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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended June 30, 2003
The Quarterly Report on Form 10-Q and cross reference index is on page 55.
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
- Overview 2
- Summary of Results 2
- Pershing 3
- Consolidated Income Statement Review 6
- Business Segments Review 11
- Consolidated Balance Sheet Review 21
- World Trade Center Disaster Update 29
- Critical Accounting Policies 30
- Liquidity 32
- Capital Resources 34
- Trading Activities 36
- Asset/Liability Management 37
- Statistical Information 39
- Forward Looking Statements 41
- Website Information 42
Consolidated Financial Statements
- Consolidated Balance Sheets
June 30, 2003 and December 31, 2002 43
- Consolidated Statements of Income
For the Three Months and Six Months
Ended June 30, 2003 and 2002 44
- Consolidated Statement of Changes In
Shareholders' Equity For the Six
Months Ended June 30, 2003 45
- Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2003 and 2002 46
- Notes to Consolidated Financial Statements 47 - 54
Form 10-Q
- Cover 55
- Controls and Procedures 56
- Legal Proceedings 56
- Submission of Matters to Vote of Security Holders 57
- Exhibits and Reports on Form 8-K 58
- Signature 60
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
June 30, March 31, June 30,
2003 2003 2002
-------- --------- --------
Quarter
- -------
Net Income $ 295 $ 295 $ 361
Basic EPS 0.39 0.41 0.50
Diluted EPS 0.39 0.41 0.50
Cash Dividends Per Share 0.19 0.19 0.19
Return on Average Common Shareholders' Equity 15.56% 17.80% 22.59%
Return on Average Assets 1.30 1.49 1.82
Year-To-Date
- ------------
Net Income $ 590 $ 295 $ 723
Basic EPS 0.80 0.41 1.00
Diluted EPS 0.80 0.41 0.99
Cash Dividends Per Share 0.38 0.19 0.38
Return on Average Common Shareholders' Equity 16.61% 17.80% 23.16%
Return on Average Assets 1.39 1.49 1.83
Assets $99,604 $79,548 $80,805
Loans 37,796 31,735 35,998
Securities 20,392 19,599 16,377
Deposits - Domestic 37,319 33,280 29,423
- Foreign 27,336 23,664 25,868
Long-Term Debt 6,515 5,685 5,668
Common Shareholders' Equity 8,113 6,874 6,610
Common Shareholders' Equity Per Share 10.50 9.41 9.09
Market Value Per Share of Common Stock 28.75 20.50 33.75
Allowance for Credit Losses as a Percent
of Loans 2.18% 2.62% 1.71%
Allowance for Credit Losses as a Percent
of Non-Margin loans 2.58 2.65 1.73
Tier 1 Capital Ratio 6.83 7.92 7.70
Total Capital Ratio 11.07 12.72 11.48
Leverage Ratio 5.85 6.68 6.82
Tangible Common Equity Ratio 4.33 5.53 5.41
Employees 23,106 19,491 19,010
Efficiency Ratio 64.8% 60.0% 55.0%
Assets Under Custody (In trillions)
Total Assets Under Custody $7.8 $6.8 $6.6
Equity Securities 32% 25% 29%
Fixed Income Securities 68 75 71
Cross-Border Assets $2.2 $1.9 $1.8
Assets Under Management (In billions)
Total Assets Under Management $83 $76 $75
Equity Securities 32% 29% 34%
Fixed Income Securities 23 24 23
Alternative Investments 9 9 8
Liquid Assets 36 38 35
Assets Under Administration (In billions) $27 $27 $30
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". When used in this report, the
words "estimate," "forecast," "project," "anticipate," "expect," "intend,"
"believe," "plan," "goal," "should," "may," "strategy," and words of similar
meaning are intended to identify forward looking statements in addition to
statements specifically identified as forward looking statements.
OVERVIEW
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
securities servicing for issuers, investors and financial intermediaries. The
Company plays an integral role in the infrastructure of the capital markets,
servicing securities in more than 100 markets worldwide. The Company provides
quality solutions through leading technology for global corporations,
financial institutions, asset managers, governments, non-profit organizations,
and individuals. Its principal subsidiary, The Bank of New York (the "Bank"),
founded in 1784, is the oldest bank in the United States and has a
distinguished history of serving clients around the world through its five
primary businesses: Securities Servicing and Global Payment Services, Private
Client Services and Asset Management, Corporate Banking, Global Market
Services, and Retail Banking. Additional information on the Company is
available at www.bankofny.com.
The Company has focused its strategy on historically high-growth, fee-
based businesses that have transformed the Company from a traditional
commercial bank into a premier global securities servicing provider. The
Company's breadth of products and services allows it to build client
relationships with investors, issuers and financial intermediaries through
many different avenues in major markets and regions throughout the world. The
Company's well-diversified franchise has become an integral part of the
infrastructure of the global capital markets.
SUMMARY OF RESULTS
The Company's second quarter earnings per diluted share on a reported
basis were 39 cents and excluding the impact of the Pershing acquisition, 42
cents per share. The Company reported earnings of 41 cents in the first
quarter of 2003. The reported results include previously announced dilution
from Pershing, which closed May 1, 2003, of 1 cent on operating earnings and
an additional 2 cents from merger and integration costs associated with the
acquisition. With Pershing, the Company earned 41 cents on an operating basis
in the second quarter.
Net income for the second quarter was $295 million compared with $361
million, or 50 cents per share a year ago. Year-to-date net income was $590
million, or 80 cents per share, compared to $723 million, or 99 cents per
share in 2002.
The second quarter results showed sequential quarter improvement in the
Company's key businesses, including securities servicing and associated
foreign exchange, global payment services, private client services and asset
management. The main reason for the improvement was the acquisition of
Pershing in May 2003, and improvement in core businesses. Including Pershing,
noninterest income was up $152 million, or 18%, over the first quarter of 2003
and increased to a record 71% of total revenue. Excluding Pershing,
securities servicing fees increased 3% over the first quarter, or 13%
annualized, as the Company's equity-linked businesses rebounded from first
quarter levels. Foreign exchange and other trading increased 22% excluding
3
Pershing. The Company's other major fee categories also showed growth on a
sequential quarter basis, including private client services and asset
management, which was up 5%, and global payment services, which was up 3%.
The second quarter results showed improvement over the second quarter of
2002 in the Company's key businesses, including securities servicing and
associated foreign exchange, global payment services, private client services
and asset management. The main reason for the improvement was the acquisition
of Pershing in 2003 and the acquisition of other securities servicing and
asset management businesses in 2002. Including Pershing, noninterest income
was up $141 million, or 16%, over the second quarter of 2002 and increased to
a record 71% of total revenue. Excluding Pershing, securities servicing fees
increased 3% over the second quarter of 2002. Foreign exchange and other
trading increased 10% excluding Pershing. Private client services and asset
management fees increased by 7% and global payment service fees increased by
11%.
The Company's diversified business model responded well to the recent
improved conditions in the equity markets, and the Company is well positioned
to benefit from further strengthening in the capital markets. At the same
time, credit costs remain stable and the Company continues to make significant
progress in its corporate credit exposure reduction program.
The second quarter also marked the successful closing of Pershing, and
the Company continues to be on target with all of its major integration
milestones, particularly client retention. The Company is confident of its
ability to realize the projected synergies and expects this acquisition to be
accretive in early 2004.
PERSHING
Supplemental Financial Information
- ----------------------------------
For the quarter ended June 30, 2003, the Company has prepared information
in four categories:
- Reported results which are in accordance with Generally Accepted Accounting
Principles (GAAP).
- Core operating results which exclude the Pershing acquisition.
- Pershing results which reflect the revenues and expenses since the May 1
acquisition of Pershing but excluding the merger and integration costs.
- Merger and integration costs.
The Company believes that providing supplemental non-GAAP financial
information is useful to investors in understanding the underlying operational
performance of the Company, its businesses and performance trends and,
therefore, facilitates comparisons with the performance of other financial
service companies and other periods. Specifically, the Company believes that
the exclusion of the transaction-related and restructuring expenses permits
evaluation and a comparison of results for ongoing business operations, and it
is on this basis that the Company's management internally assesses
performance. These non-operating items are excluded from the Company's segment
measures used internally to evaluate segment performance because management
does not consider them particularly relevant or useful in evaluating the
operating performance of our business segments. The following is a
reconciliation of the Company's financial results for the three months ended
June 30, 2003:
4
THE BANK OF NEW YORK COMPANY, INC.
Supplemental Information
(In millions, except per share amounts)
(Unaudited)
Income Statement
Quarter ended June 30
SUPPLEMENTAL GAAP
----------------------------------- -----------------------
Operating Merger 2003 2002
------------ and Reported Reported
Core Pershing (a) Integration Results Results
---- -------- ----------- -------- --------
Net Interest Income $ 387 $ 11 $ - $ 398 $ 423
- -------------------
Provision for Credit Losses 40 - - 40 35
----- ----- ----- ----- -----
Net Interest Income After
Provision for
Credit Losses 347 11 - 358 388
----- ----- ----- ----- -----
Noninterest Income
- ------------------
Servicing Fees
Securities 489 109 - 598 478
Global Payment Services 79 - - 79 71
----- ----- ----- ----- -----
568 109 - 677 549
Private Client Services and
Asset Management Fees 94 - - 94 88
Service Charges and Fees 93 - - 93 93
Foreign Exchange and Other
Trading Activities 79 9 - 88 72
Securities Gains 9 - - 9 25
Other 32 3 - 35 28
----- ----- ----- ----- -----
Total Noninterest Income 875 121 - 996 855
----- ----- ----- ----- -----
Noninterest Expense
- -------------------
Salaries and Employee Benefits 439 59 - 498 418
Net Occupancy 57 7 - 64 49
Furniture and Equipment 38 11 - 49 35
Clearing 31 9 - 40 33
Sub-custodian Expenses 19 - - 19 15
Software 36 7 - 43 29
Amortization of Intangibles 4 3 - 7 2
Merger and Integration Cost - - 25 25 -
Other 142 16 - 158 115
----- ----- ----- ----- -----
Total Noninterest Expense 766 112 25 903 696
----- ----- ----- ----- -----
Income Before Income Taxes 456 20 (25) 451 547
Income Taxes 156 9 (9) 156 186
----- ----- ----- ----- -----
Net Income $ 300 $ 11 $ (16) $ 295 $ 361
- ---------- ===== ===== ===== ===== =====
Diluted Earnings Per Share $0.42 ($0.01)(b) ($0.02) $0.39 $0.50
Notes:
Reported results agree with the Company's Consolidated Statement of Income
(a) Includes $5 million of net interest costs attributable to the Pershing acquisition financing.
(b) The ($0.01) dilution is due to changes in shares outstanding attributable to the acquisition.
5
The following is a supplemental balance sheet showing the impact of the
Pershing acquisition.
THE BANK OF NEW YORK COMPANY, INC.
Supplemental Information
(In millions)
(Unaudited)
Balance Sheet
June 30, 2003 GAAP
SUPPLEMENTAL REPORTED
----------------------------------------- ------------------
Core Pershing Elimination
June 30, June 30, Entries June 30, December 31,
2003 2003 2003 2002
---- ---- ---------- ---- ----
Assets
- ------
Cash and Due from Banks $ 4,067 $ 256 $ 4,323 $ 4,748
Interest-Bearing Deposits in Banks 6,706 38 6,744 5,104
Securities 20,377 15 20,392 18,300
Trading Assets at Fair Value 6,080 172 6,252 7,309
Federal Funds Sold and
Securities Purchased Under
Resale Agreements 8,095 3,981 12,076 1,385
Margin Loans 406 5,505 5,911 352
Loans (less allowance for
credit losses of $824 in 2003
and $831 in 2002) 31,061 31,061 30,156
Premises and Equipment 975 133 1,108 975
Due from Customers on Acceptances 191 191 351
Accrued Interest Receivable 237 7 244 204
Investment in/Advances to Pershing 2,891 $(2,891)
Goodwill & Intangible Assets 2,653 1,320 3,973 2,575
Other Assets 6,625 704 7,329 6,105
------- ------- ------- ------- -------
Total Assets $90,364 $12,131 $(2,891) $99,604 $77,564
======= ======= ======= ======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits $64,655 $64,655 $55,387
Federal Funds Purchased and
Securities Sold Under
Repurchase Agreements 699 336 1,035 636
Trading Liabilities 2,569 52 2,621 2,800
Payables to Customers and Broker-Dealers 1,684 7,723 9,407 870
Other Borrowed Funds 706 1,081 $ (871) 916 475
Acceptances Outstanding 194 194 352
Accrued Taxes and Other Expenses 4,014 19 4,033 4,066
Accrued Interest Payable 139 3 142 101
Other Liabilities 1,076 897 1,973 753
Long-Term Debt 6,515 6,515 5,440
------ ------ ------ ------- -------
Total Liabilities 82,251 10,111 (871) 91,491 70,880
------ ------ ------ ------- -------
Shareholders' Equity 8,113 2,020 (2,020) 8,113 6,684
------- ------- ------- ------- -------
Total Liabilities and
Shareholders' Equity $90,364 $12,131 $(2,891) $99,604 $77,564
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2002 has been derived from the audited financial statements
at that date.
Although the Company believes that the non-GAAP financial measures
presented in this report enhance investors' understanding of its businesses
and performance, these non-GAAP measures should not be considered an
alternative to GAAP.
6
Pershing Integration Plan
- -------------------------
The Company's integration plan related to Pershing has two main
priorities. First is the successful conversion of the clients of BNY Clearing
onto the platform of Pershing. Conversions are proceeding on schedule with
over half the domestic clients already converted and all conversions expected
to be completed early in the fourth quarter except for those clients acquired
in the Tilney acquisition. See Notes to Consolidated Financial Statements.
As expected, BNY Clearing clients have been overwhelmingly supportive of
converting to the Pershing platform and the Company expects that client
retention levels will meet the Company's targets.
The second priority is achieving projected synergies for this year and
next. Related to cost savings, planned closings of domestic and international
facilities are proceeding on schedule and are related to the client
conversions. In addition, the number of potential revenue synergies is
growing. The Company has already moved Pershing's government clearance
business to the Company's platform and has converted Lockwood, the Company's
managed account business, to the Pershing platform. The Company is also
beginning to leverage Pershing's technology facilities in India for
applications development work. On the revenue side, as projected, the Company
is gaining more transaction business in foreign exchange and execution
services. In addition, Pershing and Lockwood have begun working more closely
together to service the registered investment advisor market.
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
Noninterest income for the second quarter of 2003 was $996 million, an
increase of 18% sequentially and 16% from a year ago. Noninterest income was
71% of total revenues. Noninterest income for the six months ended June 30,
2003 was $1,841 million, an increase of 10% over the comparable 2002 period.
The increases are principally due to the Pershing acquisition and improved
performance in the core business. Pershing's contribution to the Company's
noninterest income was $121 million for the quarter and six months ended June
30, 2003.
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
----- ---- ---- ---- ----
Servicing Fees
Securities $598 $474 $478 $1,071 $ 932
Global Payment Services 79 77 71 156 144
---- ---- ---- ------ ------
677 551 549 1,227 1,076
Private Client Services
and Asset Management Fees 94 90 88 184 171
Service Charges and Fees 93 98 93 191 176
Foreign Exchange and
Other Trading Activities 88 65 72 154 134
Securities Gains 9 7 25 16 56
Other 35 33 28 69 60
---- ---- ---- ------ ------
Total Noninterest Income $996 $844 $855 $1,841 $1,673
==== ==== ==== ====== ======
Securities servicing fees were a record $598 million in the second
quarter, an increase of $124 million or 26% over the first quarter, and $120
million or 25% over the second quarter of 2002, primarily due to the Pershing
acquisition. For the first six months of 2003, securities servicing fees were
$1,071 million, an increase of $139 million from $932 million for the first
six months of 2002, principally due to Pershing and other acquisitions.
Pershing securities servicing fees in May and June included in the quarter and
six months ended June 30, 2003 were $109 million. Excluding Pershing, core
7
securities servicing fees were up 3% from the first quarter, or 13%
annualized, as a result of improved performance in the Company's equity-linked
businesses.
The Company groups its securities servicing businesses into four
categories, each comprised of separate, but related businesses. These are:
issuer services, which include corporate trust, depositary receipts and stock
transfer; investor services, which include global custody, securities lending
and separate account services; broker-dealer services, which include mutual
funds, government securities clearance, hedge fund servicing, exchange traded
funds and UITs; and execution and clearing services, which include all of the
activities in BNY Securities Group including Pershing.
Fees from investor services increased both on a sequential quarter basis
and over last year's second quarter. Strong performers on a sequential
quarter basis included global custody and securities lending. Wholesale
distribution services and securities lending were up over last year's second
quarter. Global custody benefited from the phase-in of new client wins,
higher equity prices, and increased transaction volumes. As of June 30, 2003,
assets under custody were $7.8 trillion, up from $6.8 trillion at March 31,
2003, and up from $6.6 trillion at June 30, 2002. Approximately half of the
increase in custody assets from March 31, 2003 is attributable to Pershing,
another third came from higher asset price levels, and the remainder from the
conversion of recent new business wins. At March 31, 2003, only 25% of the
custody assets were equities. As markets rose in the second quarter, the
portion in equities increased to 32%. Securities lending benefited from
seasonal factors compared to the first quarter and higher loan volume and new
business wins compared to last year.
Global issuer services declined on a sequential quarter basis and in
comparison to the second quarter of 2002. Corporate trust fees declined from
the record level attained in the first quarter of 2003. Depositary receipts
showed improved performance on a sequential quarter basis as a result of the
improved equity markets as well as seasonal corporate actions like dividends
and the completion of a major cross-border acquisition, which created strong
issue/cancel activity in this depositary receipt during the quarter.
