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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended March 31, 2004
The Quarterly Report on Form 10-Q and cross reference index is on page 52.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Introduction 2
- Overview 2
- Summary of Results 3
- Other First Quarter Developments 5
- Consolidated Income Statement Review 6
- Business Segments Review 10
- Consolidated Balance Sheet Review 20
- Critical Accounting Policies 28
- Liquidity 30
- Capital Resources 32
- Trading Activities 34
- Asset/Liability Management 35
- Statistical Information 37
- Forward Looking Statements and
Factors That Could Affect Future Results 38
- Website Information 39
Consolidated Financial Statements
- Consolidated Balance Sheets
March 31, 2004 and December 31, 2003 40
- Consolidated Statements of Income
For the Three Months Ended March 31, 2004 and 2003 41
- Consolidated Statement of Changes In
Shareholders' Equity for the Three
Months Ended March 31, 2004 42
- Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2004 and 2003 43
- Notes to Consolidated Financial Statements 44
Form 10-Q
- Cover 52
- Controls and Procedures 53
- Legal Proceedings 53
- Changes in Securities, Use of Proceeds and
Issuer Purchases of Equity Securities 54
- Exhibits and Reports on Form 8-K 54
- Signature 55
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
March 31, December 31, March 31,
2004 2003 2003
------------ ------------- ----------
Revenue (tax equivalent basis) $1,677 $1,694 $1,429
Net Income 364 307 295
Basic EPS 0.47 0.40 0.41
Diluted EPS 0.47 0.40 0.41
Cash Dividends Per Share 0.19 0.19 0.19
Return on Average Common
Shareholders' Equity 17.17% 14.81% 17.80%
Return on Average Assets 1.47 1.26 1.49
Efficiency Ratio 68.9 66.9 60.0
Assets $92,652 $92,397 $79,710
Loans 36,070 35,283 31,573
Securities 24,083 22,903 19,599
Deposits - Domestic 33,639 33,730 33,280
- Foreign 22,443 22,676 23,664
Long-Term Debt 6,276 6,121 5,685
Common Shareholders' Equity 8,760 8,428 6,874
Common Shareholders'
Equity Per Share $11.27 $10.85 $ 9.41
Market Value Per Share
of Common Stock 31.50 33.12 20.50
Allowance for Credit Losses
as a Percent of Total Loans 2.19% 2.28% 2.63%
Allowance for Credit Losses as
a Percent of Non-Margin Loans 2.64 2.72 2.67
Allowance for Loan Losses as
a Percent of Total Loans 1.75 1.89 2.12
Allowance for Loan Losses as
a Percent of Non-Margin Loans 2.11 2.26 2.14
Tier 1 Capital Ratio 7.52 7.44 7.92
Total Capital Ratio 11.57 11.49 12.72
Leverage Ratio 5.83 5.82 6.68
Tangible Common Equity Ratio 5.22 4.91 5.52
Employees 22,820 22,901 19,491
Assets Under Custody (In trillions)
Total Assets Under Custody $8.6 $8.3 $6.8
Equity Securities 33% 34% 25%
Fixed Income Securities 67 66 75
Cross-Border Assets Under Custody $2.4 $2.3 $1.9
Assets Under Administration
(In billions) 33 32 27
Assets Under Management (In billions)
Total Assets Under Management 92 89 76
Equity Securities 36% 34% 29%
Fixed Income Securities 22 22 24
Alternative Investments 13 10 9
Liquid Assets 29 34 38
2
Management's Discussion and Analysis of Financial Condition and
- ---------------------------------------------------------------
Results of Operations
- ---------------------
INTRODUCTION
The Bank of New York Company, Inc.'s (the "Company") actual results of future
operations may differ from those estimated or anticipated in certain forward-
looking statements contained herein for reasons which are discussed below and
under the heading "Forward Looking Statements and Factors That Could Affect
Future Results." When used in this report, the words "estimate," "forecast,"
"project," "anticipate," "expect," "intend," "believe," "plan," "goal,"
"should," "may," "strategy," and words of similar meaning are intended to
identify forward looking statements in addition to statements specifically
identified as forward looking statements.
OVERVIEW
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
securities servicing for investors, financial intermediaries and issuers. The
Company plays an integral role in the infrastructure of the capital markets,
servicing securities in more than 100 markets worldwide. The Company provides
services based on leading technology for global financial institutions, asset
managers, governments, non-profit organizations, corporations, and
individuals. Its principal subsidiary, The Bank of New York, founded in 1784,
is the oldest bank in the United States and has a distinguished history of
serving clients around the world through its five primary businesses:
Securities Servicing and Global Payment Services, Private Client Services and
Asset Management, Corporate Banking, Global Market Services, and Retail
Banking.
The Company has executed a consistent strategy over the past decade by
focusing on highly scalable, fee-based securities servicing and fiduciary
businesses, with top 3 market share in most of its major product lines. The
Company distinguishes itself competitively by offering the broadest array of
products and services around the investment lifecycle. These include:
advisory and asset management services to support the investment decision;
extensive trade execution, clearance and settlement capabilities; custody,
securities lending, accounting and administrative services for investment
portfolios; and sophisticated risk and performance measurement tools for
analyzing portfolios. The Company also provides services for issuers of both
equity and debt securities. By providing integrated solutions for clients'
needs, the Company strives to be the preferred partner in helping its clients
succeed in the world's rapidly evolving financial markets.
The Company consistently invests in technology to improve the breadth
and quality of its product offerings, and to increase economies of scale. The
Company believes the extent to which it is able to invest in technology is a
key long-term competitive advantage.
The Company also actively pursues strategic acquisitions to expand
product offerings and increase market share in its scale businesses. The
Company has made over 80 acquisitions since 1995, almost exclusively in its
securities servicing and fiduciary businesses. The acquisition of Pershing in
2003 for $2 billion was the largest of these acquisitions.
As part of the transformation to a leading securities servicing
provider, the Company has also de-emphasized or exited its slower growth
traditional banking businesses over the past decade. The Company's more
significant actions include selling its credit card business in 1997 and its
factoring business in 1999, and most recently, significantly reducing non-
financial corporate credit exposures by 44% from December 31, 2000 to December
31, 2003. Capital generated by these actions has been reallocated to the
Company's higher growth businesses.
3
The Company's business model is well positioned to benefit from a number
of long-term secular trends. These include the growth of worldwide financial
assets, globalization of investment activity, structural market changes, and
increased outsourcing. These trends benefit the Company by driving higher
levels of financial asset trading volume and other transactional activity, as
well as higher asset price levels and growth in client assets, all factors by
which the Company prices its services. In addition, international markets
offer excellent growth opportunities.
The start of the year exceeded the Company's expectations in several
respects. Trading volumes were strong, particularly for equities in January,
and remained at healthy levels throughout the quarter. As of March 31, 2004,
assets under custody rose to $8.6 trillion, from $8.3 trillion at December 31,
2003 and $6.8 trillion at March 31, 2003. The sequential quarter increase in
assets under custody primarily reflects new business wins. Cross-border
custody assets were $2.4 trillion at March 31, 2004. Equity securities
composed 33% of the assets under custody at March 31, 2004, while fixed income
securities were 67%. Cross-border investing and currency volatility picked up
significantly. While equity price levels ended flat for the quarter, average
daily prices were up sequentially. Average daily combined first quarter NYSE
and NASDAQ trading volume increased 13% from the fourth quarter of 2003 and
27% from the first quarter of 2003. The S&P 500 index rose 1% during the
quarter while the NASDAQ index was flat. These better business conditions
supported strong results in the Company's securities servicing businesses, led
by the investor services and execution and clearing businesses. Higher volumes
and average equity values benefited investor services on a global basis, while
Pershing responded well to strengthening retail investor activity.
The Company's asset management business continued to perform well,
responding to growing institutional investor interest in alternative
investments. In addition, record foreign exchange results benefited from
currency volatility and increased cross-border investing.
The actions the Company has taken over the past several years with
respect to reducing risk in the credit portfolio, through absolute reductions
and greater granularity, are now generating tangible results. In addition, the
strengthening economy has helped the financial condition of corporate
borrowers, leading to improved risk ratings in the Company's loan portfolio.
Credit spreads have also tightened, allowing the Company to liquidate impaired
credits or reduce the allowance allocated to these credits. These factors led
to a reduced provision for credit losses in the quarter.
The Company continued to focus on improving productivity, which resulted
in positive operating leverage for the third consecutive quarter while also
maintaining strategic spending priorities.
SUMMARY OF RESULTS
The Company reported first quarter net income of $364 million and diluted
earnings per share of 47 cents compared with net income of $295 million and
diluted earnings per share of 41 cents in the first quarter of 2003. In the
fourth quarter of 2003, the Company reported net income of $307 million and
diluted earnings per share of 40 cents, which included 4 cents of merger and
integration costs associated with the acquisition of Pershing.
The Company achieved solid organic growth in earnings this quarter
reflecting strength in nearly all major business lines. In particular, the
investor services and execution and clearing businesses benefited from
improving market conditions, higher global equity trading volumes and
increased activity by retail investors. Greater cross-border investing
activity and exchange rate volatility also drove foreign exchange revenues to
historically high levels. In addition, proactive management of the Company's
expense base resulted in the third consecutive quarter of positive operating
leverage.
The Company's credit risk reduction program continues to deliver tangible
results. These efforts, combined with the stronger economy, have led to
4
significant improvement in the Company's asset quality metrics and a lower
quarterly loan loss provision. The Company expects credit costs to remain at
lower levels through the remainder of the year.
Looking ahead, the sustainability of the improving market fundamentals
will be key for the balance of 2004. In addition, debates over market
structure as well as increased regulatory rules and oversight in industries
the Company serves have not abated and will not for the foreseeable future.
The Company is confident, however, that the breadth of its business model
enables the Company to benefit as the market evolves, and positions the
Company to meet its long-term financial goals.
First quarter highlights include record securities servicing fees of $716
million, an increase of $32 million, or 5%, over the fourth quarter of 2003.
