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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended March 31, 2005
The Quarterly Report on Form 10-Q and cross reference index is on page 60.
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
- First Quarter 2005 Highlights 3
- Consolidated Income Statement Review 4
- Business Segments Review 8
- Critical Accounting Policies 20
- Consolidated Balance Sheet Review 24
- Liquidity 30
- Capital Resources 32
- Trading Activities 34
- Asset/Liability Management 36
- Statistical Information 37
- Other Developments 38
- Forward Looking Statements and
Factors That Could Affect Future Results 43
- Website Information 46
Consolidated Financial Statements
- Consolidated Balance Sheets
March 31, 2005 and December 31, 2004 47
- Consolidated Statements of Income
For the Three Months Ended March 31, 2005 and 2004 48
- Consolidated Statement of Changes In
Shareholders' Equity For the Three
Months Ended March 31, 2005 49
- Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2005 and 2004 50
- Notes to Consolidated Financial Statements 51 - 59
Form 10-Q
- Cover 60
- Controls and Procedures 61
- Legal Proceedings 61
- Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities 62
- Exhibits 63
- Signature 64
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
March 31, December 31, March 31,
2005 2004 2004
------------ ------------ ------------
Quarter
-------
Revenue (tax equivalent basis) $ 1,917 $ 1,967 $ 1,667
Net Income 379 351 364
Basic EPS 0.49 0.45 0.47
Diluted EPS 0.49 0.45 0.47
Cash Dividends Per Share 0.20 0.20 0.19
Return on Average Common
Shareholders' Equity 16.52% 15.34% 17.17%
Return on Average Assets 1.55 1.40 1.47
Efficiency Ratio 66.2 64.8 69.3
Assets $ 96,537 $ 94,529 $ 92,652
Loans 38,764 35,781 36,070
Securities 23,907 23,802 24,083
Deposits - Domestic 33,634 35,558 33,639
- Foreign 25,328 23,163 22,443
Long-Term Debt 7,389 6,121 6,276
Common Shareholders' Equity 9,335 9,290 8,760
Common Shareholders'
Equity Per Share $ 12.02 $ 11.94 $ 11.27
Market Value Per Share
of Common Stock 29.05 33.42 31.50
Allowance for Loan Losses as
a Percent of Total Loans 1.50% 1.65% 1.75%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.78 1.99 2.11
Total Allowance for Credit Losses
as a Percent of Total Loans 1.85 2.06 2.19
Total Allowance for Credit Losses
as a Percent of Non-Margin Loans 2.19 2.48 2.64
Tier 1 Capital Ratio 8.13 8.31 7.60
Total Capital Ratio 12.54 12.21 11.70
Leverage Ratio 6.56 6.41 5.83
Tangible Common Equity Ratio 5.48 5.56 5.22
Employees 23,160 23,363 22,820
Assets Under Custody (In trillions)
Total Assets Under Custody $ 9.9 $ 9.7 $ 8.6
Equity Securities 34% 35% 33%
Fixed Income Securities 66 65 67
Cross-Border Assets Under Custody $ 2.8 $ 2.7 $ 2.4
Assets Under Administration
(In billions) $ 33 $ 33 $ 33
Assets Under Management (In billions)
Total Assets Under Management 104 102 92
Equity Securities 34% 36% 36%
Fixed Income Securities 21 21 22
Alternative Investments 15 15 13
Liquid Assets 30 28 29
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," "target, " 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
providing a comprehensive array of services that enable institutions and
individuals to move and manage their financial assets in more than 100 markets
worldwide. The Company has a long tradition of collaborating with clients to
deliver innovative solutions through its core competencies: securities
servicing, treasury management, investment management, and individual &
regional banking services. The Company's extensive global client base
includes a broad range of leading financial institutions, corporations,
government entities, endowments and foundations. Its principal subsidiary,
The Bank of New York, founded in 1784, is the oldest bank in the United States
and has consistently played a prominent role in the evolution of financial
markets worldwide.
The Company has executed a consistent strategy over the past decade by
focusing on highly scalable, fee-based securities servicing and fiduciary
businesses, with top three 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 has grown both through internal reinvestment as well as
execution of strategic acquisitions to expand product offerings and increase
market share in its scale businesses. Internal reinvestment occurs through
increased technology spending, staffing levels, marketing/branding
initiatives, quality programs, and product development. The Company
consistently invests in technology to improve the breadth and quality of its
product offerings, and to increase economies of scale. With respect to
acquisitions, the Company has acquired 93 businesses since 1995, almost
exclusively in its securities servicing and fiduciary segment. 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 47% from December 31, 2000 to December 31, 2004.
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.
FIRST QUARTER 2005 HIGHLIGHTS
The Company reported first quarter net income of $379 million and diluted
earnings per share of 49 cents, compared with net income of $351 million and
diluted earnings per share of 45 cents in the fourth quarter of 2004, and net
income of $364 million and diluted earnings per share of 47 cents in the first
quarter of 2004. In the fourth quarter of 2004, the Company recorded several
gains and charges that in aggregate reduced reported earnings by 3 cents per
share. See "Other Developments".
First quarter 2005 highlights include solid performance in securities
servicing, asset management, and foreign exchange and other trading, continued
excellent credit performance, and good expense control. Securities servicing
fees increased 1% sequentially from the seasonally robust fourth quarter to
$751 million, reflecting strong growth in investor services and broker-dealer
services. Private client services and asset management increased 5%
sequentially, reflecting continued growth in Ivy Asset Management's ("Ivy")
international business. Foreign exchange and other trading revenues increased
7% sequentially, reflecting continued strong customer flows in foreign exchange
and improved results in interest rate derivatives. Partially offsetting this
revenue growth were lower capital markets related income, fewer securities
gains, and lower other income.
On a year-over-year basis, securities servicing and asset management
increased by 5% and 12%, respectively. The increase in securities servicing
fees primarily reflects strong performance in investor services and broker-
dealer services. The increase in asset management was driven by the continued
growth in Ivy as well as higher fees from BNY Hamilton Funds. Offsetting this
revenue growth were lower capital markets related income, lower foreign
exchange and other trading, fewer securities gains and a decline in other
income.
Additional highlights for the quarter include continued growth in net
interest income of 2% sequentially and 10% year-over-year, reflecting widening
spreads as interest rates continue to rise. Asset quality remains strong, as
the provision improved to a credit of $10 million and NPA's declined by 10%
from December 31, 2004. Total expenses declined by 2% from the fourth quarter.
After adjusting for legal reserves taken in the fourth quarter, expense growth
was 1%, reflecting the Company's expense control efforts.
The Company's securities servicing businesses maintained good revenue
momentum following the very strong results in the fourth quarter of 2004. The
balance sheet remained well positioned for growth in net interest income, and
the Company's credit risk improvement efforts continue to deliver results. The
Company's intensified focus on expense management was also effective, as total
expenses were essentially unchanged sequentially.
During the first quarter of 2005, the Company continued to invest in
enhancing its service offerings, critical to sustaining revenue growth through
all types of markets, while maintaining its commitment to expense discipline
to ensure a competitive cost base. Service offerings enhancements were the
result of both internal development and acquisitions. New business momentum
remains strong as the Company is gaining traction with growth initiatives such
as hedge fund servicing, Pershing's registered investment advisor ("RIA")
offering and independent research. The outlook for Ivy continues to be very
positive, given increased allocations by institutions to alternative
investments, including hedge funds, as an asset class.
4
The key factors impacting growth going forward remain the sustainability
of a favorable investment environment and consistent focus on expense control.
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Servicing Fees
Securities $ 751 $ 742 $ 716
Global Payment Services 75 71 79
------- ------- -------
826 813 795
Private Client Services
and Asset Management Fees 121 115 108
Service Charges and Fees 92 98 96
Foreign Exchange and
Other Trading Activities 96 90 106
Securities Gains 12 18 33
Other* 31 42 82
------- ------- -------
Total Noninterest Income $ 1,178 $ 1,176 $ 1,220
======= ======= =======
* See "Other Developments."
Total noninterest income for the first quarter of 2005 was $1,178
million, essentially flat on a sequential quarter basis and a decrease of 3%
from the first quarter of 2004. The first quarter of 2005 reflects stronger
performance in securities servicing and asset management versus both prior
periods offset by decreases in service charges and fees, securities gains and
other noninterest income. The first quarter of 2004 included a $48 million
gain on the sale of a portion of the Company's investment in Wing Hang Bank
Limited, recorded in other noninterest income, as well as securities gains of
$19 million related to four sponsor fund investments.
