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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended September 30, 2003
The Quarterly Report on Form 10-Q and cross reference index is on page 57.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Introduction 2
- Overview 2
- Summary of Results 2
- Pershing 3
- Consolidated Income Statement Review 8
- Business Segments Review 12
- Consolidated Balance Sheet Review 23
- World Trade Center Disaster Update 31
- Critical Accounting Policies 32
- Liquidity 34
- Capital Resources 36
- Trading Activities 38
- Asset/Liability Management 39
- Statistical Information 41
- Forward Looking Statements 43
- Website Information 44
Consolidated Financial Statements
- Consolidated Balance Sheets
September 30, 2003 and December 31, 2002 45
- Consolidated Statements of Income
For the Three Months and Nine Months
Ended September 30, 2003 and 2002 46
- Consolidated Statement of Changes In
Shareholders' Equity For the Nine
Months Ended September 30, 2003 47
- Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2003 and 2002 48
- Notes to Consolidated Financial Statements 49 - 56
Form 10-Q
- Cover 57
- Controls and Procedures 58
- Legal Proceedings 58
- Changes in Securities and Use of Proceeds 59
- Exhibits and Reports on Form 8-K 59
- Signature 60
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
2003 2003 2002
--------------------- ------------------- ------------
Reported Operating Reported Operating Reported
--------- --------- -------- --------- ------------
Quarter
- -------
Net Income $ 260 $ 322 $ 295 $ 311 $ 79
Basic EPS 0.34 0.42 0.39 0.41 0.11
Diluted EPS 0.34 0.42 0.39 0.41 0.11
Cash Dividends Per Share 0.19 0.19 0.19 0.19 0.19
Return on Average Common
Shareholders' Equity 12.82% 15.85% 15.56% 16.41% 4.73%
Return on Average Assets 1.06 1.31 1.30 1.37 0.40
Efficiency Ratio 70.7 63.8 64.8 63.0 56.4
Year-To-Date
- ------------
Net Income $ 850 $ 929 $ 590 $ 607 $ 802
Basic EPS 1.14 1.24 0.80 0.82 1.11
Diluted EPS 1.13 1.23 0.80 0.82 1.10
Cash Dividends Per Share 0.57 0.57 0.38 0.38 0.57
Return on Average Common
Shareholders' Equity 15.23% 16.63% 16.61% 17.08% 16.74%
Return on Average Assets 1.27 1.39 1.39 1.43 1.35
Efficiency Ratio 65.5 62.4 62.5 61.6 55.0
Assets $95,193 $99,604 $80,987
Loans 37,540 37,796 34,242
Securities 22,862 20,392 18,023
Deposits - Domestic 35,660 37,319 32,964
- Foreign 23,283 27,336 24,005
Long-Term Debt 6,298 6,515 5,528
Common Shareholders' Equity 8,223 8,113 6,633
Common Shareholders'
Equity Per Share $ 10.63 $ 10.50 $ 9.15
Market Value Per Share
of Common Stock 29.11 28.75 28.74
Allowance for Credit Losses
as a Percent of Loans 2.18% 2.18% 1.99%
Allowance for Credit Losses as
a Percent of Non-Margin Loans 2.55 2.50 2.01
Tier 1 Capital Ratio 7.08 6.83 7.70
Total Capital Ratio 11.18 11.07 11.73
Leverage Ratio 5.64 5.85 6.77
Tangible Common Equity Ratio 4.66 4.33 5.38
Employees 22,926 23,106 18,905
Assets Under Custody (In trillions)
Total Assets Under Custody $7.9 $7.8 $6.6
Cross-Border Assets 2.2 2.2 1.8
Equity Securities 32% 32% 26%
Fixed Income Securities 68 68 74
Assets Under Administration
(In billions) $32 $27 $27
Total Assets Under Management
(In billions) 85 83 71
Equity Securities 31% 32% 29%
Fixed Income Securities 22 23 26
Alternative Investments 10 9 9
Liquid Assets 37 36 36
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 third quarter diluted earnings per share were 34 cents and
operating earnings were 42 cents per share, compared with reported earnings of
39 cents per share and operating earnings of 41 cents per share in the second
quarter. Third quarter reported results include previously announced merger
and integration costs associated with the acquisition of Pershing of 2 cents
per share and the cost of the settlement of claims related to the Company's
1999 sale of BNY Financial Corporation to General Motors Acceptance
Corporation ("GMAC") of 6 cents per share.
Net income for the third quarter was $260 million, compared with $79
million or 11 cents per share a year ago, when the Company incurred credit
charges and a valuation adjustment on its bank stock portfolio. Year-to-date
net income was $850 million, or $1.13 per share, compared to $802 million, or
$1.10 per share in 2002.
The third quarter results showed continued improvement in the Company's
primary businesses, including securities servicing and related foreign
exchange, and private client services and asset management. The quarter also
included a full quarter of results from Pershing, which closed on May 1, 2003.
This contributed to record securities servicing fees of $657 million in the
third quarter. Noninterest income grew to a new high of 72% of total
revenues.
3
Excluding Pershing, securities servicing fees increased 1.2% over the
second quarter, or 5% annualized, led by global custody, broker-dealer
services and mutual fund services. Core noninterest expenses were essentially
flat, as reductions in discretionary expenditures offset continued investments
in strategic initiatives. Nonperforming assets declined by $49 million, or
11% in the third quarter, while the ratio of the allowance to non-performing
assets improved from 188.6% to 210.5%.
New business wins and the general improvement in market tone assisted the
Company in achieving a second consecutive quarter of improving operating
earnings, in spite of the normal seasonal slowdown in equity transaction
volume. Combining top line growth with solid day-to-day expense control
resulted in a restoration of positive operating leverage.
The Company's program to enhance its credit risk profile advanced well as
reflected by the decline in nonperforming assets as well as further reductions
in corporate exposures. This quarter also marked the first full reporting
period with Pershing, where the Company remains on track to achieve its stated
goals for integration costs and synergy benefits.
Overall, the continued firming of the global capital markets bodes well
for the Company's business model. Pershing in particular is well positioned
to benefit from the increased level of confidence shown by the retail
investor.
PERSHING
Supplemental Financial Information
- ----------------------------------
For the quarter and nine months ended September 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.
- - Other non-operating expenses including merger and integration costs
related to the Pershing acquisition and the settlement with GMAC.
The Company believes that providing supplemental non-GAAP financial
information is useful to investors in understanding the underlying operational
performance of the Company and its businesses and performance trends and,
therefore, facilitates comparisons with the performance of other financial
service companies. Specifically, the Company believes that the exclusion of
the merger and integration costs, and the settlement with GMAC, 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. Although the Company believes that the non-GAAP financial
measures presented in this report enhance investors' understanding of the
Company's business and performance, these non-GAAP measures should not be
considered an alternative to GAAP. The following is a reconciliation of the
Company's financial results for the quarter and nine months ended September
30, 2003:
4
THE BANK OF NEW YORK COMPANY, INC.
Supplemental Information
(In millions, except per share amounts)
(Unaudited)
Income Statement
Quarter ended September 30
SUPPLEMENTAL GAAP
----------------------------------- -----------------------
Operating 2003 2002
------------ Reported Reported
Core Pershing (a) Other(c) Results Results
---- -------- ----------- -------- --------
Net Interest Income $ 387 $ 20 $ - $ 407 $ 418
- -------------------
Provision for Credit Losses 40 - - 40 225
----- ----- ----- ----- -----
Net Interest Income After
Provision for
Credit Losses 347 20 - 367 193
----- ----- ----- ----- -----
Noninterest Income
- ------------------
Servicing Fees
Securities 495 162 - 657 480
Global Payment Services 80 - - 80 74
----- ----- ----- ----- -----
575 162 - 737 554
Private Client Services and
Asset Management Fees 97 - - 97 85
Service Charges and Fees 88 1 - 89 90
Foreign Exchange and Other
Trading Activities 80 12 - 92 49
Securities Gains 9 - - 9 (188)
Other 35 4 - 39 46
----- ----- ----- ----- -----
Total Noninterest Income 884 179 - 1,063 636
----- ----- ----- ----- -----
Noninterest Expense
- -------------------
Salaries and Employee Benefits 443 90 - 533 397
Net Occupancy 57 12 - 69 76
Furniture and Equipment 35 15 - 50 32
Clearing 28 14 - 42 32
Sub-custodian Expenses 18 - - 18 18
Software 36 9 - 45 29
Amortization of Intangibles 4 4 - 8 -
Merger and Integration Costs - - 23 23 -
Other 145 28 78 251 122
----- ----- ----- ----- -----
Total Noninterest Expense 766 172 101 1,039 706
----- ----- ----- ----- -----
Income Before Income Taxes 465 27 (101) 391 123
Income Taxes 159 11 (39) 131 44
----- ----- ----- ----- -----
Net Income $ 306 $ 16 $ (62) $ 260 $ 79
- ---------- ===== ===== ===== ===== =====
Diluted Earnings Per Share $0.43 ($0.01)(b) ($0.08) $0.34 $0.11
Notes:
Reported results agree with the Company's Consolidated Statement of Income
(a) Includes $8 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.
(c) Consists of merger and integration costs related to the Pershing acquisition and the settlement
with GMAC of $78 million, net of reserves.
5
THE BANK OF NEW YORK COMPANY, INC.
Supplemental Information
(In millions, except per share amounts)
(Unaudited)
Income Statement
Nine Months ended September 30
SUPPLEMENTAL GAAP
----------------------------------- -----------------------
Operating 2003 2002
------------ Reported Reported
Core Pershing (a) Other(c) Results Results
---- -------- ----------- -------- --------
Net Interest Income $1,159 $ 31 $ - $1,190 $1,253
- -------------------
Provision for Credit Losses 120 - - 120 295
------ ----- ----- ------ ------
Net Interest Income After
Provision for
Credit Losses 1,039 31 - 1,070 958
------ ----- ----- ------ ------
Noninterest Income
- ------------------
Servicing Fees
Securities 1,457 271 - 1,728 1,411
Global Payment Services 238 - - 238 220
------ ----- ----- ------ ------
1,695 271 - 1,966 1,631
Private Client Services and
Asset Management Fees 281 - - 281 256
Service Charges and Fees 277 1 - 278 264
Foreign Exchange and Other
Trading Activities 224 22 - 246 183
Securities Gains 26 - - 26 (131)
Other 100 7 - 107 106
------ ----- ----- ------ ------
Total Noninterest Income 2,603 301 - 2,904 2,309
------ ----- ----- ------ ------
Noninterest Expense
- -------------------
Salaries and Employee Benefits 1,305 149 - 1,454 1,202
Net Occupancy 172 20 - 192 175
Furniture and Equipment 108 26 - 134 101
Clearing 89 22 - 111 91
Sub-custodian Expenses 53 - - 53 48
Software 107 16 - 123 84
Amortization of Intangibles 11 7 - 18 5
Merger and Integration Costs - - 48 48 -
Other 423 47 78 548 345
------ ----- ----- ------ ------
Total Noninterest Expense 2,268 287 126 2,681 2,051
------ ----- ----- ------ ------
Income Before Income Taxes 1,374 45 (126) 1,293 1,216
Income Taxes 473 18 (48) 443 414
------ ----- ----- ------ ------
Net Income $ 901 $ 27 $ (78) $ 850 $ 802
- ---------- ====== ===== ===== ====== ======
Diluted Earnings Per Share $1.25 ($0.02)(b) ($0.10) $1.13 $1.10
Notes:
Reported results agree with the Company's Consolidated Statement of Income
(a) Includes $14 million of net interest costs attributable to the Pershing acquisition financing.
(b) The ($0.02) dilution is due to changes in shares outstanding attributable to the acquisition.