Investor services, execution and clearing, and broker-dealer services were
strong during the quarter benefiting from active equity markets and the
conversion of new business wins. Foreign exchange and other trading increased
sequentially by $25 million, or 31%, due to higher exchange rate volatility
and significantly increased cross-border investment flows. Private client
services and asset management fees increased sequentially by $5 million, or
5%, principally due to continued strong performance by Ivy Asset Management
("Ivy"), the Company's fund of funds hedge fund manager. Nonperforming assets
and charge-offs continued to decline, reflecting continued improvement in
credit quality. As a result of this and other factors, the Company lowered
its provision for credit losses from $35 million in the fourth quarter to $12
million in the first quarter of 2004.
Reflecting this strong first quarter performance and expectations for the
future, the Company's Board of Directors increased the dividend for the
Company's common stock by 5.3% to 20 cents per quarter (80 cents on an annual
basis) on April 13, 2004.
5
OTHER FIRST QUARTER DEVELOPMENTS
During the first quarter, the Company recorded several gains and charges
that in the aggregate did not influence reported earnings per share. These
items are described in the following table:
(In millions)
Income
Statement Pre-tax After-Tax
Item Caption Income Tax Income
- ---- ------------ ------- --- ---------
SFAS 13 cumulative Net Interest
lease adjustment Income $(145) $113 $(32)
Severance Salaries and
Employee Benefits (10) 4 (6)
Lease terminations Net Occupancy (8) 3 (5)
Gain on sale of
Wing Hang Other Income 48 (21) 27
Gain on sponsor Securities
fund investments Gains 19 (7) 12
----- ---- ----
Total $ (96) $ 92 $ (4)
===== ==== ====
The first item relates to an after-tax charge of $32 million resulting
from a cumulative adjustment to the leasing portfolio, which was triggered
under Statement of Financial Accounting Standards No. 13 "Accounting for
Leases" ("SFAS 13") by the combination of a reduction in state and local taxes
and a restructuring of the lease portfolio completed this quarter. The SFAS
13 adjustment impacts the timing of lease income reported by the Company, and
resulted in a reduction in net interest income of $145 million, offset by tax
benefits of $113 million. The Company estimates that the reduction in state
and local taxes will reduce its overall effective tax rate by approximately 1%
prospectively to 34.25% for the balance of the year.
The Company also took several actions in the first quarter which were
associated with its long-term cost reduction initiatives. These actions
included an after-tax severance charge of $6 million related to staff
reductions tied to job relocations and a $5 million after-tax charge for
terminating high cost leases associated with staff redeployments.
Offsetting these charges were a $27 million after-tax gain on the
previously reported sale of a portion of the Company's interest in Wing Hang
Bank Limited ("Wing Hang"), a Hong Kong based bank, which was recorded in
other income, and $19 million ($12 million after-tax) of higher than
anticipated securities gains in the quarter resulting from realized gains on
sponsor fund investments in Kinkos, Inc., Bristol West Holdings, Inc., Willis
Group Holdings, Ltd., and True Temper Sports, Inc.
6
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2004 2003 2003
---- ---- ----
Servicing Fees
Securities $ 716 $ 684 $474
Global Payment Services 79 76 78
------ ------ ----
795 760 552
Private Client Services
and Asset Management Fees 108 103 90
Service Charges and Fees 96 97 97
Foreign Exchange and
Other Trading Activities 106 81 65
Securities Gains 33 9 7
Other 92 52 33
------ ------ ----
Total Noninterest Income $1,230 $1,102 $844
====== ====== ====
Noninterest income for the first quarter of 2004 was $1,230 million, an
increase of 12% sequentially and 46% from a year ago. Excluding the
previously mentioned gains on sale of Wing Hang and sponsor fund investments,
the sequential quarter increase in noninterest income was 6%.
Securities servicing fees were a record $716 million in the first
quarter, an increase of $32 million, or 5%, from the fourth quarter.
Execution and clearing services fees increased $13 million sequentially,
or 4%, to $303 million in the first quarter. These businesses benefited from
higher equity trading volumes in the first quarter although equity price
levels were essentially flat by the end of the quarter. This increased level
of market activity more than offset an anticipated decline in soft-dollar
related execution activities. Pershing also benefited from strong retail
investor activity, especially in January, which contributed to increased
billable trades.
Investor services fees recorded a strong quarter, increasing 8%
sequentially as a result of higher transaction volumes and average asset price
levels, the conversion of new business wins and favorable exchange rates.
Investor services include custody, global fund services, securities lending,
global liquidity services and outsourcing. As of March 31, 2004, assets under
custody rose to $8.6 trillion, from $8.3 trillion at December 31, 2003 and
$6.8 trillion at March 31, 2003.
Issuer services fees were up slightly from the fourth quarter, reflecting
a solid quarter in corporate trust and stock transfer, offset by a modest
decline in depositary receipts. While there was increased interest in cross-
border investing during the quarter, reflected in the 21% growth in DR share
trading compared to the fourth quarter of 2003, there were fewer corporate
actions in the quarter.
Broker-dealer services fees increased $2 million, or 4%, on a sequential
quarter basis, as a result of continued strong performance in global
collateral management services and securities clearance. Expanded use of the
Company's tri-party repo product by clients to fund their activities drove
revenue growth during the quarter.
Global payment services fees were up $3 million, or 4%, compared with the
prior quarter and up $1 million from the first quarter of 2003, resulting from
higher volumes and improved pricing.
7
Private client services and asset management fees for the first quarter
were up 5% from the prior quarter and 20% from the first quarter of 2003. The
sequential quarter increase reflects continued strong growth at Ivy Asset
Management and new business wins. The increase from 2003 reflects the same
factors involved in the sequential quarter increase as well as higher equity
price levels. Total assets under management were $92 billion at March 31,
2004, up from $89 billion at December 31, 2003 and $76 billion a year ago.
Service charges and fees were down marginally from the prior quarter and
one year ago, as higher service and transaction fees were offset by lower
capital market fees.
Foreign exchange and other trading revenues increased $25 million from
the prior quarter and $41 million, or 63%, from one year ago. The strong
performance this quarter in foreign exchange reflects higher levels of client
activity, resulting from several factors including hedging against currency
volatility, renewed interest in cross-border investing, and asset
reallocations into equities. The increase from a year ago was also positively
impacted by the acquisition of Pershing and new business wins.
Securities gains in the first quarter were $33 million, up from both the
prior quarter and a year ago primarily due to the realization of significant
gains in the Company's private equity portfolio, which included $19 million in
realized gains on four sponsor fund investments.
Other noninterest income was $92 million, compared with $52 million in
the prior quarter and $33 million in the first quarter of 2003. In January
2004, the Company sold 20% of its investment in Wing Hang, which generated a
pre-tax gain of $48 million. The sale was part of the Company's continuing
plan to reduce capital invested in non-strategic areas. The Company continues
to own approximately 20% of Wing Hang's outstanding shares, which are
accounted for on the equity method.
Net Interest Income
- -------------------
(Dollars in millions) 1st 1st 4th 1st
Quarter Quarter Quarter Quarter
2004 2004 2003 2003
-------- ------ -------- --------
Reported Core** Reported Reported
-------- ------ -------- --------
Net Interest Income $268 $413 $418 $386
Tax Equivalent Adjustment* 6 6 8 9
---- ---- ---- ----
Net Interest Income on a
Tax Equivalent Basis $274 $419 $426 $395
==== ==== ==== ====
Net Interest Rate Spread 1.13% 1.85% 1.92% 2.18%
Net Yield on Interest
Earning Assets 1.36 2.08 2.15 2.44
* A number of amounts related to net interest income are presented on a
"taxable equivalent basis." The Company believes that this presentation provides
comparability of net interest income arising from both taxable and tax-exempt
sources and is consistent with industry standards.
** Excludes SFAS 13 adjustment
Net interest income on a taxable equivalent basis was $274 million in the
first quarter of 2004, which reflects a net interest rate spread of 1.13% and
a net yield on interest earning assets of 1.36%. Excluding the impact of the
SFAS 13 leasing adjustment on the leveraged lease portfolio, net interest
income was down on a sequential quarter to $419 million in the first quarter
of 2004, compared with $426 million in the fourth quarter of 2003, and up from
$395 million in the first quarter of 2003. On the same basis, the net
interest rate spread was 1.85% in the first quarter of 2004, compared with
8
1.92% in the fourth quarter of 2003, and 2.18% in the first quarter of 2003,
while the net yield on interest earning assets was 2.08% in the first quarter
of 2004, compared with 2.15% in the fourth quarter of 2003, and 2.44% in the
first quarter of 2003.
Excluding the impact of the SFAS 13 leasing adjustment on the leveraged
lease portfolio, the decrease in net interest income from the fourth quarter
of 2003 is primarily due to a day variance versus the fourth quarter, as well
as higher loan breakage fees in the fourth quarter. The increase in net
interest income from the first quarter of 2003 reflects the Pershing
acquisition and higher average balances of investment securities, which were
partially offset by lower reinvestment yields on the investment securities
portfolio and lower loan balances.
Noninterest Expense and Income Taxes
- ------------------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2004 2003 2003
---- ---- ----
Salaries and Employee Benefits $ 574 $ 548 $423
Net Occupancy 81 70 58
Furniture and Equipment 51 49 36
Clearing 48 43 29
Sub-custodian Expenses 22 21 16
Software 49 46 35
Communications 24 23 20
Amortization of Intangibles 8 7 3
Merger and Integration Costs - 48 -
Other 156 161 119
------ ------ ----
Total Noninterest Expense $1,013 $1,016 $739
====== ====== ====
Noninterest expense for the first quarter of 2004 was $1,013 million,
compared with $1,016 million in the prior quarter. Noninterest expense in the
first quarter included $18 million related to cost reduction initiatives,
including lease terminations, severance and relocation expenses. Of this
amount, $10 million was in salaries and employee benefits and $8 million was
in net occupancy.
On a sequential quarter basis, after excluding $48 million of fourth
quarter merger and integration costs, and the $18 million associated with the
cost reduction initiatives, expenses increased by $27 million or 3%. Driving
this increase were higher performance related incentives and benefits, a lower
pension credit, and higher variable expenses associated with revenue growth.
Compared to a year ago, noninterest expenses were up 37% primarily due to
Pershing and higher variable costs associated with revenue growth.
