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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended June 30, 2004
The Quarterly Report on Form 10-Q and cross reference index is on page 55.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Introduction 2
- Overview 2
- Second Quarter 2004 Highlights 3
- Consolidated Income Statement Review 4
- Other Developments 8
- Business Segments Review 9
- Consolidated Balance Sheet Review 21
- Critical Accounting Policies 29
- Liquidity 31
- Capital Resources 33
- Trading Activities 35
- Asset/Liability Management 37
- Statistical Information 39
- Forward Looking Statements and
Factors That Could Affect Future Results 41
- Website Information 42
Consolidated Financial Statements
- Consolidated Balance Sheets
June 30, 2004 and December 31, 2003 43
- Consolidated Statements of Income
For the Three Months and Six Months Ended
June 30, 2004 and 2003 44
- Consolidated Statement of Changes In
Shareholders' Equity for the Six
Months Ended June 30, 2004 45
- Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2004 and 2003 46
- Notes to Consolidated Financial Statements 47
Form 10-Q
- Cover 55
- Controls and Procedures 56
- Legal Proceedings 56
- Changes in Securities, Use of Proceeds and
Issuer Purchases of Equity Securities 56
- Submission of Matters to Vote of Security Holders 57
- 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)
June 30, March 31, June 30,
2004 2004 2003
---------- ---------- ----------
Quarter
-------
Revenue (tax equivalent basis) $ 1,775 $ 1,677 $ 1,601
Net Income 371 364 295
Basic EPS 0.48 0.47 0.39
Diluted EPS 0.48 0.47 0.39
Cash Dividends Per Share 0.20 0.19 0.19
Return on Average Common
Shareholders' Equity 17.14% 17.17% 15.56%
Return on Average Assets 1.49 1.47 1.30
Efficiency Ratio 63.93 68.90 64.80
Year-to-date
------------
Revenue (tax equivalent basis) $ 3,450 $ 1,677 $ 3,031
Net Income 735 364 590
Basic EPS 0.95 0.47 0.80
Diluted EPS 0.94 0.47 0.80
Cash Dividends Per Share 0.39 0.19 0.38
Return on Average Common
Shareholders' Equity 17.15% 17.17% 16.61%
Return on Average Assets 1.48 1.47 1.39
Efficiency Ratio 66.30 68.90 62.50
Assets $ 97,536 $ 92,652 $ 99,759
Loans 38,205 36,070 37,796
Securities 22,986 24,083 20,392
Deposits - Domestic 36,279 33,639 37,319
- Foreign 24,781 22,443 27,336
Long-Term Debt 6,025 6,276 6,515
Common Shareholders' Equity 8,785 8,760 8,113
Common Shareholders'
Equity Per Share $ 11.29 $ 11.27 $ 10.50
Market Value Per Share
of Common Stock 29.48 31.50 28.75
Allowance for Credit Losses as
a Percent of Total Loans 2.03% 2.19% 2.18%
Allowance for Credit Losses as
a Percent of Non-Margin Loans 2.42 2.64 2.50
Allowance for Loan Losses as
a Percent of Total Loans 1.57 1.75 1.77
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.86 2.11 2.03
Tier 1 Capital Ratio 7.70 7.60 6.83
Total Capital Ratio 11.63 11.70 11.07
Leverage Ratio 6.00 5.83 5.85
Tangible Common Equity Ratio 4.95 5.22 4.32
Employees 23,001 22,820 23,106
Assets Under Custody (In trillions)
Total Assets Under Custody $ 8.7 $ 8.6 $ 7.8
Equity Securities 34% 33% 32%
Fixed Income Securities 66 67 68
Cross-Border Assets Under Custody $ 2.4 $ 2.4 $ 2.2
Assets Under Administration
(In billions) $ 32 $ 33 $ 27
Assets Under Management (In billions)
Total Assets Under Management 93 92 83
Equity Securities 36% 36% 32%
Fixed Income Securities 22 22 23
Alternative Investments 14 13 9
Liquid Assets 28 29 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 and Factors That Could
Affect Future Results." When used in this report, the words "estimate,"
"forecast," "project," "anticipate," "expect," "intend," "believe," "plan,"
"goal," "should," "may," "strategy," and words of similar meaning are intended
to identify forward looking statements in addition to statements specifically
identified as forward looking statements.
OVERVIEW
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
securities servicing for investors, financial intermediaries and issuers. The
Company plays an integral role in the infrastructure of the capital markets,
servicing securities in more than 100 markets worldwide. The Company provides
services based on leading technology for global financial institutions, asset
managers, governments, non-profit organizations, corporations, and individuals.
Its principal subsidiary, The Bank of New York, founded in 1784, is the oldest
bank in the United States and has a distinguished history of serving clients
around the world through its five primary businesses: Securities Servicing and
Global Payment Services, Private Client Services and Asset Management,
Corporate Banking, Global Market Services, and Retail Banking.
The Company has executed a consistent strategy over the past decade by
focusing on highly scalable, fee-based securities servicing and fiduciary
businesses, with top three market share in most of its major product lines.
The Company distinguishes itself competitively by offering the broadest array
of products and services around the investment lifecycle. These include:
advisory and asset management services to support the investment decision;
extensive trade execution, clearance and settlement capabilities; custody,
securities lending, accounting and administrative services for investment
portfolios; and sophisticated risk and performance measurement tools for
analyzing portfolios. The Company also provides services for issuers of both
equity and debt securities. By providing integrated solutions for clients'
needs, the Company strives to be the preferred partner in helping its clients
succeed in the world's rapidly evolving financial markets.
The Company has grown both through internal reinvestment as well as
execution of strategic acquisitions to expand product offerings and increase
market share in its scale businesses. Internal reinvestment occurs through
increased technology spending, staffing levels, marketing/branding initiatives,
quality programs, and product development. The Company consistently invests in
technology to improve the breadth and quality of its product offerings, and to
increase economies of scale. With respect to acquisitions, the Company has
acquired 57 businesses since 1998, almost exclusively in its securities
servicing and fiduciary segment. The acquisition of Pershing in 2003 for $2
billion was the largest of these acquisitions.
As part of the transformation to a leading securities servicing provider,
the Company has also de-emphasized or exited its slower growth traditional
banking businesses over the past decade. The Company's more significant
actions include selling its credit card business in 1997 and its factoring
business in 1999, and most recently, significantly reducing non-financial
corporate credit exposures by 44% from December 31, 2000 to December 31, 2003.
Capital generated by these actions has been reallocated to the Company's higher
growth businesses.
The Company's business model is well positioned to benefit from a number
of long-term secular trends. These include the growth of worldwide financial
3
assets, globalization of investment activity, structural market changes, and
increased outsourcing. These trends benefit the Company by driving higher
levels of financial asset trading volume and other transactional activity, as
well as higher asset price levels and growth in client assets, all factors by
which the Company prices its services. In addition, international markets
offer excellent growth opportunities.
SECOND QUARTER 2004 HIGHLIGHTS
After a strong overall market environment in the first quarter, the equity
markets fell off in the second quarter, as equity trading volumes and
volatility declined. Fixed income activity levels and foreign exchange
activity and volatility remained high, providing an offset. Against this back
drop, the Company's diversified business model performed well, achieving its
fifth consecutive quarter of sequential core earnings growth.
The Company reported second quarter net income of $371 million and diluted
earnings per share of 48 cents compared with net income of $364 million and
diluted earnings per share of 47 cents in the first quarter of 2004, and net
income of $295 million and diluted earnings per share of 39 cents in the second
quarter of 2003. Year-to-date net income was $735 million, or 94 cents of
diluted earnings per share, compared to $590 million, or 80 cents of diluted
earnings per share in 2003. Second quarter and year-to-date 2003 results
included dilution of 2 cents per share from merger and integration costs
associated with the Pershing acquisition.
Securities servicing fees held steady at $717 million for the second
quarter. Securities servicing fees were up $119 million or 20% over the second
quarter of 2003. While the noticeable drop in equity market trading volumes
impacted the Company's execution and clearing business, its fixed-income linked
businesses, including securities lending, corporate trust and global collateral
management, generated strong revenue growth. In addition, the Company's
depositary receipts ("DR") business continues to build momentum, driven by
seasonal dividend activity and higher levels of capital raisings. Continued
new business wins across the board further supported growth in revenues and
assets under custody.
At June 30, 2004 assets under custody rose to $8.7 trillion, from $8.6
trillion at March 31, 2004 and $7.8 trillion at June 30, 2003. Cross-border
custody assets were $2.4 trillion at June 30, 2004. Equity securities composed
34% of the assets under custody at June 30, 2004, while fixed income securities
were 66%.
The Company's asset management business continues to perform well,
responding to growing institutional investor interest in alternative
investments. Private client services and asset management fees increased 5% on
a sequential quarter basis. In addition, foreign exchange results continued to
benefit from currency volatility and increased cross-border investing. Foreign
exchange and other trading revenues declined by 6% relative to the first
quarter to $100 million, but remained at historically high levels, up 14%
versus a year ago.
Net interest income, excluding the first quarter impact of the leveraged
lease adjustment, was up 2% sequentially, reflecting modest growth in liquid
earning assets. On a year-over-year basis, net interest income for the quarter
increased 6%, reflecting the full impact of the Pershing acquisition and an
increase in investment securities.
The Company remains very focused on managing its expense base and
continuing to implement reengineering and profitability programs. Credit
quality remains strong, reflecting the success of the Company's risk management
program as well as the improved economic environment. As a result, the loan
loss provision came in at $10 million in the second quarter, slightly better
than the $12 million provision in the first quarter.
4
During the second quarter of 2004, the Company continued to invest in
enhancing its service offerings, critical to sustaining top line growth through
all types of markets, while maintaining its commitment to expense discipline to
ensure a competitive cost base. Service offerings enhancements were the result
of both internal development and acquisitions. In investor services, the
Company rolled out major enhancements to INFORM, the primary day to day
electronic interface between clients and the Company. In execution and
clearing, the Company acquired a leading electronic trading platform from Sonic
Financial which offers clients access to sophisticated trading tools and smart
routing capabilities. At Pershing, the Company introduced enhancements to its
platform for introducing broker-dealers enabling them to more effectively
manage and sell to their clients. The results of these investments were
demonstrated by consistent new business wins, which were key drivers for growth
in revenues and assets under custody in the quarter.
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Servicing Fees
Securities $ 717 $ 716 $ 598 $ 1,433 $ 1,071
Global Payment Services 81 79 80 160 158
------- ------- ------- ------- -------
798 795 678 1,593 1,229
Private Client Services
and Asset Management Fees 113 108 94 221 184
Service Charges and Fees 94 96 92 190 189
Foreign Exchange and
Other Trading Activities 100 106 88 206 154
Securities Gains 12 33 9 45 16
Other 49 92 35 141 69
------- ------- ------- ------- -------
Total Noninterest Income $ 1,166 $ 1,230 $ 996 $ 2,396 $ 1,841
======= ======= ======= ======= =======
Total noninterest income for the second quarter of 2004 was $1,166
million. Excluding the $48 million pre-tax gain on sale of a portion of the
Company's investment in Wing Hang Bank, Ltd. and the $19 million gain on four
sponsor fund investments in the first quarter of 2004, noninterest income
increased by $3 million. Total noninterest income for the second quarter was
up 17% over the second quarter of last year reflecting the full quarter impact
of the Pershing acquisition as well as strong performance in private client
services and asset management and improved results from foreign exchange and
other trading activities. Excluding the aforementioned gains in the first
quarter of 2004, noninterest income for the six months ended June 30, 2004 was
$2,329 million, an increase of 27% over the comparable 2003 period, reflecting
the impact of the Pershing acquisition and organic growth.