(c) Consists of merger and integration costs related to the Pershing acquisition and the settlement
with GMAC of $78 million, net of reserves.
6
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
September 30, 2003 GAAP
SUPPLEMENTAL REPORTED
----------------------------------------- ------------------
Core Pershing Elimination
September 30, September 30, Entries September 30, December 31,
2003 2003 2003 2002
---- ---- ------- ---- ----
Assets
- ------
Cash and Due from Banks $ 3,668 $ 62 $ - $ 3,730 $ 4,748
Interest-Bearing Deposits in Banks 4,873 448 - 5,321 5,104
Securities 22,845 17 - 22,862 18,300
Trading Assets at Fair Value 6,709 180 - 6,889 7,309
Federal Funds Sold and
Securities Purchased Under
Resale Agreements 2,832 3,851 - 6,683 1,385
Margin Loans 73 5,399 - 5,472 352
Loans (less allowance for
credit losses of $817 in 2003
and $831 in 2002) 29,358 1,893 - 31,251 30,156
Premises and Equipment 963 125 - 1,088 975
Due from Customers on Acceptances 233 - - 233 351
Accrued Interest Receivable 271 8 - 279 204
Investment in/Advances to Pershing 3,542 - (3,542)
Goodwill & Intangible Assets 2,645 1,327 - 3,972 2,575
Other Assets 6,256 1,157 - 7,413 6,105
------- ------- ------- ------- -------
Total Assets $84,268 $14,467 $(3,542) $95,193 $77,564
======= ======= ======= ======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits $58,943 $ - $ - $58,943 $55,387
Federal Funds Purchased and
Securities Sold Under
Repurchase Agreements 622 337 - 959 636
Trading Liabilities 2,779 70 - 2,849 2,800
Payables to Customers and Broker-Dealers 1,419 8,751 - 10,170 870
Other Borrowed Funds 739 1,755 (1,507) 987 475
Acceptances Outstanding 235 - - 235 352
Accrued Taxes and Other Expenses 3,987 112 - 4,099 4,066
Accrued Interest Payable 122 3 - 125 101
Other Liabilities 901 1,404 - 2,305 753
Long-Term Debt 6,298 - - 6,298 5,440
------ ------ ------ ------- -------
Total Liabilities 76,045 12,432 (1,507) 86,970 70,880
------ ------ ------ ------- -------
Shareholders' Equity 8,223 2,035 (2,035) 8,223 6,684
------- ------- ------- ------- -------
Total Liabilities and
Shareholders' Equity $84,268 $14,467 $(3,542) $95,193 $77,564
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2002 has been derived from the audited financial statements
at that date.
7
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
and BNY Global Clearing onto the platform of Pershing. Conversions are
proceeding on schedule with all domestic clients converted and all
international conversions expected to be completed in the fourth quarter
except for those clients acquired in the Tilney acquisition. See Notes to
Consolidated Financial Statements. As expected, the Company's existing
clearing clients have been overwhelmingly supportive of converting to the
Pershing platform and the client retention levels will meet the Company's
targets.
The second priority is achieving projected cost and revenue synergies.
Synergies were projected to be $22 million in 2003 and $115 million in 2004.
The Company is on target for the $22 million of synergies in 2003, which is
primarily achieved through cost synergies related to closing the Company's
existing clearing operations.
With respect to Pershing's results, total revenues were $207 million for
the quarter, after adjusting net interest income for $8 million of financing
costs. Third quarter monthly average revenue was equal to the monthly average
in the second quarter despite equity trading volumes being lower in the
third quarter. The current run rate is slightly less than the revenue run
rate anticipated when the transaction was announced. However, the modest
shortfall reflects more optimistic assumptions on trading volumes in the
second half of 2003 than has occurred. The operating margin, excluding
financing costs and amortization of intangibles, was 19% in the
third quarter, which was flat with last quarter.
8
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
Noninterest income for the third quarter of 2003 was $1,063 million, an
increase of 7% sequentially and 67% from a year ago. Noninterest income for
the nine months ended September 30, 2003 was $2,904 million, an increase of
26% over the comparable 2002 period. The increases are principally due to the
acquisition of Pershing, improved performance in the core businesses, and the
absence in 2003 of the negative valuation adjustment in the third quarter of
2002. Pershing's contribution to the Company's noninterest income was $179
million for the quarter and $301 million for the nine months ended September
30, 2003.
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-Date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
----- ---- ---- ---- ----
Servicing Fees
Securities $ 657 $598 $480 $1,728 $1,411
Global Payment Services 80 80 74 238 220
------ ---- ---- ------ ------
737 678 554 1,966 1,631
Private Client Services
and Asset Management Fees 97 94 85 281 256
Service Charges and Fees 89 92 90 278 264
Foreign Exchange and
Other Trading Activities 92 88 49 246 183
Securities Gains 9 9 (188) 26 (131)
Other 39 35 46 107 106
------ ---- ---- ------ ------
Total Noninterest Income $1,063 $996 $636 $2,904 $2,309
====== ==== ==== ====== ======
Securities servicing fees were up 10% sequentially to a record $657
million, primarily reflecting a full quarter's results for Pershing which
closed on May 1.
Excluding Pershing, core securities servicing fees were up 1.2%
sequentially, or 5% annualized, despite the seasonal slowdown in equity
trading volumes. The primary growth drivers were the Company's investor
services and broker-dealer services businesses, which combined were up a
healthy 5% sequentially. Within these segments, custody and mutual fund
services both grew from new business and the benefit of higher equity prices.
Government securities clearance and global collateral management
continued to generate good growth due to strength in fixed income trading
volumes and new business wins in the broker-dealer community.
Issuer services were roughly flat this quarter, as a pick up in corporate
trust fees was offset by lower activity in depositary receipts, evidenced by
light capital raising activity in the quarter.
Execution and clearing services increased overall due to the addition of
Pershing for the full quarter, but execution services businesses in particular
were negatively impacted by the decrease in equity trading volumes in the
quarter.
Global payment services fees were flat compared with the prior quarter
and increased 8% from the third quarter of 2002. Year-over-year growth is
attributable to the build-out of multi-currency product capabilities and
further penetration of the financial institutions market segment.
9
Private client services and asset management fees for the third quarter
were up 3% from the prior quarter, and 14% from the third quarter of 2002.
The sequential quarter and year-over-year increases reflect higher equity
price levels as well as the continued strong demand for alternative
investments from Ivy Asset Management and higher short-term money management
fees, partially offset by higher seasonal tax-oriented fees in the second
quarter. In addition, the year-over-year comparison also benefited from
acquisitions. Total assets under management were $85 billion at September 30,
2003, up from $83 billion at June 30, 2003 and $71 billion a year ago.
Service charges and fees have remained generally stable. The increase of
5% on a year-to-date basis over 2002 primarily reflects higher fees from loan
syndication and underwriting fees.
Foreign exchange and other trading revenues were up 5% compared with the
prior quarter and up $43 million, or 88% from one year ago. The increase from
the second quarter was primarily due to Pershing contributing for the full
third quarter compared to only two months in the second quarter. Excluding
Pershing, foreign exchange remained strong, increasing slightly from the
second quarter as higher client activity levels and volatility in September
offset the seasonal slowdown in August. Compared to a year ago, the
significant increase resulted from increased client-driven foreign exchange
and interest rate hedging activity and the Pershing acquisition. For the nine
months ended September 30, 2003, foreign exchange and other trading revenues
were up 34% over the nine months ended September 30, 2002.
Securities gains in the third quarter were $9 million, flat with the
prior quarter and up significantly from a loss of $188 million a year ago.
Year-to-date securities gains were $157 million higher than the prior year
period. Both year-to-year comparisons reflected a $210 million equity write-
down in the third quarter of 2002.
Other noninterest income increased $4 million from the second quarter of
2003 and decreased $7 million from the third quarter of 2002. Third quarter
2002 results included a $32 million Empire State Development Corporation
("ESDC") grant covering relocation and other costs.
Net Interest Income
- -------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-Date
(Dollars in millions) ------- ------- ------- ------------
2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Net Interest Income $407 $398 $418 $1,190 $1,253
Tax Equivalent Adjustment 9 9 11 27 36
---- ---- ---- ------ ------
Net Interest Income on a
Tax Equivalent Basis $416 $407 $429 $1,217 $1,289
==== ==== ==== ====== ======
Net Interest Rate
Spread 1.87% 1.95% 2.32% 1.99% 2.31%
Net Yield on Interest
Earning Assets 2.10 2.22 2.66 2.24 2.65
Net interest income on a taxable equivalent basis was $416 million in the
third quarter of 2003, compared with $407 million in the second quarter of
2003, and $429 million in the third quarter of 2002. The net interest rate
spread was 1.87% in the third quarter of 2003, compared with 1.95% in the
second quarter of 2003, and 2.32% in the third quarter of 2002. The net yield
on interest earning assets was 2.10% in the third quarter of 2003, compared
with 2.22% in the second quarter of 2003, and 2.66% in the third quarter of
2002.
The increase in net interest income from the second quarter of 2003 is
primarily due to the full quarter impact of Pershing and modest growth in the
Company's investment securities portfolio. This was partially offset by the
10
impact of the Federal Reserve rate reduction in June. The decline in net
interest income from the third quarter of 2002 reflects lower reinvestment
yields on fixed income securities, planned decreases in loan balances, and the
impact of Federal Reserve interest rate reductions in 2002 and 2003, which
were partially offset by the Pershing acquisition and higher average balances
of investment securities.
For the first nine months of 2003, net interest income on a taxable
equivalent basis amounted to $1,217 million compared with $1,289 million in
the first nine months of 2002, reflecting the same factors that affected the
comparison with last year's quarter. The year-to-date net interest spread was
1.99% in 2003 compared with 2.31% in 2002, while the net yield on interest
earning assets was 2.24% in 2003 and 2.65% 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
- ------------------------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Salaries and Employee Benefits $ 443 $439 $397 $1,305 $1,202
Net Occupancy 57 57 76 172 175
Furniture and Equipment 35 38 32 108 101
Clearing 28 31 32 89 91
Sub-custodian Expenses 18 19 18 53 48
Software 36 36 29 107 84
Amortization of Intangibles 4 4 - 11 5
Other 145 139 122 423 345
------ ---- ---- ------ ------
Total Core 766 763 706 2,268 2,051
Merger and Integration Costs 23 25 - 48 -
Pershing 172 115 - 287 -
GMAC Settlement 78 - - 78 -
------ ---- ---- ------ ------
Total Noninterest Expense $1,039 $903 $706 $2,681 $2,051
====== ==== ==== ====== ======
Noninterest expense for the third quarter of 2003 was $1,039 million,
compared with $903 million in the prior quarter. The increase principally
reflects the full quarter impact of Pershing and non-operating merger and
integration expenses as well as net costs related to the GMAC settlement.
Core noninterest expense was $766 million, essentially flat with the
second quarter of 2003. On a core basis salaries and employee benefits were
up only 1% from the second quarter. Core headcount decreased by 180 during the
quarter bringing the year-to-date core headcount reductions to 385. Other
expense categories also reflected the Company's focus on reducing
discretionary spending. The business process reviews the Company has been
conducting are also producing results and enabling the Company to absorb the
cost of investments important to its future growth, such as technology
spending, business continuity planning, quality programs, and marketing and
branding initiatives within the overall expense base.
The increase in core expenses compared with the third quarter and first
nine months of 2002 primarily reflects the impact of acquisitions, the
inception of stock option expensing in 2003, a lower pension credit, increased
technology investments and higher business continuity spending.
Reflecting the shift in the Company's business mix including the Pershing
acquisition, the efficiency ratio, excluding non-operating expenses related to
11
the GMAC settlement and the Pershing's merger and integration costs, increased
to 63.8% for the third quarter of 2003, compared with 63.0% in the previous
quarter and 56.1% in the third quarter of 2002, excluding the impact of the
ESDC grant and the associated sublease expense.