The effective tax rate for the first quarter of 2004 was 23.1%, compared
to 34.6% in the fourth quarter and 34.6% in the first quarter of 2003. The
decrease reflects the benefit associated with the SFAS 13 adjustment as
described in "Other First Quarter Developments."
9
Credit Loss Provision and Net Charge-Offs
- -----------------------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2004 2003 2003
---- ---- ----
Provision $ 12 $ 35 $ 40
==== ==== ====
Net Charge-offs:
Commercial $ (5) $ (24) $ (21)
Foreign (10) (7) -
Other - (5) (14)
Consumer (11) (12) (5)
------ ------ ------
Total $ (26) $ (48) $ (40)
====== ====== ======
Other Real Estate Expenses $ - $ - $ -
The provision for credit losses was $12 million in the first quarter of
2004 compared to $35 million in the fourth quarter of 2003 and $40 million in
the first quarter of 2003. The lower provision reflects the Company's
improved risk profile and its strong asset quality metrics including improved
borrower ratings, lower levels of expected losses, declining nonperforming
assets, and the planned reductions in the large sub-investment grade
exposures. Furthermore, continued improvements in the U.S. economy as
reflected in recent government statistics, tightening of corporate credit
spreads and lower corporate defaults all led to the reduced level of
provisioning.
Net charge-offs were $26 million in the first quarter of 2004 versus $48
million and $40 million in the fourth and first quarters of 2003. These
represent 0.29% of total loans in the most recent quarter, down from 0.54% and
0.51% in the prior periods, respectively.
10
BUSINESS SEGMENTS REVIEW
The Company has an internal information system that produces performance
data for its four business segments along product and service lines.
Business Segments Accounting Principles
- ---------------------------------------
The Company's segment data has been determined on an internal management
basis of accounting, rather than the generally accepted accounting principles
used for consolidated financial reporting. These measurement principles are
designed so that reported results of the segments will track their economic
performance. Segment results are subject to restatement whenever improvements
are made in the measurement principles or organizational changes are made. In
the first quarter of 2004, the Company changed its methodology for allocating
its pension credit to the segments. Prior periods have been restated.
The measure of revenues and profit or loss by operating segment has been
adjusted to present segment data on a taxable equivalent basis. The provision
for credit losses allocated to each reportable segment is based on
management's judgment as to average credit losses that will be incurred in the
operations of the segment over a credit cycle of a period of years.
Management's judgment includes the following factors among others: historical
charge-off experience and the volume, composition, and size of the loan
portfolio. This method is different from that required under generally
accepted accounting principles as it anticipates future losses, which are not
yet probable, and therefore not recognizable under generally accepted
accounting principles. Assets and liabilities are match funded. Support and
other indirect expenses are allocated to segments based on general internal
guidelines.
Description of Business Segments
- --------------------------------
The results of individual business segments exclude unusual items such as
the GMAC settlement and the Pershing related merger and integration costs of
2003, which are included with reconciling amounts.
The Company reports data for the four business segments: Servicing and
Fiduciary, Corporate Banking, Retail Banking, and Financial Markets.
The Servicing and Fiduciary businesses segment comprises the Company's
core services, including securities servicing, global payment services, and
private client services and asset management. These businesses all share
certain favorable attributes: they are well diversified and fee-based; the
Company serves the role of an intermediary rather than principal, thereby
limiting risk and generating more stable earnings streams; and the businesses
are scalable, which result in higher margins as revenues grow. Long-term
trends that favor these businesses include the growth of financial assets
worldwide, the globalization of investment activity, heightened demand for
financial servicing outsourcing, and continuing structural changes in
financial markets.
Securities servicing provides financial institutions, corporations and
financial intermediaries with a broad array of products and customized
services for every step of the investment lifecycle. The Company facilitates
the movement, settlement, recordkeeping and accounting of financial assets
around the world by delivering timely and accurate information to issuers,
investors and broker-dealers. The Company groups its securities servicing
businesses into four categories, each comprised of separate, but related
businesses. Issuer services include corporate trust, depositary receipts and
stock transfer. Investor services include global fund services, global
custody, securities lending, global liquidity services and outsourcing.
Broker-dealer services include government securities clearance and collateral
management. Execution and clearing services include in the execution area
institutional agency brokerage, electronic trading, transition management
services, and independent research. Through Pershing, the clearing part of
the business provides clearing, execution, financing, and custody for
introducing brokers/dealers. The Servicing and Fiduciary segment also includes
customer-related foreign exchange.
11
In Issuer Services, the Company's ADR business has over 1,300 programs
representing 65 countries. As a trustee, the Company provides diverse services
for corporate, municipal, mortgage-backed, asset-backed, derivative and
international debt securities. Over 90,000 appointments for more than 30,000
worldwide clients have resulted in the Company being trustee for more than $1
trillion in outstanding debt securities. The Company is the third largest
stock transfer agent representing over 1,950 publicly traded companies with
over 19 million shareholder accounts.
In investor services, the Company is the second largest custodian with
$8.6 trillion of assets at March 31, 2004. The Company is the second largest
mutual fund custodian with $1.3 trillion in assets. The Company is the largest
U.K. custodian. The Company services over 25% of total exchange traded fund
industry assets. In securities lending, the Company is the largest lender of
U.S. Treasury securities and depositary receipts.
The Company's broker-dealer services business clears over 50% of U.S.
Government securities. With over $800 billion in tri-party balances worldwide,
the Company is the world's largest collateral management agent.
The Company's execution and clearing services business is the largest
global institutional agency brokerage organization. In addition, it is the
world's largest institutional elective broker for global execution. The
Company provides execution and clearing services in over 80 global markets,
clearing over 600,000 trades daily. The Company has 26 seats on the New York
Stock Exchange. Pershing services over 1,100 introducing brokers and
registered investment advisors who employ approximately 100,000 investment
professionals.
Global payment services facilitate the flow of funds between the
Company's customers and their clients through such business lines as funds
transfer, cash management and trade services. Private client services and
asset management includes traditional banking and trust services to affluent
clients and investment management services for institutional and high net
worth clients.
The Company's strategy is to be a market leader in these businesses and
continue to build out its product and service capabilities and add new
clients. The Company has completed 55 acquisitions since 1998 in this
segment, has made significant investments in technology to maintain its
industry-leading position, and has continued the development of new products
and services to meet its clients' needs.
The Corporate Banking segment provides lending and credit-related
services to large public and private financial institutions and corporations
nationwide, as well as to public and private mid-size businesses in the New
York metropolitan area. Special industry groups focus on industry segments
such as banks, broker-dealers, insurance, media and telecommunications,
energy, real estate, retailing, and government banking institutions. Through
BNY Capital Markets, Inc., the Company provides syndicated loans, bond
underwriting, private placements of corporate debt and equity securities, and
merger, acquisition, and advisory services.
Corporate Banking coordinates delivery of all of the Company's services
to customers through its global relationship managers. The two main client
bases served are financial institution clients and corporate clients. The
Company's strategy is to focus on those clients and industries that are major
users of securities servicing and global payment services.
The Company believes that credit is an important product for many of its
customers to execute their business strategies. However, the Company has
continued to reduce its credit exposures in recent years by culling its loan
portfolio of non-strategic exposures, focusing on increasing total
relationship returns through cross-selling and limiting the size of its
individual credit exposures and industry concentrations to reduce earnings
volatility.
The Retail Banking segment includes retail deposit services, branch
banking, and consumer and residential mortgage lending. The Company operates
341 branches in 23 counties in the Tri-State region. The retail network is a
stable source of low cost funding and provides a platform to cross-sell core
services from the Servicing and Fiduciary businesses to both individuals and
small businesses in the New York metropolitan area.
12
The Financial Markets segment includes trading of foreign exchange and
interest rate risk management products, investing and leasing activities, and
treasury services to other business segments. The segment offers a
comprehensive array of multi-currency hedging and yield enhancement
strategies, and complements the other business segments. The Financial
Markets segment centralizes interest rate risk management for the Company.
There were no major customers from whom revenues were individually
material to the Company's performance.
Servicing and Fiduciary Businesses
- ----------------------------------
(In Millions)
1st 4th 1st
Quarter Quarter Quarter
2004 2003 2003
------- ------- -------
Net Interest Income $ 140 $ 138 $ 105
Provision for Credit Losses - - -
Noninterest Income 990 944 691
Noninterest Expense 757 732 525
Income Before Taxes 373 350 271
Average Assets 22,771 22,733 7,617
Average Deposits 35,138 34,503 31,128
Nonperforming Assets 3 9 16
Assets Under Custody (In billions)
Total Assets Under Custody 8,577 8,297 6,783
Equity Securities 33% 34% 25%
Fixed Income Securities 67 66 75
Cross-Border Assets $ 2,401 $ 2,323 $ 1,899
Assets Under Administration (In billions) 33 32 27
Assets Under Management (In billions) 92 89 76
Equity Securities 36% 34% 29%
Fixed Income Securities 22 22 24
Alternative Investments 13 10 9
Liquid Assets 29 34 38
S&P 500 Index (Period End) 1,126 1,112 848
NASDAQ Index (Period End) 1,994 2,003 1,341
NYSE Volume (In billions) 95.4 85.5 86.6
NASDAQ Volume (In billions) 128.2 112.6 88.8
The first quarter results showed continued improvement in the Company's
primary businesses, including securities servicing and related foreign
exchange, and private client services and asset management. Noninterest income
increased to $990 million from $944 million in the fourth quarter of 2003 and
$691 million in the first quarter of 2003. First quarter highlights include
record securities servicing fees of $716 million, an increase of $32 million,
or 5%, over the fourth quarter of 2003. Investor services, execution and
clearing, and broker-dealer services were strong during the quarter benefiting
from active equity markets and the conversion of new business wins.
Average daily combined first quarter NYSE and NASDAQ trading volume
increased 13% from the fourth quarter of 2003 and 27% from the first quarter
of 2003. The S&P 500 index rose 1% during the quarter while the NASDAQ index
was flat.