Notwithstanding the noticeable drop in sequential equity trading volumes,
the diversity of the securities servicing businesses allowed fees to hold
steady at $717 million for the second quarter. Securities servicing fees were
up $119 million or 20% over the second quarter of 2003. For the first six
months of 2004, securities servicing fees were $1,433 million, an increase of
$362 million from $1,071 million for the first six months of 2003. The
principal reason for the increase over last year is the inclusion of Pershing
for full periods in 2004 compared with two months in the 2003 periods.
Execution and clearing services fees decreased $23 million sequentially,
or 8%, to $280 million in the second quarter. The execution business was
impacted by lower equity market trading volumes in the second quarter, as
combined NYSE and NASDAQ trading volumes, excluding program trading, were down
15% from the first quarter. Pershing's correspondent clearing business was
also impacted by lower retail activity in May and June which reduced billable
trades.
5
Investor services fees were up slightly to $229 million, reflecting higher
securities lending, domestic custody, and global funds services fees driven by
new business wins, partially offset by slightly lower average asset price
levels over the quarter. As of June 30, 2004, assets under custody rose to
$8.7 trillion, from $8.6 trillion at March 31, 2004 and $7.8 trillion at June
30, 2003.
Issuer services fees recorded a strong quarter, increasing 13%
sequentially reflecting good growth in depositary receipts and corporate trust
and stable results in stock transfer. Depositary receipts benefited from an
increase in seasonal dividend activity, continued active cross-border
investing, and an increase in new capital issuances. Corporate trust activity
benefited from strength in issuance of global securities.
Broker-dealer services fees also showed good growth, increasing $3
million, or 6%, on a sequential quarter basis, as a result of higher volumes
due to new business wins in the collateral management businesses and higher
levels of mortgage backed and government trading activity.
Global payment services fees were up $2 million, or 3%, compared with the
prior quarter and up $1 million or 1% from a year ago resulting from higher
volumes and conversion of new business. Global payment services fees increased
by 1% on a year-to-date basis over 2003.
Private client services and asset management fees for the second quarter
were up 5% from the prior quarter and 20% from the second quarter of 2003. The
sequential quarter increase reflects continued strong growth at Ivy Asset
Management and seasonally higher private client fees related to tax services.
The increase from the second quarter of 2003 and on a year-to-date basis
reflects growth in Ivy Asset Management as well as higher equity price levels.
Total assets under management were $93 billion at June 30, 2004, up from $92
billion at March 31, 2004 and $83 billion a year ago.
Service charges and fees were down 2% from the prior quarter, as higher
retail service fees were offset by weaker demand for capital market services.
Compared to 2003, service charges and fees were up 2% on a quarterly basis and
up 1% on a year-to-date basis, reflecting higher retail services fees.
Foreign exchange and other trading revenues decreased $6 million from the
record first quarter but increased $12 million, or 14%, from a year ago. The
continued strong performance this quarter in foreign exchange reflects high
levels of client activity, tied to cross-border investing and hedging against
currency volatility. For the six months ended June 30, 2004, foreign exchange
and other trading activities were up 34% over the six months ended June 30,
2003, reflecting the same factors outlined for the second quarter.
Securities gains in the second quarter were $12 million, compared with $33
million in the first quarter of 2004 and $9 million in the second quarter of
2003. In the first quarter of 2004, securities gains included realized gains
of $19 million on four sponsor fund investments. For the six months ended June
30, 2004, securities gains were $45 million, up $29 million from the six months
ended June 30, 2003.
Other noninterest income was $49 million in the second quarter, compared
with $92 million in the first quarter of 2004 when other noninterest income
included a pre-tax gain of $48 million from the sale of a portion of the
Company's investment in Wing Hang Bank Limited. Compared to the second quarter
of 2003, other noninterest income was $49 million up from $35 million last
year. In the six months ended June 30, 2004, other noninterest income was $141
million, up from $69 million in the six months ended June 30, 2003 primarily
reflecting the gain on the sale of a portion of its investment in Wing Hang
Bank Limited.
6
Net Interest Income
- -------------------
2nd 1st 1st 2nd
Quarter Quarter Quarter Quarter Year-to-Date
-------- -------- ------- -------- -------------------------
Reported Reported Core** Reported Reported Core** Reported
(Dollars in millions) -------- -------- ------- -------- -------- ------- --------
2004 2004 2004 2003 2004 2004 2003
-------- -------- ------- -------- -------- ------- --------
Net Interest Income $ 421 $ 268 $ 413 $ 398 $ 689 $ 834 $ 784
Tax Equivalent Adjustment* 8 6 6 9 14 14 19
-------- -------- ------- -------- -------- ------- --------
Net Interest Income on a
Tax Equivalent Basis $ 429 $ 274 $ 419 $ 407 $ 703 $ 848 $ 803
======== ======== ======= ======== ======== ======= ========
Net Interest Rate
Spread 1.84% 1.13% 1.85% 1.96% 1.49% 1.84% 2.06%
Net Yield on Interest
Earning Assets 2.08 1.36 2.08 2.21 1.72 2.08 2.32
* A number of amounts related to net interest income are presented on a
"taxable equivalent basis." The Company believes that this presentation
provides comparability of net interest income arising from both taxable
and tax-exempt sources and is consistent with industry standards.
** Excludes SFAS 13 adjustment
Net interest income on a taxable equivalent basis was $429 million in the
second quarter of 2004, compared with $274 million reported in the first
quarter of 2004, and $407 million in the second quarter of 2003. The net
interest income rate spread was 1.84% in the second quarter of 2004, compared
with 1.13% reported in the first quarter of 2004, and 1.96% in the second
quarter of 2003. The net yield on interest earning assets was 2.08% in the
second quarter of 2004, compared with 1.36% reported in the first quarter of
2004, and 2.21% in the second quarter of 2003. In the first quarter of 2004,
net interest income included a pre-tax charge of $145 million resulting from a
cumulative adjustment to the leasing portfolio, which was triggered under
Statement of Financial Accounting Standards No. 13 ("SFAS 13") "Accounting for
Leases". Excluding the SFAS 13 adjustment, net interest income on a taxable
equivalent basis was $419 million in the first quarter of 2004, which reflected
a net interest rate spread of 1.85% and a net yield on interest earning assets
of 2.08%.
The increase in net interest income from the core first quarter of 2004
results is primarily due to a slightly higher level of liquid earning assets,
which resulted from the greater deposit flows from servicing customers, as well
as a modest shift from fixed rate investment securities to short-term floating
assets to better position for higher rates. The increase in net interest
income from the second quarter of 2003 reflects the full quarter impact of the
Pershing acquisition.
For the first six months of 2004, net interest income on a taxable
equivalent basis was $703 million, compared with $803 million in the first half
of 2003, reflecting the SFAS 13 adjustment partially offset by the full impact
of the Pershing acquisition. The year-to-date net interest income spread was
1.49% in 2004 (core of 1.84%) compared with 2.06% in 2003, while the net yield
on interest earning assets was 1.72% in 2004 (core of 2.08%) and 2.32% in 2003.
7
Noninterest Expense and Income Taxes
- ------------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in million) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Salaries and Employee Benefits $ 570 $ 574 $ 498 $ 1,144 $ 921
Net Occupancy 72 81 64 153 122
Furniture and Equipment 51 51 49 102 85
Clearing 44 48 40 92 69
Sub-custodian Expenses 22 22 19 44 35
Software 50 49 43 99 78
Communications 23 24 23 47 44
Amortization of Intangibles 8 8 7 16 10
Merger and Integration Costs - - 25 - 25
Other 172 156 135 328 253
------- ------- ------- ------- -------
Total Noninterest Expense $ 1,012 $ 1,013 $ 903 $ 2,025 $ 1,642
======= ======= ======= ======= =======
Noninterest expense for the second quarter of 2004 was $1,012 million,
compared with $1,013 million in the prior quarter, and $903 million in the
second quarter of 2003. Noninterest expense in the first quarter included $18
million related to cost reduction initiatives, including lease terminations,
severance and relocation expenses.
After adjusting for the $4 million step-up in stock option expensing this
quarter as well as $10 million in severance and $8 million in lease termination
costs in the first quarter, sequential expense growth was only 1.3%. Salaries
and employee benefits were well controlled increasing just $2 million, or 0.4%,
after the aforementioned adjustments. Headcount was up 181 for the quarter
increasing by only 85 excluding acquisitions. Option expense levels will not
increase in the third and fourth quarter of 2004 with the last step-up in
option expensing coming in the second quarter of 2005, reflecting the
completion of the three year phase-in period. Clearing expenses in the second
quarter, which are tied to transaction volumes, were down $4 million
sequentially to $44 million while sub-custodian expenses, which are also tied
to volumes, held steady at $22 million due to stronger activity trends in
Europe. The increase in other operating expenses of $16 million on a
sequential quarter basis was driven largely by higher legal costs, increased
use of consultants in connection with cost restructuring programs, and seasonal
travel and entertainment.
Second quarter of 2003 included $25 million of merger and integration
costs related to the Pershing acquisition. After excluding merger and
integration costs, noninterest expense for the second quarter of 2004 was
$1,012 million compared with $878 million in the second quarter of 2003. On
the same basis, noninterest expense for the first six months of 2004 was $2,025
million compared with $1,617 million last year. The increases mainly reflect
higher business activity and the full impact of the Pershing acquisition in the
second quarter and first half of 2004.
The effective tax rate for the second quarter of 2004 was 34.2%, compared
to 23.1% in the first quarter and 34.6% in the second quarter of 2003. The
effective tax rate for the six months period ended June 30, 2004 was 29.2%,
compared with 34.6% for the six months period ended June 30, 2003. The year-
over-year decreases reflect the benefit associated with the SFAS 13 adjustment
in the first quarter of 2004.
8
Credit Loss Provision and Net Charge-offs
- -----------------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-Date
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Provision $ 10 $ 12 $ 40 $ 22 $ 80
======= ======= ======= ======= =======
Net Charge-offs:
Commercial $ (11) $ (5) $ (34) $ (16) $ (59)
Foreign (8) (10) (7) (18) (7)
Other - - - - (10)
Consumer (6) (11) (5) (17) (10)
------- ------- ------- ------- -------
Total $ (25) $ (26) $ (46) $ (51) $ (86)
======= ======= ======= ======= =======
Other Real Estate Expenses $ - $ - $ - $ - $ -
The provision was $10 million in the second quarter of 2004 compared to
$12 million in the first quarter of 2004 and $40 million in the second quarter
of 2003. For the first six months of 2004, the provision was $22 million
compared with $80 million in 2003. The lower provision compared with the
second quarter of 2003 reflects the Company's improved risk profile as well as
improvements in the U.S. economy. Declines in nonperforming and criticized
assets, improved borrower ratings, and reductions in large exposures are
indicative of the Company's reduced credit risk.
Net charge-offs were $25 million in the second quarter of 2004 versus $26
million and $46 million in the first quarter of 2004 and second quarter of
2003. These represent 0.26% of total loans in the most recent quarter, down
from 0.29% and 0.49% in the prior periods, respectively.
OTHER DEVELOPMENTS
In May 2004, the Company made a strategic investment in London-based
Netik, LLC. Netik provides market-leading data management and consolidated
reporting capabilities that leverage its data warehouse for portfolio and
investment information, reference data, and analytics. The Company uses Netik
products as part of its BNY SmartSource(service mark) outsourcing solution,
and will also partner with Netik to make the product available to other
financial institutions.
