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 February 28, 2005
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 April 7, 2005, the latest practicable date, there were 113,673,478
shares of Common Stock, $1 par value, outstanding.
TABLE OF CONTENTS
Page
Available Information 4
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income (Unaudited)
for the three months ended February 28, 2005 and February 29, 2004 5
Condensed Consolidated Statements of Financial Condition
as of February 28, 2005 (Unaudited) and November 30, 2004 (Audited) 6
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the three months ended February 28, 2005 and February 29, 2004 7
Notes to Condensed Consolidated Financial Statements (Unaudited) 8
Note 1 Summary of Significant Accounting Policies 8
Note 2 Financial Instruments 14
Note 3 Derivatives and Hedging Activities 15
Note 4 Transfers of Financial Assets and Liabilities 16
Note 5 Variable Interest Entities and Mortgage Loan Special
Purpose Entities 19
Note 6 Collateralized Financing Arrangements 20
Note 7 Earnings Per Share 21
Note 8 Regulatory Requirements 21
Note 9 Commitments and Contingencies 22
Note 10 Guarantees 24
Note 11 Segment Data 26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 29
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 30
Introduction 30
Certain Factors Affecting Results of Operations 30
Forward-Looking Statements 31
Executive Overview 31
Summary of Results 31
Business Environment 32
Results of Operations 33
Firmwide Results 33
Business Segments 35
Capital Markets 36
Global Clearing Services 37
Wealth Management 38
Liquidity and Capital Resources 38
Financial Leverage 38
Funding Strategy & Liquidity Risk Management 40
Capital Resources 42
2
Stock Repurchase Program 43
Cash Flows 43
Regulated Subsidiaries 44
Merchant Banking and Private Equity Investments 44
High Yield Positions 44
Contractual Obligations 45
Commitments 46
Off-Balance-Sheet Arrangements 46
Derivative Financial Instruments 47
Critical Accounting Policies 48
Valuation of Financial Instruments 48
Controls Over Valuation of Financial Instruments 49
Merchant Banking 50
Accounting and Reporting Developments 50
Effects of Inflation 51
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 52
Value-At-Risk 52
Distribution of Daily Net Trading Revenues 55
Credit Risk 56
Item 4. CONTROLS AND PROCEDURES 57
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 58
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES
AND USE OF PROCEEDS 60
Item 6. EXHIBITS 61
Signature 62
Exhibit Index 63
3
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. 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.
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 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.
4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Income
(Unaudited)
Three Months Ended
--------------------------------------------------------------------------------
February 28, February 29,
(in thousands, except share and per share data) 2005 2004
---------------------------
REVENUES
Commissions $ 297,377 $ 308,103
Principal transactions 960,364 946,862
Investment banking 271,618 260,410
Interest and dividends 1,021,619 520,464
Other income 71,391 45,606
---------------------------
Total revenues 2,622,369 2,081,445
Interest expense 784,709 355,522
---------------------------
Revenues, net of interest expense 1,837,660 1,725,923
---------------------------
NON-INTEREST EXPENSES
Employee compensation and benefits 906,775 849,148
Floor brokerage, exchange and clearance fees 57,318 56,900
Communications and technology 98,939 93,828
Occupancy 39,594 33,615
Advertising and market development 28,572 25,901
Professional fees 46,719 41,800
Other expenses 81,415 93,753
---------------------------
Total non-interest expenses 1,259,332 1,194,945
---------------------------
Income before provision for income taxes 578,328 530,978
Provision for income taxes 199,523 169,913
---------------------------
Net income $ 378,805 $ 361,065
===========================
Net income applicable to common shares $ 372,327 $ 353,646
===========================
Basic earnings per share $ 2.94 $ 2.88
Diluted earnings per share $ 2.64 $ 2.57
===========================
Weighted average common shares outstanding:
Basic 131,261,212 129,118,964
Diluted 149,193,402 147,108,483
===========================
Cash dividends declared per common share $ 0.25 $ 0.20
===========================
See Notes to Condensed Consolidated Financial Statements.
5
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Financial Condition
(Unaudited)
February 28 November 30,
(in thousands, except share data) 2005 2004
-------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 2,223,573 $ 4,173,385
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations 5,895,811 4,422,698
Securities purchased under agreements to resell 44,212,533 45,395,149
Securities received as collateral 8,941,293 8,823,117
Securities borrowed 72,095,896 69,793,266
Receivables:
Customers 35,659,729 32,114,305
Brokers, dealers and others 1,898,594 128,382
Interest and dividends 214,079 315,686
Financial instruments owned, at fair value
Pledged as collateral 14,249,657 36,906,933
Not pledged as collateral 68,581,633 44,296,167
Assets of variable interest entities and mortgage loan special
purpose entities 9,280,544 4,837,121
Property, equipment and leasehold improvements, net of accumulated
depreciation and amortization of $872,366 and $816,646 in 2005
and 2004, respectively 394,421 381,403
Other assets 4,781,311 4,362,282
------------------------------
Total Assets $ 268,429,074 $ 255,949,894
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 15,168,509 $ 12,210,832
Securities sold under agreements to repurchase 56,338,454 58,604,250
Obligation to return securities received as collateral 8,941,293 8,823,117
Securities loaned 13,004,585 10,718,592
Payables:
Customers 82,505,825 79,383,952
Brokers, dealers and others 2,775,934 2,344,731
Interest and dividends 536,869 568,525
Financial instruments sold, but not yet purchased, at fair value 29,037,921 29,475,880
Liabilities of variable interest entities and mortgage loan special
purpose entities 9,176,629 4,761,981
Accrued employee compensation and benefits 754,827 1,677,655
Other liabilities and accrued expenses 1,697,216 1,546,230
------------------------------
219,938,062 210,115,745
------------------------------
Commitments and contingencies (Note 9)
Long-term borrowings 38,972,114 36,843,277
------------------------------
STOCKHOLDERS' EQUITY
Preferred stock 442,938 448,148
Common stock, $1.00 par value; 500,000,000 shares authorized and
184,805,848 shares issued as of both February 28, 2005 and
November 30, 2004 184,806 184,806
Paid-in capital 3,819,521 3,548,379
Retained earnings 6,511,506 6,176,871
Employee stock compensation plans 2,221,301 2,666,879
Unearned compensation (136,603) (158,662)
Treasury stock, at cost:
Common stock: 71,594,514 and 81,018,928 shares as of February 28,
2005 and November 30, 2004, respectively (3,524,571) (3,875,549)
------------------------------
Total Stockholders' Equity 9,518,898 8,990,872
------------------------------
Total Liabilities and Stockholders' Equity $ 268,429,074 $ 255,949,894
==============================
See Notes to Condensed Consolidated Financial Statements.
Note: Certain prior year items have been reclassified to conform to the current
period's presentation.
6
THE BEAR STEARNS COMPANIES INC.
Condensed Consolidated Statements of
Cash Flows
(Unaudited)
Three Months Ended
---------------------------
February 28, February 29,
(in thousands) 2005 2004
------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 378,805 $ 361,065
Adjustments to reconcile net income to cash used in operating
activities:
Noncash items included in net income:
Depreciation and amortization 33,814 32,565
Deferred income taxes (25,415) (15,536)
Employee stock compensation plans 21,424 14,364
Other 1,848 2,354
Changes in operating assets and liabilities:
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations (1,473,114) 30,948
Securities borrowed, net of securities loaned (16,637) 1,660,859
Net receivables from customers (423,551) 2,593,084
Net receivables from brokers, dealers and others (1,449,353) 1,606,946
Financial instruments owned (1,735,560) (9,150,789)
Other assets (234,307) (101,722)
Securities sold under agreements to repurchase, net of securities
purchased under agreements to resell (1,083,180) (4,938,709)
Financial instruments sold, but not yet purchased (437,959) 6,027,274
Accrued employee compensation and benefits (927,756) (619,055)
Other liabilities and accrued expenses 378,378 280,606
---------------------------
Cash used in operating activities (6,992,563) (2,215,746)
---------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (46,832) (28,194)
---------------------------
Cash used in investing activities (46,832) (28,194)
---------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for) short-term borrowings 2,957,677 (942,522)
Net proceeds from issuance of long-term borrowings 3,950,471 3,356,788
Payments for retirement/repurchase of long-term borrowings (1,802,858) (1,831,578)
Proceeds from issuances of derivatives with a financing element, net 110,344 70,590
Issuance of common stock 81,063 99,978
Redemption of preferred stock (5,210) (40,963)
Redemption of preferred stock issued by a subsidiary -- (300,000)
Treasury stock purchases - common stock (166,102) (89,580)
Cash dividends paid (35,802) (28,448)
---------------------------
Cash provided by financing activities 5,089,583 294,265
---------------------------
Net decrease in cash and cash equivalents (1,949,812) (1,949,675)
Cash and cash equivalents, beginning of year 4,173,385 3,837,570
---------------------------
Cash and cash equivalents, end of period $ 2,223,573 $ 1,887,895
===========================
See Notes to Condensed Consolidated Financial Statements.
Note: Certain prior year items have been reclassified to conform to the current
period's presentation.
7
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. (the "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 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 comprises
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 comprises the private client services
("PCS") and asset management areas. See Note 11, "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.,
Bear Stearns Credit Products Inc., Bear Stearns Forex Inc., EMC Mortgage
Corporation and Bear Stearns Commercial Mortgage, Inc. The Company
participates, through a majority-owned joint venture, in specialist
activities on the New York Stock Exchange ("NYSE") and International
Securities Exchange ("ISE").
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 interest. In accordance with Financial
Accounting Standards Board ("FASB") Interpretation ("FIN") No. 46 (R),
"Consolidation of Variable Interest Entities" ("FIN No. 46 (R)"), 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 mortgage loan special purpose entities" and
"Liabilities of variable interest entities and mortgage loan special
purpose entities." See Note 5, "Consolidation of Variable Interest
Entities and Mortgage Loan Special Purpose Entities," in the Notes to
Condensed Consolidated Financial Statements.
When the Company does not have a controlling interest in an entity, but
exerts significant influence over the entity's operating and financial
decisions (generally defined as owning a voting or economic interest of
20% to 50%), the Company applies the equity method of accounting.
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 February 28, 2005, the Condensed
Consolidated Statements of Income for the three months ended February 28,
2005 and February 29, 2004 and the Condensed Consolidated Statements of
Cash Flows for the three months ended February 28, 2005 and February 29,
2004 are unaudited. The Condensed Consolidated Statement of Financial
Condition at November 30, 2004 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 together with the
Company's Annual Report on Form 10-K for the fiscal year ended November
30, 2004, filed by the Company under the Securities Exchange Act of 1934.
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
8
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
estimates and assumptions, including those regarding inventory valuations,
stock compensation, certain accrued liabilities and the potential outcome
of litigation and tax matters, 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 measurements.
The Company follows Emerging Issues Task Force ("EITF") Statement No.
02-3, "Issues Involved in Accounting for Derivative Contracts Held for
Trading Purposes and Contracts Involved in Energy Trading and Risk
Management Activities." This guidance generally eliminates the practice of
recognizing profit at the inception of a derivative contract unless the
fair value of the derivative is obtained from a quoted market price in an
active market or is otherwise evidenced by comparison to other observable
current market transactions or based on a valuation technique that
incorporates observable market data.
Equity interests and securities acquired as a result of private equity and
merchant banking activities are reflected in the condensed 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.
Derivative Instruments and Hedging Activities
The Company follows Statement of Financial Accounting Standards ("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 fair value, with changes in fair
value recorded in current earnings. Designated hedged items are marked for
the risk being hedged, with such changes recorded in current earnings.
9
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Customer Transactions
Customer securities transactions are recorded on the Condensed
Consolidated Statements of Financial Condition 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.
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 are recognized when control is established and derecognized
when control has been surrendered or the liability has been extinguished.
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.
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 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.
10
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Investment Banking and Advisory Services
Underwriting revenues and fees for mergers & acquisitions advisory
services are accrued when services for the transactions are substantially
completed. Transaction expenses are deferred until the related revenue is
recognized.
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 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."
Earnings Per Share
Earnings per share ("EPS") is computed in accordance with SFAS No. 128,
"Earnings Per Share" and Emerging Issues Task Force Statement No. 03-6,
"Participating Securities and the Two Class Method Under FASB Statement
No. 128, Earnings Per Share" ("EITF No. 03-6"). 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.