13
Securities Servicing Fees
- -------------------------
1st 4th 3rd
Quarter Quarter Quarter
------- ------- -------
(In millions) 2004 2003 2003
---- ---- ----
Execution and Clearing Services $ 303 $ 290 $ 271
Investor Services 226 210 212
Issuer Services 137 136 127
Broker-Dealer Services 50 48 47
------ ------ ------
Securities Servicing Fees $ 716 $ 684 $ 657
====== ====== ======
Securities servicing fees were a record $716 million in the first
quarter, an increase of $32 million, or 5%, from the fourth quarter.
Execution and clearing services fees increased $13 million sequentially,
or 4%, to $303 million in the first quarter. These businesses benefited from
higher equity trading volumes in the first quarter although equity price
levels were essentially flat by the end of the quarter. This increased level
of market activity more than offset an anticipated decline in soft-dollar
related execution activities. Pershing also benefited from strong retail
investor activity, especially in January, which contributed to increased
billable trades. Other metrics such as customer accounts, money fund and
mutual fund balance were all higher than the fourth quarter and stayed strong
throughout the quarter. In comparison to a year ago, execution and clearing
services were up significantly as a result of the Pershing acquisition.
Investor services fees recorded a strong quarter, increasing 8%
sequentially as a result of higher transaction volumes and average asset price
levels, the conversion of new business wins and favorable exchange rates.
Investor services include custody, global fund services, securities lending,
global liquidity services and outsourcing. Investor services were also up
significantly over the first quarter of 2003 reflecting strength in custody,
global fund services, and securities lending. As of March 31, 2004, assets
under custody rose to $8.6 trillion, from $8.3 trillion at December 31, 2003
and $6.8 trillion at March 31, 2003. The sequential quarter increase in assets
under custody primarily reflects new business wins. Cross-border custody
assets were $2.4 trillion at March 31, 2004. Equity securities composed 33%
of the assets under custody at March 31, 2004, while fixed income securities
were 67%.
Issuer services fees were up slightly from the fourth quarter, reflecting
a solid quarter in corporate trust and stock transfer, offset by a modest
decline in depositary receipts. While there was increased interest in cross-
border investing during the quarter, reflected in the 21% growth in DR share
trading compared to the fourth quarter of 2003, there were fewer corporate
actions in the quarter. Issuer services were up modestly over the first
quarter of 2003 led by depositary receipts and stock transfer.
Broker-dealer services fees increased $2 million, or 4%, on a sequential
quarter basis, as a result of continued strong performance in global
collateral management services and securities clearance. Expanded use of the
Company's tri-party repo product by clients to fund their activities drove
revenue growth during the quarter. In comparison to a year ago, broker-dealer
service fees were up strongly driven by the same factors that impacted
sequential quarter growth.
Global payment services fees were up $3 million, or 4%, compared with the
prior quarter and up $1 million from the first quarter of 2003, resulting from
higher volumes and improved pricing.
14
Private client services and asset management fees for the first quarter
were up 5% from the prior quarter and 20% from the first quarter of 2003. The
sequential quarter increase reflects continued strong growth at Ivy Asset
Management and new business wins. The increase from 2003 reflects the same
factors involved in the sequential quarter increase as well as higher equity
price levels.
Assets under management ("AUM") were $92 billion at March 31, 2004, up
from $89 billion at December 31, 2003 and $76 billion at March 31, 2003.
Assets under administration were $33 billion compared with $32 billion at
December 31, 2003 and $27 billion at March 31, 2003. The sequential quarter
and year-over-year increases in assets under management reflect growth in the
Company's alternative investments business and a rise in equity market value.
Institutional clients represent 66% of AUM while individual clients equal 34%.
AUM at March 31, 2004, are 36% invested in equities, 22% in fixed income, 13%
in alternative investments and the remainder in liquid assets. At Ivy, AUM
climbed to $11.7 billion at March 31, 2004 from $9.1 billion at December 31,
2003 and $6.5 billion at March 31, 2003.
Foreign exchange and other trading revenues increased $25 million from
the prior quarter and $41 million, or 63%, from one year ago. The strong
performance this quarter in foreign exchange reflects higher levels of client
activity, resulting from several factors including hedging against currency
volatility, renewed interest in cross-border investing, and asset
reallocations into equities. The increase from a year ago was also positively
impacted by the acquisition of Pershing and new business wins.
Net interest income in the Servicing and Fiduciary businesses segment was
$140 million for the first quarter of 2004 compared with $138 million for the
fourth quarter of 2003 and $105 million in the first quarter of 2003. The
increase in net interest income on a sequential quarter basis is primarily
attributable to higher levels of client activity which led to an increase in
the average level of deposits. The increase in net interest income from the
first quarter of 2003 is primarily due to the Pershing acquisition partially
offset by the decline in interest rates. Average assets for the quarter ended
March 31, 2004 were $22.8 billion compared with $22.7 billion in the fourth
quarter of 2003 and $7.6 billion in the first quarter of 2003. The increase in
assets in 2004 compared with 2003 is primarily attributable to the Pershing
acquisition. The first quarter of 2004 average deposits were $35.1 billion
compared with $34.5 billion in the fourth quarter of 2003 and $31.1 billion in
the first quarter of 2003.
Net charge-offs in the Servicing and Fiduciary Businesses segment were $5
million in the first quarter of 2004, compared with $7 million in the fourth
quarter of 2003 and zero in the first quarter of 2003. Nonperforming assets
were $3 million in the first quarter of 2004, compared with $9 million in the
fourth quarter of 2003 and $16 million in the first quarter of 2003.
Noninterest expense for the first quarter of 2004 was $757 million,
compared with $732 million in the fourth quarter of 2003 and $525 million in
the first quarter of 2003. The rise in noninterest expense from fourth quarter
of 2003 was primarily due to the Company's continued investment in technology,
a reduced pension credit, as well as higher volume-related expenses related to
revenue growth. In addition to the above factors, the increase from the first
quarter of 2003 also reflects the Pershing acquisition.
15
Corporate Banking
- -----------------
(In Millions)
1st 4th 1st
Quarter Quarter Quarter
2004 2003 2003
------- ------- -------
Net Interest Income $ 89 $ 94 $ 92
Provision for Credit Losses 20 26 30
Noninterest Income 80 73 71
Noninterest Expense 53 52 48
Income Before Taxes 96 89 85
Average Assets $17,358 $18,685 $20,708
Average Deposits 6,800 6,049 7,219
Nonperforming Assets 325 327 409
Net Charge-offs 11 30 35
The Corporate Banking segment's net interest income was $89 million in the
first quarter of 2004, compared with $94 million in the fourth quarter of 2003
and $92 million in the first quarter of 2003. The decline from both the first
and fourth quarters of 2003 reflects continued reduction in lending to
corporate borrowers. Average assets for the quarter were $17.4 billion
compared with $18.7 billion in the fourth quarter of 2003 and $20.7 billion in
the first quarter of last year. Average deposits in the corporate bank were
$6.8 billion versus $6.0 billion in the fourth quarter of 2003 and $7.2
billion in 2003.
The first quarter 2004 provision for credit losses was $20 million
compared with $26 million in the fourth quarter of 2003 and $30 million last
year. The decline in the provision from the fourth and first quarters of 2003
reflects reduced credit exposures. Net charge-offs in the Corporate Banking
segment were $11 million in the first quarter of 2004, $30 million in the
fourth quarter of 2003, and $35 million in the first quarter of 2003. The
charge-offs in 2004 primarily relate to loans to media and foreign borrowers.
Nonperforming assets were $325 million at March 31, 2004, down from $327
million at December 31, 2003 and $409 million in the first quarter of 2003.
The decrease in nonperforming assets from the first quarter of 2003 primarily
reflects paydowns and charge-offs of commercial and foreign loans.
Noninterest income was $80 million in the current quarter, compared with
$73 million in the fourth quarter and $71 million in the first quarter of
2003. The increase on a sequential quarter basis and year-over-year reflects
higher income from unconsolidated subsidiaries and better results from credit
derivatives.
Noninterest expense in the first quarter was $53 million, compared with
$52 million in the fourth quarter of 2003 and $48 million in the first quarter
of 2003. The increases over 2003 reflect higher compensation costs due in part
to a reduced pension credit and higher stock option expense.
16
Retail Banking
- --------------
(In Millions)
1st 4th 1st
Quarter Quarter Quarter
2004 2003 2003
------- ------- -------
Net Interest Income $ 123 $ 123 $ 116
Provision for Credit Losses 5 5 4
Noninterest Income 29 28 29
Noninterest Expense 93 93 87
Income Before Taxes 54 53 54
Average Assets $ 5,377 $ 5,752 $ 5,387
Average Noninterest Bearing Deposits 5,028 4,955 4,830
Average Deposits 14,807 14,761 14,122
Nonperforming Assets 15 13 10
Net Charge-offs 6 5 5
Number of Branches 341 341 341
Total Deposit Accounts (In Thousands) 1,133 1,163 1,192
Number of ATMS 378 378 370
Net interest income in the first quarter of 2004 was $123 million,
compared with $123 million in the fourth quarter of 2003 and $116 million in
the first quarter of 2003. On a sequential quarter basis, net interest income
was flat as spread compression on deposits was offset by higher levels of
noninterest bearing deposits. The increase from the first quarter of 2003
reflects higher levels of deposits primarily from municipalities in the retail
bank's service area.
Noninterest income was $29 million for the quarter compared with $28
million on a sequential quarter basis and $29 million in last year's first
quarter.
Noninterest expense in the first quarter of 2004 was $93 million,
compared with $93 million in the fourth quarter of 2003 and $87 million last
year. The increase from the first quarter of 2003 reflects higher advertising,
legal, and occupancy expenses.
Net charge-offs were $6 million in the first quarter of 2004, compared
with $5 million in the fourth quarter and first quarter of 2003. Nonperforming
assets were $15 million in the first quarter of 2004 compared with $13 million
at December 31, 2003 and $10 million at March 31, 2003 reflecting an increase
in the level of nonperforming small business loans.
Average deposits generated by the Retail Banking segment were $14.8
billion in the first quarter of 2004, compared with $14.8 billion in the
fourth quarter of 2003 and $14.1 billion in the first quarter of 2003.
Noninterest bearing deposits were $5.0 billion this quarter, compared with
$5.0 billion in the fourth quarter of 2003 and $4.8 billion in the first
quarter of 2003. Average assets in the retail banking sector were $5.4
billion, compared with $5.8 billion in the fourth quarter of 2003 and $5.4
billion in the first quarter of 2003.
