for Senior Managing Directors, as
amended ("CAP Plan"), as well as the effect of the redemption of preferred
stock, by the weighted average number of common shares outstanding. Common
shares outstanding includes vested units issued under certain stock
compensation plans, which will be distributed as shares of common stock.
Diluted EPS includes the determinants of Basic EPS and, in addition, gives
effect to dilutive potential common shares related to stock compensation
plans.
Statement of Cash Flows
For purposes of the Condensed Consolidated Statements of Cash Flows, the
Company has defined cash equivalents as liquid investments not held for
sale in the ordinary course of business with original maturities of three
months or less. Cash payments for interest approximated interest expense
for the six months ended May 31, 2004 and May 31, 2003. Income taxes paid
totaled $301.5 million and $212.8 million for the six months ended May 31,
2004 and May 31, 2003, respectively.
Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides three
alternative methods for a voluntary change to fair value accounting for
stock-based compensation as permitted under SFAS No. 123. Effective
December 1, 2002, the Company elected to adopt fair value accounting for
stock-based compensation consistent with SFAS No. 123 using the
prospective method with guidance provided by SFAS No. 148. As a result,
commencing with options granted after November 30, 2002, the Company
expenses the fair value of stock options issued to employees over the
related vesting period. Prior to December 1, 2002, the Company elected to
account for its stock-based compensation plans using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"), as permitted by
SFAS No. 123. Under the provisions of APB No. 25, compensation cost for
stock options is measured as the excess, if any, of the quoted market
price of the Company's common stock at the date of grant over the amount
an employee must pay to acquire the stock. Accordingly, no compensation
expense had been recognized for stock option awards granted prior to
December 1, 2002 because the exercise price was at the fair market value
of the Company's common stock on the grant date.
The cost related to stock-based compensation included in the determination
of net income for the three months and six months ended May 31, 2004 and
May 31, 2003 is less than that which would have been recognized if the
fair value based method had been applied to stock option awards since the
original effective date of SFAS No. 123.
10
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The following table illustrates the effect on net income and earnings per
share if the fair value based method had been applied to all outstanding
awards in each period.
Three Months Ended Six Months Ended
--------------------------------------------------------------------------------------------------------------------------
May 31, May 31, May 31, May 31,
(in millions, except per share amounts) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------------------------
Net income, as reported $347.8 $280.4 $708.9 $554.7
Add: Stock-based employee compensation plans
expense included in reported net income, net of
related tax effects 3.7 10.5 11.9 16.9
Deduct: Total stock-based employee
compensation plans expense determined under
the fair value based method, net of related tax
effects (11.7) (23.8) (28.1) (43.5)
--------------------------------------------------------------------------------------------------------------------------
Pro forma net income $339.8 $267.1 $692.7 $528.1
==========================================================================================================================
Earnings per share:
Basic - as reported $2.77 $2.27 $5.65 $4.48
Basic - pro forma $2.71 $2.17 $5.53 $4.28
Diluted - as reported $2.49 $2.05 $5.07 $4.05
Diluted - pro forma $2.44 $1.96 $4.96 $3.86
==========================================================================================================================
Investment Banking and Advisory Services
Underwriting revenues and fees for mergers and acquisitions advisory
services are accrued when services for the transactions are substantially
completed. Transaction expenses are deferred until the related revenue is
recognized.
Derivative Instruments and Hedging Activities
The Company follows SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended by SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," and SFAS
No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for
stand-alone derivative instruments, derivatives embedded within other
contracts or securities, and hedging activities. Accordingly, all
derivatives, whether stand-alone or embedded within other contracts or
securities (except in narrowly defined circumstances), are carried in the
Company's Condensed Consolidated Statements of Financial Condition at
their then fair value, with changes in fair value recorded in current
earnings. Designated hedged items not carried at fair value are marked (to
the extent of the profit or loss on the derivative) for the risk being
hedged, with such changes in the fair value recorded in current earnings.
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
The Company follows SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities--a Replacement of
FASB Statement No. 125," to account for securitizations and other
transfers of financial assets and collateral. SFAS No. 140 establishes
accounting and reporting standards with a financial-components approach
that focuses on control. Under this approach, financial assets or
liabilities
11
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
are recognized when control is established and derecognized when control
has been surrendered or the liability has been extinguished. In addition,
specific implementation guidelines have been established to further
distinguish transfers of financial assets that are sales from transfers
that are secured borrowings.
2. FINANCIAL INSTRUMENTS
Financial instruments owned and financial instruments sold, but not yet
purchased, consisting of the Company's proprietary trading inventories, at
fair value, were as follows:
May 31, November 30,
(in thousands) 2004 2003
--------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS OWNED:
US government and agency $ 5,570,722 $ 4,963,125
Other sovereign governments 1,060,459 1,019,394
Corporate equity and convertible debt 14,857,033 12,531,849
Corporate debt and other 12,282,190 9,554,939
Mortgages, mortgage- and asset-backed 24,345,935 21,377,386
Derivative financial instruments 12,498,203 9,785,965
--------------------------------------------------------------------------------
$70,614,542 $59,232,658
================================================================================
FINANCIAL INSTRUMENTS SOLD, BUT NOT YET PURCHASED:
US government and agency $12,337,363 $ 9,991,764
Other sovereign governments 920,853 740,052
Corporate equity and convertible debt 5,291,130 6,301,051
Corporate debt and other 2,875,040 1,477,448
Mortgages, mortgage- and asset-backed 1,162,744 278,294
Derivative financial instruments 9,537,963 8,320,538
--------------------------------------------------------------------------------
$32,125,093 $27,109,147
================================================================================
As of May 31, 2004 and November 30, 2003, all financial instruments owned
that were pledged to counterparties where the counterparty has the right,
by contract or custom, to rehypothecate these securities are classified as
"Financial Instruments Owned, Pledged as Collateral" in the Condensed
Consolidated Statements of Financial Condition.
Financial instruments sold, but not yet purchased represent obligations of
the Company to deliver the specified financial instrument at the
contracted price and thereby create a liability to purchase the financial
instrument in the market at prevailing prices. Accordingly, these
transactions result in off-balance-sheet risk as the Company's ultimate
obligation to repurchase such securities may exceed the amount recognized
in the Condensed Consolidated Statements of Financial Condition.
12
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. DERIVATIVES AND HEDGING ACTIVITIES
SFAS No. 133 requires that all derivatives, whether stand-alone or
embedded within other contracts or securities (except in very defined
circumstances) be carried on the Company's Condensed Consolidated
Statement of Financial Condition at their then fair value. SFAS No. 133
requires that all derivatives be carried at fair value, including those
used as hedges. SFAS No. 133 also requires items designated as being
hedged, previously carried at accrued values, now be marked to market for
the risk being hedged, provided that the intent to hedge is fully
documented. Any resultant net change in value for both the hedging
derivative and the hedged item is recognized in earnings immediately, such
net effect being deemed the "ineffective" portion of the hedge. The gains
and losses associated with the ineffective portion of the fair value
hedges are included in "Principal Transactions" revenues in the Condensed
Consolidated Statements of Income and were not material for the three
month and six month periods ended May 31, 2004 and May 31, 2003.
To measure derivative activity, notional or contract amounts are
frequently used. Notional/contract amounts are used to calculate
contractual cash flows to be exchanged and are generally not actually paid
or received, with the exception of currency swaps, foreign exchange
forwards and mortgage-backed securities forwards. The notional/contract
amounts of financial instruments that give rise to off-balance-sheet
market risk are indicative only to the extent of involvement in the
particular class of financial instrument and are not necessarily an
indication of overall market risk.
As of May 31, 2004 and November 30, 2003, the Company had
notional/contract amounts of approximately $3.03 trillion and $2.15
trillion, respectively, of derivative financial instruments, of which
$687.3 billion and $413.1 billion, respectively, were listed futures and
option contracts. The aggregate notional/contract value of derivative
contracts is a reflection of the level of activity and does not represent
the amounts that are recorded in the Condensed Consolidated Statements of
Financial Condition. The Company's derivative financial instruments
outstanding, which either are used to hedge trading positions, fixed-rate
debt, or are part of its derivative dealer activities, are marked to fair
value.
The Company's derivatives had a weighted average maturity of approximately
3.8 years and 4.2 years at May 31, 2004 and November 30, 2003,
respectively. The maturities of notional/contract amounts outstanding for
derivative financial instruments as of May 31, 2004 were as follows:
Greater
Less Than One to Three to Than
(in billions) One Year Three Years Five Years Five Years Total
=======================================================================================================================
Swap agreements, including options,
swaptions, caps, collars and floors $ 464.6 $ 573.9 $ 530.6 $ 648.8 $ 2,217.9
Futures contracts 179.1 98.9 9.8 0.1 287.9
Forward contracts 89.6 -- -- -- 89.6
Options held 280.5 25.3 0.7 0.1 306.6
Options written 117.5 9.3 1.0 -- 127.8
-----------------------------------------------------------------------------------------------------------------------
Total $ 1,131.3 $ 707.4 $ 542.1 $ 649.0 $ 3,029.8
=======================================================================================================================
Percent of total 37.3% 23.4% 17.9% 21.4% 100.0%
=======================================================================================================================
13
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has commitments in
connection with various activities, the most significant of which are as
follows:
Commercial Lending
In connection with certain of the Company's business activities, the
Company provides financing or financing commitments to investment-grade
and non-investment-grade companies in the form of senior and subordinated
debt, including bridge financing. Commitments have varying maturity dates
and are generally contingent on the accuracy and validity of certain
representations, warranties and contractual conditions applicable to the
borrower. Commercial lending commitments to investment-grade borrowers
aggregated approximately $1.29 billion at May 31, 2004 (gross commitments
of $2.03 billion less $740.3 million of associated hedges). Commercial
lending commitments to non-investment-grade borrowers approximated $1.31
billion at May 31, 2004.
Private Equity-Related Investments and Partnerships
In connection with the Company's merchant banking activities, the Company
has commitments to invest in merchant banking and private equity-related
investment funds as well as commitments to invest directly in private
equity-related investments. At May 31, 2004, such commitments aggregated
$434.9 million. These commitments will be funded, if called, through the
end of the respective investment periods, the longest of such periods
ending in 2013.
Underwriting
In connection with the Company's mortgage-backed securitizations and fixed
income/equity underwriting, the Company had commitments to purchase and
sell new issues of securities aggregating $649.7 million at May 31, 2004.
Commercial and Residential Loans
The Company participates in the acquisition, securitization, servicing,
financing and disposition of commercial and residential loans. At May 31,
2004, the Company had entered into commitments to purchase, sell or
finance mortgage loans of $2.0 billion.
Letters of Credit
At May 31, 2004, the Company was contingently liable for unsecured letters
of credit of approximately $2.09 billion and letters of credit of $1.1
billion secured by financial instruments, primarily used to provide
collateral for securities borrowed and to satisfy margin requirements at
option and commodity exchanges.
Borrow Versus Pledge
At May 31, 2004, the Company had pledged securities, primarily US
government and agency securities with a market value of approximately
$3.46 billion as collateral for securities borrowed, with an approximate
market value of $3.41 billion.
14
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Other
The Company had commitments to purchase Chapter 13 and other credit card
receivables of $87.3 million at May 31, 2004.
The Company has entered into agreements with providers of hardware,
software, data processing and systems consulting services. At May 31,
2004, commitments over the remaining life of these agreements aggregated
$62.5 million.
With respect to certain of the commitments outlined above, the Company
utilizes various hedging strategies to actively manage its market, credit
and liquidity exposures. Additionally, since these commitments may expire
unused, the total commitment amount may not necessarily reflect the actual
future cash funding requirements.
Litigation
In the normal course of business, the Company has been named as a
defendant in various lawsuits that involve claims for substantial amounts.
Also, the Company is involved from time to time in investigations and
proceedings by governmental agencies and self-regulatory organizations.
Although the ultimate outcome of the various matters cannot be ascertained
at this time, it is the opinion of management, after consultation with
counsel, that the resolution of the foregoing matters will not have a
material adverse effect on the financial condition of the Company, taken
as a whole; such resolution may, however, have a material effect on the
operating results in any future period, depending on the level of income
for such period.
5. GUARANTEES
In the ordinary course of business, the Company issues various guarantees
to counterparties in connection with certain derivative, leasing,
securitization and other transactions. The guarantees covered by FIN No.
45, "Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others," include
contracts that contingently require the guarantor to make payments to the
guaranteed party based on changes related to an asset, a liability or an
equity security of the guaranteed party, contracts that contingently
require the guarantor to make payments to the guaranteed party based on
another entity's failure to perform under an agreement and indirect
guarantees of the indebtedness of others, even though the payment to the
guaranteed party may not be based on changes to an asset, liability or
equity security of the guaranteed party. In addition, FIN No. 45 covers
certain indemnification agreements that contingently require the guarantor
to make payments to the indemnified party, such as an adverse judgment in
a lawsuit or the imposition of additional taxes due to either a change in
the tax law or an adverse interpretation of the tax law.
15
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. GUARANTEES (continued)
The following table sets forth the maximum payout/notional amounts
associated with the Company's guarantees as of May 31, 2004:
Amount of Guarantee Expiration Per Period
------------------------------------------------------------------
Greater
Less Than One to Three to than
(in millions) One Year Three Years Five Years Five Years Total
================================================================================================================================
Certain derivative contracts (notional) (1) $ 260,544 $ 176,548 $ 157,149 $ 72,764 $ 667,005
Municipal securities 2,387 65 -- -- 2,452
Residual value guarantee -- -- 570 -- 570
--------------------------------------------------------------------------------------------------------------------------------
(1) The carrying value of these derivatives approximated $8.7 billion.
Derivative Contracts
The Company's dealer activities cause it to make markets and trade a
variety of derivative instruments. Certain derivative contracts that the
Company has entered into meet the accounting definition of a guarantee
under FIN No. 45. Derivatives that meet the FIN No. 45 definition of
guarantees include credit default swaps (whereby a default or significant
change in the credit quality of the underlying financial instrument may
obligate the Company to make a payment), certain written call and put
options, swaptions, as well as floors, caps and collars. Since the Company
does not track the counterparties' purpose for entering into a derivative
contract, it has disclosed derivative contracts that are likely to be used
to protect against a change in an underlying financial instrument,
regardless of their actual use.
On certain of these contracts, such as written interest rate caps and
floors and foreign currency options, the maximum payout cannot be
quantified since the increase in interest rates and foreign exchange rates
is not contractually limited by the terms of the contracts. As such, the
Company has disclosed notional amounts as a measure of the extent of its
involvement in these classes of derivatives rather than maximum payout.
Notional amounts do not represent the maximum payout and generally
overstate the Company's exposure to these contracts. These derivative
contracts are recorded at fair value which approximated $8.7 billion at
May 31, 2004.
In connection with these activities, the Company attempts to mitigate its
exposure to market risk by entering into a variety of offsetting
derivative contracts and security positions. For a discussion of
derivatives, see Risk Management and Management's Discussion and Analysis
of Financial Condition and Results of Operations in the Company's Annual
Report on Form 10-K for the fiscal year ended November 30, 2003.
Municipal Securities
In 1997, the Company established a program whereby it creates a series of
municipal securities trusts in which it has retained interests. These
trusts purchase fixed-rate, long-term, highly rated, insured or escrowed
municipal bonds financed by the issuance of trust certificates. Certain of
the trust certificates entitle the holder to receive future payments of
principal and variable interest and to tender such certificates at the
option of the holder on a periodic basis. The Company acts as placement
agent and as liquidity provider. The purpose of the program is to allow
the Company's clients to purchase synthetic short-term, floating-rate
municipal debt that does not otherwise exist in the marketplace. In the
Company's capacity as liquidity provider to the trusts, the maximum
exposure to loss at May 31, 2004 was approximately $2.45 billion, which
represents the outstanding amount of
16
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. GUARANTEES (continued)
all trust certificates. This exposure to loss is mitigated by the
underlying municipal bonds. The underlying municipal bonds in the trusts
are either AAA- or AA-rated, insured or escrowed to maturity. Such bonds
had a market value, net of related hedges, approximating $2.43 billion at
May 31, 2004.
Residual Value Guarantee
The Company has entered into an operating lease arrangement for its
worldwide headquarters at 383 Madison Avenue (the "Synthetic Lease").
Under the terms of the Synthetic Lease, the Company is obligated to make
monthly payments based on the lessor's underlying interest costs. The
Synthetic Lease expires on August 15, 2008, after which the Company may
request a renewal. If the lease renewal cannot be negotiated, the Company
has the right to purchase the building for the amount of the then
outstanding indebtedness of the lessor or to arrange for the sale of the
property with the proceeds of the sale to be used to satisfy the lessor's
debt obligation. If the sale of the property does not generate sufficient
proceeds to satisfy the lessor's debt obligation, the Company is required
to fund the shortfall up to a maximum residual value guarantee. As of May
31, 2004, there was no expected shortfall and the maximum residual value
guarantee approximated $570 million.
Indemnifications
The Company provides representations and warranties to counterparties in
connection with a variety of commercial transactions, including certain
asset sales and securitizations and occasionally indemnifies them against
potential losses caused by the breach of those representations and
warranties. To mitigate these risks with respect to assets being
securitized that have been originated by third parties, the Company seeks
to obtain appropriate representations and warranties from such third party
originators upon acquisition of such assets. The Company generally
performs due-diligence on assets purchased and maintains underwriting
standards for assets originated. The Company may also provide
indemnifications to some counterparties to protect them in the event
additional taxes are owed or payments are withheld, due either to a change
in or adverse application of certain tax laws. These indemnifications
generally are standard contractual terms and are entered into in the
normal course of business. Generally, there are no stated or notional
amounts included in these indemnifications, and the contingencies
triggering the obligation to indemnify are not expected to occur.
Maximum payout information under these indemnifications is not readily
available because of the number, size, and lives of these transactions.