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.
11
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The cost related to stock-based compensation included in the determination
of net income for the three months ended February 28, 2005 and February
29, 2004 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.
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
--------------------------
February 28, February 29,
(in millions, except per share amounts) 2005 2004
--------------------------------------------------------------------
Net income, as reported $ 378.8 $ 361.1
Add: Stock-based employee compensation
plans expense included in reported net
income, net of related tax effect 12.2 8.2
Deduct: Total stock-based employee
compensation plans expense determined
under the fair value based method, net
of related tax effect (15.7) (16.4)
--------------------------------------------------------------------
Pro forma net income $ 375.3 $ 352.9
====================================================================
Earnings per share:
Basic - as reported $ 2.94 $ 2.88
Basic - pro forma $ 2.92 $ 2.81
Diluted - as reported $ 2.64 $ 2.57
Diluted - pro forma $ 2.62 $ 2.52
====================================================================
Statement of Cash Flows
For purposes of the Condensed Consolidated Statements of Cash Flows, the
Company has defined cash equivalents as liquid investments with original
maturities of three months or less. Cash payments for interest
approximated interest expense for the three months ended February 28, 2005
and February 29, 2004. Income taxes paid totaled $5.5 million and $53.2
million for the three months ended February 28, 2005 and February 29,
2004, respectively.
Income Taxes
The Company and certain of its subsidiaries file a US 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.
The Company is under continuous examination by various tax authorities in
jurisdictions in which the Company has significant business operations.
The Company regularly assesses the likelihood of additional assessments in
each of the tax jurisdictions resulting from these examinations. Tax
reserves have been established, which the Company believes to be adequate
in relation to the potential for additional assessments. Once established,
reserves are adjusted as information becomes available or when an event
requiring a change to the reserve occurs. The resolution of tax matters
could have an impact on the Company's effective tax rate.
12
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
Accounting and Reporting Developments
The American Jobs Creation Act ("the Act"), which was signed into law on
October 22, 2004, provides a temporary incentive for US companies to
repatriate accumulated foreign earnings. A corporation that is a US
shareholder of controlled foreign corporations may (subject to various
limitations) elect to deduct 85% of certain cash dividends that it
receives from those controlled foreign corporations during the election
year. The election year may be either the last taxable year beginning
before the date of enactment or the first taxable year beginning during
the one-year period starting on the date of enactment. With respect to the
Company, the election year could be either the fiscal year ended November
30, 2004 or the fiscal year ending November 30, 2005. Since the Act became
effective during the fourth quarter of the Company's fiscal year ended
November 30, 2004 and the US Treasury Department had not yet issued
necessary regulatory guidance with respect to these statutory provisions,
the Company was unable to evaluate the effects of the repatriation
provision with respect to any unrepatriated foreign earnings as of
November 30, 2004 and accordingly did not elect to remit qualifying cash
dividends for the November 30, 2004 fiscal year. For the fiscal year
ending November 30, 2005, the Company will complete its evaluation as soon
as Congress passes expected Technical Corrections to the Act and the US
Treasury issues final and complete guidance on these provisions. However,
if the Company decides to repatriate under these provisions, it does not
expect the income tax on such repatriation, if any, to be material.
In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment."
SFAS No. 123 (R) is a revision of SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
amends SFAS No. 95 "Statement of Cash Flows." SFAS No. 123 (R) eliminates
the ability to account for share-based compensation transactions using APB
Opinion No. 25 and requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the
financial statements using a fair value-based method. 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. SFAS No. 123
(R) is effective as of the beginning of the first interim period that
begins after June 15, 2005. The Company will adopt SFAS No. 123 (R) on
September 1, 2005, as required.
In March 2005, the SEC staff issued Staff Accounting Bulletin No. 107
("SAB No. 107") to provide guidance on SFAS No. 123 (R). SAB No. 107
provides the staff's view regarding the valuation of share-based payment
arrangements for public companies. In particular, this SAB provides
guidance related to share-based payment transactions with non-employees,
the transition from non public to public entity status, valuation methods
(including assumptions such as expected volatility and expected term), the
accounting for certain redeemable financial instruments issued under
share-based payment arrangements, the classification of compensation
expense, non-GAAP financial measures, first time adoption of SFAS No. 123
(R), the modification of employee share options prior to the adoption of
SFAS No. 123 (R) and disclosure in Management's Discussion and Analysis
subsequent to adoption of SFAS No. 123 (R). SAB No. 107 is effective March
29, 2005. The impact of SFAS No. 123 (R) and SAB No. 107 on the Company's
consolidated financial statements is currently being evaluated.
13
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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:
February 28, November 30,
(in thousands) 2005 2004
-------------------------------------------------------------------------
FINANCIAL INSTRUMENTS OWNED:
US government and agency $ 7,207,863 $ 6,043,204
Other sovereign governments 1,222,618 1,316,206
Corporate equity and convertible debt 16,474,396 15,788,681
Corporate debt and other 16,163,569 14,857,555
Mortgages, mortgage- and asset-backed 30,243,753 30,485,546
Derivative financial instruments 11,519,091 12,711,908
-------------------------------------------------------------------------
$82,831,290 $81,203,100
=========================================================================
FINANCIAL INSTRUMENTS SOLD, BUT NOT YET
PURCHASED:
US government and agency $ 9,723,395 $ 8,851,452
Other sovereign governments 1,154,612 1,240,916
Corporate equity and convertible debt 4,911,667 6,386,064
Corporate debt and other 3,012,924 2,896,233
Mortgages, mortgage- and asset-backed 238,116 428,909
Derivative financial instruments 9,997,207 9,672,306
-------------------------------------------------------------------------
$29,037,921 $29,475,880
=========================================================================
As of February 28, 2005 and November 30, 2004, all financial instruments
owned that were pledged to counterparties where the counterparty has the
right, by contract or custom, to rehypothecate those 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 purchase the specified financial instrument at the then
current market price. 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.
Concentration Risk
The Company is subject to concentration risk by holding large positions or
committing to hold large positions in certain types of securities,
securities of a single issuer (including governments), issuers located in
a particular country or geographic area, or issuers engaged in a
particular industry. Positions taken and commitments made by the Company,
including underwritings, often involve substantial amounts and significant
exposure to individual issuers and businesses, including
non-investment-grade issuers. At February 28, 2005, the Company's most
significant concentrations are related to US government and agency
inventory positions, including those of the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation. In addition, a
substantial portion of the collateral held by the Company for reverse
repurchase agreements consists of securities issued by the US government
and agencies.
14
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. DERIVATIVES AND HEDGING ACTIVITIES
The Company, in its capacity as a dealer in over-the-counter derivative
financial instruments and its proprietary market-making and trading
activities, enters into transactions in a variety of cash and derivative
financial instruments for proprietary trading and to manage its exposure
to market and credit risk. These risks include interest rate, exchange
rate and equity price risk. A derivative is defined as a financial
contract whose value is based on underlying reference interest rates,
currencies, commodities, market indices or securities. This includes
futures, forward, swap or option contracts, as well as caps, floors and
collars. Generally, these financial instruments represent commitments or
rights to exchange interest payment streams or currencies or to purchase
or sell other securities at specific terms at specified future dates.
Option contracts generally provide the holder with the right, but not the
obligation, to purchase or sell a financial instrument at a specific price
on or before an established date or dates. These financial instruments may
result in market and/or credit risk in excess of amounts recorded in the
Condensed Consolidated Statements of Financial Condition.
Market Risk
Derivative financial instruments involve varying degrees of
off-balance-sheet market risk whereby changes in the level or volatility
of interest rates, foreign currency exchange rates or market values of the
underlying financial instruments may result in changes in the value of the
financial instrument in excess of the amounts currently reflected in the
Condensed Consolidated Statements of Financial Condition. The Company's
exposure to market risk is influenced by a number of factors, including
the relationships among and between financial instruments with
off-balance-sheet risk, the Company's proprietary securities, futures and
derivatives inventories as well as the volatility and liquidity in the
markets in which the financial instruments are traded. In many cases, the
use of financial instruments serves to modify or offset market risk
associated with other transactions and, accordingly, serves to decrease
the Company's overall exposure to market risk. The Company attempts to
control its exposure to market risk through the use of hedging strategies
and various statistical monitoring techniques.
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 derivatives
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.
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
15
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
Non-Trading Derivatives Activity
To modify the interest rate characteristics of its long- and short-term
debt, the Company also engages in non-trading derivatives activities. The
Company has issued US dollar- and foreign currency-denominated debt with
both variable- and fixed-rate interest payment obligations. The Company
has entered into interest rate swaps, primarily based on LIBOR, to convert
fixed-rate interest payments on its debt obligations into variable-rate
payments. In addition, for foreign currency debt obligations that are not
used to fund assets in the same currency, the Company has entered into
currency swap agreements that effectively convert the debt into US dollar
obligations. Such transactions are accounted for as fair value hedges.
Interest payment obligations on variable-rate debt obligations may also be
modified through interest rate swaps, which may change the underlying
basis or reset frequency.
These financial instruments are subject to the same market and credit
risks as those that are traded in connection with the Company's
market-making and trading activities. The Company has similar controls in
place to monitor these risks.
SFAS No. 133, as amended by SFAS No. 138 and SFAS No. 149, establishes
accounting and reporting standards for stand-alone derivative instruments,
derivatives embedded within other contracts or securities and for hedging
activities. It 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 fair value. SFAS No. 133 also requires
items designated as being fair value hedged be recorded at fair value, as
defined in SFAS No. 133, 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. These amounts were immaterial for the
three month periods ended February 28, 2005 and February 29, 2004.
4. TRANSFERS OF FINANCIAL ASSETS AND LIABILITIES
Securitizations
The Company is a market leader in mortgage-backed securitization and other
structured financing arrangements. In the normal course of business, the
Company regularly securitizes commercial and residential mortgages,
consumer receivables and other financial assets. Securitization
transactions are generally treated as sales, provided that control has
been relinquished. In connection with securitization transactions, the
Company establishes special-purpose entities ("SPEs"), in which
transferred assets, including commercial and residential mortgages,
consumer receivables and other financial assets are sold to an SPE and
repackaged into securities or similar beneficial interests. Transferred
assets are accounted for at fair value prior to securitization. The
majority of the Company's involvement with SPEs relates to securitization
transactions meeting the definition
16
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
of QSPE under the provisions of SFAS No. 140. Provided it has relinquished
control over such assets, the Company derecognizes financial assets
transferred in securitizations and does not consolidate the financial
statements of QSPEs. For SPEs that do not meet the QSPE criteria, the
Company uses the guidance in FIN No. 46 (R) to determine whether the SPE
should be consolidated.
In connection with these securitization activities, the Company may retain
interests in securitized assets 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. 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 based on observable transactions in similar
securities and are further verified by external pricing sources, when
available.
The Company's securitization activities are detailed below:
Other
Agency Other Asset-
Mortgage-Backed Mortgage-Backed Backed
-------------------------------------------------------------------------------------
(in billions)
-------------------------------------------------------------------------------------
Total securitizations
Quarter ended February 28, 2005 $6.4 $21.1 $0.1
Quarter ended February 29, 2004 $4.7 $12.8 $0.6
Retained interests
As of February 28, 2005 $2.3 $1.8 $0.1
As of November 30, 2004 $2.6 $1.8 $0.1
-------------------------------------------------------------------------------------
The following table summarizes cash flows from securitization trusts
related to securitization transactions during the quarter ended February
28, 2005 and February 28, 2004:
Agency Other Other
Mortgage-Backed Mortgage-Backed Asset-Backed
--------------------------------------------------------------------------------------------------
(in millions)
--------------------------------------------------------------------------------------------------
Cash flows received from retained interests
Quarter ended February 28, 2005 $ 22.9 $ 34.0 N/A
Quarter ended February 29, 2004 $ 22.4 $ 29.7 $ 0.9
Cash flows from servicing
Quarter ended February 28, 2005 $ 0.1 $ 3.0 N/A
Quarter ended February 29, 2004 N/A $ 0.8 N/A
--------------------------------------------------------------------------------------------------
The Company is an active market maker in these securities and therefore
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 February 28,
2005 were 3.94% for two-year swaps, 4.77% for 10-year swaps, and ranged
from 2.93% to 4.78%. 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.