17
Financial Markets
- -----------------
(In Millions)
1st 4th 1st
Quarter Quarter Quarter
2004 2003 2003
------- ------- -------
Net Interest Income $ 80 $ 85 $ 77
Provision for Credit Losses 5 5 5
Noninterest Income 50 41 50
Noninterest Expense 27 28 24
Income Before Taxes 98 93 98
Average Assets $50,051 $45,476 $44,334
Average Deposits 3,864 3,568 4,917
Average Investment Securities 22,997 22,352 17,977
Net Charge-offs 4 5 -
Net interest income for the first quarter was $80 million compared with
$85 million on a sequential quarter basis and $77 million a year ago. The
decrease from the fourth quarter of 2003 reflects a slightly lower yield on
the investment portfolio, one less day in the quarter as well as higher loan
breakage fees in the fourth quarter. The increase from the first quarter of
2003 reflects higher average balances of investment securities partially
offset by lower reinvestment yields. Average first quarter 2004 assets in the
Financial Markets segment composed primarily of short-term liquid assets and
investment securities were $50.1 billion, up from $45.5 billion on a
sequential quarter basis and $44.3 billion last year. The increase in assets
reflects the Company's continuing strategy to reduce investment in higher risk
corporate loans and increase holdings of highly rated, more liquid investment
securities. The Company continues to invest in adjustable or short life
classes of structured mortgage-backed securities, both of which have short
average lives.
Noninterest income was $50 million in the first quarter of 2004, compared
with $41 million in the fourth quarter of 2003 and $50 million in the first
quarter of 2003. The positive variance versus the fourth quarter of 2003
reflects higher trading-related revenues in both foreign exchange and fixed
income as well as improved hedging of foreign currency investments.
Net charge-offs were $4 million in the first quarter of 2004, compared
with $5 million in the fourth quarter of 2003 and zero a year ago.
Noninterest expense was $27 million in the first quarter of 2004, essentially
flat compared with $28 million in the fourth quarter of 2003 and up from $24
million in last year's first quarter. The increase from last year's first
quarter is attributable to higher employee incentive and other compensation.
18
The consolidating schedule below shows the contribution of the Company's
segments to its overall profitability.
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2004 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
(In Millions)
Net Interest Income $ 140 $ 89 $ 123 $ 80 $(164) $ 268
Provision for
Credit Losses - 20 5 5 (18) 12
Noninterest Income 990 80 29 50 81 1,230
Noninterest Expense 757 53 93 27 83 1,013
----- ---- ----- ---- ----- ------
Income Before Taxes $ 373 $ 96 $ 54 $ 98 $(148) $ 473
===== ==== ===== ==== ===== ======
Contribution Percentage 60% 15% 9% 16%
Average Assets $22,771 $17,358 $5,377 $50,051 $4,121 $99,678
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
December 31, 2003 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 138 $ 94 $ 123 $ 85 $ (22) $ 418
Provision for
Credit Losses - 26 5 5 (1) 35
Noninterest Income 944 73 28 41 16 1,102
Noninterest Expense 732 52 93 28 111 1,016
----- ---- ----- ---- ----- ------
Income Before Taxes $ 350 $ 89 $ 53 $ 93 $(116) $ 469
===== ==== ===== ==== ===== ======
Contribution Percentage 60% 15% 9% 16%
Average Assets $22,733 $18,685 $5,752 $45,476 $ 3,975 $96,621
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2003 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 105 $ 92 $ 116 $ 77 $ (4) $ 386
Provision for
Credit Losses - 30 4 5 1 40
Noninterest Income 691 71 29 50 3 844
Noninterest Expense 525 48 87 24 55 739
----- ---- ----- ---- ----- -----
Income Before Taxes $ 271 $ 85 $ 54 $ 98 $ (57) $ 451
===== ==== ===== ==== ===== =====
Contribution Percentage 53% 17% 11% 19%
Average Assets $ 7,617 $20,708 $5,387 $44,334 $2,605 $80,651
19
Reconciling Items
- -----------------
Description - Reconciling items for net interest income primarily relate to
the recording of interest income on a taxable equivalent basis, reallocation
of capital and the funding of goodwill and intangibles. Reconciling items for
noninterest income primarily relate to the sale of certain securities and
certain other gains. Reconciling items for noninterest expense primarily
reflects corporate overhead as well as amortization of intangibles and
severance.
In the first quarter of 2004, the following adjustments (see "Other First
Quarter Developments") were included in reconciling items: (i) SFAS 13
cumulative adjustment to the leasing portfolio, which impacted net interest
income by $145 million, (ii) four large securities gains and the gain on sale
of Wing Hang Bank, which impacted noninterest income by $67 million, and (iii)
severance and lease termination expense, which impacted noninterest expense by
$18 million.
In the fourth quarter of 2003, merger and integration costs associated
with Pershing were a reconciling item. The adjustment to the provision for
credit losses reflects the difference between the aggregate of the credit
provision over a credit cycle for the reportable segments and the Company's
recorded provision. The reconciling items for average assets consist of
goodwill and other intangible assets.
1st 4th 1st
Quarter Quarter Quarter
(In millions) 2004 2003 2003
------- ------- -------
Segments' revenue $1,581 $1,526 $1,231
Adjustments:
Earnings associated with
assignment of capital (29) (30) (20)
Securities gains 19 - -
Other gains 62 16 3
SFAS 13 cumulative lease adjustment (145) - -
Taxable equivalent basis and
other tax-related items 10 8 16
------- ------ ------
Subtotal-revenue adjustments (83) (6) (1)
------- ------ ------
Consolidated revenue $1,498 $1,520 $1,230
======= ====== ======
Segments' income before tax $ 621 $ 585 $ 508
Adjustments:
Revenue adjustments (above) (83) (6) (1)
Provision for credit losses
different than GAAP 18 1 (1)
Severance (11) (2) (2)
Goodwill and
intangible amortization (8) (7) (3)
Pershing-related
integration expenses - (48) -
Lease termination (8) - -
Corporate overhead (56) (54) (50)
------- ------- ------
Consolidated income
before tax $ 473 $ 469 $ 451
======= ======= ======
Segments' total
average assets $95,557 $92,646 $78,046
Adjustments:
Goodwill and intangibles 4,121 3,975 2,605
------- ------- -------
Consolidated average assets $99,678 $96,621 $80,651
======= ======= =======
20
Allocation to Segments - Earnings associated with the assignment of capital
relate to preferred trust securities which are assigned as capital to
segments. Since the Company considers these issues to be capital, it does not
allocate the interest expense associated with these securities to individual
segments. If this interest expense were allocated to segments, it could be
assigned based on segment capital, assets, risks, or some other basis.
The reconciling item for securities gains relates to the Financial
Markets business. The taxable equivalent adjustment is not allocated to
segments because all segments contribute to the Company's taxable income and
the Company believes it is arbitrary to assign the tax savings to any
particular segment. Most of the assets that are attributable to the tax
equivalent adjustment are recorded in the Financial Markets segment. In 2004,
the $145 million reconciling item related to SFAS 13 cumulative lease
adjustment would be attributable to the Financial Markets segment. In
addition, the gain on the sale of Wing Hang would be attributable to the
Corporate Banking segment.
The reconciling item for the provision for loan losses primarily relates
to Corporate Banking. Goodwill and intangible amortization primarily relates
to the Securities Servicing and Fiduciary segment. Corporate overhead is
difficult to specifically identify with any particular segment. Approaches to
allocating corporate overhead to segments could be based on revenues,
expenses, number of employees, or a variety of other measures. In 2004, the
$18 million of severance and lease termination would be allocated primarily to
the Servicing and Fiduciary segment. Merger and integration charges would be
allocated to the Securities and Fiduciary businesses segment.
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $92.7 billion at March 31, 2004, compared with $92.4
billion at December 31, 2003, and $79.7 billion at March 31, 2003. The
increase versus a year ago mainly reflects the Pershing acquisition. Total
shareholders' equity was $8.8 billion at March 31, 2004, compared with $8.4
billion at December 31, 2003, and $6.9 billion at March 31, 2003. The major
reasons for the increase in shareholders' equity from a year ago are the
issuance of common stock to finance the Pershing acquisition, the retention of
earnings, and an increase in the securities valuation allowance.
Return on average common equity for the first quarter of 2004 was 17.17%,
compared with 14.81% in the fourth quarter of 2003, and 17.80% in the first
quarter of 2003.
Return on average assets for the first quarter of 2004 was 1.47%,
compared with 1.26% in the fourth quarter of 2003, and 1.49% in the first
quarter of 2003.
21
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities portfolio:
Investment Securities (at Fair Value)
(In millions) 03/31/04 12/31/03
-------- --------
Fixed Income:
Mortgage-Backed Securities $19,942 $18,703
Asset-Backed Securities 20 20
Corporate Debt 1,294 1,326
Short-Term Money Market Instruments 855 917
U.S. Treasury Securities 440 505
U.S. Government Agencies 305 241
State and Political Subdivisions 241 251
Emerging Market Debt 111 109
Other Foreign Debt 525 518
------- -------
Subtotal Fixed Income 23,733 22,590
Equity Securities:
Money Market Funds 248 200
Federal Reserve Bank Stock 96 96
Other 12 12
------- -------
Subtotal Equity Securities 356 308
------- -------
Total Securities $24,089 $22,898
======= =======
Total investment securities were $24.1 billion at March 31, 2004,
compared with $22.9 billion at December 31, 2003. Average investment
securities were $23.0 billion in the first quarter of 2004, compared with
$18.0 billion in the first quarter of 2003. The increases were primarily due
to growth in the Company's portfolio of highly rated mortgage-backed
securities which are 94% rated AAA, 2% AA, and 4% A. Since December 31, 2002,
the Company has added approximately $6.8 billion of mortgage-backed securities
to its investment portfolio. The Company has been adding either adjustable or
short life classes of structured mortgage-backed securities, both of which
have short average lives. The Company has maintained an effective duration of
approximately 1.7 years on its mortgage portfolio to better match its
liabilities and reduce the adverse impact from a rise in interest rates.