Securities servicing fees were up $9 million, or 1%, sequentially and $35
million, or 5%, from a year ago. For a discussion of securities servicing
fees see "Securities Servicing Fees" in the segment results section under
"Servicing and Fiduciary Businesses."
Global payment services fees increased $4 million, or 6%, compared with
the fourth quarter of 2004 and decreased $4 million, or 5%, from the first
quarter of 2004. The sequential increase reflects strength in cash management
due to new business wins which offset lower revenue from trade finance. The
decline versus the first quarter of 2004 reflects lower fees due to customers
choosing to pay with higher compensating balances partially offset by new
business.
Private client services and asset management fees for the first quarter
were up 5% from the prior quarter and 12% from the first quarter of 2004. The
sequential quarter increase reflects continued growth at Ivy and higher fees
in institutional equity and retail investment products. The increase from the
first quarter of 2004 is primarily due to growth at Ivy as well as higher fees
from BNY Hamilton Funds. Total assets under management were $104 billion at
March 31, 2005, up from $102 billion at December 31, 2004 and $92 billion a
year ago.
Service charges and fees were down 6% from the fourth quarter of 2004 and
4% from the first quarter of 2004. The sequential and year-over-year
decreases reflect lower capital markets fees due to reduced activity in loan
syndications and bond underwriting. As a result of its credit risk reduction
efforts, the Company has narrowed its capital markets focus to selective
5
industry segments, such as utilities and media, which were less active this
quarter.
Foreign exchange and other trading revenues were $96 million, up $6
million, or 7%, sequentially and down $10 million, or 9%, from the first
quarter of 2004. The strong sequential quarter performance reflects improved
results in interest rate derivatives, while the decrease from the record first
quarter of 2004 performance resulted from lower foreign exchange revenues.
Securities gains in the first quarter were $12 million, compared with $18
million in the fourth quarter of 2004 and $33 million in the first quarter of
2004. Securities gains in the first quarter of 2005 primarily derived from
the Company's leveraged buy-out sponsor portfolio. In the first quarter of
2004, securities gains included $19 million of realized gains on four sponsor
fund investments.
Other noninterest income was $31 million, compared with $42 million in
the prior quarter and $82 million in the first quarter of 2004. The
sequential quarter decline reflects lower event-driven revenue such as gains
on asset dispositions. Other noninterest income in the first quarter of 2004
included a pre-tax gain of $48 million on the sale of a portion of the
Company's investment in Wing Hang Bank Limited ("Wing Hang").
Net Interest Income
- -------------------
1st 4th 4th 1st 1st
Quarter Quarter Quarter Quarter Quarter
(Dollars in millions) -------- -------- -------- -------- --------
Reported Reported Core** Reported Core**
-------- -------- -------- -------- --------
2005 2004 2004 2004 2004
-------- -------- -------- -------- --------
Net Interest Income $ 455 $ 527 $ 448 $ 268 $ 413
Tax Equivalent
Adjustment* 7 9 9 6 6
-------- -------- -------- -------- --------
Net Interest Income on a
Tax Equivalent Basis $ 462 $ 536 $ 457 $ 274 $ 419
======== ======== ======== ======== ========
Net Interest Rate
Spread 1.93% 2.26% 1.87% 1.13% 1.85%
Net Yield on Interest
Earning Assets 2.36 2.64 2.25 1.36 2.08
* 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 adjustments. See "Other Developments."
Net interest income on a taxable equivalent basis was $462 million in the
first quarter of 2005, compared with $536 million in the fourth quarter of
2004, and $274 million in the first quarter of 2004. The net interest rate
spread was 1.93% in the first quarter of 2005, compared with 2.26% in the
fourth quarter of 2004, and 1.13% in the first quarter of 2004. The net yield
on interest earning assets was 2.36% in the first quarter of 2005, compared
with 2.64% in the fourth quarter of 2004, and 1.36% in the first quarter of
2004.
Excluding the impact of the SFAS 13 leasing adjustments on the leveraged
lease portfolio in 2004, net interest income on a taxable equivalent basis was
up on a sequential quarter basis to $462 million, compared with $457 million
in the fourth quarter of 2004 and $419 million in the first quarter of 2004.
6
On the same basis, the net interest rate spread was 1.93% in the first quarter
of 2005, compared with 1.87% in the fourth quarter of 2004, and 1.85% in the
first quarter of 2004 while the net yield on interest earning assets was 2.36%
in the first quarter of 2005, compared with 2.25% in the fourth quarter of
2004 and 2.08% in the first quarter of 2004.
The increase in net interest income from the fourth and first quarters of
2004 core results is primarily due to the repricing of the Company's assets at
a faster rate than its liabilities and higher volume and values of interest
free deposits given the rise in short term rates. These improvements were
partially offset by a slight decline in average assets and fewer days in the
quarter. The Company's asset sensitivity is becoming more neutral relative to
year-end as the higher rate environment is beginning to limit its ability to
lag deposit repricing as rates increase further. In comparison to the first
quarter of 2004, net interest income was also impacted by customers making
greater use of compensating balances to pay for services.
Noninterest Expense and Income Taxes
- ------------------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Salaries and Employee Benefits $ 618 $ 617 $ 574
Net Occupancy 78 75 81
Furniture and Equipment 52 51 51
Clearing 46 45 48
Sub-custodian Expenses 23 22 22
Software 53 43 49
Communications 23 23 24
Amortization of Intangibles 8 9 8
Other 176 212 156
------- ------- -------
Total Noninterest Expense $ 1,077 $ 1,097 $ 1,013
======= ======= =======
Noninterest expense for the first quarter of 2005 was $1,077 million,
compared with $1,097 million in the prior quarter and $1,013 million in the
first quarter of 2004. The fourth quarter of 2004 included $30 million legal
reserves in other noninterest expense while the first quarter of 2004 results
included $18 million related to cost reduction initiatives, including lease
terminations, severance and relocation expenses.
Salaries and employee benefits expense for the first quarter was
essentially unchanged on a sequential quarter basis, reflecting higher pension
and seasonal social security expenses tied to bonuses, offset by lower new
business conversion costs and lower restricted stock expense. In addition,
incentive compensation and outside help were down compared with a seasonally
high fourth quarter. On a sequential quarter basis, pension expense increased
by $11 million. In the first quarter of 2005, the number of employees
declined by approximately 200 reflecting strict cost control. Relative to the
first quarter of 2004, salaries and employee benefits expense increased by $44
million, or 8%, reflecting higher pension and stock option expense as well as
higher staffing levels associated with growth in investor services and
expansion of certain staff functions.
7
Occupancy expenses were up $3 million sequentially, reflecting higher
energy costs and higher depreciation associated with a back up data center.
First quarter 2004 occupancy expense included lease termination expenses of $8
million.
Clearing and sub-custodian expenses, which are tied to transaction
volumes, were up slightly sequentially on a combined basis to $69 million. The
increase reflects a higher level of business activity.
Other expenses in the fourth quarter of 2004 included $30 million of
expenses associated with legal reserves. Excluding the legal reserves, other
expenses declined by $6 million sequentially, reflecting lower travel expenses
and professional fees.
The effective tax rate for the first quarter of 2005 was 33.1%, compared
to 42.8% in the fourth quarter of 2004 and 21.5% in the first quarter of 2004.
The effective tax rate in the fourth quarter of 2004 reflects the net of the
increase in the tax reserve related to LILO exposures and the impact of the
SFAS 13 leasing adjustments related to cross-border rail equipment leases and
aircraft leases. The effective tax rate in the first quarter of 2004 reflects
the SFAS 13 leasing adjustment related to the Company's leasing portfolio.
The effective tax rates in all periods reflect a reclassification related to
Section 42 tax credits. See "Other Developments".
Credit Loss Provision and Net Charge-Offs
- -----------------------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Provision $ (10) $ (7) $ 12
======= ======= =======
Net Charge-offs:
Commercial $ (3) $ (1) $ (5)
Foreign - 2 (10)
Regional Commercial (2) (8) -
Consumer (5) (5) (11)
------- ------- -------
Total $ (10) $ (12) $ (26)
======= ======= =======
The Company recorded a $10 million credit to the provision in the first
quarter of 2005, compared to $7 million credit to the provision in the fourth
quarter of 2004 and $12 million provision in the first quarter of 2004. The
lower provision in 2005 reflects the Company's improved asset quality and a
continued strong credit environment. The Company expects the provision to be
less favorable in the second quarter of 2005. The first quarter results
reflected unanticipated favorable outcomes on a couple of specific credits.