The effective tax rate for the third quarter of 2003 was 33.4%, compared
to 34.6% in the second quarter of 2003, and 35.9% in the third quarter 2002.
The effective tax rate for the nine months ended September 30, 2003 was 34.3%,
compared with 34.0% for the nine months ended September 30, 2002. The
decrease in the effective tax rate reflects the tax benefit on the GMAC
settlement and lower state and local taxes.
Credit Loss Provision and Net Charge-Offs
- -----------------------------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-Date
------- ------- ------- ------------
(In millions) 2003 2003 2002 2003 2002
---- ---- ---- ---- ----
Provision $ 40 $ 40 $225 $120 $295
==== ==== ==== ==== ====
Net Charge-offs:
Commercial $ (25) $ (34) $(150) $ (85) $(197)
Foreign (12) (7) (5) (18) (5)
Other (4) - - (15) (14)
Consumer (6) (5) (5) (16) (14)
------ ------ ------ ----- ------
Total $ (47) $ (46) $(160) $(134) $(230)
====== ====== ====== ===== ======
Other Real Estate Expenses $ - $ - $ - $ - $ -
The provision for credit losses was $40 million in the third quarter of
2003, flat with $40 million in the second quarter of 2003 and down
significantly from $225 million in the third quarter of 2002. The larger
provision in 2002 was attributable to the deterioration in the loan portfolio
particularly in a limited number of borrowers in the telecommunications
portfolio. On a year-to-date basis, the provision was $120 million in 2003
compared with $295 million in 2002.
The allowance for credit losses was $817 million at September 30, 2003,
$824 million at June 30, 2003, and $681 million at September 30, 2002. The
allowance for credit losses as a percent of non-margin loans was 2.55% at
September 30, 2003, compared with 2.50% at June 30, 2003, and 2.01% at
September 30, 2002. The ratio of the allowance to nonperforming assets was
210.5% at September 30, 2003, compared with 188.6% at June 30, 2003, and
123.5% at September 30, 2002.
12
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 fund services, government securities
clearance, collateral management, 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.
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.
13
The Company's strategy is to be a market leader in these businesses and
continue to build out its product and service capabilities and add new
clients. The Company has completed 51 acquisitions since 1998 in this
segment, has made significant investments in technology to maintain its
industry-leading position, and has continued the development of new products
and services to meet its clients' needs.
The Corporate Banking segment provides lending and credit-related
services to large public and private financial institutions and corporations
nationwide, as well as to public and private mid-size businesses in the New
York metropolitan area. Special industry groups focus on industry segments
such as banks, broker-dealers, insurance, media and telecommunications,
energy, real estate, retailing, and government banking institutions. Through
BNY Capital Markets, Inc., the Company provides syndicated loans, bond
underwriting, private placements of corporate debt and equity securities, and
merger, acquisition, and advisory services.
Corporate Banking coordinates delivery of all of the Company's services
to customers through its global relationship managers. The two main client
bases served are financial institution clients and corporate clients. The
Company's strategy is to focus on those clients and industries that are major
users of securities servicing and global payment services 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 the other business segments. The Financial
Markets segment centralizes interest rate risk management for the Company.
There were no major customers from whom revenues were individually
material to the Company's performance.
14
Servicing and Fiduciary Businesses
- ----------------------------------
(In Millions)
3rd 2nd 3rd
Quarter Quarter Quarter Year to date
2003 2003 2002 2003 2002
------- ------- ------- ---- ----
Net Interest Income $ 132 $ 120 $ 118 $ 357 $ 362
Provision for
Credit Losses - - - - -
Noninterest Income 904 838 685 2,430 2,035
Noninterest Expense 709 650 488 1,882 1,434
Income Before Taxes 327 308 315 905 963
Average Assets $21,385 $15,724 $ 8,086 $14,959 $ 8,507
Average Deposits 34,039 33,499 32,008 32,899 30,846
Nonperforming Assets 16 16 16 16 16
(In billions)
Assets Under Custody $ 7,878 $ 7,787 $ 6,609 $ 7,878 $ 6,609
Assets Under Management 85 83 71 85 71
S&P 500 Index (Period End) 996 975 815 996 815
NASDAQ Index (Period End) 1,787 1,623 1,172 1,787 1,172
NYSE Volume (In billions) 87.3 93.0 99.2 266.9 269.8
NASDAQ Volume (In billions) 110.7 112.5 107.4 312.0 330.3
The third quarter results showed continued improvement in the Company's
primary businesses, including securities servicing and related foreign
exchange, and private client services and asset management. The quarter also
included a full quarter of results from Pershing, which closed on May 1, 2003.
This contributed to record securities servicing fees of $657 million in the
third quarter. For the first nine months of 2003, securities servicing fees
were $1,728 million, an increase of $317 million from $1,411 million for the
first nine months of 2002, principally due to Pershing and other acquisitions.
Pershing's securities servicing fees included in the quarter and nine months
ended September 30, 2003 were $162 million and $271 million, respectively.
Earnings were strong in business areas that benefited from rising equity
prices in the capital markets during the quarter. At the same time, areas that
are dependent on equity trading volumes, particularly execution services
businesses, had a more challenging quarter, due to the seasonal declines in
trading volumes that normally occur in August. In addition, the depositary
receipts business continued to be challenged by the lower level of corporate
actions, such as new equity issues and cross-border acquisitions that drive
client demand for the Company's services.
As of September 30, 2003, assets under custody rose to $7.9 trillion,
from $7.8 trillion at June 30, 2003 and $6.6 trillion at September 30, 2002.
The modest sequential quarter increase in assets under custody reflects higher
equity market values as well as net new business converted, however, as nearly
two-thirds of the Company's custody assets are in fixed income assets, these
were negatively impacted by higher interest rates and this mitigated the
impact of new business wins and higher equity prices. Cross-border custody
assets were $2.2 trillion at September 30, 2003. The acquisition of Pershing
added approximately $557 billion to custody assets at September 30, 2003.
Equity securities composed 32% of the assets under custody at September 30,
2003, while fixed income securities were 68%.
Strong new business momentum in global custody and higher equity prices
drove investor services fees higher on both a sequential quarter and year-
over-year basis. The higher fees compared to last year were also due to
strong performance in securities lending.
15
Global issuer services fees were essentially flat on a sequential quarter
basis and down from a year ago. Corporate trust fees were up modestly from
the second quarter, while depositary receipts (DRs) decreased on a sequential
quarter basis due to a lack of equity market activity in August and fewer
corporate actions during the quarter. The decline versus a year ago was also
related to DRs.
Broker-dealer services fees also increased significantly both
sequentially and year-over-year driven by strong performance in government
securities clearance and collateral management services. These businesses
continue to benefit from new business wins and higher fixed income transaction
volumes. Mutual fund servicing also increased in the third quarter due to
higher equity price levels.
Execution and clearing services fees increased both sequentially and in
comparison with last year due to the full quarter impact of Pershing.
Execution services decreased sequentially and in comparison with last year due
to lower equity market trading volumes. Average daily combined third quarter
NYSE and NASDAQ trading volume was down 5% from the second quarter of 2003 and
4% from the third quarter of 2002. Average monthly fees from Pershing
remained flat with last quarter despite the lower trading volumes due to
relative strength in retail investor activity. Pershing's operating margin,
excluding financing costs and amortization of intangibles, was 19% in the
third quarter, which was flat with last quarter.
Global payment services fees were flat compared with the prior quarter
and increased 8% from the third quarter of 2002. Year-over-year growth is
attributable to the build-out of multi-currency product capabilities and
further penetration of the financial institutions market segment.
Private client services and asset management fees for the third quarter
were up 3% from the prior quarter, and 14% from the third quarter of 2002.
The sequential quarter and year-over-year increases reflect higher equity
price levels as well as the continued strong demand for alternative
investments from Ivy Asset Management and higher short-term money management
fees, partially offset by higher seasonal tax-oriented fees in the second
quarter. In addition, the year-over-year comparison also benefited from
acquisitions. Ivy Asset Management has grown assets under management from $2.4
billion when it was acquired in 2000 to $8 billion at September 30, 2003.
Assets under management ("AUM") were $85 billion at September 30, 2003,
up from $83 billion at June 30, 2003 and $71 billion at September 30, 2002.
Assets under administration were $32 billion compared with $27 billion at June
30, 2003 and September 30, 2002. The increase in assets under management since
June 30, 2003 reflects growth in the Company's alternative investments
business, and a rise in asset values. The increase in AUM since September 30,
2002 reflects acquisitions, growth in the Company's alternative investment
business, and a rise in equity market values. Institutional clients represent
66% of AUM while individual clients equal 34%. AUM at September 30, 2003, are
31% invested in equities, 22% in fixed income, 10% in alternative investments
and the remainder in liquid assets.
Client-driven foreign exchange remained robust as September was one of
the Company's strongest months ever due to exchange rate movements and
increased activity from equity fund managers offsetting the seasonally slow
August.
Net interest income in the Servicing and Fiduciary businesses segment was
$132 million for the third quarter of 2003 compared with $120 million for the
second quarter of 2003 and $118 million in the third quarter of 2002. The
increase in net interest income on a sequential quarter basis is primarily
attributable to the full quarter impact of the Pershing acquisition. The
increase in net interest income from the third quarter of 2002 is primarily
due to the Pershing acquisition partially offset by the decline in interest
rates. Net interest income for the nine months ended September 30, 2003 was
$357 million compared with $362 million in the first nine months 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
16
assets for the quarter ended September 30, 2003 were $21.4 billion compared
with $15.7 billion in the second quarter of 2003 and $8.1 billion in the third
quarter of 2002. Average assets for the nine months ended September 30, 2003
were $15.0 billion compared with $8.5 billion in the first nine months of
2002. The increase in assets in 2003 compared with 2002 is attributable to
the Pershing acquisition. The third quarter of 2003 average deposits were
$34.0 billion compared with $33.5 billion in the second quarter of 2003 and
$32.0 billion in the third quarter of 2002. Average deposits for the first
nine months of 2003 were $32.9 billion compared with $30.8 billion for the
first nine 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 in
each of the relevant periods.
Noninterest expense for the third quarter of 2003 was $709 million,
compared with $650 million in the second quarter of 2003 and $488 million in
the third quarter of 2002. The rise in noninterest expense from the second
quarter reflects the full quarter impact of the Pershing acquisition. For the
first nine months of 2003, noninterest expense was $1,882 million compared
with $1,434 million in 2002. The rise in noninterest expense from 2002 was
primarily due to the Pershing acquisition, 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)
3rd 2nd 3rd
Quarter Quarter Quarter Year to date
2003 2003 2002 2003 2002
------- ------- ------- ---- ----
Net Interest Income $ 95 $ 95 $ 105 $282 $ 319
Provision for
Credit Losses 27 30 35 87 105
Noninterest Income 72 86 74 233 216
Noninterest Expense 52 53 52 155 148
Income Before Taxes 88 98 92 273 282
Average Assets $18,900 $19,858 $22,250 $19,760 $23,029
Average Deposits 6,699 6,583 6,802 6,832 6,904
Nonperforming Assets 368 410 526 368 526
Net Charge-offs 41 42 155 118 215
The Corporate Banking segment's net interest income was $95 million in the
third quarter of 2003, flat with the second quarter of 2003 and down from $105
million in the third quarter of 2002. On a year-to-date basis, net interest
income for 2003 was $282 million compared with $319 million in 2002. The
decrease from the 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 $18.9 billion compared with $19.9 billion in the second
quarter of 2003 and $22.3 billion in the third quarter of last year. Average
deposits in the corporate bank were $6.7 billion versus $6.6 billion in the
second quarter of 2003 and $6.8 billion in 2002. For the nine months ended
September 30, 2003, average assets were $19.8 billion compared to $23.0
billion for the first nine months of 2002. For the first nine months of 2003
and 2002, average deposits were $6.8 billion and $6.9 billion.