Fees from broker-dealer services increased for the quarter in terms of
both sequential quarter and year-over-year comparisons. Strong performers
included government securities clearance and domestic and global collateral
management services, which benefited from new business wins and higher fixed
income transaction volumes driven by refinancing activity.
Execution and clearing services increased on both a sequential quarter
and year-over-year basis, reflecting the acquisition of Pershing as well as an
increase in market trading volumes in the second quarter of 2003. Total
combined second quarter NYSE and NASDAQ trading volume was up 17% from the
first quarter of 2003. Excluding Pershing, sequential quarter fee growth for
these services was strong across all business units, in particular BNY
Brokerage, B-Trade, and G-Trade.
Global payment services fees increased by 3% from the prior quarter and
11% from the second quarter of 2002. The increased revenues over both periods
reflect greater funds transfer activity, particularly multi-currency payments,
and new business wins in key client segments, such as U.S. and international
banks and mortgage banks. Global payment services fees increased by 8% on a
year-to-date basis over 2002.
Private client services and asset management fees for the second quarter
were up 5% from the prior quarter, and 7% from the second quarter of 2002.
The sequential quarter increase reflects the continued strong demand for
alternative investments from Ivy Asset Management as well as higher fees from
the private client services business. The increase from the second quarter of
2002 and on a year-to-date basis was due to strong performance from Ivy Asset
Management and acquisitions. Total assets under management were $83 billion
at June 30, 2003, up from $76 billion at March 31, 2003 and $75 billion a year
ago.
Service charges and fees were down $5 million from the prior quarter, and
flat with one year ago. The decrease from the prior quarter reflects lower
fees from structured products. Service charges and fees were up 9% on a year-
to-date basis over 2002, reflecting higher fees from capital markets and
structured products.
8
Foreign exchange and other trading revenues were up $23 million, or 35%,
compared with the prior quarter, and $16 million, or 22%, from one year ago.
The main reasons for the increase were higher foreign exchange activity and
the addition of Pershing, which contributed $9 million to other trading
revenues for the quarter and six months ended June 30, 2003. The strong
foreign exchange performance in the second quarter reflects greater client
activity resulting from increased cross-border investing. As conditions in
the equity markets improved, equity fund managers became more active and more
willing to enter into cross border investments. In addition, as activity
picked up, currency volatility increased, and intraday trading ranges widened.
Excluding Pershing, other trading revenues comprised primarily of fixed income
execution and interest rate risk management products were down from the strong
first quarter results but up from the quarter and six month period ending June
30, 2002. In the second quarter of 2003, the flatter yield curve and lower
interest rates caused clients to delay their hedging activities. For the six
months ended June 30, 2003, foreign exchange and other trading revenues were
up 15% over the six months ended June 30, 2002.
Securities gains in the second quarter were $9 million, up modestly from
$7 million in the prior quarter and down significantly from $25 million a year
ago. Gains were principally derived from the Company's fixed income
securities portfolio. Year-to-date securities gains are down $40 million from
the first six months of 2002. Comparisons with the prior year periods reflect
the Company's reduction in its equity investing activities in 2002.
Other noninterest income increased $2 million from the first quarter of
2003 and $7 million from the second quarter of 2002. Pershing contributed $3
million to other income for the quarter and six months ended June 30, 2003.
Net Interest Income
- -------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
(Dollars in millions) ------- ------- ------- ------------
2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Net Interest Income $398 $386 $423 $784 $835
Tax Equivalent Adjustment 9 9 13 19 26
---- ---- ---- ---- ----
Net Interest Income on a
Tax Equivalent Basis $407 $395 $436 $803 $861
==== ==== ==== ==== ====
Net Interest Rate
Spread 1.95% 2.18% 2.31% 2.05% 2.31%
Net Yield on Interest
Earning Assets 2.22 2.44 2.65 2.32 2.64
Net interest income on a taxable equivalent basis was $407 million in the
second quarter of 2003, compared with $395 million in the first quarter of
2003, and $436 million in the second quarter of 2002. Pershing contributed
$11 million of net interest income for the second quarter of 2003. The net
interest rate spread was 1.95% in the second quarter of 2003, compared with
2.18% in the first quarter of 2003, and 2.31% in the second quarter of 2002.
The net yield on interest earning assets was 2.22% in the second quarter of
2003, compared with 2.44% in the first quarter of 2003, and 2.65% in the
second quarter of 2002. The impact of Pershing assets was to depress the
spread and yield by approximately 13 basis points, as Pershing added
approximately $9 billion of high quality but relatively lower yielding assets,
namely margin loans and reverse repurchase agreements.
The increase in net interest income from the first quarter of 2003 is
primarily due to the Pershing acquisition, higher earning assets arising from
higher levels of client deposits, and a positive day count variance. This was
partially offset by lower reinvestment yields in the fixed income securities
portfolio. The decrease in net interest income from the second quarter of
2002 reflects lower reinvestment yields on fixed income securities, planned
decreases in corporate loan balances, and the impact of Federal Reserve
interest rate reductions in 2002 and 2003, partially offset by the Pershing
acquisition. Barring any further rate cuts, going forward the Company will
get a positive impact from a full quarter of Pershing as well as the full
9
quarter benefit of refinancing of trust preferred and long-term debt in the
second quarter.
For the first six months of 2003, net interest income on a taxable
equivalent basis amounted to $803 million compared with $861 million in the
first half of 2002, reflecting the same factors that affected the comparison
with last year's quarter. The year-to-date net interest spread was 2.05% in
2003 compared with 2.31% in 2002, while the net yield on interest earning
assets was 2.32% in 2003 and 2.64% in 2002.
In this report 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.
Noninterest Expense and Income Taxes
- ------------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Salaries and Employee Benefits $498 $423 $418 $ 921 $ 805
Net Occupancy 64 58 49 122 98
Furniture and Equipment 49 36 35 85 70
Clearing 40 29 33 69 60
Sub-custodian Expenses 19 16 15 35 30
Software 43 35 29 78 55
Amortization of Intangibles 7 3 2 10 4
Merger and Integration Costs 25 - - 25 -
Other 158 139 115 297 223
---- ---- ---- ------ ------
Total Noninterest Expense $903 $739 $696 $1,642 $1,345
==== ==== ==== ====== ======
Noninterest expense for the second quarter of 2003 was $903 million,
compared with $739 million in the prior quarter. The increase principally
reflects noninterest expense from Pershing of $112 million, as well as $25
million of merger and integration costs related to the Pershing acquisition.
Core noninterest expense was $766 million, up $27 million from the first
quarter of 2003, reflecting higher variable compensation and other revenue-
related costs as well as the full quarter impact of stock option expense. The
Company continues to focus on expense management while continuing to follow
through on investment initiatives critical to the Company's long-term
positioning and growth such as technology, business continuity, quality,
training, and marketing.
Salaries and employee benefits increased by $75 million on a sequential
quarter basis primarily due to the Pershing acquisition, increased incentive
compensation tied to revenues, and an increase in stock option expense of $6
million in the second quarter of 2003. Pershing salaries and employee
benefits were $59 million for the quarter ended June 30, 2003. The increase
from the second quarter of 2002 primarily reflects the impact of the Pershing
acquisition, the inception of stock option expensing in 2003, a lower pension
credit, increased technology investments, and higher business continuity
spending. Excluding acquisitions, headcount is down by nearly 200 from the
start of the year.
Noninterest expense for the first six months of 2003 was $1,642 million
compared with $1,345 million last year, mainly reflecting the same factors
that explain the second quarter to second quarter increase.
The efficiency ratio for the second quarter was 64.8%, compared to 60.0%
in the previous quarter and 55.0% in 2002. For the first half of 2003, the
efficiency ratio was 62.5% compared with 54.3% last year. The increase in the
efficiency ratio is largely attributable to the Pershing acquisition. The
Company's continued focus on cost control was obscured by factors such as the
Pershing acquisition and the full phase-in of stock option expensing. The
Company continues to take proactive steps to keep its cost basis competitive,
such as moving staff to lower cost environments, implementing enhanced
10
procurement practices, and gaining efficiencies through six sigma and process
reengineering efforts. The Company has been relocating staff to lower cost
areas such as upstate New York, Orlando, Florida, and Liverpool, England. In
addition, approximately a third of the Pershing technology staff is based in
India and the Company has begun to leverage off this base for other technology
projects.
The effective tax rate for the second quarter of 2003 was 34.6%,
unchanged from the first quarter of 2003, and up from 34.0% in the second
quarter 2002. The effective tax rate for the six month period ended June 30,
2003 was 34.6%, compared with 33.8% for the six month period ended June 30,
2002. The increase in the effective tax rate reflects fewer tax credits.
Credit Loss Provision and Net Charge-Offs
- -----------------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Provision $ 40 $ 40 $ 35 $ 80 $ 70
==== ==== ==== ==== ====
Net Charge-offs:
Commercial $ (34) $ (25) $(17) $(59) $(47)
Foreign (7) - - (7) 1
Other - (10) (14) (10) (14)
Consumer (5) (5) (4) (10) (10)
------ ------ ----- ----- ----
Total $ (46) $ (40) $(35) $(86) $(70)
====== ====== ===== ===== ====
Other Real Estate Expenses $ - $ - $ - $ - $ -
The provision for credit losses was $40 million in the second quarter of
2003, flat with $40 million in the first quarter of 2003 and up from $35
million in the second quarter of 2002. On a year to date basis, the provision
was $80 million in 2003 compared with $70 million in 2002.
The allowance for credit losses was $824 million at June 30, 2003, $830
million at March 31, 2003, and $616 million at June 30, 2002. The excess of
charge-offs over provision of $6 million reflects the Company's proactive
steps to reduce exposure in the secondary market.
The allowance for credit losses as a percent of non-margin loans was
2.58% at June 30, 2003, compared with 2.65% at March 31, 2003, and 1.73% at
June 30, 2002. See "Loans - Allowance".
11
BUSINESS SEGMENTS REVIEW
The Company has an internal information system that produces performance data
for its four business segments along product and service lines.
Business Segments Accounting Principles
- ---------------------------------------
The Company's segment data has been determined on an internal management basis
of accounting, rather than the generally accepted accounting principles used
for consolidated financial reporting. These measurement principles are
designed so that reported results of the segments will track their economic
performance. Segment results are subject to restatement whenever improvements
are made in the measurement principles or organizational changes are made. In
the second quarter of 2003 the Company modified the funds transfer rates based
on an updated analysis of the duration of assets and liabilities. Prior
periods have been restated.
The measure of revenues and profit or loss by operating segment has been
adjusted to present segment data on a taxable equivalent basis. The provision
for credit losses allocated to each reportable segment is based on
management's judgment as to average credit losses that will be incurred in the
operations of the segment over a credit cycle of a period of years.
Management's judgment includes the following factors among others: historical
charge-off experience and the volume, composition, and size of the loan
portfolio. This method is different from that required under generally
accepted accounting principles as it anticipates future losses which are not
yet probable and therefore not recognizable under generally accepted
accounting principles. Assets and liabilities are match funded. Support and
other indirect expenses are allocated to segments based on general internal
guidelines.
Description of Business Segments
- --------------------------------
The Company reports data for the four business segments: Servicing and
Fiduciary, Corporate Banking, Retail Banking, and Financial Markets.
The Servicing and Fiduciary businesses segment comprises the Company's
core services, including securities servicing, global payment services, and
private client services and asset management. These businesses all share
certain favorable attributes: they are well diversified and fee-based; the
Company serves the role of an intermediary rather than principal, thereby
limiting risk and generating more stable earnings streams; and the businesses
are scalable, which result in higher margins as revenues grow. Long-term
trends that favor these businesses include the growth of financial assets
worldwide, the globalization of investment activity, heightened demand for
financial servicing outsourcing, and continuing structural changes in
financial markets.
Securities servicing provides financial institutions, corporations and
financial intermediaries with a broad array of products and customized
services for every step of the investment lifecycle. The Company facilitates
the movement, settlement, recordkeeping and accounting of financial assets
around the world by delivering timely and accurate information to issuers,
investors and broker-dealers. The Company groups its securities servicing
businesses into four categories, each comprised of separate, but related
businesses. These are: issuer services, which include corporate trust,
depositary receipts and stock transfer; investor services, which include
global custody, securities lending and separate account services; broker-
dealer services, which include mutual funds, government securities clearance,
hedge fund servicing, exchange traded funds and UITs; and execution and
clearing services, which include all of the activities in BNY Securities Group
including Pershing. This segment also includes customer-related foreign
exchange trading.
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.
12
The Company is a market leader in many of these businesses and has
aggressively expanded to both enhance and expand its product and service
offerings and to add new clients. The Company has completed 51 acquisitions
since 1998 in these core services, has made significant investments in
technology to maintain its industry-leading position, and has continued the
development of new products and services that 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 and by leveraging
existing relationships to create new business opportunities.
The Company believes that credit is an important product for many of its
customers to execute their business strategies. However, the Company has
continued to reduce its credit exposures in recent years by culling its loan
portfolio of non-strategic exposures, focusing on increasing total
relationship returns through cross-selling and limiting the size of its
individual credit exposures and industry concentrations to reduce earnings
volatility.
The Retail Banking segment includes retail deposit services, branch
banking, and consumer and residential mortgage lending. The Company operates
341 branches in 23 counties in the Tri-State region. The retail network is a
stable source of low cost funding and provides a platform to cross-sell core
services from the Servicing and Fiduciary businesses to both individuals and
small businesses in the New York metropolitan area.
The Financial Markets segment includes trading of foreign exchange and
interest rate risk management products, investing and leasing activities, and
treasury services to other business segments. The segment offers a
comprehensive array of multi-currency hedging and yield enhancement
strategies, and complements 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.
13
Servicing and Fiduciary Businesses
- ----------------------------------
(In Millions)
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
2003 2003 2002 2003 2002
------- ------- ------- ----- -----
Net Interest Income $ 120 $ 105 $ 122 $ 225 $ 244
Provision for
Credit Losses - - - - -
Noninterest Income 838 688 691 1,526 1,350
Noninterest Expense 650 523 486 1,173 946
Income Before Taxes 308 270 327 578 648
Average Assets $15,724 $ 7,615 $ 8,475 $11,692 $ 8,721
Average Deposits 33,499 31,128 30,295 32,320 30,255
Nonperforming Assets 16 16 16 16 16
(In billions)
Assets Under Custody $ 7,787 $ 6,783 $ 6,613 $ 7,787 $ 6,613
Assets Under Management 83 76 75 83 75
S&P 500 Index (Period End) 975 848 990 975 990
NASDAQ Index (Period End) 1,623 1,341 1,463 1,623 1,463
NYSE Volume (In billions) 93.0 86.6 87.7 179.6 170.6
NASDAQ Volume (In billions) 112.5 88.8 115.2 201.3 222.9
The Servicing and Fiduciary Services businesses are affected by market
conditions which improved in May and June, and were characterized by higher
equity trading volumes, improved equity price levels, and increased foreign
exchange volume and volatility.
The S&P 500 Index was down 2% at the end of the second quarter of 2003
from the second quarter of 2002, with average daily price levels off 12% from
2002. Total combined second quarter NYSE and NASDAQ trading volume was up 17%
from the first quarter of 2003 and 1% from the second quarter of 2002.
Excluding Pershing, in securities servicing, sequential quarter fee growth was
strong across all the business units except global issuer services.
The Company's diversified business model responded well to the recent
improved conditions in the equity markets, and it is well positioned to
benefit from further strengthening in the capital markets. The second quarter
results showed sequential quarter improvement in the Company's key businesses,
including securities servicing and associated foreign exchange, global payment
services, private client services and asset management. Noninterest income
for the second quarter of 2003 and the six months ending June 30, 2003 was
$838 million and $1,526 million. This is an increase of 22% sequentially and
21% from a year ago quarter. Excluding Pershing, noninterest income was $717
million in the second quarter of 2003, which represents growth of 4% over the
first quarter of 2003 and second quarter of 2002. Noninterest income for the
first six months increased 13% over the comparable 2002 period, 4% excluding
the impact of Pershing.
As of June 30, 2003, the Company had assets under custody of $7.8
trillion up from $6.8 trillion at March 31, 2003 and $6.6 trillion at June 30,
2002. Cross-border custody assets were $2.2 trillion at June 30, 2003. The
acquisition of Pershing added approximately $500 billion to custody assets at
June 30, 2003. Equity securities composed 32% of the assets under custody at
June 30, 2003, while fixed income securities were 68%.
Fees from investor services increased both on a sequential quarter basis
and over last year's second quarter. Strong performers on a sequential
quarter basis included global custody and securities lending. Typically
dividends are paid on foreign equities in the second quarter which creates
global equity lending opportunities related to dividend arbitrage business.
Wholesale distribution services and securities lending were up over last
14
year's second quarter. Global custody benefited from the phase-in of new
client wins, higher equity prices, and increased transaction volumes.
Global issuer services declined on a sequential quarter basis and in
comparison to the second quarter of 2002. Corporate trust fees declined from
the record level attained in the first quarter of 2003. Depositary receipts
showed improved performance on a sequential quarter basis as a result of the
improved equity markets as well as seasonal corporate actions, but remain
below year ago levels.
Fees from broker-dealer services increased for the quarter in terms of
both sequential quarter and year-over-year comparisons. Strong performers
included government securities clearance and domestic and global collateral
management services, which benefited from new business wins and higher fixed
income transaction volumes driven by refinancing activity.