17
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Weighted average key economic assumptions used in measuring the fair value
of retained interests in assets the Company securitized at February 28,
2005 were as follows:
Agency Other Other
Mortgage-Backed Mortgage-Backed Asset-Backed
----------------------------------------------------------------------------------------------
Weighted average life (years) 6.5 4.6 1.8
Average prepayment speeds (annual rate) 7% - 39% 0% - 63% N/A
Credit losses 0.57% 4.13% 2.24%
----------------------------------------------------------------------------------------------
The following hypothetical sensitivity analysis as of February 28, 2005
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
Mortgage-Backed Mortgage-Backed Asset-Backed
----------------------------------------------------------------------------------------------------
(in millions)
----------------------------------------------------------------------------------------------------
Interest rates
Impact of 50 basis point adverse change $ (72.5) $ (41.6) (0.3)
Impact of 100 basis point adverse change (138.3) (84.2) (0.5)
----------------------------------------------------------------------------------------------------
Prepayment speeds
Impact of 10% adverse change (4.6) (12.5) N/A
Impact of 20% adverse change (10.0) (23.6) N/A
----------------------------------------------------------------------------------------------------
Credit losses
Impact of 10% adverse change (7.9) (15.4) (0.1)
Impact of 20% adverse change (15.5) (30.0) (0.3)
----------------------------------------------------------------------------------------------------
In the normal course of business, the Company purchases conforming and
non-conforming, fixed-rate and adjustable-rate residential mortgage loans
and sells such loans to investors. In connection with these activities,
the Company may retain mortgage servicing rights ("MSRs") that entitle the
Company to a future stream of cash flows based on the contractual
servicing fee. In addition, the Company may purchase and sell MSRs. At
February 28, 2005, key economic assumptions and the sensitivity of the
current fair value of MSRs to immediate changes in those assumptions were
as follows:
Adjustable-Rate
Sub-Prime Loans Fixed-Rate Prime Prime & Alt-A
& Alt-A Loans Loans
-----------------------------------------------------------------------------------------------------
(in millions)
-----------------------------------------------------------------------------------------------------
Fair Value of MSRs $ 127.8 $ 48.9 $ 88.9
Constant prepayment rate (in CPR) 20% - 40% 20% - 25% 25% - 30%
Impact on fair value of:
5 CPR adverse change $(11.5) $(10.1) $(11.2)
10 CPR adverse change (21.2) (15.0) (20.6)
Discount Rate 14% 10% 13%
Impact on fair value of:
5% adverse change $ (9.9) $ (6.3) $(8.3)
10% adverse change (17.9) (10.6) (15.1)
-----------------------------------------------------------------------------------------------------
The previous tables 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
18
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
outlined in the table. Changes in fair value based on a 10% adverse
variation in assumptions generally cannot be extrapolated because the
relationship of the change in assumptions to the change in fair value is
not usually linear. In addition, the tables do not consider the change in
fair value of hedging positions, which would generally offset the changes
detailed in the tables, nor do they 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 portfolio level and allocating the impact would not be
practicable.
MSRs, which are included in "Other Assets" on the Condensed Consolidated
Statements of Financial Condition, are reported at the lower of amortized
cost or market. MSRs are amortized in proportion to and over the period of
estimated net servicing income. MSRs are periodically evaluated for
impairment based on the fair value of those rights determined by using
market-based models which discounts anticipated future net cash flows
considering loan prepayment predictions, interest rates, default rates,
servicing costs and other economic factors. For purposes of impairment
evaluation and measurement, the Company stratifies MSRs by
securitizations, which are collateralized by loans with similar
predominant risk characteristics. The excess of amortized cost over market
value is reflected as a valuation allowance at balance sheet dates. The
Company's MSRs activities for the quarters ended February 28, 2005 and
February 29, 2004 were as follows:
February 28, 2005 February 29, 2004
-------------------------------------------------------------------------
(in millions)
-------------------------------------------------------------------------
Balance, beginning of quarter $ 230.2 $ 108.0
Additions 59.9 41.8
Amortization (24.8) (10.7)
Recovery/(impairment) 2.6 (4.2)
-------------------------------------------------------------------------
Balance, end of quarter $ 267.9 $ 134.9
=========================================================================
Changes in the MSR valuation allowance for the quarters ended February 28,
2005 and February 29, 2004 were as follows:
February 28, 2005 February 29, 2004
----------------------------------------------------------------------
(in millions)
----------------------------------------------------------------------
Balance, beginning of quarter $ (33.7) $ (6.6)
Recovery/(impairment) 2.6 (4.2)
----------------------------------------------------------------------
Balance, end of quarter $ (31.1) $ (10.8)
======================================================================
5. VARIABLE INTEREST ENTITIES AND MORTGAGE LOAN SPECIAL PURPOSE 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. The
Company adopted FIN No. 46 (R) for its variable interests in fiscal 2004.
The Company consolidates those VIEs in which the Company is the primary
beneficiary.
The Company may perform various functions, including being the seller,
investor, structurer or underwriter in securitization transactions. These
transactions typically involve entities that are considered to be QSPEs as
defined in SFAS No. 140. Under FIN No. 46 (R), these QSPE entities are
exempt from the requirements of FIN No. 46 (R). For securitization
vehicles that do not qualify as QSPEs, the holders of the beneficial
interest have no recourse to the Company, only to the assets held by the
related VIE. In certain of these VIEs, the Company is the primary
beneficiary often through its ownership of certain beneficial interests,
and is, therefore, required to consolidate the assets and liabilities of
the VIE.
19
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 because the Company
is the primary beneficiary approximated $0.5 billion at February 28, 2005.
At February 28, 2005, the Company's maximum exposure to loss as a result
of its relationship with these VIEs is approximately $350,000, which
represents the fair value of its interests in the VIEs.
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 February 28, 2005, the Company's maximum
exposure to loss from these entities approximates $28.7 million, which
represents the fair value of its interests and is reflected in the
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 held by the Company in future periods.
The Company has retained call options on a limited number of
securitization transactions that require the Company to continue
recognizing the assets subject to the call options, which approximated
$6.0 billion at February 28, 2005.
The Company has a limited number of mortgage securitizations which did not
meet the criteria for sale treatment under SFAS No. 140 as the
securitization vehicles were not QSPEs. The assets in the mortgage
securitizations approximated $2.8 billion at February 28, 2005.
6. 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. 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. In many instances, the Company is also permitted by
contract or custom to rehypothecate securities received as collateral.
These securities may be used to secure repurchase agreements, enter into
securities lending or derivative transactions or cover short positions.
At February 28, 2005 and November 30, 2004, the Company had received
securities pledged as collateral that can be repledged, delivered or
otherwise used with a fair value of approximately $257.25 billion and
$259.01 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 $187.52 billion and $163.95 billion were delivered
or repledged, generally as collateral under repurchase or securities
lending agreements or to cover short sales at February 28, 2005 and
November 30, 2004, respectively.
The carrying value of securities and other inventory positions owned that
have been pledged or otherwise encumbered to counterparties where those
counterparties do not have the right to sell or repledge was approximately
$18.7 billion at February 28, 2005.
20
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. 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.
The computations of Basic and Diluted EPS are set forth below:
Three Months Ended
--------------------------------------------------------------------------
February 28, February 29,
(in thousands, except per share amounts) 2005 2004
--------------------------------------------------------------------------
Net income $ 378,805 $ 361,065
Preferred stock dividends (6,478) (7,419)
Income adjustment (net of tax) applicable to
deferred compensation arrangements-vested
shares 13,884 17,754
--------------------------------------------------------------------------
Net earnings used for basic EPS $ 386,211 $ 371,400
Income adjustment (net of tax) applicable to
deferred compensation arrangements-nonvested
shares 7,821 7,378
--------------------------------------------------------------------------
Net earnings used for diluted EPS $ 394,032 $ 378,778
==========================================================================
Total basic weighted average common
shares outstanding (1) 131,261 129,119
--------------------------------------------------------------------------
Effect of dilutive securities:
CAP and restricted units 13,584 14,495
Employee stock options 4,348 3,494
--------------------------------------------------------------------------
Dilutive potential common shares 17,932 17,989
--------------------------------------------------------------------------
Weighted average number of common shares
outstanding and dilutive potential common
shares 149,193 147,108
==========================================================================
Basic EPS $ 2.94 $ 2.88
Diluted EPS $ 2.64 $ 2.57
==========================================================================
(1) Includes 20,293,510 and 25,908,503 vested units for the three months
ended February 28, 2005 and February 29, 2004, respectively, issued
under stock compensation plans which will be distributed as shares
of common stock.
8. 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 NYSE, the Commodity Futures
Trading Commission ("CFTC") and other principal exchanges of which Bear
Stearns and BSSC are members. At February 28, 2005, Bear Stearns' net
capital of $1.49 billion exceeded the minimum requirement by $1.39
billion. Bear Stearns' net capital computation, as defined, includes
$447.0 million, which is net capital of BSSC in excess of 5.5% of
aggregate debit items arising from customer transactions.
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.
21
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 February 28, 2005, Bear Stearns, BSSC, BSIL, BSIT and BSB were in
compliance with their respective regulatory capital requirements.
In June 2004, the SEC adopted rule amendments relating to "Alternative Net
Capital Requirements for Broker-Dealers That Are Part of Consolidated
Supervised Entities" that allow investment banks to voluntarily submit to
be regulated by the SEC on a global consolidated basis. These regulations
(referred to as CSE) were in response to what is known as the "Financial
Conglomerates Directive" (2002/87/EC) of the European Parliament, which
served to compel globally active institutions doing business in Europe to
be regulated on a global consolidated basis. The Company anticipates
applying to the SEC during fiscal 2005 to be regulated under this new CSE
regime. The new framework will be a notable change in the Company's
regulation, as activities which are currently transacted outside of
SEC-regulated entities will come under the scope of SEC regulation and
capital adequacy requirements. On becoming subject to the SEC's
consolidated supervision, the Company will be required to report to the
SEC computations of the Company's consolidated capital adequacy. Although
the application process is not yet complete, the Company believes that it
will meet the requirements of the SEC to be regulated on a consolidated
basis.
9. 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:
Leases
The Company occupies office space under leases that expire at various
dates through 2024. At February 28, 2005, future minimum aggregate annual
rentals payable under non-cancelable leases (net of subleases), including
383 Madison Avenue in New York City, for fiscal years 2005 through 2009
and the aggregate amount thereafter, are as follows:
---------------------------------------
(in thousands)
---------------------------------------
FISCAL YEAR
2005 (remaining) 43,460
2006 64,055
2007 63,375
2008 64,985
2009 55,312
Thereafter 247,967
---------------------------------------
Lending - Related Commitments
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. Lending-related commitments to investment grade borrowers
aggregated approximately $2.18 billion at February 28, 2005. Of this
amount, approximately $0.4 billion was hedged at February 28, 2005.
Lending-related commitments to non-investment-grade borrowers approximated
$1.59 billion at February 28, 2005.
22
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company also has contingent commitments to investment grade and
non-investment-grade companies of approximately $2.69 billion as of
February 28, 2005. Generally, these commitments are provided in connection
with leveraged acquisitions. These commitments are not indicative of the
Company's actual risk because the borrower may never draw upon the
commitment. In fact, the borrower may not be successful in the
acquisition, the borrower may access the capital markets instead of
drawing on the commitment, or the Company's portion of the commitment may
be reduced through the syndication process. Additionally, the borrower's
ability to draw may be subject to there being no material adverse change
in either market conditions or the borrower's financial condition, among
other factors. These commitments generally contain certain flexible
pricing features to adjust for changing market conditions prior to
closing.
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 February 28, 2005, such commitments
aggregated $378.4 million. These commitments will be funded, if called,
through the end of the respective investment periods, with the longest of
such periods ending in 2013.
Underwriting
In connection with the Company's mortgage-backed securitizations and high
yield underwriting, the Company had commitments to purchase and sell new
issues of securities aggregating $2.2 billion at February 28, 2005.
Commercial and Residential Loans
The Company participates in the acquisition, securitization, servicing,
financing and disposition of commercial and residential loans. At February
28, 2005, the Company had entered into commitments to purchase or finance
mortgage loans of $2.22 billion.
Letters of Credit
At February 28, 2005, the Company was contingently liable for unsecured
letters of credit of approximately $2.56 billion and letters of credit of
$1.19 billion secured by financial instruments, primarily used to provide
collateral for securities borrowed and to satisfy margin requirements at
option and commodity exchanges.