The third quarter 2003 provision for credit losses was $27 million
compared with $30 million in the second quarter of 2003 and $35 million last
year. On a year-to-date basis, the provision for credit losses was $87 million
for 2003 and $105 million for 2002. The lower provision primarily reflects the
benefits of the Company's corporate loan exposure reduction program. Net
charge-offs in the Corporate Banking segment were $41 million in the third
quarter of 2003, $42 million in the second quarter of 2003, and $155 million
17
in the third quarter of 2002. The charge-offs in 2003 primarily relate to
loans to corporate borrowers. The charge-offs in 2002 primarily reflects
deterioration in the Company's portfolio of telecom credits. Net charge-offs
for the first nine months of 2003 were $118 million compared with $215 million
in 2002. Nonperforming assets were $368 million at September 30, 2003, down
from $410 million at June 30, 2003 and $526 million in the third quarter of
2002. The decrease in nonperforming assets from the third quarter of 2002
primarily reflects reductions in the levels of nonperforming cable and telecom
credits.
Noninterest income was $72 million in the current quarter, compared with
$86 million in the second quarter of 2003 and $74 million in the third quarter
a year ago. The second quarter of 2003 benefited from unusually high volumes
of standby letters of credit and increased capital markets activity. For the
first nine months of 2003, noninterest income was $233 million compared with
$216 million for the first nine months of 2002.
Noninterest expense in the third quarter were $52 million, compared with
$53 million in the second quarter of 2003 and $52 million in the third quarter
of 2002. For the first nine months of 2003, noninterest expense was $155
million compared with $148 million in 2002. The increases over 2002 reflect
higher compensation costs due in part to a reduced pension credit.
Retail Banking
- --------------
(In Millions)
3rd 2nd 3rd
Quarter Quarter Quarter Year to date
2003 2003 2002 2003 2002
------- ------- ------- ---- ----
Net Interest Income $ 120 $ 118 $ 121 $354 $ 359
Provision for
Credit Losses 5 5 2 14 8
Noninterest Income 30 33 30 92 88
Noninterest Expense 88 90 79 265 238
Income Before Taxes 57 56 70 167 201
Average Assets $ 5,018 $ 5,329 $ 5,245 $5,242 $ 5,056
Average Noninterest
Bearing Deposits 4,738 4,565 4,109 4,711 4,040
Average Deposits 14,585 14,252 13,224 14,321 13,161
Nonperforming Assets 4 11 9 4 9
Net Charge-offs 6 5 5 16 15
Number of Branches 341 341 342 341 342
Total Deposit Accounts
(In Thousands) 1,170 1,183 1,222 1,170 1,222
Net interest income in the third quarter of 2003 was $120 million,
compared with $118 million in the second quarter of 2003 and $121 million in
the third quarter of 2002. Net interest income on a year-to-date basis for
2003 and 2002 was $354 million and $359 million. Net interest income has been
essentially flat as spread compression on deposits has been offset by higher
levels of noninterest bearing deposits.
Noninterest income was $30 million for the quarter compared with $33
million on a sequential quarter basis and $30 million last year. Noninterest
income for the first nine months of 2003 was $92 million compared with $88
million in the first nine months of 2002. The sequential quarter decline in
noninterest income as well as the year-to-date increase from 2002 reflects a
gain on the sale of $230 million of mortgage loans in the second quarter of
2003.
Noninterest expense in the third quarter of 2003 was $88 million,
compared with $90 million in the second quarter of 2003 and $79 million last
18
year. Noninterest expense for the first nine months of 2003 was $265 million
compared with $238 million in the first nine months of 2002. The year-over-
year change reflects a reduced pension credit and higher medical benefit
expenses.
Net charge-offs were $6 million in the third quarter of 2003, compared
with $5 million in the second quarter of 2003 and third quarter of 2002. Net
charge-offs were $16 million and $15 million for the nine months ending
September 30, 2003 and September 30, 2002. Nonperforming assets were $4
million in the third quarter of 2003 compared with $11 million at June 30,
2003 and $9 million at September 30, 2002 reflecting a reduction in the level
of nonperforming small business loans.
Average deposits generated by the Retail Banking segment were $14.6
billion in the third quarter of 2003, compared with $14.3 billion in the
second quarter of 2003 and $13.2 billion in the third quarter of 2002. For the
first nine months of 2003, average deposits were $14.3 billion as compared to
$13.2 billion in the first nine months of 2002. Noninterest bearing deposits
were $4.7 billion this quarter, compared with $4.6 billion in the second
quarter of 2003 and $4.1 billion in the third 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 nine months of 2003 were $4.7 billion compared with
$4.0 billion in the first nine months of 2002. Average assets in the retail
banking sector were $5.0 billion, compared with $5.3 billion in the second
quarter of 2003 and $5.2 billion in the third quarter of 2002. On a year-to-
date basis, average assets were $5.2 billion for 2003 and $5.1 billion for
2002.
19
Financial Markets
- -----------------
(In Millions)
3rd 2nd 3rd
Quarter Quarter Quarter Year to date
2003 2003 2002 2003 2002
------- ------- ------- ---- ----
Net Interest Income $ 80 $ 80 $ 84 $237 $245
Provision for
Credit Losses 5 6 5 16 15
Noninterest Income 53 33 37 136 154
Noninterest Expense 26 25 20 75 63
Income Before Taxes 102 82 96 282 321
Average Assets $47,920 $46,463 $40,850 $46,252 $40,481
Average Deposits 4,355 4,153 1,593 4,473 1,800
Average Investment
Securities 20,604 18,720 16,798 19,110 14,747
Net Charge-offs - - - - -
Net interest income for the third quarter was $80 million compared with
$80 million on a sequential quarter basis and $84 million a year ago. Net
interest income was $237 million in the first nine months of 2003 compared to
$245 million in the first nine months of 2002. The declines from 2002 reflect
lower reinvestment yields partially offset by an increase in assets, primarily
highly-rated mortgage-backed securities. Average third quarter 2003 assets in
the Financial Markets segment composed primarily of short-term liquid assets
and investment securities were $47.9 billion, up from $46.5 billion on a
sequential quarter basis and $40.9 billion last year. Average assets for the
first nine months of 2003 were $46.3 billion compared to $40.5 billion for the
first nine months 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 $53 million in the third quarter of 2003, compared
with $33 million in the second quarter of 2003 and $37 million in the third
quarter of 2002. On a year-to-date basis, noninterest income was $136 million
in 2003 and $154 million in 2002. The positive variance versus the second
quarter of 2003 reflects higher trading related revenues related both to
foreign exchange and fixed income activities as well as improved hedging of
foreign currency investments. 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 $26 million in the third quarter of 2003,
compared with $25 million in the second quarter of 2003 but up from $20
million in last year's third quarter. Noninterest expense for the nine months
ended September 30, 2003 was $75 million, compared with $63 million for the
nine months ended September 30, 2002 reflecting higher compensation costs.
20
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
September 30, 2003 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
(In Millions)
Net Interest Income $ 132 $ 95 $ 120 $ 80 $ (20) $ 407
Provision for
Credit Losses - 27 5 5 3 40
Noninterest Income 904 72 30 53 4 1,063
Noninterest Expense 709 52 88 26 164 1,039
----- ---- ----- ---- ----- ------
Income Before Taxes $ 327 $ 88 $ 57 $102 $(183) $ 391
===== ==== ===== ==== ===== ======
Contribution Percentage 57% 15% 10% 18%
Average Assets $21,385 $18,900 $5,018 $47,920 $ 3,930 $97,153
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
September 30, 2002 Businesses Banking Banking Markets Items Total
- --------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 118 $105 $ 121 $ 84 $ (10) $ 418
Provision for
Credit Losses - 35 2 5 183 225
Noninterest Income 685 74 30 37 (190) 636
Noninterest Expense 488 52 79 20 67 706
----- ---- ----- ---- ----- -----
Income Before Taxes $ 315 $ 92 $ 70 $ 96 $(450) $ 123
===== ==== ===== ==== ===== =====
Contribution Percentage 55% 16% 12% 17%
Average Assets $ 8,086 $22,250 $5,245 $40,850 $ 2,379 $78,810
21
In Millions
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2003 Businesses Banking Banking Markets Items Total
- ----------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 357 $ 282 $ 354 $ 237 $ (40) $1,190
Provision for
Credit Losses - 87 14 16 3 120
Noninterest Income 2,430 233 92 136 13 2,904
Noninterest Expense 1,882 155 265 75 304 2,681
------ ----- ----- ----- ----- ------
Income Before Taxes $ 905 $ 273 $ 167 $ 282 $(334) $1,293
====== ===== ===== ===== ===== ======
Contribution Percentage 56% 17% 10% 17%
Average Assets $14,959 $19,760 $ 5,242 $46,252 $ 3,366 $89,579
In Millions
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2002 Businesses Banking Banking Markets Items Total
- ----------------------- ---------- --------- ------- --------- ----------- ------------
Net Interest Income $ 362 $ 319 $ 359 $ 245 $ (32) $1,253
Provision for
Credit Losses - 105 8 15 167 295
Noninterest Income 2,035 216 88 154 (184) 2,309
Noninterest Expense 1,434 148 238 63 168 2,051
------ ----- ----- ----- ----- ------
Income Before Taxes $ 963 $ 282 $ 201 $ 321 $(551) $1,216
====== ===== ===== ===== ===== ======
Contribution Percentage 55% 16% 11% 18%
Average Assets $ 8,507 $23,029 $ 5,056 $40,481 $ 2,293 $79,366
22
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 and third quarter of 2003, merger and integration
costs associated with Pershing and in the third quarter of 2003 the GMAC
settlement are also reconciling items. In the third quarter of 2002 the loss
on a sublease was also a reconciling item. The adjustment to the provision for
credit losses reflects the difference between the aggregate of the credit
provision over a credit cycle for the reportable segments and the Company's
recorded provision. The reconciling items for average assets consist of
goodwill and other intangible assets.
3rd 2nd 3rd
Quarter Quarter Quarter Year to date
(In millions) 2003 2003 2002 2003 2002
------- ------- ------- ------ -----
Segments' revenue $ 1,486 $1,403 $1,254 $4,121 $3,778
Adjustments:
Earnings associated with
assignment of capital (33) (28) (24) (81) (74)
Securities gains - - (215) - (213)
Other gains 4 6 25 13 29
Taxable equivalent basis and
other tax-related items 13 13 14 41 42
------- ------ ------ ------ ------
Subtotal-revenue adjustments (16) (9) (200) (27) (216)
------- ------ ------ ------ ------
Consolidated revenue $1,470 $1,394 $1,054 $4,094 $3,562
======= ====== ====== ====== ======
Segments' income before tax $ 574 $ 544 $ 573 $1,627 $1,767
Adjustments:
Revenue adjustments (above) (16) (9) (200) (27) (216)
Provision for credit losses
different than GAAP (3) 1 (183) (3) (167)
Severance (2) (4) (1) (8) (15)
Goodwill and
intangible amortization (8) (7) - (18) (4)
Pershing-related
integration expenses (23) (25) - (48) -
GMAC settlement (78) - - (78) -
Loss on sublease - - (22) - (22)
Corporate overhead (53) (49) (44) (152) (127)
------- ------- ------ ------ ------
Consolidated income
before tax $ 391 $ 451 $ 123 $1,293 $1,216
======= ======= ====== ====== ======
Segments' total
average assets $93,223 $87,374 $76,431 $86,213 $77,073
Adjustments:
Goodwill and intangibles 3,930 3,550 2,379 3,366 2,293
------- ------- ------- ------- -------
Consolidated average assets $97,153 $90,924 $78,810 $89,579 $79,366
======= ======= ======= ======= =======
23
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. Other gains in 2002 include a $32 million ESDC grant. 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. The
GMAC settlement would be allocated to Corporate Banking.