Execution and clearing services increased on both a sequential quarter
and on a year-over-year basis, reflecting the acquisition of Pershing as well
as an increase in market trading volumes in the second quarter of 2003. Total
combined second quarter NYSE and NASDAQ trading volume was up 17% from the
first quarter of 2003. Excluding Pershing, sequential quarter fee growth for
these services was strong across all the business units, in particular BNY
Brokerage, B-Trade, and G-Trade.
Global payment services fees were $79 million at June 30, 2003 and $156
million for the six months ending June 30, 2003. This is an increase of 3%
from the prior quarter and 11% from the second quarter of 2002. The increased
revenues over both periods reflect greater funds transfer activity,
particularly multi-currency payments, and new business wins in key client
segments, such as U.S. and international banks and mortgage banks. Global
payment services fees increased by 8% on a year-to-date basis over 2002.
Private client services and asset management fees for the second quarter
were $94 million and $184 million for the six months ending June 30, 2003.
This is an increase of 5% from the prior quarter, and 7% from the second
quarter of 2002. The sequential quarter increase reflects the continued
strong demand for alternative investments from Ivy Asset Management as well as
higher fees from the private client services business. The increase from the
second quarter of 2002 and on a year-to-date basis was due to strong
performance from Ivy Asset Management and acquisitions.
Assets under management ("AUM") were $83 billion at June 30, 2003
compared with $76 billion at March 31, 2003 and $75 billion at June 30, 2002.
Assets under administration were $27 billion unchanged as compared with March
31, 2003 and down from $30 billion at June 30, 2002. The increase in assets
under management since March 31, 2003 reflects acquisitions, growth in the
Company's alternative investments business, and a rise in asset values. The
increase in AUM since June 30, 2002 reflects acquisitions and growth in the
Company's alternative investment business. Institutional clients represent
66% of AUM while individual clients equal 34%. AUM at June 30, 2003, are 32%
invested in equities, 23% in fixed income, 9% in alternative investments and
the remainder in liquid assets.
Net interest income in the Servicing and Fiduciary businesses segment was
$120 million for the second quarter of 2003 compared with $105 million in the
first quarter of 2003 and $122 million in the second quarter of 2002. The
increase in net interest income on a sequential quarter basis is primarily
attributable to the Pershing acquisition. The decrease in net interest income
from the second quarter of 2002 is primarily due to the decline in interest
rates partially offset by the Pershing acquisition. Net interest income for
the six months ended June 30, 2003 was $225 million compared with $244 million
in the first half of 2002. The decline in net interest income mainly reflects
the Federal Reserve rate cuts in 2003 and 2002, partially offset by the
Pershing acquisition. Average assets for the quarter ended June 30, 2003 were
$15.7 billion compared with $7.6 billion in the first quarter of 2003 and $8.5
billion in the second quarter of 2002. Average assets for the six months ended
June 30, 2003 were $11.7 billion compared with $8.7 billion in the first six
months of 2002. These increases reflect the Pershing acquisition. The second
15
quarter of 2003 average deposits were $33.5 billion compared with $31.1
billion in the first quarter of 2003 and $30.3 billion in the second quarter
of 2002. Average deposits for the first half of 2003 were $32.3 billion
compared with $30.3 billion for the first half of 2002.
Net charge-offs in the Servicing and Fiduciary Businesses segment were
zero in each of the relevant periods. Nonperforming assets were $16 million
at June 30, 2003, March 31, 2003 and June 30, 2002. The increase in
nonperforming loans since June 30, 2002 is attributable to the Company's
private client services business.
Noninterest expense for the second quarter of 2003 was $650 million,
compared with $523 million in the first quarter of 2003 and $486 million in
the second quarter of 2002. The rise in noninterest expense from the first
quarter reflects the Pershing acquisition. For the first half of 2003,
noninterest expense was $1,173 million compared with $946 million in 2002.
The rise in noninterest expense from 2002 was primarily due to acquisitions,
the Company's continued investment in technology, a reduced pension credit,
higher insurance expense, as well as higher volume-related sub-custodian
expenses and higher variable compensation related to revenue growth.
Corporate Banking
- -----------------
(In Millions)
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
2003 2003 2002 2003 2002
------- ------- ------- ------- -----
Net Interest Income $ 95 $ 92 $ 106 $ 187 $ 214
Provision for
Credit Losses 30 30 35 60 70
Noninterest Income 86 75 73 161 142
Noninterest Expense 53 50 50 103 96
Income Before Taxes 98 87 94 185 190
Average Assets $19,858 $20,540 $22,979 $20,197 $23,424
Average Deposits 6,583 7,219 7,011 6,899 6,956
Nonperforming Assets 410 409 292 410 292
Net Charge-offs 42 35 30 77 60
The Corporate Banking segment's net interest income was $95 million in
the second quarter of 2003, up from $92 million in the first quarter of 2003
and down from $106 million in the second quarter of 2002. On a year-to-date
basis, net interest income for 2003 was $187 million compared with $214
million in 2002. The decreases from the quarter and year-to-date 2002 periods
reflect the continued reduction of average loans outstanding as well as a
decline in the value of low cost short-term deposits given the lower interest
rate environment. Average assets for the quarter were $19.9 billion compared
with $20.5 billion in the first quarter of 2003 and $23.0 billion in the
second quarter of last year. Average deposits in the corporate bank were $6.6
billion versus $7.2 billion in the first quarter of 2003 and $7.0 billion in
2002. For the six months ended June 30, 2003, average assets were $20.2
billion compared to $23.4 billion for the first six months of 2002. For the
first half of 2003 and 2002, average deposits were $6.9 billion and $7.0
billion.
The second quarter 2003 provision for credit losses was $30 million
compared with $30 million in the first quarter of 2003 and $35 million last
year. On a year-to-date basis the provision for credit losses was $60 million
for 2003 and $70 million for 2002. Net charge-offs in the Corporate Banking
segment were $42 million in the second quarter of 2003, $35 million in the
first quarter of 2003, and $30 million in the second quarter of 2002. The
charge-offs in 2003 primarily relate to loans to corporate borrowers. Net
charge-offs for the first six months of 2003 were $77 million compared with
$60 million in 2002. Nonperforming assets were $410 million at June 30, 2003,
essentially flat compared with $409 million in the first quarter of 2003 and
up from $292 million in the second quarter of 2002. The increase in
16
nonperforming assets from the second quarter of 2002 primarily reflects
exposures to the operating subsidiaries of a large cable operator.
Noninterest income was $86 million in the current quarter, compared with
$75 million in the first quarter of 2003 and $73 million in the second quarter
a year ago reflecting higher volumes of standby letters of credit and
increased capital markets activity. For the first half of 2003, noninterest
income was $161 million compared with $142 million for the first half of 2002.
Noninterest expense in the second quarter increased to $53 million from
$50 million in both the first quarter of 2003 and second quarter of 2002. For
the first six months of 2003 noninterest expense was $103 million compared
with $96 million in 2002. The increases over 2002 reflect higher compensation
costs due in part to a reduced pension credit.
Retail Banking
- --------------
(In Millions)
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
2003 2003 2002 2003 2002
------- ------- ------- ------- -----
Net Interest Income $ 118 $ 116 $ 122 $234 $238
Provision for
Credit Losses 5 4 3 9 6
Noninterest Income 33 29 28 62 58
Noninterest Expense 90 87 78 177 159
Income Before Taxes 56 54 69 110 131
Average Assets $ 5,329 $ 5,382 $ 5,108 $5,355 $ 4,959
Average Noninterest
Bearing Deposits 4,565 4,830 3,858 4,697 4,005
Average Deposits 14,252 14,122 13,011 14,187 13,128
Nonperforming Assets 11 10 7 11 7
Net Charge-offs 5 5 5 10 10
Number of Branches 341 341 342 341 342
Total Deposit Accounts
(In Thousands) 1,183 1,192 1,231 1,183 1,231
Net interest income in the second quarter of 2003 was $118 million,
compared with $116 million in the first quarter of 2003 and $122 million in
the second quarter of 2002. Net interest income on a year-to-date basis for
2003 and 2002 was $234 million and $238 million. The decline in net interest
income reflects spread compression on deposits.
Noninterest income was $33 million for the quarter compared with $29
million on a sequential quarter basis and $28 million last year. Noninterest
income for the first six months of 2003 was $62 million compared with $58
million in the first six months of 2002. The increase in noninterest income
reflects a gain on the sale of $230 million of mortgage loans as well as
higher fee-based customer activity.
Noninterest expense in the second quarter of 2003 was $90 million
compared with $87 million in the first quarter of 2003 and $78 million last
year. These increases reflect a reduced pension credit, and higher medical
benefit expense. Noninterest expense for the first half of 2003 was $177
million compared with $159 million in the first half of 2002. The year-over-
year change reflects a reduced pension credit, higher occupancy, advertising,
and medical benefit expenses.
Net charge-offs were $5 million in the second quarter of 2003, $5 million
in the first quarter of 2003 and $5 million in the second quarter of 2002. Net
charge-offs were $10 million for the six months ending June 30, 2003 and June
30, 2002. Nonperforming assets were $11 million in the second quarter of 2003
compared with $10 million at March 31, 2003 and $7 million at June 30, 2002
17
reflecting modest deterioration in the Company's small business loan
portfolio.
Average deposits generated by the Retail Banking segment were $14.3
billion in the second quarter of 2003, compared with $14.1 billion in the
first quarter of 2003 and $13.0 billion in the second quarter of 2002. For the
first half of 2003 average deposits were $14.2 billion as compared to $13.1
billion in the first half of 2002. Noninterest bearing deposits were $4.6
billion this quarter, compared with $4.8 billion in the first quarter of 2003
and $3.9 billion in the second quarter of 2002. The increase in total deposits
reflects current consumer preferences for the safety of bank deposits versus
the volatility of the equity markets as well as the low interest rates offered
on other investment choices. Noninterest bearing deposits for the first six
months of 2003 were $4.7 billion compared with $4.0 billion in the first six
months of 2002. Average assets in the retail banking sector were $5.3 billion,
compared with $5.4 billion in the first quarter of 2003 and $5.1 billion in
the second quarter of 2002. On a year-to-date basis, average assets were $5.4
billion for 2003 and $5.0 billion for 2002. The increases over 2002 reflect
strong demand for home equity loans, as well as increased small business
lending.
Financial Markets
- -----------------
(In Millions)
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
2003 2003 2002 2003 2002
------- ------- ------- ------- -----
Net Interest Income $ 80 $ 77 $ 85 $ 157 $ 161
Provision for
Credit Losses 6 5 5 11 10
Noninterest Income 33 50 64 83 117
Noninterest Expense 25 24 21 49 43
Income Before Taxes 82 98 123 180 225
Average Assets $46,463 $44,334 $40,822 $45,404 $40,295
Average Deposits 4,153 4,917 1,792 4,533 1,905
Average Investment
Securities 18,720 17,977 14,614 18,351 13,707
Net Charge-offs - - - - -
Net interest income for the second quarter was $80 million compared with
$77 million on a sequential quarter basis and $85 million a year ago. The
sequential quarter increase reflects higher average assets, and an additional
day in the quarter, offset in part by lower investment yields. The declines
from 2002 reflect lower reinvestment yields partially offset by an increase in
assets, primarily highly-rated mortgage-backed securities. Net interest income
was $157 million in the first six months of 2003 compared to $161 million in
the first six months of 2002. Average second quarter 2003 assets in the
Financial Markets segment were $46.5 billion, up from $44.3 billion on a
sequential quarter basis and $40.8 billion last year. Average assets for the
first half of 2003 were $45.4 billion compared to $40.3 billion for the first
half of 2002. The increase in assets reflects the Company's continuing
strategy to reduce investment in higher risk corporate loans and increase
holdings of highly rated, more liquid investment securities.
Noninterest income was $33 million in the second quarter of 2003,
compared with $50 million in the first quarter of 2003 and $64 million in the
second quarter of 2002. On a year-to-date basis, noninterest income was $83
million in 2003 and $117 million in 2002. The negative variance versus the
first quarter of 2003 reflects lower structured product fees and lower trading
related revenues, as the flatter yield curve and lower interest rates caused
clients to reduce or delay their hedging activities. The decrease versus a
year ago was caused by declines in securities gains and structured product
fees.
Net charge-offs were zero in each of the relevant periods. Noninterest
expense was essentially flat at $25 million in the second quarter of 2003,
compared with $24 million in the first quarter of 2003 but up from $21 million
18
in last year's second quarter. Noninterest expense for the six months ended
June 30, 2003 was $49 million, compared with $43 million for the six months
ended June 30, 2002 reflecting higher compensation costs.
The consolidating schedule below shows the contribution of the Company's
segments to its overall profitability.
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2003 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
(In Millions)
Net Interest Income $ 120 $ 95 $ 118 $ 80 $ (15) $ 398
Provision for
Credit Losses - 30 5 6 (1) 40
Noninterest Income 838 86 33 33 6 996
Noninterest Expense 650 53 90 25 85 903
----- ---- ----- ---- ----- -----
Income Before Taxes $ 308 $ 98 $ 56 $ 82 $ (93) $ 451
===== ==== ===== ==== ===== =====
Contribution Percentage 57% 18% 10% 15%
Average Assets $15,724 $19,858 $5,329 $46,463 $ 3,550 $90,924
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2003 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
(In Millions)
Net Interest Income $ 105 $ 92 $ 116 $ 77 $ (4) $ 386
Provision for
Credit Losses - 30 4 5 1 40
Noninterest Income 688 75 29 50 2 844
Noninterest Expense 523 50 87 24 55 739
----- ---- ----- ---- ----- -----
Income Before Taxes $ 270 $ 87 $ 54 $ 98 $ (58) $ 451
===== ==== ===== ==== ===== =====
Contribution Percentage 53% 17% 11% 19%
Average Assets $ 7,615 $20,540 $5,382 $44,334 $ 2,605 $80,476
In Millions
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2002 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 122 $106 $ 122 $ 85 $ (12) $ 423
Provision for
Credit Losses - 35 3 5 (8) 35
Noninterest Income 691 73 28 64 (1) 855
Noninterest Expense 486 50 78 21 61 696
----- ---- ----- ---- ----- -----
Income Before Taxes $ 327 $ 94 $ 69 $123 $ (66) $ 547
===== ==== ===== ==== ===== =====
Contribution Percentage 54% 15% 11% 20%
Average Assets $8,475 $22,979 $5,108 $40,822 $ 2,303 $79,687
19
In Millions
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2003 Businesses Banking Banking Markets Items Total
- ----------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 225 $187 $ 234 $157 $ (19) $ 784
Provision for
Credit Losses - 60 9 11 - 80
Noninterest Income 1,526 161 62 83 9 1,841
Noninterest Expense 1,173 103 177 49 140 1,642
----- ---- ----- ---- ----- -----
Income Before Taxes $ 578 $185 $ 110 $180 $(150) $ 903
===== ==== ===== ==== ===== =====
Contribution Percentage 55% 18% 10% 17%
Average Assets $11,692 $20,197 $5,355 $45,404 $ 3,080 $85,728
In Millions
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2002 Businesses Banking Banking Markets Items Total
- ----------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 244 $214 $ 238 $161 $ (22) $ 835
Provision for
Credit Losses - 70 6 10 (16) 70
Noninterest Income 1,350 142 58 117 6 1,673
Noninterest Expense 946 96 159 43 101 1,345
----- ---- ----- ---- ----- -----
Income Before Taxes $ 648 $190 $ 131 $225 $(101) $1,093
===== ==== ===== ==== ===== =====
Contribution Percentage 54% 16% 11% 19%
Average Assets $8,721 $23,424 $4,959 $40,295 $ 2,249 $79,648
20
Reconciling Items
- -----------------
Description - Reconciling items for net interest income primarily relate to
the recording of interest income on a taxable equivalent basis, reallocation
of capital and the funding of goodwill and intangibles. Reconciling items for
noninterest income primarily relate to the sale of certain securities and
certain other gains. Reconciling items for noninterest expense primarily
reflects corporate overhead as well as amortization of intangibles and
severance. In the second quarter of 2003, merger and integration costs
associated with Pershing are also reconciling items. The adjustment to the
provision for credit losses reflects the difference between the aggregate of
the credit provision over a credit cycle for the reportable segments and the
Company's recorded provision. The reconciling items for average assets consist
of goodwill and other intangible assets.
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(In millions) 2003 2003 2002 2003 2002
------- ------- ------- ------ -----
Segment's revenue $1,403 $1,232 $1,291 $2,635 $2,524
Adjustments:
Earnings associated with
assignment of capital (28) (21) (24) (48) (50)
Securities gains - - (2) - 2
Other gains 6 4 - 10 4
Taxable equivalent basis and
other tax-related items 13 15 13 28 28
------- ------ ------ ------ ------
Subtotal-revenue adjustments (9) (2) (13) (10) (16)
------- ------ ------ ------ ------
Consolidated revenue $1,394 $1,230 $1,278 $2,625 $2,508
======= ====== ====== ====== ======
Segment's income before tax $ 544 $ 509 $ 613 $1,053 $1,194
Adjustments:
Revenue adjustments (above) (9) (2) (13) (10) (16)
Provision for credit losses
different than GAAP 1 (1) 8 - 16
Severance (4) (2) (11) (6) (14)
Goodwill and
intangible amortization (7) (3) (2) (10) (4)
Pershing-related
integration expenses (25) - - (25) -
Corporate overhead (49) (50) (48) (99) (83)
------ ------ ------ ------ ------
Consolidated income
before tax $ 451 $ 451 $ 547 $ 903 $1,093
====== ====== ====== ====== ======
Segments' total
average assets $87,374 $77,871 $77,384 $82,648 $77,399
Adjustments:
Goodwill and intangibles 3,550 2,605 2,303 3,080 2,249
------- ------- ------- ------ ------
Consolidated average assets $90,924 $80,476 $79,687 $85,728 $79,648
======= ======= ======= ======= =======
21
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.