Other
The Company had commitments to purchase Chapter 13 and other credit card
receivables of $212.0 million at February 28, 2005.
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 legal actions, including arbitrations, class actions
and other litigation. Certain of the legal actions include claims for
substantial compensatory and/or punitive damages or claims for
indeterminate amounts of damages. The Company is also involved in other
reviews, investigations and proceedings by governmental and
self-regulatory agencies regarding the Company's business, certain of
which may result in adverse judgments, settlements,
23
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
fines, penalties, injunctions or other relief.
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 CFTC, the National Association of Securities
Dealers, Inc., 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 and BSSC 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.
Because litigation is inherently unpredictable, particularly in cases
where claimants seek substantial or indeterminate damages or where
investigations and proceedings are in the early stages, the Company cannot
predict with certainty the loss or range of loss related to such matters,
how such matters will be resolved, when they will ultimately be resolved,
or what the eventual settlement, fine, penalty or other relief might be.
Consequently, the Company cannot estimate losses or ranges of losses for
matters where there is only a reasonable possibility that a loss may have
been incurred. Although the ultimate outcome of these 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.
The Company has provided reserves for such matters in accordance with SFAS
No. 5, "Accounting for Contingencies". The ultimate resolution may differ
from the amounts reserved.
10. GUARANTEES
In the ordinary course of business, the Company issues various guarantees
to counterparties in connection with certain derivative, leasing,
securitization and other transactions. FIN No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others," requires the Company to recognize a liability
at the inception of certain guarantees and to disclose information about
its obligations under certain guarantee arrangements.
The guarantees covered by FIN No. 45 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.
24
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table sets forth the maximum payout/notional amounts
associated with the Company's guarantees as of February 28, 2005:
Amount of Guarantee Expiration Per Period
------------------------------------------------------------------
Greater
Less Than One to Three Three to than Five
(in millions) One Year Years Five Years Years Total
--------------------------------------------------------------------------------------------------------------
Certain derivative contracts (notional)(1) $ 269,537 $222,276 $197,502 $ 114,794 $ 804,109
Municipal securities 2,549 93 - - 2,642
Residual value guarantee - - 570 - 570
--------------------------------------------------------------------------------------------------------------
(1) The carrying value of these derivatives approximated $6.7 billion as
of February 28, 2005.
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
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. The derivative
contracts are recorded at fair value, which approximated $6.7 billion at
February 28, 2005.
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, 2004.
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 February 28, 2005 was approximately $2.64 billion,
which represents the outstanding amount of 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 $2.68 billion at February 28, 2005.
25
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 14, 2009, 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
February 28, 2005, 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. In
implementing this accounting interpretation, 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 these 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 remote. Accordingly, no
contingent liability is recorded in the Condensed Consolidated Statements
of Financial Condition for these arrangements.
11. 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
26
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 the NYSE and ISE 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.
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
between 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.
27
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended
--------------------------
February 28, February 29,
2005 2004
-------------------------------------------------------------------
(in thousands)
NET REVENUES (1)
Capital Markets
Institutional Equities $ 312,940 $ 293,211
Fixed Income 823,899 818,738
Investment Banking 259,002 253,179
-------------------------------------------------------------------
Total Capital Markets 1,395,841 1,365,128
-------------------------------------------------------------------
Global Clearing Services 270,392 225,333
Wealth Management
Private Client Services (2) 113,875 110,897
Asset Management 55,315 41,890
-------------------------------------------------------------------
Total Wealth Management 169,190 152,787
-------------------------------------------------------------------
Other (3) 2,237 (17,325)
-------------------------------------------------------------------
Total net revenues $ 1,837,660 $ 1,725,923
===================================================================
PRE-TAX INCOME (1)
Capital Markets $ 481,683 $ 508,650
Global Clearing Services 137,774 86,221
Wealth Management 14,979 20,867
Other (3) (56,108) (84,760)
-------------------------------------------------------------------
Total pre-tax income $ 578,328 $ 530,978
===================================================================
(1) Certain prior period items have been reclassified within the Capital
Markets and Global Clearing Services segments to conform to the
current period's presentation.
Three months ended
--------------------------
February 28, February 29,
2005 2004
--------------------------
(2) Private Client Services:
Gross revenues, before transfer to Capital Markets segment $ 133,295 $ 137,629
Revenue transferred to Capital Markets segment (19,420) (26,732)
--------- ---------
Private Client Services net revenues $ 113,875 $ 110,897
========= =========
(3) 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 were $38.0 million and $44.0 million for
the three months ended February 28, 2005 and February 29, 2004,
respectively.
As of
------------------------------------------------------
February 28, November 30, February 29,
(in thousands) 2005 2004 2004
------------------------------------------------------------------------------------------------
SEGMENT ASSETS (4)
Capital Markets $ 152,180,300 $ 157,141,644 $ 135,338,929
Global Clearing Services 106,753,628 87,793,151 83,349,768
Wealth Management 2,682,327 2,679,697 2,155,965
Other 6,812,819 8,335,402 5,806,238
------------------------------------------------------------------------------------------------
Total segment assets $ 268,429,074 $ 255,949,894 $ 226,650,900
================================================================================================
(4) Certain prior period items have been reclassified within segment
assets to conform to the current period's presentation.
28
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 February 28,
2005, and the related condensed consolidated statements of income and cash flows
for the three month periods ended February 28, 2005 and February 29, 2004. 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, 2004, 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, 2004; and in our report dated
February 11, 2005, 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, 2004 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
April 8, 2005
29
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The Bear Stearns Companies Inc. (the "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. BSSC, a subsidiary of Bear Stearns, provides
professional and correspondent clearing services, in addition to clearing and
settling customer transactions and certain proprietary transactions of the
Company. 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., Bear Stearns Credit Products Inc., Bear Stearns Forex Inc., EMC
Mortgage Corporation and Bear Stearns Commercial Mortgage, Inc. The Company is
primarily engaged in business as a securities broker-dealer operating in three
principal segments: Capital Markets, Global Clearing Services and Wealth
Management. As used in this report, the "Company" refers (unless the context
requires otherwise) to The Bear Stearns Companies Inc. and its subsidiaries.
Unless specifically noted otherwise, all references to the three months of 2005
and 2004 refer to the three months ended February 28, 2005 and February 29,
2004, respectively, and all references to quarters are to the Company's fiscal
quarters.
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, 2004 filed by the Company under the Securities Exchange Act
of 1934 ("Exchange Act").
The Management's Discussion and Analysis of Financial Condition and Results
of Operations should be read together with the Management's Discussion and
Analysis of Financial Condition and Results of Operations and the Consolidated
Financial Statements in the Company's Annual Report on Form 10-K for the fiscal
year ended November 30, 2004 filed by the Company under the Exchange Act.
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.
These and other factors can affect the Company's volume of security new issues,
mergers and acquisitions and business restructurings; the stability and
liquidity of securities and futures markets; and ability of issuers, other
securities firms and counterparties to perform on their obligations. A decrease
in the volume of security new issues, mergers and acquisitions or restructurings
generally results in lower revenues from investment banking and, to a lesser
extent, reduced principal transactions. A reduced volume of securities and
futures transactions and reduced market liquidity generally results in lower
revenues from principal transactions and commissions. Lower price levels for
securities may result in a reduced volume of transactions, and may also result
in losses from declines in the market value of securities held in proprietary
trading and underwriting accounts. In periods of reduced sales and trading or
investment banking activity, profitability may be adversely affected because
certain expenses remain relatively fixed. The Company's securities trading,
derivatives, arbitrage, market-making, specialist, leveraged lending, leveraged
buyout and underwriting activities are conducted by it on a principal basis and
expose the Company to significant risk of loss. Such risks include market,
counterparty credit and liquidity risks. For a discussion of how the Company
seeks to manage risks, see the "Risk Management" and "Liquidity and Capital
Resources" sections of the Company's Annual Report on Form 10-K for the fiscal
year ended November 30, 2004 filed by the Company under the Exchange Act.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Substantial legal liability or a significant regulatory action against the
Company could have a material adverse effect or cause significant reputational
harm to the Company, which in turn could seriously harm the Company's business
prospects. Firms in the financial services industry have been operating in a
difficult regulatory environment. The Company faces significant legal risks in
its businesses, and the volume of claims and amount of damages and penalties
claimed in litigation and regulatory proceedings against financial institutions
have been increasing.
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 paragraphs, 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.
EXECUTIVE OVERVIEW
Summary of Results
A generally favorable operating environment characterized by improving US
capital market conditions and active equity and fixed income markets provided a
healthy climate for the Company's businesses during the three months ended
February 28, 2005. Revenues, net of interest expense for the three months ended
February 28, 2005 increased 6.5% from the three months ended February 29, 2004
while pre-tax earnings increased 8.9% during the same period. Pre-tax profit
margins for the fiscal 2005 quarter increased to 31.5% when compared with 30.8%
in the fiscal 2004 quarter. Annualized return on average common equity was 17.8%
for the fiscal quarter ended February 28, 2005 versus 21.3% in the prior year
quarter.
Capital Markets net revenues increased 2.2% to $1.40 billion for the 2005
quarter compared to $1.37 billion for the 2004 quarter. Within the Capital
Markets segment, institutional equities net revenues for the 2005 quarter
increased 6.7% to $312.9 million from $293.2 million for the comparable prior
year quarter. US listed and international equity sales and trading net revenues
increased due to higher trading volumes and continued market share gains. Risk
arbitrage and equity derivatives net revenues also increased on improved market
conditions and customer activity. Fixed income net revenues increased slightly
to $823.9 million for the 2005 quarter from $818.7 million for the comparable
prior year quarter. This increase is primarily due to increases related to the
credit and interest rate product areas, which benefited from increased customer
volumes. Investment banking revenues increased 2.3% to $259.0 million for the
2005 quarter from $253.2 million for the 2004 quarter, as a result of increased
underwriting and merchant banking revenues, partially offset by a decrease in
advisory services revenues.
Global Clearing Services net revenues increased 20.0% to $270.4 million from
$225.3 million in the 2004 quarter. Improving US equity markets resulted in an
increase in net interest revenues of 40.7% to $198.1 million from $140.7 million
in the 2004 quarter as customer margin debt and short-sale balances increased.
Partially offsetting the increase in net interest revenues was a 15.6% decline
in clearance commission revenues to $67.1 million in the 2005 quarter from $79.6
million in the 2004 quarter.
Wealth Management net revenues increased 10.7% to $169.2 million from $152.8
million in the fiscal quarter ended
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
February 29, 2004, reflecting active equity markets and strong customer volume.
Revenues from private client services increased on higher net interest revenues
as well as increased fee income from the Company's private client advisory
services product. Asset management revenues similarly increased due to increased
performance fees and the growth in assets under management.
Business Environment
Fiscal 2005 Quarter
The business environment during the Company's first quarter ended February 28,
2005 was generally favorable due to a combination of factors, including an
expanding US economy, improved corporate profitability and low interest rates.
Positive job growth reports served to boost consumer confidence during the
quarter. The Federal Reserve Board (the "Fed") met twice during the quarter and
raised the federal funds rate, in 25 basis point increments, from 2.00% to 2.50%
while maintaining its position of taking a "measured" approach to monetary
policy. The rate increases reflect the Fed's concern that the US economy was
showing signs of inflationary risk.
The major equity indices were mixed during the first quarter of 2005. The Dow
Jones Industrial Average ("DJIA"), and the Standard & Poor's 500 Index ("S&P
500") increased 3.2% and 2.5%, respectively, while the Nasdaq Composite Index
("NASDAQ") decreased 2.2% during the quarter. Average daily trading volume on
the New York Stock Exchange ("NYSE") and Nasdaq increased 6.4% and 5.0%,
respectively, compared to the 2004 quarter. Industry-wide announced mergers and
acquisitions ("M&A") volumes increased 59% while industry-wide completed M&A
volumes decreased 15% in the 2005 quarter compared to the first quarter of 2004.
Fixed income activity continued to be robust during the 2005 quarter, despite
the increase in short term interest rates and a flattening yield curve.