Late in the second quarter of 2004, the Company acquired a unit investment
trust business that services approximately $20 billion in assets for over 4,200
different series of unit investment trusts.
During the second quarter of 2004, the Company agreed to acquire Osprey
Partners LLC's portfolio accounting technology to broaden its managed account
services offering. The acquisition will allow the Company to integrate the
portfolio accounting function within its proprietary managed account services
offering and fully support the comprehensive portfolio view created by unified
managed account platforms.
In July 2004, the Company's new $2 billion shelf registration became
effective. Combined with the existing shelf registration the Company now has
the capacity to issue approximately $2.5 billion of debt, preferred stock,
preferred trust securities, or common stock.
9
BUSINESS SEGMENTS REVIEW
The Company has an internal information system that produces performance
data for its four business segments along product and service lines.
Business Segments Accounting Principles
- ---------------------------------------
The Company's segment data has been determined on an internal management
basis of accounting, rather than the generally accepted accounting principles
used for consolidated financial reporting. These measurement principles are
designed so that reported results of the segments will track their economic
performance. Segment results are subject to restatement whenever improvements
are made in the measurement principles or organizational changes are made. In
the first quarter of 2004, the Company changed its methodology for allocating
its pension credit to the segments. Prior periods have been restated.
The measure of revenues and profit or loss by operating segment has been
adjusted to present segment data on a taxable equivalent basis. The provision
for credit losses allocated to each reportable segment is based on management's
judgment as to average credit losses that will be incurred in the operations of
the segment over a credit cycle of a period of years. Management's judgment
includes the following factors among others: historical charge-off experience
and the volume, composition, and size of the loan portfolio. This method is
different from that required under generally accepted accounting principles as
it anticipates future losses, which are not yet probable, and therefore not
recognizable under generally accepted accounting principles. Assets and
liabilities are match funded. Support and other indirect expenses are allocated
to segments based on general internal guidelines.
Description of Business Segments
- --------------------------------
The results of individual business segments exclude unusual items such as
the GMAC settlement and the Pershing related merger and integration costs of
2003, which are included with reconciling amounts.
The Company reports data for the four business segments: Servicing and
Fiduciary Businesses, Corporate Banking, Retail Banking, and Financial Markets.
The Servicing and Fiduciary Businesses segment comprises the Company's
core services, including securities servicing, global payment services, and
private client services and asset management. These businesses all share
certain favorable attributes: they are well diversified and fee-based; the
Company serves the role of an intermediary rather than principal, thereby
limiting risk and generating more stable earnings streams; and the businesses
are scalable, which result in higher margins as revenues grow. Long-term
trends that favor these businesses include the growth of financial assets
worldwide, the globalization of investment activity, heightened demand for
financial servicing outsourcing, and continuing structural changes in financial
markets.
Securities servicing provides financial institutions, corporations and
financial intermediaries with a broad array of products and customized services
for every step of the investment lifecycle. The Company facilitates the
movement, settlement, recordkeeping and accounting of financial assets around
the world by delivering timely and accurate information to issuers, investors
and broker-dealers. The Company groups its securities servicing businesses
into four categories, each comprised of separate, but related businesses.
Issuer services include corporate trust, depositary receipts and stock
transfer. Investor services include global fund services, global custody,
securities lending, global liquidity services and outsourcing. Broker-dealer
services include government securities clearance and collateral management.
Execution and clearing services include in the execution area institutional
agency brokerage, electronic trading, transition management services, and
independent research. Through Pershing, the clearing part of the business
provides clearing, execution, financing, and custody for introducing
brokers/dealers. The Servicing and Fiduciary Businesses segment also includes
customer-related foreign exchange.
10
In issuer services, the Company's American and global depositary receipt
("DR") business has over 1,180 programs representing 60 countries. As a
trustee, the Company provides diverse services for corporate, municipal,
mortgage-backed, asset-backed, derivative and international debt securities.
Over 90,000 appointments for more than 30,000 worldwide clients have resulted
in the Company being trustee for more than $1 trillion in outstanding debt
securities. The Company is the third largest stock transfer agent representing
over 1,950 publicly traded companies with over 19 million shareholder accounts.
In investor services, the Company is the second largest custodian with
$8.7 trillion of assets at June 30, 2004. The Company is the second largest
mutual fund custodian with $1.4 trillion in assets. The Company is the largest
U.K. custodian. The Company services over 25% of total exchange traded fund
industry assets. In securities lending, the Company is the largest lender of
U.S. Treasury securities and depositary receipts.
The Company's broker-dealer services business clears approximately 50% of
U.S. Government securities. With over $800 billion in tri-party balances
worldwide, the Company is the world's largest collateral management agent.
The Company's execution and clearing services business is the largest
global institutional agency brokerage organization. In addition, it is the
largest institutional electronic broker for non-U.S. dollar equity execution.
The Company provides execution and clearing services in over 80 markets,
executing trades for more than 600 million shares and clearing 650,000 trades
daily. The Company has 21 seats on the New York Stock Exchange. Pershing
services nearly 1,100 introducing brokerage firms and registered investment
advisors who collectively represent more than 5 million individual investors.
Global payment services facilitate the flow of funds between the Company's
customers and their clients through such business lines as funds transfer, cash
management and trade services. Private client services and asset management
includes traditional banking and trust services to affluent clients and
investment management services for institutional and high net worth clients.
The Company's strategy is to be a market leader in these businesses and
continue to build out its product and service capabilities and add new
clients. The Company has completed 57 acquisitions since 1998 in this segment,
has made significant investments in technology to maintain its industry-leading
position, and has continued the development of new products and services to
meet its clients' needs.
The Corporate Banking segment provides lending and credit-related services
to large public and private financial institutions and corporations nationwide,
as well as to public and private mid-size businesses in the New York
metropolitan area. Special industry groups focus on industry segments such as
banks, broker-dealers, insurance, media and telecommunications, energy, real
estate, retailing, and government banking institutions. Through BNY Capital
Markets, Inc., the Company provides syndicated loans, bond underwriting,
private placements of corporate debt and equity securities, and merger,
acquisition, and advisory services.
Corporate Banking coordinates delivery of all of the Company's services to
customers through its global relationship managers. The two main client bases
served are financial institution clients and corporate clients. The Company's
strategy is to focus on those clients and industries that are major users of
securities servicing and global payment services.
The Company believes that credit is an important product for many of its
customers to execute their business strategies. However, the Company has
continued to reduce its credit exposures in recent years by culling its loan
portfolio of non-strategic exposures, focusing on increasing total relationship
returns through cross-selling and limiting the size of its individual credit
exposures and industry concentrations to reduce earnings volatility.
The Retail Banking segment includes retail deposit services, branch
banking, and consumer and residential mortgage lending. The Company operates
341 branches in 23 counties in the Tri-State region. The retail network is a
stable source of low cost funding and provides a platform to cross-sell core
services from the Servicing and Fiduciary Businesses to both individuals and
small businesses in the New York metropolitan area.
11
The Financial Markets segment includes trading of foreign exchange and
interest rate risk management products, investing and leasing activities, and
treasury services to other business segments. The segment offers a
comprehensive array of multi-currency hedging and yield enhancement strategies,
and complements the other business segments. The Financial Markets segment
centralizes interest rate risk management for the Company.
There were no major customers from whom revenues were individually
material to the Company's performance.
Servicing and Fiduciary Businesses
- ----------------------------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) 2004 2004 2003 2004 2003
--------- --------- --------- --------- ---------
Net Interest Income $ 144 $ 140 $ 120 $ 284 $ 225
Provision for Credit Losses 1 - - 1 -
Noninterest Income 994 990 843 1,984 1,534
Noninterest Expense 764 757 651 1,521 1,176
Income Before Taxes 373 373 312 746 583
Average Assets $ 22,891 $ 22,771 $ 15,727 $ 22,831 $ 11,695
Average Deposits 35,520 35,138 33,499 35,329 32,320
Nonperforming Assets 3 3 16 3 16
(In billions)
Assets Under Custody $ 8,662 $ 8,577 $ 7,787 $ 8,662 $ 7,787
Equity Securities 34% 33% 32% 34% 32%
Fixed Income Securities 66 67 68 66 68
Cross-Border Assets $ 2,425 $ 2,401 $ 2,180 $ 2,425 $ 2,180
(In billions)
Assets Under Administration $ 32 $ 33 $ 27 $ 32 $ 27
Assets Under Management 93 92 83 93 83
Equity Securities 36% 36% 32% 36% 32%
Fixed Income Securities 22 22 23 22 23
Alternative investments 14 13 9 14 9
Liquid Assets 28 29 36 28 36
S&P 500 Index (Period End) 1,141 1,126 975 1,141 975
NASDAQ Index (Period End) 2,048 1,994 1,623 2,048 1,623
NYSE Volume (In billions) 90.8 95.4 93.0 186.2 179.6
NASDAQ Volume (In billions) 108.3 126.3 112.5 234.6 201.3
Second quarter results showed continued strength in the Company's primary
businesses, including securities servicing and private client services and
asset management. In the second quarter of 2004, pre-tax income was $373
million, compared with $373 million in the first quarter of 2004 and $312
million a year ago. On a year-to-date basis, pre-tax income was $746 million,
up 28% from $583 million in 2003.
Noninterest income increased to $994 million from $990 million in the
first quarter of 2004 and $843 million in the second quarter of 2003.
Notwithstanding the noticeable drop in sequential equity trading volumes, fees
held steady at $717 million for the second quarter given the diversity of the
securities servicing businesses. Second quarter securities servicing fees
increased $119 million, or 20%, over the second quarter of 2003, and on a year-
to-date basis, securities servicing fees were $1,433 million, up 34% over the
comparable 2003 period principally due to the inclusion of Pershing for six
months in 2004 compared with two months in the first half of 2003.
12
Securities Servicing Fees
- -------------------------
2nd 1st 4th 3rd
Quarter Quarter Quarter Quarter
(Dollars in millions) 2004 2004 2003 2003
------- ------- ------- -------
Execution and Clearing Services $ 280 $ 303 $ 290 $ 271
Investor Services 229 226 210 212
Issuer Services 155 137 136 127
Broker-Dealer Services 53 50 48 47
------- ------- ------- -------
Securities Servicing Fees $ 717 $ 716 $ 684 $ 657
======= ======= ======= =======
Execution and clearing services fees decreased $23 million sequentially,
or 8%, to $280 million in the second quarter. The execution business was
impacted by lower equity market trading volumes in the second quarter, as
combined NYSE and NASDAQ trading volumes, excluding program trading, were down
15% from the first quarter. BNY Brokerage, B-Trade, and G-Trade volumes were
down, but less than the overall market decline. The execution business also
experienced a slowdown in transition management activity from the robust first
and fourth quarter levels consistent with overall trends in the fund industry.
The impact of lower trading volumes was partly offset by new business wins
across the Company's product lines and several significant wins with existing
public fund clients. The Company has received a favorable response to Sonic,
the electronic trading portal it acquired in March. Since the acquisition, the
Company has installed 30 money managers on the platform that are responsible
for $700 billion in assets under management. Lower trading volumes had a more
muted impact on Pershing which generates the majority of its revenues from non-
transactional activities like asset gathering and technology services.
Pershing's correspondent clearing business was impacted by lower retail
activity in May and June which reduced billable trades. Margin loans held
steady at $6.1 billion which indicates that retail investor sentiment remains
positive. In addition, as a result of new business wins and organic growth,
other key metrics like total active accounts, retirement accounts, and client
assets were all up for the quarter and year-to-date.