The total allowance for credit losses was $716 million at March 31, 2005,
$736 million at December 31, 2004, and $790 million at March 31, 2004. The
total allowance for credit losses as a percent of non-margin loans was 2.19%
at March 31, 2005, compared with 2.48% at December 31, 2004, and 2.64% at
March 31, 2004.
Net charge-offs were $10 million in the first quarter of 2005 versus $12
million in the fourth quarter of 2004 and $26 million in the first quarter of
2004. These represent 0.10% of total loans in the most recent quarter, down
from 0.13% and 0.29% in the respective prior periods.
8
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
2004, the Company made several methodology changes. These include a
modification to the method for allocating its pension expense to the segments;
changes to the method used to allocate earnings on capital, which caused a
slight reallocation from reconciling items to the individual segments; and
greater allocations of corporate expenses previously included in reconciling
items to the individual segments. See "Reconciling Items." 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 two factors among others:
historical charge-off experience and the volume, composition, and size of the
credit portfolio. This method is different from that required under generally
accepted accounting principles as it anticipates future losses which are not
yet probable and therefore not recognizable under generally accepted
accounting principles. Balance sheet assets and liabilities and their related
income or expense are specifically assigned to each segment. Funds transfer-
pricing methods are used to allocate a cost of funds used or credit for funds
provided to all segment assets or liabilities using a matched funding concept.
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 SFAS 13 lease adjustments and the RW Matter in 2004, which are included
within 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 should 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
9
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 Businesses segment
also includes customer-related foreign exchange.
In issuer services, the Company's American and global depositary receipt
business has over 1,190 programs representing over 60 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 $2.75 trillion in outstanding debt
securities. The Company is the third largest stock transfer agent
representing over 550 publicly traded companies with over 19 million
shareholder accounts maintained on its recordkeeping system.
In investor services, the Company is the largest custodian with $9.9
trillion of assets under custody and administration at March 31, 2005. The
Company is the second largest mutual fund custodian for U.S. funds and one of
the largest providers of fund services in the world with over $1.6 trillion in
total assets. The Company is the largest U.K. custodian. 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 approximately 50%
of U.S. Government securities. With over $1 trillion 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 electronic broker for non-U.S. dollar equity
execution. The Company provides execution, clearing and financial services
outsourcing solutions in over 80 global markets, executing trades for 650
million shares and clearing more than 600,000 trades daily. The Company has
21 seats on the New York Stock Exchange. Pershing services more than 1,100
institutional and retail financial organizations and independent investment
advisors who collectively represent nearly 6 million individual investors.
Global payment services facilitates 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 on its product and service capabilities and add new clients.
The Company has completed 93 acquisitions since 1995 primarily 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.
10
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, branch banking, and consumer and
residential mortgage lending. The Company's retail franchise includes more
than 610,800 customer relationships and 77,400 business relationships. The
Company operates 341 branches in 23 counties in the Tri-State region. The
Company has 241 branches in New York, 92 in New Jersey and 8 in Connecticut.
The New York branches are primarily suburban based with 118 in upstate New
York, 85 on Long Island and 38 in New York City. The retail network is a
growing 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. The branches are a
meaningful source of private client referrals. Small business and investment
centers are set up in the largest 100 branches.
The Financial Markets segment includes non-client related trading of
foreign exchange, trading of 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
- ----------------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Net Interest Income $ 168 $ 167 $ 132
Provision for
Credit Losses 1 1 -
Noninterest Income 1,025 1,010 990
Noninterest Expense 847 848 779
Income Before Taxes 345 328 343
Average Assets $22,987 $23,209 $22,771
Average Deposits 36,072 36,299 35,138
Nonperforming Assets 1 1 3
(Dollars in billions)
Assets Under Custody $ 9,859 $ 9,657 $ 8,577
Equity Securities 34% 35% 33%
Fixed Income Securities 66 65 67
Cross-Border Assets Under Custody $ 2,761 $ 2,704 $ 2,401
Assets Under Administration $ 33 $ 33 $ 33
Assets Under Management 104 102 92
Equity Securities 34% 36% 36%
Fixed Income Securities 21 21 22
Alternative Investments 15 15 13
Liquid Assets 30 28 29
S&P(Registered Mark) 500 Index (Period End) 1,181 1,212 1,126
NASDAQ(Registered Mark) Index (Period End) 1,999 2,175 1,994
Lehman Brothers Aggregate Bond(Service Mark) Index 214.0 220.6 199.3
MSCI(Registered Mark) EAFE Index 1,503.9 1,515.5 1,337.1
NYSE(Registered Mark) Volume (In billions) 99.4 96.0 95.4
NASDAQ(Registered Mark) Volume (In billions) 121.2 119.7 128.2
11
The S&P 500 Index was down 3% for the first quarter of 2005, with
average daily price levels up 2.5% from the fourth quarter of 2004. The
NASDAQ Index also decreased by 8% for the first quarter of 2005, with
average daily prices remained flat compared with the fourth quarter of 2004.
Globally, the MSCI EAFE index was down 1%. Combined NYSE and NASDAQ
non-program trading volumes were up only 1% during the first quarter of 2005.
As the Company's business model is more volume than price sensitive, this
created a drag on the Company's equity-linked businesses. The Lehman Brothers
Aggregate Bond index was down 3% for the first quarter of 2005. Average
fixed income trading volume was up 13% offsetting some of the weakness in
equities.
First quarter results showed continued strength in several of the
Company's primary businesses, including investor services, broker-dealer
services, asset management, and foreign exchange and other trading.
Offsetting this strength were volume related declines in the Company's
execution and clearing services businesses. In the first quarter of 2005,
pre-tax income was $345 million, compared with $328 million in the fourth
quarter of 2004 and $343 million a year ago.
Noninterest income for the first quarter of 2005 increased $15 million to
$1,025 million on a sequential quarter basis and $35 million from a year ago.
Securities Servicing Fees
- -------------------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Execution and Clearing Services $ 293 $ 302 $ 303
Investor Services 263 239 226
Issuer Services 139 149 137
Broker-Dealer Services 56 52 50
------- ------- -------
Securities Servicing Fees $ 751 $ 742 $ 716
======= ======= =======
Securities servicing fees were $751 million in the first quarter, an
increase of $9 million, or 1%, from the fourth quarter of 2004 and $35
million, or 5%, from the first quarter of 2004.
Execution and clearing services fees decreased $9 million, or 3%, from
the fourth quarter of 2004 and $10 million, or 3%, from the first quarter of
2004. In the first quarter of 2005 in execution services, transition business
was relatively soft following particularly robust fourth quarter levels.
Transition activity can vary significantly from quarter to quarter and has no
correlation to market volumes. Execution services was also impacted by a
decrease in portfolio rebalancing activity from the seasonally high fourth
quarter levels as well as three fewer trading days in the first quarter
compared with the fourth quarter of 2004. While average daily non-program
volumes for the market increased by 6%, after adjusting for fewer trading
days, total non-program market volumes increased by only 1%. The sequential
decline in execution and clearing services is slightly below the total non-
program market volumes.
Pershing's fees were essentially flat compared with the fourth quarter of
2004 and down from a year ago. The year-over-year decrease reflects growth in
non-transactional fees offset by lower transaction-based revenue. Total
retail market volumes decreased approximately 3% sequentially. Although
average billable trades for Pershing increased by 7%, total trades increased
by only 2% due to a lower day count. The majority of Pershing's revenues is
generated from non-transactional activities, such as asset gathering and
technology services to broker-dealers, with revenues tied to both assets under
administration and services provided. Despite a 3% sequential decline in the
S&P 500 Index, Pershing's assets under administration were $708 billion at
quarter-end, compared with $706 billion at December 31, 2004. As of March 31,
2005, margin loans remained flat compared with the fourth quarter of 2004,
reflecting the current lack of direction in the equity markets.
12
Investor services fees were up $24 million, or 10%, over the fourth
quarter of 2004, and $37 million, or 16%, from the first quarter of 2004.