The Company reviewed its experience with the indemnifications on these
structures. Based on such experience, it is unlikely that the Company will
have to make significant payments under these arrangements.
Other Guarantees
The Company is a member of numerous exchanges and clearinghouses. Under
the membership agreements, members are generally required to guarantee the
performance of other members. Additionally, if a member becomes unable to
satisfy its obligations to the clearinghouse, other members would be
required to meet shortfalls. To mitigate these performance risks, the
exchanges and clearinghouses often require members to post collateral. The
Company's maximum potential liability under these arrangements cannot be
quantified. However, the potential for the Company to be required to make
payments under these arrangements is unlikely. Accordingly, no contingent
liability is recorded in the Condensed Consolidated Financial Statements
for these arrangements.
17
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. REGULATORY REQUIREMENTS
Bear Stearns and BSSC are registered broker-dealers and, accordingly, are
subject to Rule 15c3-1 under the Securities Exchange Act of 1934 ("Net
Capital Rule") and the capital rules of the New York Stock Exchange, Inc.
("NYSE"), the Commodity Futures Trading Commission ("CFTC") and other
principal exchanges of which Bear Stearns and BSSC are members. Included
in the computation of net capital of Bear Stearns, as defined, is $686.2
million, which is net capital of BSSC in excess of 5.5% of aggregate debit
items arising from customer transactions. At May 31, 2004, Bear Stearns'
net capital of $2.27 billion exceeded the minimum requirement by $2.19
billion.
BSIL and Bear Stearns International Trading Limited ("BSIT"), London-based
broker-dealer subsidiaries, are subject to the regulatory capital
requirements of the Financial Services Authority.
BSB, an Ireland-based bank principally involved in the trading and sales
of fixed income products, is registered in Ireland and is subject to the
regulatory capital requirements of the Irish Financial Services Regulatory
Authority.
At May 31, 2004, Bear Stearns, BSSC, BSIL, BSIT and BSB were in compliance
with their respective regulatory capital requirements.
7. EARNINGS PER SHARE
EPS is computed in accordance with SFAS No. 128, "Earnings Per Share."
Basic EPS is computed by dividing net income applicable to common shares,
adjusted for costs related to vested shares under the Capital Accumulation
Plan for Senior Managing Directors, as amended ("CAP Plan"), as well as
the effect of the redemption of preferred stock, by the weighted average
number of common shares outstanding. Common shares outstanding includes
vested units issued under certain stock compensation plans, which will be
distributed as shares of common stock. Diluted EPS includes the
determinants of Basic EPS and, in addition, gives effect to dilutive
potential common shares related to stock compensation plans.
18
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. EARNINGS PER SHARE (continued)
The computations of Basic and Diluted EPS are set forth below:
Three Months Ended Six Months Ended
------------------------------------------------------------------------------------------------------------------------------
May 31, May 31, May 31, May 31,
(in thousands, except per share amounts) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------------------
Net income $ 347,803 $ 280,411 $ 708,868 $ 554,664
Preferred stock dividends (7,194) (7,795) (14,613) (15,786)
Redemption of preferred stock -- 642 -- 720
Income adjustment (net of tax) applicable to deferred
compensation arrangements-vested shares 17,553 19,374 35,178 39,628
-----------------------------------------------------------------------------------------------------------------------------
Net earnings used for basic EPS 358,162 292,632 729,433 579,226
Income adjustment (net of tax) applicable to deferred
compensation arrangements-nonvested shares 7,865 6,901 15,372 14,064
-----------------------------------------------------------------------------------------------------------------------------
Net earnings used for diluted EPS $ 366,027 $ 299,533 $ 744,805 $ 593,290
=============================================================================================================================
Total basic weighted average common
shares outstanding (1) 129,071 128,711 129,030 129,240
-----------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Employee stock options 3,471 2,224 3,471 1,937
CAP and restricted units 14,380 15,128 14,444 15,432
-----------------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 17,851 17,352 17,915 17,369
-----------------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares
outstanding and dilutive potential common shares 146,922 146,063 146,945 146,609
=============================================================================================================================
Basic EPS $ 2.77 $ 2.27 $ 5.65 $ 4.48
Diluted EPS $ 2.49 $ 2.05 $ 5.07 $ 4.05
=============================================================================================================================
(1) Includes 24,573,060 and 29,891,922 vested units for the three months
ended May 31, 2004 and May 31, 2003, respectively, and 25,171,895
and 30,064,127 vested units for the six months ended May 31, 2004
and May 31, 2003, respectively, issued under certain stock
compensation plans which will be distributed as shares of common
stock.
8. SEGMENT DATA
The Company operates in three principal segments -- Capital Markets,
Global Clearing Services and Wealth Management. These segments offer
different products and services and are managed separately as different
levels and types of expertise are required to effectively manage the
segments' transactions.
The Capital Markets segment comprises the institutional equities, fixed
income and investment banking areas. The Capital Markets segment operates
as a single integrated unit that provides the sales, trading and
origination effort for various fixed income, equity and advisory products
and services. Each of the three businesses works in tandem to deliver
these services to institutional and corporate clients.
Institutional equities consists of research, sales and trading in areas
such as domestic and international equities, block trading, convertible
bonds, over-the-counter equities, equity derivatives, risk and convertible
arbitrage and through a majority-owned subsidiary, the NYSE, American
Stock Exchange, Inc. ("AMEX") and International Securities Exchange
specialist activities. Fixed income includes sales, trading and research
provided to institutional clients across a variety of products such as
mortgage- and asset-backed securities, corporate and government bonds,
municipal bonds, high yield products, foreign exchange and interest rate
and
19
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. SEGMENT DATA (continued)
credit derivatives. Investment banking provides services in capital
raising, strategic advice, mergers and acquisitions and merchant banking.
Capital raising encompasses the Company's underwriting of equity,
investment-grade, municipal and high yield debt products.
The Global Clearing Services segment provides execution, clearing, margin
lending and securities borrowing to facilitate customer short sales to
clearing clients worldwide. Prime brokerage clients include hedge funds
and clients of money managers, short sellers and other professional
investors. Fully disclosed clients engage in either the retail or
institutional brokerage business.
The Wealth Management segment is comprised of the Private Client Services
("PCS") and Asset Management areas. PCS provides high-net-worth
individuals with an institutional level of investment service, including
access to the Company's resources and professionals. Asset management
manages equity, fixed income and alternative assets for leading corporate
pension plans, public systems, endowments, foundations, multi-employer
plans, insurance companies, corporations, families and high net-worth
individuals in the US and abroad.
The three business segments comprise many business areas with interactions
among each. Revenues and expenses include those that are directly related
to each segment. Revenues from intersegment transactions are based upon
specific criteria or agreed-upon rates with such amounts eliminated in
consolidation. Individual segments also include revenues and expenses
relating to various items, including corporate overhead and interest,
which are internally allocated by the Company primarily based on
balance-sheet usage or expense levels. The Company generally evaluates
performance of the segments based on net revenues and profit or loss
before provision for income taxes.
20
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. SEGMENT DATA (continued)
Three Months Ended Six Months Ended
------------------------------------- ------------------------------------
May 31, May 31, May 31, May 31,
(in thousands) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
NET REVENUES
Capital Markets
Institutional Equities $ 252,004 $ 189,346 $ 549,404 $ 465,807
Fixed Income 844,436 765,190 1,666,704 1,556,407
Investment Banking 254,872 223,439 508,051 411,203
-------------------------------------------------------------------------------------------------------------------
Total Capital Markets 1,351,312 1,177,975 2,724,159 2,433,417
Global Clearing Services 223,676 187,405 441,290 363,183
Wealth Management
Private Client Services (1) 117,272 91,142 228,169 175,295
Asset Management 59,244 33,263 101,134 64,695
-------------------------------------------------------------------------------------------------------------------
Total Wealth Management 176,516 124,405 329,303 239,990
Other (2) (27,966) (27,065) (45,291) (58,436)
-------------------------------------------------------------------------------------------------------------------
Total net revenues $ 1,723,538 $ 1,462,720 $ 3,449,461 $ 2,978,154
===================================================================================================================
PRE-TAX INCOME
Capital Markets $ 491,002 $ 483,971 $ 1,007,371 $ 949,890
Global Clearing Services 86,705 37,798 165,207 89,948
Wealth Management 25,719 4,948 46,586 10,667
Other (2) (91,950) (98,587) (176,710) (197,176)
-------------------------------------------------------------------------------------------------------------------
Total pre-tax income $ 511,476 $ 428,130 $ 1,042,454 $ 853,329
===================================================================================================================
As of
--------------------------------------------------------
May 31, November 30, May 31,
(in thousands) 2004 2003 2003
-----------------------------------------------------------------------------------------------
SEGMENT ASSETS
Capital Markets $ 175,247,414 $ 143,866,138 $ 142,323,343
Global Clearing Services 73,655,826 69,974,025 69,563,378
Wealth Management 4,015,910 3,705,922 3,346,690
Other (3) (11,324,377) (5,377,975) (7,322,779)
-----------------------------------------------------------------------------------------------
Total segment assets $ 241,594,773 $ 212,168,110 $ 207,910,632
===============================================================================================
Three months ended Six months ended
May 31, 2004 May 31, 2003 May 31, 2004 May 31, 2003
----------------------------------------------------------------
(1) Private Client Services Detail:
Gross revenues, before transfer to
Capital Markets segment $ 139,266 $ 115,033 $ 276,895 $ 218,502
Revenue transferred to
Capital Markets segment (21,994) (23,891) (48,726) (43,207)
----------- ----------- ----------- -----------
Private Client Services net revenues $ 117,272 $ 91,142 $ 228,169 $ 175,295
=========== =========== =========== ===========
(2) Includes consolidation and elimination entries, unallocated revenues
(predominantly interest), and certain corporate administrative
functions, including certain legal costs and costs related to the
CAP Plan. CAP Plan costs approximated $44.5 million and $46.0
million for the three months ended May 31, 2004 and May 31, 2003,
respectively, and $88.5 million and $94.0 million for the six months
ended May 31, 2004 and May 31, 2003, respectively.
(3) Includes consolidation and elimination entries.
Note: Certain prior period items have been reclassified within the Wealth
Management segment to conform to the current period's presentation.
21
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES
Securitizations
The Company regularly securitizes commercial and residential mortgages,
consumer receivables and other financial assets. Interests in these
securitized assets may be retained in the form of senior or subordinated
securities or as residual interests. These retained interests are included
in "Financial Instruments Owned" in the Condensed Consolidated Statements
of Financial Condition and are carried at fair value. Securitization
transactions are generally treated as sales, with resulting gain or loss
included in "Principal Transactions" revenue in the Condensed Consolidated
Statements of Income. Consistent with the valuation of similar inventory,
fair value is determined by broker-dealer price quotations and internal
valuation pricing models that utilize variables such as yield curves,
prepayment speeds, default rates, loss severity, interest rate
volatilities and spreads. The assumptions used for pricing variables are
primarily based on observable transactions in similar securities and are
further verified by external pricing sources, when available.
The Company's securitization activity relating to transfers of its
financial assets is detailed below:
Agency Other Other
Mortgage- Mortgage- Asset-
Backed Backed Backed
--------------------------------------------------------------------
(in billions)
--------------------------------------------------------------------
Total securitizations
Quarter ended May 31, 2004 $ 11.7 $ 14.5 $ 0.4
Quarter ended May 31, 2003 $ 14.7 $ 9.9 $ 2.9
Retained interests
As of May 31, 2004 $ 2.4 $ 1.0 $ 0.1
As of November 30, 2003 $ 1.8 $ 1.4 $ 0.2
--------------------------------------------------------------------
The Company is an active market-maker in these securities and as a result,
may retain interests in assets it securitizes, predominantly highly rated
or government agency-backed securities. The models employed in the
valuation of retained interests use discount rates that are based on the
swap curve plus a spread. Key points on the swap curve at May 31, 2004
were 2.94% for 2-year swaps and 5.13% for 10-year swaps. These models also
consider prepayment speeds, as well as credit losses. Credit losses are
considered through option-adjusted spreads that also utilize additional
factors such as liquidity and optionality.
Key valuation assumptions used in measuring the current fair value of
retained interests in assets the Company securitized at May 31, 2004 were
as follows:
Agency Other Other
Mortgage-Backed Mortgage-Backed Asset-Backed
-----------------------------------------------------------------------------------------------------
Weighted average life (years) 6.71 4.91 3.01
Average prepayment speeds (annual rate) 7% - 37% 0% - 41% N/A
Credit losses 0.68% 4.35% 1.69%
-----------------------------------------------------------------------------------------------------
22
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES (continued)
The following hypothetical sensitivity analysis as of May 31, 2004
illustrates the potential change in fair value of these retained interests
due to a specified change in the key valuation assumptions. The interest
rate changes represent a parallel shift in the swap curve. This shift
considers the effect of other variables, including prepayments. The
remaining valuation assumptions are changed independently.
Agency Other Other
(in millions) Mortgage-Backed Mortgage-Backed Asset-Backed
-------------------------------------------------------------------------------------------
Interest rates
50 basis point increase $ (73.1) $ (26.1) $ 0.1
100 basis point increase (148.5) (49.6) (0.8)
50 basis point decrease 66.8 20.7 0.4
100 basis point decrease 123.1 29.5 0.8
-------------------------------------------------------------------------------------------
Prepayment speeds
10% increase 7.0 (2.3) N/A
20% increase 13.5 (4.5) N/A
10% decrease (7.4) 2.9 N/A
20% decrease (15.1) 6.1 N/A
-------------------------------------------------------------------------------------------
Credit losses
10% increase (3.4) (9.1) (0.4)
20% increase (6.8) (17.2) (0.9)
10% decrease 3.5 10.6 0.4
20% decrease 7.0 23.3 0.7
-------------------------------------------------------------------------------------------
The previous table should be viewed with caution since the changes in a
single variable generally cannot occur without changes in other variables
or conditions that may counteract or amplify the effect of the changes
outlined in the table. In addition, the table does not consider the change
in fair value of hedging positions which would generally offset the
changes detailed in the table, nor does it consider any corrective action
that the Company may take in response to changes in these conditions. The
impact of hedges is not presented because hedging positions are
established on a macro level and allocating the effect would not be
practicable.
The following table summarizes cash flows from securitization trusts
related to securitization transactions during the quarter ended May 31,
2004:
Agency Other Other
(in millions) Mortgage-Backed Mortgage-Backed Asset-Backed
-------------------------------------------------------------------------------------------------------
Cash flows received from retained interests $ 85.9 $ 57.5 $ 1.4
Cash flows from servicing N/A $ 4.9 N/A
-------------------------------------------------------------------------------------------------------
Collateralized Financing Arrangements
The Company enters into secured borrowing or lending agreements to obtain
collateral necessary to effect settlements, finance inventory positions,
meet customer needs or re-lend as part of its dealer operations.
The Company receives collateral under reverse repurchase agreements,
securities borrowing transactions, derivative transactions, customer
margin loans and other secured money-lending activities. In many
instances, the Company is permitted to rehypothecate such securities. The
Company also pledges financial instruments owned to collateralize certain
financing arrangements. These securities are recorded as "Financial
Instruments Owned, Pledged As Collateral" in the Condensed Consolidated
Statements of Financial Condition.
23
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES (continued)
At May 31, 2004 and November 30, 2003, the Company had received securities
pledged as collateral that can be repledged, delivered or otherwise used
with a fair value of approximately $246.0 billion and $223.1 billion,
respectively. This collateral was generally obtained under reverse
repurchase, securities borrowing or margin lending agreements. Of these
securities received as collateral, those with a fair value of
approximately $144.8 billion and $140.7 billion were delivered or
repledged, generally as collateral under repurchase or securities lending
agreements or to cover short sales at May 31, 2004 and November 30, 2003,
respectively.
10. CONSOLIDATION OF VARIABLE INTEREST ENTITIES
The Company regularly creates or transacts with entities that may be VIEs.
These entities are an essential part of its securitization, asset
management and structured finance businesses. In addition, the Company
purchases and sells instruments that may be variable interests.
In fiscal 2003, the Company adopted the provisions of FIN No. 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB
No. 51," for VIEs created after January 31, 2003 and for VIEs in which the
Company acquired an interest after January 31, 2003, with no material
effect on the consolidated financial statements. In October 2003, the FASB
deferred the effective date of FIN No. 46 for arrangements with VIEs
existing prior to February 1, 2003 to fiscal periods ending after December
15, 2003. In December 2003, the FASB issued FIN No. 46 (R), a revision of
FIN No. 46 to address certain technical corrections and implementation
issues that have arisen. As of May 31, 2004, the Company has adopted FIN
No. 46 or FIN No. 46 (R) for its variable interests. For these variable
interests, the Company has consolidated those VIEs in which the Company is
the primary beneficiary. In accordance with FIN No. 46 (R) the Company has
deconsolidated Capital Trust III, which had issued $262.5 million of
Preferred Securities, beginning on February 29, 2004. As a result, the
junior subordinated deferrable interest debentures issued by the Company
to Capital Trust III are included within long-term borrowings. In
addition, the Preferred Securities issued by Capital Trust III will no
longer be included in the Company's Condensed Consolidated Statement of
Financial Condition. The adoption of FIN No. 46 and FIN No. 46 (R) did not
have a material effect on the Company's condensed consolidated financial
statements.
The Company acts as transferor, seller, investor, structurer, underwriter
or derivative counterparty in securitization transactions. These
transactions typically involve entities that are qualifying special
purpose entities as defined in SFAS No. 140. However, occasionally such
entities are VIEs. The VIEs in these transactions own the securitized
assets and issue beneficial interests in the assets. The holders of the
beneficial interest have no recourse to the Company, only to the assets
held by the VIE. In certain of these VIEs, the Company is the primary
beneficiary through its ownership of certain beneficial interests, which
it may sell in the normal course of business.