Net unrealized gains for securities available-for-sale were $359 million
at March 31, 2004, compared with $201 million at December 31, 2003. As
interest rates rise, the Company expects the unrealized gains will decline,
which will lower shareholders' equity and adversely impact the Company's
tangible common equity ratio.
Loans
- -----
(In billions) Period End Average
--------------------------- ---------------------------
Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------
March 31, 2004 $36.1 $30.0 $6.1 $36.5 $30.3 $6.2
December 31, 2003 35.3 29.6 5.7 37.3 31.5 5.8
March 31, 2003 31.6 31.1 0.5 32.0 31.6 0.4
Total loans were $36.1 billion at March 31, 2004, compared with $35.3
billion at December 31, 2003. The increase in total loans primarily reflects
higher loans to the securities industry and higher margin loans. Non-margin
loans were $30.0 billion at March 31, 2004, compared with $29.6 billion at
December 31, 2003. The Company continues to focus on its strategy of reducing
22
non-strategic and outsized corporate loan exposures to improve its credit risk
profile. Average total loans were $36.5 billion in the first quarter of 2004,
compared with $32.0 billion in the first quarter of 2003 reflecting the
Pershing acquisition.
During the quarter, the Company achieved two previously announced goals
in its credit portfolio: to reduce corporate exposure below $24 billion and
telcom exposure below $750 million by year-end 2004. The following tables
provide additional details on the Company's loan exposures and outstandings at
March 31, 2004 in comparison to December 31, 2003.
Overall Loan Portfolio
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
----------------------------- ------------------------------
3/31/04 3/31/04 3/31/04 12/31/03 12/31/03 12/31/03
-------- ------- ------- -------- -------- --------
Financial Institutions $10.1 $22.0 $32.1 $ 9.2 $21.8 $31.0
Corporate 3.7 20.0 23.7 4.0 20.5 24.5
----- ----- ----- ----- ----- -----
13.8 42.0 55.8 13.2 42.3 55.5
----- ----- ----- ----- ----- -----
Consumer & Middle Market 8.3 4.2 12.5 8.2 4.1 12.3
Leasing Financings 5.6 0.1 5.7 5.8 - 5.8
Commercial Real Estate 2.3 0.8 3.1 2.4 0.8 3.2
Margin Loans 6.1 - 6.1 5.7 - 5.7
----- ----- ----- ----- ----- -----
Total $36.1 $47.1 $83.2 $35.3 $47.2 $82.5
===== ===== ===== ===== ===== =====
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $32.1 billion March 31, 2004
compared to $31.0 billion at December 31, 2003. These exposures are of high
quality, with 88% meeting the investment grade criteria of the Company's
rating system. The exposures are generally short-term, with 67% expiring
within one year and are frequently secured. For example, mortgage banking,
securities industry, and investment managers often borrow against marketable
securities held in custody at the Company. The diversity of the portfolio is
shown in the accompanying table.
(Dollars in billions)
03/31/04 12/31/03
------------------------------ -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Banks $ 3.0 $ 3.6 $ 6.6 73% 83% $2.6 $ 3.1 $ 5.7
Securities
Industry 2.5 3.0 5.5 87 85 1.9 3.5 5.4
Insurance 0.3 5.0 5.3 97 52 0.3 5.0 5.3
Government 0.1 5.8 5.9 99 41 0.2 5.6 5.8
Asset Managers 3.7 3.4 7.1 85 73 3.6 3.5 7.1
Mortgage Banks 0.3 0.6 0.9 88 59 0.4 0.5 0.9
Endowments 0.2 0.6 0.8 98 56 0.2 0.6 0.8
----- ----- ----- --- ---- ---- ----- -----
Total $10.1 $22.0 $32.1 88% 67% $9.2 $21.8 $31.0
===== ===== ===== === ==== ==== ===== =====
23
Corporate
- ---------
The corporate portfolio exposure declined to $23.7 billion at March 31,
2004 from $24.5 billion at year-end 2003. The Company has reached its goal of
reducing corporate exposure below $24.0 billion. Approximately 75% of the
portfolio is investment grade while 22% of the portfolio matures within one
year.
(Dollars in billions)
03/31/04 12/31/03
----------------------------- -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Media $ 0.9 $ 2.2 $ 3.1 66% 13% $0.9 $ 2.3 $ 3.2
Cable 0.8 0.5 1.3 30 1 0.7 0.7 1.4
Telecom 0.2 0.5 0.7 56 17 0.3 0.6 0.9
----- ----- ----- -- -- ---- ----- -----
Subtotal 1.9 3.2 5.1 55% 11% 1.9 3.6 5.5
Energy 0.3 4.4 4.7 85 30 0.4 4.2 4.6
Retailing 0.1 2.2 2.3 79 32 0.1 2.3 2.4
Automotive 0.1 2.0 2.1 77 37 0.1 2.1 2.2
Healthcare 0.2 1.3 1.5 88 13 0.2 1.3 1.5
Other* 1.1 6.9 8.0 76 19 1.3 7.0 8.3
----- ----- ----- -- -- ---- ----- -----
Total $ 3.7 $20.0 $23.7 75% 22% $4.0 $20.5 $24.5
===== ===== ===== == == ==== ===== =====
* Diversified portfolio of industries and geographies
The Company had previously targeted the telecom exposure for reduction to
a total of $750 million by December 31, 2004. This goal was accomplished in
the first quarter as exposures were reduced to $730 million with the
percentage of investment grade borrowers rising from 52% at year-end 2003 to
56% at March 31, 2004. The improved quality of the portfolio is largely due to
reductions in lower rated credits.
The Company's exposure to the airline industry consists of a $579 million
leasing portfolio (including a $14 million real estate lease exposure) as well
as $23 million of direct lending. The airline leasing portfolio consists of
$265 million to major U.S. carriers, $225 million to foreign airlines and $89
million to U.S. regionals.
During the first quarter of 2004, the industry continued to face the
dilemma of strong competition from the regionals, a relatively high cost
structure, and weak demand. The industry's stagnant demand and considerable
excess capacity has negatively impacted valuation of the industry's aircraft
in the secondary market. Because of these factors, the Company continues to
maintain a sizable allowance for loan losses against these exposures and to
closely monitor the portfolio.
24
Nonperforming Assets
- --------------------
Change
3/31/04 vs.
(Dollars in millions) 3/31/04 12/31/03 12/31/03
-------- -------- ------------
Loans:
Commercial $231 $219 $ 12
Foreign 66 79 (13)
Other 46 51 (5)
---- ---- ----
Total Nonperforming Loans 343 349 (6)
Other Real Estate - - -
---- ---- ----
Total Nonperforming Assets $343 $349 $ (6)
==== ==== ====
Nonperforming Assets Ratio 1.2% 1.2%
Allowance for Loan
Losses/Nonperforming Loans 184.4 191.2
Allowance for Loan
Losses/Nonperforming Assets 184.4 191.2
Allowance for Credit
Losses/Nonperforming Loans 230.5 230.2
Allowance for Credit
Losses/Nonperforming Assets 230.5 230.2
Nonperforming assets declined by $6 million, or 2% during the first
quarter of 2004 to $343 million and are down 21% from a year ago. The
decrease primarily reflects paydowns, sales of assets and charge-offs of
commercial and foreign loans. The improved quality of the portfolio is
largely due to reductions in lower rated credits. A loan to a bankrupt
cable operator accounts for 33% of the total of nonperforming assets.
The ratio of the allowance for credit losses to nonperforming
assets increased to 230.5% at March 31, 2004, compared with 230.2% at
December 31, 2003 and 190.4% at March 31, 2003.
Activity in Nonperforming Assets
(In millions) Quarter Quarter
End End
March 31, December 31,
2004 2003
--------- -----------
Balance at Beginning of Period $ 349 $ 388
Additions 34 50
Charge-offs (19) (42)
Paydowns/Sales (21) (47)
Other - -
----- -----
Balance at End of Period $ 343 $ 349
===== =====
Interest income would have been increased by $4 million and $5 million
for the first quarters of 2004 and 2003 if loans on nonaccrual status at March
31, 2004 and 2003 had been performing for the entire period.
25
Impaired Loans
- --------------
The table below sets forth information about the Company's impaired loans. The
Company uses the discounted cash flow, collateral value, or market price
methods for valuing its impaired loans:
March 31 December 31 March 31
(Dollars in millions) 2004 2003 2003
---------- ----------- ----------
Impaired Loans with an Allowance $197 $287 $371
Impaired Loans without an Allowance(1) 124 41 40
---- ---- ----
Total Impaired Loans $321 $328 $411
==== ==== ====
Allowance for Impaired Loans(2) $ 88 $106 $183
Average Balance of Impaired Loans
during the Quarter $306 $373 $407
Interest Income Recognized on
Impaired Loans during the Quarter $0.9 $0.7 $1.0
(1) When the discounted cash flows, collateral value or market price equals
or exceeds the carrying value of the loan, then the loan does not require
an allowance under the accounting standard related to impaired loans.
(2) The allowance for impaired loans is included in the Company's allowance
for loan losses.
Allowance
- ---------
March 31 December 31 March 31
(Dollars in millions) 2004 2003 2003
-------- ----------- --------
Margin Loans $ 6,130 $ 5,712 $ 467
Non-Margin Loans 29,940 29,571 31,106
Total Loans 36,070 35,283 31,573
Allowance for Loan Losses 632 668 668
Allowance for Lending-Related
Commitments 158 136 162
Total Allowance for Credit Losses 790 804 830
Allowance for Credit Losses
As a Percent of Total Loans 2.19% 2.28% 2.63%
Allowance for Credit Losses As a
Percent of Non-Margin Loans 2.64 2.72 2.67
Allowance for Loan Losses
As a Percent of Total Loans 1.75 1.89 2.12
Allowance for Loan Losses
As a Percent of Non-Margin Loans 2.11 2.26 2.14
The Company adopts new accounting policies as they become accepted as
a best practice or required by generally accepted accounting principles.
Accordingly, at December 31, 2003, the Company split its allowance for credit
losses into an allowance for loan losses and an allowance for lending-related
commitments such as unfunded loan commitments, and standby letters of credit.