Investment grade and high yield origination volumes rose as issuers continued to
take advantage of low borrowing rates. However, higher interest rates on 30-year
fixed rate mortgages resulted in an industry-wide decline in agency
collateralized mortgage obligation ("CMO") activity. This decline was
substantially offset by growth in non-agency volumes. Long-term interest rates,
as measured by the 10-year Treasury bond, were flat during the 2005 quarter. At
the close of the Company's first quarter of 2005 the 10-year Treasury bond yield
was 4.36%, exactly the same rate as at the beginning of the quarter. The
mortgage purchase index increased approximately 3% during the first quarter of
fiscal 2005, reflecting the continued low level of interest rates and strong
home purchasing market.
Fiscal 2004 Quarter
Global and US economic conditions improved during the first quarter of fiscal
2004. Economic data indicated a relatively robust US economy, but the lack of
job growth raised concerns about the sustainability of any recovery. Consumer
confidence declined during the first quarter of fiscal 2004 amid concerns about
weak job growth. However, mortgage rates remained at historically low levels,
continuing to fuel consumer spending and a strong housing market. The Fed met
twice during the first quarter of fiscal 2004 and left the federal funds rate
unchanged at 1.00%.
Equity valuations climbed with all major indices up strongly during the first
quarter of fiscal 2004. The DJIA and the S&P 500 each increased 8.2% during the
quarter ended February 29, 2004, while the NASDAQ increased 3.5% during the
quarter ended February 29, 2004, reaching a 2 1/2 year high in January 2004.
Average daily trading volume on the NYSE and Nasdaq increased 9.0% and 40.2%,
respectively, compared with the fiscal quarter ended February 28, 2003.
Favorable equity market conditions served to increase equity new issue activity
during the 2004 quarter as well as US announced and completed mergers and
acquisition volumes, which increased more than 100% industry-wide compared to
the February 2003 quarter.
The fixed income markets performed extremely well in the first quarter of fiscal
2004, benefiting from the combination of the low level of interest rates, steep
yield curve and narrow corporate credit spreads. However, higher interest rates
and diminished refinancing activity resulted in a significant decline in agency
CMO activity with industry-wide issuance down approximately 72%. This decline
was partially offset by active origination in certain sectors of the whole loan
markets and higher secondary mortgage-backed securities activity levels. These
factors led to the industry's improved performance in the first quarter of
fiscal 2004. The yield on the 10-year treasuries dropped approximately 35 basis
points from late February to mid-
32
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March. Consequently, the weekly mortgage refinance index increased from 3532 at
quarter-end to almost 5000 by mid-March.
RESULTS OF OPERATIONS
Firmwide Results
The following table sets forth an overview of the Company's financial results:
Three Months Ended
----------------------------------------------------
(in thousands, except per share amounts, pre-tax February 28, February 29,
profit margin and return on average common equity) 2005 2004 % Increase
------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense $ 1,837,660 $ 1,725,923 6.5%
Income before provision for income tax $ 578,328 $ 530,978 8.9%
Net income $ 378,805 $ 361,065 4.9%
Diluted earnings per share $ 2.64 $ 2.57 2.7%
Pre-tax profit margin 31.5% 30.8%
Return on average common equity (annualized) 17.8% 21.3%
The Company reported net income of $378.8 million, or $2.64 per share (diluted),
for the quarter ended 2005, which represented an increase of 4.9% from $361.1
million, and 2.7% from $2.57 per share (diluted), for the quarter ended 2004.
Revenues, net of interest expense ("net revenues") increased 6.5% to $1.84
billion for the quarter ended 2005 from $1.73 billion for the quarter ended
2004, due to an increase in net interest revenues, principal transactions
revenues and investment banking revenues, partially offset by a decrease in
commission revenues.
The Company's commission revenues by reporting category were as follows:
Three Months Ended
--------------------------------------------
February 28, February 29, % Increase
(in thousands) 2005 2004 (Decrease)
---------------------------------------------------------------------------
Institutional $ 165,803 $ 163,026 1.7%
Clearance 67,143 79,558 (15.6%)
Retail & other 64,431 65,519 (1.7%)
---------------------------------------------------------------------------
Total commissions $ 297,377 $ 308,103 (3.5%)
===========================================================================
Commission revenues for the 2005 quarter decreased 3.5% to $297.4 million from
$308.1 million for the comparable prior year quarter. Institutional commissions
increased 1.7% to $165.8 million for the 2005 quarter from $163.0 million for
the comparable prior year quarter. The increase in institutional commissions is
due to increased daily average trading volume on the NYSE. Clearance commissions
decreased 15.6% to $67.1 million for the 2005 quarter from $79.6 million for the
comparable prior year quarter reflecting lower trading volumes and rates from
prime brokerage and fully disclosed clients. Retail and other commissions
decreased 1.7% to $64.4 million in the 2005 quarter from $65.5 million in the
comparable prior year quarter.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's principal transactions revenues by reporting category were as
follows:
Three Months Ended
----------------------------------------------
February 28, February 29, % (Decrease)/
(in thousands) 2005 2004 Increase
--------------------------------------------------------------------------------
Fixed income $ 612,601 $ 673,551 (9.0)%
Equities 97,141 122,032 (20.4)%
Derivative financial instruments 250,622 151,279 65.7%
--------------------------------------------------------------------------------
Total principal transactions $ 960,364 $ 946,862 1.4%
================================================================================
Revenues from principal transactions for the 2005 quarter increased 1.4% to
$960.4 million from $946.9 million for the corresponding prior year quarter due
to an increase in derivative financial instruments revenues, partially offset by
a decrease in fixed income revenues and equities revenues. Fixed income revenues
decreased 9.0% to $612.6 million for the 2005 quarter from $673.6 million for
the prior year quarter attributable to a decrease in mortgage-backed securities,
partially offset by an increase in credit products. Mortgage-backed securities
revenues declined when compared to the outstanding results of the prior year
quarter as the flattening yield curve resulted in a more challenging
environment. Higher interest rates on 30-year fixed rate mortgages in the 2005
quarter when compared to the 2004 quarter resulted in a 28% decline in CMO
activity. This decline was partially offset by increased revenues from
adjustable rate mortgages reflecting higher secondary trading activity in the
2005 quarter. In addition, credit products net revenues reached record levels
resulting from improved credit spreads and increased customer volumes. Revenues
derived from equities activities decreased 20.4% to $97.1 million during the
2005 quarter from $122.0 million in the corresponding prior year quarter due to
a decrease in NYSE specialist and convertible arbitrage revenues. Revenues from
derivative financial instruments increased 65.7% to $250.6 million in the 2005
quarter from $151.3 million in the 2004 quarter, due to increases in equity,
fixed income and credit derivatives as a result of increased customer volume.
The Company's investment banking revenues by reporting category were as follows:
Three Months Ended
---------------------------------------------
February 28, February 29, % Increase
(in thousands) 2005 2004 (Decrease)
-------------------------------------------------------------------------------
Underwriting $ 172,420 $ 160,935 7.1%
Advisory services 89,607 96,769 (7.4)%
Merchant banking 9,591 2,706 254.4%
-------------------------------------------------------------------------------
Total investment banking $ 271,618 $ 260,410 4.3%
===============================================================================
Investment banking revenues increased 4.3% to $271.6 million for the 2005
quarter from $260.4 million for the 2004 quarter. Underwriting revenues
increased 7.1% to $172.4 million for the 2005 quarter from $160.9 million for
the corresponding prior year quarter, as fixed income underwriting revenues
increased, reflecting a favorable high grade, high yield and municipal
underwriting environment. Equity underwriting revenues decreased slightly
compared to the 2004 quarter, reflecting a decline in initial public offerings
("IPOs") and follow-on offerings. Advisory services revenues for the 2005
quarter decreased 7.4% to $89.6 million from $96.8 million for the prior year
quarter reflecting the decline in completed M&A volume.
Net interest revenues (interest and dividend revenue less interest expense)
increased 43.6% to $236.9 million for the 2005 quarter from $164.9 million for
the 2004 quarter. The increase in net interest revenues was primarily
attributable to higher levels of customer interest-bearing balances and improved
net interest margins reflecting more favorable US equity market conditions.
Average customer margin debt balances increased 24.5% to $58.0 billion for the
2005 quarter from $46.6 billion for the prior year quarter. Average customer
short balances increased 19.1% to $88.5 billion for the 2005 quarter from $74.3
billion for the 2004 quarter and average securities borrowed balances increased
11.2% to $69.6 billion for the 2005 quarter from $62.6 billion for the 2004
quarter.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Non-Interest Expenses
The Company's non-interest expenses were as follows:
Three Months Ended
------------------------------------------
February 28, February 29, % Increase
(in thousands) 2005 2004 (Decrease)
--------------------------------------------------------------------------------
Employee compensation and
benefits $ 906,775 $ 849,148 6.8%
Floor brokerage, exchange and
clearance fees 57,318 56,900 0.7%
Communications and technology 98,939 93,828 5.4%
Occupancy 39,594 33,615 17.8%
Advertising and market development 28,572 25,901 10.3%
Professional fees 46,719 41,800 11.8%
Other expenses 81,415 93,753 (13.2)%
--------------------------------------------------------------------------------
Total non-interest expenses $1,259,332 $1,194,945 5.4%
================================================================================
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 6.8% to $906.8 million for the 2005
quarter from $849.1 million for the 2004 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 49.3% for
the 2005 quarter compared to 49.2% for the 2004 quarter. Full-time employees
increased to 11,019 at February 28, 2005 from 10,431 at February 29, 2004.
Non-compensation expenses increased 2.0% to $352.6 million for the 2005 quarter
from $345.8 million for the 2004 quarter. Non-compensation expenses as a
percentage of net revenues decreased to 19.2% for the 2005 quarter compared with
20.0% for the corresponding prior year quarter. Contributing to the increase in
non-compensation expenses is a 17.8% increase in occupancy costs which resulted
from an increase in leased office space and higher maintenance and operating
costs. Communications and technology costs increased 5.4% reflecting increased
vendor costs and information technology consulting fees. Professional fees
increased 11.8% due to employment agency and temporary help fees. Partially
offsetting these increases was a decline in other expenses, primarily
attributable to a reduction in CAP Plan related costs, which decreased to $38
million for the 2005 quarter from $44 million in the comparable prior year
quarter. The Company achieved a pre-tax profit margin of 31.5% for the 2005
quarter versus 30.8% for the 2004 quarter.
The Company's effective tax rate increased to 34.5% for the 2005 quarter
compared to 32.0% for the 2004 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 prior year items have
been reclassified between the Capital Markets and Global Clearing Services
segments to conform to the current period's presentation.
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. See Note 11,
"Segment Data" in the Notes to Condensed Consolidated Financial Statements for
complete segment information.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capital Markets
Three Months Ended
---------------------------------------------
February 28, February 29, % Increase
(in thousands) 2005 2004 (Decrease)
-------------------------------------------------------------------------------
Net revenues
Institutional equities $ 312,940 $ 293,211 6.7%
Fixed income 823,899 818,738 0.6%
Investment banking 259,002 253,179 2.3%
-------------------------------------------------------------------------------
Total net revenues $1,395,841 $ 1,365,128 2.2%
Pre-tax income $ 481,683 $ 508,650 (5.3)%
-------------------------------------------------------------------------------
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 sales, trading and research, 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 and International Securities
Exchange ("ISE") 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 2.2% to $1.40 billion for the 2005
quarter compared to $1.37 billion for the 2004 quarter. Pre-tax income for
Capital Markets decreased 5.3% to $481.7 million for the 2005 quarter from
$508.7 million for the comparable prior year quarter.
Institutional equities net revenues for the 2005 quarter increased 6.7% to
$312.9 million from $293.2 million for the comparable prior year quarter. Equity
derivatives revenue increased during the 2005 quarter reflecting increased
customer activity. US listed and international equity sales and trading net
revenues increased due to higher trading volumes and continued market share
gains. Revenues related to risk arbitrage also increased as a result of
increased announced M&A deals during the 2005 quarter. These increases were
partially offset by lower levels of convertible arbitrage and specialist
revenues which have been adversely affected by lower market volatility levels.