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $95.2 billion at September 30, 2003, compared with
$99.6 billion at June 30, 2003, and $77.6 billion at December 31, 2002. The
decrease in total assets on a sequential quarter basis reflects lower client
deposit levels given a more orderly securities settlement process across the
industry relative to the June quarter end. Within the asset composition of the
balance sheet, while loans continue to be reduced, average investment
securities, largely high quality short duration mortgage-backed securities,
were up $2.3 billion, continuing a strategic shift to enhance the liquidity
and risk profile of the Company's balance sheet. The increase versus a year
ago mainly reflects the Pershing acquisition. Total shareholders' equity was
$8.2 billion at September 30, 2003, compared with $8.1 billion at June 30,
2003, and $6.7 billion at December 31, 2002. The major reasons for the
increase in shareholders' equity from a year ago are the issuance of
approximately $1 billion of common stock to fund the Pershing acquisition and
the retention of earnings.
Return on average common equity on a reported basis for the third quarter
of 2003 was 12.82%, compared with 15.56% in the second quarter of 2003, and
4.73% in the third quarter of 2002. On an operating basis, return on average
common equity for the third quarter of 2003 was 15.85%, compared with 16.41%
in the second quarter of 2003.
For the first nine months of 2003, the reported return on average common
equity was 15.23% compared with 16.74% in 2002 and the return on average
assets was 1.27% for the first nine months of 2003 compared with 1.35% in
2002. On an operating basis, return on average common equity was 16.63% and
the return on average assets was 1.39% for the first nine months of 2003.
On a reported basis, return on average assets for the third quarter of
2003 was 1.06%, compared with 1.30% in the second quarter of 2003, and 0.40%
in the third quarter of 2002. On an operating basis, return on average assets
for the third quarter of 2003 was 1.31%, compared with 1.37% in the second
quarter of 2003.
24
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities portfolio:
Investment Securities (at Fair Value)
(In millions) 09/30/03 12/31/02
-------- --------
Fixed Income:
Mortgage-Backed Securities $18,497 $13,084
Asset-Backed Securities 96 37
Corporate Debt 1,339 1,112
Short-Term Money Market Instruments 1,156 1,999
U.S. Treasury Securities 456 537
U.S. Government Agencies 207 469
State and Political Subdivisions 306 403
Emerging Market Debt 111 114
Other Foreign Debt 516 273
------- -------
Subtotal Fixed Income 22,684 18,028
Equity Securities:
Money Market Funds 53 91
Bank Stocks - 91
Federal Reserve Bank Stock 96 66
Other 27 22
------- -------
Subtotal Equity Securities 176 270
------- -------
Total Securities $22,860 $18,298
======= =======
Total investment securities were $22.9 billion at September 30, 2003,
compared with $20.4 billion at June 30, 2003, and $18.3 billion at December
31, 2002. Average investment securities were $20.6 billion in the third
quarter of 2003, compared with $18.7 billion in the second quarter of 2003 and
$16.8 billion in the third quarter of last year. Average investment
securities were $19.1 billion in the nine months ended September 30, 2003,
compared with $14.7 billion in the nine months ended September 30, 2002. The
increases were primarily due to growth in the Company's portfolio of highly
rated mortgage-backed securities which are 97% rated AAA, 1% AA, and 2% A.
Since December 31, 2002, the Company has added approximately $5.4 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 2.3 years on its mortgage 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 $245 million
at September 30, 2003, compared with $338 million at December 31, 2002. As
interest rates rise, the Company expects the unrealized gains will decline,
which will lower shareholders' equity and adversely impact the Company's
tangible common equity ratio.
Loans
- -----
Total loans were $37.5 billion at September 30, 2003, compared with $37.8
billion at June 30, 2003, and $31.3 billion at December 31, 2002. The increase
in total loans since year-end 2002 primarily reflects the addition of margin
loans from the Pershing acquisition, which were partially offset by a
reduction in Corporate exposures. Non-margin loans were $32.1 billion at
September 30, 2003, compared with $32.9 billion at June 30, 2003, and $33.8
billion at December 31, 2002. The decrease reflects the Company's strategy of
reducing non-strategic and outsized corporate loan exposures to improve its
credit risk profile. Average total loans were $37.4 billion in the third
25
quarter of 2003, compared with $35.7 billion in the second quarter of 2003 and
$33.7 billion at September 30, 2002. Pershing contributed $6.6 billion to the
increase in average loans from September 30, 2002. Excluding Pershing, average
loans were $30.8 billion in the third quarter of 2003 and $32.7 billion in the
second quarter of 2003.
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 third quarter.
Corporate exposures were reduced by over $1 billion, bringing the total
reductions to date to $6.7 billion. Telecom industry exposures were reduced to
approximately $0.9 billion at September 30, 2003, down from $1.5 billion at
December 31, 2002. The Company's $9 billion corporate exposure reduction
program is ahead of schedule with the Company 74% towards its targeted goal
with five quarters remaining. The improvement in credit spreads in 2003 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 following tables provide additional details on
the Company's loan exposures and outstandings at September 30, 2003 in
comparison to December 31, 2002.
Overall Loan Portfolio
Unfunded Total Unfunded Total
(dollars in billions) Loans Commitments Exposure Loans Commitments Exposure
----------------------------- ------------------------------
9/30/03 9/30/03 9/30/03 12/31/02 12/31/02 12/31/02
-------- ------- ------- -------- -------- --------
Financial Institutions(4) $10.7 $21.1 $31.8 $ 6.6 $24.1 $30.7
Corporate(4) 5.3 21.0 26.3 8.2 23.4 31.6
----- ----- ----- ----- ----- ----
16.0 42.1 58.1 14.8 47.5 62.3
----- ----- ----- ----- ----- ----
Consumer & Middle Market 8.0 4.0 12.0 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 5.5 - 5.5 0.4 - 0.4
----- ----- ----- ----- ----- -----
Total $37.5 $47.0 $84.5 $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.
26
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $31.8 billion at September
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 76%
expiring within one year and are frequently secured. For example, mortgage
banking, securities industry, and investment managers often borrow against
marketable securities held in custody at the Company. The diversity of the
portfolio is shown in the accompanying table.
(Dollars in billions)
09/30/03 12/31/02
------------------------------ -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Banks $ 3.4 $ 3.1 $ 6.5 71% 82% $2.9 $ 4.5 $ 7.4
Securities
Industry 2.6 3.5 6.1 93 96 1.3 3.9 5.2
Insurance 0.3 4.8 5.1 96 61 0.4 5.5 5.9
Government 0.1 5.3 5.4 99 57 0.2 5.5 5.7
Asset Managers 3.7 3.4 7.1 86 79 1.2 3.9 5.1
Mortgage Banks 0.4 0.5 0.9 87 78 0.4 0.5 0.9
Endowments 0.2 0.5 0.7 98 87 0.2 0.3 0.5
----- ----- ----- --- ---- ---- ----- -----
Total $10.7 $21.1 $31.8 88% 76% $6.6 $24.1 $30.7
===== ===== ===== === ==== ==== ===== =====
Corporate
- ---------
The corporate portfolio exposure declined to $26.3 billion at September
30, 2003 from $31.6 billion at year-end 2002. Approximately 74% of the
portfolio is investment grade while 34% of the portfolio matures within one
year. In December 2002, the Company announced its intention to reduce its
corporate exposure by $9 billion to $24 billion by the end of 2004. Since that
time, corporate credit exposures have been reduced by $6.7 billion of the $9
billion target. Reductions have been achieved through loan run-offs and
reduced rollover commitments, as well as loans sales which have taken
advantage of improved liquidity in the secondary loan market.
(Dollars in billions)
09/30/03 12/31/02
----------------------------- -----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Media $ 1.5 $ 2.3 $ 3.8 68% 18% $1.9 $ 2.4 $4.3
Cable 0.7 0.6 1.3 36 4 1.0 0.6 1.6
Telecom 0.3 0.6 0.9 60 29 0.7 0.8 1.5
----- ----- ----- -- -- ---- ----- -----
Subtotal 2.5 3.5 6.0 59% 17% 3.6 3.8 7.4
Utilities 0.2 2.8 3.0 87 67 0.7 3.0 3.7
Retailing 0.1 2.4 2.5 75 46 0.2 2.6 2.8
Automotive 0.2 2.1 2.3 77 39 0.2 2.6 2.8
Oil & Gas 0.2 1.5 1.7 81 36 0.4 1.7 2.1
Healthcare 0.3 1.4 1.7 84 35 0.4 1.5 1.9
Other* 1.8 7.3 9.1 75 29 2.7 8.2 10.9
----- ----- ----- -- -- ---- ----- -----
Total $ 5.3 $21.0 $26.3 74% 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
27
the first nine months of 2003, the Company reduced telecom exposure by $0.6
billion. The percentage of investment grade borrowers in the telecom
portfolio has increased to 60% from 54% at year-end 2002, due to reductions in
lower rated exposures.
The Company's exposure to the airline industry consists of a $635 million
leasing portfolio as well as $48 million of direct lending. The airline
leasing portfolio consists of $286 million to major U.S. carriers, $254
million to foreign airlines and $95 million to U.S. regionals. During 2003,
the domestic airline industry witnessed structural improvements, including
favorable labor developments, continued cost containment, and increased
liquidity due to government aid. Notwithstanding the recent improvements, the
industry faces sustained challenges from a tepid recovery in air travel,
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
9/30/03 vs. 9/30/03 vs.
(Dollars in millions) 9/30/03 6/30/03 6/30/03 12/31/02 12/31/02
-------- -------- -------- -------- --------
Category of Loans:
Commercial $265 $312 $(47) $321 $(56)
Foreign 79 84 (5) 84 (5)
Other 44 41 3 34 10
---- ---- ---- ---- ----
Total Nonperforming Loans 388 437 (49) 439 (51)
Other Real Estate - - - 1 (1)
---- ---- ---- ---- ----
Total Nonperforming Assets $388 $437 $(49) $440 $(52)
==== ==== ===== ==== ====
Nonperforming Assets Ratio 1.2% 1.3% 1.4%
Allowance/Nonperforming Loans 210.5 188.6 189.1
Allowance/Nonperforming Assets 210.5 188.6 188.7
Nonperforming assets declined $49 million during the third quarter to
$388 million from $437 million at June 30, 2003. The decrease primarily
reflects sales and charge-offs of commercial loans.
Interest income would have been increased by $4 million and $8 million
for the third quarters of 2003 and 2002 if loans on nonaccrual status at
September 30, 2003 and 2002 had been performing for the entire period.
Interest income would have been increased by $12 million and $15 million for
the nine months ended September 30, 2003 and 2002 if loans on nonaccrual
status at September 30, 2003 and 2002 had been performing for the entire
period.
28
Impaired Loans
- --------------
The table below sets forth information about the Company's impaired loans. The
Company uses the discounted cash flow, collateral value, or market price
methods for valuing its impaired loans:
September 30 June 30 December 31
(Dollars in millions) 2003 2003 2002
------------ ------- -----------
Impaired Loans with an Allowance $352 $393 $376
Impaired Loans without an Allowance(1) - 4 27
---- ---- ----
Total Impaired Loans $352 $397 $403
==== ==== ====
Allowance for Impaired Loans(2) $150 $189 $167
Average Balance of Impaired Loans
during the Quarter $387 $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
- ---------
September 30 June 30 September 30
(Dollars in millions) 2003 2003 2002
------- -------- -------
Total Loans $37,540 $37,796 $34,242
Margin Loans 5,472 4,877 407
Non-Margin Loans 32,068 32,919 33,835
Allowance 817 824 681
Allowance for Loan Losses
As a Percent of Loans 2.18% 2.18% 1.99%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 2.55 2.50 2.01
The allowance for credit losses to total loans was $817 million, or 2.18%
of loans at September 30, 2003, compared with $824 million, or 2.18% of loans
at June 30, 2003, and $831 million, or 2.65% of loans at December 31, 2002.