Investor services fees were up slightly to $229 million, reflecting higher
securities lending, domestic custody, and global funds services fees driven by
new business wins, partially offset by slightly lower average asset price
levels over the quarter. As of June 30, 2004, assets under custody rose to
$8.7 trillion, from $8.6 trillion at March 31, 2004 and $7.8 trillion at June
30, 2003. The sequential quarter increase in assets under custody primarily
reflects new business wins. Cross-border custody assets were $2.4 trillion at
June 30, 2004. Equity securities composed 34% of the assets under custody at
June 30, 2004 compared with 32% at June 30, 2003, while fixed income securities
were 66% compared with 68% last year. Securities lending fees showed good
growth relative to the first quarter benefiting from increased loan assets due
to new business wins and slightly higher spreads due to seasonal factors.
Issuer services fees recorded a strong quarter, increasing 13%
sequentially reflecting good growth in depositary receipts and corporate trust
and stable results in stock transfer. Depositary receipts benefited from an
increase in seasonal dividend activity, continued active cross-border
investing, and an increase in new capital issuances. Net DR issuance has
occurred for ten straight months and in 15 of the last 18 months, demonstrating
the continued strengthened interest in cross-border investing activity.
Corporate trust activity benefited from strength in issuance of international
securities which more than offset flat performance on the municipal side.
13
Broker-dealer services fees increased $3 million, or 6%, on a sequential
quarter basis, as a result of higher volumes due to new business wins in the
collateral management businesses and higher levels of mortgage backed and
government trading activity. The Company now processes approximately $850
billion of financing for the Company's broker-dealer clients daily through tri-
party collateralized financing agreements, up 26% from a year ago.
Global payment services fees were up $2 million, or 3%, compared with the
prior quarter and up $1 million, or 1% from a year ago, resulting from higher
volumes and conversion of new business. Global payment services increased by
1% on a year-to-date basis over 2003.
Private client services and asset management fees for the second quarter
were up 5% from the prior quarter and 20% from the second quarter of 2003. The
sequential quarter increase reflects continued strong growth at Ivy Asset
Management and seasonally higher private client fees related to tax services.
The increase from the second quarter of 2003 and on a year-to-date basis
reflects growth in Ivy Asset Management as well as higher equity price levels.
Assets under management ("AUM") were $93 billion at June 30, 2004, up from
$92 billion at March 31, 2004 and $83 billion at June 30, 2003. Assets under
administration were $32 billion compared with $33 billion at March 31, 2004 and
$27 billion at June 30, 2003. The sequential quarter and year-over-year
increases in assets under management reflect growth in the Company's
alternative investments business and a rise in equity market value.
Institutional clients represent 67% of AUM while individual clients equal 33%.
AUM at June 30, 2004, are 36% invested in equities, 22% in fixed income, 14% in
alternative investments and the remainder in liquid assets. At Ivy, AUM
climbed to $13.2 billion at June 30, 2004 from $11.7 billion at March 31, 2003
and $7.3 billion at June 30, 2003 reflecting continued strong demand from
institutional and foreign investors.
Foreign exchange and other trading revenues decreased $6 million from the
prior quarter and increased $12 million, or 14%, from one year ago. The
continued strong performance this quarter in foreign exchange reflects high
levels of client activity, tied to cross-border investing and hedging against
currency volatility. Other trading was down sequentially due to a slowdown in
client driven activity at Pershing which acts as a riskless principal taker to
facilitate customer order flow. For the six months ended June 30, 2004,
foreign exchange and other trading activities were up 34% over the six months
ended June 30, 2003, reflecting the same factors outlined for the second
quarter.
Net interest income in the Servicing and Fiduciary Businesses segment was
$144 million for the second quarter of 2004 compared with $140 million for the
first quarter of 2004 and $120 million in the second quarter of 2003. The
increase in net interest income on a sequential quarter basis is primarily
attributable to higher levels of client activity which led to an increase in
the average level of assets and deposits. The increase in net interest income
from the second quarter of 2003 is primarily due to the Pershing acquisition.
Net interest income for the six months ended June 30, 2004 was $284 million
compared with $225 million in the first half of 2003, mainly due to the
Pershing acquisition. Average assets for the quarter ended June 30, 2004 were
$22.9 billion compared with $22.8 billion in the first quarter of 2004 and
$15.7 billion in the second quarter of 2003. Average assets for the six months
ended June 30, 2004 were $22.8 billion compared with $11.7 billion in the first
six months of 2003. The increase in assets in 2004 compared with 2003 is
primarily attributable to the Pershing acquisition. The second quarter of 2004
average deposits were $35.5 billion compared with $35.1 billion in the first
quarter of 2004 and $33.5 billion in the second quarter of 2003. Average
deposits for the first half of 2004 were $35.3 billion compared with $32.3
billion for the first half of 2003.
14
Net charge-offs in the Servicing and Fiduciary Businesses segment were
zero in the second quarter of 2004, compared with $5 million in the first
quarter of 2004 and zero in the second quarter of 2003. Nonperforming assets
were $3 million at June 30, 2004, compared with $3 million at March 31, 2004
and $16 million at June 30, 2003.
Noninterest expense for the second quarter of 2004 was $764 million,
compared with $757 million in the first quarter of 2004 and $651 million in the
second quarter of 2003. The rise in noninterest expense from first quarter of
2004 was primarily due to the Company's continued investment in technology, as
well as higher volume-related expenses related to revenue growth. Noninterest
expense for the first six months of 2004 was $1,521 million, compared with
$1,176 million for the same period in 2003. The increase over last year's
quarter and year-to-date periods reflects the Pershing acquisition.
Corporate Banking
- -----------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) 2004 2004 2003 2004 2003
-------- -------- -------- -------- --------
Net Interest Income $ 87 $ 89 $ 95 $ 176 $ 187
Provision for Credit Losses 15 20 30 35 60
Noninterest Income 84 80 82 164 153
Noninterest Expense 54 53 51 107 99
Income Before Taxes 102 96 96 198 181
Average Assets $ 17,308 $ 17,358 $ 19,851 $ 17,333 $ 20,189
Average Deposits 6,345 6,800 6,583 6,573 6,899
Nonperforming Assets 293 325 410 293 410
Net Charge-offs 9 11 42 20 77
In the second quarter of 2004, pre-tax income was $102 million, compared
with $96 million in the first quarter of 2004 and the second quarter of 2003.
On a year-to-date basis, pre-tax income was $198 million, up 9% from $181
million in 2003. The improvement in all periods is primarily attributable to a
reduction in credit risk, resulting in a lower provision for credit losses.
The Company has achieved its principal risk management objectives, and assets
are now flat to slightly growing.
The Corporate Banking segment's net interest income was $87 million in the
second quarter of 2004, compared with $89 million in the first quarter of 2004
and $95 million in the second quarter of 2003. The decline from both the first
quarter of 2004 and second quarter of 2003 reflects continued reduction in
lending to corporate borrowers as well as a decline in deposits. On a year-to-
date basis, net interest income for 2004 was $176 million compared with $187
million in 2003. Average assets for the quarter were $17.3 billion compared
with $17.4 billion in the first quarter of 2004 and $19.9 billion in the second
quarter of last year. Average deposits in the corporate bank were $6.3 billion
versus $6.8 billion in the first quarter of 2004 and $6.6 billion in 2003. For
the six months ended June 30, 2004, average assets were $17.3 billion compared
to $20.2 billion for the first six months of 2003. For the first half of 2004
and 2003, average deposits were $6.6 billion and $6.9 billion.
The second quarter of 2004 provision for credit losses was $15 million
compared with $20 million in the first quarter of 2004 and $30 million last
year. On a year-to-year basis, the provision for credit losses was $35 million
for 2004 and $60 million for 2003. The decline in the provision from the
second quarter and year-to-date 2003 reflects reduced credit exposures and an
improvement in overall asset quality. Net charge-offs in the Corporate Banking
segment were $9 million in the second quarter of 2004, $11 million in the first
quarter of 2004, and $42 million in the second quarter of 2003. Net charge-
offs for the first six months of 2004 were $20 million compared with $77
million in 2003. The charge-offs for the first six months of 2004 primarily
relate to loans to media and foreign borrowers. Nonperforming assets were $293
15
million at June 30, 2004, down from $325 million at March 31, 2004 and $410
million at June 30, 2003. The decrease in nonperforming assets from the second
quarter of 2003 primarily reflects paydowns and charge-offs of commercial and
foreign loans.
Noninterest income was $84 million in the current quarter, compared with
$80 million in the first quarter of 2004 and $82 million in the second quarter
of 2003. On a sequential quarter basis, the increase reflects higher
syndication fees. The increase year-over-year reflects higher income from
unconsolidated subsidiaries. On a year-to-date basis, noninterest income was
$164 million, up $11 million from $153 million in 2003, reflecting higher
income from the Company's investment in Wing Hang Bank as well as higher
capital markets fees and trading income.
Noninterest expense in the second quarter was $54 million, compared with
$53 million in the first quarter of 2004 and $51 million in the second quarter
of 2003. The increase over 2003 reflects higher compensation costs due in part
to a reduced pension credit and higher stock option expense. On a year-to-date
basis, noninterest expense was $107 million, compared with $99 million in 2003,
reflecting higher compensation and medical costs.
Retail Banking
- --------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Net Interest Income $ 126 $ 123 $ 118 $ 249 $ 234
Provision for Credit Losses 5 5 5 10 9
Noninterest Income 28 29 33 57 62
Noninterest Expense 95 93 91 188 178
Income Before Taxes 54 54 55 108 109
Average Assets $ 5,317 $ 5,377 $ 5,333 $ 5,347 $ 5,360
Average Noninterest
Bearing Deposits 5,209 5,028 4,565 5,118 4,697
Average Deposits 15,162 14,807 14,252 14,985 14,187
Nonperforming Assets 15 15 11 15 11
Net Charge-offs 5 6 5 11 10
Number of Branches 341 341 341 341 341
Total Deposit Accounts
(In Thousands) 1,129 1,133 1,183 1,129 1,183
Number of ATMS 379 378 371 379 371
The Retail Banking segment continues to demonstrate stable results in
spite of increased competition in the New York metropolitan area. In the
second quarter of 2004, pre-tax income was $54 million, compared with $54
million in the first quarter of 2004 and $55 million a year ago. On a year-to-
date basis, pre-tax income was $108 million, compared with $109 million in
2003. The Company has been able to steadily grow its deposit balances, with
average deposits reaching $15.2 billion during the quarter.
Net interest income in the second quarter of 2004 was $126 million,
compared with $123 million in the first quarter of 2004 and $118 million in the
second quarter of 2003. On a sequential quarter basis, net interest income
increased slightly reflecting higher levels of deposits. Net interest income
on a year-to-year basis for 2004 and 2003 was $249 million and $234 million.
The increases from 2003 reflect increased noninterest bearing deposits and
interest bearing deposits from municipalities in the retail bank's service area
as well as increased asset yield. The rise in deposits reflects the segment's
focus on small business owners and professionals such as lawyers, doctors and
certified public accountants. In addition, product offerings such as BNY On-
Line and the debit card along with promotional campaigns have helped build
deposit volumes.
16
Noninterest income was $28 million for the quarter compared with $29
million on a sequential quarter basis and $33 million in last year's second
quarter. Noninterest income for the first six months of 2004 was $57 million
compared with $62 million in the first six months of 2003. The decreases in
noninterest income reflect lower monthly service fees and lower debit card
fees. Monthly service charges are down as a result of promotional offerings
made in response to the competitive environment. Other deposit service fees
increased over 2003. Although the average size of a debit card transaction and
the number of transactions are up, debit card fees are down due to an industry
wide settlement that reduced intercharge income by 30%. The second quarter of
2003 included a gain on the sale of $230 million of mortgage loans.