Sequential and year-over-year results reflect strong performance across all
business lines. New business wins drove performance in global fund services
and securities lending in the first quarter of 2005. Global fund services was
also favorably impacted by stronger levels of client activity, new business
conversions in the U.S. and continued expansion of the Company's hedge fund
servicing client base. At quarter-end, hedge fund assets under administration
totaled $56 billion up 17% from $48 billion at year-end 2004. The Company
expects the pipeline for new business from domestic and offshore funds to
continue to be strong. Global custody also experienced higher activity levels
and asset inflows from new and existing clients. Securities lending fees
increased sequentially reflecting strong demand for U.S. treasuries as well as
the beginning of the European dividend season in March. The year-over-year
results reflect the same factors influencing the sequential quarter increase
as well as new business wins. Outsourcing benefited relative to both the
fourth and first quarters of 2004 from the conversion of new business wins.
At March 31, 2005, assets under custody rose to $9.9 trillion, from $9.7
trillion at December 31, 2004 and $8.6 trillion at March 31, 2004. Cross-
border custody assets were $2.8 trillion at March 31, 2005 up from $2.7
trillion at December 31, 2004 and $2.4 trillion at March 31, 2004. A
substantial portion of the increase in assets under custody since year-end
2004 was due to new business and business line growth.
Issuer services fees were $139 million in the first quarter, down $10
million, or 7%, sequentially but up $2 million, or 1%, from the first quarter
of 2004. The sequential decrease in the first quarter of 2005 reflects reduced
depositary receipts ("DR") fees and a decline in corporate trust fees due to
lower municipal issuance volumes. DR revenues decreased sequentially due to
seasonally lower dividend-related activity, and were essentially flat compared
with the first quarter of 2004. While capital raising activity increased
sequentially and year-over-year, mergers and acquisitions activity remained
soft in the first quarter of 2005. The increase in issuer services fees versus
the first quarter of 2004 primarily reflects higher corporate trust fees due to
continued strength in international issuance and corporate specialty products.
Broker-dealer services fees increased to $56 million from $52 million in
the fourth quarter of 2004 and $50 million in the first quarter of 2004. The
sequential and year-over-year results reflect increased collateral management
activity and higher volumes in securities clearance. Both the U.S. and
European markets contributed to the strong growth in collateral management.
The Company continues to attract new business to its collateral management
services. In addition, the Company has grown by helping accelerate the trend
toward utilizing non-traditional securities such as equities, corporate bonds
and municipal securities. In the first quarter of 2005, the Company's average
tri-party balances exceeded $1 trillion, which represents an increase of over
33% for the last 15 months. The Company expects sustained future growth since
the use of tri-party structure in the German and Japanese markets is still at
a very early stage.
Global payment services fees increased $4 million, or 6%, from the fourth
quarter of 2004, and decreased $4 million, or 5%, from the first quarter of
2004. The sequential increase reflects strength in cash management due to new
business wins, which offset lower revenue from trade finance. The decline
versus the first quarter of 2004 reflects customers choosing to pay with
higher compensating balances rather than fees, partially offset by new
business.
Private client services and asset management revenues continue to
demonstrate solid performance with fees up 5% sequentially and 12% compared
with the first quarter of 2004. The sequential quarter increase reflects
continued growth at Ivy and higher fees in institutional equity and retail
investment products. The increase from the first quarter of 2004 primarily
reflects growth at Ivy as well as higher fees from BNY Hamilton Funds.
13
Assets under management ("AUM") were $104 billion at March 31, 2005, up
from $102 billion at December 31, 2004 and $92 billion at March 31, 2004. The
sequential increase in AUM was driven by growth in money market and
alternative classes, offsetting the impact of lower equity prices. Ivy
continued its solid growth with AUM increasing by 5% to $15.6 billion,
compared with $14.8 billion at year-end and $11.7 billion at March 31, 2004.
The increase in Ivy's AUM reflects strong growth in the Europe and Asia
markets. To better leverage the growth opportunities in Europe and Asia, Ivy
opened a new office in Tokyo in January and is expanding its presence in
London. In addition, the growth in AUM reflects an inflow of funds into
personal trust assets and short-term money market product for
institutional/corporate investors. Institutional clients represent 69% of AUM
while individual clients equal 31%. AUM at March 31, 2005, are 34% invested
in equities, 21% in fixed income, 15% in alternative investments and the
remainder in liquid assets.
In the first quarter of 2005, noninterest income attributable to foreign
exchange and other trading activities was $47 million, down from $52 million
in the fourth quarter of 2004 and $59 million in the first quarter of 2004.
The sequential and year-over-year declines reflect lower levels of client
activity, continued low volatility, and lower fixed income trading.
Net interest income in the Servicing and Fiduciary businesses segment was
$168 million for the first quarter of 2005, compared with $167 million for the
fourth quarter of 2004 and $132 million in the first quarter of 2004. The
increase in net interest income from the first quarter of 2004 is primarily
due to the rise in interest rates and customers' increased use of compensating
balances to pay for services. Average assets for the quarter ended March 31,
2005 were $23.0 billion, compared with $23.2 billion in the fourth quarter of
2004 and $22.8 billion in the first quarter of 2004. The first quarter of
2005 average deposits were $36.1 billion, compared with $36.3 billion in the
fourth quarter of 2004 and $35.1 billion in the first quarter of 2004. The
sequential quarter decline in deposits reflects a decline in activity from
customers in issuer services.
Net charge-offs in the Servicing and Fiduciary Businesses segment were
zero in the first quarter of 2005, compared with $5 million in the fourth
quarter of 2004 and $5 million in the first quarter of 2004. Nonperforming
assets were $1 million at March 31, 2005, compared with $1 million at December
31, 2004 and $3 million at March 31, 2004.
Noninterest expense for the first quarter of 2005 was $847 million,
compared with $848 million in the fourth quarter of 2004 and $779 million in
the first quarter of 2004. The increase in noninterest expense from first
quarter of 2004 reflects the impact of several 2004 acquisitions as well as
the Company's continued investment in technology and business continuity, and
increased pension and stock option expense.
Corporate Banking
- -----------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Net Interest Income $ 87 $ 88 $ 88
Provision for Credit Losses 18 20 20
Noninterest Income 76 66 71
Noninterest Expense 57 58 57
Income Before Taxes 88 76 82
Average Assets $17,534 $17,774 $17,666
Average Deposits 5,528 5,323 6,800
Nonperforming Assets 177 198 325
Net Charge-offs 5 8 11
14
The Corporate Banking segment coordinates all banking and credit-related
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.
Over the past several years, the Company has been seeking to improve its
overall risk profile by reducing its credit exposures through elimination of
non-strategic exposures, cutting back large individual exposures and avoiding
outsized industry concentrations. In 2002, the Company set a goal of reducing
corporate credit exposure to $24 billion by December 31, 2004. This goal was
accomplished in early 2004 and exposures have since declined to $22.7 billion.
In the first quarter of 2005, pre-tax income was $87 million, compared
with $76 million in the fourth quarter of 2004 and $82 million in the first
quarter of 2004. The improvement in results versus both periods primarily
reflects lower credit costs and higher noninterest income.
The Corporate Banking segment's net interest income was $87 million in
the first quarter of 2005, compared with $88 million in the fourth and first
quarters of 2004. Average assets for the quarter were $17.5 billion, compared
with $17.8 billion in the fourth quarter of 2004 and $17.7 billion in the
first quarter of last year. Average deposits in the Corporate Banking segment
were $5.5 billion versus $5.3 billion in the fourth quarter of 2004 and $6.8
billion in first quarter of 2004.
The first quarter of 2005 provision for credit losses was $18 million
compared with $20 million in the fourth quarter of 2004 and $20 million in the
first quarter of last year. The decline in the provision from the fourth and
first quarters of 2004 reflects reduced credit exposures and an improvement in
overall asset quality. Net charge-offs in the Corporate Banking segment were
$5 million in the first quarter of 2005, $8 million in the fourth quarter of
2004, and $11 million in the first quarter of 2004. Nonperforming assets were
$177 million at March 31, 2005, down from $198 million at December 31, 2004
and $325 million at March 31, 2004. The decrease in nonperforming assets from
the first quarter of 2004 primarily reflects paydowns and charge-offs of
commercial loans.
Noninterest income was $76 million in the current quarter, compared with
$66 million in the fourth quarter of 2004 and $71 million in the first quarter
of 2004. On a sequential quarter basis, the increase reflects higher foreign
exchange and other trading revenues and gains on asset dispositions partially
offset by lower capital markets fees. The increase year-over-year reflects
the same factors influencing the quarterly increase.