The ratio of the allowance for credit losses to non-margin loans was
2.55% for September 30, 2003, compared with 2.50% for June 30, 2003 and 2.68%
at December 31, 2002, reflecting stability in credit quality in the first nine
months of 2003. The May 1 acquisition of Pershing added $5.4 billion of
secured margin loans to the Company's balance sheet at September 30, 2003.
The Company has rarely suffered a loss on these types of loans and doesn't
allocate any of its allowance for credit losses to these loans. The Company
believes the ratio of allowance for credit losses to non-margin loans 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 210.5% at
September 30, 2003, up from 188.6% at June 30, 2003, and 188.7% at December
31, 2002. Included in the Company's allowance for credit losses at September
30, 2003 is an allocated transfer risk reserve related to Argentina of $20
million.
The allowance for credit losses consists of four elements: (1) an
allowance for impaired credits (nonaccrual commercial credits over $1
million), (2) an allowance for higher risk rated credits, (3) an allowance for
29
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 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
30
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:
September 30 December 31
2003 2002
------------ -----------
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 $58.9 billion at September 30, 2003, compared with
$64.7 billion at June 30, 2003 and $55.4 billion at December 31, 2002. The
decrease on a sequential quarter basis was primarily due to lower cash
balances from securities processing customers. At June 30, 2003, high
securities settlement volumes resulted in a higher than normal level of
uncompleted trades across the industry, which added to the cash levels in
customer accounts. The settlement process across the industry was more
orderly at September 30, 2003. Noninterest-bearing deposits were $16.4
billion at September 30, 2003, compared with $13.3 billion at December 31,
2002. Interest-bearing deposits were $42.6 billion at September 30, 2003,
compared with $42.1 billion at December 31, 2002.
31
WORLD TRADE CENTER DISASTER UPDATE
During the first nine months of 2003, the Company incurred $34 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 September 30, 2003, the Company had terminated or sublet
1,000,000 square feet and had 300,000 square feet remaining to sublet. The
Company has recorded a liability for its sublease loss as of September 30,
2003 of $173 million. At September 30, 2003, the Company had reserved for
approximately 57% 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 $ 34
Insurance Recovery 34
-----
Pre-tax Impact $ -
=====
Cumulative Insurance Recovery $ 678
Cumulative Cash Advances from
Insurance Companies (600)
-----
Receivable from Insurance Companies
at September 30, 2003 $ 78
=====
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 $678 million as it completes the move of its data
centers from interim locations to final locations.
32
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 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 September 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 $57 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$71 million.
For non pass rated credits, if the loss given default were 10% worse, the
allowance would have increased by $43 million, while if the loss given default
were 10% better, the allowance would have decreased by $54 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $20 million,
respectively.
33
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 judgement 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 sharp 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 September
30, 2003, approximately $2.8 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 $69 million.
Goodwill and Other Intangibles
- ------------------------------
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill, indefinite-lived intangibles, and other
intangibles, at fair value as required by SFAS 141. Goodwill ($3,156 million
at September 30, 2003) and indefinite-lived intangible assets ($370 million at
September 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 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
their fair value to their carrying value.
Other identifiable intangible assets ($446 million at September 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
34
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 September 30, 2003. The impact
of a 5% impairment charge would result in a change of pre-tax income of
approximately $200 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 $14.9 billion and $13.8 billion on an
average basis for the first nine months of 2003 and 2002. Stable foreign
deposits, primarily from the Company's European based securities servicing
business, were $24.1 billion and $24.3 billion at September 30, 2003 and 2002.
Savings and other time deposits were $10.2 billion on a year-to-date average
basis at September 30, 2003 compared to $9.7 billion at September 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 September 30, 2003, the amount of dividends the Bank could pay to the
Parent without prior regulatory approval and remain in compliance with federal
bank regulatory requirements was $588 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 $382
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 September 30, 2003, the Parent could use
the subsidiaries' liquid securities as collateral to allow it to borrow $39
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 September 30, 2003.
For the quarter ended September 30, 2003, the Parent's quarterly average
commercial paper borrowings were $74 million compared with $88 million in
2002. At September 30, 2003, the Parent had cash of $479 million compared with
cash of $691 million at June 30, 2003 and $398 million at December 31, 2002.
Net of commercial paper outstanding, the Parent's cash position at September
30, 2003 was up $132 million compared with December 31, 2002.
35
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 September 30, 2003 and September 30,
2002.
The Parent also has the ability to access the capital markets. At October
31, 2003, the Parent had a shelf registration statement with a capacity of
$782 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 October 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 Stable
Fitch F1+ A+ AA- AA Stable
In the third quarter of 2003, Moody's changed the Company's outlook
from negative to 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 September 30, 2003 and $300 million of long-term
debt that is due in 2004. In addition, at September 30, 2003, the Parent has
the option to call $95 million of subordinated debt in 2003 and $175 million
in 2004, which it will call and refinance if market conditions are favorable.
In the third quarter and first nine months of 2003, the Company redeemed $175
million and $730 million of debt. In October 2003, the Company called for
redemption $95 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 September 30, 2003 and 2002 was 101.96% and 99.31%.
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 September 30, 2003, compared with $1.6 billion provided by
operating activities through September 30, 2002. The sources of cash flows
from operations in 2003 and 2002 were principally the result of net income.
In the first nine months of 2003, cash used by investing activities was
$7.4 billion as compared to cash provided by investing activities in the first
nine months of 2002 of $0.7 billion. In the first nine 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,
securities purchased under resale agreements and acquisitions. 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 nine months of 2003, cash provided by financing activities
was $5.4 billion as compared to cash used by financing activities in the first
36
nine months of 2002 of $1.7 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 cash was repayment of
other borrowed funds.
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,
among other things, 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 September 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:
September 30, 2003 September 30, 2002
--------------------- --------------------- Well Adequately
Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
------- ---- ------- ------ ------- ----------- -----------
Tier 1* 7.08% 7.19% 7.70% 7.64% 7.75% 6% 4%
Total Capital** 11.18 11.45 11.73 11.80 11.75 10 8
Leverage 5.64 5.71 6.77 6.70 6.50 5 3-5
Tangible Common
Equity 4.66 5.43 5.38 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 regulatory Tier 1 capital and Total capital ratios were
7.08% and 11.18% at September 30, 2003, compared with 6.83% and 11.07% at
June 30, 2003, and 7.70% and 11.73% at September 30, 2002. The regulatory
leverage ratio was 5.64% at September 30, 2003, compared with 5.85% at June
30, 2003, and 6.77% at September 30, 2002. The Company's tangible common
equity as a percentage of total assets was 4.66% at September 30, 2003,
compared with 4.33% at June 30, 2003, and 5.38% at September 30, 2002. The
improvement in the Company's capital ratios versus June 30, 2003 reflects
the retention of equity during the quarter as well as the decrease in
balance sheet assets. The Company's capital ratios at September 30, 2003
and 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 balances 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.
See Accounting Changes and New Accounting Pronouncements in the Notes
to Consolidated Financial Statements for discussion of possible change in
capital treatment of trust preferred securities.
37
The following table presents the components of the Company's risk-based
capital at September 30, 2003 and 2002:
(in millions) 2003 2002
---- ----
Common Stock $8,223 $6,633
Preferred Stock - -
Preferred Trust Securities 1,150 1,100
Adjustments: Intangibles (3,967) (2,396)
Securities Valuation Allowance (161) (176)
Merchant Banking Investments (5) (2)
------ ------
Tier 1 Capital 5,240 5,159
------ ------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,239 2,053
Qualifying Allowance for Loan Losses 797 650
------ ------
Tier 2 Capital 3,036 2,703
------ ------
Total Risk-based Capital $8,276 $7,862
====== ======
Risk-Adjusted Assets $74,013 $67,016
======= =======
38
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at September 30, 2003 and September 30,
2002 are as follows:
2003
September 30, 2003 Average
---------------------------- -------------------
(In millions) Fair Value Fair Value
------------------ -------------------
Notional
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 74,988 $ 122 $ - $ - $ 41
Swaps 174,255 1,737 421 1,668 341
Written Options 136,286 - 1,465 - 1,314
Purchased Options 61,330 228 - 205 -
Foreign Exchange Contracts:
Swaps 2,973 - - - -
Written Options 11,939 - 73 - 71
Purchased Options 15,173 57 - 44 -
Commitments to Purchase
and Sell Foreign Exchange 59,797 553 621 342 392
Debt Securities - 4,164 257 4,345 162
Credit Derivatives 1,692 5 4 5 7
Equity Derivatives 102 23 8 9 7
------ ------ ------ ------
Total Trading Account $6,889 $2,849 $6,618 $2,335
====== ====== ====== ======
2002
September 30, 2002 Average
---------------------------- -------------------
(In millions) Fair Value Fair Value
------------------ -------------------
Notional
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 31,141 $ 91 $ - $ 115 $ -
Swaps 149,431 1,847 612 2,981 1,281
Written Options 125,020 - 1,662 - 1,371
Purchased Options 48,881 272 - 329 -
Foreign Exchange Contracts:
Swaps 1,891 - - - -
Written Options 14,287 - 104 - 141
Purchased Options 17,145 84 - 87 -
Commitments to Purchase
and Sell Foreign Exchange 60,121 441 471 731 743
Debt Securities - 6,653 197 6,822 154
Credit Derivatives 1,943 23 8 14 11
Equity Derivatives - 17 - 17 1
------ ------ ------- ------
Total Trading Account $9,428 $3,054 $11,096 $3,702
====== ====== ======= ======
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
39
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) 3rd Quarter 2003 Year-to-Date 2003
------------------------------ -------------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/03
-------- -------- -------- ------- ------- ------- -------
Interest rate $7.2 $1.9 $13.8 $6.1 $1.9 $13.8 $1.9
Foreign Exchange 0.9 0.6 1.4 0.8 0.5 1.9 1.0
Equity 0.4 0.1 1.0 0.2 - 1.0 0.6
Credit Derivatives 2.2 2.1 2.3 2.0 1.4 2.8 2.1
Diversification (1.8) NM NM (1.6) NM NM (0.5)
Overall Portfolio 8.9 5.1 14.7 7.5 3.4 14.7 5.1
(In millions) 3rd Quarter 2002 Year-to-Date 2002
------------------------------ -------------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/02
-------- -------- -------- ------- ------- ------- -------
Interest rate $4.1 $2.6 $5.8 $4.7 $2.6 $9.2 $4.1
Foreign Exchange 1.1 0.6 2.5 1.2 0.6 3.8 0.9
Equity 0.1 - 0.9 - - 1.1 -
Credit Derivatives - - - - - - -
Diversification (1.4) NM NM (1.7) NM NM (1.2)
Overall Portfolio 3.9 2.5 5.7 4.2 2.5 8.3 3.8
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 nine months of 2003, interest rate risk generated
approximately 67% of average VAR, credit derivatives generated 22% of average
VAR, foreign exchange accounted for 9% of average VAR, and equity generated 2%
of average VAR. During the third quarter and first nine months of 2003, the
Company's daily trading loss did not exceed the Company's 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.
40
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:
(Dollars in millions) September 30, 2003
$ %
---- ----
+200 bp Ramp vs. Stable Rate $ (17) (1.04)%
+100 bp Ramp vs. Stable Rate - -
-25 bp Shock vs. Stable Rate (11) (0.67)
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 September 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.