Noninterest expense in the second quarter of 2004 was $95 million,
compared with $93 million in the first quarter of 2004 and $91 million last
year. The increase from the second quarter of 2003 reflects higher
compensation and marketing costs. Noninterest expense for the first half of
2004 was $188 million compared with $178 million in the first half of 2003.
The year-over-year change reflects the same factors influencing the quarterly
increase as well as higher legal expenses.
Net charge-offs were $5 million in the second quarter of 2004, compared
with $6 million in the first quarter of 2004 and $5 million in the second
quarter of 2003. Nonperforming assets were $15 million at June 30, 2004,
compared with $15 million at March 31, 2004, and $11 million at June 30, 2003.
The rise over the second quarter of 2003 is attributable to an increase in the
level of nonperforming small business loans. For the first six months of 2004,
net charge-offs were $11 million, up $1 million from $10 million for the first
six months of 2003.
Average deposits generated by the Retail Banking segment were $15.2
billion in the second quarter of 2004, compared with $14.8 billion in the first
quarter of 2004 and $14.3 billion in the second quarter of 2003. For the first
half of 2004 average deposits were $15.0 billion compared to $14.2 billion in
the first half of 2003. Average noninterest bearing deposits for the first six
months of 2004 were $5.1 billion compared with $4.7 billion in the first six
months of 2003. Average assets in the Retail Banking sector were $5.3 billion,
compared with $5.4 billion in the first quarter of 2004 and $5.3 billion in the
second quarter of 2003. On a year-to-year basis, average assets were $5.3
billion for 2004 and $5.4 billion in 2003.
Financial Markets
- -----------------
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) 2004 2004 2003 2004 2003
-------- -------- -------- -------- --------
Net Interest Income $ 83 $ 80 $ 80 $ 163 $ 157
Provision for Credit Losses 5 5 6 10 11
Noninterest Income 43 50 33 93 83
Noninterest Expense 28 27 25 55 49
Income Before Taxes 93 98 82 191 180
Average Assets $ 50,728 $ 50,051 $ 46,463 $ 50,390 $ 45,404
Average Deposits 5,460 3,864 4,153 4,662 4,533
Average Investment Securities 22,982 22,997 18,720 22,989 18,351
Net Charge-offs 10 4 - 14 -
In the second quarter of 2004, pre-tax income was $93 million, compared
with $98 million in the first quarter of 2004 and $82 million in the second
quarter of 2003. The sequential quarter decline is due to a drop in trading
revenue. On a year-to-date basis, pre-tax income was $191 million, up 6% from
$180 million in 2003. The increases over the second quarter and year-to-date
2003 periods are primarily due to a rise in both trading income and net
interest income.
17
Net interest income for the second quarter was $83 million compared with
$80 million on a sequential quarter and year-over-year basis. The increase
from the first quarter of 2004 reflects a slightly higher level of liquid
earning assets, which resulted from greater deposit flows from servicing
customers as well as a modest shift from fixed rate investment securities to
short-term floating assets to better position for higher rates. The increase
from the second quarter of 2003 reflects higher average balances of investment
securities partially offset by lower yields. Net interest income was $163
million in the first six months of 2004 compared to $157 million in the first
six months of 2003. Average second quarter 2004 assets in the Financial
Markets segment composed primarily of short-term liquid assets and investment
securities were $50.7 billion, up from $50.1 billion on a sequential quarter
basis and $46.5 billion last year. Average assets for the first half of 2004
were $50.4 billion compared to $45.4 billion for the first half of 2003. The
increase in assets reflects the Company's continuing strategy to reduce
investment in higher risk corporate loans and increase holdings of highly
rated, more liquid investment securities. The Company continues to invest in
adjustable or short life classes of structured mortgage-backed securities, both
of which have short durations.
Noninterest income was $43 million in the second quarter of 2004, compared
with $50 million in the first quarter of 2004 and $33 million in the second
quarter of 2003. On a year-to-date basis, noninterest income was $93 million
in 2004 and $83 million in 2003. The negative variance versus the first
quarter of 2004 reflects a slowdown in client driven activity in fixed income
trading.
Net charge-offs were $10 million in the second quarter of 2004, compared
with $4 million in the first quarter of 2004 and zero a year ago. Net charge-
offs for the first six months of 2004 and 2003 were $14 million and zero,
respectively. Charge-offs in 2004 are primarily related to the Company's
airline exposure. Noninterest expense was $28 million in the second quarter of
2004, compared with $27 million in the first quarter of 2004 and $25 million in
last year's second quarter. The increase from last year's second quarter is
attributable to higher employee incentive and other compensation. Noninterest
expense for the six months ended June 30, 2004 was $55 million, compared with
$49 million for the first six months ended June 30, 2003.
18
The consolidating schedule below shows the contribution of the Company's
segments to its overall profitability.
(Dollars in millions)
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2004 Businesses Banking Banking Markets Items Total
- ------------------------ ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 144 $ 87 $ 126 $ 83 $ (19) $ 421
Provision for
Credit Losses 1 15 5 5 (16) 10
Noninterest Income 994 84 28 43 17 1,166
Noninterest Expense 764 54 95 28 71 1,012
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 373 $ 102 $ 54 $ 93 $ (57) $ 565
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 16% 9% 15%
Average Assets $ 22,891 $ 17,308 $ 5,317 $ 50,728 $ 4,129 $ 100,373
(Dollars in millions)
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
March 31, 2004 Businesses Banking Banking Markets Items Total
- ------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 140 $ 89 $ 123 $ 80 $ (164) $ 268
Provision for
Credit Losses - 20 5 5 (18) 12
Noninterest Income 990 80 29 50 81 1,230
Noninterest Expense 757 53 93 27 83 1,013
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 373 $ 96 $ 54 $ 98 $ (148) $ 473
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 15% 9% 16%
Average Assets $ 22,771 $ 17,358 $ 5,377 $ 50,051 $ 4,121 $ 99,678
(Dollars in millions)
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2003 Businesses Banking Banking Markets Items Total
- ------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 120 $ 95 $ 118 $ 80 $ (15) $ 398
Provision for
Credit Losses - 30 5 6 (1) 40
Noninterest Income 843 82 33 33 5 996
Noninterest Expense 651 51 91 25 85 903
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 312 $ 96 $ 55 $ 82 $ (94) $ 451
========== ========= ========= ========= =========== ============
Contribution Percentage 57% 18% 10% 15%
Average Assets $ 15,727 $ 19,851 $ 5,333 $ 46,463 $ 3,550 $ 90,924
19
(Dollars in millions)
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2004 Businesses Banking Banking Markets Items Total
- ------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 284 $ 176 $ 249 $ 163 $ (183) $ 689
Provision for
Credit Losses 1 35 10 10 (34) 22
Noninterest Income 1,984 164 57 93 98 2,396
Noninterest Expense 1,521 107 188 55 154 2,025
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 746 $ 198 $ 108 $ 191 $ (205) $ 1,038
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 16% 9% 15%
Average Assets $ 22,831 $ 17,333 $ 5,347 $ 50,390 $ 4,125 $ 100,026
(Dollars in millions)
Servicing
and
For the Six Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
June 30, 2003 Businesses Banking Banking Markets Items Total
- ------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 225 $ 187 $ 234 $ 157 $ (19) $ 784
Provision for
Credit Losses - 60 9 11 - 80
Noninterest Income 1,534 153 62 83 9 1,841
Noninterest Expense 1,176 99 178 49 140 1,642
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 583 $ 181 $ 109 $ 180 $ (150) $ 903
========== ========= ========= ========= =========== ============
Contribution Percentage 56% 17% 10% 17%
Average Assets $ 11,695 $ 20,189 $ 5,360 $ 45,404 $ 3,080 $ 85,728
20
Reconciling Items
- -----------------
Description - Reconciling items for net interest income primarily relate
to the recording of interest income on a taxable equivalent basis, reallocation
of capital and the funding of goodwill and intangibles. Reconciling items for
noninterest income primarily relate to the sale of certain securities and
certain other gains. Reconciling items for noninterest expense primarily
reflects corporate overhead as well as amortization of intangibles and
severance.
In the first quarter and first half of 2004, the following adjustments
were included in reconciling items:(i) SFAS 13 cumulative adjustment to the
leasing portfolio, which impacted net interest income by $145 million, (ii)
four large securities gains and the gain on sale of Wing Hang Bank, which
impacted noninterest income by $67 million, and (iii) severance and lease
termination expense, which impacted noninterest expense by $18 million.
The adjustment to the provision for credit losses reflects the difference
between the aggregate of the credit provision over a credit cycle for the
reportable segments and the Company's recorded provision. The reconciling
items for average assets consist of goodwill and other intangible assets.
2nd 1st 2nd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) 2004 2004 2003 2004 2003
--------- --------- --------- --------- ---------
Segment's revenue $ 1,589 $ 1,581 $ 1,404 $ 3,170 $ 2,635
Adjustments:
Earnings associated with
assignment of capital (23) (29) (29) (52) (49)
Securities gains - 19 - 19 -
SFAS 13 cumulative lease adjustment - (145) - (145) -
Taxable equivalent basis and
other tax-related items 3 10 13 13 30
Other 18 62 6 80 9
--------- --------- --------- --------- ---------
Subtotal-revenue adjustments (2) (83) (10) (85) (10)
--------- --------- --------- --------- ---------
Consolidated revenue $ 1,587 $ 1,498 $ 1,394 $ 3,085 $ 2,625
========= ========= ========= ========= =========
Segment's income before tax $ 623 $ 621 $ 545 $ 1,244 $ 1,053
Adjustments:
Revenue adjustments (above) (2) (83) (10) (85) (10)
Provision for credit losses
different than GAAP 15 18 1 33 -
Severance - (11) (4) (11) (6)
Goodwill and
intangible amortization (8) (8) (7) (16) (10)
Pershing-related
integration expenses - - (25) - (25)
Lease termination - (8) - (8) -
Corporate overhead (63) (56) (49) (119) (99)
--------- --------- --------- --------- ---------
Consolidated income before tax $ 565 $ 473 $ 451 $ 1,038 $ 903
========= ========= ========= ========= =========
Segments' total average assets $ 96,244 $ 95,557 $ 87,374 $ 95,901 $ 82,648
Adjustments:
Goodwill and intangibles 4,129 4,121 3,550 4,125 3,080
--------- --------- --------- --------- ---------
Consolidated average assets $ 100,373 $ 99,678 $ 90,924 $ 100,026 $ 85,728
========= ========= ========= ========= =========
21
Allocation to Segments - Earnings associated with the assignment of capital
relate to preferred trust securities which are assigned as capital to segments.
Since the Company considers these issues to be capital, it does not allocate
the interest expense associated with these securities to individual segments.
If this interest expense were allocated to segments, it could be assigned based
on segment capital, assets, risks, or some other basis.
The reconciling item for securities gains relates to the Financial Markets
business. The taxable equivalent adjustment is not allocated to segments
because all segments contribute to the Company's taxable income and the Company
believes it is arbitrary to assign the tax savings to any particular segment.
Most of the assets that are attributable to the tax equivalent adjustment are
recorded in the Financial Markets segment. In the first quarter of 2004, the
$145 million reconciling item related to SFAS 13 cumulative lease adjustment
would be attributable to the Financial Markets segment. In addition, the first
quarter $48 million gain on the sale of Wing Hang recorded in Other would be
attributable to the Corporate Banking segment.