Fixed income net revenues increased slightly to $823.9 million for the 2005
quarter from $818.7 million for the comparable prior year quarter. Despite
increases in short term interest rates, fixed income markets remained strong as
primary issuance volumes increased, credit spreads tightened and the yield
curve, while flattening, remained favorable. As a result, fixed income net
revenues remained strong as secondary trading volumes increased significantly
and origination activity remained robust. Net revenues from the credit product
businesses, particularly the distressed debt and credit derivatives areas,
increased during the 2005 quarter reflecting active primary and secondary
volumes. In addition, leveraged finance revenues increased on higher volume. The
interest rate product businesses net revenues increased during the 2005 quarter
as the Company's interest rate derivatives and foreign exchange areas achieved
higher revenues on increased customer volume. These increases were partially
offset by a decrease in mortgage-backed securities revenues. Mortgage-backed
securities revenues declined in the 2005 quarter when compared to the
outstanding results of the prior year quarter as the flattening yield curve
resulted in a more challenging environment. Higher interest rates on 30-year
fixed rate mortgages in the 2005 quarter when compared to the 2004 quarter
resulted in a 28% decline in CMO activity. However, non-agency volumes continued
to show significant growth with origination levels increasing 86% principally
reflecting the continuing strength of purchase mortgage activity, refinancing
volumes and a shift from fixed rate to adjustable rate mortgages.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Investment banking revenues increased 2.3% to $259.0 million for the 2005
quarter from $253.2 million for the 2004 quarter. Underwriting revenues
increased 7.4% to $177.5 million for the 2005 quarter from $165.3 million for
the corresponding prior year quarter, as fixed income underwriting revenues
increased, reflecting a favorable high grade, high yield and municipal
underwriting environment. Equity underwriting revenues decreased slightly
compared to the 2004 quarter, reflecting a decline in IPO and follow-on
offerings. Advisory services revenues for the 2005 quarter decreased 15.7% to
$71.8 million from $85.2 million for the prior year quarter reflecting the
industry-wide decline in completed M&A volume. Merchant banking revenues were
$9.6 million for the 2005 quarter, compared to $2.7 million for the 2004
quarter.
Global Clearing Services
Three Months Ended
------------------------------------------------
(in thousands) February 28, 2005 February 29, 2004 %Increase
--------------------------------------------------------------------
Net revenues $ 270,392 $225,333 20.0%
Pre-tax income $ 137,774 $ 86,221 59.8%
--------------------------------------------------------------------
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 February 28, 2005 and February 29, 2004, the Company held
approximately $251.1 billion and $218.5 billion, respectively, in equity in
Global Clearing Services client accounts.
Net revenues for Global Clearing Services increased 20.0% to $270.4 million for
the 2005 quarter from $225.3 million in the 2004 quarter. Net interest revenues
increased 40.7% to $198.1 million for the 2005 quarter from $140.8 million for
the prior year quarter primarily reflecting increased average customer margin
and short sale balances. Commission revenues decreased 15.6% to $67.1 million
for the 2005 quarter from $79.6 million for the comparable prior year quarter
reflecting lower trading volumes and rates from prime brokerage and fully
disclosed clients. Pre-tax income increased 59.8% to $137.8 million, from $86.2
million for the 2004 quarter, reflecting higher net revenues. Pre-tax profit
margin was 51.0% for the 2005 quarter compared to 38.3% for the 2004 quarter.
The following table presents the Company's interest-bearing balances for the
fiscal periods ended:
--------------------------------------------------------------------------------
(in billions) February 28, 2005 February 29, 2004
--------------------------------------------------------------------------------
Margin debt balances, average for period $ 58.0 $ 46.6
Margin debt balances, at period end $ 61.3 $ 47.9
Customer short balances, average for period $ 88.5 $ 74.3
Customer short balances, at period end $ 93.9 $ 77.0
Securities borrowed, average for period $ 69.6 $ 62.0
Securities borrowed, at period end $ 67.8 $ 62.6
Free credit balances, average for period $ 31.1 $ 26.5
Free credit balances, at period end $ 30.2 $ 26.1
Equity held in client accounts $ 251.1 $ 218.5
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Wealth Management
Three Months Ended
-------------------------------------------
February 28, February 29, % Increase
(in thousands) 2005 2004 (Decrease)
--------------------------------------------------------------------------------
Net revenues
Private Client Services $113,875 $110,897 2.7%
Asset Management 55,315 41,890 32.0%
--------------------------------------------------------------------------------
Total net revenues $169,190 $152,787 10.7%
Pre-tax income $ 14,979 $ 20,867 (28.2)%
--------------------------------------------------------------------------------
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 February 28, 2005, 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 10.7% to $169.2 million for the
2005 quarter from $152.8 million for the 2004 quarter. PCS revenues increased
2.7% to $113.9 million for the 2005 quarter from $110.9 million for the 2004
quarter reflecting increased net interest revenues associated with higher margin
balances and higher levels of fee income attributable to the Company's private
client advisory services product. Asset management revenues increased 32.0% to
$55.3 million for the 2005 quarter from $41.9 million for the 2004 quarter. This
increase reflects increased management fees on traditional and alternative
assets under management, together with improved performance fees on proprietary
hedge fund products. Pre-tax income for Wealth Management decreased 28.2% to
$15.0 million in the 2005 quarter from $20.9 million for the 2004 quarter due to
increased compensation costs and increased legal costs resulting from the
settlement of a legal case.
Assets under management were $37.0 billion at February 28, 2005, reflecting a
27.1% increase from $29.1 billion in assets under management at February 29,
2004. The increase in assets under management is due to the acquisition in the
fourth quarter of 2004 of $6.1 billion of fixed income assets of Times Square
Capital Management, Inc. together with growth in traditional equity assets.
During the second quarter of 2004, the Company sold its mutual fund business to
Dreyfus, which reduced assets under management by $2.4 billion. Assets under
management at February 28, 2005 include $6.2 billion of assets from alternative
investment products, a slight increase from $6.1 billion at February 29, 2004.
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
38
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
leverage can and do fluctuate, depending largely on economic and market
conditions, volume of activity and customer demand.
The Company's total assets at February 28, 2005 increased to $268.4 billion from
$255.9 billion at November 30, 2004. The increase was primarily attributable to
increases in assets of variable interest entities and mortgage loan special
purpose entities, receivables from customers, securities borrowed and cash and
securities deposited with clearing organizations or segregated in compliance
with federal regulations, partially offset by a decrease in cash and cash
equivalents and securities purchased under agreements to resell. The Company's
total capital base, which consists of long-term debt, preferred equity issued by
subsidiaries and total stockholders' equity, increased to $48.5 billion at
February 28, 2005 from $45.8 billion at November 30, 2004. This change was
primarily due to a net increase in long-term debt and an increase in equity
associated with increased retained earnings.
The Company's total capital base as of February 28, 2005 and November 30, 2004
was as follows:
February 28, November 30,
2005 2004
-------------------------------------------------------------
(in millions)
-------------------------------------------------------------
Long-Term Borrowings:
Senior debt $ 38,709.6 $ 36,580.8
Subordinated debt (1) 262.5 262.5
-------------------------------------------------------------
Total Long-Term Borrowings $ 38,972.1 $ 36,843.3
Stockholders' equity:
Common stockholders' equity $ 9,076.0 $ 8,542.8
Preferred stockholders' equity 442.9 448.1
-------------------------------------------------------------
Total Stockholders' Equity $ 9,518.9 $ 8,990.9
-------------------------------------------------------------
Total Capital $ 48,491.0 $ 45,834.2
=============================================================
(1) Represents junior subordinated deferrable interest debentures issued by
the Company, held by Bear Stearns Capital Trust III.
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 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 February 28, 2005 and November 30,
2004, total assets of $268.4 billion and $255.9 billion were approximately 5.2%
and 6.4%, respectively, lower than the average of the month-end balances
observed over the trailing 12-month period. Despite reduced total assets at
quarter end, the Company's overall market, credit and liquidity risk profile
does not change 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.
39
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Leverage Ratios
The following table presents total assets, adjusted assets and net adjusted
assets with the resultant leverage ratios at February 28, 2005 and November 30,
2004. 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.
(in billions, except ratios) February 28, 2005 November 30, 2004
----------------------------------------------------------------------------
Total assets $ 268.4 $ 255.9
Adjusted assets (1) $ 209.4 $ 197.3
Net adjusted assets (2) $ 137.3 $ 127.5
Leverage ratio (3) 27.4 27.7
Adjusted leverage ratio (4) 21.4 21.3
Net adjusted leverage ratio(5) 14.0 13.8
----------------------------------------------------------------------------
(1) Adjusted assets is total assets of $268.4 billion less securities
purchased under agreements to resell of $44.2 billion, securities received
as collateral of $8.9 billion and cash and securities deposited with
clearing organizations or segregated in compliance with federal
regulations of $5.9 billion.
(2) Net adjusted assets is adjusted assets of $209.4 billion less securities
borrowed of $72.1 billion.
(3) Leverage ratio equals total assets divided by stockholders' equity and
junior subordinated debt issued to Bear Stearns Capital Trust III.
(4) Adjusted leverage ratio equals adjusted assets divided by stockholders'
equity and junior subordinated debt issued to Bear Stearns Capital Trust
III.
(5) Net adjusted leverage ratio equals net adjusted assets 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 under
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, 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 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 and mitigates liquidity risk.
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
40
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
more than 12 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 nor does it contemplate 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 February 28, 2005, the market value of higher quality unencumbered,
unhypothecated securities owned by the Company was approximately $20.4 billion
with a borrowing value of $17.0 billion. The assets primarily comprise US
government and agency securities, mortgage- and asset-backed securities,
investment grade municipal and corporate bonds and US equities. The average
advance rate on these different asset types ranges from 76% 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 202% over the previous 12 months including unused
committed unsecured bank credit, and 188% excluding the unsecured portion of the
Company's $3.7 billion committed revolving credit facility.
The cash capital framework is utilized to evaluate the Company's long-term
funding sources and requirements in their entirety. Cash capital required to
support all of the Company's assets is determined on a regular basis. The two
basic categories of cash capital usage can be characterized broadly as (1)
firmwide haircuts and (2) illiquid assets/long-term investments. The first
category represents the aggregation of the "non-financeable" portion of assets
that can be readily financed on a secured basis. Incorporated in this component
is capital needed to support the vast majority of the Company's assets,
including trading-related assets, inventory, reverse repos, margin loans and
committed funding obligations. The second category consists of items not easily
or readily financed on a secured basis and includes fixed assets, goodwill,
merchant banking investments as well as other items. At February 28, 2005 the
Company's net cash capital position was $2.4 billion. Fluctuations in net cash
capital are common and are a function of fluctuations in total assets, balance
sheet composition and total capital. The Company typically maintains in excess
of $1.0 billion of net cash capital. Over the previous 12 months, the Company's
net cash capital position has averaged $1.5 billion.
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. An important component of the Company's
funding and liquidity risk management efforts involves ongoing dialogues with a
large number of creditor constituents. Strong relationships with a diverse base
of creditors and debt investors are crucial to the Company's liquidity. 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.
With respect to the management of refinancing risk, the maturity of the
long-term debt portfolio is monitored on an ongoing basis and structured within
the context of two diversification guidelines. The Company has a general
guideline of approximately no more than 20% of its long-term debt portfolio
maturing in any one year, as well as no more than 10% maturing in any one
quarter over the next five years. The Company continued to meet these guidelines
at the end of the first fiscal quarter of 2005. As of February 28, 2005, the
weighted average maturity of the Company's long-term debt was 4.2 years.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Committed Credit Facilities
The Company has a committed revolving credit facility ("Facility") totaling
$3.70 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 $1.85
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 advance rates 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 2006, with all loans outstanding at that date payable no
later than February 2007. There were no borrowings outstanding under the
Facility at February 28, 2005.
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
2005, with all repos outstanding at that date payable no later than August 2006.
There were no borrowings outstanding under the Repo Facility at February 28,
2005.
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 2005 with all loans outstanding at that
date payable no later than December 2006. There were no borrowings outstanding
under the Pan Asian Facility at February 28, 2005.
The Company also maintains a series of committed credit facilities to support
liquidity needs for the financing of investment-grade and non-investment-grade
corporate loans, residential mortgages, commercial mortgages and listed options.
The facilities are expected to be drawn from time to time and expire at various
dates, the longest of such periods ending in fiscal 2007. 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 $2.80 billion. At February 28, 2005,
the borrowings outstanding under these committed credit facilities were $377.0
million.
Capital Resources
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., Bear Stearns Credit Products Inc., Bear Stearns Forex Inc., EMC Mortgage
Corporation and Bear Stearns Commercial Mortgage, 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
February 28, 2005, the Parent Company's equity double leverage ratio was
approximately 0.70 based on common equity and 0.67 including preferred equity.