The Company also acts as portfolio manager and/or underwriter in several
collateralized debt obligation transactions. In these transactions, the
Company establishes a trust that purchases a portfolio of assets and
issues trust certificates that represent interests in the portfolio of
assets. In addition to receiving variable compensation for managing the
portfolio, the Company may also retain certain trust certificates. In
certain of these transactions, these interests result in the Company
becoming the primary beneficiary of these entities. The holders of the
trust certificates have recourse only to the underlying assets of the
trusts and not to other assets of the Company.
Assets held by VIEs, which are currently consolidated, in which the
Company is the primary beneficiary, as discussed in the preceding two
paragraphs, approximated $1.1 billion. At May 31, 2004, the Company's
maximum exposure to
24
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. CONSOLIDATION OF VARIABLE INTEREST ENTITIES (continued)
loss as a result of its relationship with these VIEs is approximately
$28.2 million, which represents the fair value of its interests and is
reflected in the Company's condensed consolidated financial statements.
The Company also owns significant variable interests in several VIEs
related to collateralized debt obligations or asset securitizations for
which the Company is not the primary beneficiary and therefore does not
consolidate these entities. In aggregate, these VIEs have assets
approximating $4.8 billion. At May 31, 2004, the Company's maximum
exposure to loss from these entities approximates $17 million, which
represents the fair value of its interests and is reflected in the
Company's condensed consolidated financial statements.
The Company purchases and sells interests in entities that may be deemed
to be VIEs in its market-making capacity in the ordinary course of
business. As a result of these activities, it is reasonably possible that
such entities may be consolidated and deconsolidated at various points in
time. Therefore, the Company's variable interests included above may not
be consolidated or even held by the Company in future periods.
11. PREFERRED STOCK ISSUED BY SUBSIDIARIES
On December 15, 2003, the Company exercised its option and prepaid all of
the outstanding Debentures, resulting in the corresponding redemption of
$300.0 million aggregate principal amount of preferred securities issued
by Bear Stearns Capital Trust II.
Bear Stearns Capital Trust III ("Capital Trust III"), a wholly owned
subsidiary of the Company, has issued $262.5 million (10,500,000 shares)
of Guaranteed Preferred Beneficial Interests in Company Subordinated Debt
Securities ("Preferred Securities"). The Preferred Securities are
fixed-rate securities, which have a liquidation value of $25 per security.
Holders of the Preferred Securities are entitled to receive quarterly
preferential cash distributions at an annual rate of 7.8% through May 15,
2031. The proceeds of the issuance of the Preferred Securities were used
to acquire junior subordinated deferrable interest debentures
("Debentures") issued by the Company. The Debentures have terms that
correspond to the terms of the Preferred Securities and are the sole
assets of Capital Trust III. The Preferred Securities will mature on May
15, 2031. The Company, at its option, may redeem the Preferred Securities
at their principal amount plus accrued distributions beginning May 15,
2006.
In accordance with FIN No. 46 (R) the Company has deconsolidated Capital
Trust III effective beginning with the quarter ended February 29, 2004. As
a result, the Debentures issued by the Company to Capital Trust III are
included within long-term borrowings. The $262.5 million of Preferred
Securities issued by Capital Trust III is still outstanding, providing the
funding for such Debentures. In addition, the Preferred Securities issued
by Capital Trust III will no longer be included in the Company's Condensed
Consolidated Statements of Financial Condition.
25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Bear Stearns Companies Inc.
We have reviewed the accompanying condensed consolidated statement of
financial condition of The Bear Stearns Companies Inc. and subsidiaries as
of May 31, 2004, and the related condensed consolidated statements of
income for the three month and six month periods ended May 31, 2004 and
2003 and cash flows for the six month periods ended May 31, 2004 and 2003.
These interim financial statements are the responsibility of The Bear
Stearns Companies Inc.'s management.
We conducted our reviews in accordance with standards of the Public
Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical
procedures and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit
conducted in accordance with standards of the Public Company Accounting
Oversight Board (United States), the objective of which is the expression
of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to such condensed consolidated interim financial statements
for them to be in conformity with accounting principles generally accepted
in the United States of America.
We have previously audited, in accordance with standards of the Public
Company Accounting Oversight Board (United States), the consolidated
statement of financial condition of The Bear Stearns Companies Inc. and
subsidiaries as of November 30, 2003, and the related consolidated
statements of income, cash flows and changes in stockholders' equity for
the fiscal year then ended (not presented herein) included in The Bear
Stearns Companies Inc.'s Annual Report on Form 10-K for the fiscal year
ended November 30, 2003; and in our report dated February 13, 2004, (which
reports express unqualified opinions and explanatory paragraphs relating
to the adoption of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No.
148, "Accounting for Stock-Based Compensation--Transition and Disclosure,
an amendment of FASB Statement No. 123," in 2003, discussed in note 1 to
the consolidated financial statements) we expressed an unqualified opinion
on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated statement
of financial condition as of November 30, 2003 is fairly stated, in all
material respects, in relation to the consolidated statement of financial
condition from which it has been derived.
/s/ Deloitte & Touche LLP
New York, New York
July 13, 2004
26
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Bear Stearns Companies Inc. ("Company") is a holding company that through
its broker-dealer and international bank subsidiaries, principally Bear, Stearns
& Co. Inc. ("Bear Stearns"); Bear, Stearns Securities Corp. ("BSSC"); Bear,
Stearns International Limited ("BSIL") and Bear Stearns Bank plc ("BSB") is a
leading investment banking, securities and derivatives trading, clearance and
brokerage firm serving corporations, governments, institutional and individual
investors worldwide. The Company also conducts significant activities through
other wholly owned subsidiaries including: Bear Stearns Global Lending Limited,
Custodial Trust Company, Bear Stearns Financial Products Inc., Bear Stearns
Capital Markets Inc., EMC Mortgage Corporation, Bear Stearns Mortgage Capital
Corporation, Bear Stearns Credit Products Inc. and Bear Stearns Forex Inc. The
Company is primarily engaged in business as a securities broker and dealer
operating in three principal segments: Capital Markets, Global Clearing Services
and Wealth Management.
For a description of the Company's business, including its trading in cash
instruments and derivative products, its underwriting and trading policies, and
their respective risks, and the Company's risk management policies and
procedures, see the Company's Annual Report on Form 10-K for the fiscal year
ended November 30, 2003.
Certain Factors Affecting Results of Operations
The Company's principal business activities -- investment banking, securities
and derivatives sales and trading, clearance and brokerage -- are, by their
nature, highly competitive and subject to various risks, including volatile
trading markets and fluctuations in the volume of market activity. Consequently,
the Company's net income and revenues have been, and are likely to continue to
be, subject to wide fluctuations, reflecting the effect of many factors,
including general economic conditions, securities market conditions, the level
and volatility of interest rates and equity prices, competitive conditions,
liquidity of global markets, international and regional political conditions,
regulatory and legislative developments, monetary and fiscal policy, investor
sentiment, availability and cost of capital, technological changes and events,
outcome of legal proceedings, changes in currency values, inflation, credit
ratings and the size, volume and timing of transactions.
Forward-Looking Statements
Certain statements contained in this discussion are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements concerning management's expectations, strategic
objectives, business prospects, anticipated economic performance and financial
condition and other similar matters are subject to risks and uncertainties,
including those described in the prior paragraph, which could cause actual
results to differ materially from those discussed in the forward-looking
statements. Forward-looking statements speak only as of the date of the document
in which they are made. We disclaim any obligation or undertaking to provide any
updates or revisions to any forward-looking statement to reflect any change in
our expectations or any change in events, conditions or circumstances on which
the forward-looking statement is based.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Overview
Revenues, net of interest expense and pre-tax earnings for the quarter ended May
31, 2004 increased 17.8% and 19.5%, respectively, from the quarter ended May 31,
2003. In addition, pre-tax profit margins increased to 29.7% when compared to
29.3% in the fiscal 2003 quarter. Return on equity was 19.6% for the quarter
ended May 31, 2004 versus 19.7% in the 2003 quarter. A generally favorable
operating environment characterized by active fixed income markets, a recovering
US economy and improving US capital market conditions provided a healthy climate
for the Company's business during the quarter.
Capital Markets net revenues increased 14.7% to $1.35 billion from $1.18
billion. In Institutional Equities, net revenues increased 33.1% when compared
to the second quarter of fiscal 2003 reflecting increased commission revenues.
In addition, net revenues include the revenues of the Company's majority-owned
specialist subsidiary, Bear Wagner Specialists, LLC. The Fixed Income area
achieved record revenues for the quarter, up 10.4% from a year ago, with
mortgages and interest rate products reporting significant year-over-year
improvement. Investment banking revenues were up 14.1% as merger and acquisition
fees increased on positive market conditions. Global Clearing Services net
revenues increased 19.4% due to increased customer activity and higher customer
margin debt balances. In Wealth Management, revenues from private client
services increased on higher levels of private client investment activity and
asset management revenues rose primarily reflecting the sale of the mutual funds
business to Dreyfus completed during the second quarter of 2004.
Business Environment
The business environment during the Company's second quarter ended May 31, 2004
was characterized by a strengthening US economy and low inflation. Consumer
confidence increased during the second quarter of fiscal 2004 reflecting the
largest job growth rate in four years. Despite the Federal Reserve Board's
decision to leave the federal funds rate unchanged at 1.00%, the expectation of
higher interest rates pushed the rate on the benchmark 10-year treasury from
3.98% to 4.66% during the quarter. As a result, refinancing volumes slowed from
the record levels as mortgage rates continued to slowly rise.
The major indices were all slightly down during the quarter ended May 31, 2004.
The Dow Jones Industrial Average ("DJIA") and the Standard & Poors 500 Index
("S&P 500") decreased 3.7% and 2.1%, respectively, while the NASDAQ decreased
2.1%. Average daily trading volume on the New York Stock Exchange, Inc. ("NYSE")
and Nasdaq increased 4.2% and 15.8%, respectively, compared to the 2003 quarter.
Continued fiscal and monetary stimulus and encouraging corporate profit reports
served to increase equity new issue activity as well as US announced and
completed mergers and acquisitions volumes, which increased 26.7% industry-wide
compared to the May 2003 quarter.
The fixed income markets continued to perform extremely well in the second
quarter of fiscal 2004, benefiting from the combination of a steep yield curve
and the continued low level of interest rates. However diminished refinancing
activity resulted in a significant decline in agency collateralized mortgage
obligation ("CMO") activity with agency industry-wide issuance down
approximately 40%. The decline in CMO activity was substantially offset by
higher secondary mortgage-backed securities activity levels. Also, the
steepening yield curve and favorable housing market experienced during the 2004
second quarter resulted in mortgage origination volume shifting to adjustable
rate mortgages, contributing to strong non-agency CMO activity. These factors
led to the industry's continued solid performance in the second quarter of
fiscal 2004.
Weak global and US economic conditions characterized the business environment
during the second quarter of fiscal 2003. The lack of capital spending,
prolonged slump in the labor markets and high energy prices contributed to
difficult market conditions. The Federal Reserve Board met twice during the
fiscal quarter and kept the federal funds rate unchanged at 1.25%. At its May
2003 meeting, the Federal Reserve Board changed its economic bias to weakness,
citing that the balance of risks is
28
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
weighted toward economic weakness in the foreseeable future. However,
geopolitical tensions subsided during the second quarter of fiscal 2003. In
addition, there was growing sentiment that the economy and corporate profits
were strengthening and, as a result, consumer confidence increased during the
quarter. The major indices were all up for the quarter ended May 31, 2003. The
DJIA increased 12.2%, while the S&P 500 and the Nasdaq Composite Index increased
14.6% and 19.3%, respectively. Weak equity market conditions continued to
negatively impact equity-related businesses. Trading volumes on the exchanges
were mixed. Average daily trading volume on the NYSE increased 12.4%, while
average daily trading volume on the NASDAQ declined 10.1% from the quarter ended
May 31, 2002. Global and US announced merger and acquisition volumes remained at
low levels. However, the interest rate environment provided favorable conditions
for fixed income activities. A combination of low interest rates, a steep yield
curve and tightening of corporate credit spreads resulted in very strong demand
for domestic debt issuances and strong secondary market activity.
Mortgage-backed securities underwriting benefited from high levels of
residential mortgage refinancings.
Results of Operations
In the discussion to follow, results for the quarter ended May 31, 2004 will be
compared with the results for the quarter ended May 31, 2003 and results for the
six months ended May 31, 2004 will be compared with the results for the six
months ended May 31, 2003.
Three Months Ended May 31, 2004
Compared to Three Months Ended May 31, 2003
-------------------------------------------
The following table sets forth an overview of the Company's financial results:
Three Months Ended
--------------------------------
(in thousands, except per share amounts, May 31, May 31,
pre-tax profit margin and return on average common equity) 2004 2003
-------------------------------------------------------------------------------------------------------
Revenues, net of interest expense $ 1,723,538 $ 1,462,720
Income before provision for income tax $ 511,476 $ 428,130
Net Income $ 347,803 $ 280,411
Diluted earnings per share $ 2.49 $ 2.05
Pre-tax profit margin 29.7% 29.3%
Return on average common equity (annualized) 19.6% 19.7%
The Company reported net income of $347.8 million, or $2.49 per share (diluted),
for the quarter ended May 31, 2004 which represented an increase of 24.0% from
$280.4 million, or $2.05 per share (diluted), for the quarter ended May 31,
2003.
Revenues, net of interest expense ("net revenues") increased 17.8% to $1.72
billion for the quarter ended May 31, 2004 from $1.46 billion for the quarter
ended May 31, 2003, due to an increase in principal transactions revenues,
investment banking revenues, commission revenues and net interest revenues.
The Company's commission revenues were as follows:
Three Months Ended
-------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-------------------------------------------------------------------------
Institutional $ 155,791 $ 135,465 15.0%
Clearance 82,557 77,124 7.0%
Retail & other 68,802 55,093 24.9%
-------------------------------------------------------------------------
Total commissions $ 307,150 $ 267,682 14.7%
=========================================================================
Note: Certain prior period items have been reclassified within commission
revenues to conform to the current period's presentation.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Commission revenues for the 2004 quarter increased 14.7% to $307.2 million from
$267.7 million for the 2003 quarter. Institutional commissions increased 15.0%
to $155.8 million for the 2004 quarter from $135.5 million for the 2003 quarter.
The increase in institutional commissions is primarily due to increased trading
volumes as well as the impact of the consolidation of Bear Wagner Specialists,
LLC commencing in the first quarter of 2004. Clearance commissions increased
7.0% to $82.6 million for the 2004 quarter from $77.1 million for the 2003
quarter due primarily to increased levels of fully disclosed customer activity
resulting from an improvement in global equity market conditions. Retail and
other commissions increased 24.9% to $68.8 million in the 2004 quarter from
$55.1 million in the 2003 quarter due to an increase in individual customer
activity levels.
The Company's principal transactions revenues by reporting category were as
follows:
Three Months Ended
-----------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
------------------------------------------------------------------------------------------
Fixed income $ 678,705 $ 656,223 3.4%
Equities 93,684 42,945 118.1%
Derivative financial instruments 143,080 110,747 29.2%
------------------------------------------------------------------------------------------
Total principal transactions $ 915,469 $ 809,915 13.0%
==========================================================================================
Revenues from principal transactions for the 2004 quarter increased 13.0% to
$915.5 million from $809.9 million for the 2003 quarter, due to an increase in
the Company's equities activities, derivative financial instruments activities
and fixed income activities. Fixed income revenues increased 3.4% to $678.7
million for the 2004 quarter from $656.2 million for the 2003 quarter due
primarily to increases in the mortgage-backed securities and interest rate
products areas, partially offset by declines in the Company's credit products
business, particularly in the high yield and corporate bonds trading areas.
Mortgage-backed securities revenues achieved record levels primarily due to an
increase in the volume of non-agency CMOs and the secondary trading activities.
Revenues derived from equities activities increased 118.1% to $93.7 million
during the 2004 quarter from $42.9 million in the 2003 quarter, primarily due to
the impact of the consolidation of Bear Wagner Specialists, LLC. In addition,
international equities revenues increased during the 2004 quarter, as a result
of increased volumes triggered by increased investor confidence and improved
economic conditions in international markets. Revenues from derivative financial
instruments increased 29.2% to $143.1 million in the 2004 quarter from $110.7
million in the 2003 quarter, due to increases in fixed income derivatives and
foreign exchange trading activities as a result of the favorable market
environment.
The Company's investment banking revenues by reporting category were as follows:
Three Months Ended
-----------------------------------------------
(in thousands) May 31, May 31, % Increase /
2004 2003 (Decrease)
------------------------------------------------------------------------------------
Underwriting $ 130,594 $ 89,658 45.7%
Advisory services 89,640 78,604 14.0%
Merchant banking 41,330 44,288 (6.7)%
------------------------------------------------------------------------------------
Total investment banking $ 261,564 $ 212,550 23.1%
====================================================================================
Investment banking revenues increased 23.1% to $261.6 million for the 2004
quarter from $212.6 million for the 2003 quarter. Investment banking revenues
include fees earned for underwriting public and private offerings of fixed
income and equity securities and advising clients on mergers and acquisitions
and other services, and merchant banking revenues. Underwriting revenues
increased 45.7% to $130.6 million for the 2004 quarter from $89.7 million for
the 2003 quarter, reflecting an increase in equity underwriting due to increased
volume of new issue activity. Fixed income underwriting increased
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
marginally from the 2003 quarter as a result of improved high yield underwriting
revenues based on increased new issues volumes and market share. These increases
were partially offset by lower high grade underwriting revenues, reflecting the
impact of lower new issue activity. Advisory services revenues for the 2004
quarter increased 14.0% to $89.6 million from $78.6 million for the 2003 quarter
reflecting increased completed mergers and acquisitions activity. Merchant
banking revenues decreased 6.7% to $41.3 million for the 2004 quarter, compared
to $44.3 million for the 2003 quarter.