This resulted in a decrease in the allowance for loan losses of $136 million
and a corresponding increase in other liabilities (which includes the allowance
for lending-related commitments). Prior period balance sheets have been
restated. Credit expenses related to the allowance for loan losses and the
allowance for lending-related commitments are reported in the provision for
credit losses in the income statement. To aid in the comparison of the
Company's results with other companies that have not yet adopted this practice,
the Company provides various credit ratios based both on the allowance for
credit losses and the allowance for loan losses.
The allowance for credit losses to total loans was $790 million, or
2.19% of total loans at March 31, 2004, compared with $804 million, or
2.28% of total loans at December 31, 2003, and $830 million, or 2.63% of
total loans at March 31, 2003.
26
The acquisition of Pershing added $6.1 billion of secured margin loans to
the Company's balance sheet at March 31, 2004. The Company has rarely
suffered a loss on these types of loans and doesn't allocate any of its
allowance for credit losses to these loans. As a result, the Company believes
the ratio of allowance for credit losses to non-margin loans is a more
appropriate metric to measure the adequacy of the reserve.
The ratio of the allowance for credit losses to non-margin loans
decreased to 2.64% at March 31, 2004, compared with 2.72% at December 31, 2003
and 2.67% at March 31, 2003, reflecting continued improvement in the credit
quality in the first quarter of 2004. The Company expects credit costs to
remain at lower levels through the remainder of the year as both external and
internal credit metrics continue to improve.
Nonperforming assets declined another 2% this quarter, but have declined
by over 20% from a year ago, and the Company's criticized and classified loans
experienced a mid-teens decline from the fourth quarter of 2003 and are down
by over a third from a year ago.
The ratio of the allowance to nonperforming assets was 184.4% at March
31, 2004, down from 191.2% at December 31, 2003, and 190.4% at March 31, 2003.
Included in the Company's allowance for credit losses at March 31, 2004 is an
allocated transfer risk reserve related to Argentina of $20 million.
The allowance for loan losses and the allowance for lending-related
commitments consist of four elements: (1) an allowance for impaired credits,
(2) an allowance for higher risk rated loans and exposures, (3) an allowance
for pass rated loans and exposures, and (4) an unallocated allowance based on
general economic conditions and certain risk factors in the Company's
individual portfolio and markets.
The first element (impaired credits) is based on individual analyses of
all nonperforming commercial credits over $1 million. The allowance is
measured by the difference between the recorded value of impaired loans and
their fair value in accordance with FASB 114. Fair value is either the
present value of the expected future cash flows from borrowers, the market
value of the loan, or the fair value of the collateral securing the
obligation.
The second element (higher risk rated credits) is based on the assignment
of loss factors for each specific risk category of higher risk credits. The
Company risk rates each credit in its portfolio that exceeds $1 million and
assigns the credits to specific pools. A potential loss factor is assigned to
each pool, and an amount is included in the allowance equal to the multiple of
the amount of the loan in the pool times a risk factor. Reviews of higher
risk rated loans and exposures are conducted at least quarterly and each
loan's rating is reaffirmed or updated, as necessary. The Company maintains
and updates loss migration analysis by comparing actual loss experiences to
the loss factors assigned to each exposure pool. Past due consumer
obligations are included in specific risk categories based on the length of
time the loan is past due.
The third element (pass rated credits) is based on the Company's expected
loss model. Borrowers are assigned to pools based on their credit rating, the
maturity of the loan, the estimated exposure at default, and the loss given a
default. The credit rating is derived from the borrower's probability of
default. The loss given default incorporates an analysis of structure and
collateral. These ratings are frequently reviewed by the relationship
managers and their respective division portfolio managers and more formally on
a semi-annual basis. The ratings are mapped to independent parties, including
the rating agencies in order to ensure consistency and validity. At the time
of approval, loans are individually analyzed and assigned a risk rating and
loss given default rating. Performing consumer loans are included in the pass
rated consumer pools. The Company uses an exposure at default estimate as a
way of quantifying the amount the Company will lose in case of default. This
estimate varies depending on the level of commitment, the type of exposure,
and the credit rating of the borrower.
27
The fourth element (the unallocated allowance) is based on management's
judgment regarding the following factors:
- Economic conditions including duration of the current cycle
- Past experience including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm existing
credit deterioration
- Geopolitical issues and their impact on the economy
Based on an evaluation of these four elements, including individual
credits, historical credit losses, and global economic factors, the Company
has allocated its allowance for credit losses as follows:
March 31 December 31
2004 2003
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 75 74
Consumer 1 1
Foreign 8 9
Unallocated 14 14
--- ---
100% 100%
=== ===
Such an allocation is inherently judgmental, and the entire allowance for
credit losses is available to absorb credit losses regardless of the nature of
the loss.
Deposits
- --------
Total deposits were $56.1 billion at March 31, 2004, compared with $56.4
billion at December 31, 2003 and $56.9 billion at March 31, 2003. Noninterest-
bearing deposits were $14.4 billion at March 31, 2004, compared with $14.8
billion at December 31, 2003. Interest-bearing deposits were $41.7 billion at
March 31, 2004, compared with $41.6 billion at December 31, 2003.
28
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in the "Notes to
Consolidated Financial Statements" under "Summary of Significant Accounting
and Reporting Policies" in the Company's 2003 Annual Report on Form 10-K.
Three of the Company's more critical accounting policies are those related to
the allowance for credit losses, to the valuation of derivatives and
securities where quoted market prices are not available, and goodwill and
other intangibles.
Allowance for Credit Losses
- ---------------------------
The allowance for credit losses represents management's estimate of
probable losses inherent in the Company's loan portfolio. This evaluation
process is subject to numerous estimates and judgments. Probabilities of
default/borrower ratings are assigned after analyzing the credit quality of
each borrower/counterparty and the Company's internal ratings are consistent
with external rating agency default databases. Loss given default ratings are
driven by the collateral, structure, and seniority of each individual asset
and are consistent with external loss given default/recovery databases. The
Company uses an exposure at default estimate as a way of quantifying the
amount the Company could lose in case of default. This estimate varies
depending on the level of commitment, the type of exposure, and the credit
rating of the borrower. The portion of the allowance related to impaired
credits is based on the present value of future cash flows, market prices, or
collateral values. Changes in the estimates of probability of default, risk
ratings, loss given default/recovery rates, and cash flows could have a direct
impact on the allocated allowance for loan losses.
The Company's unallocated allowance is established via a process that
begins with estimates of probable loss inherent in the portfolio, based upon
the following factors:
- Economic conditions, including duration of the current cycle
- Past experience, including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm existing
credit deterioration
- Geopolitical issues and their impact on the economy
To the extent actual results differ from forecasts or management's
judgment the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand
the variables that drive the allowance for credit losses.
One key variable in determining the allowance is management's judgment
around the size of the unallocated portion of the allowance. At March 31,
2004, the unallocated allowance was 14% of the total allowance. If the
unallocated allowance were five percent higher or lower, the allowance would
have increased or decreased by $40 million, respectively.
The credit rating assigned to each pass credit is another significant
variable in determining the allowance. If each pass credit were rated one
grade better, the allowance would have decreased by $67 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$96 million.
29
For higher risk rated credits, if the loss given default were 10% worse,
the allowance would have increased by $19 million, while if the loss given
default were 10% better, the allowance would have decreased by $25 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $23 million,
respectively.
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
- --------------------------------------------------------------------------
Available
----------
When quoted market prices are not available for derivatives and securities
values, such values are determined at fair value, which is defined as the
value at which positions could be closed out or sold in a transaction with a
willing counterparty over a period of time consistent with the Company's
trading or investment strategy. Fair value for these instruments is determined
based on discounted cash flow analysis, comparison to similar instruments, and
the use of financial models. Financial models use as their basis independently
sourced market parameters including, for example, interest rate yield curves,
option volatilities, and currency rates. Discounted cash flow analysis is
dependent upon estimated future cash flows and the level of interest rates.
Model-based pricing uses inputs of observable prices for interest rates,
foreign exchange rates, option volatilities and other factors. Models are
benchmarked and validated by external parties. The Company's valuation process
takes into consideration factors such as counterparty credit quality,
liquidity and concentration concerns. The Company applies judgment in the
application of these factors. In addition, the Company must apply judgment
when no external parameters exist. Finally, other factors can affect the
Company's estimate of fair value including market dislocations, incorrect
model assumptions, and unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in the footnote 1 "Summary of Significant Accounting and
Reporting Policies" in the Company's 2003 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at March 31,
2004, approximately $3.1 billion of the Company's portfolio of securities and
derivatives is not priced based on quoted market prices. A change of 2.5% in
the valuation of these securities and derivatives would result in a change in
pre-tax income of $76 million.
Goodwill and Other Intangibles
- ------------------------------
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill, indefinite-lived intangibles, and other
intangibles, at fair value as required by SFAS 141. Goodwill ($3,355 million
at March 31, 2004) and indefinite-lived intangible assets ($370 million at
March 31, 2004) are not amortized but are subject to annual tests for
impairment or more often if events or circumstances indicate they may be
impaired. Other intangible assets are amortized over their estimated useful
lives and are subject to impairment if events or circumstances indicate a
possible inability to realize the carrying amount. The initial recording of
goodwill and other intangibles requires subjective judgments concerning
estimates of the acquired assets fair value. The goodwill impairment test is
performed in two phases. The first step of the goodwill impairment test
compares the fair value of the reporting unit with its carrying amount,
including goodwill. If the fair value of the reporting unit exceeds its
carrying amount, goodwill of the reporting unit is considered not impaired;
however, if the carrying amount of the reporting unit exceeds its fair value,
an additional procedure must be performed. That additional procedure compares
the implied fair value of the reporting unit's goodwill with the carrying
amount of that goodwill. An impairment loss is recorded to the extent that the
carrying amount of goodwill exceeds its implied fair value. Indefinite-lived
intangible assets are evaluated for impairment at least annually by comparing
its fair value to its carrying value.