At November 30, 2004, these measures were 0.70 based on common equity and 0.66
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 both capital or borrowings
having a maturity profile and relative mix consistent with the nature and
self-funding ability of the assets being financed.
Long-term debt totaling $32.6 billion and $30.7 billion had remaining maturities
beyond one year at February 28, 2005 and November 30, 2004, 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
42
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 February 28, 2005, 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 $1.16 billion in additional collateral for outstanding
over-the-counter derivatives contracts.
At February 28, 2005, the Company's long-term/short-term debt ratings were as
follows:
Rating
-----------------------------------------------------------------
Dominion Bond Rating Service Limited A(high)/R-1 (middle)
Fitch A+/F1+
Moody's Investors Service A1/P-1
Rating & Investment Information, Inc. A+/NR
Standard & Poor's (1) A/A-1
-----------------------------------------------------------------
NR - does not assign a short-term rating
(1) On September 29, 2004, Standard & Poor's affirmed the Company's credit
ratings and maintained a "stable" outlook.
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 5, 2005, 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 2005 and beyond. During the quarter ended February 28, 2005, the
Company purchased under the current and prior authorizations a total of
1,220,782 shares at a cost of approximately $124.1 million. Approximately $940.3
million was available to be purchased under the current authorization as of
February 28, 2005.
During the quarter ended February 28, 2005, the Company purchased a total of
413,038 shares of its common stock at a total cost of $42.0 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
30, 2004. Approximately $158.0 million is available to be purchased under the
current authorization as of February 28, 2005.
Cash Flows
Cash and cash equivalents during the three month period ended February 28, 2005
decreased $1.95 billion to $2.22 billion. Cash used in operating activities was
$6.99 billion, primarily attributable to increases in financial instruments
owned, net receivables from brokers, dealers and others and cash and securities
deposited with clearing organizations or segregated in compliance with federal
regulations and a decrease in securities sold under agreements to repurchase,
net of securities purchased under agreements to resell, which occurred in the
normal course of business as a result of changes in customer needs, market
conditions and trading strategies. Cash used in investing activities of $46.8
million reflected purchases of property, equipment and leasehold improvements.
Cash provided by financing activities of $5.09 billion reflected net proceeds
from the issuance of long-term borrowings and net proceeds relating to
short-term borrowings partially offset by net payments for the retirement of
long-term borrowings.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Authority. At February 28, 2005, Bear Stearns, BSSC, BSIL, BSIT and
BSB were in compliance with their respective regulatory capital requirements.
The Company's broker-dealer subsidiaries and other regulated subsidiaries are
subject to minimum capital requirements and may also be subject to certain
restrictions on the payment of dividends, which could limit the Company's
ability to withdraw capital from such regulated subsidiaries, which in turn
could limit the Company's ability to pay dividends. See Note 8, "Regulatory
Requirements," in the Notes to Condensed Consolidated Financial Statements.
In June 2004, the SEC adopted rule amendments relating to "Alternative Net
Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised
Entities" that allow investment banks to voluntarily submit to be regulated by
the SEC on a global consolidated basis. These regulations (referred to as CSE)
were in response to what is known as the "Financial Conglomerates Directive"
(2002/87/EC) of the European Parliament, which served to compel globally active
institutions doing business in Europe to be regulated on a global consolidated
basis. The Company anticipates applying to the SEC during fiscal 2005 to be
regulated under this new CSE regime. The new framework will be a notable change
in the Company's regulation, as activities which are currently transacted
outside of SEC-regulated entities will come under the scope of SEC regulation
and capital adequacy requirements. On becoming subject to the SEC's consolidated
supervision, the Company will be required to report to the SEC computations of
the Company's consolidated capital adequacy. Although the application process is
not yet complete, the Company believes that it will meet the requirements of the
SEC to be regulated on a consolidated basis.
Merchant Banking and Private Equity Investments
In connection with the Company's merchant banking activities, the Company had
investments in merchant banking and private equity-related investment funds as
well as direct investments in private equity-related investments. At February
28, 2005, the Company held investments with an aggregate recorded value of
approximately $510.3 million, reflected in the Condensed Consolidated Statements
of Financial Condition in "Other Assets." At November 30, 2004, the Company held
investments with an aggregate recorded value of approximately $469.4 million. In
addition to these 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 February 28, 2005 and November 30,
2004, the Company held high yield positions approximating $8.15 billion and
$7.09 billion, respectively, substantially all of which are in "Financial
Instruments Owned" in the Condensed Consolidated Statements of Financial
Condition, and $1.29 billion and $1.09 billion, 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 $1.44 billion
at February 28, 2005 and $1.29 billion at November 30, 2004. Also included in
the high yield positions are extensions of credit to highly leveraged companies.
At February 28, 2005 and November 30, 2004, the amount
44
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
outstanding to highly leveraged borrowers totaled $2.42 billion and $2.14
billion, respectively. The largest industry concentration was the
telecommunications industry, which approximated 41.0% at February 28, 2005 and
20.4% at November 30, 2004 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 which amounts are not included in the
aggregate high yield positions above. These amounts, net of collateral, were
approximately $182 million and $340 million at February 28, 2005 and November
30, 2004, 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
and concentrations of risk by individual issuer. High yield positions generally
involve greater risk than investment grade debt securities due to credit
considerations, 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.
Contractual Obligations
In connection with its operating activities, the Company enters into contractual
obligations that require future cash payments. At February 28, 2005, the
Company's contractual obligations by maturity, excluding derivative financial
instruments, were as follows:
Payments Due By Period
------------------------------------------------------
Remaining Fiscal Fiscal
Fiscal 2006- 2008-
(in millions) 2005 2007 2009 Thereafter Total
-----------------------------------------------------------------------------------------------
Long-term borrowings (1) (2) $4,863 $12,914 $9,759 $11,436 $38,972
Future minimum lease payments (3) (4) 44 127 120 248 539
-----------------------------------------------------------------------------------------------
(1) Amounts include fair value adjustments in accordance with SFAS No. 133 as
well as $262.5 million of junior subordinated deferrable interest
debentures ("Debentures"). The Debentures will mature on May 15, 2031;
however, the Company, at its option, may redeem the Debentures beginning
May 15, 2006. The Debentures are reflected in the table at their
contractual maturity dates.
(2) Included in fiscal 2006 are approximately $1.48 billion of floating-rate
medium-term notes that are redeemable prior to maturity at the option of
the noteholder. These notes contain certain provisions that effectively
enable noteholders to put these notes back to the Company and, therefore,
are reflected in the table at the date such notes first become redeemable.
The final maturity date of these notes is during fiscal 2009.
(3) Includes 383 Madison Avenue in New York City.
(4) See Note 9, "Commitments and Contingencies," in the Notes to Condensed
Consolidated Financial Statements.
45
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Commitments
The Company has commitments(1) under a variety of commercial arrangements. At
February 28, 2005 the Company's commitments associated with lending and
financing, private equity-related investments and partnerships, outstanding
letters of credit, underwriting and other commercial commitments summarized by
period of expiration were as follows:
Amount of Commitment Expiration Per Period
---------------------------------------------------
Remaining Fiscal Fiscal
Fiscal 2006- 2008-
(in millions) 2005 2007 2009 Thereafter Total
-----------------------------------------------------------------------------------------------------
Lending-Related commitments:
Investment-grade (2) $1,138 $368 $676 $ -- $2,182
Non-investment grade 124 552 590 320 1,586
Contingent commitments 1,762 930 -- -- 2,692
Commitments to invest in private equity-related
investments and partnerships (3) 378
Underwriting commitments 2,202 -- -- -- 2,202
Commercial and residential loans 2,090 133 -- -- 2,223
Letters of credit 3,652 60 34 -- 3,746
Other commercial commitments (4) 91 223 9 -- 382
-----------------------------------------------------------------------------------------------------
(1) See Note 9, "Commitments and Contingencies," in the Notes to Condensed
Consolidated Financial Statements.
(2) In order to mitigate the exposure to investment-grade borrowings the
Company entered into credit default swaps aggregating $402.8 million at
February 28, 2005.
(3) At February 28, 2005, commitments to invest in private equity-related
investments and partnerships aggregated $378.4 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 $59.2 million in commitments with no stated maturity.
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.
SPEs are corporations, trusts or partnerships that 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 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 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 4, "Transfers of Financial Assets
and Liabilities," in the Notes to Condensed Consolidated Financial Statements
for a more complete discussion of the Company's securitization activities.
The Company regularly creates or transacts with entities that may be VIEs. These
entities are an essential part of its
46
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
securitization, asset management and structured finance businesses. In addition,
the Company purchases and sells instruments that may be variable interests. The
Company adopted FIN No. 46 (R) for its variable interests in fiscal 2004. The
Company consolidates those VIEs in which the Company is the primary beneficiary.
See Note 5, "Consolidation of Variable Interest Entities and Mortgage Loan
Special Purpose 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 little or 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 follows the criteria in FIN No. 46 (R)
in determining whether it should consolidate such entities. 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.
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 10, "Guarantees," in
the Notes to Condensed Consolidated Financial Statements for a complete
discussion on guarantees.
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments are contractual commitments between
counterparties that derive their values from changes in an underlying interest
rate, currency exchange rate, index (e.g., S&P 500), reference rate (e.g.,
LIBOR), or asset value referenced in the related contract. Some derivatives,
such as futures contracts, certain options and index-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, 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 that may include over-the-counter derivatives contracts or the
purchase or sale of interest-bearing securities, equity securities, financial
futures and forward contracts. The Company also utilizes derivative instruments
to hedge proprietary market-making and trading activities. 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, futures contracts and US Treasury positions to hedge its
debt issuances as part of its asset and liability management.
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 February 28, 2005 and November 30, 2004, the Company had notional/contract
amounts of approximately $4.02 trillion and $3.50 trillion, respectively, of
derivative financial instruments, of which $893.5 billion and $692.0 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
47
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
outstanding, which either are used to hedge trading positions, modify the
interest rate characteristics of its long- and short-term debt, or are part of
its derivative dealer activities, are marked to fair value.
The Company's derivatives had a notional weighted average maturity of
approximately 3.9 years and 4.0 years at February 28, 2005 and November 30,
2004, respectively. The maturities of notional/contract amounts outstanding for
derivative financial instruments as of February 28, 2005 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 $ 624.5 $ 806.5 $ 683.6 $ 884.6 $2,999.2
Futures contracts 316.8 185.9 26.8 -- 529.5
Forward contracts 87.1 -- -- -- 87.1
Options held 214.4 71.9 0.6 0.1 287.0
Options written 110.3 5.5 0.8 0.1 116.7
-----------------------------------------------------------------------------------------------------------
Total $1,353.1 $1,069.8 $ 711.8 $ 884.8 $4,019.5
===========================================================================================================
Percent of total 33.7% 26.6% 17.7% 22.0% 100.0%
===========================================================================================================
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 Condensed 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 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
48
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
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 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.
The Company is also 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.
At February 28, 2005 and November 30, 2004, the total of all positions
(primarily fixed income cash positions) aggregated approximately $4.5 billion
and $4.0 billion, respectively, in "Financial Instruments Owned" and $2.0
billion and $1.6 billion, respectively, in "Financial Instruments Sold, But Not
Yet Purchased" in the Condensed Consolidated Statements of Financial Condition.
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
49
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
("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 interests and securities acquired as a result of leveraged acquisition
transactions are reflected in the condensed 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. 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. 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 and Private Equity
Investments" in Management's Discussion and Analysis for additional details.
ACCOUNTING AND REPORTING DEVELOPMENTS
The American Jobs Creation Act ("the Act"), which was signed into law on October
22, 2004, provides a temporary incentive for US companies to repatriate
accumulated foreign earnings. A corporation that is a US shareholder of
controlled foreign corporations may (subject to various limitations) elect to
deduct 85% of certain cash dividends that it receives from those controlled
foreign corporations during the election year. The election year may be either
the last taxable year beginning before the date of enactment or the first
taxable year beginning during the one-year period starting on the date of
enactment. With respect to the Company, the election year could be either the
fiscal year ended November 30, 2004 or the fiscal year ending November 30, 2005.