Net interest revenues (interest and dividend revenue less interest expense)
increased 17.1% to $158.2 million for the 2004 quarter, from $135.1 million for
the 2003 quarter. The increase in net interest revenues was primarily
attributable to higher levels of customer interest-bearing balances reflecting
improved US equity market conditions. Average customer margin debt balances
increased 18.2% to $46.7 billion for the 2004 quarter from $39.5 billion for the
2003 quarter. Average customer short balances increased 24.5% to $77.2 billion
for the 2004 quarter from $62.0 billion for the 2003 quarter and average stock
borrowed balances increased 22.5% to $58.7 billion for the 2004 quarter from
$47.9 billion for the 2003 quarter.
Non-Interest Expenses
The Company's non-interest expenses were as follows:
Three Months Ended
------------------------------------------------
May 31, May 31, %Increase
(in thousands) 2004 2003 (Decrease)
---------------------------------------------------------------------------------------------------------
Employee compensation and benefits $ 860,053 $ 692,181 24.3%
Floor brokerage, exchange and clearance fees 59,647 47,540 25.5%
Communications and technology 88,321 90,744 (2.7)%
Occupancy 34,768 33,088 5.1%
Advertising and market development 29,315 27,507 6.6%
Professional fees 42,370 28,995 46.1%
Other expenses 97,588 114,535 (14.8)%
---------------------------------------------------------------------------------------------------------
Total non-interest expenses $ 1,212,062 $ 1,034,590 17.2%
=========================================================================================================
Employee compensation and benefits includes the cost of salaries and benefits
and incentive compensation, including restricted stock and option awards.
Employee compensation and benefits increased 24.3% to $860.1 million for the
2004 quarter from $692.2 million for the 2003 quarter, primarily due to higher
discretionary compensation associated with the increase in net revenues.
Employee compensation and benefits as a percentage of net revenues was 49.9% for
the 2004 quarter compared to 47.3% for the 2003 quarter. Such second quarter
compensation to net revenue percentages brought six months ended May 31, 2004
and May 31, 2003 amounts to 49.5% and 48.7%, respectively. Full-time employees
remained relatively unchanged at 10,469 at May 31, 2004 from 10,472 at May 31,
2003.
Non-compensation expenses increased 2.8% to $352.0 million for the 2004 quarter
from $342.4 million for the 2003 quarter. Non-compensation expenses as a
percentage of net revenues decreased to 20.4% for the 2004 quarter, compared
with 23.4% for the 2003 quarter, which is attributable to a relatively stable
cost base combined with a significant increase in net revenues. The increase in
non-compensation expenses of 2.8% when compared to the comparable prior year
quarter reflects the consolidation of Bear Wagner Specialists, LLC.
Non-compensation expenses related to Bear Wagner Specialists, LLC amounted to
$24.5 million for the 2004 quarter. Excluding the impact of the consolidation of
Bear Wagner Specialists, LLC, non-compensation expenses declined 4.4% to $327.5
million in the 2004 quarter. Specifically, the decline in non-compensation
expenses, excluding specialist related costs, is primarily related to a
reduction in other expenses of $31.4 million, primarily attributable to a
reduction in litigation and litigation-related costs.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Partially offsetting these decreases was an increase in professional fees and
increased floor brokerage, exchange and clearance fees. CAP Plan related costs
decreased to $44.5 million for the 2004 quarter from $46.0 million in the
comparable prior year quarter. The Company achieved a pre-tax profit margin of
29.7% for the 2004 quarter versus 29.3% for the 2003 quarter.
The Company's effective tax rate decreased to 32.0% for the 2004 quarter
compared to 34.5% for the 2003 quarter.
Business Segments
The remainder of "Results of Operations" is presented on a business segment
basis. The Company's three business segments--Capital Markets, Global Clearing
Services and Wealth Management--are analyzed separately due to the distinct
nature of the products they provide and the clients they serve. Certain Capital
Markets products are distributed by the Wealth Management and Global Clearing
Services distribution networks, with the related revenues of such intersegment
services allocated to the respective segments. Certain reclassifications have
been made to prior period amounts to conform to the current period's
presentation, including the reclassification of certain revenues within the
Wealth Management segment from asset management to private client services.
The following segment operating results exclude certain unallocated revenues
(predominantly interest) as well as certain corporate administrative functions,
such as certain legal costs and costs related to the CAP Plan.
Capital Markets
Three Months Ended
----------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-----------------------------------------------------------------------------------------
Net revenues
Institutional equities $ 252,004 $ 189,346 33.1%
Fixed income 844,436 765,190 10.4%
Investment banking 254,872 223,439 14.1%
-----------------------------------------------------------------------------------------
Total net revenues $ 1,351,312 $ 1,177,975 14.7%
Pre-tax income $ 491,002 $ 483,971 1.5%
-----------------------------------------------------------------------------------------
The Capital Markets segment comprises the institutional equities, fixed income
and investment banking areas. The Capital Markets segment operates as a single
integrated unit that provides the sales, trading and origination effort for
various fixed income, equity and advisory products and services. Each of the
three businesses works in tandem to deliver these services to institutional and
corporate clients.
Institutional equities consists of research, sales and trading in areas such as
domestic and international equities, block trading, convertible bonds,
over-the-counter equities, equity derivatives, risk and convertible arbitrage
and through a majority-owned subsidiary, the NYSE, AMEX and International
Securities Exchange specialist activities. Fixed income includes sales, trading
and research provided to institutional clients across a variety of products such
as mortgage- and asset-backed securities, corporate and government bonds,
municipal bonds, high yield products, foreign exchange and interest rate and
credit derivatives. Investment banking provides services in capital raising,
strategic advice, mergers and acquisitions and merchant banking. Capital raising
encompasses the Company's underwriting of equity, investment-grade, municipal
and high yield debt products.
Net revenues for Capital Markets increased 14.7% to $1.4 billion for the 2004
quarter from $1.2 billion for the 2003 quarter. Pre-tax income for Capital
Markets increased 1.5% to $491.0 million for the 2004 quarter from $484.0
million for the 2003 quarter. Pre-tax profit margin was 36.3% for the 2004
quarter compared to 41.1% for the 2003 quarter.
Institutional equities net revenues for the 2004 quarter increased 33.1% to
$252.0 million from $189.3 million for the 2003 quarter. During the 2004
quarter, US equity market conditions showed improvement when compared to the
2003 quarter which stimulated activity across the Company's equity franchise. As
a result, institutional equities
32
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
commissions in the Company's US-listed and over-the-counter businesses
increased, reflecting increased trading volume and improved market share.
International equity sales and trading net revenues also increased
significantly, reflecting more favorable global equity market conditions and
increased customer order flow. Included within the Company's institutional
equities revenues for the 2004 quarter are the revenues of the Company's
majority-owned specialist subsidiary, Bear Wagner Specialists, LLC. These
results, which were consolidated beginning with the first quarter of 2004,
resulted in an increase in net revenues from specialist activities of
approximately $50 million over the 2003 quarter. These increases are partially
offset by lower levels of equity derivative and convertible arbitrage revenues
resulting from reduced customer activity along with lower equity market
volatility.
Fixed income net revenues increased 10.4% to $844.4 million for the 2004 quarter
from $765.2 million from the 2003 quarter, primarily reflecting strong results
from the Company's mortgage and interest rate product areas. The mortgage-backed
securities business achieved record levels of net revenues during the quarter
reflecting a significant increase in the volume of secondary trading activity.
In addition, despite the decline in mortgage origination volume caused by the
increase in interest rates, adjustable rate mortgage volumes increased
significantly due to the steepening yield curve. As a result, the Company's
non-agency CMO activity increased significantly. Secondary trading revenues also
increased due to higher levels of customer activity and the diminished supply of
new issue agency mortgage-backed securities. In addition, the Company's interest
rate businesses again achieved near record results on increased customer order
flow and a favorable market environment. In particular, interest rate
derivatives and foreign exchange businesses continued to deliver strong results
reflecting increased volatility levels, customer volumes and market share. These
results were partially offset by reduced net revenues from the Company's credit
businesses which decreased from the record results they achieved in the 2003
quarter.
Investment banking revenues increased 14.1% to $254.9 million for the 2004
quarter from $223.4 million for the 2003 quarter. Investment banking revenues
include fees earned for underwriting public and private offerings of fixed
income and equity securities and advising clients on mergers and acquisitions
and other services, and merchant banking revenues. Underwriting revenues
increased 32.1% to $140.2 million for the 2004 quarter from $106.2 million for
the 2003 quarter, reflecting an increase in equity underwriting due to increased
volume of secondary offerings and private placements. Fixed income underwriting
increased marginally from the 2003 quarter due to improved high yield
underwriting revenues based on increased new issues volumes and market share.
These increases were partially offset by lower high grade underwriting revenues,
reflecting the impact of reduced new issue activity. Advisory services revenues
for the 2004 quarter increased slightly to $73.3 million from $72.9 million for
the 2003 quarter reflecting an increase in advisory fees caused by increased
mergers and acquisitions activity. Merchant banking revenues decreased 6.7% to
$41.3 million for the 2004 quarter, compared to $44.3 million for the 2003
quarter.
Global Clearing Services
Three Months Ended
------------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-------------------------------------------------------------------------------------------
Net revenues $ 223,676 $ 187,405 19.4%
Pre-tax income $ 86,705 $ 37,798 129.4%
-------------------------------------------------------------------------------------------
The Global Clearing Services segment provides execution, clearing, margin
lending and securities borrowing to facilitate customer short sales to clearing
clients worldwide. Prime brokerage clients include hedge funds and clients of
money managers, short sellers, arbitrageurs and other professional investors.
Fully disclosed clients engage in either the retail or institutional brokerage
business. At May 31, 2004 and May 31, 2003, the Company held approximately $225
billion and $177 billion, respectively, in equity in Global Clearing Services
client accounts.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net revenues for Global Clearing Services increased 19.4% to $223.7 million for
the 2004 quarter from $187.4 million in the 2003 quarter. Commission revenues
increased 7.1% to $82.6 million for the 2004 quarter, from $77.1 million for the
2003 quarter reflecting increased levels of fully disclosed customer activity.
Net interest revenues increased 25.5% to $134.6 million for the 2004 quarter,
from $107.3 million for the 2003 quarter, primarily reflecting increased
customer margin and short sale balances. Pre-tax income increased 129.4% to
$86.7 million, from $37.8 million for the 2003 quarter, reflecting higher net
revenues and reduced expenses. Pre-tax profit margin was 38.8% for the 2004
quarter compared to 20.2% for the quarter ended May 31, 2003.
Average customer margin balances were $46.7 billion during the 2004 quarter
compared to $39.5 billion during the 2003 quarter. Customer margin balances
totaled $44.4 billion at May 31, 2004, an increase from $44.1 billion at May 31,
2003. Average customer short balances were $77.2 billion during the 2004 quarter
compared to $62.0 billion during the 2003 quarter and totaled $74.9 billion at
May 31, 2004, an increase from $66.2 billion at May 31, 2003. Average stock
borrowed balances were $58.7 billion during the 2004 quarter compared to $47.9
billion for the 2003 quarter and totaled $53.6 billion at May 31, 2004, an
increase from $48.6 billion at May 31, 2003. Average free credit balances were
$28.1 billion during the 2004 quarter compared to $19.3 billion during the 2003
quarter and totaled $28.8 billion at May 31, 2004, an increase from $20.4
billion at May 31, 2003.
Wealth Management
Three Months Ended
-----------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
------------------------------------------------------------------------------------------
Net revenues
Private Client Services $ 117,272 $ 91,142 28.7%
Asset Management 59,244 33,263 78.1%
------------------------------------------------------------------------------------------
Total net revenues $ 176,516 $ 124,405 41.9%
Pre-tax income $ 25,719 $ 4,948 419.8%
------------------------------------------------------------------------------------------
Note: Certain prior period items have been reclassified within the Wealth
Management segment to conform to the current period's presentation.
The Wealth Management segment is composed of the Private Client Services ("PCS")
and asset management areas. PCS provides high-net-worth individuals with an
institutional level of investment service, including access to the Company's
resources and professionals. At May 31, 2004, PCS has approximately 500 account
executives in its principal office, six regional offices and two international
offices. Asset management manages equity, fixed income and alternative assets
for corporate pension plans, public systems, endowments, foundations,
multi-employer plans, insurance companies, corporations, families and
high-net-worth individuals in the US and abroad.
Net revenues for Wealth Management increased 41.9% to $176.5 million for the
2004 quarter, from $124.4 million for the 2003 quarter. PCS revenues increased
28.7% to $117.3 million for the 2004 quarter from $91.1 million for the 2003
quarter reflecting increased levels of retail investor activity on improving US
equity markets as well as the continued expansion of the Company's PCS sales
force. Asset management revenues increased 78.1% to $59.2 million for the 2004
quarter, from $33.3 million for the 2003 quarter. This increase reflects the
sale of the mutual funds business to Dreyfus, resulting in an increase to net
revenues of approximately $22 million. In addition, asset management revenues
increased on higher management fees attributable to increased assets under
management in both traditional and alternative investment products. Pre-tax
income for Wealth Management increased 419.8% to $25.7 million in the 2004
quarter from $4.9 million for the 2003 quarter, reflecting higher net revenues.
The current quarter included approximately $7 million of non-recurring
transaction costs related to the mutual fund sale.
Assets under management were $27.3 billion at May 31, 2004, reflecting a 11.7%
increase from $24.4 billion in assets under management at May 31, 2003. Assets
under management include $6.2 billion of assets from alternative investment
products at May 31, 2004, an increase of 9.3% from $5.7 billion at May 31, 2003.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Six Months Ended May 31, 2004
Compared to Six Months Ended May 31, 2003
-----------------------------------------
The following table sets forth an overview of the Company's financial results:
Six Months Ended
-----------------------------------
(in thousands, except per share amounts, May 31, May 31,
pre-tax profit margin and return on average common equity) 2004 2003
----------------------------------------------------------------------------------------------------------
Revenues, net of interest expense $ 3,449,461 $ 2,978,154
Income before provision for income tax $ 1,042,454 $ 853,329
Net Income $ 708,868 $ 554,664
Diluted earnings per share $ 5.07 $ 4.05
Pre-tax profit margin 30.2% 28.7%
Return on average common equity (annualized) 20.5% 19.8%
The Company reported net income of $708.9 million, or $5.07 per share (diluted),
for the six months ended May 31, 2004 which represented an increase of 27.8%
from $554.7 million, or $4.05 per share (diluted), for the six months ended May
31, 2003.
Revenues, net of interest expense ("net revenues") increased 15.8% to $3.5
billion for the six months ended May 31, 2004 from $3.0 billion for the six
months ended May 31, 2003 due to increases in investment banking revenues,
principal transactions revenues, commission revenues and net interest revenues.
The Company's commission revenues were as follows:
Six Months Ended
---------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-------------------------------------------------------------------------
Institutional $318,817 $258,099 23.5%
Clearance 162,115 148,612 9.1%
Retail & other 134,321 102,886 30.6%
-------------------------------------------------------------------------
Total commissions $615,253 $509,597 20.7%
=========================================================================
Note: Certain prior period items have been reclassified within commission
revenues to conform to the current period's presentation.
Commission revenues for the six months ended May 31, 2004 increased 20.7% to
$615.3 million from $509.6 million for the 2003 quarter. Institutional
commissions increased 23.5% to $318.8 million for the 2004 period from $258.1
million for the 2003 period, primarily due to increased trading volumes as well
as the impact of the consolidation of Bear Wagner Specialists, LLC commencing
in the first quarter of 2004. Clearance commissions increased 9.1% to $162.1
million for the 2004 period from $148.6 million for the 2003 period due
primarily to increased levels of fully disclosed customer activity resulting
from an improvement in global equity market conditions. Retail and other
commissions increased 30.6% to $134.3 million in the 2004 period from $102.9
million in the 2003 period due to an increase in individual customer activity
levels.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's principal transactions revenues by reporting category were as
follows:
Six Months Ended
------------------------------------------------
May 31, May 31, % (Decrease)
(in thousands) 2004 2003 Increase
-------------------------------------------------------------------------------------------
Fixed income $ 1,352,256 $ 1,386,988 (2.5)%
Equities 215,716 133,340 61.8%
Derivative financial instruments 294,359 258,051 14.1%
-------------------------------------------------------------------------------------------
Total principal transactions $ 1,862,331 $ 1,778,379 4.7%
===========================================================================================
Revenues from principal transactions for the six months ended May 31, 2004
increased 4.7% to $1.9 billion from $1.8 billion for the six months ended May
31, 2003 quarter, due to increases in equities activities and derivative
financial instruments activities, partially offset by a decrease in fixed income
activities. Fixed income revenues decreased 2.5% to $1.35 billion during the
2004 period from $1.39 billion when compared to the same period in the prior
year. This decrease is largely due to reduced net revenues from the high yield
and corporate bonds areas which were adversely affected by wider credit spreads
and reduced volumes. This decrease was substantially offset by the increased net
revenues achieved in the mortgage-backed securities business with strong
performances across many sectors, particularly in the whole loans, adjustable
rate mortgage securities and the commercial securitization businesses. Revenues
derived from equities activities increased 61.8% to $215.7 million during the
2004 period from $133.3 million in the 2003 period primarily due to the impact
of the consolidation of Bear Wagner Specialists, LLC. In addition,
equities-related businesses, particularly the over-the-counter stock, risk
arbitrage and international equities revenues increased during the 2004 period,
as a result of higher average daily trading volumes and increased announced
mergers and acquisitions activity. These increases were partially offset by
decreased revenues in convertible and equity arbitrage due to decreased levels
of market volatility. Revenues from derivative financial instruments increased
14.1% to $294.4 million in the 2004 period from $258.1 million in the 2003
period, primarily due to increases in foreign exchange, credit derivatives and
fixed income derivatives activities as a result of the favorable market
environment.