The reconciling item for the provision for loan losses primarily relates
to Corporate Banking. Goodwill and intangible amortization primarily relates
to the Securities Servicing and Fiduciary segment. Corporate overhead is
difficult to specifically identify with any particular segment. Approaches to
allocating corporate overhead to segments could be based on revenues, expenses,
number of employees, or a variety of other measures. In the first quarter of
2004, the $18 million of severance and lease termination would be allocated
primarily to the Servicing and Fiduciary Businesses segment. Merger and
integration charges would be allocated to the Securities and Fiduciary
Businesses segment.
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $97.5 billion at June 30, 2004, compared with $92.7
billion at March 31, 2004, and $99.8 billion at June 30, 2003. The increase in
assets from March 31, 2004 reflects the significant liquidity in the markets at
June 30, 2004 which the Company's clients left on deposit rather than invested
in the equity and fixed income markets. Total shareholders' equity was $8.8
billion at June 30, 2004, compared with $8.8 billion at March 31, 2004, and
$8.1 billion at June 30, 2003. Shareholders' equity at June 30, 2004 compared
to March 31, 2004 reflects a decline in the securities valuation allowance
offset by the retention of earnings. The decline in the securities valuation
allowance reflects the recent rise in interest rates. The major reason for the
increase in shareholders' equity from a year ago is the retention of earnings.
Return on average common equity for the second quarter of 2004 was 17.14%,
compared with 17.17% in the first quarter of 2004, and 15.56% in the second
quarter of 2003. For the first six months of 2004, return on average common
equity was 17.15% compared with 16.61% in 2003.
Return on average assets for the second quarter of 2004 was 1.49%,
compared with 1.47% in the first quarter of 2004, and 1.30% in the second
quarter of 2003. For the first six months of 2004, return on average assets
was 1.48% compared with 1.39% in 2003.
22
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(Dollars in millions) 06/30/04 12/31/03
-------- --------
Fixed Income:
Mortgage-Backed Securities $ 18,782 $ 18,703
Asset-Backed Securities - 20
Corporate Debt 1,267 1,326
Short-Term Money Market Instruments 786 917
U.S. Treasury Securities 470 505
U.S. Government Agencies 241 241
State and Political Subdivisions 229 251
Emerging Market Debt 112 109
Other Foreign Debt 512 518
-------- --------
Subtotal Fixed Income 22,399 22,590
Equity Securities:
Money Market Funds 432 200
Federal Reserve Bank Stock 99 96
Other 20 12
-------- --------
Subtotal Equity Securities 551 308
-------- --------
Total Securities $ 22,950 $ 22,898
======== ========
Total investment securities were $23.0 billion at June 30, 2004, compared
with $24.1 billion at March 31, 2004, and $22.9 billion at December 31, 2003.
Average investment securities were $23.0 billion in the second quarter of 2004,
compared with $23.0 billion in the first quarter of 2004 and $18.7 billion in
the second quarter of last year. Average investment securities were $23.0
billion in the six months ended June 30, 2004, compared with $18.4 billion in
the six months ended June 30, 2003. On a year-to-date basis, the increase was
primarily due to growth in the Company's portfolio of highly rated mortgage-
backed securities which are 92% rated AAA, 3% AA, and 5% A. Since December 31,
2002, the Company has added approximately $5.7 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 durations. The Company has maintained an effective
duration of approximately 2.2 years on its mortgage portfolio to better match
its liabilities and reduce the adverse impact from a rise in interest rates.
Net unrealized gains for securities available-for-sale were $14 million at
June 30, 2004, compared with $359 million at March 31, 2004 and $201 million at
December 31, 2003. The decline in unrealized gains reflects the rise in
interest rates in the second quarter. The asymmetrical accounting treatment of
the impact of a change in interest rates on the Company's balance sheet may
create a situation in which an increase in interest rates can adversely affect
reported equity and regulatory capital, even though economically there may be
no impact on the economic capital position of the Company. For example, an
increase in rates will result in a decline in the value of the fixed rate
portion of the Company's fixed income investment portfolio, which will be
reflected through a reduction in other comprehensive income in the Company's
shareholders' equity, thereby affecting the tangible common equity ("TCE")
ratio. Under current accounting rules, there is no corresponding change in
value of the Company's fixed rate liabilities, even though economically these
liabilities are more valuable as rates rise.
23
Loans
- -----
(Dollars in billions) Quarterly Year-to-date
Period End Average Average
------------------------- ------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------ ----- ---------- ------
June 30, 2004 $38.2 $ 32.1 $ 6.1 $37.7 $ 31.2 $ 6.5 $37.0 $ 30.7 $ 6.3
December 31, 2003 35.3 29.6 5.7 37.3 31.5 5.8 35.6 31.8 3.8
June 30, 2003 37.8 32.9 4.9 35.7 32.2 3.5 33.9 31.9 2.0
Total loans were $38.2 billion at June 30, 2004, compared with $35.3
billion at December 31, 2003. The rise in total loans primarily reflects an
increase in overdrafts, securities industry loans, and margin loans. The
Company continues to focus on its strategy of reducing non-strategic and
outsized corporate loan exposures to improve its credit risk profile. Average
total loans were $37.7 billion in the second quarter of 2004, compared with
$35.7 billion in the second quarter of 2003 while for the six months ended June
30, 2004, average loans were $37.0 billion compared with $33.9 billion for
2003. The increase in average loans in both periods results from higher margin
loans due to the Pershing acquisition.
The following tables provide additional details on the Company's loan
exposures and outstandings at June 30, 2004 in comparison to December 31, 2003.
Overall Loan Portfolio
- ----------------------
Unfunded Total Unfunded Total
(Dollars in billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
06/30/04 06/30/04 06/30/04 12/31/03 12/31/03 12/31/03
-------- -------- -------- -------- -------- --------
Financial Institutions $ 12.3 $ 21.2 $ 33.5 $ 9.2 $ 21.8 $ 31.0
Corporate 3.5 19.8 23.3 4.0 20.5 24.5
-------- ------- ------- -------- -------- --------
15.8 41.0 56.8 13.2 42.3 55.5
-------- ------- ------- -------- -------- --------
Consumer & Middle Market 8.5 4.4 12.9 8.2 4.1 12.3
Leasing Financings 5.6 0.1 5.7 5.8 - 5.8
Commercial Real Estate 2.2 0.9 3.1 2.4 0.8 3.2
Margin Loans 6.1 - 6.1 5.7 - 5.7
-------- -------- -------- -------- -------- --------
Total $ 38.2 $ 46.4 $ 84.6 $ 35.3 $ 47.2 $ 82.5
======== ======== ======== ======== ======== ========
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $33.5 billion June 30,
2004 compared to $31.0 billion at December 31, 2003. These exposures are of
high quality, with 86% meeting the investment grade criteria of the Company's
rating system. The exposures are generally short-term, with 77% 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 following table.
24
(Dollars in billions)
06/30/04 12/31/03
---------------------------- ----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Banks $ 4.7 $ 3.2 $ 7.9 69% 88% $ 2.6 $ 3.1 $ 5.7
Securities
Industry 2.5 3.0 5.5 87 95 1.9 3.5 5.4
Insurance 0.4 4.8 5.2 96 64 0.3 5.0 5.3
Government 0.1 5.4 5.5 100 57 0.2 5.6 5.8
Asset Managers 4.1 3.6 7.7 85 81 3.6 3.5 7.1
Mortgage Banks 0.4 0.5 0.9 86 73 0.4 0.5 0.9
Endowments 0.1 0.7 0.8 98 58 0.2 0.6 0.8
------ ----------- --------- ----- ------ ------ ----------- ---------
Total $ 12.3 $ 21.2 $ 33.5 86% 77% $ 9.2 $ 21.8 $ 31.0
====== =========== ========= ===== ====== ====== =========== =========
Corporate
- ---------
The corporate portfolio exposure declined to $23.3 billion at June 30,
2004 from $24.5 billion at year-end 2003. Approximately 77% of the portfolio
is investment grade while 29% of the portfolio matures within one year.
(Dollars in billions)
06/30/04 12/31/03
---------------------------- ----------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ---------------- ------ ----------- --------- ----- ------ ------ ----------- ---------
Media $ 0.8 $ 2.1 $ 2.9 66% 13% $ 0.9 $ 2.3 $ 3.2
Cable 0.6 0.5 1.1 29 1 0.7 0.7 1.4
Telecom 0.1 0.5 0.6 72 13 0.3 0.6 0.9
------ ----------- --------- ------ ----- ------ ----------- ---------
Subtotal 1.5 3.1 4.6 58% 10% 1.9 3.6 5.5
Energy 0.3 4.3 4.6 85 33 0.4 4.2 4.6
Retailing 0.2 2.4 2.6 82 46 0.1 2.3 2.4
Automotive 0.1 1.9 2.0 72 50 0.1 2.1 2.2
Healthcare 0.2 1.4 1.6 90 20 0.2 1.3 1.5
Other* 1.2 6.7 7.9 80 29 1.3 7.0 8.3
------ ---------- ---------- ------ ----- ------ ----------- ---------
Total $ 3.5 $ 19.8 $ 23.3 77% 29% $ 4.0 $ 20.5 $ 24.5
====== ========== ========== ====== ===== ====== =========== =========
* Diversified portfolio of industries and geographies
The Company had previously targeted the telecom exposure for reduction to
a total of $750 million by December 31, 2004. This goal was accomplished in
the first quarter and exposures have since declined to $559 million. The
percentage of investment grade borrowers in the telecom portfolio has increased
to 72% from 52% at year-end 2003. The improved quality of the portfolio is
largely due to reductions in lower rated credits.
The Company's exposure to the airline industry consists of a $556 million
leasing portfolio (including a $14 million real estate lease exposure) as well
as $23 million of direct lending. The airline leasing portfolio consists of
$265 million to major U.S. carriers, $202 million to foreign airlines and $89
million to U.S. regionals.
During the second quarter of 2004, the industry continued to face the
dilemma of an increasingly uncompetitive cost structure, weak demand and strong
competition from the regionals. The industry's stagnant demand and considerable
excess capacity have negatively impacted the valuations of the industry's
aircraft in the secondary market. Because of these factors, the Company
continues to maintain a sizable allowance for loan losses against these
exposures and to closely monitor the portfolio.
25
Nonperforming Assets
- -------------------------
Change Change
06/30/04 vs. 06/30/04 vs.
(Dollars in millions) 06/30/04 03/31/04 03/31/04 12/31/03 12/31/03
-------- -------- ----------- -------- ------------
Loans:
Commercial $ 208 $ 231 $ (23) $ 219 $ (11)
Foreign 53 66 (13) 79 (26)
Other 50 46 4 51 (1)
-------- -------- ----------- -------- ------------
Total Nonperforming Loans 311 343 (32) 349 (38)
Other Real Estate - - - - -
-------- -------- ----------- -------- ------------
Total Nonperforming Assets $ 311 $ 343 $ (32) $ 349 $ (38)
======== ======== =========== ======== ============
Nonperforming Assets Ratio 1.0% 1.1% 1.2%
Allowance for Loan
Losses/Nonperforming Loans 192.2 184.4 191.2
Allowance for Loan
Losses/Nonperforming Assets 192.2 184.4 191.2
Allowance for Credit
Losses/Nonperforming Loans 249.1 230.5 230.2
Allowance for Credit
Losses/Nonperforming Assets 249.1 230.5 230.2
Nonperforming assets declined by $32 million, or 9% during the second
quarter of 2004 to $311 million and are down 29% from a year ago. The
sequential quarter decrease primarily reflects paydowns and charge-offs of
commercial and foreign loans. The ratio of the allowance for credit losses to
nonperforming assets increased to 249.1% at June 30, 2004, compared with 230.5%
at March 31, 2004, and 188.6% at June 30, 2003.