Noninterest expense in the first quarter was $57 million, compared with
$58 million in the fourth quarter of 2004 and $57 million in the first quarter
of 2004.
15
Retail Banking
- --------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(Dollars in millions) 2005 2004 2004
------- ------- -------
Net Interest Income $ 128 $ 125 $ 117
Provision for Credit Losses 5 4 5
Noninterest Income 26 29 29
Noninterest Expense 98 98 93
Income Before Taxes 51 52 48
Average Assets $ 6,105 $ 6,241 $ 5,377
Average Noninterest
Bearing Deposits 5,499 5,585 5,028
Average Deposits 15,015 15,301 14,807
Nonperforming Assets 14 15 15
Net Charge-offs 5 5 6
Number of Branches 341 341 341
Number of ATMs 375 378 378
The Retail Banking segment provides the Company with a stable source of
core deposits. The segment represents an attractive distribution channel, and
the Company has continued to expand the products offered through the retail
branch system. The branch system is focused on the suburban Tri-State New
York metropolitan area.
The Retail Banking segment continues to demonstrate stable results in
spite of increased competition in the New York metropolitan area. In the
first quarter of 2005, pre-tax income was $51 million, compared with $52
million in the fourth quarter of 2004 and $48 million a year ago.
The Company continues to enhance the services offered through the branch
system. This includes leveraging its retail client base to distribute BNY
Asset Management and third party investment products. Currently, investment
products are cross sold to over 10% of the client base. The Company is also
seeking selective expansion opportunities within its current branch footprint.
Net interest income in the first quarter of 2005 was $128 million,
compared with $125 million in the fourth quarter of 2004 and $117 million in
the first quarter of 2004. Net interest income has increased on a sequential
quarter basis and over the first quarter of last year as rates have risen,
benefiting spreads. The increase in average assets and deposits since the
first quarter of 2004 has also contributed to the increase in net interest
income.
Noninterest income was $26 million for the quarter compared with $29
million in the fourth quarter and $29 million in the first quarter of last
year. The decreases in noninterest income compared to the fourth quarter of
2004 reflect lower monthly service fees and lower debit card fees. This is
partially attributable to the lower day count in the first quarter.
Noninterest expense in the first quarter of 2005 was $98 million,
compared with $98 million in the fourth quarter of 2004 and $93 million last
year. The increase from the first quarter of 2004 reflects higher
compensation and marketing costs.
Net charge-offs were $5 million in the first quarter of 2005, compared
with $5 million in the fourth quarter of 2004 and $6 million in the first
quarter of 2004. Nonperforming assets were $14 million at March 31, 2005,
compared with $15 million at December 31, 2004, and $15 million at March 31,
2004.
Average deposits generated by the Retail Banking segment were $15.0
billion in the first quarter of 2005, compared with $15.3 billion in the
fourth quarter of 2004 and $14.8 billion in the first quarter of 2004.
Average assets in the Retail Banking sector were $6.1 billion, compared with
16
$6.2 billion in the fourth quarter of 2004 and $5.4 billion in the first
quarter of 2004.
Financial Markets
- -----------------
1st 4th 1st
Quarter Quarter Quarter
------- ------- -------
(In millions) 2005 2004 2004
------- ------- -------
Net Interest Income $ 68 $ 71 $ 81
Provision for Credit Losses 5 5 5
Noninterest Income 46 65 49
Noninterest Expense 33 33 27
Income Before Taxes 76 98 98
Average Assets $48,370 $48,547 $49,743
Average Deposits 3,964 3,795 3,864
Average Investment
Securities 23,540 23,358 22,901
Net Charge-offs - - 4
In the first quarter of 2005, pre-tax income was $76 million, compared
with $98 million in the fourth quarter of 2004 and $98 million a year ago.
The sequential quarter decrease is due to a decline in trading revenue. The
decrease over the first quarter of 2004 is primarily due to a decline in net
interest income and in trading income.
Net interest income for the first quarter was $68 million compared with
$71 million for the fourth quarter of 2004 and $81 million a year ago. The
decrease from the fourth quarter of 2004 primarily reflects fewer days in the
quarter. The decrease from the first quarter of 2004 reflects the rising rate
environment which increased funding costs. Average first quarter 2005 assets
in the Financial Markets segment, composed primarily of short-term liquid
assets and investment securities, were $48.4 billion, down from $48.5 billion
on a sequential quarter basis and $49.7 billion in the first quarter last
year. The decrease in assets from first quarter of 2004 reflects a decline in
liquidity from securities servicing customers which reduced the overall size
of the Company's balance sheet resulting in a decline in liquid assets.
Average investment securities increased as the Company continues to invest in
adjustable or short life classes of structured mortgage-backed securities,
both of which have short durations.
Noninterest income was $46 million in the first quarter of 2005, compared
with $65 million in the fourth quarter of 2004 and $49 million in the first
quarter of 2004. The negative variance compared with the fourth quarter of
2004 reflects weaker trading results, lower securities gains, and lower gains
on disposals of lease assets.
Net charge-offs were zero in the first quarter of 2005, compared with
zero in the fourth quarter of 2004 and $4 million a year ago. Noninterest
expense was $33 million in the first quarter of 2005, compared with $33
million in the fourth quarter of 2004 and $27 million in last year's first
quarter. The increase from last year's first quarter is attributable to
higher employee incentive compensation and technology expenses.
17
The consolidating schedule below shows the contribution of the Company's
segments to its overall profitability.
(Dollars in millions) Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2005 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 168 $ 87 $ 128 $ 68 $ 4 $ 455
Provision for Credit Losses 1 18 5 5 (39) (10)
Noninterest Income 1,025 76 26 46 5 1,178
Noninterest Expense 847 57 98 33 42 1,077
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 345 $ 88 $ 51 $ 76 $ 6 $ 566
========== ========= ========= ========= =========== ============
Contribution Percentage 62% 15% 9% 14%
Average Assets $ 22,987 $ 17,534 $ 6,105 $ 48,370 $ 4,246 $ 99,242
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
December 31, 2004 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 167 $ 88 $ 125 $ 71 $ 76 $ 527
Provision for Credit Losses 1 20 4 5 (37) (7)
Noninterest Income 1,010 66 29 65 6 1,176
Noninterest Expense 848 58 98 33 60 1,097
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 328 $ 76 $ 52 $ 98 $ 59 $ 613
========== ========= ========= ========= =========== ============
Contribution Percentage 59% 14% 9% 18%
Average Assets $ 23,209 $ 17,774 $ 6,241 $ 48,547 $ 4,196 $ 99,967
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2004 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 132 $ 88 $ 117 $ 81 $ (150) $ 268
Provision for Credit Losses - 20 5 5 (18) 12
Noninterest Income 990 71 29 49 81 1,220
Noninterest Expense 779 57 93 27 57 1,013
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 343 $ 82 $ 48 $ 98 $ (108) $ 463
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 14% 9% 17%
Average Assets $ 22,771 $ 17,666 $ 5,377 $ 49,743 $ 4,121 $ 99,678
18
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. 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 Company's approach to acquisitions is
highly centralized and controlled by senior management. Accordingly, the
resulting goodwill and other intangible assets are reconciling items for
average assets. The related amortization is a reconciling item for
noninterest expense. Other reconciling items for noninterest expense
primarily reflect corporate overhead and severance.
To assess as accurately as possible the performance of its segments in
2004, the Company analyzed reconciling items related to corporate overhead.
As a result of this analysis, the Company reclassified from reconciling items
to the individual segments certain items related to insurance, compliance, and
incentive compensation expenses. In addition, a minor modification was made
to the method used to allocate earnings on capital. The impact of these
changes was a decline in pre-tax income of the segments and a reduction in the
amount of reconciling items as shown below:
1st 4th
Segment Quarter Quarter
--------- ---------
(In millions) 2004 2004
- ----------------------- --------- ---------
Servicing and Fiduciary $ (30)$ (25)
Corporate Banking (5) (4)
Retail Banking (6) (3)
Financial Markets 1 (3)
--------- ---------
Subtotal (40) (35)
Reconciling 40 35
--------- ---------
Total $ - $ -
========= =========
19
The detail of reconciling items for the first quarter of 2005 and fourth
and first quarters of 2004 is presented in the following table.