41
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 September 30, 2003 ended September 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 7,085 $ 38 2.12% $ 4,029 $ 28 2.76%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 9,200 22 0.96 2,736 11 1.64
Margin Loans 5,419 31 2.25 434 3 2.84
Loans
Domestic Offices 21,409 208 3.86 18,954 237 4.92
Foreign Offices 10,571 76 2.85 14,360 122 3.40
------- ----- ------- -----
Total Loans 31,980 284 3.52 33,314 359 4.26
------- ----- ------- -----
Securities
U.S. Government Obligations 313 2 3.00 521 7 5.14
U.S. Government Agency Obligations 3,464 30 3.44 3,741 47 5.07
Obligations of States and
Political Subdivisions 311 6 7.17 504 8 6.55
Other Securities 16,516 144 3.49 12,032 139 4.63
Trading Securities 4,357 27 2.47 6,792 58 3.38
------- ----- ------- -----
Total Securities 24,961 209 3.35 23,590 259 4.39
------- ----- ------- -----
Total Interest-Earning Assets 78,645 584 2.94% 64,103 660 4.09%
----- -----
Allowance for Credit Losses (822) (616)
Cash and Due from Banks 2,914 2,601
Other Assets 16,416 12,722
------- -------
TOTAL ASSETS $97,153 $78,810
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 7,657 $ 13 0.67% $ 6,661 $ 22 1.32%
Savings 9,281 17 0.72 8,144 22 1.07
Certificates of Deposit
$100,000 & Over 3,840 14 1.47 3,322 18 2.14
Other Time Deposits 1,183 4 1.49 1,475 8 2.17
Foreign Offices 24,452 65 1.06 23,234 95 1.63
------- ----- ------- -----
Total Interest-Bearing Deposits 46,413 113 0.97 42,836 165 1.53
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,687 3 0.68 2,040 8 1.51
Other Borrowed Funds 2,464 6 1.00 1,155 7 2.25
Payables to Customers and Broker-Dealers 5,407 10 0.72 145 1 1.47
Long-Term Debt 6,310 36 2.27 5,467 50 3.59
------- ----- ------- -----
Total Interest-Bearing Liabilities 62,281 168 1.07% 51,643 231 1.77%
----- -----
Noninterest-Bearing Deposits 13,266 10,792
Other Liabilities 13,555 9,760
Common Shareholders' Equity 8,051 6,615
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $97,153 $78,810
======= =======
Net Interest Earnings
and Interest Rate Spread $ 416 1.87% $ 429 2.32%
===== ==== ===== ====
Net Yield on Interest-Earning Assets 2.10% 2.66%
==== ====
42
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the nine months For the nine months
ended September 30, 2003 ended September 30, 2002
------------------------------ ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 6,381 $ 109 2.28% $ 4,992 $ 106 2.85%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 7,394 61 1.11 2,957 38 1.70
Margin Loans 3,133 54 2.33 446 9 2.66
Loans
Domestic Offices 20,124 642 4.27 18,824 716 5.09
Foreign Offices 11,799 262 2.97 15,361 392 3.41
------- ----- ------- -----
Total Loans 31,923 904 3.79 34,185 1,108 4.34
------- ----- ------- -----
Securities
U.S. Government Obligations 282 8 3.55 663 26 5.31
U.S. Government Agency Obligations 3,246 93 3.82 3,299 134 5.43
Obligations of States and
Political Subdivisions 348 19 7.10 550 27 6.57
Other Securities 15,234 421 3.69 10,235 370 4.82
Trading Securities 4,802 103 2.88 7,882 199 3.38
------- ----- ------- -----
Total Securities 23,912 644 3.59 22,629 756 4.46
------- ----- ------- -----
Total Interest-Earning Assets 72,743 1,772 3.26% 65,209 2,017 4.14%
----- -----
Allowance for Credit Losses (826) (616)
Cash and Due from Banks 2,825 2,656
Other Assets 14,837 12,117
------- -------
TOTAL ASSETS $89,579 $79,366
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 7,493 $ 48 0.86% $ 6,661 $ 66 1.33%
Savings 8,971 54 0.81 8,124 70 1.15
Certificates of Deposit
$100,000 & Over 4,402 54 1.62 1,701 30 2.35
Other Time Deposits 1,268 16 1.62 1,548 27 2.32
Foreign Offices 24,051 225 1.25 24,283 291 1.60
------- ----- ------- -----
Total Interest-Bearing Deposits 46,185 397 1.15 42,317 484 1.53
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,470 10 0.90 2,148 24 1.48
Other Borrowed Funds 1,510 13 1.17 3,286 60 2.43
Payables to Customers and Broker-Dealers 3,160 19 0.79 179 1 1.07
Long-Term Debt 6,077 116 2.54 5,316 159 3.96
------- ----- ------- -----
Total Interest-Bearing Liabilities 58,402 555 1.27% 53,246 728 1.83%
----- -----
Noninterest-Bearing Deposits 12,341 10,394
Other Liabilities 11,370 9,321
Common Shareholders' Equity 7,466 6,405
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $89,579 $79,366
======= =======
Net Interest Earnings
and Interest Rate Spread $1,217 1.99% $1,289 2.31%
====== ==== ====== ====
Net Yield on Interest-Earning Assets 2.24% 2.65%
==== ====
43
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 further 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 subsequent U.S. military actions, 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.
44
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. In
addition, the Company's earnings releases and management conference calls and
presentations are available through the website.
45
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, December 31,
2003 2002
---- ----
Assets
- ------
Cash and Due from Banks $ 3,730 $ 4,748
Interest-Bearing Deposits in Banks 5,321 5,104
Securities
Held-to-Maturity (fair value of $268 in 2003
and $952 in 2002) 270 954
Available-for-Sale 22,592 17,346
------- -------
Total Securities 22,862 18,300
Trading Assets at Fair Value 6,889 7,309
Federal Funds Sold and Securities Purchased
Under Resale Agreements 6,683 1,385
Loans (less allowance for credit losses of $817 in 2003
and $831 in 2002) 36,723 30,508
Premises and Equipment 1,088 975
Due from Customers on Acceptances 233 351
Accrued Interest Receivable 279 204
Goodwill 3,156 2,497
Intangible Assets 816 78
Other Assets 7,413 6,105
------- -------
Total Assets $95,193 $77,564
======= =======
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $16,385 $13,301
Interest-Bearing
Domestic Offices 19,874 19,997
Foreign Offices 22,684 22,089
------- -------
Total Deposits 58,943 55,387
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 959 636
Trading Liabilities 2,849 2,800
Payables to Customers and Broker-Dealers 10,170 870
Other Borrowed Funds 987 475
Acceptances Outstanding 235 352
Accrued Taxes and Other Expenses 4,099 4,066
Accrued Interest Payable 125 101
Other Liabilities 2,305 753
Long-Term Debt 6,298 5,440
------- -------
Total Liabilities 86,970 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
1,039,086,738 shares in 2003 and
993,697,297 shares in 2002 7,793 7,453
Additional Capital 1,594 847
Retained Earnings 5,168 4,736
Accumulated Other Comprehensive Income 105 134
------- -------
14,660 13,170
Less: Treasury Stock (265,248,941 shares in 2003
and 267,240,854 shares in 2002), at cost 6,434 6,483
Loan to ESOP (485,533 shares in 2003
and in 2002), at cost 3 3
------- -------
Total Shareholders' Equity 8,223 6,684
------- -------
Total Liabilities and Shareholders' Equity $95,193 $77,564
======= =======
- ----------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2002 has been derived from the audited financial
statements at that date.
46
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(In millions, except per share amounts)
(Unaudited)
For the three For the nine
months ended months ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Interest Income
- ---------------
Loans $ 284 $ 359 $ 904 $1,108
Margin loans 31 3 54 9
Securities
Taxable 162 175 477 474
Exempt from Federal Income Taxes 11 15 37 47
------ ----- ------ ------
173 190 514 521
Deposits in Banks 38 28 109 106
Federal Funds Sold and Securities Purchased
Under Resale Agreements 22 11 61 38
Trading Assets 27 58 103 199
------ ----- ------ ------
Total Interest Income 575 649 1,745 1,981
------ ----- ------ ------
Interest Expense
- ----------------
Deposits 113 165 397 484
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 3 8 10 24
Other Borrowed Funds 6 7 13 60
Customer Payables 10 1 19 1
Long-Term Debt 36 50 116 159
------ ----- ------ ------
Total Interest Expense 168 231 555 728
------ ----- ------ ------
Net Interest Income 407 418 1,190 1,253
- -------------------
Provision for Credit Losses 40 225 120 295
------ ----- ------ ------
Net Interest Income After Provision
for Credit Losses 367 193 1,070 958
------ ----- ------ ------
Noninterest Income
- ------------------
Servicing Fees
Securities 657 480 1,728 1,411
Global Payment Services 80 74 238 220
------ ----- ------ ------
737 554 1,966 1,631
Private Client Services and Asset Management Fees 97 85 281 256
Service Charges and Fees 89 90 278 264
Foreign Exchange and Other Trading Activities 92 49 246 183
Securities Gains 9 (188) 26 (131)
Other 39 46 107 106
------ ----- ------ ------
Total Noninterest Income 1,063 636 2,904 2,309
------ ----- ------ ------
Noninterest Expense
- -------------------
Salaries and Employee Benefits 533 397 1,454 1,202
Net Occupancy 69 76 192 175
Furniture and Equipment 50 32 134 101
Other 364 201 853 573
Merger and Integration Costs 23 - 48 -
------ ----- ------ ------
Total Noninterest Expense 1,039 706 2,681 2,051
------ ----- ------ ------
Income Before Income Taxes 391 123 1,293 1,216
Income Taxes 131 44 443 414
------ ----- ------ ------
Net Income $ 260 $ 79 $ 850 $ 802
- ---------- ====== ===== ====== ======
Per Common Share Data:
- ----------------------
Basic Earnings $0.34 $0.11 $1.14 $1.11
Diluted Earnings 0.34 0.11 1.13 1.10
Cash Dividends Paid 0.19 0.19 0.57 0.57
Diluted Shares Outstanding 774 727 753 729
- -------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
47
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the nine months ended September 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 40
-------
Balance, September 30 7,793
-------
Additional Capital
Balance, January 1 847
Issuance of Common Stock related to Pershing 696
Issuances in Connection with Employee Benefit Plans 51
-------
Balance, September 30 1,594
-------
Retained Earnings
Balance, January 1 4,736
Net Income $ 850 850
Cash Dividends on Common Stock (418)
-------
Balance, September 30 5,168
-------
Accumulated Other Comprehensive Income
Securities Valuation Allowance
Balance, January 1 155
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of ($43) Million (55) (55)
Reclassification Adjustment, Net of Taxes of $22 Million 29 29
-------
Balance, September 30 129
-------
Foreign Currency Items
Balance, January 1 (47)
Foreign Currency Translation Adjustment,
Net of Taxes of $(7) Million (4) (4)
-------
Balance, September 30 (51)
-------
Unrealized Derivative Gains
Balance, January 1 26
Net Unrealized Derivative Gains on Cash Flow Hedges,
Net of Taxes of $- Million 1 1
------ ------
Balance, September 30 27
------
Total Comprehensive Income $ 821
======
Less Treasury Stock
Balance, January 1 6,483
Issued (66)
Acquired 17
-------
Balance, September 30 6,434
-------
Less Loan to ESOP
Balance, January 1 3
-------
Balance, September 30 3
-------
Total Shareholders' Equity, September 30 $ 8,223
=======
- ------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended September 30, 2003 and 2002 was $207 million and
$170 million.
Comprehensive Income for the nine months ended September 30, 2003 and 2002 was $821 million and
$845 million.