Activity in Nonperforming Assets
(Dollars in millions) Quarter End Year-to-Date
June 30, 2004 June 30, 2004
------------- --------------
Balance at Beginning of Period $ 343 $ 349
Additions 45 79
Charge-offs (21) (40)
Paydowns/Sales (56) (77)
------------- --------------
Balance at End of Period $ 311 $ 311
============= ==============
Interest income would have been increased by $3 million for the second
quarters of 2004 and 2003 if loans on nonaccrual status at June 30, 2004 and
2003 had been performing for the entire period. Interest income would have
been increased by $7 million and $8 million for the six months ended June 30,
2004 and 2003 if loans on nonaccrual status at June 30, 2004 and 2003 had been
performing for the entire period.
26
Impaired Loans
- --------------
The table below sets forth information about the Company's impaired loans.
The Company uses the discounted cash flow, collateral value, or market price
methods for valuing its impaired loans:
June 30, March 31, June 30,
(Dollars in millions) 2004 2004 2003
---------- ----------- ----------
Impaired Loans with an Allowance $ 168 $ 197 $ 393
Impaired Loans without an Allowance(1) 121 124 4
---------- ----------- ----------
Total Impaired Loans $ 289 $ 321 $ 397
========== =========== ==========
Allowance for Impaired Loans(2) $ 69 $ 88 $ 189
Average Balance of Impaired Loans
during the Quarter $ 305 $ 306 $ 404
Interest Income Recognized on
Impaired Loans during the Quarter $ 0.6 $ 0.9 $ 0.4
(1) When the discounted cash flows, collateral value or market price equals
or exceeds the carrying value of the loan, then the loan does not require
an allowance under the accounting standard related to impaired loans.
(2) The allowance for impaired loans is included in the Company's allowance
for loan losses.
Allowance
- ---------
June 30, March 31, June 30,
(Dollars in millions) 2004 2004 2003
---------- ----------- ----------
Margin Loans $ 6,114 $ 6,130 $ 4,877
Non-Margin Loans 32,091 29,940 32,919
Total Loans 38,205 36,070 37,796
Allowance for Loan Losses 598 632 669
Allowance for Lending-Related
Commitments 177 158 155
Total Allowance for Credit Losses 775 790 824
Allowance for Credit Losses
As a Percent of Total Loans 2.03% 2.19% 2.18%
Allowance for Credit Losses
As a Percent of Non-Margin Loans 2.42 2.64 2.50
Allowance for Loan Losses
As a Percent of Total Loans 1.57 1.75 1.77
Allowance for Loan Losses
As a Percent of Non-Margin Loans 1.86 2.11 2.03
The Company adopts new accounting policies as they become accepted as a
best practice or required by generally accepted accounting principles.
Accordingly, at December 31, 2003, the Company split its allowance for credit
losses into an allowance for loan losses and an allowance for lending-related
commitments such as unfunded loan commitments, and standby letters of credit.
This resulted in a decrease in the allowance for loan losses of $136 million
and a corresponding increase in other liabilities (which includes the allowance
for lending-related commitments). Prior period balance sheets have been
restated. Credit expenses related to the allowance for loan losses and the
allowance for lending-related commitments are reported in the provision for
credit losses in the income statement. To aid in the comparison of the
Company's results with other companies that have not yet adopted this practice,
the Company provides various credit ratios based both on the allowance for
credit losses and the allowance for loan losses.
27
The allowance for credit losses was $775 million, or 2.03% of total loans
at June 30, 2004, compared with $790 million, or 2.19% of total loans at March
31, 2004, and $824 million, or 2.18% of total loans at June 30, 2003.
The Company has $6.1 billion of secured margin loans on its balance sheet
at June 30, 2004. The Company has rarely suffered a loss on these types of
loans and doesn't allocate any of its allowance for credit losses to these
loans. As a result, the Company believes the ratio of allowance for credit
losses to non-margin loans is a more appropriate metric to measure the adequacy
of the reserve.
The ratio of the allowance for credit losses to non-margin loans decreased
to 2.42% at June 30, 2004, compared with 2.64% at March 31, 2004 and 2.50% at
June 30, 2003, reflecting continued improvement in the credit quality in the
second quarter of 2004. The Company expects credit costs to remain at lower
levels through the remainder of the year as both external and internal credit
metrics continue to improve.
Nonperforming assets declined another 9% this quarter, and have declined
by 29% from a year ago. The Company's criticized and classified loans
experienced a mid-teens decline from the first quarter of 2004 and are down by
over a third from a year ago.
The ratio of the allowance for loan losses to nonperforming assets was
192.2% at June 30, 2004, up from 184.4% at March 31, 2004, and 153.09% at June
30, 2003. Included in the Company's allowance for credit losses at June 30,
2004 is an allocated transfer risk reserve related to Argentina of $13 million.
The allowance for loan losses and the allowance for lending-related
commitments consist of four elements: (1) an allowance for impaired credits,
(2) an allowance for higher risk rated loans and exposures, (3) an allowance
for pass rated loans and exposures, and (4) an unallocated allowance based on
general economic conditions and certain risk factors in the Company's
individual portfolio and markets.
The first element (impaired credits) is based on individual analyses of
all nonperforming commercial credits over $1 million. The allowance is
measured by the difference between the recorded value of impaired loans and
their fair value in accordance with FASB 114. Fair value is either the present
value of the expected future cash flows from borrowers, the market value of the
loan, or the fair value of the collateral securing the obligation.
The second element (higher risk rated credits) is based on the assignment
of loss factors for each specific risk category of higher risk credits. The
Company risk rates each credit in its portfolio that exceeds $1 million and
assigns the credits to specific pools. A potential loss factor is assigned to
each pool, and an amount is included in the allowance equal to the multiple of
the amount of the loan in the pool times a risk factor. Reviews of higher risk
rated loans and exposures are conducted at least quarterly and each loan's
rating is reaffirmed or updated, as necessary. The Company maintains and
updates loss migration analysis by comparing actual loss experiences to the
loss factors assigned to each exposure pool. Past due consumer obligations are
included in specific risk categories based on the length of time the loan is
past due.
The third element (pass rated credits) is based on the Company's expected
loss model. Borrowers are assigned to pools based on their credit rating, the
maturity of the loan, the estimated exposure at default, and the loss given a
default. The credit rating is derived from the borrower's probability of
default. The loss given default incorporates an analysis of structure and
collateral. These ratings are frequently reviewed by the relationship managers
and their respective division portfolio managers and more formally on a semi-
annual basis. The ratings are mapped to independent parties, including the
rating agencies in order to ensure consistency and validity. At the time of
approval, loans are individually analyzed and assigned a risk rating and loss
28
given default rating. Performing consumer loans are included in the pass rated
consumer pools. The Company uses an exposure at default estimate as a way of
quantifying the amount the Company will lose in case of default. This estimate
varies depending on the level of commitment, the type of exposure, and the
credit rating of the borrower.
The fourth element (the unallocated allowance) is based on management's
judgment regarding the following factors:
- Economic conditions including duration of the current cycle
- Past experience including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm existing
credit deterioration
- Geopolitical issues and their impact on the economy
Based on an evaluation of these four elements, including individual
credits, historical credit losses, and global economic factors, the Company has
allocated its allowance for credit losses as follows:
June 30, 2004 December 31, 2003
------------- -----------------
Domestic
Real Estate 2% 2%
Commercial 75 74
Consumer 1 1
Foreign 7 9
Unallocated 15 14
------------- -----------------
100% 100%
============= =================
Such an allocation is inherently judgmental, and the entire allowance for
credit losses is available to absorb credit losses regardless of the nature of
the loss.
Deposits
- --------
Total deposits were $61.1 billion at June 30, 2004, compared with $56.1
billion at March 31, 2004 and $64.7 billion at June 30, 2003. The increase on
a sequential quarter basis was primarily due to the significant liquidity in
the markets at June 30, 2004 which the Company's clients left on deposit rather
than invested in the equity and fixed income markets. Noninterest-bearing
deposits were $16.1 billion at June 30, 2004, compared with $14.8 billion at
December 31, 2003. Interest-bearing deposits were $45.0 billion at June 30,
2004, compared with $41.6 billion at December 31, 2003.
29
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in the "Notes
to Consolidated Financial Statements" under "Summary of Significant Accounting
and Reporting Policies" in the Company's 2003 Annual Report on Form 10-K.
Three of the Company's more critical accounting policies are those related to
the allowance for credit losses, to the valuation of derivatives and securities
where quoted market prices are not available, and goodwill and other
intangibles.
Allowance for Credit Losses
- ---------------------------
The allowance for credit losses represents management's estimate of
probable losses inherent in the Company's loan portfolio. This evaluation
process is subject to numerous estimates and judgments. Probabilities of
default/borrower ratings are assigned after analyzing the credit quality of
each borrower/counterparty and the Company's internal ratings are consistent
with external rating agency default databases. Loss given default ratings are
driven by the collateral, structure, and seniority of each individual asset and
are consistent with external loss given default/recovery databases. The
Company uses an exposure at default estimate as a way of quantifying the amount
the Company could lose in case of default. This estimate varies depending on
the level of commitment, the type of exposure, and the credit rating of the
borrower. The portion of the allowance related to impaired credits is based on
the present value of future cash flows, market prices, or collateral values.
Changes in the estimates of probability of default, risk ratings, loss given
default/recovery rates, and cash flows could have a direct impact on the
allocated allowance for loan losses.
The Company's unallocated allowance is established via a process that
begins with estimates of probable loss inherent in the portfolio, based upon
the following factors:
- Economic conditions, including duration of the current cycle
- Past experience, including recent loss experience
- Credit quality trends
- Collateral values
- Volume, composition, and growth of the loan portfolio
- Specific credits and industry conditions
- Results of bank regulatory and internal credit exams
- Actions by the Federal Reserve Board
- Delay in receipt of information to evaluate loans or confirm existing
credit deterioration
- Geopolitical issues and their impact on the economy
To the extent actual results differ from forecasts or management's
judgment the allowance for credit losses may be greater or less than future
charge-offs.
The Company considers it difficult to quantify the impact of changes in
forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand the
variables that drive the allowance for credit losses.
One key variable in determining the allowance is management's judgment
around the size of the unallocated portion of the allowance. At June 30, 2004,
the unallocated allowance was 15% of the total allowance. If the unallocated
allowance were five percent higher or lower, the allowance would have increased
or decreased by $39 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 $51 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$99 million.
30
For higher risk rated credits, if the loss given default were 10% worse,
the allowance would have increased by $19 million, while if the loss given
default were 10% better, the allowance would have decreased by $25 million.
For impaired credits, if the fair value of the loans were 10% higher or
lower, the allowance would have increased or decreased by $22 million,
respectively.