1st 4th 1st
Quarter Quarter Quarter
--------- --------- ---------
(In millions) 2005 2004 2004
--------- --------- ---------
Segments' Revenue $ 1,624 $ 1,621 $ 1,557
Adjustments:
Earnings Associated with
Assignment of Capital (9) (13) (20)
Securities Gains - - 19
SFAS 13 Cumulative
Lease Adjustment - 79 (145)
Taxable Equivalent Basis and
Other Tax-Related Items 13 10 15
Other 5 6 62
--------- --------- ---------
Subtotal-Revenue Adjustments 9 82 (69)
--------- --------- ---------
Consolidated Revenue $ 1,633 $ 1,703 $ 1,488
========= ========= =========
Segments' Income Before Tax $ 560 $ 554 $ 571
Adjustments:
Revenue Adjustments (Above) 9 82 (69)
Provision for Credit Losses
Different than GAAP 39 37 18
Severance (1) (4) (11)
Goodwill and
Intangible Amortization (8) (9) (8)
Lease Termination - - (8)
RW Matter - (30) -
Corporate Overhead (33) (17) (30)
--------- --------- ---------
Consolidated Income
Before Tax $ 566 $ 613 $ 463
========= ========= =========
Segments' Total
Average Assets $ 94,996 $ 95,771 $ 95,557
Adjustments:
Goodwill and Intangibles 4,246 4,196 4,121
--------- --------- ---------
Consolidated Average Assets $ 99,242 $ 99,967 $ 99,678
========= ========= =========
In addition to the recurring items discussed above, other significant
items may be included as reconciling items. In the fourth quarter of 2004,
SFAS 13 cumulative adjustments to the leasing portfolio and RW Matter were
reconciling items. In the first quarter of 2004, SFAS 13 cumulative
adjustments to the leasing portfolio, securities gains on four large sponsor
funds, gains on sale on Wing Hang Bank, and severance and lease termination
expenses were reconciling items.
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 the
first quarter of 2004, the $145 million reconciling item related to SFAS 13
cumulative lease adjustment and the $19 million gain on sponsor fund
investments would be attributable to the Financial Markets segment. In
20
addition, the $48 million gain on the sale of Wing Hang recorded in Other
would be attributable to the Corporate Banking segment. The charge for the RW
Matter in the fourth quarter of 2004 would be attributable to the Retail
Banking segment.
The reconciling item for the provision for loan losses primarily relates
to Corporate Banking. Severance and lease termination costs primarily relate
to the Servicing and Fiduciary segment, the Corporate Banking segment, and to
staff areas that cut across all business lines. 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.
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 2004 Annual Report on Form 10-K.
Four of the Company's more critical accounting policies are those related to
the allowance for credit losses, the valuation of derivatives and securities
where quoted market prices are not available, goodwill and other intangibles,
and pension accounting.
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 ratings are assigned after analyzing the credit quality of each
borrower/counterparty and the Company's internal ratings are generally
consistent with external rating agencies' default databases. Loss given
default ratings are driven by the collateral, structure, and seniority of each
individual asset and are consistent with external loss given default/recovery
databases. The portion of the allowance related to impaired credits is based
on the present value of future cash flows. Changes in the estimates of
probability of default, risk ratings, loss given default/recovery rates, and
cash flows could have a direct impact on the allocated allowance for loan
losses.
To the extent actual results differ from forecasts or management's
judgment, the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand
the variables that drive the allowance for credit losses.
Another key variable in determining the allowance is management's
judgment in determining the size of the unallocated allowance. At March 31,
2005, the unallocated allowance was 16% of the total allowance. If the
unallocated allowance were five percent higher or lower, the allowance would
have increased or decreased by $36 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 $52 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$82 million.
For higher risk rated credits, if the loss given default were 10% worse,
the allowance would have increased by $20 million, while if the loss given
default were 10% better, the allowance would have decreased by $14 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $14 million,
respectively.
21
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
- --------------------------------------------------------------------------
Available
---------
When quoted market prices are not available for derivatives and
securities values, such values are determined at fair value, which is defined
as the value at which positions could be closed out or sold in a transaction
with a willing counterparty over a period of time consistent with the
Company's trading or investment strategy. Fair value for these instruments is
determined based on discounted cash flow analysis, comparison to similar
instruments, and the use of financial models. Financial models use as their
basis independently sourced market parameters including, for example, interest
rate yield curves, option volatilities, and currency rates. Discounted cash
flow analysis is dependent upon estimated future cash flows and the level of
interest rates. Model-based pricing uses inputs of observable prices for
interest rates, foreign exchange rates, option volatilities and other factors.
Models are benchmarked and validated by independent parties. The Company's
valuation process takes into consideration factors such as counterparty credit
quality, liquidity and concentration concerns. The Company applies judgment
in the application of these factors. In addition, the Company must apply
judgment when no external parameters exist. Finally, other factors can affect
the Company's estimate of fair value including market dislocations, incorrect
model assumptions, and unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in footnote 1 "Summary of Significant Accounting and
Reporting Policies" in the Company's 2004 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at March 31,
2005, approximately $2.5 billion of the Company's portfolio of securities and
derivatives is not priced based on quoted market prices because no such quoted
market prices are available. A change of 2.5% in the valuation of these
securities and derivatives would result in a change in pre-tax income of $62
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 ($3,487 million
at March 31, 2005) and indefinite-lived intangible assets ($370 million at
March 31, 2005) 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 fair value of acquired assets. 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 their implied fair value. Indefinite-
lived intangible assets are evaluated for impairment at least annually by
comparing their fair value to their carrying value.
Other identifiable intangible assets ($423 million at March 31, 2005) 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
22
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 $4.3
billion of goodwill and intangible assets at March 31, 2005. The impact of a
5% impairment charge would result in a change of pre-tax income of
approximately $214 million.
Pension Accounting
- ------------------
The Company has defined benefit plans covering approximately 14,700 U.S.
employees and approximately 2,400 non-U.S. employees at September 30, 2004.
The Company has three defined benefit pension plans in the U.S. and six
overseas. At December 31, 2004, the U.S. plans account for 86% of the
projected benefit obligation. Pension credits were $24 million, $39 million,
and $95 million in 2004, 2003 and 2002. In addition to its pension plans, the
Company also has an Employee Stock Ownership Plan ("ESOP") which may provide
additional benefits to certain employees. Upon retirement, covered employees
are entitled to the higher of their benefit under the ESOP or the defined
benefit plan. If the benefit is higher under the defined benefit plan, the
employees' ESOP account is contributed to the pension plan.
A number of key assumption and measurement date values determine pension
expense. The key elements include the long-term rate of return on plan
assets, the discount rate, the market-related value of plan assets, and for
the primary U.S. plan the price used to value stock in the ESOP. Since 2002,
these key elements have varied as follows:
2005 2004 2003 2002
Domestic Plans: -------- -------- -------- --------
Long-Term Rate of Return
on Plan Assets 8.25% 8.75% 9.00% 10.50%
Discount Rate 6.00 6.25 6.50 7.25
Market-Related Value of
Plan Assets(1) (in millions) $ 1,502 $ 1,523 $ 1,483 $ 1,449
ESOP Stock Price(1) 30.67 27.88 33.30 42.58
Net U.S Pension Credit/(Expense) $ 31 $ 46 $ 100
All other Pension Credit/(Expense) (7) (7) (5)
-------- -------- --------
Total Pension Credit $ 24 $ 39 $ 95
======== ======== ========
- ------------
(1) Actuarially smoothed data. See "Critical Accounting Policies" in the MD&A
section of the Company's 2004 Annual Report on Form 10-K.
The discount rate for U.S. pension and postretirement plans is based on,
among other factors, a spread over the Lehman AA Long-Term Corporate Bond
Index Yield. At September 30, 2004 and 2003, the Lehman AA Long-Term
Corporate Bond Index Yields were 5.36% and 5.35%, and the discount rates were
6.00% and 6.25%, respectively. The discount rates for foreign pension plans
are based on high quality corporate bonds rates in countries that have an
active corporate bond market. In those countries with no active corporate
bond market, discount rates are based on local government bond rates plus a
credit spread.
23
The Company's expected long-term rate of return on plan assets is based
on anticipated returns for each asset class. For 2005 and 2004, the
assumptions for the long-term rates of return on plan assets were 8.25% and
8.75%, respectively. Anticipated returns are weighted for the target
allocation for each asset class. Anticipated returns are based on forecasts
for prospective returns in the equity and fixed income markets, which should
track the long-term historical returns for these markets. The Company also
considers the growth outlook for U.S. and global economies, as well as current
and prospective interest rates.