The Company's investment banking revenues by reporting category were as follows:
Six Months Ended
-------------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
--------------------------------------------------------------------------------------------
Underwriting $ 291,529 $ 188,697 54.5%
Advisory services 186,409 153,803 21.2%
Merchant banking 44,036 37,633 17.0%
--------------------------------------------------------------------------------------------
Total investment banking $ 521,974 $ 380,133 37.3%
============================================================================================
Investment banking revenues increased 37.3% to $522.0 million for the six months
ended May 31, 2004 from $380.1 million for the six months ended May 31, 2003.
Investment banking revenues include fees earned for underwriting public and
private offerings of fixed income and equity securities and advising clients on
mergers and acquisitions and other services, and merchant banking revenues.
Underwriting revenues increased 54.5% to $291.5 million for the 2004 period from
$188.7 million for the 2003 period, reflecting an increase in equity
underwriting due to increased volume of new issue activity. High yield
underwriting revenues also improved significantly on increased new issue
activity. These increases were partially offset by reduced municipal
underwriting revenues, reflecting the impact of lower new issue activity.
Advisory services revenues for the 2004 period increased 21.2% to $186.4 million
from $153.8 million for the 2003 period reflecting increased completed mergers
and acquisitions activity. Merchant banking revenues increased 17.0% to $44.0
million for the 2004 period, compared to $37.6 million for the 2003 period.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net interest revenues (interest and dividend revenue less interest expense)
increased 31.0% to $323.2 million for the six months ended May 31, 2004, up from
$246.8 million for the six months ended May 31, 2003. The increase in net
interest revenues was primarily attributable to higher levels of customer
interest-bearing balances reflecting improved US equity market conditions.
Average customer margin debt balances increased 23.1% to $46.7 billion for the
2004 period from $37.9 billion for the 2003 period. Average customer short
balances increased 27.3% to $75.8 billion for the 2004 period from $59.5 billion
for the 2003 period and average stock borrowed balances increased 26.0% to $58.6
billion for the 2004 period from $46.5 billion for the 2003 period.
Non-Interest Expenses
The Company's non-interest expenses were as follows:
Six Months Ended
------------------------------------------------
May 31, May 31, % Increase
(in thousands) 2004 2003 (Decrease)
-------------------------------------------------------------------------------------------------------
Employee compensation and benefits $ 1,709,201 $ 1,450,070 17.9%
Floor brokerage, exchange and clearance fees 116,547 92,220 26.4%
Communications and technology 182,149 183,484 (0.7)%
Occupancy 68,383 68,031 0.5%
Advertising and market development 55,216 52,717 4.7%
Professional fees 84,170 57,448 46.5%
Other expenses 191,341 220,855 (13.4)%
-------------------------------------------------------------------------------------------------------
Total non-interest expenses $ 2,407,007 $ 2,124,825 13.3%
=======================================================================================================
Employee compensation and benefits includes the cost of salaries and benefits
and incentive compensation, including restricted stock and option awards.
Employee compensation and benefits increased 17.9% to $1.7 million for the six
months ended May 31, 2004 from $1.5 billion for the six months ended May 31,
2003, primarily due to higher discretionary compensation associated with the
increase in net revenues. Employee compensation and benefits as a percentage of
net revenues was 49.5% for the 2004 period compared to 48.7% for the 2003
period. Full-time employees decreased to 10,469 at May 31, 2004 from 10,472 at
May 31, 2003.
Non-compensation expenses increased 3.4% to $697.8 million for the six months
ended May 31, 2004 from $674.8 million for the six months ended May 31, 2003.
Non-compensation expenses as a percentage of net revenues decreased to 20.2% for
the 2004 period, compared with 22.7% for the 2003 period, which is attributable
to a relatively stable cost base combined with significantly increased net
revenues. The increase in non-compensation expenses of 3.4% when compared to the
comparable prior year period primarily reflects the consolidation of Bear Wagner
Specialists, LLC beginning in the first quarter of 2004. Non-compensation
expenses related to Bear Wagner Specialists, LLC amounted to approximately $50
million for the 2004 period. Excluding the impact of the consolidation of Bear
Wagner Specialists, LLC, non-compensation expenses declined 4.2% to $646.3
million in the 2004 period. The decline in non-compensation expenses is
primarily attributable to a decline in other expenses partially offset by
increases in professional fees and floor brokerage, exchange and clearance fees.
The decline in other expenses consisted of a $20.5 million charge for impairment
of goodwill associated with the Company's electronic options market making
business recorded in 2003 and reduced litigation and litigation-related expenses
in the current period. CAP Plan related costs were $88.5 million for the 2004
period, a decrease from $94.0 million in the comparable prior year period. The
Company achieved a pre-tax profit margin of 30.2% for the six months ended May
31, 2004 versus 28.7% for the six months ended May 31, 2003.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's effective tax rate decreased to 32.0% for the 2004 period compared
to 35.0% for the 2003 period.
Business Segments
Capital Markets
Six Months Ended
-----------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-----------------------------------------------------------------------------------
Net revenues
Institutional equities $ 549,404 $ 465,807 17.9%
Fixed income 1,666,704 1,556,407 7.1%
Investment banking 508,051 411,203 23.6%
-----------------------------------------------------------------------------------
Total net revenues $ 2,724,159 $ 2,433,417 11.9%
Pre-tax income $ 1,007,371 $ 949,890 6.1%
-----------------------------------------------------------------------------------
Net revenues for Capital Markets increased 11.9% to $2.7 billion for the six
months ended May 31, 2004 from $2.4 billion for the six months ended May 31,
2003. Pre-tax income for Capital Markets increased 6.1% to $1.0 billion for the
2004 period from $949.9 million for the 2003 period. Pre-tax profit margin was
37.0% for the 2004 period compared to 39.0% for the 2003 period.
Institutional equities net revenues for the six months ended May 31, 2004
increased 17.9% to $549.4 million from $465.8 million for the six months ended
May 31, 2003. During the 2004 period, market indices showed improvement when
compared to the 2003 period and average daily trading volumes increased on the
NYSE and Nasdaq. As a result, institutional equities commissions in the
Company's US-listed and over-the-counter businesses increased, reflecting
increased trading volume. International equity sales and trading net revenues
also increased significantly, reflecting more favorable global equity market
conditions and increased customer order flow. Risk arbitrage revenues improved,
reflecting a significant increase in the total value of announced mergers and
acquisitions activity. Included within the Company's institutional equities
revenues for the 2004 period are the revenues of the Company's majority-owned
specialist subsidiary, Bear Wagner Specialists, LLC. These results, which were
consolidated beginning with the first quarter of 2004, resulted in an increase
in net revenues from specialist activities of approximately $83 million over the
2003 period. A decline in customer activity levels and reduced market volatility
resulted in lower levels of equity derivative and convertible arbitrage
revenues.
Fixed income net revenues increased 7.1% to $1.7 billion for the six months
ended May 31, 2004 from $1.6 billion from the six months ended May 31, 2003,
primarily reflecting strong results from the Company's mortgage and interest
rate product areas. In particular, mortgage-backed securities, foreign exchange
and interest rate derivatives areas increased during the 2004 period when
compared to the prior year period. The mortgage-backed securities business
achieved record levels of net revenues during the period reflecting a
significant increase in the volume of secondary trading activity. In addition,
despite the decline in mortgage origination volume caused by the increase in
interest rates, adjustable rate mortgage volumes increased significantly due to
the steepening yield curve. As a result, the Company's non-agency CMO activity
increased significantly. In addition, the Company's interest rate businesses
achieved near record results on increased customer order flow and a favorable
market environment. In particular, the interest rate derivatives and foreign
exchange businesses continued to deliver strong results reflecting increased
volatility levels, customer volumes and market share. These results were
partially offset by a decrease in net revenues from the Company's credit
businesses from the strong results they achieved in the 2003 period.
Investment banking revenues increased 23.6% to $508.1 million for the six months
ended May 31, 2004 from $411.2 million for the six months ended May 31, 2003.
Investment banking revenues include fees earned for underwriting public and
private offerings of fixed income and equity securities and advising clients on
mergers and acquisitions and other services, and merchant banking revenues.
Underwriting revenues increased 32.3% to $305.5 million for the 2004 period from
$230.9 million for the 2003 period, reflecting an increase in
38
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
equity underwriting on strong new issue activity. High yield underwriting
revenues also improved significantly on strong new issue activity. These
increases were partially offset by reduced municipal underwriting revenues,
reflecting the impact of lower new issue activity. Advisory services revenues
for the 2004 period increased 11.1% to $158.5 million from $142.7 million for
the 2003 period reflecting an increase in US completed mergers and acquisitions
activity. Merchant banking revenues increased 17.2% to $44.0 million for the
2004 period, compared to $37.6 million for the 2003 period.
Global Clearing Services
Six Months Ended
---------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
-------------------------------------------------------------------------
Net revenues $ 441,290 $363,183 21.5%
Pre-tax income $ 165,207 $ 89,948 83.7%
-------------------------------------------------------------------------
Net revenues for Global Clearing Services increased 21.5% to $441.3 million for
the six months ended May 31, 2004 from $363.2 million for the six months ended
May 31, 2003. Commission revenues increased 9.1% to $162.1 million for the 2004
period, from $148.6 million for the 2003 period reflecting increased prime
broker and fully disclosed customer activity. Net interest revenues increased
28.7% to $267.7 million for the 2004 period, from $207.9 million for the 2003
period, primarily reflecting increased margin balances from prime brokerage and
fully disclosed clearance clients due to improving US equity market conditions.
Pre-tax income increased 83.7% to $165.2 million, from $89.9 million for the
2003 period, reflecting higher net revenues. Pre-tax profit margin was 37.4% for
the 2004 period compared to 24.8% for the period ended May 31, 2003.
Average customer margin balances were $46.7 billion during the 2004 period
compared to $37.9 billion during the 2003 period. Customer margin balances
totaled $44.4 billion at May 31, 2004, an increase from $44.1 billion at May 31,
2003. Average customer short balances were $75.8 billion during the 2004 period
compared to $59.5 billion during the 2003 period and totaled $74.9 billion at
May 31, 2004, an increase from $66.2 billion at May 31, 2003. Average stock
borrowed balances were $58.6 billion during the 2004 period compared to $46.5
billion for the 2003 period and totaled $53.6 billion at May 31, 2004, an
increase from $48.6 billion at May 31, 2003. Average free credit balances were
$27.3 billion during the 2004 period compared to $19.1 billion during the 2003
period and totaled $28.8 billion at May 31, 2004, an increase from $20.4 billion
at May 31, 2003.
Wealth Management
Six Months Ended
-------------------------------------------
May 31, May 31,
(in thousands) 2004 2003 % Increase
--------------------------------------------------------------------------------
Net revenues
Private Client Services $ 228,169 $ 175,295 30.2%
Asset Management 101,134 64,695 56.3%
--------------------------------------------------------------------------------
Total net revenues $ 329,303 $ 239,990 37.2%
Pre-tax income $ 46,586 $ 10,667 336.7%
--------------------------------------------------------------------------------
Note: Certain prior period items have been reclassified within the Wealth
Management segment to conform to the current period's presentation.
Net revenues for Wealth Management increased 37.2% to $329.3 million for the six
months ended May 31, 2004, from $240.0 million for the six months ended May 31,
2003. PCS revenues increased 30.2% to $228.2 million for the 2004 period from
$175.3 million for the 2003 period reflecting increased levels of retail
customer activity on improving US equity markets as well as the continued
expansion of the Company's PCS sales force. Asset management revenues increased
56.3% to $101.1 million for the 2004 period, from $64.7 million for the 2003
period. This increase reflects the sale of the mutual funds business to Dreyfus,
resulting in an increase to net revenues of approximately $22 million, higher
management fees attributable to increased assets under management in both
traditional and hedge fund products as well as improved performance fees on
alternative investment
39
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
products, principally hedge funds. Pre-tax income for Wealth Management
approximated $46.6 million in the 2004 period, a 336.7% increase compared to
pre-tax income of $10.7 million for the 2003 period, reflecting higher net
revenues. The current period includes approximately $7 million of non-recurring
transaction costs associated with the sale of the mutual fund business.
Liquidity and Capital Resources
Financial Leverage
------------------
Asset Composition
The Company's actual level of capital, capital requirements and thereby the
level of financial leverage, are a function of numerous variables, including
asset composition, rating agency/creditor perception, business prospects,
regulatory requirements, balance sheet liquidity, cost/availability of capital
and risk of loss. The Company consistently maintains a highly liquid balance
sheet, with the vast majority of the Company's assets consisting of cash,
marketable securities inventories and collateralized receivables arising from
customer-related and proprietary securities transactions.
Collateralized receivables consist of resale agreements secured predominantly by
US government and agency securities, customer margin loans and securities
borrowed, which are typically secured by marketable corporate debt and equity
securities. The nature of the Company's business as a securities dealer requires
it to carry significant levels of securities inventories to meet its customer
and proprietary trading needs. Additionally, the Company's role as a financial
intermediary for customer activities, which it conducts on a principal basis,
together with its customer-related activities in its clearance business, results
in significant levels of customer-related balances, including customer margin
debt, securities borrowed and repurchase activity. The Company's total assets
and financial leverage can and do fluctuate, depending largely on economic and
market conditions, volume of activity and customer demand.
The Company's total assets at May 31, 2004 increased to $241.6 billion from
$212.2 billion at November 30, 2003. The increase was primarily attributable to
increases in financial instruments owned, securities purchased under agreements
to resell and customer receivables, partially offset by a decrease in cash and
securities borrowed. The Company's total capital base, which consists of
long-term debt, preferred equity issued by subsidiaries and total stockholders'
equity, increased to $40.0 billion at May 31, 2004 from $37.5 billion at
November 30, 2003. This change was primarily due to an increase in equity
associated with net income and a net increase in long-term debt, partially
reduced by the redemption of preferred stock issued by a subsidiary, common
stock repurchases and cash dividends paid.
The amount of long-term debt, as well as total capital, that the Company
maintains is driven by a number of factors with particular focus on asset
composition. The Company's ability to support increases in total assets is a
function of its ability to obtain short-term secured and unsecured funding, as
well as its access to longer-term sources of capital (i.e., long-term debt and
equity). The Company regularly measures and monitors its total capital
requirements, which are primarily a function of the self-funding ability of its
assets. The equity portion of total capital is primarily a function of on- and
off-balance-sheet risks (i.e., market, credit and liquidity) and regulatory
capital requirements. As such, the liquidity and risk characteristics of assets
being held are especially decisive determinants of both total capital and the
equity portion thereof, thus significantly influencing the amount of leverage
that the Company can employ.
Given the nature of the Company's market-making and customer-financing activity,
the overall size of the balance sheet fluctuates from time to time. The
Company's total assets at quarter end are frequently lower than would be
observed on an average basis. At quarter end, the Company typically uses excess
cash to finance high-quality, highly liquid securities inventory that otherwise
would be funded via the repurchase agreement market. In addition, the Company
reduces its matched book repurchase and reverse repurchase activities at quarter
end. Finally, the Company may reduce the aggregate level of inventories through
ordinary course, open market activities in the most liquid portions of the
balance sheet, which are principally US government and agency securities and
agency mortgage pass-through securities. At May 31, 2004 and November 30, 2003,
total assets of $241.6 billion and $212.2 billion were approximately 6.4% and
10.1% lower than the average of the month-end balances observed over
40
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the trailing twelve-month period. Despite reduced total assets at quarter end,
the Company's overall market, credit and liquidity risk profile is not changed
materially, since the reduction in asset balances is predominantly in highly
liquid, short-term instruments that are financed on a secured basis. This
periodic reduction verifies the inherently liquid nature of the balance sheet
and provides consistency with respect to creditor constituents' evaluation of
the Company's financial condition.
Leverage Ratios
The following table presents total assets, adjusted assets, and net adjusted
assets with the resultant leverage ratios at May 31, 2004 and November 30, 2003.
With respect to a comparative measure of financial risk and capital adequacy,
the Company believes that the low-risk, collateralized nature of its resale,
securities borrowed and segregated cash assets renders net adjusted leverage as
the most relevant measure. The Company maintains a financial statement date
guideline for the net adjusted leverage ratio of no greater than 15.0, which the
Company continued to meet at May 31, 2004.
May 31, November 30,
(in billions, except ratios) 2004 2003
-------------------------------------------------------------
Total assets $ 241.6 $ 212.2
Adjusted assets (1) $ 176.2 $ 164.2
Net adjusted assets (2) $ 106.1 $ 90.9
Leverage ratio (3) 29.2 26.4
Adjusted leverage ratio (4) 21.3 20.4
Net adjusted leverage ratio(5) 12.8 11.3
-------------------------------------------------------------
(1) Adjusted assets is Total assets less securities purchased under agreements
to resell, securities received as collateral and cash and securities
deposited with clearing organizations or segregated in compliance with
federal regulations ("segregated cash").
(2) Net adjusted assets is Adjusted assets less securities borrowed.
(3) Leverage ratio equals Total assets divided by stockholders' equity and
preferred stock issued by subsidiaries.
(4) Adjusted leverage ratio equals Adjusted assets divided by stockholders'
equity and preferred stock issued by subsidiaries.
(5) Net adjusted leverage ratio equals Net adjusted assets divided by
stockholders' equity and preferred stock issued by subsidiaries.
Note: As of May 31, 2004, the leverage ratio, adjusted leverage ratio and net
adjusted leverage ratio equals total assets, adjusted assets and net
adjusted assets, respectively, divided by stockholders' equity and junior
subordinated debt issued to Bear Stearns Capital Trust III. The Company
views the junior subordinated debt issued to Bear Stearns Capital Trust
III as a component of its equity capital base given the equity-like
characteristics of the securities. The Company also receives rating agency
equity credit for these securities.