Since the Act became effective during the fourth quarter of the Company's fiscal
year ended November 30, 2004 and the US Treasury Department had not yet issued
necessary regulatory guidance with respect to these statutory provisions, the
Company was unable to evaluate the effects of the repatriation provision with
respect to any unrepatriated foreign earnings as of November 30, 2004 and
accordingly did not elect to remit qualifying cash dividends for the November
30, 2004 fiscal year. For the fiscal year ending November 30, 2005, the Company
will complete its evaluation as soon as Congress passes expected Technical
Corrections to the Act and the US Treasury issues final and complete guidance on
these provisions. However, if the Company decides to repatriate under these
provisions, it does not expect the income tax on such repatriation, if any, to
be material.
In December 2004, the FASB issued SFAS No. 123 (R), "Share-Based Payment." SFAS
No. 123 (R) is a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation," and supersedes Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and amends SFAS No. 95
"Statement of Cash Flows." SFAS No. 123 (R) eliminates the ability to account
for share-based compensation transactions using APB Opinion No. 25 and requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the financial statements using a fair value-based
method. 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. SFAS No. 123 (R) is
effective as of the beginning of the first interim period that begins after June
15, 2005. The Company will adopt SFAS No. 123 (R) on September 1, 2005, as
required.
In March 2005, the SEC staff issued Staff Accounting Bulletin No. 107 ("SAB No.
107") to provide guidance on SFAS No. 123 (R). SAB No. 107 provides the staff's
view regarding the valuation of share-based payment
50
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
arrangements for public companies. In particular, this SAB provides guidance
related to share-based payment transactions with non-employees, the transition
from non public to public entity status, valuation methods (including
assumptions such as expected volatility and expected term), the accounting for
certain redeemable financial instruments issued under share-based payment
arrangements, the classification of compensation expense, non-GAAP financial
measures, first time adoption of SFAS No. 123 (R), the modification of employee
share options prior to the adoption of SFAS No. 123 (R) and disclosure in
Management's Discussion and Analysis subsequent to adoption of SFAS No. 123 (R).
SAB No. 107 is effective March 29, 2005. The impact of SFAS No. 123 (R) and SAB
No. 107 on the Company's consolidated financial statements is currently being
evaluated.
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.
51
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, 2004.
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 seek 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.
The Company uses a historical simulation approach for VaR, which is supplemented
by statistical risk add-ons for risk factors that do not lend themselves readily
to historical simulation. Historical simulation involves the generation of price
movements in a portfolio using price sensitivities, and actual historical
movements of the underlying risk factors to which the securities are sensitive.
Risk factors incorporated via historical simulation include interest rate
movements, yield curve shape, general market credit spreads, equity price
movement, option volatility movement (for certain option types) and foreign
exchange movement, among others. Risk factors incorporated via add-on factors
include the risk of specific bond issuers, among others. The Company believes
that its VaR methodologies are consistent with industry practices for these
calculations.
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 trading days. VaR is not likely
to accurately predict exposures in markets that exhibit sudden fundamental
changes or shifts in market conditions or established trading relationships.
Many of the Company's hedging strategies are structured around likely
established trading relationships and, consequently, those hedges may not be
effective and VaR models may not accurately predict actual results. Furthermore,
VaR calculated for a one-day horizon does not fully capture the market risk of
positions that cannot be liquidated in a one-day period. However, the Company
believes VaR models are an established methodology for the quantification of
risk in the financial services industry despite these limitations. VaR is best
used in conjunction with other financial disclosures in order to assess the
Company's risk profile.
52
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The aggregate VaR presented here 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. Diversification benefit
equals the difference between Aggregate VaR and the sum of the VaRs for the
three risk categories. This benefit arises because the simulated one-day losses
for each of the three primary market risk categories occur on different days and
because of general diversification benefits introduced when risk is measured
across a larger set of specific risk factors than exist in the respective
categories; similar diversification benefits also are taken into account across
risk factors within each category. The following table illustrates the VaR for
each component of market risk as of February 28, 2005, November 30, 2004 and
February 29, 2004. Commodity risk has been excluded due to immateriality at
February 28, 2005, November 30, 2004 and February 29, 2004.
February 28, November 30, February 29,
(in millions) 2005 2004 2004
--------------------------------------------------------------------------------
MARKET RISK
Interest rate $22.5 $15.3 $15.7
Currency 1.3 1.4 1.6
Equity 5.2 2.8 3.9
Diversification benefit (9.2) (4.7) (4.9)
--------------------------------------------------------------------------------
Aggregate VaR $19.8 $14.8 $16.3
================================================================================
The table below illustrates the high, low and average (calculated on a daily
basis) VaR for each component of market risk and aggregate market risk during
the 2005 quarter:
(in millions) High Low Average
=========================================================================
MARKET RISK
Interest rate $ 26.9 $ 11.9 $17.1
Currency 2.5 0.7 1.5
Equity 5.2 2.0 3.1
Aggregate VaR 23.9 11.9 15.6
-------------------------------------------------------------------------
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 "Credit Risk"). 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 February 28,
2005 and February 29, 2004, 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 $15.7 million and $15.5 million for the quarter ended February 28,
2005 and February 29,
53
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
2004, respectively. There were no daily trading losses for the quarter ended
February 28, 2005. During the quarter ended February 29, 2004, there was one day
with a reported trading loss and the total daily trading loss did not exceed the
reported aggregate period end VaR amount. The frequency distribution of the
Company's daily net trading revenues reflects the Company's historical ability
to manage its exposure to market risk and the diversified nature of its trading
activities. Market conditions were favorable for the Company's trading activity
in both quarters ending February 28, 2005 and February 29, 2004, respectively.
Hedging strategies were generally effective as established trading relationships
remained substantially intact and volatility tended to be lower than historical
norms. No guarantee can be given regarding future net trading revenues or future
earnings volatility. However, the Company believes that these results are
indicative of its commitment to the management of market trading risk.
54
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
DISTRIBUTION OF DAILY NET TRADING REVENUES
Quarter Ended February 28, 2005
[GRAPH CHART]
Daily Net Trading Number of
Revenues ($ in millions) Trading Days
(10)+ -
(10)-(5) -
(5)-0 -
0-5 4
5-10 11
10-15 11
15-20 22
20-25 9
25-30 3
30+ 1
--
Total 61
Quarter Ended February 29, 2004
[GRAPH CHART]
Daily Net Trading Number of
Revenues ($ in millions) Trading Days
(10)+ -
(10)-(5) -
(5)-0 1
0-5 4
5-10 8
10-15 20
15-20 13
20-25 9
25-30 3
30+ 3
--
Total 61
55
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Credit Risk
The Company measures its actual credit exposure (the replacement cost of
counterparty contracts) on a daily basis. Master netting agreements, collateral
and credit insurance are used to mitigate counterparty credit risk. The credit
exposures reflect these risk-reducing features to the extent they are legally
enforceable. The Company's net replacement cost of derivatives contracts in a
gain position at February 28, 2005 and November 30, 2004 approximated $3.74
billion and $4.56 billion, respectively. Exchange-traded financial instruments,
which typically are guaranteed by a highly rated clearing organization, have
margin requirements that substantially mitigate risk of credit loss.
The following table summarizes the counterparty credit quality of the Company's
exposure with respect to over-the-counter derivatives (including foreign
exchange and forward-settling mortgage transactions) as of February 28, 2005:
Over-the-Counter Derivative Credit Exposure (1)
($ in millions)
Exposure, Percentage of
Net of Exposure, Net
Rating (2) Exposure Collateral(3) Collateral(4) of Collateral
------------------------------------------------------------------------------
AAA $1,491 $ 370 $1,170 31%
AA 2,116 951 1,237 33%
A 1,904 987 970 26%
BBB 383 394 177 5%
BB and lower 1,332 2,885 179 5%
Non-rated 4 1 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.
56
Item 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) of 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 have been no such changes during the quarter covered by
this quarterly report.
57
Part II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
In the normal course of business, the Company has been named as a defendant in
various legal actions, including arbitrations, class actions and other
litigation. Certain of the legal actions include claims for substantial
compensatory and/or punitive damages or claims for indeterminate amounts of
damages. The Company is also involved in other reviews, investigations and
proceedings by governmental and self-regulatory agencies regarding the Company's
business, certain of which may result in adverse judgments, settlements, fines,
penalties, injunctions or other relief.
Because litigation is inherently unpredictable, particularly in cases where
claimants seek substantial or indeterminate damages or where investigations and
proceedings are in the early stages, the Company cannot predict with certainty
the loss or range of loss related to such matters, how such matters will be
resolved, when they will ultimately be resolved, or what the eventual
settlement, fine, penalty or other relief might be. Consequently, the Company
cannot estimate losses or ranges of losses for matters where there is only a
reasonable possibility that a loss may have been incurred. Although the ultimate
outcome of these 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.
The Company has provided reserves for such matters in accordance with Statement
of Financial Accounting Standards No. 5, "Accounting for Contingencies". The
ultimate resolution may differ from the amounts reserved.
Fezanni, et al. v. Bear, Stearns & Co. Inc., et al.
As previously reported in the Company's Form 10-K for the fiscal year ended
November 30, 2004 ("Form 10-K"), Bear Stearns, BSSC and a former officer of
BSSC, were named as defendants in a lawsuit in United States District Court for
the Southern District of New York brought by eleven individuals and entities
that allegedly purchased securities underwritten by A.R. Baron & Company, Inc.,
a firm for which BSSC provided clearing services. On April 6, 2004, the district
court granted motions to dismiss all causes of action that plaintiffs brought
against Bear Stearns, BSSC, and the former officer of BSSC.
On or about September 23, 2004, as also reported in the Company's Form 10-K, the
plaintiffs filed an amended complaint against Bear Stearns, BSSC, a former
officer of BSSC and other individuals and entities. As a result of plaintiffs'
failure to seek the district court's leave prior to filing their amended
complaint, the court subsequently mandated plaintiffs to formally move the court
for permission to file an amended complaint. On March 1, 2005, the court granted
in part and denied in part plaintiffs' motion seeking permission to file an
amended complaint. Plaintiffs have until April 8, 2005 to re-file their amended
complaint consistent with the court's March 1, 2005 order.
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 ("IPOs"). In June 2004, plaintiffs and a
substantial number of the non-bankrupt issuer defendants and their officers
jointly moved for preliminary approval of a proposed settlement among the
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 litigation, 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.
By opinion and order dated February 15, 2005, the Court preliminarily approved
the proposed settlement among the plaintiffs and a substantial number of the
non-bankrupt issuer defendants and their officers. That preliminary approval,
however, was conditioned upon certain changes being made to the terms of the
settlement.
58
LEGAL PROCEEDINGS
The Company denies all allegations of wrongdoing asserted against it in these
litigations and believes that it has substantial defenses to these claims.
59
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The table below sets forth the information with respect to purchases made by the
Company of the Company's common stock during the first quarter of fiscal 2005:
-----------------------------------------------------------------------------------------------------------------
Total Number of Approximate Dollar
Shares Purchased as Value of Shares that
Part of Publicly May Yet Be Purchased
Total Number of Shares Average Price Paid Announced Plans or Under the Plans or
Period Purchased per Share Programs (1) Programs (1)
-----------------------------------------------------------------------------------------------------------------
12/1/04 - 12/31/04 750,480 $ 102.89 750,480 $ 561,268,066
1/1/05 - 1/31/05 459,976 100.79 459,976 1,140,866,784
2/1/05 - 2/28/05 423,364 100.44 423,364 1,098,342,814
--------- ---------
Total 1,633,820 101.67 1,633,820
========= ---------
(1) On January 5, 2005, the Board of Directors of the Company approved an
amendment to the Repurchase Program to replenish the previous authorization to
allow the Company to purchase up to $1.0 billion of common stock in fiscal 2005
and beyond. 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 and beyond. On November 30, 2004, the Compensation Committee of the Board
of Directors approved a $200 million CAP Plan Earnings Purchase Authorization to
allow the Company to purchase up to $200 million of common stock in fiscal 2005.
The Repurchase Program has no set expiration or termination date.
60
Item 6. EXHIBITS
Exhibits
(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
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: April 11, 2005 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
----------- ----------- ----
(12) Computation of Ratio of Earnings to Fixed Charges and to Combined 64
Fixed Charges and Preferred Stock Dividends
(15) Letter re: Unaudited Interim Financial Information 65
(31.1) Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) 66
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) 67
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. 68
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. 69
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
63