The reconciling item for the provision for loan losses primarily relates
to Corporate Banking and in 2003 to aircraft leases in Financial Markets.
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. Merger and integration charges
would be allocated to the securities and fiduciary businesses segment.
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $99.6 billion at June 30, 2003, compared with $79.5
billion at March 31, 2003, and $77.6 billion at December 31, 2002. The
increase in total assets reflects $12.1 billion in assets related to Pershing
as well as an increase of $8 billion in liquid assets primarily related to the
Company's securities servicing business. As a result, federal funds sold and
securities purchased under resale agreements were $12.1 billion at June 30,
2003 compared with $1.4 billion at December 31, 2002. In addition, overdrafts
were $3.5 billion at June 30, 2003 compared with $1.8 billion at December 31,
2002. Customers have left higher cash balances with the Company in the low
interest rate environment due to a lack of favorable overnight investment
alternatives. In addition, high securities settlement volumes at quarter end
resulted in a higher than normal level of uncompleted trades across the
industry, which added to the cash levels in customer accounts. Historically,
the balance in certain customer accounts at the Company tend to increase at
period end compared to daily average balances in these accounts, resulting in
distortion in the Company's period-end balance sheets. To minimize these
distortions, the Company plans to enter into agreements with certain customers
to manage the level of excess balances. Total shareholders' equity was $8.1
billion at June 30, 2003, compared with $6.9 billion at March 31, 2003, and
$6.7 billion at December 31, 2002. The increase in shareholders' equity is
primarily attributable to the issuance of approximately $1 billion of common
stock related to the Pershing acquisition, as well as the retention of
earnings.
Return on average common equity on a reported basis for the second
quarter of 2003 was 15.56%, compared with 17.80% in the first quarter of 2003,
and 22.59% in the second quarter of 2002. On a reported basis, return on
average assets for the second quarter of 2003 was 1.30%, compared with 1.49%
in the first quarter of 2003, and 1.82% in the second quarter of 2002.
Excluding the merger-related costs of $25 million, return on average common
equity for the second quarter of 2003 was 16.41%, while return on average
assets was 1.37%. For the first six months of 2003, return on average common
equity was 16.61% compared with 23.16% in 2002. On a reported basis, return
on average assets was 1.39% for the first six months of 2003 compared with
1.83% in 2002 on a reported basis. Excluding the merger-related costs of $25
million, return on average common equity for the first six months of 2003 was
17.08%, while return on average assets was 1.43%.
22
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities portfolio:
Investment Securities (at Fair Value)
(In millions) 06/30/03 12/31/02
-------- --------
Fixed Income:
Mortgage-Backed Securities $16,216 $13,084
Asset-Backed Securities 36 37
Corporate Debt 1,286 1,112
Short-Term Money Market Instruments 1,149 1,999
U.S. Treasury Securities 245 537
U.S. Government Agencies 344 469
State and Political Subdivisions 324 403
Emerging Market Debt 111 114
Other Foreign Debt 542 273
------- -------
Subtotal Fixed Income 20,253 18,028
Equity Securities:
Money Market Funds 52 91
Bank Stocks - 91
Federal Reserve Bank Stock 66 66
Other 22 22
------- -------
Subtotal Equity Securities 140 270
------- -------
Total Securities $20,393 $18,298
======= =======
Total investment securities were $20.4 billion at June 30, 2003, compared
with $19.6 billion at March 31, 2003, and $18.3 billion at December 31, 2002.
Average investment securities were $18.7 billion in the second quarter of
2003, compared with $18.0 billion in the first quarter of 2003 and $14.6
billion in the second quarter of last year. Average investment securities
were $18.4 billion in the six months ended June 30, 2003, compared with $13.7
billion in the six months ended June 30, 2002. The increases were primarily
due to growth in the Company's portfolio of highly rated mortgage-backed
securities which are 98% rated AAA, 1% AA, and 1% A. Since December 31, 2002,
the Company has added approximately $3 billion of mortgage-backed securities
to its investment portfolio. The Company has been adding either adjustable or
short life classes of structured mortgage-backed securities, both of which
have short average lives. The Company has maintained a duration of
approximately 2.2 years on its overall fixed income portfolio to best match
its liabilities and reduce the adverse impact from a rise in interest rates.
Net unrealized gains for securities available-for-sale were $363 million
at June 30, 2003, compared with $338 million at December 31, 2002. As
interest rates rise, the Company expects the unrealized gains will decline.
Loans
- -----
Total loans including margin loans were $37.8 billion at June 30, 2003,
compared with $31.7 billion at March 31, 2003, and $31.3 billion at December
31, 2002. Average loans were $35.7 billion in the second quarter of 2003,
compared with $32.0 billion in the first quarter of 2003 and $34.2 billion in
the second quarter of 2002. Pershing contributed $3.0 billion to the increase
in average loans. Excluding Pershing, average loans were $32.7 billion in the
second quarter of 2003, $32.0 billion in the first quarter of 2003, and $34.2
billion in the second quarter of 2002. The increase on a sequential quarter
basis reflects overdrafts related to uncompleted securities trades.
The decrease from 2002 reflects the Company's continued reduction of
corporate loan exposures, as it reallocates capital towards its fee-based
businesses.
23
The Company has made steady progress in reducing its exposure to higher
risk credits and will continue its intensive efforts to do so in the telecom
segment as well as throughout the loan portfolio. The Company continued to
make progress in its risk reduction efforts during the second quarter. Total
exposures to corporate clients were reduced by $2.0 billion, with telecom
exposures reduced by approximately $244 million. The Company's $9 billion
corporate exposure reduction program is ahead of schedule with the Company
over halfway to its targeted goal with six quarters remaining. The
improvement in credit spreads in the second quarter and resulting price
improvement and greater liquidity in the secondary loan market created
favorable conditions for the Company to reduce non-strategic exposure and
certain large credits. The increase in margin loans reflects the acquisition
of Pershing. The following tables provide additional details on the Company's
loan exposures and outstandings at June 30, 2003 in comparison to December 31,
2002.
Overall Loan Portfolio
Unfunded Total Unfunded Total
(dollars in billions) Loans Commitments Exposure Loans Commitments Exposure
----------------------------- ------------------------------
6/30/03 6/30/03 6/30/03 12/31/02 12/31/02 12/31/02
-------- ------- ------- -------- -------- --------
Financial Institutions(4) $ 9.7 $21.7 $31.4 $ 6.6 $24.1 $30.7
Corporate(4) 6.2 21.5 27.7 8.2 23.4 31.6
----- ----- ----- ----- ----- ----
15.9 43.2 59.1 14.8 47.5 62.3
----- ----- ----- ----- ----- ----
Consumer & Middle Market 8.0 4.1 12.1 8.0 4.1 12.1
Leasing Financings 5.6 0.1 5.7 5.6 0.1 5.7
Commercial Real Estate 2.4 0.8 3.2 2.5 0.8 3.3
Margin loans 5.9 - 5.9 0.4 - 0.4
----- ----- ----- ----- ----- -----
Total $37.8 $48.2 $86.0 $31.3 $52.5 $83.8
===== ===== ===== ===== ===== =====
(1) Includes assets held for sale.
(2) Unfunded commitments include letters of credit.
(3) Excludes acceptances due from customers.
(4) The Company reclassified $0.9 billion of exposures from Corporate to Financial Institutions
to better reflect the underlying nature of the credit. Prior periods have been restated.
24
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $31.4 billion at June 30,
2003 compared to $30.7 billion at December 31, 2002. These exposures are of
high quality, with 88% meeting the investment grade criteria of the Company's
rating system. The exposures are generally short-term, with 74% expiring
within one year and are frequently secured. For example, mortgage banks,
securities firms, and asset managers often borrow against marketable
securities held in custody at the Company. The diversity of the portfolio is
shown in the accompanying table.
(Dollars in billions)
06/30/03 12/31/02
------------------------------ -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Banks $ 3.4 $ 3.4 $ 6.8 74% 80% $2.9 $ 4.5 $ 7.4
Securities
Industry 3.3 3.5 6.8 88 97 1.3 3.9 5.2
Insurance 0.4 5.1 5.5 96 65 0.4 5.5 5.9
Government 0.1 5.3 5.4 98 52 0.2 5.5 5.7
Asset Managers 1.9 3.3 5.2 86 69 1.2 3.9 5.1
Mortgage Banks 0.4 0.6 1.0 87 77 0.4 0.5 0.9
Endowments 0.2 0.5 0.7 99 84 0.2 0.3 0.5
----- ----- ----- --- ---- ---- ----- -----
Total $ 9.7 $21.7 $31.4 88% 74% $6.6 $24.1 $30.7
===== ===== ===== === ==== ==== ===== =====
Corporate
- ---------
The corporate portfolio exposure declined to $27.7 billion at June 30, 2003
from $31.6 billion at year-end 2002. Approximately 73% of the portfolio is
investment grade, with 34% of the portfolio maturing in one year. In 2002, the
Company announced it expects to reduce its corporate exposure by $9 billion to
$24 billion by the end of 2004. At June 30, 2003, this portfolio had been
reduced by $5.3 billion of the $9 billion target.
(Dollars in billions)
06/30/03 12/31/02
----------------------------- -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Media $ 1.7 $ 2.3 $ 4.0 66% 14% $1.9 $ 2.4 $4.3
Cable 0.8 0.6 1.4 36 4 1.0 0.6 1.6
Telecom 0.5 0.7 1.2 57 30 0.7 0.8 1.5
----- ----- ----- -- -- ---- ----- -----
Subtotal 3.0 3.6 6.6 58% 15% 3.6 3.8 7.4
Utilities 0.3 2.6 2.9 87 67 0.7 3.0 3.7
Retailing 0.1 2.5 2.6 75 44 0.2 2.6 2.8
Automotive 0.2 2.1 2.3 76 41 0.2 2.6 2.8
Oil & Gas 0.3 1.6 1.9 79 37 0.4 1.7 2.1
Healthcare 0.3 1.3 1.6 85 31 0.4 1.5 1.9
Other* 2.0 7.8 9.8 73 32 2.7 8.2 10.9
----- ----- ----- -- -- ---- ----- -----
Total $ 6.2 $21.5 $27.7 73% 34% $8.2 $23.4 $31.6
===== ===== ===== == == ==== ===== =====
* Diversified portfolio of industries and geographies
Media, cable, and telecommunications has been a significant industry
specialization of the Company historically. The Company has specifically
targeted the telecom portfolio for continued reduction in exposure with a goal
of reducing the telecom portfolio below $750 million by December 31, 2004. In
the first six months of 2003, the Company reduced telecom exposure by $344
million. The percentage of investment grade borrowers in the telecom
25
portfolio has increased to 57% from 54% at year end 2002, due to reductions in
lower rated exposures.
The Company's exposure to the airline industry consists of a $632 million
aircraft leasing portfolio as well as $55 million of direct lending. The
aircraft leasing portfolio consists of $284 million to major U.S. carriers,
$253 million to foreign airlines and $95 million to U.S. regionals. During
the second quarter, the domestic airline industry witnessed structural
improvements, including favorable labor developments, continued cost
containment, and increased liquidity due to government aid. Notwithstanding
the quarter's improvements, the industry faces sustained challenges from a
tepid economic recovery, ongoing tension in labor relations, intense domestic
competition, future pension funding requirements, and geopolitical
uncertainty. Because of these factors, the Company continues to carefully
monitor its airline exposure.
Nonperforming Assets
- --------------------
Change Change
6/30/03 vs. 6/30/03 vs.
(Dollars in millions) 6/30/03 3/31/03 3/31/03 12/31/02 12/31/02
-------- -------- -------- -------- --------
Category of Loans:
Commercial $312 $327 $(15) $321 $(9)
Foreign 84 75 9 84 -
Other 41 34 7 34 7
---- ---- --- --- ---
Total Nonperforming Loans 437 436 1 439 (2)
Other Real Estate - - - 1 (1)
---- ---- ---- ---- ----
Total Nonperforming Assets $437 $436 $ 1 $440 $(3)
==== ==== ==== ==== ====
Nonperforming Assets Ratio 1.4% 1.4% 1.4%
Allowance/Nonperforming Loans 188.6 190.4 189.1
Allowance/Nonperforming Assets 188.6 190.4 188.7
Nonperforming assets totaled $437 million at June 30, 2003, essentially
unchanged from $436 million at March 31, 2003. The level of nonperforming
assets prospectively will depend upon the strength and pace of the U.S.
economic recovery.
Interest income would have been increased by $3 million and $4 million
for the second quarters of 2003 and 2002 if loans on nonaccrual status at June
30, 2003 and 2002 had been performing for the entire period. Interest income
would have been increased by $8 million for the six months ended June 30, 2003
and 2002 if loans on nonaccrual status at June 30, 2003 and 2002 had been
performing for the entire period.
26
Impaired Loans
- --------------
The table below sets forth information about the Company's impaired loans. The
Company uses the discounted cash flow method as its primary method for valuing
its impaired loans:
(Dollars in millions) 6/30/03 12/31/02
-------- --------
Impaired Loans with an Allowance $393 $376
Impaired Loans without an Allowance(1) 4 27
---- ----
Total Impaired Loans $397 $403
==== ====
Allowance for Impaired Loans(2) $189 $167
Average Balance of Impaired Loans
during the Quarter $404 $343
Interest Income Recognized on
Impaired Loans during the Quarter $0.4 $0.1
(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
- ---------
June 30 March 31 June 30
(Dollars in millions) 2003 2003 2002
------- -------- -------
Loans $37,796 $31,735 $35,998
Margin Loans 5,911 467 487
Non-Margin Loans 31,885 31,268 35,511
Allowance 824 830 616
Allowance for Loan Losses
As a Percent of Loans 2.18% 2.62% 1.71%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 2.58 2.65 1.73
The allowance for credit losses to total loans was $824 million, or 2.18%
of loans at June 30, 2003, compared with $830 million, or 2.62% at March 31,
2003 and $616 million, or 1.71% of loans at June 30, 2002.
The ratio of the allowance for credit losses to non-margin loans was
2.58% for June 30, 2003, compared with 2.65% at March 31, 2003 and 1.73% at
June 30, 2002, reflecting stability in credit quality in the first six months
of 2003. The Pershing acquisition added $5.5 billion of secured margin loans
to the Company's balance sheet at June 30, 2003. The Company has rarely
suffered a loss on these types of loans and does not allocate any of its
allowance for credit losses to these credits. The Company believes the ratio
of allowance for credit losses to non-margin loan is a more appropriate metric
for the allowance for credit losses than the ratio of allowance for loan
losses to total loans.
The ratio of the allowance to nonperforming assets was 188.6% at June 30,
2003, compared with 190.4% at March 31, 2003, and 194.9% at June 30, 2002.
The ratio of the allowance to nonperforming loans was 188.6% at June 30, 2003,
compared with 190.4% at March 31, 2003, and 195.7% at June 30, 2002. Included
in the Company's allowance for credit losses at June 30, 2003 is an allocated
transfer risk reserve related to Argentina of $23 million.
The allowance for credit losses consists of four elements: (1) an
allowance for impaired credits (nonaccrual commercial credits over $1
27
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 borrowers, 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, estimated exposure at default, and
maturity. The credit rating is judgmental and is dependent upon the borrower's
estimated probability of default. The loss given default incorporates a
recovery expectation based on historical experience, collateral, and
structure. Borrower and loss given default ratings are reviewed semi-annually
at 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. All current consumer loans are included in the
pass rated consumer pools.
The fourth element - an unallocated allowance - is based on management's
judgment regarding the following factors:
- Economic conditions including duration of the current economic cycle
- Past experience including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm
existing credit deterioration
- Geopolitical issues and their impact on the economy
28
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:
6/30/03 12/31/02
------- -------
Domestic
Real Estate 2% 3%
Commercial 75 75
Consumer 1 1
Foreign 9 9
Unallocated 13 12
--- ---
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 $64.7 billion at June 30, 2003, compared with $55.4
billion at December 31, 2002. The increase was primarily due to additional
deposits from customers who have left higher cash balances with the Company in
the low interest rate environment due to a lack of favorable overnight
investment alternatives. In addition, high securities settlement volumes at
quarter end resulted in a higher than normal level of uncompleted trades
across the industry, which added to the cash levels in customer accounts.
Noninterest-bearing deposits were $16.4 billion at June 30, 2003, compared
with $13.3 billion at December 31, 2002. Interest-bearing deposits were $48.2
billion at June 30, 2003, compared with $42.1 billion at December 31, 2002.
29
WORLD TRADE CENTER DISASTER UPDATE
During the first six months of 2003, the Company incurred $20 million in
expenses associated with interim space, business interruption, and the
restoration of facilities, which was offset by an insurance recovery.
The Company is actively engaged in subletting its interim operating
facilities. Through June 30, 2003, the Company had terminated or sublet
700,000 square feet and had 600,000 square feet remaining to sublet. The
Company has recorded a liability for its sublease loss as of June 30, 2003 of
$216 million. At June 30, 2003, the Company had reserved for approximately 53%
of the future costs associated with the subleases. The Company expects the
remainder of the costs to be covered by income from subletting these
properties.
The financial statement impact of the WTC disaster is shown in the table
below:
(In millions) 2003
----
WTC Expenses $ 20
Insurance Recovery 20
-----
Pre-tax Impact $ -
=====
Cumulative Insurance Recovery $ 673
Cumulative Cash Advances from
Insurance Companies (600)
-----
Receivable from Insurance Companies
at July 31, 2003 $ 73
=====
Future cash advances will largely relate to business interruption costs.