The market-related value of plan assets also influences the level of
pension expense. Differences between expected and actual returns are
recognized over five years to compute an actuarially derived market-related
value of plan assets. In 2005, the Company expects the market-related value
of plan assets to decline as the extraordinary actual return in 2000 is
replaced with a more modest return.
Unrecognized actuarial gains and losses are amortized over the future
service period (11 years) of active employees if they exceed a threshold
amount. The Company currently has unrecognized losses which are being
amortized.
In 2005, based on the Company's review of changes in prospective
assumptions, the amortization of unrecognized pension losses and the
anticipated decline in the market-related value of plan assets, the pre-tax
U.S. pension credit is expected to decline by approximately $48 million.
The annual impact on the primary U.S. plan of hypothetical changes in the
key elements on the pension credit are shown in the table below.
(Dollars in millions) Increase in Decrease in
Pension Expense 2005 Base Pension Expense
--------------- ------------- ---------------
Long-Term Rate of Return
on Plan Assets 7.25% 7.75% 8.25% 8.75% 9.25%
Change in Pension Expense $ 14.6 $ 7.3 $ - $ 7.3 $ 14.6
Discount Rate 5.50% 5.75% 6.00% 6.25% 6.50%
Change in Pension Expense $ 7.4 $ 3.7 $ - $ 3.6 $ 7.2
Market-Related Value of
Plan Assets -20.00% -10.00% $1,502 +10.00% +20.00%
Change in Pension Expense $ 58.2 $ 29.1 - $ 27.2 $ 39.6
ESOP Stock Price $20.67 $25.67 $30.67 $35.67 $40.67
Change in Pension Expense $ 14.6 $ 7.0 $ - $ 6.5 $ 12.6
24
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $96.5 billion at March 31, 2005, compared with $94.5
billion at December 31, 2004, and $92.7 billion at March 31, 2004. The
increase in assets from December 31, 2004 reflects increased loans to
securities industry customers. Total shareholders' equity was $9.3 billion at
March 31, 2005, compared with $9.3 billion at December 31, 2004, and $8.8
billion at March 31, 2004. In comparison to the fourth quarter of 2004,
shareholders' equity reflects the retention of earnings offset by a decline in
the securities valuation allowance and the repurchase of common stock. The
major reason for the increase in shareholders' equity from a year ago is the
retention of earnings.
Return on average common equity for the first quarter of 2005 was 16.52%,
compared with 15.34% in the fourth quarter of 2004, and 17.17% in the first
quarter of 2004. Return on average assets for the first quarter of 2005 was
1.55%, compared with 1.40% in the fourth quarter of 2004, and 1.47% in the
first quarter of 2004.
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(In millions) 03/31/05 12/31/04
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 19,799 $ 19,393
Asset-Backed Securities 25 -
Corporate Debt 1,243 1,259
Short-Term Money Market Instruments 809 982
U.S. Treasury Securities 445 403
U.S. Government Agencies 484 505
State and Political Subdivisions 203 197
Emerging Market Debt (Collateralized
By U.S. Treasury Zero Coupon Obligations) 112 107
Other Foreign Debt 525 545
---------- ----------
Subtotal Fixed Income 23,645 23,391
Equity Securities:
Money Market Funds 224 388
Other 11 10
---------- ----------
Subtotal Equity Securities 235 398
---------- ----------
Total Securities $ 23,880 $ 23,789
========== ==========
Total investment securities were $23.9 billion at March 31, 2005,
compared with $23.8 billion at December 31, 2004. Average investment
securities were $23.5 billion in the first quarter of 2005, compared with
$23.4 billion in the fourth quarter of 2004 and $22.9 billion in the first
quarter of last year. The increases were primarily due to growth in the
Company's portfolio of highly rated mortgage-backed securities which are 89%
rated AAA, 7% AA, and 4% A. The Company has been adding either adjustable or
short life classes of structured mortgage-backed securities, both of which
have short durations. The effective duration of the Company's mortgage
portfolio at March 31, 2005 was approximately 1.8 years.
Net unrealized losses for securities available-for-sale were $51 million
at March 31, 2005 compared with net unrealized gains of $75 million at
December 31, 2004. Net unrealized losses at March 31, 2005 reflects the rise
in long-term interest rates over the quarter. The asymmetrical accounting
treatment of the impact of a change in interest rates on the Company's balance
sheet may create a situation in which an increase in interest rates can
adversely affect reported equity and regulatory capital, even though
economically there may be no impact on the economic capital position of the
25
Company. For example, an increase in rates will result in a decline in the
value of the fixed rate portion of the Company's fixed income investment
portfolio, which will be reflected through a reduction in other comprehensive
income in the Company's shareholders' equity, thereby affecting the tangible
common equity ("TCE") ratio. Under current accounting rules, there is no
corresponding change in value of the Company's fixed rate liabilities, even
though economically these liabilities are more valuable as rates rise.
Loans
- -----
(In billions) Period End Quarterly Average
------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------
March 31, 2005 $38.8 $ 32.8 $ 6.0 $38.8 $ 32.4 $ 6.4
December 31, 2004 35.8 29.7 6.1 39.4 33.0 6.4
March 31, 2004 36.1 30.0 6.1 36.5 30.3 6.2
Total loans were $38.8 billion at March 31, 2005 compared with $35.8
billion at December 31, 2004. The increase in total loans from December 31,
2004 primarily reflects an increase in overdrafts and securities industry
loans. The Company continues to focus on its strategy of reducing non-
strategic and outsized corporate loan exposures to improve its credit risk
profile. Average total loans were $38.8 billion in the first quarter of 2005,
compared with $36.5 billion in the first quarter of 2004. The increase in
average loans from March 31, 2004 results from increased lending to financial
institutions.
The following tables provide additional details on the Company's credit
exposures and outstandings at March 31, 2005 in comparison to December 31,
2004.
Overall Loan Portfolio
- ----------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
03/31/05 03/31/05 03/31/05 12/31/04 12/31/04 12/31/04
-------- -------- -------- -------- -------- --------
Financial Institutions $ 12.4 $ 21.9 $ 34.3 $ 9.5 $ 21.6 $ 31.1
Corporate 3.5 19.2 22.7 3.6 19.4 23.0
-------- -------- -------- -------- -------- --------
15.9 41.1 57.0 13.1 41.0 54.1
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 9.1 4.4 13.5 8.9 4.5 13.4
Leasing Financings 5.6 - 5.6 5.6 - 5.6
Commercial Real Estate 2.2 1.2 3.4 2.1 1.2 3.3
Margin loans 6.0 - 6.0 6.1 - 6.1
-------- -------- -------- -------- -------- --------
Total $ 38.8 $ 46.7 $ 85.5 $ 35.8 $ 46.7 $ 82.5
======== ======== ======== ======== ======== ========
26
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $34.3 billion at March
31, 2005 compared to $31.1 billion at December 31, 2004. These exposures are
of high quality, with 85% meeting the investment grade criteria of the
Company's rating system. These exposures are generally short-term, with 78%
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.
(In billions)
March 31, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 4.5 $ 4.0 $ 8.5 71% 90% $ 4.2 $ 3.5 $ 7.7
Securities Industry 3.3 2.7 6.0 85 96 1.5 3.0 4.5
Insurance 0.4 4.8 5.2 94 47 0.5 4.8 5.3
Government 0.1 4.9 5.0 100 73 - 5.0 5.0
Asset Managers 3.8 3.7 7.5 85 80 3.0 3.8 6.8
Mortgage Banks 0.2 0.7 0.9 86 69 0.2 0.7 0.9
Endowments 0.1 1.1 1.2 99 47 0.1 0.8 0.9
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $12.4 $ 21.9 $ 34.3 85% 78% $ 9.5 $ 21.6 $ 31.1
===== =========== ========= ===== ===== ===== =========== =========
Corporate
- ---------
The corporate portfolio exposure declined to $22.7 billion at March 31,
2005 from $23.0 billion at year-end 2004. Approximately 76% of the portfolio
is investment grade while 23% of the portfolio matures within one year.