Funding Strategy & Liquidity Risk Management
--------------------------------------------
General Funding Strategy
The Company's general funding strategy seeks to ensure liquidity and diversity
of funding sources to meet the Company's financing needs at all times and in all
market environments. The Company attempts to finance its balance sheet by
maximizing, where economically competitive, its use of secured funding.
Short-term sources of cash consist principally of collateralized borrowings,
including repurchase transactions, sell/buy arrangements, securities lending
arrangements and customer free credit balances. Short-term unsecured funding
sources expose the Company to rollover risk, as providers of credit are not
obligated to refinance the instruments at maturity. Within this context, the
Company seeks to prudently manage its reliance on short-term unsecured
borrowings by maintaining an adequate total capital base and extensive use of
secured funding. Beyond this, the Company's emphasis on diversification by
product, geography, maturity and instrument seeks to further ensure prudent,
moderate usage of more credit-sensitive, potentially less stable funding.
Short-term unsecured funding includes commercial paper, medium-term notes and
bank borrowings, which generally have maturities ranging from overnight to one
year. Due to the collateralized nature of the borrowing, the Company views its
secured funding as inherently less credit sensitive and therefore a more stable
source of funding.
In addition to short-term funding sources, the Company utilizes equity and
long-term debt, including floating- and fixed-rate notes and medium-term notes
as longer-term sources of unsecured financing. The Company regularly monitors
and analyzes the size, composition and liquidity characteristics of its asset
base in the context of each asset's ability to be used to obtain secured
financing. This analysis results in a determination of the Company's
41
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
aggregate need for longer-term funding sources (i.e., long-term debt and
equity). The Company views long-term debt as a stable source of funding which
effectively strengthens its overall liquidity profile.
Alternative Funding Strategy
The Company maintains an alternative funding strategy focused on the liquidity
and self-funding ability of the underlying assets. The objective is to maintain
sufficient cash capital (i.e., equity plus long-term debt maturing in more than
twelve months) and funding sources to enable the Company to refinance
short-term, unsecured borrowings with fully secured borrowings. As such, the
Company is not reliant upon or contemplating forced balance sheet reduction to
endure a period of constrained funding availability. This underlying approach is
supported by maintenance of a formal contingency funding plan, which includes a
detailed delegation of authority and precise action steps for managing an
event-driven liquidity crisis. The plan identifies the crisis management team,
details an effective internal and external communication strategy, and
facilitates the greater information flow required to effect a rapid and
efficient transition to a secured funding environment.
As it relates to the alternative funding strategy discussed above, the Company
prepares an analysis that focuses on a 12-month time period and assumes that the
Company does not liquidate assets and cannot issue any new unsecured debt,
including commercial paper. In light of these assumptions, the Company monitors
its cash position and the borrowing value of unencumbered, unhypothecated
marketable securities in relation to its unsecured debt maturing over the next
12 months, striving to maintain the ratio of liquidity sources to maturing debt
at 100% or greater. Also within this strategy, the Company endeavors to maintain
cash capital in excess of that portion of its assets that cannot be funded on a
secured basis (i.e. positive net cash capital). These two measures, liquidity
ratio and net cash capital, are complementary and constitute the core elements
of the Company's alternative funding strategy and, consequently, its approach to
funding and liquidity risk management.
As of May 31, 2004, the market value of unencumbered, unhypothecated securities
owned by the Company was approximately $23.5 billion with a borrowing value of
$19.7 billion. The assets are comprised primarily of US government and agency
securities, mortgage-backed and asset-backed securities, investment-grade
corporate debt and US equities. The average advance rate on these different
asset types ranges from 70% to 98% and is based predominantly on committed,
secured facilities that the Company and its subsidiaries maintain in different
regions globally. The liquidity ratio (explained above) has averaged 205% over
the previous twelve months including unused committed unsecured bank credit and
194% excluding the unsecured portion of the Company's $3.4 billion committed
revolving credit facility. The firm's net cash capital position has averaged
just over $2.5 billion over the same twelve-month period.
In addition, the Company monitors the maturity profile of its unsecured debt to
minimize refinancing risk, maintains relationships with a broad global base of
debt investors and bank creditors, establishes and adheres to strict short-term
debt investor concentration limits, and periodically tests its secured and
unsecured committed credit facilities. The Company also maintains available
sources of short-term funding that exceed actual utilization, thus allowing it
to endure changes in investor appetite and credit capacity to hold the Company's
debt obligations. The Company has a general guideline of approximately no more
than 20% of its long-term debt portfolio maturing in any one year. As of May 31,
2004 the weighted average maturity of the firm's long-term debt was 4.0 years.
Committed Credit Facilities
The Company has a committed revolving credit facility ("Facility") totaling
$3.40 billion, which permits borrowing on a secured basis by Bear Stearns, BSSC,
BSIL and certain other subsidiaries. The Facility also provides that The Bear
Stearns Companies Inc. ("Parent Company") and BSIL may borrow up to $1.70
billion of the Facility on an unsecured basis. Secured borrowings can be
collateralized by both investment-grade and non-investment-grade financial
instruments as the Facility provides for defined margin levels on a wide range
of financial instruments eligible to be pledged. The Facility contains financial
covenants, the most significant of which require maintenance of specified levels
of stockholders' equity of the Company and net capital of BSSC. The facility
terminates in February 2005, with all loans outstanding at that date payable no
later than February 2006. There were no borrowings outstanding under the
Facility at May 31, 2004.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company has a $1.50 billion committed revolving securities repo facility
("Repo Facility"), which permits borrowings secured by a broad range of
collateral, under a repurchase arrangement, by BSIL, Bear Stearns International
Trading Limited ("BSIT") and BSB. The Repo Facility contains financial covenants
that require, among other things, maintenance of specified levels of
stockholders' equity of the Company. The Repo Facility terminates in August
2004, with all repos outstanding at that date payable no later than August 2005.
There were no borrowings outstanding under the Repo Facility at May 31, 2004.
The Company has a $350 million committed revolving credit facility ("Pan Asian
Facility"), which permits borrowing on a secured basis collateralized by foreign
securities at pre-specified advance rates. The Pan Asian Facility contains
financial covenants that require, among other things, maintenance of specified
levels of stockholders' equity of the Company and net capital of BSSC. The Pan
Asian Facility terminates in December 2004, with all loans outstanding at that
date payable no later than December 2005. There were no borrowings outstanding
under the Pan Asian Facility at May 31, 2004.
The Company also maintains a series of committed credit facilities to support
liquidity needs for the financing of non-investment-grade loans, auto loans,
residential mortgages, commercial mortgages and listed options. The facilities
are expected to be drawn from time to time and expire at various dates during
fiscal 2004. All of these facilities contain a term out option of one year or
more for borrowings outstanding at expiration. The banks providing these
facilities are committed to provide up to an aggregate of approximately $3.60
billion.
Capital Resources
-----------------
The Company conducts a substantial portion of its operating activities within
its regulated subsidiaries Bear Stearns, BSSC, BSIL, BSIT and BSB. The Company
also conducts significant activities through other wholly owned subsidiaries
including: Bear Stearns Global Lending Limited, Custodial Trust Company, Bear
Stearns Financial Products Inc., Bear Stearns Capital Markets Inc., EMC Mortgage
Corporation, Bear Stearns Mortgage Capital Corporation, Bear Stearns Credit
Products Inc. and Bear Stearns Forex Inc. In connection with these operating
activities, a substantial portion of the Company's long-term borrowings and
equity has been used to fund investments in, and advances to, these
subsidiaries, including subordinated debt advances. Within this funding
framework, the Company attempts to fund equity investments in subsidiaries with
equity from the Parent Company (i.e., utilize no equity double leverage). At May
31, 2004, the Parent Company's equity double leverage ratio was approximately
0.97 based on common equity and 0.91 including preferred equity. At November 30,
2003, these measures were 0.91 based on common equity and 0.84 including
preferred equity. Additionally, all subordinated debt advances to regulated
subsidiaries for use as regulatory capital are funded with long-term debt issued
by the Company that have maturities equal to or greater than the maturity of the
subordinated debt advance. The Company regularly monitors the nature and
significance of assets or activities conducted outside the regulated
subsidiaries and attempts to fund such assets with either capital or borrowings
having maturities consistent with the nature and self-funding ability of the
assets being financed.
Long-term debt totaling $26.9 billion and $24.6 billion had remaining maturities
beyond one year at May 31, 2004 and November 30, 2003, respectively. The
Company's access to external sources of financing, as well as the cost of that
financing, is dependent on various factors and could be adversely affected by a
deterioration of the Company's long- and short-term debt ratings, which are
influenced by a number of factors. These include, but are not limited to:
material changes in operating margins; earnings trends and volatility; the
prudence of funding and liquidity management practices; financial leverage on an
absolute basis or relative to peers; the composition of the balance sheet and/or
capital structure; geographic and business diversification; and the Company's
market share and competitive position in the business segments in which it
operates. Material deterioration in any one or a combination of these factors
could result in a downgrade of the Company's credit ratings, thus increasing the
cost of and/or limiting the availability of unsecured financing. Additionally, a
reduction in the Company's credit ratings could also trigger incremental
collateral requirements, predominantly in the over-the-counter derivatives
market. As of May 31, 2004, a downgrade by either Moody's Investors Service or
Standard & Poor's to the Company's long-term ratings to the level of A3 or A-
would have required the Company to post approximately $1.1 billion in additional
collateral for outstanding over-the-counter derivatives contracts.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At May 31, 2004, the Company's long-term/short-term debt ratings were as
follows:
Rating
------------------------------------------------------------------------------
Dominion Bond Rating Service Limited(1) A(high)/R-1 (middle)
Fitch A+/F1+
Moody's Investors Service(2) A1/P-1
Rating & Investment Information, Inc. A+/nr
Standard & Poor's A/A-1
------------------------------------------------------------------------------
nr - does not assign a short-term rating
(1) On August 26, 2003, Dominion Bond Rating Service Limited upgraded the
Company's long-term debt ratings from "A" to "A (high)" with a "stable" trend,
while simultaneously affirming the Company's short-term credit ratings.
(2) On October 22, 2003, Moody's Investors Service raised the Company's
long-term debt ratings from A2 to A1 placing a "stable" outlook at the higher
rating level, while simultaneously affirming the Company's short-term credit
ratings.
Stock Repurchase Program
------------------------
The Company has various employee stock compensation plans designed to increase
the emphasis on stock-based incentive compensation and align the compensation of
its key employees with the long-term interests of stockholders. Such plans
provide for annual grants of stock units and stock options. The Company intends
to offset the potentially dilutive impact of the annual grants by purchasing
common stock throughout the year in open market and private transactions. On
January 7, 2004, the Board of Directors of the Company approved an amendment to
the Stock Repurchase Program ("Repurchase Program") to replenish the previous
authorizations to allow the Company to purchase up to $1.0 billion of common
stock in fiscal 2004 or beyond. During the quarter ended May 31, 2004, the
Company purchased under the current authorization a total of 1,753,457 shares at
a cost of approximately $140.5 million. Approximately $852.1 million remains
available to be purchased under the current authorization as of May 31, 2004.
During the quarter ended May 31, 2004, the Company purchased a total of 508,329
shares of its common stock at a total cost of approximately $42.2 million
pursuant to a $200 million CAP Plan Earnings Purchase Authorization, which was
approved by the Compensation Committee of the Board of Directors of the Company
on November 24, 2003. Approximately $114.9 million remains available to be
purchased under the current authorization as of May 31, 2004.
Cash Flows
----------
Cash and cash equivalents during the six month period ended May 31, 2004
decreased $1.9 billion to $2.0 billion. Cash used in operating activities was
$1.3 billion, primarily attributable to increases in securities purchased under
agreements to resell and financial instruments owned, which occurred in the
normal course of business as a result of changes in customer needs, market
conditions and trading strategies. These results were partially offset by
increases in payables to customers, securities sold under agreements to
repurchase and financial instruments sold but not yet purchased. Cash used in
investing activities of $0.1 billion primarily reflected net purchases of
investment securities and other assets in connection with the Company's merchant
banking activities and purchases of property, equipment and leasehold
improvements. Cash used in financing activities of $0.5 billion reflected the
repayment of long-term borrowings, the redemption of preferred stock and net
payments relating to short-term borrowings significantly offset by net proceeds
from issuances of long-term borrowings used primarily to fund normal operating
activities.
Regulated Subsidiaries
----------------------
As registered broker-dealers, Bear Stearns and BSSC are subject to the net
capital requirements of the Securities Exchange Act of 1934, as amended, the
NYSE and the Commodity Futures Trading Commission, which are designed to measure
the general financial soundness and liquidity of broker-dealers. BSIL and BSIT,
London-based broker-dealer subsidiaries, are subject to the regulatory capital
requirements of the Financial Services Authority. Additionally, BSB is subject
to the regulatory capital requirements of the Irish Financial Services
Regulatory
44
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Authority. At May 31, 2004, Bear Stearns, BSSC, BSIL, BSIT and BSB were in
compliance with their respective regulatory capital requirements.
Merchant Banking and Private Equity Investments
-----------------------------------------------
At May 31, 2004, the Company held investments in eight transactions with an
aggregate recorded value of approximately $38.9 million, reflected in the
Condensed Consolidated Statements of Financial Condition in "Other Assets." Six
transactions are private principal investments aggregating $30.7 million at May
31, 2004. Two transactions are principal investments in public entities,
aggregating $8.2 million at May 31, 2004. At November 30, 2003, the Company held
investments in eight leveraged transactions with an aggregate recorded value of
approximately $19.6 million. Five transactions were private principal
investments aggregating $11.0 million at November 30, 2003. Three transactions
were principal investments in public entities, aggregating $8.6 million at
November 30, 2003.
In connection with the Company's merchant banking activities, the Company had
investments in private equity-related investment funds aggregating $365.3
million and $333.7 million at May 31, 2004 and November 30, 2003. In addition to
the various direct and indirect principal investments, the Company has made
commitments to invest in private equity-related investments and partnerships
(see the summary table under "Commitments").
High Yield Positions
--------------------
As part of the Company's fixed income activities, it participates in the
underwriting, securitization and trading of non-investment-grade debt
securities, non-performing mortgage-related assets, non-investment-grade
commercial and leveraged loans and securities of companies that are the subject
of pending bankruptcy proceedings (collectively, "high yield positions"). Also
included in high yield positions is a portfolio of Chapter 13 and other credit
card receivables from individuals. Non-investment-grade debt securities have
been defined as non-investment-grade corporate debt, asset securitization
positions and emerging market debt rated BB+ or lower or equivalent ratings
recognized by credit rating agencies. At May 31, 2004 and November 30, 2003, the
Company held high yield positions approximating $5.3 billion and $5.0 billion,
respectively, substantially all of which are in "Financial Instruments Owned" in
the Condensed Consolidated Statements of Financial Condition, and $969.7 million
and $847.6 million, respectively, reflected in "Financial Instruments Sold, But
Not Yet Purchased" in the Condensed Consolidated Statements of Financial
Condition. Included in these amounts is a portfolio of non-performing
mortgage-related assets as well as a portfolio of Chapter 13 and other credit
card receivables jointly aggregating $1.5 billion at May 31, 2004 and November
30, 2003.
Included in the high yield positions are extensions of credit to highly
leveraged companies. At May 31, 2004 and November 30, 2003, the amount
outstanding to highly leveraged borrowers totaled $1.15 billion (gross position
of $1.17 billion less $25.0 million of associated hedges) and $902.8 million
(gross position of $922.8 million less $20.0 million of associated hedges),
respectively. The largest industry concentration was the telecommunications
industry, which approximated 25.4% at May 31, 2004 and 18.8% at November 30,
2003, of these high yield positions. Additionally, the Company has lending
commitments with these non-investment-grade borrowers (see the summary table
under "Commitments"). The Company also has exposure to non-investment-grade
counterparties through its trading-related derivative activities. These amounts,
net of collateral, were $106.4 million and $214.0 million at May 31, 2004 and
November 30, 2003, respectively.
The Company's Risk Management Department and senior trading managers monitor
exposure to market and credit risk for high yield positions and establish limits
for overall market exposure and concentrations of risk by individual issuer.
High yield positions generally involve greater risk than investment-grade debt
securities due to credit considerations, reduced liquidity of secondary trading
markets and increased vulnerability to changes in general economic conditions.
The level of the Company's high yield positions, and the impact of such
activities on the Company's results of operations, can fluctuate from period to
period as a result of customer demand and economic and market considerations.
45
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Contractual Obligations
-----------------------
The Company's contractual obligations, excluding derivative financial
instruments, as of May 31, 2004:
Payments Due By Period
-----------------------------------------------------------------------------
Remaining Fiscal Fiscal
Fiscal 2005- 2007-
(in millions) 2004 2006 2008 Thereafter Total
-------------------------------------------------------------------------------------------------------------------
Long-term borrowings (1) $ 1,815 $ 12,439 $ 7,873 $ 9,840 $ 31,967
Future minimum lease payments (2) 24 102 97 204 427
-------------------------------------------------------------------------------------------------------------------
(1) Amounts include fair value adjustment in accordance with SFAS No. 133 as
well as $262.5 million of junior subordinated deferrable interest
debentures (see Note 11 in the Notes to Condensed Consolidated Financial
Statements).
(2) Includes 383 Madison Avenue in New York City.
Commitments
-----------
The Company's commitments (1) as of May 31, 2004:
Amount of Commitment Expiration Per Period
-----------------------------------------------------------------------------
Remaining Fiscal Fiscal
Fiscal 2005- 2007-
(in millions) 2004 2006 2008 Thereafter Total
--------------------------------------------------------------------------------------------------------------------------------
Commercial loan commitments: (2)
Investment-grade $ 1,020 $ 530 $ 367 $ 110 $ 2,027
Non-investment grade 164 431 279 440 1,314
Commitments to invest in private equity-related
investments and partnerships (3) 435
Underwriting commitments 650 -- -- -- 650
Commercial and residential loans 566 1,399 -- -- 1,965
Letters of credit 3,062 77 75 -- 3,214
Other (4) 53 94 3 -- 182
--------------------------------------------------------------------------------------------------------------------------------
(1) See Note 4, "Commitments and Contingencies," in the Notes to Condensed
Consolidated Financial Statements.