The Company expects to record modest additional insurance recoveries in 2003
and 2004 above the current $673 million as it completes the move of its data
centers from interim locations to final locations.
30
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 2002 Annual Report on Form 10-K.
Three of the Company's more critical accounting policies are those related to
the allowance for credit losses, to the valuation of derivatives and
securities where quoted market prices are not available, and to the valuation
of goodwill and other intangibles.
Allowance for Credit Losses
- ---------------------------
The allowance for credit losses represents management's estimate of
probable losses inherent in the Company's loan portfolio. This evaluation
process is subject to numerous estimates and judgments. Probabilities of
default ratings are assigned after analyzing the credit quality of each
borrower/counterparty and the Company's internal ratings are consistent with
external rating agency default databases. Loss given default ratings are
driven by the collateral, structure, and seniority of each individual asset
and are consistent with external loss given default/recovery databases. The
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.
The Company's unallocated allowance is established via a process that
begins with estimates of probable loss inherent in the portfolio, based upon
the following factors:
- Economic conditions, including duration of the current cycle
- Past experience, including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm existing
credit deterioration
- Geopolitical issues and their impact on the economy
To the extent actual results differ from forecasts or management's
judgment the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand
the variables that drive the allowance for credit losses.
One key variable in determining the allowance is management's judgment in
determining the size of the unallocated allowance. At June 30, 2003, the
unallocated allowance was 13% of the total allowance. If the unallocated
allowance were five percent higher or lower, the allowance would have
increased or decreased by $41 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 $62 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$84 million.
For non pass rated credits, if the loss given default were 10% worse, the
allowance would have increased by $34 million, while if the loss given default
were 10% better, the allowance would have decreased by $51 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have decreased or increased by $21 million,
respectively.
31
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
- --------------------------------------------------------------------------
Available
----------
When quoted market prices are not available for derivatives and securities
values, such values are determined at fair value, which is defined as the
value at which positions could be closed out or sold in a transaction with a
willing counterparty over a period of time consistent with the Company's
trading or investment strategy. Fair value for these instruments is determined
based on discounted cash flow analysis, comparison to similar instruments, and
the use of financial models. Financial models use as their basis independently
sourced market parameters including, for example, interest rate yield curves,
option volatilities, and currency rates. Discounted cash flow analysis is
dependent upon estimated future cash flows and the level of interest rates.
Model-based pricing uses inputs of observable prices for interest rates,
foreign exchange rates, option volatilities and other factors. Models are
benchmarked and validated by external parties. The Company's valuation process
takes into consideration factors such as counterparty credit quality,
liquidity and concentration concerns. The Company applies judgment in the
application of these factors. In addition, the Company must apply judgment
when no external parameters exist. Finally, other factors can affect the
Company's estimate of fair value including market dislocations, incorrect
model assumptions, and unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in the footnote 1 "Summary of Significant Accounting and
Reporting Policies" in the Company's 2002 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at June 30,
2003, approximately $3.2 billion of the Company's portfolio of securities and
derivatives is not priced based on quoted market prices. A change of 2.5% in
the valuation of these securities and derivatives would result in a change in
pre-tax income of $79 million.
Valuation of 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 ($3,149 million
at June 30, 2003) and indefinite-lived intangible assets ($370 million at June
30, 2003) are not amortized but are subject to annual tests for impairment or
more often if events or circumstances indicate they may be impaired. Other
intangible assets are amortized over their estimated useful lives and are
subject to impairment if events or circumstances indicate a possible inability
to realize the carrying amount. The initial recording of goodwill and other
intangibles requires subjective judgments concerning estimates of the acquired
assets fair value. The goodwill impairment test is performed in two phases.
The first step of the goodwill impairment test compares the fair value of the
reporting unit with its carrying amount, including goodwill. If the fair value
of the reporting unit equals or exceeds its carrying amount, goodwill of the
reporting unit is considered not impaired; however, if the carrying amount of
the reporting unit exceeds its fair value, an additional procedure must be
performed. That additional procedure compares the implied fair value of the
reporting unit's goodwill with the carrying amount of that goodwill. An
impairment loss is recorded to the extent that the carrying amount of goodwill
exceeds its implied fair value. Indefinite lived intangible assets are
evaluated for impairment at least annually by comparing its fair value to its
carrying value.
Other identifiable intangible assets ($454 million at June 30, 2003) are
evaluated for impairment if events and circumstances indicate a possible
impairment. Such evaluation of other intangible assets is based on
undiscounted cash flow projections. Fair value may be determined using: market
prices, comparison to similar assets, market multiples, discounted cash flow
analysis and other determinates. Estimated cash flows may extend far into the
future and, by their nature, are difficult to determine over an extended
32
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 $4.0 billion
of goodwill and intangible assets at June 30, 2003. The impact of a 5%
impairment charge would result in a change of pre-tax income of
approximately $199 million.
LIQUIDITY
The Company maintains its liquidity through the management of its assets
and liabilities, utilizing worldwide financial markets. The diversification of
liabilities reflects the Company's efforts to maintain flexibility of funding
sources under changing market conditions. Stable core deposits, including
demand, retail time, and trust deposits from processing businesses, are
generated through the Company's diversified network and managed with the use
of trend studies and deposit pricing. The use of derivative products such as
interest rate swaps and financial futures enhances liquidity by enabling the
Company to issue long-term liabilities with limited exposure to interest rate
risk. Liquidity also results from the maintenance of a portfolio of assets
which can be easily sold and the monitoring of unfunded loan commitments,
thereby reducing unanticipated funding requirements. Liquidity is managed on
both a consolidated basis and also at The Bank of New York Company, Inc.
parent company ("Parent").
On a consolidated basis, non-core sources of funds such as money market
rate accounts, certificates of deposits greater than $100,000, federal funds
purchased and other borrowings were $14.3 billion and $14.1 billion on an
average basis for the first six months of 2003 and 2002. Stable foreign
deposits, primarily from the Company's European based securities servicing
business, were $23.8 billion and $24.8 billion at June 30, 2003 and 2002.
Savings and other time deposits were $10.1 billion on a year-to-date average
basis at June 30, 2003 compared to $9.7 billion at June 30, 2002. A
significant reduction in the Company's securities businesses would reduce its
access to foreign deposits.
The Parent has five major sources of liquidity: dividends from its
subsidiaries, a collateralized line of credit with the Bank, the commercial
paper market, a revolving credit agreement with third party financial
institutions, and access to the capital markets.
At June 30, 2003, the amount of dividends the Bank could pay to the
Parent and remain in compliance with federal bank regulatory requirements was
$390 million. This dividend capacity would increase in the remainder of 2003
to the extent of net income, less dividends. Nonbank subsidiaries of the
Parent have liquid assets of approximately $423 million. These assets could be
liquidated and the proceeds delivered by dividend or loan to the Parent.
The Parent has a line of credit with the Bank, which is subject to limits
imposed by federal banking law. At June 30, 2003, the Parent could use the
subsidiaries' liquid securities as collateral to allow it to borrow $53
million rather than liquidate the securities and loan or dividend the proceeds
to the Parent and remain in compliance with federal banking regulations. The
Parent had no borrowings from the Bank at June 30, 2003.
For the quarter ended June 30, 2003, the Parent's quarterly average
commercial paper borrowings were $118 million compared with $66 million in
2002. At June 30, 2003, the Parent had cash of $691 million compared with cash
of $398 million at December 31, 2002 and $866 million at June 30, 2002. Net of
commercial paper outstanding, the Parent's cash position at June 30, 2003 was
up $345 million compared with December 31, 2002.
33
The Parent has back-up lines of credit of $275 million at financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at June 30, 2003 and June 30, 2002.
The Parent also has the ability to access the capital markets. At July
31, 2003, the Parent has a shelf registration statement with a capacity of
$1,055 million of debt, preferred stock, preferred trust securities, or common
stock. Access to the capital markets is partially dependent on the Company's
credit ratings, which as of July 31, 2003 were as follows:
The Bank of
Parent Parent Parent Senior New York
Commercial Subordinated Long-Term Long-Term
Paper Long-Term Debt Debt Deposits Outlook
----------- --------------- ------------- ------------ --------
Standard &
Poor's A-1 A A+ AA- Stable
Moody's P-1 A1 Aa3 Aa2 Negative
Fitch F1+ A+ AA- AA Stable
The Parent's major uses of funds are payment of principal and interest on
its borrowings, acquisitions, and additional investment in its subsidiaries.
The Parent has approximately $410 million of long-term debt that becomes
due in 2003 subsequent to June 30, 2003. In addition, at June 30, 2003, the
Parent has the option to call $270 million of subordinated debt in 2003 which
it will call and refinance if market conditions are favorable. In the second
quarter of 2003, the Company redeemed $360 million of debt. In July 2003, the
Company called for redemption $50 million of subordinated debt. The Parent
expects to refinance any debt it repays by issuing a combination of senior and
subordinated debt.
Double leverage is the ratio of investment in subsidiaries divided by the
Company's consolidated equity plus trust preferred securities. The Company's
double leverage ratio at June 30, 2003 and 2002 was 101.19% and 101.58%. The
Company's target double leverage ratio is a maximum of 120%. The double
leverage ratio is monitored by regulators and rating agencies and is an
important constraint on the Company's ability to invest in its subsidiaries to
expand its businesses.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Earnings and other operating activities provided $1.0 billion in cash
flows through June 30, 2003, compared with $4.0 billion provided by operating
activities through June 30, 2002. The sources of cash flows from operations in
2003 and 2002 were principally the result of changes in trading activities and
net income.
In the first six months of 2003, cash used by investing activities was
$12.1 billion as compared to cash used by investing activities in the first
six months of 2002 of $2.8 billion. In the first six months of 2003 and 2002,
cash was used to increase the Company's investment securities portfolio, which
is part of an ongoing strategy to shift the Company's asset mix from loans
towards highly rated investment securities and short-term liquid assets. In
addition, there was a significant increase in federal funds sold and
securities purchased under resale agreements. In 2002, the increase in
securities was offset by reductions in interest bearing deposits in banks and
federal funds sold and securities purchased under resale agreements.
In the first six months of 2003, cash provided by financing activities
was $10.6 billion as compared to cash used by financing activities in the
first six months of 2002 of $1.5 billion. Sources of funds in 2003 include
deposits, payables to customers and broker-dealers and the issuance of long-
term debt and common stock. In 2002 the major use of funds was deposits.
34
CAPITAL RESOURCES
Regulators establish certain levels of capital for bank holding companies
and banks, including the Company and The Bank of New York ("the Bank"), in
accordance with established quantitative measurements. In order for the
Company to maintain its status as a financial holding company, the Bank must
qualify as well capitalized. In addition, major bank holding companies such as
the Company are expected by the regulators to be well capitalized. As of June
30, 2003 and 2002, the Company and the Bank were considered well capitalized
on the basis of the ratios (defined by regulation) of Total and Tier 1 capital
to risk-weighted assets and leverage (Tier 1 capital to average assets). If a
bank holding company or bank fails to qualify as "adequately capitalized",
regulatory sanctions and limitations are imposed. The Company's and the Bank's
capital ratios are as follows:
June 30, 2003 June 30, 2002
--------------------- --------------------- Well Adequately
Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
------- ---- ------- ------ ------- ----------- -----------
Tier 1* 6.83% 6.91% 7.70% 7.57% 7.75% 6% 4%
Total Capital** 11.07 11.17 11.48 11.17 11.75 10 8
Leverage 5.85 5.90 6.82 6.70 6.50 5 3-5
Tangible Common
Equity 4.33 5.01 5.41 6.07 5.25-6.00 N.A. N.A.
* Tier 1 capital consists, generally, of common equity and certain qualifying preferred
stock, less goodwill.
**Total Capital consists of Tier 1 capital plus Tier 2 capital. Tier 2 capital consists,
generally, of certain qualifying preferred stock and subordinated debt and a portion of the
loan loss allowance.
The Company's estimated regulatory Tier 1 capital and Total capital
ratios were 6.83% and 11.07% at June 30, 2003, compared with 7.92% and
12.72% at March 31, 2003, and 7.70% and 11.48% at June 30, 2002. The
regulatory leverage ratio was 5.85% at June 30, 2003, compared with 6.68%
at March 31, 2003, and 6.82% at June 30, 2002. The Company's tangible
common equity as a percentage of total assets was 4.33% at June 30, 2003,
compared with 5.53% at March 31, 2003, and 5.41% at June 30, 2002. The
Company's capital ratios at June 30, 2003 reflect the increased size of the
balance sheet as well as an additional $1.3 billion of intangible assets
(which are deducted from regulatory capital) related to Pershing. The
Company remains well capitalized. Historically, the balance in certain
customer accounts at the Company tend to increase at period end compared to
daily average balances in those accounts, resulting in distortions in the
Company's period-end balance sheets. To minimize these distortions, the
Company plans to enter into agreements with certain customers to manage the
level of excess balances. In addition, the Company is active in addressing
industry settlement issues. The Company expects its capital ratios to
return to their targeted ranges over the next year.
35
The following table presents the components of the Company's risk-based
capital at June 30, 2003 and 2002:
(in millions) 2003 2002
---- ----
Common Stock $8,113 $6,610
Preferred Stock - -
Preferred Trust Securities 1,150 1,100
Adjustments: Intangibles (3,966) (2,364)
Securities Valuation Allowance (214) (84)
Merchant Banking Investments (5) (2)
------ ------
Tier 1 Capital 5,078 5,260
------ ------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,356 1,996
Qualifying Allowance for Loan Losses 800 583
------ ------
Tier 2 Capital 3,156 2,579
------ ------
Total Risk-based Capital $8,234 $7,839
====== ======
Risk-Adjusted Assets $74,378 $68,271
======= =======
36
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at June 30, 2003 and June 30, 2002 are
as follows:
2003
June 30, 2003 Average
---------------------------- -------------------
(In millions) Fair Value Fair Value
------------------ -------------------
Notional
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 62,181 $ 43 $ - $ 86 $ -
Swaps 158,635 1,952 537 2,089 698
Written Options 119,304 - 1,502 - 1,432
Purchased Options 63,197 268 - 271 -
Foreign Exchange Contracts:
Swaps 2,791 - - - -
Written Options 16,387 - 96 - 79
Purchased Options 18,912 73 - 520 -
Commitments to Purchase
and Sell Foreign Exchange 63,020 407 456 374 489
Debt Securities - 3,488 26 4,360 35
Credit Derivatives 1,801 5 4 6 4
Equity Derivatives - 16 - 22 17
------ ------ ------ ------
Total Trading Account $6,252 $2,621 $7,728 $2,754
====== ====== ====== ======
2002
June 30, 2002 Average
---------------------------- -------------------
(In millions) Fair Value Fair Value
------------------ -------------------
Notional
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 43,100 $ 98 $ - $ 81 $ -
Swaps 144,429 1,423 811 1,448 881
Written Options 123,597 - 1,066 - 1,023
Purchased Options 44,083 188 - 174 -
Foreign Exchange Contracts:
Swaps 1,969 - - - -
Written Options 15,278 - 166 - 83
Purchased Options 17,611 68 - 79 -
Commitments to Purchase
and Sell Foreign Exchange 59,371 825 835 437 463
Debt Securities - 3,938 142 4,473 37
Credit Derivatives 2,075 8 1 17 7
Equity Derivatives - 29 12 27 7
------ ------ ------- ------
Total Trading Account $6,577 $3,033 $ 6,736 $2,501
====== ====== ======= ======
The Company's trading activities are focused on acting as a market maker
for the Company's customers. The risk from these market making activities and
from the Company's own positions is managed by the Company's traders and
limited in total exposure as described below.
The Company manages trading risk through a system of position limits, a
value at risk (VAR) methodology, based on a Monte Carlo simulation, stop loss
advisory triggers, and other market sensitivity measures. Risk is monitored
and reported to senior management by an independent unit on a daily basis. The
VAR methodology captures, based on certain assumptions, the potential
37
overnight pre-tax dollar loss from adverse changes in fair values of all
trading positions. The calculation assumes a one day holding period for most
instruments, utilizes a 99% confidence level, and incorporates the non-linear
characteristics of options. The VAR model is used to calculate economic
capital which is allocated to the business units for computing risk-adjusted
performance. As the VAR methodology does not evaluate risk attributable to
extraordinary financial, economic or other occurrences, the risk assessment
process includes a number of stress scenarios based upon the risk factors in
the portfolio and management's assessment of market conditions. Additional
stress scenarios based upon historic market events are also tested.
The following table indicates the calculated VAR amounts for the trading
portfolio for the periods indicated.
(In millions) 2nd Quarter 2003 Year-to-Date 2003
------------------------------ -------------------------------------
Average Minimum Maximum Average Minimum Maximum 6/30/03
-------- -------- -------- ------- ------- ------- -------
Interest rate $6.4 $3.2 $10.4 $5.6 $2.2 $11.2 $9.7
Foreign Exchange 0.9 0.5 1.9 0.8 0.5 1.9 0.9
Equity 0.1 - 0.3 0.1 - 0.4 0.3
Credit Derivatives 2.0 1.6 2.8 1.0 - 2.8 1.8
Diversification (1.9) NM NM (0.6) NM NM (1.2)
Overall Portfolio 7.5 5.1 14.7 6.9 2.0 14.7 11.5
(In millions) 2nd Quarter 2002 Year-to-Date 2002
------------------------------ -------------------------------------
Average Minimum Maximum Average Minimum Maximum 6/30/02
-------- -------- -------- ------- ------- ------- -------
Interest rate $4.8 $3.5 $6.6 $5.0 $3.4 $9.2 $4.6
Foreign Exchange 1.5 0.7 3.8 1.2 0.6 3.8 0.9
Equity - - 1.1 - - 1.1 0.8
Credit Derivatives - - - - - - -
Diversification (2.1) NM NM (1.8) NM NM (1.8)
Overall Portfolio 4.2 3.0 7.2 4.4 3.0 8.3 4.5
NM - Because the minimum and maximum may occur on different days for different risk components,
it is not meaningful to compute a portfolio diversification effect.