30
Other identifiable intangible assets ($417 million at March 31, 2004) are
evaluated for impairment if events and circumstances indicate a possible
impairment. Such evaluation of other intangible assets is based on
undiscounted cash flow projections. Fair value may be determined using: market
prices, comparison to similar assets, market multiples, discounted cash flow
analysis and other determinates. Estimated cash flows may extend far into the
future and, by their nature, are difficult to determine over an extended
timeframe. Factors that may significantly affect the estimates include, among
others, competitive forces, customer behaviors and attrition, changes in
revenue growth trends, cost structures and technology, and changes in discount
rates and specific industry or market sector conditions. Other key judgments
in accounting for intangibles include useful life and classification between
goodwill and indefinite lived intangibles or other intangibles which require
amortization. See Note 4 of the Notes to Consolidated Financial Statements
for additional information regarding intangible assets.
The following discussion may assist investors in assessing the impact of
a goodwill or intangible asset impairment charge. The Company has $4.1
billion of goodwill and intangible assets at March 31, 2004. The impact of a
5% impairment charge would result in a change of pre-tax income of
approximately $205 million.
LIQUIDITY
The Company maintains its liquidity through the management of its assets
and liabilities, utilizing worldwide financial markets. The diversification of
liabilities reflects the Company's efforts to maintain flexibility of funding
sources under changing market conditions. Stable core deposits, including
demand, retail time, and trust deposits from processing businesses, are
generated through the Company's diversified network and managed with the use
of trend studies and deposit pricing. The use of derivative products such as
interest rate swaps and financial futures enhances liquidity by enabling the
Company to issue long-term liabilities with limited exposure to interest rate
risk. Liquidity also results from the maintenance of a portfolio of assets
which can be easily sold and the monitoring of unfunded loan commitments,
thereby reducing unanticipated funding requirements. Liquidity is managed on
both a consolidated basis and also at The Bank of New York Company, Inc.
parent company ("Parent").
On a consolidated basis, non-core sources of funds such as money market
rate accounts, certificates of deposits greater than $100,000, federal funds
purchased and other borrowings were $14.6 billion and $14.4 billion on an
average basis for the first three months of 2004 and 2003. Average foreign
deposits, primarily from the Company's European based securities servicing
business, were $25.8 billion and $23.9 billion at March 31, 2004 and 2003.
Savings and other time deposits were $10.2 billion on an average basis at
March 31, 2004 compared to $9.8 billion at March 31, 2003. Average payables to
customers and broker-dealers rose to $7.0 billion from $0.1 billion and long-
term debt increased to $6.2 billion from $5.4 billion reflecting the Pershing
acquisition.
The Parent has five major sources of liquidity: dividends from its
subsidiaries, a line of credit with the Bank, the commercial paper market, a
revolving credit agreement with third party financial institutions, and access
to the capital markets.
At March 31, 2004, the Bank could pay dividends of approximately $761
million to the Parent without the need for regulatory wavier. This dividend
capacity would increase in the remainder of 2004 to the extent of the Bank's
net income less dividends. Nonbank subsidiaries of the Parent have liquid
assets of approximately $264 million. These assets could be liquidated and the
proceeds delivered by dividend or loan to the Parent.
The Parent has a $300 million line of credit with the Bank, which is
subject to limits imposed by federal banking law. At March 31, 2004, the
Parent could use the subsidiaries' liquid securities as collateral to allow it
to borrow $47 million rather than liquidate the securities and loan or
dividend the proceeds to the Parent and remain in compliance with federal
banking regulations. The Parent had no borrowings from the Bank at March 31,
2004.
31
For the quarter ended March 31, 2004, the Parent's quarterly average
commercial paper borrowings were $77 million compared with $161 million in
2003. At March 31, 2004, the Parent had cash of $585 million compared with
cash of $434 million at December 31, 2003 and $518 million at March 31, 2003.
Net of commercial paper outstanding, the Parent's cash position at March 31,
2004 was up $151 million compared with March 31, 2003.
The Parent has a back-up line of credit of $275 million with 15 financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at March 31, 2004 and March 31, 2003.
The Parent also has the ability to access the capital markets. At March
31, 2004, the Parent had a shelf registration statement with a capacity of
$591 million of debt, preferred stock, preferred trust securities, or common
stock. Access to the capital markets is partially dependent on the Company's
credit ratings, which as of March 31, 2004 were as follows:
The Bank of
Parent Parent Parent Senior New York
Commercial Subordinated Long-Term Long-Term
Paper Long-Term Debt Debt Deposits Outlook
---------- -------------- ------------- ------------ -------
Standard &
Poor's A-1 A A+ AA- Stable
Moody's P-1 A1 Aa3 Aa2 Stable
Fitch F1+ A+ AA- AA Stable
The Parent's major uses of funds are payment of principal and interest on
its borrowings, acquisitions, and additional investment in its subsidiaries.
The Parent has $300 million of long-term debt that becomes due in 2004
subsequent to March 31, 2004 and $100 million of long-term debt that is due in
2005. In addition, at March 31, 2004, the Parent has the option to call $175
million of subordinated debt in 2004 and $93 million in 2005, which it will
call and refinance if market conditions are favorable. As of April 30, 2004,
the Company redeemed $20 million of debt. The Parent expects to refinance any
debt it repays by issuing a combination of senior and subordinated debt.
Double leverage is the ratio of investment in subsidiaries divided by the
Company's consolidated equity plus trust preferred securities. The Company's
double leverage ratio at March 31, 2004 and 2003 was 99.28% and 100.82%. The
Company's target double leverage ratio is a maximum of 120%. The double
leverage ratio is monitored by regulators and rating agencies and is an
important constraint on the Company's ability to invest in its subsidiaries to
expand its businesses.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Earnings and other operating activities provided $2.1 billion in cash
flows through March 31, 2004, compared with $0.8 billion used by operating
activities through March 31, 2003. The sources of cash flows from operations
in 2004 were principally the result of changes in trading activities and net
income.
In the first quarter of 2004, cash used by investing activities was $2.5
billion as compared to cash used by investing activities in the first quarter
of 2003 of $1.7 billion. In the first quarter of 2004 and 2003, purchases of
securities available-for-sale were a significant use of funds.
In the first quarter of 2004, cash used by financing activities was $0.9
billion as compared to cash provided by financing activities in the first
quarter of 2003 of $2.2 billion. Sources of funds in 2004 include other
borrowed funds, the issuance of long-term debt and common stock. In first
quarter of 2004, deposits and payables to customers and broker-dealers were a
net use of funds, while these items were a source of funds the Company used to
finance its investing activities in the first quarter of 2003.
32
CAPITAL RESOURCES
Regulators establish certain levels of capital for bank holding companies
and banks, including the Company and the Bank, in accordance with established
quantitative measurements. In order for the Company to maintain its status as
a financial holding company, the Bank must qualify as well capitalized. In
addition, major bank holding companies such as the Company are expected by the
regulators to be well capitalized. As of March 31, 2004 and 2003, the Company
and the Bank were considered well capitalized on the basis of the ratios
(defined by regulation) of Total and Tier 1 capital to risk-weighted assets
and leverage (Tier 1 capital to average assets), which are shown as follows:
March 31, 2004 March 31, 2003
--------------------- --------------------- Well Adequately
Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
------- ---- ------- ------ ------- ----------- -----------
Tier 1* 7.52% 7.35% 7.92% 7.92% 7.75% 6% 4%
Total Capital** 11.57 11.51 12.72 12.34 11.75 10 8
Leverage 5.83 5.66 6.68 6.63 6.50 5 3-5
Tangible Common
Equity 5.22 5.77 5.52 6.26 5.25-6.00 N.A. N.A.
* Tier 1 capital consists, generally, of common equity, preferred trust securities, and
certain qualifying preferred stock, less goodwill and most other intangibles.
**Total Capital consists of Tier 1 capital plus Tier 2 capital. Tier 2 capital consists,
generally, of certain qualifying preferred stock and subordinated debt and a portion of the
loan loss allowance.
The Company's estimated regulatory Tier 1 capital and Total capital
ratios were 7.52% and 11.57% at March 31, 2004, compared with 7.44% and
11.49% at December 31, 2003, and 7.92% and 12.72% at March 31, 2003. The
regulatory leverage ratio was 5.83% at March 31, 2004, compared with 5.82% at
December 31, 2003, and 6.68% at March 31, 2003. The Company's tangible common
equity as a percentage of total assets was 5.22% at March 31, 2004, up from
4.91% at December 31, 2003, and close to the Company's target of 5.25%. This
ratio varies depending on the size of the balance sheet at quarter-end and
the impact of interest rates on unrealized gains and losses among other
things. The Company expects to repurchase 3 million shares of common stock
later this year. The improvement in the Company's capital ratios versus
December 31, 2003 reflects the retention of earnings during the quarter as
well as an increase in the securities valuation allowance. The decline
from March 31, 2003 primarily reflects the Pershing acquisition.
The Federal Reserve has indicated that it is reviewing the continued
treatment of preferred trust securities as Tier 1 Capital. See "Accounting
Changes and New Accounting Pronouncements" in the Footnotes to the
Consolidated Financial Statements.
33
The following table presents the components of the Company's risk-based
capital at March 31, 2004 and 2003:
(in millions) 2004 2003
---- ----
Common Stock $8,760 $6,874
Preferred Stock - -
Preferred Trust Securities 1,150 1,100
Adjustments:
Intangibles (4,136) (2,612)
Securities Valuation Allowance (212) (179)
Merchant Banking Investments (6) (3)
------ ------
Tier 1 Capital 5,556 5,180
------ ------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,227 2,330
Qualifying Allowance for Loan Losses 770 804
------ ------
Tier 2 Capital 2,997 3,134
------ ------
Total Risk-based Capital $8,553 $8,314
====== ======
Risk-Adjusted Assets $73,904 $65,378
======= =======
34
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at March 31, 2004 and March 31, 2003 are
as follows:
1st Quarter 2004
March 31, 2004 Average
---------------------------- -------------------
(In millions) Fair Value Fair Value
------------------ -------------------
Notional
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 63,241 $ 93 $ - $ 101 $ -
Swaps 194,504 1,286 80 1,451 171
Written Options 149,946 - 1,442 - 1,400
Purchased Options 94,357 215 - 214 -
Foreign Exchange Contracts:
Swaps 3,080 - - - -
Written Options 10,623 - 84 - 69
Purchased Options