(2) Commitments are shown gross of associated hedges of $740.3 million for
investment-grade borrowers.
(3) At May 31, 2004, commitments to invest in private equity-related
investments and partnerships aggregated $435 million. These commitments
will be funded, if called, through the end of the respective investment
periods, the longest of such periods ending in 2013.
(4) Includes $32 million of commitments with no stated maturity.
Critical Accounting Policies
The condensed consolidated financial statements of the Company are prepared in
conformity with accounting principles generally accepted in the United States of
America. These principles require management to make certain estimates and
assumptions which could materially affect reported amounts in the financial
statements (see Note 1, "Summary of Significant Accounting Policies," in the
Notes to Consolidated Financial Statements). Critical accounting policies are
those policies that are the most important to the financial statements and/or
those that require significant management judgment related to matters that are
uncertain.
Valuation of Financial Instruments
The Company has identified the valuation of financial instruments as a critical
accounting policy due to the complex nature of certain of its products, the
degree of judgment required to appropriately value these products and the
pervasive impact of such valuation on the financial condition and earnings of
the Company.
The Company's financial instruments can be aggregated in three broad categories:
(1) those whose fair value is based on quoted market prices or for which the
Company has independent external valuations, (2) those whose fair
46
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
value is determined based on readily observable price levels for similar
instruments and/or models or methodologies that employ data that are observable
from objective sources, and (3) those whose fair value is estimated based on
internally developed models or methodologies utilizing significant assumptions
or other data that are generally less readily observable from objective sources.
(1) Financial Instruments Valued Based on Quoted Market Prices or for Which the
Company Has Independent External Valuations
The Company's valuation policy is to use quoted market prices from securities
and derivatives exchanges where they are available and reliable. Financial
instruments valued based on quoted market prices are primarily exchange-traded
derivatives and listed equities. Financial instruments that are most typically
valued using alternative approaches but for which the Company typically receives
independent external valuation information include US treasuries, most
mortgage-backed securities and corporate, emerging market, high yield and
municipal bonds. Unlike most equities, which tend to be traded on exchanges, the
vast majority of fixed income trading (including US treasuries) occurs in
over-the-counter markets, and, accordingly, the Company's valuation policy is
based on its best estimate of the prices at which these financial instruments
trade in those markets. The Company is an active dealer in most of the
over-the-counter markets for these financial instruments, and typically has
considerable insight into the trading level of financial instruments held in
inventory and/or related financial instruments that it uses as a basis for its
valuation.
(2) Financial Instruments Whose Fair Value Is Determined Based on Internally
Developed Models or Methodologies That Employ Data That Are Readily Observable
from Objective Sources
The second broad category consists of financial instruments for which the
Company does not receive quoted prices; therefore, models or other methodologies
are utilized to value these financial instruments. Such models are primarily
industry-standard models that consider various assumptions, including time
value, yield curve, volatility factors, prepayment speeds, default rates, loss
severity, current market and contractual prices for the underlying financial
instruments, as well as other relevant economic measures. Substantially all
these assumptions are observable in the marketplace, can be derived from
observable data or are supported by observable levels at which transactions are
executed in the marketplace. A degree of subjectivity is required to determine
appropriate models or methodologies as well as appropriate underlying
assumptions. This subjectivity makes these valuations inherently less reliable
than quoted market prices. Financial instruments in this category include
non-exchange-traded derivatives such as interest rate swaps, certain
mortgage-backed securities and certain other cash instruments. For an indication
of the Company's involvement in derivatives, including maturity terms, see the
table setting forth notional contract amounts outstanding in the preceding
"Derivative Financial Instruments" section.
(3) Financial Instruments Whose Fair Value Is Estimated Based on Internally
Developed Models or Methodologies Utilizing Significant Assumptions or Other
Data That Are Generally Less Readily Observable from Objective Sources
Certain complex financial instruments and other investments have significant
data inputs that cannot be validated by reference to readily observable data.
These instruments are typically illiquid, long-dated or unique in nature and
therefore engender considerable judgment by traders and their management who, as
dealers in many of these instruments, have the appropriate knowledge to estimate
data inputs that are less readily observable. For certain instruments,
extrapolation or other methods are applied to observed market or other data to
estimate assumptions that are not observable. At May 31, 2004 and November 30,
2003, such positions (primarily fixed income cash positions) aggregated
approximately $3.2 billion and $3.4 billion, respectively, in "Financial
Instruments Owned" and $1.1 billion and $740 million, respectively, in
"Financial Instruments Sold, But Not Yet Purchased" in the Condensed
Consolidated Statements of Financial Condition.
As part of the Company's fixed income activities, the Company participates in
the underwriting, securitization or trading of non-performing mortgage-related
assets, real estate assets and certain residuals. In addition, the Company has a
portfolio of Chapter 13 and other credit card receivables from individuals.
Certain of these high yield positions have limited price observability. In these
instances, fair values are determined by statistical analysis of historical
47
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
cash flows, default probabilities, recovery rates, time value of money and
discount rates considered appropriate given the level of risk in the instrument
and associated investor yield requirements.
As a major dealer in derivatives, the Company is engaged in structuring and
acting as principal in complex derivative transactions. Complex derivatives
include certain long-dated equity derivatives, certain credit and municipal
derivatives and other exotic derivative structures. These non-exchange-traded
instruments may have immature or limited markets and, by their nature, involve
complex valuation methodologies and models, which are often refined to correlate
with the market risk of these instruments.
Controls Over Valuation of Financial Instruments
In recognition of the importance the Company places on the accuracy of its
valuation of financial instruments as described in the three categories above,
the Company engages in an ongoing internal review of its valuations. Members of
the Controllers and Risk Management Departments perform analysis of internal
valuations, typically on a monthly basis but often on an intra-month basis as
well. These departments are independent of the trading areas responsible for
valuing the positions. Results of the monthly validation process are reported to
the Mark-to-Market (MTM) Committee, which is composed of senior management from
the Risk Management and Controllers Departments. The MTM Committee is
responsible for ensuring that the approaches used to independently validate the
Company's valuations are robust, comprehensive and effective. Typical approaches
include valuation comparisons with external sources, comparisons with observed
trading, independent comparisons of key model valuation inputs, independent
trade modeling and a variety of other techniques.
Merchant Banking
As part of its merchant banking activities, the Company participates from time
to time in principal investments in leveraged transactions. As part of these
activities, the Company originates, structures and invests in merger,
acquisition, restructuring and leveraged capital transactions, including
leveraged buyouts. The Company's principal investments in these transactions are
generally made in the form of equity investments, equity-related investments or
subordinated loans and have not historically required significant levels of
capital investment.
Equity securities acquired as a result of leveraged acquisition transactions are
reflected in the consolidated financial statements at their initial cost until
significant transactions or developments indicate that a change in the carrying
value of the securities is appropriate. Generally, the carrying values of these
securities will be increased only in those instances where market values are
readily ascertainable by reference to substantial transactions occurring in the
marketplace or quoted market prices. Reductions to the carrying value of these
securities are made in the event that the Company's estimate of net realizable
value has declined below the carrying value. See "Merchant Banking Investments"
in Management's Discussion and Analysis for additional details.
Off-Balance-Sheet Arrangements
In the normal course of business, the Company enters into arrangements with
special-purpose entities ("SPEs"), also known as variable interest entities
("VIEs"). SPEs are corporations, trusts or partnerships which are established
for a limited purpose. SPEs, by their nature, generally are not controlled by
their equity owners, as the establishing documents govern all material
decisions. The Company's primary involvement with SPEs relates to securitization
transactions in which transferred assets, including commercial and residential
mortgages, consumer receivables, securities and other financial assets are sold
to an SPE and repackaged into securities or similar beneficial interests. SPEs
may also be used to create securities with a unique risk profile desired by
investors and as a means of intermediating financial risk. The Company, in the
normal course of business may establish SPEs, sell assets to SPEs, underwrite,
distribute, and make a market in securities or other beneficial interests issued
by SPEs, transact derivatives with SPEs, own securities or other beneficial
interests, including residuals, in SPEs and provide liquidity or other
guarantees for SPEs.
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities--a Replacement of FASB Statement No. 125," to
account for securitizations and other transfers of financial assets. In
accordance with SFAS No. 140, the Company
48
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
accounts for transfers of financial assets as sales provided that control has
been relinquished. Control is deemed to be relinquished only when all of the
following conditions have been met: (1) the assets have been isolated from the
transferor, even in bankruptcy or other receivership; (2) the transferee is a
Qualifying Special Purpose Entity ("QSPE") or has the right to pledge or
exchange the assets received and (3) the transferor has not maintained effective
control over the transferred assets. Therefore, the Company derecognizes
financial assets transferred in securitizations provided that such transfer
meets all of these criteria. See Note 9, "Transfers of Financial Assets and
Liabilities," in the Notes to Condensed Consolidated Financial Statements for a
complete discussion of the Company's securitization activities.
Effective beginning with the quarter ended February 29, 2004, the Company
adopted Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51"
("FIN No. 46") or FIN No. 46 as revised ("FIN No. 46 (R)") for VIEs in which it
held a variable interest. The Company uses this guidance to determine whether an
SPE should be consolidated. See Note 10, "Consolidation of Variable Interest
Entities," in the Notes to Condensed Consolidated Financial Statements for a
complete discussion of the consolidation of VIEs.
The majority of the SPEs that the Company sponsors or transacts with are QSPEs,
which the Company does not consolidate in accordance with this guidance. QSPEs
are entities that have no discretionary activities and may only passively hold
assets and distribute cash generated by the assets they hold. The Company
reflects the fair value of its interests in QSPEs on its balance sheet but does
not recognize the assets or liabilities of QSPEs. QSPEs are employed extensively
in the Company's mortgage and asset securitization business.
Certain other SPEs do not meet the requirements of a QSPE, because their
activities are not sufficiently limited or they have entered into certain
non-qualifying transactions. The Company generally consolidates these entities
under FIN No. 46 if it owns a majority of the variable interests. These SPEs are
commonly employed in collateralized debt obligation transactions where portfolio
managers require the ability to buy and sell assets or in synthetic credit
transactions. These transactions typically involve no recourse to the Company.
In addition to the above, in the ordinary course of business the Company issues
various guarantees to counterparties in connection with certain derivative,
leasing, securitization and other transactions. See Note 5, "Guarantees," in the
Notes to Condensed Consolidated Financial Statements for a complete discussion
on guarantees.
Specialist Activities
The Company participates, through a majority-owned joint venture, in specialist
activities on the NYSE, AMEX and International Securities Exchange. Due to the
occurrence of a Control Event triggered in December 2003, the Company began
consolidating this entity. Included in the Condensed Consolidated Statements of
Financial Condition at May 31, 2004 are total assets of $1.8 billion, including
approximately $360 million of goodwill and identifiable intangible assets.
Effects of Inflation
The Company's assets are primarily recorded at their current market value and to
a large extent are liquid in nature. The rate of inflation affects the Company's
expenses, such as employee compensation, office leasing costs, information
technology and communications charges, which may not be readily recoverable in
the price of services offered by the Company. In addition, to the extent that
inflation causes interest rates to rise and has other adverse effects on the
securities markets and on the value of securities held in inventory, it may
adversely affect the Company's financial position and results of operations.
49
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
For a description of the Company's risk management policies, including a
discussion of the Company's primary market risk exposures, which include
interest rate risk, foreign exchange rate risk and equity price risk, as well as
a discussion of the Company's credit risk and a discussion of how those
exposures are managed, refer to the Company's Annual Report on Form 10-K for the
fiscal year ended November 30, 2003.
Value-at-Risk
An estimation of potential losses that could arise from changes in market
conditions is typically accomplished through the use of statistical models,
known as value-at-risk ("VaR"), that seeks to predict risk of loss based on
historical and/or market-implied price and volatility patterns. VaR estimates
the probability of the value of a financial instrument rising above or falling
below a specified amount. The calculation uses the simulated changes in value of
the market risk-sensitive financial instruments to estimate the amount of change
in the current value that could occur at a specified probability level.
The Company has performed an entity-wide VaR analysis of the Company's financial
assets and liabilities, including financial instruments owned and sold,
repurchase and resale agreements, and funding assets and liabilities. The
Company regularly evaluates and enhances such VaR models in an effort to more
accurately measure risk of loss. Certain equity-method investments and
non-publicly traded investments are not reflected in the VaR results. The VaR
related to certain non-trading financial instruments has been included in this
analysis and is not reported separately because the amounts are not material.
The calculation is based on a methodology that uses a one-day interval and a 95%
confidence level. Interest rate risk and equity price risk for most desks use a
historical simulation approach for VaR. Foreign exchange rate risk and for a
limited number of desks the interest rate risk, use a "Monte Carlo"
value-at-risk approach. Historical simulation involves the generation of price
movements in a portfolio using price sensitivities, and historical movements of
the underlying risk factors to which the securities are sensitive. Monte Carlo
simulation involves the generation of price movements in a portfolio using a
random number generator. The generation of random numbers is based on the
statistical properties of the securities in the portfolio. For interest rates,
each country's yield curve has five factors that describe possible curve
movements, where appropriate. These were generated from principal component
analysis. In addition, volatility and spread risk factors as well as
intercountry correlations were used, where appropriate.
VaR has inherent limitations, including reliance on historical data, which may
not accurately predict future market risk, and the quantitative risk information
generated is limited by the parameters established in creating the models. There
can be no assurance that actual losses occurring on any one day arising from
changes in market conditions will not exceed the VaR amounts shown below or that
such losses will not occur more than once in 20 days. However, the Company
believes VaR models are an appropriate methodology for comparison of risk
profiles across companies in the financial services industry.
The aggregate VaR presented below is less than the sum of the individual
components (i.e., interest rate risk, foreign exchange rate risk, equity risk)
due to the benefit of diversification among the risks. The following table
illustrates the VaR for each component of market risk as of May 31, 2004,
November 30, 2003 and May 31, 2003. Commodity risk has been excluded due to
immateriality at May 31, 2004, November 30, 2003 and May 31, 2003.
May 31, November 30, May 31,
(in millions) 2004 2003 2003
-----------------------------------------------------------------------------
MARKET RISK
Interest rate $ 16.3 $14.9 $13.1
Currency 1.4 0.9 1.1
Equity 2.7 3.7 4.2
Diversification benefit (3.8) (4.2) (4.6)
-----------------------------------------------------------------------------
Aggregate VaR $16.6 $15.3 $13.8
=============================================================================
50
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The table below illustrates the high, low and average (calculated on a monthly
basis) VaR for each component of market risk and aggregate market risk during
the 2004 quarter:
(in millions) High Low Average
-----------------------------------------------------------------------------
MARKET RISK
Interest rate $ 16.3 $ 14.6 $ 15.4
Currency 1.8 1.2 1.5
Equity 3.9 2.7 3.4
Aggregate VaR 16.6 15.0 15.9
-----------------------------------------------------------------------------
As previously discussed, the Company utilizes a wide variety of market risk
management methods, including trading limits; marking all positions to market on
a daily basis; daily profit and loss statements; position reports; daily risk
highlight reports; aged inventory position reports; and independent verification
of inventory pricing. Additionally, management of each trading department
reports positions, profits and losses and notable trading strategies to the Risk
Committee on a weekly basis. The Company believes that these procedures, which
stress timely communication between traders, trading department management and
senior management, are the most important elements of the risk management
process.
Stress testing (also referred to as scenario analysis) measures the risk of loss
over a variety of extreme market conditions that are defined in advance. Stress
testing is a key methodology used in the management of market risk as well as
counterparty credit risk (see "Derivatives Credit Risk" below). Stress tests are
calculated at the firmwide level, for particular trading books, for particular
customer accounts and for particular individual positions. Stress tests are
performed on a regular basis as well as on an ad hoc basis, as deemed
appropriate. The ongoing evaluation process of trading risks as well as the
consideration of new trading positions commonly incorporates an ad hoc
discussion of "what-if" stressed market conditions and their impact on
profitability. This analysis varies in its degree of formality based on the
judgment of trading department management, risk management and senior managers.
While the Company recognizes that no methodology can perfectly predict future
market conditions, it believes that these tools are an important supplement to
the Company's risk management process. The Company expects to continue to
develop and refine its formal stress testing methodologies.
The following charts represent a summary of the daily principal transactions
revenues and reflect a combination of trading revenues, net interest revenues
for certain trading areas and other revenues for the quarters ended May 31, 2004
and May 31, 2003, respectively. These charts represent a historical summary of
the results generated by the Company's trading activities as opposed to the
probability approach used by the VaR model. The average daily trading profit was
$14.3 million and $12.9 million for the quarters ended May 31, 2004 and May 31,
2003, respectively. During the quarter ended May 31, 2004, there were two days
with a reported trading loss and the trading losses on these days did not exceed
the reported aggregate period end VaR amount. There were no daily trading losses
for the quarter ended May 31, 2003. The frequency distribution of the Company's
daily net trading revenues reflects the Company's historical ability to manage
its exposure to market risk and the diversified nature of its trading
activities. No guarantee can be given regarding future net trading revenues or
future earnings volatility. The Company believes that these results are
indicative of its commitment to the management of market trading risk.
51
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
DISTRIBUTION OF DAILY NET TRADING REVENUES
Quarter Ended May 31, 2004
[The following table was depicted as a bar graph in the printed material.]
DAILY NET TRADING REVENUES NUMBER OF TRADING DAYS
-------------------------- ----------------------
($ in millions)
(10)+
(10)-(5)
(5)-0 2
0-5 11
5-10 11
10-15 13
15-20 14
20-25 4
25-30 4
30+ 5
Quarter Ended May 31, 2003
[The following table was depicted as a bar graph in the printed material.]