During the first six months of 2003, interest rate risk generated
approximately 75% of average VAR, credit derivatives generated 13% of average
VAR, foreign exchange generated 11% of average VAR, and equity generated 1% of
average VAR. During the second quarter and first six months of 2003, the daily
trading loss did not exceed the calculated VAR amounts on any given day.
ASSET/LIABILITY MANAGEMENT
The Company's asset/liability management activities include lending, investing
in securities, accepting deposits, raising money as needed to fund assets, and
processing securities and other transactions. The market risks that arise from
these activities are interest rate risk, and to a lesser degree, foreign
exchange risk. The Company's primary market risk is exposure to movements in
US dollar interest rates. Exposure to movements in foreign currency interest
rates also exists, but to a significantly lower degree. The Company actively
manages interest rate sensitivity. In addition to gap analysis, the Company
uses earnings simulation and discounted cash flow models to identify interest
rate exposures.
An earnings simulation model is the primary tool used to assess changes
in pre-tax net interest income. The model incorporates management's
assumptions regarding interest rates, balance changes on core deposits, and
changes in the prepayment behavior of loans and securities. These assumptions
have been developed through a combination of historical analysis and future
expected pricing behavior. Derivative financial instruments used for interest
rate risk management purposes are also included in this model.
38
The Company evaluates the effect on earnings by running various interest
rate ramp scenarios up and down from a baseline scenario which assumes no
changes in interest rates. These scenarios are reviewed to examine the impact
of large interest rate movements. Interest rate sensitivity is quantified by
calculating the change in pre-tax net interest income between the scenarios
over a 12 month measurement period. The measurement of interest rate
sensitivity is the percentage change in net interest income as shown in the
following table:
(In millions) 2003 %
---- ----
+200 bp Ramp vs. Stable Rate $(12.0) (0.71)%
+100 bp Ramp vs. Stable Rate 10.6 0.63
-25 bp Shock vs. Stable Rate (13.9) (0.82)
These scenarios do not include the strategies that management could
employ to limit the impact as interest rate expectations change. The Company's
interest rate positioning continues to be relatively neutral to changes in
interest rates in either direction with Pershing not having a material impact.
The above table relies on certain critical assumptions including
depositors' behavior related to interest rate fluctuations and the prepayment
and extension risk in certain of the Company's assets. For example, based on
the level of interest rates at June 30, 2003, the Company does not believe it
would be able to reduce rates on all its deposit products if there are further
declines in interest rates. In addition, if interest rates rise, the Company's
portfolio of mortgage related assets would have reduced returns if the owners
of the underlying mortgages pay off their mortgages later than anticipated. To
the extent that actual behavior is different from that assumed in the models,
there could be a change in interest rate sensitivity.
The Company earns substantial distribution fee income from investing
customer funds in various liquid investments as directed by the customer.
Declines in interest rates have reduced the return available to be shared by
investors, asset managers and the Company. Further cuts in interest rates may
cause a reduction in noninterest income as the returns from these investments
are no longer adequate to compensate all of the parties involved in the
transaction. The actual impact on the Company will depend on negotiations with
the parties engaged in these transactions.
39
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended June 30, 2003 ended June 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 7,049 $ 41 2.37% $ 5,737 $ 44 3.03%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 7,931 24 1.20 2,834 12 1.69
Margin Loans 3,492 21 2.42 449 3 3.01
Loans
Domestic Offices 20,281 219 4.34 18,619 240 5.17
Foreign Offices 11,964 90 3.01 15,566 132 3.40
------- ----- ------- -----
Total Loans 32,245 309 3.84 34,185 372 4.37
------- ----- ------- -----
Securities
U.S. Government Obligations 209 2 4.16 669 9 5.40
U.S. Government Agency Obligations 3,019 29 3.84 3,253 45 5.54
Obligations of States and
Political Subdivisions 352 6 7.30 580 9 6.54
Other Securities 15,140 140 3.67 10,112 124 4.89
Trading Securities 4,346 32 2.95 8,124 68 3.36
------- ----- ------- -----
Total Securities 23,066 209 3.62 22,738 255 4.49
------- ----- ------- -----
Total Interest-Earning Assets 73,783 604 3.28% 65,943 686 4.18%
----- -----
Allowance for Credit Losses (826) (616)
Cash and Due from Banks 2,748 2,726
Other Assets 15,219 11,634
------- -------
TOTAL ASSETS $90,924 $79,687
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 7,239 $ 17 0.94% $ 6,405 $ 21 1.33%
Savings 9,039 18 0.81 8,171 22 1.10
Certificates of Deposit
$100,000 & Over 4,649 19 1.63 1,252 8 2.50
Other Time Deposits 1,350 5 1.55 1,567 9 2.27
Foreign Offices 23,827 79 1.32 24,459 98 1.60
------- ----- ------- -----
Total Interest-Bearing Deposits 46,104 138 1.20 41,854 158 1.51
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,428 4 1.10 2,299 8 1.47
Payables to Customers and Broker-Dealers 4,289 8 0.80 195 1 0.53
Other Borrowed Funds 983 5 1.90 4,199 27 2.66
Long-Term Debt 6,469 42 2.53 5,450 56 4.06
------- ----- ------- -----
Total Interest-Bearing Liabilities 59,273 197 1.33% 53,997 250 1.87%
----- -----
Noninterest-Bearing Deposits 12,383 10,257
Other Liabilities 11,661 9,017
Common Shareholders' Equity 7,607 6,416
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $90,924 $79,687
======= =======
Net Interest Earnings
and Interest Rate Spread $ 407 1.95% $ 436 2.31%
===== ==== ===== ====
Net Yield on Interest-Earning Assets 2.22% 2.65%
==== ====
40
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the six months For the six months
ended June 30, 2003 ended June 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 6,024 $ 71 2.38% $ 5,481 $ 79 2.88%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 6,475 39 1.21 3,069 26 1.72
Margin Loans 1,970 24 2.43 452 6 2.57
Loans
Domestic Offices 19,471 433 4.48 18,759 480 5.16
Foreign Offices 12,424 186 3.03 15,869 270 3.43
------- ----- ------- -----
Total Loans 31,895 619 3.91 34,628 750 4.37
------- ----- ------- -----
Securities
U.S. Government Obligations 267 5 3.88 736 20 5.37
U.S. Government Agency Obligations 3,135 63 4.02 3,075 87 5.66
Obligations of States and
Political Subdivisions 367 13 7.07 574 19 6.57
Other Securities 14,582 278 3.80 9,322 231 4.96
Trading Securities 5,025 76 3.06 8,435 141 3.38
------- ----- ------- -----
Total Securities 23,376 435 3.73 22,142 498 4.51
------- ----- ------- -----
Total Interest-Earning Assets 69,740 1,188 3.43% 65,772 1,359 4.18%
----- -----
Allowance for Credit Losses (828) (616)
Cash and Due from Banks 2,780 2,683
Other Assets 14,036 11,809
------- -------
TOTAL ASSETS $85,728 $79,648
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 7,457 $ 35 0.96% $ 6,661 $ 44 1.34%
Savings 8,766 38 0.87 8,114 48 1.18
Certificates of Deposit
$100,000 & Over 4,687 39 1.69 877 12 2.74
Other Time Deposits 1,311 11 1.68 1,585 19 2.38
Foreign Offices 23,847 161 1.36 24,816 195 1.59
------- ----- ------- -----
Total Interest-Bearing Deposits 46,068 284 1.24 42,053 318 1.53
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,360 7 1.04 2,203 16 1.47
Payables to Customers and Broker-Dealers 2,219 9 0.80 196 1 0.94
Other Borrowed Funds 823 5 1.30 4,370 54 2.45
Long-Term Debt 5,958 80 2.68 5,239 109 4.15
------- ----- ------- -----
Total Interest-Bearing Liabilities 56,428 385 1.38% 54,061 498 1.87%
----- -----
Noninterest-Bearing Deposits 11,871 10,192
Other Liabilities 10,261 9,097
Common Shareholders' Equity 7,168 6,298
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $85,728 $79,648
======= =======
Net Interest Earnings
and Interest Rate Spread $ 803 2.05% $ 861 2.31%
===== ==== ===== ====
Net Yield on Interest-Earning Assets 2.32% 2.64%
==== ====
41
FORWARD LOOKING STATEMENTS
The information presented with respect to, among other things, earnings
outlook, projected business growth, the outcome of legal, regulatory and
investigatory proceedings, the Company's plans, objectives and strategies for
reallocating assets and moving into fee-based businesses, and future loan
losses, is forward looking information. Forward looking statements are the
Company's current estimates or expectations of future events or future
results.
The Company or its executive officers and directors on behalf of the
Company, may from time to time make forward looking statements. When used in
this report, any press release or oral statements, the words "estimate,"
"forecast," "project," "anticipate," "expect," "intend," "believe," "plan,"
"goal," "should," "may," "strategy," and words of similar meaning are intended
to identify forward looking statements in addition to statements specifically
identified as forward looking statements.
Forward looking statements, including the Company's discussions and
projections of future results of operations and discussions of future plans
contained in Management's Discussion and Analysis and elsewhere in this Form
10-Q, are based on management's current expectations and assumptions and are
subject to risks and uncertainties, some of which are discussed herein, that
could cause actual results to differ materially from projected results.
Forward looking statements could be affected by a number of factors that the
Company is necessarily unable to predict with accuracy, including disruptions
in general economic activity, the economic and other effects of the WTC
disaster and the subsequent U.S. military action, lower than expected
performance or higher than expected costs in connection with acquisitions and
integration of acquired businesses, changes in relationships with customers,
the ability to satisfy customer requirements, investor sentiment, variations
in management projections, methodologies used by management to evaluate risk
or market forecasts and the actions that management could take in response to
these changes, management's ability to achieve efficiency goals and set
adequate reserve levels for contingent liabilities, changes in customer credit
quality, future changes in interest rates, general credit quality, the levels
of economic, capital market, and merger and acquisition activity, consumer
behavior, government monetary policy, domestic and foreign legislation,
regulation and investigation, competition, credit, market and operating risk,
and loan demand, as well as the pace of recovery of the domestic economy,
market demand for the Company's products and services and future global
political, economic, business, market, competitive and regulatory conditions.
This is not an exhaustive list and as a result of variations in any of these
factors actual results may differ materially from any forward looking
statements.
Forward looking statements speak only as of the date they are made. The
Company will not update forward looking statements to reflect facts,
assumptions, circumstances or events which have changed after a forward
looking statement was made.
Government Monetary Policies
- ----------------------------
The Federal Reserve Board has the primary responsibility for United
States monetary policy. Its actions, and, to a lesser extent, the actions of
monetary policy authorities of other major countries, have an important
influence on the demand for credit and investments and the level of interest
rates and thus on the earnings of the Company.
42
Competition
- -----------
The businesses in which the Company operates are very competitive.
Competition is provided by both unregulated and regulated financial services
organizations, whose products and services span the local, national, and
global markets in which the Company conducts operations.
International, national, and regional commercial banks, trust banks,
investment banks, specialized processing companies, outsourcing companies,
data processing companies, stock exchanges, and other business firms offer
active competition for securities servicing and global payment services.
Commercial banks, savings banks, savings and loan associations, and credit
unions actively compete for deposits, and money market funds and brokerage
houses offer deposit-like services. These institutions, as well as consumer
and commercial finance companies, national retail chains, factors, insurance
companies and pension trusts, are important competitors for various types of
loans. Issuers of commercial paper compete actively for funds and reduce
demand for bank loans. In the private client services and asset management
markets, international, national, and regional commercial banks, standalone
asset management companies, mutual funds, securities brokerage firms,
insurance companies, investment counseling firms, and other business firms and
individuals actively compete for business.
WEBSITE INFORMATION
The Company makes available, on its website: www.bankofny.com its annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and all amendments to these reports as soon as reasonably practicable
after such material is electronically filed with or furnished to the SEC.
43
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
June 30, December 31,
2003 2002
---- ----
Assets
- ------
Cash and Due from Banks $ 4,323 $ 4,748
Interest-Bearing Deposits in Banks 6,744 5,104
Securities
Held-to-Maturity (fair value of $375 in 2003 374 954
and $952 in 2002)
Available-for-Sale 20,018 17,346
------- -------
Total Securities 20,392 18,300
Trading Assets at Fair Value 6,252 7,309
Federal Funds Sold and Securities Purchased
Under Resale Agreements 12,076 1,385
Loans (less allowance for credit losses of $824 in 2003
and $831 in 2002) 36,972 30,508
Premises and Equipment 1,108 975
Due from Customers on Acceptances 191 351
Accrued Interest Receivable 244 204
Goodwill 3,149 2,497
Intangible Assets 824 78
Other Assets 7,329 6,105
------- -------
Total Assets $99,604 $77,564
======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $16,406 $13,301
Interest-Bearing
Domestic Offices 21,940 19,997
Foreign Offices 26,309 22,089
------- -------
Total Deposits 64,655 55,387
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 1,035 636
Trading Liabilities 2,621 2,800
Payables to Customers and Broker-Dealers 9,407 870
Other Borrowed Funds 916 475
Acceptances Outstanding 194 352
Accrued Taxes and Other Expenses 4,033 4,066
Accrued Interest Payable 142 101
Other Liabilities 1,973 753
Long-Term Debt 6,515 5,440
------- -------
Total Liabilities 91,491 70,880
------- -------
Shareholders' Equity
Class A Preferred Stock - par value $2.00 per share,
authorized 5,000,000 shares, outstanding 3,000 shares
in 2003 and in 2002 - -
Common Stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,038,852,034 shares in 2003 and
993,697,297 shares in 2002 7,791 7,453
Additional Capital 1,564 847
Retained Earnings 5,053 4,736
Accumulated Other Comprehensive Income 158 134
------- -------
14,566 13,170
Less: Treasury Stock (265,946,234 shares in 2003
and 267,240,854 shares in 2002), at cost 6,450 6,483
Loan to ESOP (485,533 shares in 2003
and in 2002), at cost 3 3
------- -------
Total Shareholders' Equity 8,113 6,684
------- -------
Total Liabilities and Shareholders' Equity $99,604 $77,564
======= =======
- ----------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2002 has been derived from the audited financial
statements at that date.
44
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(In millions, except per share amounts)
(Unaudited)
For the three For the six
months ended months ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Interest Income
- ---------------
Loans $ 330 $ 375 $642 $756
Securities
Taxable 155 158 315 299
Exempt from Federal Income Taxes 13 16 26 32
----- ----- ----- -----
168 174 341 331
Deposits in Banks 41 44 71 79
Federal Funds Sold and Securities Purchased
Under Resale Agreements 24 12 39 26
Trading Assets 32 68 76 141
----- ----- ----- -----
Total Interest Income 595 673 1,169 1,333
----- ----- ----- -----
Interest Expense
- ----------------
Deposits 138 158 284 318
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 4 8 7 16
Other Borrowed Funds 13 28 14 55
Long-Term Debt 42 56 80 109
----- ----- ----- -----
Total Interest Expense 197 250 385 498
----- ----- ----- -----
Net Interest Income 398 423 784 835
- -------------------
Provision for Credit Losses 40 35 80 70
----- ----- ----- -----
Net Interest Income After Provision
for Credit Losses 358 388 704 765
----- ----- ----- -----
Noninterest Income
- ------------------
Servicing Fees
Securities 598 478 1,071 932
Global Payment Services 79 71 156 144
----- ----- ----- -----
677 549 1,227 1,076
Private Client Services and
Asset Management Fees 94 88 184 171
Service Charges and Fees 93 93 191 176
Foreign Exchange and Other Trading Activities 88 72 154 134
Securities Gains 9 25 16 56
Other 35 28 69 60
----- ----- ----- -----
Total Noninterest Income 996 855 1,841 1,673
----- ----- ----- -----
Noninterest Expense
- -------------------
Salaries and Employee Benefits 498 418 921 805
Net Occupancy 64 49 122 98
Furniture and Equipment 49 35 85 70
Other 267 194 489 372
Merger and Integration Costs 25 - 25 -
----- ----- ----- -----
Total Noninterest Expense 903 696 1,642 1,345
----- ----- ----- -----
Income Before Income Taxes 451 547 903 1,093
Income Taxes 156 186 313 370
----- ----- ----- -----
Net Income $ 295 $ 361 $ 590 $ 723
- ---------- ===== ===== ===== =====
Per Common Share Data:
- ----------------------
Basic Earnings $0.39 $0.50 $0.80 $1.00
Diluted Earnings 0.39 0.50 0.80 0.99
Cash Dividends Paid 0.19 0.19 0.38 0.38
Diluted Shares Outstanding 757 729 742 729
- ------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
45
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the six months ended June 30, 2003
(In millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,453
Issuance of Common Stock related to Pershing 300
Issuances in Connection with Employee Benefit Plans 38
-------
Balance, June 30 7,791
-------
Additional Capital
Balance, January 1 847
Issuance of Common Stock related to Pershing 696
Issuances in Connection with Employee Benefit Plans 21
-------
Balance, June 30 1,564
-------
Retained Earnings
Balance, January 1 4,736
Net Income $ 590 590
Cash Dividends on Common Stock (273)
-------
Balance, June 30 5,053
-------
Accumulated Other Comprehensive Income
Securities Valuation Allowance
Balance, January 1 155
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $30 Million 50 50
Reclassification Adjustment, Net of Taxes of $(21) Million (27) (27)
-------
Balance, June 30 178
-------
Foreign Currency Items
Balance, January 1 (47)
Foreign Currency Translation Adjustment,
Net of Taxes of $(2) Million (5) (5)
-------
Balance, June 30 (52)
-------
Unrealized Derivative Gains
Balance, January 1 26
Net Unrealized Derivative Gains on Cash Flow Hedges,
Net of Taxes of $5 Million 6 6
------ ------
Balance, June 30 32
------
Total Comprehensive Income $ 614
======
Less Treasury Stock
Balance, January 1 6,483
Issued (48)
Acquired 15
-------
Balance, June 30 6,450
-------
Less Loan to ESOP
Balance, January 1 3
-------
Balance, June 30 3
-------
Total Shareholders' Equity, June 30 $ 8,113
=======
- ------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended June 30, 2003 and 2002 was $331 million and
$387 million.