See accompanying Notes to Consolidated Financial Statements.
48
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
For the nine months
ended September 30,
2003 2002
---- ----
Operating Activities
Net Income $ 850 $ 802
Adjustments to Determine Net Cash Attributable to
Operating Activities
Provision for Losses on Loans and Other Real Estate 120 295
Depreciation and Amortization 307 147
Deferred Income Taxes 314 195
Securities Gains (26) 131
Change in Trading Activities 501 (295)
Change in Accruals and Other, Net (1,086) 333
------ ------
Net Cash Provided by Operating Activities 980 1,608
------ ------
Investing Activities
Change in Interest-Bearing Deposits in Banks (16) 2,537
Change in Margin Loans (734) 45
Purchases of Securities Held-to-Maturity - (60)
Paydowns of Securities Held-to-Maturity 670 107
Maturities of Securities Held-to-Maturity 10 18
Purchases of Securities Available-for-Sale (22,408) (15,433)
Sales of Securities Available-for-Sale 5,047 4,471
Paydowns of Securities Available-for-Sale 7,406 2,182
Maturities of Securities Available-for-Sale 4,642 3,632
Net Principal Received (Disbursed) on Loans to Customers (434) 1,370
Sales of Loans and Other Real Estate 542 244
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (1,100) 2,385
Purchases of Premises and Equipment (98) (165)
Acquisitions, Net of Cash Acquired (1,773) (348)
Proceeds from the Sale of Premises and Equipment 7 1
Other, Net 826 (267)
------ ------
Net Cash (Used) Provided by Investing Activities (7,413) 719
------ ------
Financing Activities
Change in Deposits 2,961 417
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements (310) (500)
Change in Payables to Customers and Broker-Dealers 1,689 (220)
Change in Other Borrowed Funds (530) (1,195)
Proceeds from the Issuance of Long-Term Debt 1,915 1,325
Repayments of Long-Term Debt (1,029) (1,005)
Issuance of Common Stock 1,153 163
Treasury Stock Acquired (17) (280)
Cash Dividends Paid (418) (412)
------ ------
Net Cash Provided (Used) by Financing Activities 5,414 (1,707)
------ ------
Effect of Exchange Rate Changes on Cash 1 (89)
------ ------
Change in Cash and Due From Banks (1,018) 531
Cash and Due from Banks at Beginning of Period 4,748 3,222
------ ------
Cash and Due from Banks at End of Period $3,730 $3,753
====== ======
- ----------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 531 $ 702
Income Taxes 386 222
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - 1
- ----------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
49
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
----------------------------------------------------
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.
On January 1, 2003, the Company adopted the fair value method of
accounting for its options under 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.
For the nine months ended September 30, 2003, approximately 18 million
options were granted. In the first nine months of 2003, the Company recorded
$19 million of stock option expense.
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, 3rd Quarter Year-to-date
except per share amounts) 2003 2002 2003 2002
----- ----- ---- ----
Reported net income $260 $ 79 $850 $802
Stock based employee compensation costs,
using prospective method, net of tax 6 - 13 -
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (22) (24) (62) (64)
---- ---- ---- ----
Pro forma net income $244 $ 55 $801 $738
==== ==== ==== ====
Reported diluted earnings per share $0.34 $0.11 $1.13 $1.10
Impact on diluted earnings per share (0.02) (0.03) (0.05) (0.08)
----- ----- ----- -----
Pro forma diluted earnings per share $0.32 $0.08 $1.08 $1.02
===== ===== ===== =====
50
The fair value of options granted in 2003 and 2002 were estimated at the
grant date using the following weighted average assumptions:
Third Quarter Year to date
2003 2002 2003 2002
---- ---- ---- ----
Dividend yield 3.00% 3.00% 3.00% 3.00%
Expected volatility 33.92 30.40 32.79 29.78
Risk free interest rates 3.25 3.12 3.49 4.35
Expected options lives 5 5 5 5
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.
On October 1, 2002, the Company adopted 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.
On July 1, 2003, the Company adopted SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" (SFAS 149).
SFAS 149 amends and clarifies accounting for derivative instruments. The
adoption of SFAS 149 did not have an impact on the Company's results of
operations or financial condition.
On July 1, 2003, the Company adopted SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity".
The provisions of this 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
adoption of SFAS 150 did not have an impact on the Company's results of
operations or financial condition.
On January 1, 2003, the Company adopted 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.
On February 1, 2003, the Company adopted 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
51
also requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The consolidation requirements of FIN
46 applied immediately to VIEs created after January 31, 2003 and apply to
previously established entities effective October 1, 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
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 fourth 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.
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 third quarter of 2003, there were no businesses acquired.
During the first nine months of 2003, 5 businesses were acquired for the total
cost of $2,045 million, primarily paid in cash. The principal acquisition was
Pershing. 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.
Goodwill related to third quarter and first nine months of 2003
acquisition transactions was zero and $622 million, respectively. The tax
deductible portion of goodwill for the third quarter and first nine months of
2003 is zero and $614 million. All of the goodwill was assigned to the
Company's Servicing and Fiduciary Business segment. At September 30, 2003, the
Company was liable for potential contingent payments related to acquisitions
in the amount of $693 million. During the third quarter and first nine months
of 2003, the Company paid zero and $26 million for contingent payments related
52
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 approximately 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 $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 September 30,
2003.
The Company expects the acquisition to be dilutive to its earnings by
approximately $0.02 per share in 2003 (not including dilution in 2003 of
approximately $0.07 per share from merger and integration charges associated
with the acquisition), and accretive by $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 added new clients in execution services
and improves market coverage in the Chicago area/Midwest. It was 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, expanded 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.
53
4. Goodwill and Intangibles
------------------------
Goodwill by segment as of September 30, 2003 is as follows:
Servicing
and
Fiduciary Corporate Retail Financial Consolidated
(In millions) Businesses Banking Banking Markets Total
---------- --------- ------- --------- -----------
Balance as of
September 30, 2003 $3,016 $31 $109 $ - $3,156
====== === ==== === ======
The Company's business segments are tested annually for goodwill
impairment.
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 (51) 446 16
The aggregate amortization expense of intangibles was $8 million and $0.4
million for the quarters ended September 30, 2003 and 2002, respectively. The
aggregate amortization expense of intangibles was $18 million and $5 million
for the nine months ended September 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 $27
2004 33
2005 33
2006 33
2007 33
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 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.
54
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:
Nine months ended
September 30,
(In millions) 2003 2002
---- ----
Balance, Beginning of Period $831 $616
Charge-Offs (147) (242)
Recoveries 13 12
---- ----
Net Charge-Offs (134) (230)
Provision 120 295
---- ----
Balance, End of Period $817 $681
==== ====
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 $54 million of subordinated debt
in the third quarter of 2003 and $584 million for the first nine 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 Trust
Preferred Securities. At October 31, 2003, the Company has a registration
statement with a remaining capacity of approximately $782 million of debt,
preferred stock, preferred trust securities, or common stock.
55
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
(In millions, except per share amounts)
2003 2002 2003 2002
---- ---- ---- ----
Net Income (1) $260 $ 79 $850 $802
==== ==== ==== ====
Basic Weighted Average
Shares Outstanding 766 721 746 722
Shares Issuable on Exercise of
Employee Stock Options 8 6 7 7
---- ---- ---- ----
Diluted Weighted Average Shares Outstanding 774 727 753 729
==== ==== ==== ====
Basic Earnings Per Share: $0.34 $0.11 $1.14 $1.11
Diluted Earnings Per Share: 0.34 0.11 1.13 1.10
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
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 September 30, 2003 and December
31, 2002 follows:
Off-Balance-Sheet Credit Risks
- ------------------------------
September 30, December 31,
In millions 2003 2002
- ----------- ------------ ------------
Lending Commitments $ 35,824 $ 40,330
Standby Letters of Credit, net 9,654 9,577
Commercial Letters of Credit 1,050 1,052
Securities Lending Indemnifications 175,330 138,264
Standby Bond Purchase Agreements 1,507 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 September 30, 2003 and December 31, 2002 was $89 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 September 30, 2003 and December
31, 2002, securities lending indemnifications were secured by collateral of
$183.9 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.
56
Standby letters of credit principally support corporate obligations and
include $0.8 billion and $0.5 billion that were collateralized with cash and
securities on September 30, 2003 and December 31, 2002. At September 30, 2003,
approximately $6.7 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 September 30, 2003 and December 31, 2002
were $38 million and $40 million.
At September 30, 2003, the notional amounts and credit exposures for the
Company's credit derivatives swaps were $1,692 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 or 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. The IRS recently issued internal guidance
reiterating its intent to challenge these transactions, but, at the same time,
also indicated that it may consider settlement discussions with taxpayers. It
is not known at this time whether the IRS would consider settling on terms
that would be acceptable to the Company.
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. Earlier this year, the IRS has
publicly indicated that it planned 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.
In October, however, the IRS announced that it had completed its review and
concluded that the test procedures and results are scientifically valid if
applied in a consistent and unbiased manner. As a result, the IRS will resume
issuing private letter rulings on the same basis as the rulings issued in
respect of the Company's investments. 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.
57
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 September 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 October 31, 2003, The Bank of New York Company, Inc. had
773,582,157 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
September 30, 2003 and December 31, 2002 45
Consolidated Statements of Income for
the three months and nine months
ended September 30, 2003 and 2002 46
Consolidated Statement of Changes in
Shareholders' Equity for the nine months
Ended September 30, 2003 47
Consolidated Statement of Cash Flows for the
nine months ended September 30, 2003 and 2002 48
Notes to Consolidated Financial Statements 49 - 56
Consolidated Average Balance Sheet
and Net Interest Analysis 41
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 2 - 44
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 38 - 40
58
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) and
15d-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.
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
the Bank. Plaintiffs have sought leave to appeal to the New York State Court
of Appeals. On September 16, 2003, that request was denied.
The Company does not expect that any of the foregoing civil actions will
have a material impact on the Company's consolidated financial statements.
On September 29, 2003, the Company announced that it had agreed to a
settlement regarding GMAC's claims relating to the Company's 1999 sale to GMAC
of BNY Financial Corporation, the Company's factoring and asset-based finance
business. The settlement resolved claims between the parties with a payment
of $110 million by the Company to GMAC. After accounting for a previously
established reserve for this matter, the net impact of the settlement was
approximately 6 cents per fully diluted share, recorded by the Company as a
non-operating charge in the third quarter of 2003. The Bank of New York sold
BNY Financial Corporation to GMAC for $1.8 billion in cash in 1999.
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
59
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.
The Company is broadly involved with the mutual fund industry, and various
governmental and self-regulatory agencies have sought information from it in
connection with investigations relating to that industry.
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 2. Changes in Securities and Use of Proceeds
Shares of the Company's common stock were issued in the following
transactions exempt from registration under the Securities Act of 1933
pursuant to Section 4(2) thereof:
(a) On June 16, 2003, 9,600 shares of common stock were issued to serving
non-employee directors as part of their annual retainer.
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) The exhibits filed as part of this report are as follows:
Exhibit 10 - Severance Agreement dated August 20, 2003.
Exhibit 12 - Statement Re: Ratio of Earnings to Fixed Charges
for the Three Months and Nine Months Ended September 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
June 30, 2003:
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.
On October 22, 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 third quarter of 2003 contained in the
Company's press release dated October 22, 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: November 12, 2003 By: /s/ Thomas J. Mastro
-------------------------
Name: Thomas J. Mastro
Title: Comptroller
61
EXHIBIT INDEX
-------------
Exhibit Description
- ------- -----------
10 Severance Agreement dated August 20, 2003.
12 Ratio of Earnings to Fixed Charges for the
Three Months and Nine Months Ended September 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.