(In billions)
March 31, 2005 December 31, 2004
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.0 $ 2.1 $ 3.1 64% 14% $ 0.9 $ 2.2 $ 3.1
Cable 0.5 0.5 1.0 34 - 0.6 0.4 1.0
Telecom 0.1 0.5 0.6 77 27 0.1 0.5 0.6
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.6 3.1 4.7 59% 13% 1.6 3.1 4.7
Energy 0.3 4.6 4.9 86 19 0.4 4.4 4.8
Retailing 0.2 2.0 2.2 80 32 0.1 2.1 2.2
Automotive 0.1 1.7 1.8 66 51 0.1 1.7 1.8
Healthcare 0.2 1.5 1.7 88 19 0.3 1.5 1.8
Other* 1.1 6.3 7.4 80 23 1.1 6.6 7.7
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 3.5 $ 19.2 $ 22.7 76% 23% $ 3.6 $ 19.4 $ 23.0
===== =========== ========= ===== ===== ===== =========== =========
* 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 of 2004 and exposures have since declined to $582 million.
The percentage of investment grade borrowers in the telecom portfolio remained
steady at 77% the same as at year-end 2004.
The Company's exposure to the airline industry consists of a $471 million
leasing portfolio (including a $15 million real estate lease exposure). The
airline leasing portfolio consists of $249 million to major U.S. carriers,
$133 million to foreign airlines and $89 million to U.S. regionals. The
Company's exposure to foreign airlines declined by $47 million during the
quarter.
During the first quarter of 2005, the airline industry continued to face
liquidity issues driven by persistently high fuel prices and the inability to
implement meaningful fare increases. The industry's considerable excess
capacity and higher oil prices continue to negatively impact the valuations of
27
aircraft, especially the less fuel efficient models, 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.
Counterparty Risk Ratings Profile
- ---------------------------------
The table below summarizes the risk ratings of the Company's foreign
exchange and interest rate derivative counterparty credit exposure for the
past year.
For the Quarter Ended
--------------------------------------------------
Rating(1) 3/31/05 12/31/04 9/30/04 6/30/04 3/31/04
- --------------------- --------------------------------------------------
AAA to AA- 74% 68% 68% 70% 61%
A+ to A- 13 19 21 16 24
BBB+ to BBB- 10 10 8 11 12
Noninvestment Grade 3 3 3 3 3
-------- --------- ---------- --------- ----------
Total 100% 100% 100% 100% 100%
======== ========= ========== ========= ==========
(1) Represents credit rating agency equivalent of internal credit ratings.
Nonperforming Assets
- --------------------
Change
03/31/05 vs.
(Dollars in millions) 03/31/05 12/31/04 12/31/04
-------- -------- ----------
Category of Loans:
Commercial $ 124 $ 132 $ (8)
Foreign 19 28 (9)
Regional Commercial 49 53 (4)
-------- -------- ----------
Total Nonperforming Loans 192 213 (21)
Other Real Estate - 1 (1)
-------- -------- ----------
Total Nonperforming Assets $ 192 $ 214 $ (22)
======== ======== ==========
Nonperforming Assets Ratio 0.6% 0.7%
Allowance for Loan
Losses/Nonperforming Loans 304.0 277.5
Allowance for Loan
Losses/Nonperforming Assets 304.0 276.5
Total Allowance for Credit
Losses/Nonperforming Loans 373.4 345.6
Total Allowance for Credit
Losses/Nonperforming Assets 373.4 344.3
Nonperforming assets declined by $22 million, or 10%, during the first
quarter of 2005 to $192 million and are down 44% from a year ago. The
sequential quarter decrease primarily reflects paydowns and sales of $19
million and charge-offs of $6 million. The ratio of the total allowance for
credit losses to nonperforming assets increased to 373.4% at March 31, 2005,
compared with 344.3% at December 31, 2004, and 230.5% at March 31, 2004.
Activity in Nonperforming Assets
(In millions) Quarter End Quarter End
March 31, 2005 December 31, 2004
------------------ ------------------
Balance at Beginning of Period $ 214 $ 287
Additions 3 13
Charge-offs (6) (11)
Paydowns/Sales (19) (65)
Other - (10)
------------------ ------------------
Balance at End of Period $ 192 $ 214
================== ==================
28
Interest income would have been increased by $1 million and $4 million
for the first quarters of 2005 and 2004 if loans on nonaccrual status at March
31, 2005 and 2004 had been performing for the entire period.
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,
(In millions) 2005 2004 2004
------------ ----------- ----------
Impaired Loans with an Allowance $ 68 $ 128 $ 197
Impaired Loans without an Allowance(1) 103 65 124
------------ ----------- ----------
Total Impaired Loans $ 171 $ 193 $ 321
============ =========== ==========
Allowance for Impaired Loans(2) $ 34 $ 52 $ 88
Average Balance of Impaired Loans
during the Quarter $ 182 $ 268 $ 306
Interest Income Recognized on
Impaired Loans during the Quarter $ 2.2 $ 2.3 $ 0.9
(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 credit losses.
Allowance
- ---------
March 31, December 31, March 31,
(Dollars in millions) 2005 2004 2004
------------ ----------- ----------
Margin Loans $ 6,038 $ 6,059 $ 6,130
Non-Margin Loans 32,726 29,722 29,940
------------ ----------- ----------
Total Loans $ 38,764 $ 35,781 $ 36,070
============ =========== ==========
Allowance for Loan Losses $ 583 $ 591 $ 632
Allowance for Lending-Related
Commitments 133 145 158
------------ ----------- ----------
Total Allowance for Credit Losses $ 716 $ 736 $ 790
============ =========== ==========
Allowance for Loan Losses As a
Percent of Total Loans 1.50% 1.65% 1.75%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 1.78 1.99 2.11
Total Allowance for Credit Losses
As a Percent of Total Loans 1.85 2.06 2.19
Total Allowance for Credit Losses
As a Percent of Non-Margin Loans 2.19 2.48 2.64
The total allowance for credit losses was $716 million, or 1.85% of total
loans at March 31, 2005, compared with $736 million, or 2.06% of total loans
at December 31, 2004, and $790 million, or 2.19% of total loans at March 31,
2004.
The Company has $6.0 billion of secured margin loans on its balance sheet
at March 31, 2005. 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 total allowance for
credit losses to non-margin loans is a more appropriate metric to measure the
adequacy of the reserve.
The ratio of the total allowance for credit losses to non-margin loans
decreased to 2.19% at March 31, 2005, compared with 2.48% at December 31, 2004
29
and 2.64% at March 31, 2004, reflecting continued improvement in the credit
quality in the first quarter of 2005.
Nonperforming assets declined another 10% this quarter, and have declined
by 44% from a year ago. The Company's criticized and classified exposures
continued to show improvement on a risk weighted basis versus the fourth
quarter of 2004 and a year ago.
The ratio of the allowance for loan losses to nonperforming assets was
304.0% at March 31, 2005, up from 276.5% at December 31, 2004, and 184.4% at
March 31, 2004.
The allowance for loan losses and the allowance for lending related
commitments consists of four elements: (1) an allowance for impaired credits
(nonaccrual commercial credits over $1 million), (2) an allowance for higher
risk rated credits, (3) an allowance for pass rated credits, and (4) an
unallocated allowance based on general economic conditions and risk factors in
the Company's individual markets.
The first element: impaired credits, is based on individual analysis 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. Fair value is either the present value of the expected future cash flows
from borrower, the market value of the loan, or the fair value of the
collateral.
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 rates each credit in its portfolio that exceeds $1 million and assigns
the credits to specific risk pools. A potential loss factor is assigned to each
pool, and an amount is included in the allowance equal to the product of the
amount of the loan in the pool and the risk factor. Reviews of higher risk
rated loans are conducted quarterly and the loan's rating is updated as
necessary. The Company prepares a loss migration analysis and compares its
actual loss experience to the loss factors on an annual basis to attempt to
ensure the accuracy of the loss factors assigned to each pool. Pools of past
due consumer loans are included in specific risk categories based on their
length of time 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 ratings. The
expected loss for each loan in a pool incorporates the borrower's credit rating,
loss given default rating and maturity. The credit rating is dependent upon the
borrower's probability of default. The loss given default incorporates a
recovery expectation. Borrower and loss given default ratings are reviewed
semi-annually at a minimum and are periodically mapped to third party, including
rating agency, default and recovery data bases to ensure ongoing consistency and
validity. Commercial loans over $1 million are individually analyzed before
being assigned a credit rating. The Company also applies this technique to its
leasing and consumer portfolios. All current consumer loans are included in the
pass rated consumer pools.
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;
30
* 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; and
* 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,
2005 2004
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 72 75
Consumer 8 3
Foreign 2 4
Unallocated 16 16
------------ -----------
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 $59.0 billion