Comprehensive Income for the six months ended June 30, 2003 and 2002 was $614 million and
$675 million.
See accompanying Notes to Consolidated Financial Statements.
46
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
For the six months
ended June 30,
2003 2002
---- ----
Operating Activities
Net Income $ 590 $ 723
Adjustments to Determine Net Cash Attributable to
Operating Activities
Provision for Losses on Loans and Other Real Estate 80 70
Depreciation and Amortization 194 91
Deferred Income Taxes 210 329
Securities Gains (16) (56)
Change in Trading Activities 891 2,464
Change in Accruals and Other, Net (979) 427
------ ------
Net Cash Provided by Operating Activities 970 4,048
------ ------
Investing Activities
Change in Interest-Bearing Deposits in Banks (1,386) (831)
Change in Margin Loans (249) (34)
Purchases of Securities Held-to-Maturity - (60)
Paydowns of Securities Held-to-Maturity 567 51
Maturities of Securities Held-to-Maturity 10 18
Purchases of Securities Available-for-Sale (13,273) (10,353)
Sales of Securities Available-for-Sale 2,556 2,818
Paydowns of Securities Available-for-Sale 4,202 1,161
Maturities of Securities Available-for-Sale 3,880 2,888
Net Principal Disbursed on Loans to Customers (1,128) (474)
Sales of Loans and Other Real Estate 410 205
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (6,492) 2,150
Purchases of Premises and Equipment (69) (126)
Acquisitions, Net of Cash Acquired (1,769) (323)
Proceeds from the Sale of Premises and Equipment 2 -
Other, Net 626 66
------ ------
Net Cash Used by Investing Activities (12,113) (2,844)
------ ------
Financing Activities
Change in Deposits 8,856 (1,073)
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements (234) (69)
Change in Payables to Customers and Broker-Dealers 942 (301)
Change in Other Borrowed Funds (803) (315)
Proceeds from the Issuance of Long-Term Debt 1,811 675
Repayments of Long-Term Debt (804) (60)
Issuance of Common Stock 1,105 128
Treasury Stock Acquired (15) (235)
Cash Dividends Paid (273) (275)
------ ------
Net Cash Provided (Used) by Financing Activities 10,585 (1,525)
------ ------
Effect of Exchange Rate Changes on Cash 133 (16)
------ ------
Change in Cash and Due From Banks (425) (337)
Cash and Due from Banks at Beginning of Period 4,748 3,222
------ ------
Cash and Due from Banks at End of Period $4,323 $2,885
====== ======
- ----------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 347 $ 541
Income Taxes 292 24
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - 1
- ----------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
47
THE BANK OF NEW YORK COMPANY, INC.
Notes to Consolidated Financial Statements
1. General
-------
The accounting and reporting policies of The Bank of New York Company,
Inc., a financial holding company, and its consolidated subsidiaries (the
"Company") conform with generally accepted accounting principles and general
practice within the banking industry. Such policies are consistent with those
applied in the preparation of the Company's annual financial statements.
The accompanying consolidated financial statements are unaudited. In the
opinion of management, all adjustments necessary for a fair presentation of
financial position, results of operations and cash flows for the interim
periods have been made.
2. Accounting Changes and New Accounting Pronouncements
----------------------------------------------------
On January 1, 2003, the Company adopted Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143").
SFAS 143 addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The adoption of this pronouncement did not
have an impact on the Company's results of operations or financial condition.
On January 1, 2003, the Company adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities". The standard requires
costs associated with exit or disposal activities to be recognized when they
are incurred rather than at the date of a commitment to an exit or disposal
plan. The adoption of this pronouncement did not have an impact on the
Company's results of operations or financial condition.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of Certain
Financial Institutions." This standard eliminates specialized accounting
guidance related to certain acquisitions. The adoption of this pronouncement
did not have an impact on the Company's results of operations or financial
condition.
The Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," in 1995. At that time, as permitted by the standard, the
Company elected to continue to apply the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
accounted for the options granted to employees using the intrinsic value
method, under which no expense is recognized for stock options because they
were granted at the stock price on the grant date and therefore have no
intrinsic value.
Effective January 1, 2003, the Company began accounting for its options
under the fair value method of SFAS 123 as amended by SFAS 148 "Accounting for
Stock-Based Compensation- Transition and Disclosure". SFAS 148 permits three
different methods of adopting fair value: (1) the prospective method, (2) the
modified prospective method, and (3) the retroactive restatement method. Under
the prospective method, options issued after January 1, 2003 are expensed
while all options granted prior to January 1, 2003 are accounted for under APB
25 using the intrinsic value method. Consistent with industry practice, the
Company elected the prospective method of adopting fair value accounting.
During the quarter and six months ended June 30, 2003, approximately 18
million options were granted with a weighted average fair value of $5.35 per
share. In the second quarter and first six months of 2003, the Company
recorded $8 million and $11 million of stock option expense.
48
The retroactive restatement method requires the Company's financial
statements to be restated as if fair value accounting had been adopted in
1995. The following table discloses the pro forma effects on the Company's
net income and earnings per share as if the retroactive restatement method had
been adopted.
(In millions, 2nd Quarter Year to date
except per share amounts) 2003 2002 2003 2002
----- ----- ---- ----
Reported net income $295 $361 $590 $723
Stock based employee compensation costs,
using prospective method, net of tax 5 - 7 -
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (21) (24) (40) (40)
---- ---- ---- ----
Pro forma net income $279 $337 $557 $683
==== ==== ==== ====
Reported diluted earnings per share $0.39 $0.50 $0.80 $1.00
Impact on diluted earnings per share (0.02) (0.03) (0.04) (0.04)
----- ----- ----- -----
Pro forma diluted earnings per share $0.37 $0.47 $0.76 $0.96
===== ===== ===== =====
The fair value of options granted in 2003 and 2002 were estimated at the
grant date using the following weighted average assumptions:
Second Quarter Year to date
2003 2002 2003 2002
---- ---- ---- ----
Dividend yield 3.00% 2.50% 3.00% 2.50%
Expected volatility 33.54 29.71 32.78 29.77
Risk free interest rates 2.22 3.87 2.66 4.36
Expected options lives 5 5 5 5
In January 2003, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". This interpretation expands
the disclosures to be made by a guarantor in its financial statements about
its obligations under certain guarantees and requires the guarantor to
recognize a liability for the fair value of an obligation assumed under a
guarantee. The disclosure requirements of FIN 45 are effective for the Company
as of December 31, 2002, and require disclosure of the nature of the
guarantee, the maximum potential amount of future payments that the guarantor
could be required to make under the guarantee, and the current amount of the
liability, if any, for the guarantor's obligations under the guarantee. The
recognition requirements of FIN 45 are to be applied prospectively to
guarantees issued or modified after December 31, 2002. Significant guarantees
that have been entered into by the Company are disclosed in footnote 8. The
adoption of FIN 45 did not have an impact on the Company's results of
operations or financial condition.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities". This interpretation requires a
company that holds a variable interest in an entity to consolidate the entity
if the company's interest in the variable interest entities (VIE) is such that
the company will absorb a majority of the VIE's expected losses and/or
receives a majority of the entity's expected residual returns. FIN 46 also
requires additional disclosures by primary beneficiaries and other significant
variable interest holders. The provisions of this interpretation became
effective upon issuance. The consolidation requirements of FIN 46 applied
immediately to VIEs created after January 31, 2003 and apply to previously
established entities in the third quarter of 2003.
As of December 31, 2002, the Company had variable interests in 7
securitization trusts, which are discussed in footnote 8 of the Company's 2002
Annual Report. These trusts are qualifying special-purpose entities, which
49
are exempt from the consolidation requirements of FIN 46. FIN 46 may require
the Company to consolidate a modest amount of assets currently held off-
balance sheet in asset management investment vehicles. If necessary, the
Company will attempt to restructure these entities so that consolidation is
not required.
FIN 46 has also raised questions about whether variable interest entities
similar to the trusts used to issue trust preferred securities should be
treated as a consolidated subsidiary. The Company has $1,150 million of trust
preferred securities outstanding. Traditionally, issuer trusts used for
issuing trust preferred securities have been consolidated by their parent
companies and trust preferred securities have been treated as eligible for
"Tier 1" regulatory capital treatment by bank holding companies under Federal
Reserve Board rules and regulations. Accordingly, the Company has consolidated
its existing issuer trusts in preparing its consolidated financial statements
in the past and its outstanding trust preferred securities have been treated
as Tier 1 regulatory capital by the Company. This is consistent with the
approach taken by similarly situated financial institutions. The industry is
currently assessing, in dialogue with its independent accountants and
regulators, whether or not the issuer trusts should continue to be
consolidated. If the answer is no, the Company would be required to make
certain adjustments to its financial statements during the third quarter of
2003 to reflect the deconsolidation. Moreover, if deconsolidation is required
under FIN 46, then it is possible that the Federal Reserve Board may conclude
that trust preferred securities should no longer be treated as Tier 1
regulatory capital. On July 2, 2003, the Board of Governors of the Federal
Reserve issued a letter, SR 03-13, stating that notwithstanding FIN 46, trust
preferred securities will continue to be included in Tier 1 capital until
notice is given to the contrary. In the event of a disallowance, there would
be a reduction in the Company's consolidated capital ratios. However, the
Company believes that the Bank would remain "well capitalized" under Federal
Reserve Board guidelines.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" (SFAS 149). SFAS 149 amends
and clarifies accounting for derivative instruments. This Statement is
generally effective after June 30, 2003 and is not expected to have a material
impact on the Company's financial statements. The Company does not expect the
adoption of this pronouncement to have an impact on its results of operations
or financial condition.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". The
provisions of SFAS 150 are effective for financial instruments entered into or
modified after May 31, 2003, and otherwise are effective at the beginning of
the first interim period beginning after June 15, 2003. The Company does not
expect the adoption of the provisions of this Statement to have a material
effect on the Company's operating results or financial position.
Certain other prior year information has been reclassified to conform its
presentation with the 2003 financial statements.
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing and
asset management businesses.
During the second quarter of 2003, 3 businesses were acquired for the
total cost of $2,013 million, primarily paid in cash. During the first six
months of 2003, 5 businesses were acquired for the total cost of $2,045
million, primarily paid in cash. The Company frequently structures its
acquisitions with both an initial payment and a later contingent payment tied
to post-closing revenue or income growth. The Company records the fair value
of contingent payments as an additional cost of the entity acquired in the
period that the payment becomes probable.
50
Goodwill related to second quarter and first six months of 2003
acquisition transactions was $583 million and $610 million, respectively. The
tax deductible portion of goodwill for the second quarter and first six months
of 2003 is $583 million and $603 million. All of the goodwill was assigned to
the Company's Servicing and Fiduciary Business segment. At June 30, 2003, the
Company was liable for potential contingent payments related to acquisitions
in the amount of $693 million. During the second quarter and first six months
of 2003, the Company paid $5 million and $26 million for contingent payments
related to acquisitions made in prior years. The pro forma effect of the 2003
acquisitions is not material to year to date 2003 net income.
2003
- ----
On May 1, 2003, the Company acquired Credit Suisse First Boston's
Pershing unit, headquartered in Jersey City, New Jersey. Pershing is a leading
global provider of correspondent clearing services and outsourcing solutions
for broker-dealers, asset managers and other financial intermediaries.
Pershing had 3,677 employees worldwide at 13 locations in the U.S., Europe and
Asia on June 30, 2003. The Company paid a purchase price of $2 billion in
cash, with the premium to book value of $1.3 billion, which may be adjusted
upwards by up to $50 million if certain revenue targets are met in 2003.
The Company financed the purchase price through settlement of its forward
sale of 40 million common shares in exchange for approximately $1 billion.
The remainder of the purchase price was financed using long-term debt.
The acquisition was accounted for under the purchase method of accounting
in accordance with SFAS 141,"Business Combinations". The purchase price of $2
billion was allocated as follows: goodwill $0.6 billion, customer
relationships $0.4 billion, trademarks $0.4 billion, and other tangible assets
$0.6 billion. The results of Pershing are included in the accompanying
statement of income for the period from May 1, 2003 through June 30, 2003.
The Company expects the acquisition to be dilutive to its earnings by
approximately $0.02 per share in 2003 (not including dilution of approximately
$0.07 per share from a 2003 integration charge associated with the
acquisition), and accretive by at least $0.02 to $0.03 per share in 2004.
In the second quarter 2003, the Company acquired Capital Resource
Financial Services, LLC (CRFS), a Chicago-based provider of commission
recapture, transition management and third-party services to plan sponsors and
investment managers. This acquisition adds new clients in execution services
and improves market coverage in the Chicago area/Midwest. It will be folded
into BNY Brokerage, part of BNY Securities Group.
In the second quarter 2003, the Company acquired the corporate trust
business of INTRUST Bank, N.A., headquartered in Wichita, Kansas. The
transaction involves the transfer of more than 300 bond trust and agency
appointments for corporations and municipalities in Kansas and the surrounding
states.
Two other transactions announced in 2002 closed in early 2003. In January
2003, the Company acquired the back-office clearance and settlement
capabilities of Tilney Investment Management through the acquisition of
certain assets. This acquisition based in Liverpool, England, expands the
Company's United Kingdom correspondent clearing capability.
In February 2003, the Company acquired the stock of International Fund
Administration Ltd. (IFA), a Bermuda-based, alternative investment fund
administrator. IFA offers service solutions for alternative investments,
including hedge funds, and will offer services to funds domiciled in Bermuda,
Cayman Islands, Ireland, Jersey, Luxembourg and the United States.
4. Goodwill and Intangibles
------------------------
Goodwill by segment as of June 30, 2003 is as follows:
51
Servicing
and
Fiduciary Corporate Retail Financial Consolidated
(In millions) Businesses Banking Banking Markets Total
---------- --------- ------- --------- -----------
Balance as of
June 30, 2003 $3,009 $31 $109 $ - $3,149
====== === ==== === ======
The Company's business segments are tested annually for goodwill
impairment. The Company completed its initial evaluation of goodwill for
impairment in 2002 and its annual evaluation in 2003 and 2002 and determined
that no impairment loss was required.
Intangible Assets
- ---------------------
Weighted
Gross Net Average
(In millions) Carrying Accumulated Carrying Amortization
Amount Amortization Amount Period in Years
-------- ------------ -------- ---------------
Trade Names $370 $ - $370 Indefinite Life
Other Intangible Assets 497 43 454 16
The aggregate amortization expense of intangibles was $6 million and $2
million for the quarters ended June 30, 2003 and 2002, respectively. The
aggregate amortization expense of intangibles was $9 million and $4 million
for the six months ended June 30, 2003 and 2002, respectively. Estimated
amortization expense for the next five years is as follows:
For the Year Ended Amortization
(In millions) December 31, Expense
------------------ ------------
2003 $28
2004 35
2005 35
2006 35
2007 35
5. Allowance for Credit Losses
---------------------------
The allowance for credit losses is maintained at a level that, in
management's judgment, is adequate to absorb probable losses associated with
specifically identified loans, as well as estimated probable credit losses
inherent in the remainder of the loan portfolio at the balance sheet date.
Management's judgment includes the following factors, among others: risks of
individual credits; past experience; the volume, composition, and growth of
the loan portfolio; and economic conditions.
The Company conducts a quarterly portfolio review to determine the
adequacy of its allowance for credit losses. All commercial loans over $1
million are assigned to specific risk categories. Smaller commercial and
consumer loans are evaluated on a pooled basis and assigned to specific risk
categories. Following this review, senior management of the Company analyzes
the results and determines the allowance for credit losses. The Audit and
Examining Committee of the Company's Board of Directors, in conjunction with
the Risk Committee of the Company's Board of Directors, reviews the allowance
at the end of each quarter.
The portion of the allowance for credit losses allocated to impaired
loans (nonaccrual commercial loans over $1 million) is measured by the
difference between their recorded value and fair value. Fair value is the
present value of the expected future cash flows from borrowers, the market
value of the loan, or the fair value of the collateral.
52
Commercial loans are placed on nonaccrual status when collateral is
insufficient and principal or interest is past due 90 days or more, or when
there is reasonable doubt that interest or principal will be collected.
Accrued interest is usually reversed when a loan is placed on nonaccrual
status. Interest payments received on nonaccrual loans may be recognized as
income or applied to principal depending upon management's judgment.