DAILY NET TRADING REVENUES NUMBER OF TRADING DAYS
-------------------------- ----------------------
($ in millions)
(10)+
(10)-(5)
(5)-0
0-5 9
5-10 18
10-15 18
15-20 6
20-25 7
25-30 2
30+ 3
52
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Derivatives Credit Risk
Derivative financial instruments represent contractual commitments between
counterparties that derive their value from changes in an underlying interest
rate, currency exchange rate, index (e.g., Standard & Poor's 500 Index),
reference rate (e.g., London Interbank Offered Rate "LIBOR"), or asset value
referenced in the related contract. Some derivatives, such as futures contracts,
certain options and indexed referenced warrants, can be traded on an exchange.
Other derivatives, such as interest rate and currency swaps, caps, floors,
collars, swaptions, equity swaps and options, credit derivatives, structured
notes and forward contracts, are negotiated in the over-the-counter markets.
Derivatives generate both on- and off-balance-sheet risks depending on the
nature of the contract. The Company is engaged as a dealer in over-the-counter
derivatives and, accordingly, enters into transactions involving derivative
instruments as part of its customer-related and proprietary trading activities.
The Company's dealer activities require it to make markets and trade a variety
of derivative instruments. In connection with these activities, the Company
attempts to mitigate its exposure to market risk by entering into hedging
transactions which may include over-the-counter derivative contracts or the
purchase or sale of interest-bearing securities, equity securities, financial
futures and forward contracts. In this regard, the utilization of derivative
instruments is designed to reduce or mitigate market risks associated with
holding dealer inventories or in connection with arbitrage-related trading
activities. The Company also utilizes interest rate and currency swaps as well
as futures contracts and US treasury positions to hedge its debt issuances as
part of its asset and liability management.
Credit risk arises from the potential inability of counterparties to perform in
accordance with the terms of the contract. At any point in time, the Company's
exposure to credit risk associated with counterparty non-performance is
generally limited to the net replacement cost of over-the-counter contracts net
of the value of collateral held. Such financial instruments are reported at fair
value on a net-by-counterparty basis pursuant to enforceable netting agreements.
Exchange-traded financial instruments, such as futures and options, generally do
not give rise to significant unsecured counterparty exposure due to the
Company's margin requirements, which may be greater than those prescribed by the
individual exchanges. Options written generally do not give rise to counterparty
credit risk since they obligate the Company (not its counterparty) to perform.
The Company has controls in place to monitor credit exposures by assessing the
future creditworthiness of counterparties and limiting transactions with
specific counterparties. The Company also seeks to control credit risk by
following an established credit approval process, monitoring credit limits and
requiring collateral where appropriate.
53
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The following table summarizes the counterparty credit quality of the Company's
exposure with respect to over-the-counter derivatives (including foreign
exchange and forward-settling mortgage transactions) as of May 31, 2004:
Over-the-Counter Derivative Credit Exposure (1)
($ in millions)
Percentage of
Exposure, Exposure, Net
Rating (2) Exposure Collateral (3) Net of Collateral (4) of Collateral
---------------------------------------------------------------------------------------------
AAA $ 1,535 $ 509 $ 1,088 29%
AA 2,363 1,293 1,188 31%
A 1,418 661 928 24%
BBB 401 489 225 6%
BB and lower 956 1,795 387 10%
Non-rated 54 12 3 0%
---------------------------------------------------------------------------------------------
(1) Excluded are covered transactions structured to ensure that the
market values of collateral will at all times equal or exceed the
related exposures. The net exposure for these transactions will,
under all circumstances, be zero.
(2) Internal counterparty credit ratings, as assigned by the Company's
Credit Department, converted to rating agency equivalents.
(3) For lower-rated counterparties, the Company generally receives
collateral in excess of the current market value of derivatives
contracts.
(4) In calculating exposure net of collateral, collateral amounts are
limited to the amount of current exposure for each counterparty.
Excess collateral is not applied to reduce exposure because such
excess in one counterparty portfolio cannot be applied to deficient
collateral in a different counterparty portfolio.
54
Item 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of its disclosure controls and procedures as of the end of the period covered by
this quarterly report. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were
effective as of the end of the period covered by this quarterly report. As
required by Rule 13a-15(d) under the Exchange Act, the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, has
evaluated the Company's internal control over financial reporting to determine
whether any changes occurred during the quarter covered by this quarterly report
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting. Based on that evaluation, there
has been no such change during the quarter covered by this quarterly report.
55
Part II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
David Shaev Profit Sharing Account F/B/O David Shaev v. James E. Cayne, et al.
------------------------------------------------------------------------------
As previously reported in the Company's Report on Form 10-K for the fiscal year
ended November 30, 2003 ("Form 10-K"), on or about May 22, 2003, the David Shaev
Profit Sharing Account F/B/O David Shaev commenced a purported shareholder
derivative action in the Supreme Court of the State of New York, County of New
York. On July 12, 2004, the Supreme Court of the State of New York dismissed the
complaint, which had named as defendants members of the Company's board of
directors and, as a nominal defendant, the Company.
IPO Allocation Securities and Antitrust Litigations
---------------------------------------------------
As previously reported in the Company's Form 10-K, the Company, along with many
other financial services firms, has been named as a defendant in many putative
class actions filed during 2001 and 2002 in the United States District Court for
the Southern District of New York involving the allocation of securities in
certain initial public offerings. In June 2004, plaintiffs and a substantial
number of the non-bankrupt issuer defendants and their officers and directors
jointly moved for preliminary approval of a proposed settlement among these
parties. The terms of the proposed settlement are complex but generally provide
that (1) the insurers of these issuers will guarantee an ultimate recovery by
plaintiffs, in this and related litigations, of $1 billion; (2) these issuers
will assign to plaintiffs so-called "excess compensation" claims against the
underwriter defendants, including Bear Stearns, that these issuers allegedly
possess; and (3) plaintiffs will, upon final approval of the settlement, dismiss
all claims against these issuers and the individual director and officer
defendants. To date, the Court has not yet ruled on the parties' motion seeking
preliminary approval.
IPO and Research Investigation
------------------------------
As previously reported in the Company's Form 10-K, Bear Stearns, among other
major brokerage firms, was the subject of an NASD industry-wide investigation
into certain initial public offering practices. On May 3, 2004, without
admitting or denying the allegations or findings and without an adjudication of
any issue of law or fact, Bear Stearns consented to a settlement with the NASD.
Pursuant to the settlement agreement, Bear Stearns agreed to a censure and the
payment of $450,000 as penalty and $4.5 million as disgorgement. On May 18,
2004, the NASD accepted the settlement.
Mutual Fund Matters: Inquiries and Investigations
-------------------------------------------------
As previously reported in the Company's Form 10-K, the Company and/or its
subsidiaries have received requests for information and subpoenas from a number
of federal and state agencies seeking information in connection with mutual fund
trading investigations, including the United States Attorney's Office for the
Southern District of New York, the SEC, the Commodity Futures Trading
Commission, the NASD, the NYSE, the Office of the New York Attorney General, and
the Office of the New Jersey Attorney General. With respect to the investigation
by the SEC, Bear, Stearns & Co. Inc. and Bear, Stearns Securities Corp. have
received a notice that the staff of the SEC is considering recommending that the
SEC bring a civil injunctive action and/or issue an administrative cease and
desist order against them. Such action could result in, among other things,
disgorgement, civil monetary penalties, and/or other remedial sanctions. The
Company and its subsidiaries are cooperating fully with all regulatory and law
enforcement agencies in connection with these matters.
Specialist Matters
------------------
As previously reported in the Company's Form 10-K, Bear Wagner Specialists, LLC
("Bear Wagner"), along with numerous other defendants, has been named in
purported class actions commenced in the United States District Court for the
Southern District of New York, on behalf of investors alleging violations of the
federal securities laws in connection with NYSE specialist activities. On May
27, 2004, the district court consolidated these purported class actions under
the caption In re NYSE Specialists Securities Litigation, No. 03 Civ. 8264
(RWS). A purported class action, naming Bear Wagner and the Company as
defendants, that was filed in December 2003 in California Superior Court, Los
Angeles County, alleging violations of California law in connection with the
NYSE specialist activities has recently been transferred to the United States
District Court for the Southern District of New York and it is anticipated this
case will soon be added to the consolidated proceedings referenced above.
------------------------
The Company also is involved from time to time in investigations and proceedings
by governmental agencies and self-regulatory organizations.
56
Item 2: CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
The following table provides information as of May 31, 2004 with respect to the
shares of common stock repurchased by the Company during the second quarter of
fiscal 2004:
Issuer Purchases of Equity Securities
------------------------------------------------------------------------------------------------------------------------------------
Approximate Dollar
Total Number of Shares Value of Shares that
Purchased as Part of May Yet Be Purchased
Total Number of Shares Average Price Paid per Publicly Announced Under the Plans or
Period Purchased Share Plans or Programs (1) Programs (1)
------------------------------------------------------------------------------------------------------------------------------------
3/1/04 - 3/31/04 170,582 $ 87.74 170,582 $ 1,134,990,588
4/1/04 - 4/30/04 598,097 82.72 598,097 1,085,515,073
5/1/04 - 5/31/04 1,493,107 79.36 1,493,107 967,024,335
---------------- ----------------
Total 2,261,786 80.88 2,261,786
================ ================
(1) On January 7, 2004, the Board of Directors of the Company approved an
amendment to the Repurchase Program to replenish the previous authorizations to
allow the Company to purchase up to $1.0 billion of common stock in fiscal 2004
or beyond. On November 24, 2003, the Compensation Committee of the Board of
Directors of the Company approved a $200 million CAP Plan Earnings Purchase
Authorization. The stock repurchase program has no set expiration or termination
date.
57
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of the Company held on March 31, 2004 (the "Annual
Meeting"), the stockholders of the Company approved an amendment to the
Company's Capital Accumulation Plan for Senior Managing Directors to set a
termination date of December 31, 2013, approved an amendment to the Stock Award
Plan to increase the number of shares of Common Stock available under the Stock
Award Plan from 35,000,000 to 40,000,000 shares and approved the Restricted
Stock Unit Plan, as amended. In addition, at the Annual Meeting the stockholders
of the Company elected eleven directors to serve until the next Annual Meeting
of Stockholders or until successors are duly elected and qualified and ratified
the appointment of Deloitte & Touche LLP as independent registered public
accounting firm for the fiscal year ending November 30, 2004.
The affirmative vote of a majority of the shares of common stock represented at
the Annual Meeting and entitled to vote was required for the approval of the
amendments to the Capital Accumulation Plan for Senior Managing Directors and
the Stock Award Plan, approval of the Restricted Stock Unit Plan, as amended,
and ratification of the independent registered public accounting firm, while the
affirmative vote of a plurality of the votes cast by holders of shares of common
stock was required to elect the directors.
With respect to the approval of the amendments to the Capital Accumulation Plan
for Senior Managing Directors and the Stock Award Plan, approval of the
Restricted Stock Unit Plan, as amended, and ratification of the independent
registered public accounting firm, set forth below is information on the results
of the votes cast at the Annual Meeting.
Broker
For Against Abstained Non-Votes
---------- ---------- --------- -----------
Amendment to the Capital
Accumulation Plan for Senior
Managing Directors 46,476,615 32,705,553 647,226 14,133,251
Amendment to the Stock
Award Plan 41,399,896 37,786,165 643,335 14,133,249
Approval of the Restricted Stock
Unit Plan, as amended 41,717,291 37,465,750 645,355 14,134,249
Ratification of the independent
registered public accounting firm 89,533,438 3,925,698 503,509 N/A
With respect to the election of directors, set forth below is information with
respect to the nominees elected as directors of the Company at the Annual
Meeting and the votes cast for and withheld with respect to each such nominee.
Nominees For Withheld
------------------------- -------------- --------------
James E. Cayne 89,189,270 4,773,375
Carl D. Glickman 86,152,103 7,810,542
Alan C. Greenberg 90,170,207 3,792,438
Donald J. Harrington 87,284,408 6,678,237
William L. Mack 91,384,256 2,578,389
Frank T. Nickell 87,735,838 6,226,807
Paul A. Novelly 90,377,993 3,584,652
Frederic V. Salerno 89,885,973 4,076,672
Alan D. Schwartz 90,151,832 3,810,813
Warren J. Spector 90,154,215 3,808,430
Vincent Tese 85,713,102 8,249,543
--------------------------------------------------------------
58
Item 5. OTHER INFORMATION
In accordance with Section 10A of the Securities Exchange Act of 1934, as
amended by Section 202 of the Sarbanes-Oxley Act of 2002, non-audit services
were approved by the Company's Audit Committee to be performed by Deloitte &
Touche LLP, the Company's independent registered public accounting firm,
principally relating to the following: 1) agreed upon procedures relating to (a)
securitization offerings and related periodic filings, (b) reports on internal
controls, and (c) compliance by Bear Stearns Financial Products Inc. with
certain contractual requirements; 2) readiness services in connection with
Section 404 of the Sarbanes-Oxley Act of 2002; 3) tax related services; 4)
issuance of comfort letters and consents relating to offerings of the Company's
own securities; 5) reviews of quarterly financial statements; 6) consulting
services with respect to client web-based technology (non-financial systems);
and 7) other accounting, attest and regulatory related services.
59
EXHIBITS AND REPORTS ON FORM 8-K
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10)(a) (1) Capital Accumulation Plan for Senior Managing Directors, amended and restated as of
October 28, 1999 and further amended as of March 31, 2004
(10) (a) (2) Capital Accumulation Plan for Senior Managing Directors, amended and restated
November 29, 2000 for Plan Years beginning on or after July 1, 1999, and further
amended as of March 31, 2004
(10) (a) (3) Stock Award Plan, amended and restated as of March 31, 2004
(10) (a) (4) Restricted Stock Unit Plan, amended and restated as of March 31, 2004
(11) Computation of Per Share Earnings. (The calculation of per share earnings is in Note 7,
"Earnings Per Share," of Notes to Condensed Consolidated Financial Statements
(Earnings Per Share) and is omitted here in accordance with Section (b) (11) of Item 601
of Regulation S-K)
(12) Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and
Preferred Stock Dividends
(15) Letter re: Unaudited Interim Financial Information
(31.1) Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d -14(a) of the
Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
(31.2) Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of the
Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
(32.1) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(32.2) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
During the quarter, the Company filed the following Current Reports on
Form 8-K.
(i) A Current Report on Form 8-K dated March 3, 2004 and filed on March 8,
2004, announcing its regular quarterly cash dividend on its outstanding
shares of Preferred Stock, Series E, F and G.
(ii) A Current Report on Form 8-K dated March 17, 2004 and filed on March 18,
2004 pertaining to the Company's results of operations for the three
months ended February 29, 2004.
(iii) A Current Report on Form 8-K dated March 18, 2004 and filed on March 23,
2004, pertaining to the form of Medium-Term Note, Series B (principal
protected notes linked to the Dow Jones Industrial Average due March 2011)
("DJIA Notes") issued by the Company, an opinion of Cadwalader, Wickersham
& Taft LLP as to certain federal income tax consequences in connection
with the offering of the DJIA Notes and a consent in connection with the
offering of the DJIA Notes.
(iv) A Current Report on Form 8-K dated March 18, 2004 and filed on March 25,
2004, an opinion of Cadwalader, Wickersham & Taft LLP as to the legality
of the 3.25% Global Notes due 2009 ("Global
60
EXHIBITS AND REPORTS ON FORM 8-K
Notes") issued by the Company, an opinion of Cadwalader, Wickersham & Taft
LLP as to certain federalincome tax consequences in connection with the
offering of the Global Notes and a consent in connection with the offering
of the Global Notes.
(v) A Current Report on Form 8-K dated April 1, 2004 and filed on April 2,
2004, announcing its regular quarterly cash dividend on its outstanding
shares of Common Stock.
(vi) A Current Report on Form 8-K dated May 25, 2004 and filed on May 28, 2004,
pertaining to the form of Medium-Term Note, Series B (principal protected
notes linked to the S&P 500 Index due November 2009) ("S&P 500 Notes")
issued by the Company, an opinion of Cadwalader, Wickersham & Taft LLP as
to certain federal income tax consequences in connection with the offering
of the S&P 500 Notes and a consent in connection with the offering of the
S&P 500 Notes.
61
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Bear Stearns Companies Inc.
-------------------------------
(Registrant)
Date: July 15, 2004 By: /s/ Jeffrey M. Farber
Jeffrey M. Farber
Controller
(Principal Accounting Officer)
62
THE BEAR STEARNS COMPANIES INC.
FORM 10-Q
EXHIBIT INDEX
Exhibit No. Description Page
----------- ----------- ----
(10) (a) (1) Capital Accumulation Plan for Senior Managing Directors, amended 64
and restated as of October 28, 1999, and further amended as of
March 31, 2004
(10) (a) (2) Capital Accumulation Plan for Senior Managing Directors, amended 98
and restated November 29, 2000 for Plan Years beginning on or
after July 1, 1999, and further amended as of March 31, 2004
(10) (a) (3) Stock Award Plan, amended and restated as of March 31, 2004 128
(10) (a) (4) Restricted Stock Unit Plan, amended and restated as of March 31, 136
2004
(12) Computation of Ratio of Earnings to Fixed Charges and to Combined 145
Fixed Charges and Preferred Stock Dividends
(15) Letter re: Unaudited Interim Financial Information 146
(31.1) Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) 147
or 15d -14(a) of the Securities Exchange Act of 1934, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(31.2) Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) 148
or 15d -14(a) of the Securities Exchange Act of 1934, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(32.1) Certification of Chief Executive Officer Pursuant to 18 U.S.C. 149
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(32.2) Certification of Chief Financial Officer Pursuant to 18 U.S.C. 150
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
63