Nonaccrual loans are restored to accrual status when principal and interest
are current or they become fully collateralized. Consumer loans are not
classified as nonperforming assets, but are charged off and interest accrued
is suspended based upon an established delinquency schedule determined by
product. Real estate acquired in satisfaction of loans is carried in other
assets at the lower of the recorded investment in the property or fair value
minus estimated costs to sell.
Transactions in the allowance for credit losses are summarized as
follows:
Six months ended
June 30,
(In millions) 2003 2002
---- ----
Balance, Beginning of Period $831 $616
Charge-Offs (93) (76)
Recoveries 6 6
---- ----
Net Charge-Offs (87) (70)
Provision 80 70
---- ----
Balance, End of Period $824 $616
==== ====
6. Capital Transactions
--------------------
In connection with the acquisition of Pershing on May 1, 2003, the
Company settled its forward sale of 40 million common shares in exchange for
approximately $1 billion. The Company issued $108 million of subordinated debt
in the second quarter of 2003 and $530 million for the first six months of
2003. In April 2003, the Company sold $350 million of 5.95% trust preferred
securities and called for redemption its $300 million 7.05% Series D Fund
Preferred Securities. At July 31, 2003, the Company has a registration
statement with a remaining capacity of approximately $1,055 million of debt,
preferred stock, preferred trust securities, or common stock.
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
Three Months Ended Six Months Ended
June 30, June 30,
(In millions, except per share amounts)
2003 2002 2003 2002
---- ---- ---- ----
Net Income (1) $295 $361 $590 $723
==== ==== ==== ====
Basic Weighted Average
Shares Outstanding 751 722 736 722
Shares Issuable on Exercise of
Employee Stock Options 6 7 6 7
---- ---- ---- ----
Diluted Weighted Average Shares Outstanding 757 729 742 729
==== ==== ==== ====
Basic Earnings Per Share: $0.39 $0.50 $0.80 $1.00
Diluted Earnings Per Share: 0.39 0.50 0.80 0.99
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
53
8. Commitments and Contingent Liabilities
--------------------------------------
In the normal course of business, various commitments and contingent
liabilities are outstanding which are not reflected in the accompanying
consolidated balance sheets. Management does not expect any material losses to
result from these matters.
A summary of the notional amount of the Company's off-balance-sheet
credit transactions, net of participations, at June 30, 2003 and December 31,
2002 follows:
Off-Balance-Sheet Credit Risks
June 30, December 31,
In millions 2003 2002
- ----------- --------- ------------
Lending Commitments $ 36,203 $ 40,330
Standby Letters of Credit, net 10,044 9,577
Commercial Letters of Credit 1,168 1,052
Securities Lending Indemnifications 161,911 138,264
Standby Bond Purchase Agreements 1,531 2,587
The total potential loss on undrawn commitments, standby and commercial
letters of credit, and securities lending indemnifications is equal to the
total notional amount if drawn upon, which does not consider the value of any
collateral. Since many of the commitments are expected to expire without being
drawn upon, the total amount does not necessarily represent future cash
requirements. The allowance for credit losses allocated to undrawn commitments
at June 30, 2003 and December 31, 2002 was $100 million and $117 million.
In securities lending transactions, the Company generally requires the
borrower to provide 102% cash collateral which is monitored on a daily basis,
thus reducing credit risk. Security lending transactions are generally entered
into only with highly rated counterparties. At June 30, 2003 and December 31,
2002, securities lending indemnifications were secured by collateral of $165.1
billion and $142.5 billion.
The notional amounts for other off-balance-sheet risks express the dollar
volume of the transactions; however, credit risk is much smaller. The Company
performs credit reviews and enters into netting agreements to minimize the
credit risk of foreign currency and interest rate risk management products.
The Company enters into offsetting positions to reduce exposure to foreign
exchange and interest rate risk.
Standby letters of credit principally support corporate obligations and
include $0.6 billion and $0.5 billion that were collateralized with cash and
securities at June 30, 2003 and December 31, 2002. At June 30, 2003,
approximately $6.9 billion of the standbys will expire within one year, and
the balance between one to five years. The allowance for credit losses
allocated to letters of credit at June 30, 2003 and December 31, 2002 was $40
million.
At June 30, 2003, the notional amounts and credit exposures for the
Company's credit derivatives swaps were $1,801 million and $4 million,
compared to $1,818 million and $6 million at December 31, 2002.
Other
In the ordinary course of business, the Company makes certain investments
that have tax consequences. From time to time, the IRS may question or
challenge the tax position taken by the Company. The Company engaged in
certain types of structured leasing transactions prior to mid-1999 that the
IRS has indicated it intends to challenge. The Company believes that its tax
position related to these transactions was proper based upon applicable
statutes, regulations and case law and that it should prevail with respect to
these challenges. However, a court, other judicial or administrative
authority, if presented with the transactions could disagree. The Company
intends to defend its position vigorously in accordance with its view of the
law controlling these investments.
54
The Company has also entered into two investments that produce synthetic
fuel from coal byproducts. Section 29 of the Internal Revenue Code provides a
tax credit for these types of transactions. Recently the IRS has publicly
indicated that it plans to conduct independent research at several leading
sponsors of these investments to verify that the chemical changes required to
achieve the tax credit are in fact taking place. Both the Company's
investments have an ongoing program for testing production in order to verify
that the required chemical change occurs, and an independent testing
laboratory provides documentation attesting to this result. In addition, both
investments were reviewed by the IRS and were issued favorable private letter
rulings as to the investments' qualification for Section 29 credit purposes.
Accordingly, the Company believes its tax position is proper as it relates to
these investments and that it should prevail if challenged.
The Company currently believes it has adequate tax reserves to cover
these and other potential tax exposures the IRS could raise.
In the ordinary course of business, there are various claims pending
against the Company and its subsidiaries. In the opinion of management,
liabilities arising from such claims, if any, would not have a material effect
upon the Company's consolidated financial statements. See "Legal Proceedings"
under Part 2, Item 1 for further details.
55
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 2003
Commission file number 1-6152
THE BANK OF NEW YORK COMPANY, INC.
Incorporated in the State of New York
I.R.S. Employer Identification No. 13-2614959
Address: One Wall Street
New York, New York 10286
Telephone: (212) 495-1784
As of July 31, 2003, The Bank of New York Company, Inc. had
772,585,506 shares of common stock ($7.50 par value) outstanding.
The Bank of New York Company, Inc. (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months(or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
The registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The following sections of the Financial Review set forth in the cross-
reference index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
- ----------------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of
June 30, 2003 and December 31, 2002 43
Consolidated Statements of Income for
the three months and six months
ended June 30, 2003 and 2002 44
Consolidated Statement of Changes in
Shareholders' Equity for the six months
ended June 30, 2003 45
Consolidated Statement of Cash Flows for the
six months ended June 30, 2003 and 2002 46
Notes to Consolidated Financial Statements 47 - 54
Consolidated Average Balance Sheet
and Net Interest Analysis 39
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 2 - 42
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 36 - 38
56
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
the Company's management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934). Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the design
and operation of these disclosure controls and procedures were effective. No
significant changes were made in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date
of their evaluation.
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------
The Company continues to cooperate with investigations by federal and state
law enforcement and bank regulatory authorities. The investigations focus on
funds transfer activities in certain accounts at the Bank, principally
involving wire transfers from Russian and other sources in Eastern Europe, as
well as certain other matters involving the Bank and its affiliates. The funds
transfer investigations center around accounts controlled by Peter Berlin, his
wife, Lucy Edwards (until discharged in September 1999, an officer of the
Bank), and companies and persons associated with them. Berlin and Edwards pled
guilty to various federal criminal charges. The Company cannot predict when or
on what basis the investigations will conclude or their effect, if any, on the
Company.
Two consolidated shareholder derivative actions were filed (one in United
States District Court for the Southern District of New York and one in New
York Supreme Court, County of New York) against certain current and former
directors and officers of the Company and the Bank. Both actions alleged that
the defendants breached their fiduciary duties of due care and loyalty by (i)
aggressively pursuing business with Russian banks and other business entities
without implementing sufficient safeguards, and (ii) failing to supervise
properly those responsible for that business. In addition, the federal
complaint included allegations that certain current and former officers of the
Bank and the Company participated in an improper scheme to transfer cash from
Russia to off-shore accounts. The federal district court dismissed the
consolidated federal action in November 2001; the Court of Appeals for the
Second Circuit affirmed the district court's dismissal on February 12, 2003,
and plaintiffs have not appealed.
The parties in the state derivative action reached a settlement of the
consolidated action providing for payment of $26.5 million by defendants'
insurance carriers to the Company and requiring the Company and the Bank to
undertake certain prophylactic measures. The state court approved the
settlement on April 30, 2003, and that decision is now final.
On October 24, 2000, three alleged shareholders of Inkombank, Morgenthow
& Latham, New York International Insurance Group, and Oriental XL Funds, filed
an action in the New York Supreme Court, New York County. The complaint
alleges that (i) Bank representatives fraudulently induced plaintiffs to
maintain their $40 million investment in Inkombank by concealing from the
plaintiffs information about Inkombank's true financial state and the
corruptness of Inkombank's senior management, and (ii) Bank representatives,
including senior management, were involved in a complex scheme to loot
Inkombank assets. The complaint states a cause of action for fraud, seeks $40
million, interest, costs, attorneys' fees, and unspecified punitive damages.
On May 20, 2003, the Appellate Division, First Department reversed the
trial court's denial of the Company and the Bank's motion to dismiss the
Complaint, and entered judgment dismissing the complaint as to the Company and
57
the Bank. Plaintiffs have sought leave to appeal to the New York State Court
of Appeals. The request is pending.
The Company does not expect that any of the foregoing civil actions will
have a material impact on the Company's consolidated financial statements.
General Motors Acceptance Corporation ("GMAC") has informed the Company
of claims it believes entitle it to adjustment of the purchase price it paid
to the Company in the 1999 sale of BNY Financial Corporation ("BNYFC"), a
factoring and asset-based finance business. These claims assert, among other
things, misrepresentations with respect to certain asset valuations and income
items.
Although the Company and GMAC are engaged in discussions that could lead
to a settlement, it is possible that GMAC will assert sizable claims against
the Company if no settlement is reached. The Company believes that either a
settlement will be reached soon or GMAC will commence litigation. The Company
believes it has meritorious defenses to GMAC's potential claims and that a
material purchase price adjustment is not warranted, and would vigorously
defend its position if GMAC were to proceed against the Company. The Company
has a reserve that it believes is adequate to cover the expected outcome of
the case in litigation, based on probabilities of various potential outcomes.
The probabilities and outcomes will be reviewed as events unfold, and it may
be necessary to make future adjustments to the reserve.
The Company's principal banking subsidiary, The Bank of New York (the
"Bank"), is currently a defendant in two civil actions relating to RW
Professional Leasing Services Corp. ("RW"), a former customer of a Long Island
branch of the Bank. These actions, which arise from the conduct of an alleged
fraudulent scheme by RW, allege that the Bank breached certain obligations and
engaged in certain misrepresentations. The actions seek damages of
approximately $46 million. The Bank believes it has meritorious defenses to
these actions. Several federal criminal charges have been filed against RW,
certain of its principals and other individuals. The U.S. Attorney's Office
for the Eastern District of New York (the "Office") has informed the Bank that
it and certain of its employees are subjects of the Office's ongoing
investigation relating to RW. The Bank is cooperating fully in that
investigation.
In the ordinary course of business, there are various legal claims
pending against the Company and its subsidiaries. In the opinion of
management, liabilities arising from such claims, if any, would not have a
material effect on the Company's consolidated financial statements.
Item 4. Submission of Matters to Vote of Security Holders
- ----------------------------------------------------------
The Company held its annual meeting on May 13, 2003 at The Bank of New
York at 101 Barclay St. in New York, New York. The shareholders:
(1) elected thirteen persons to serve as directors of the Company;
(2) ratified the appointment of Ernst & Young LLP as the Company's
independent public accountants for 2004;
(3) approved a proposal with respect to the Company's 2003 Long-Term
Incentive Plan;
(4) approved a proposal with respect to the Company's 2004
Management Incentive Compensation Plan; and
(5) defeated a shareholder proposal with respect to political
contributions.
58
The number of votes cast for, against or withheld, and the number of
abstentions with respect to each such matter is set forth below, as are the
number of broker non-votes, where applicable. Pursuant to New York law,
abstentions and broker non-votes are not counted toward the election of
directors.
FOR AGAINST/WITHHELD ABSTAINED BROKER NON-VOTES
(1) Election of Directors:
Frank J. Biondi, Jr. 617,282,026 28,705,462
Nicholas M. Donofrio 625,853,458 20,134,030
Alan R. Griffith 632,733,819 13,253,669
Gerald L. Hassell 631,998,438 13,989,050
Richard J. Kogan 616,264,979 29,722,509
Michael J. Kowalski 633,250,680 12,736,808
John A. Luke, Jr. 624,715,135 21,272,353
John C. Malone 609,836,239 36,151,249
Paul Myners 624,766,020 21,221,468
Catherine A. Rein 625,774,497 20,212,991
Thomas A. Renyi 628,943,041 17,044,447
William C. Richardson 625,714,502 20,272,986
Brian L. Roberts 629,323,190 16,664,298
(2) Ratification of Auditors 617,797,820 23,133,382 5,056,286
(3) Approval of Proposal
With Respect to 2003
Long-Term Incentive Plan 402,649,864 135,881,379 7,942,349 99,513,896
(4) Approval of Proposal
With Respect to 2004
Management Incentive
Compensation Plan 589,707,207 46,504,836 9,775,445
(5) Approval of Shareholder
Proposal With Respect to
Political Contributions 25,147,921 481,513,447 39,812,224 99,513,896
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) The exhibits filed as part of this report are as follows:
Exhibit 3(ii) - By-laws of the registrant.
Exhibit 12 - Statement Re: Ratio of Earnings to Fixed Charges
for the Three Months and Six Months Ended June 30, 2003 and 2002.
Exhibit 31 - Certification of Chairman and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.1 - Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32 - Certification of Chairman and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) The Company filed the following reports on Form 8-K since
March 31, 2003:
On April 1, 2003, the Company filed a Form 8-K Current Report (Item 5 and
7), which report included ten exhibits in connection with the Registration
Statement on Form S-3 (File Nos. 333-103003, 333-103003-01, 333-103003-02,
333-103003-03, 333-103003-04) covering the Company's Senior Subordinated
Medium-Term Notes, Series F and Senior Medium-Term Notes Series E, issuable
under an Indenture, dated as of October 1, 1993 between the Company and
J.P.Morgan Trust Company, National Association and an Indenture, dated as of
July 18, 1991 between the Company and Deutsche Bank Trust Company Americas,
respectively. The exhibits consist of a Distribution Agreement dated June 26,
2002; a Distribution Agreement dated March 28, 2003; Form of the Company's
Global Medium Term Fixed Rate Note; Form of the Company's Global Medium Term
Floating Rate Note; Officers' Certificate dated June 26, 2002 pursuant to
Sections 201 and 301 of the Senior Subordinated Indenture; Officers'
59
Certificate dated June 26, 2002 pursuant to Sections 201 and 301 of the Senior
Indenture; Officers' Certificate dated March 28, 2003 pursuant to Section 301
of the Senior Subordinated Indenture; Officers' Certificate dated March 28,
2003 pursuant to Section 301 of the Senior Indenture; Opinion of counsel as to
the legality of the Notes; and Consent of counsel.
On April 16, 2003, the Company filed a Form 8-K Current report (Item 5, 9
and 12), which report included unaudited interim financial information and
accompanying discussion for the first quarter of 2003 contained in the
Company's press release dated April 16, 2003 and the Definitive agreement
between Credit Suisse First Boston (USA),Inc. and The Bank of New York
Company, Inc. for the acquisition of the Pershing unit of Credit Suisse First
Boston (USA), Inc.
On May 2, 2003, the Company filed a Form 8-K Current report (Item 5 and
7), which report included eight exhibits in connection with the issuance by
BNY Capital V (the "Trust") of 14,000,000 of its 5.95% Trust Preferred
Securities, Series F, which represent beneficial interests in the Trust, in a
public offering registered under the Securities Act of 1933, as amended
(Registration Statement Nos. 333-103003, 333-103003-1, 333-103003-02, 333-
103003-03, 333-103003-04). The exhibits consist of the Pricing agreement dated
April 22, 2003; Letter Agreement dated April 30, 2003; Junior Subordinated
Indenture dated December 26, 1996; Specimen of the 5.95% Junior Subordinated
Deferrable Interest Debentures, Series F; Amended and Restated Trust Agreement
dated April 30, 2003; Specimen of the 5.95% Trust Preferred Securities, Series
F, of BNY Capital V; Guarantee Agreement dated April 30, 2003; and Agreement
as to Expenses and Liabilities dated April 30, 2003.
On May 14, 2003, the Company filed a Form 8-K Current report (Item 9),
which report included the certifications required by the Securities and
Exchange Commission pursuant to 18 U.S.C. Section 1350.
On June 18, 2003, the Company filed a Form 8-K Current report (Item 9),
which report included a press release dated June 18, 2003, providing an update
with respect to its acquisition of Pershing LLC.
On July 17, 2003, the Company filed a Form 8-K Current report (Item 5, 7
and 12), which report included unaudited interim financial information and
accompanying discussion for the second quarter of 2003 contained in the
Company's press release dated July 17, 2003.
60
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: August 13, 2003 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
61
EXHIBIT INDEX
-------------
Exhibit Description
- ------- -----------
3(ii) By-laws of the registrant.
12 Ratio of Earnings to Fixed Charges for the
Three Months and Six Months Ended June 30, 2003 and 2002.
31 Certification of Chairman and Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.1 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chairman and Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.