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
- --------------------------------------------------------------------------
Available
----------
When quoted market prices are not available for derivatives and securities
values, such values are determined at fair value, which is defined as the value
at which positions could be closed out or sold in a transaction with a willing
counterparty over a period of time consistent with the Company's trading or
investment strategy. Fair value for these instruments is determined based on
discounted cash flow analysis, comparison to similar instruments, and the use
of financial models. Financial models use as their basis independently sourced
market parameters including, for example, interest rate yield curves, option
volatilities, and currency rates. Discounted cash flow analysis is dependent
upon estimated future cash flows and the level of interest rates. Model-based
pricing uses inputs of observable prices for interest rates, foreign exchange
rates, option volatilities and other factors. Models are benchmarked and
validated by external parties. The Company's valuation process takes into
consideration factors such as counterparty credit quality, liquidity and
concentration concerns. The Company applies judgment in the application of
these factors. In addition, the Company must apply judgment when no external
parameters exist. Finally, other factors can affect the Company's estimate of
fair value including market dislocations, incorrect model assumptions, and
unexpected correlations.
These valuation methods could expose the Company to materially different
results should the models used or underlying assumptions be inaccurate. See
"Use of Estimates" in the footnote 1 "Summary of Significant Accounting and
Reporting Policies" in the Company's 2003 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at June 30,
2004, approximately $2.2 billion of the Company's portfolio of securities and
derivatives is not priced based on quoted market prices. A change of 2.5% in
the valuation of these securities and derivatives would result in a change in
pre-tax income of $56 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 ($3,373 million
at June 30, 2004) and indefinite-lived intangible assets ($370 million at June
30, 2004) are not amortized but are subject to annual tests for impairment or
more often if events or circumstances indicate they may be impaired. Other
intangible assets are amortized over their estimated useful lives and are
subject to impairment if events or circumstances indicate a possible inability
to realize the carrying amount. The initial recording of goodwill and other
intangibles requires subjective judgments concerning estimates of the acquired
assets' fair value. The goodwill impairment test is performed in two phases.
The first step of the goodwill impairment test compares the fair value of the
reporting unit with its carrying amount, including goodwill. If the fair value
of the reporting unit exceeds its carrying amount, goodwill of the reporting
unit is considered not impaired; however, if the carrying amount of the
reporting unit exceeds its fair value, an additional procedure must be
performed. That additional procedure compares the implied fair value of the
reporting unit's goodwill with the carrying amount of that goodwill. An
impairment loss is recorded to the extent that the carrying amount of goodwill
exceeds its implied fair value. Indefinite-lived intangible assets are
evaluated for impairment at least annually by comparing its fair value to its
carrying value.
31
Other identifiable intangible assets ($422 million at June 30, 2004) are
evaluated for impairment if events and circumstances indicate a possible
impairment. Such evaluation of other intangible assets is based on undiscounted
cash flow projections. Fair value may be determined using: market prices,
comparison to similar assets, market multiples, discounted cash flow analysis
and other determinates. Estimated cash flows may extend far into the future
and, by their nature, are difficult to determine over an extended timeframe.
Factors that may significantly affect the estimates include, among others,
competitive forces, customer behaviors and attrition, changes in revenue growth
trends, cost structures and technology, and changes in discount rates and
specific industry or market sector conditions. Other key judgments in
accounting for intangibles include useful life and classification between
goodwill and indefinite lived intangibles or other intangibles which require
amortization. See Note 4 of the Notes to Consolidated Financial Statements for
additional information regarding intangible assets.
The following discussion may assist investors in assessing the impact of a
goodwill or intangible asset impairment charge. The Company has $4.2 billion
of goodwill and intangible assets at June 30, 2004. The impact of a 5%
impairment charge would result in a change of pre-tax income of approximately
$208 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 $14.7 billion and $14.3 billion on an
average basis for the six months of 2004 and 2003. Average foreign deposits,
primarily from the Company's European based securities servicing business, were
$26.2 billion and $23.8 billion at June 30, 2004 and 2003. Savings and other
time deposits were $10.2 billion on a year-to-date average basis at June 30,
2004 compared to $10.1 billion at June 30, 2003. Average payables to customers
and broker-dealers rose to $6.9 billion from $2.2 billion and long-term debt
increased to $6.2 billion from $6.0 billion reflecting the Pershing
acquisition.
The Parent has five major sources of liquidity: dividends from its
subsidiaries, a line of credit with the Bank, the commercial paper market, a
revolving credit agreement with third party financial institutions, and access
to the capital markets.
At June 30, 2004, the Bank could pay dividends of approximately $867
million to the Parent without the need for regulatory wavier. This dividend
capacity would increase in the remainder of 2004 to the extent of the Bank's
net income less dividends. Nonbank subsidiaries of the Parent have liquid
assets of approximately $302 million. These assets could be liquidated and the
proceeds delivered by dividend or loan to the Parent.
The Parent has a $300 million line of credit with the Bank, which is
subject to limits imposed by federal banking law. The Parent had no borrowings
from the Bank at June 30, 2004.
32
For the quarter ended June 30, 2004, the Parent's quarterly average
commercial paper borrowings were $75 million compared with $118 million in
2003. At June 30, 2004, the Parent had cash of $631 million compared with cash
of $585 million at March 31, 2004 and $691 million at June 30, 2003. Net of
commercial paper outstanding, the Parent's cash position at June 30, 2004 was
down $44 million compared with June 30, 2003.
The Parent has a back-up line of credit of $275 million with 15 financial
institutions. This line of credit matures in October 2006. There were no
borrowings under the line of credit at June 30, 2004 and June 30, 2003.
The Parent also has the ability to access the capital markets. At July
31, 2004, the Parent had shelf registration statements with a capacity of $2.5
billion 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 June 30, 2004 were as follows:
The Bank of
Parent Parent Parent Senior New York
Commercial Subordinated Long-Term Long-Term
Paper Long-Term Debt Debt Deposits Outlook
---------- -------------- ------------- ------------ -------
Standard &
Poor's A-1 A A+ AA- Stable
Moody's P-1 A1 Aa3 Aa2 Stable
Fitch F1+ A+ AA- AA Stable
The Parent's major uses of funds are payment of principal and interest on
its borrowings, acquisitions, and additional investment in its subsidiaries.
The Parent has $300 million of long-term debt that becomes due in 2004
subsequent to June 30, 2004 and $100 million of long-term debt that is due in
2005. In addition, at June 30, 2004, the Parent has the option to call $75
million of subordinated debt in 2004 and $94 million in 2005, which it will
call and refinance if market conditions are favorable. The Company did not
redeem any long-term debt in the month of July. The Parent expects to
refinance any debt it repays by issuing a combination of senior and
subordinated debt.
Double leverage is the ratio of investment in subsidiaries divided by the
Company's consolidated equity plus trust preferred securities. The Company's
double leverage ratio at June 30, 2004 and 2003 was 98.63% and 101.19%. 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 $3.4 billion in cash
flows through June 30, 2004, compared with $1.0 billion provided by operating
activities through June 30, 2003. The sources of cash flows from operations in
2004 and 2003 were principally the result of changes in trading activities and
net income.
In the first six months of 2004, cash used by investing activities was
$8.4 billion as compared to cash used by investing activities in the first six
months of 2003 of $12.1 billion. In the first six months of 2004 and 2003,
purchases of securities available-for-sale were a significant use of funds.
In the first six months of 2004, cash provided by financing activities was
$4.4 billion as compared to cash provided by financing activities in the first
six months of 2003 of $10.6 billion. Sources of funds in 2004 include deposits
and other borrowed funds. Deposits were the primary source of funds in 2003.
33
CAPITAL RESOURCES
Regulators establish certain levels of capital for bank holding companies
and banks, including the Company and the Bank, in accordance with established
quantitative measurements. In order for the Company to maintain its status as
a financial holding company, the Bank must qualify as well capitalized. In
addition, major bank holding companies such as the Company are expected by the
regulators to be well capitalized. As of June 30, 2004 and 2003, the Company
and the Bank were considered well capitalized on the basis of the ratios
(defined by regulation) of Total and Tier 1 capital to risk-weighted assets and
leverage (Tier 1 capital to average assets), which are shown as follows:
June 30, 2004 June 30, 2003
--------------------- -------------------- Well Adequately
Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
---------- -------- --------- -------- -------- ----------- -----------
Tier 1* 7.70% 7.32% 6.83% 6.91% 7.75% 6% 4%
Total Capital** 11.63 11.36 11.07 11.17 11.75 10 8
Leverage 6.00 5.70 5.85 5.90 6.50 5 3-5
Tangible Common
Equity ("TCE") 4.95 5.31 4.32 5.01 5.25-6.00 N.A. N.A.
* Tier 1 capital consists, generally, of common equity, preferred trust securities, and
certain qualifying preferred stock, less goodwill and most other intangibles.
**Total Capital consists of Tier 1 capital plus Tier 2 capital. Tier 2 capital consists,
generally, of certain qualifying preferred stock and subordinated debt and a portion of the
loan loss allowance.
The Company's regulatory Tier 1 capital and Total capital ratios were
7.70% and 11.63% at June 30, 2004, compared with 7.60% and 11.70% at March 31,
2004, and 6.83% and 11.07% at June 30, 2003. The regulatory leverage ratio was
6.00% at June 30, 2004, compared with 5.83% at March 31, 2004, and 5.85% at
June 30, 2003. The improvement in the Company's regulatory capital ratios
versus March 31, 2004 reflects the retention of earnings during the quarter.
The Company's tangible common equity as a percentage of total assets was 4.95%
at June 30, 2004, down from 5.22% at March 31, 2004 reflecting a decline in the
securities valuation allowance and an increase in short-term high quality
assets. This ratio varies depending on the size of the balance sheet at
quarter-end and the impact of interest rates on unrealized gains and losses
among other things. A billion dollar change in assets changes the TCE ratio 6
basis points while a $100 million change in common equity changes the TCE ratio
11 basis points. Given the Company's improving capital ratios and consistent
capital generation it expects to repurchase 2-3 million shares of common stock
in the second half of this year.
The Federal Reserve has indicated that it is reviewing the continued
treatment of preferred trust securities as Tier 1 Capital. See "Accounting
Changes and New Accounting Pronouncements" in the Footnotes to the Consolidated
Financial Statements.
34
The following table presents the components of the Company's risk-based
capital at June 30, 2004 and 2003:
(Dollars in millions) 2004 2003
---------- ----------
- ----------------
Common Stock $ 8,777 $ 8,113
Preferred Stock - -
Preferred Trust Securities 1,150 1,150
Adjustments:
Intangibles (4,159) (3,966)
Securities Valuation Allowance - (214)
Merchant Banking Investments (5) (5)
---------- ----------
Tier 1 Capital 5,763 5,078
---------- ----------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,174 2,356
Qualifying Allowance for Loan Losses 763 800
---------- ----------
Tier 2 Capital 2,937 3,156
---------- ----------
Total Risk-based Capital $ 8,700 $ 8,234
========== ==========
Risk-Adjusted Assets $ 74,809 $ 74,378
========== ==========
35
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial instruments
held for trading purposes at June 30, 2004 and June 30, 2003 are as follows:
June 30, 2004 2004 Average
------------------------------ -------------------
(Dollars in millions) Fair Value Fair Value
Notional ------------------- -------------------
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 58,295 $ - $ 15 $ - $ 39
Swaps 208,624 1,816 853 1,282 201
Written Options 169,638 - 1,178 - 1,183
Purchased Options 100,969 206 - 99 -
Foreign Exchange Contracts:
Swaps 2,806 - - - -
Written Options 8,732 - 15 - 21
Purchased Options 10,783 50 - 51 -
Commitments to Purchase
and Sell Foreign
Exchange 67,333 286 316 206 242
Debt Securities - 952 74 2,064 83
Credit Derivatives 1,562 2 3 2 7
Equity Derivatives 1,602 150 122 158 112
------ ----------- ------ -----------
Total Trading Account $3,462 $ 2,576 $3,862 $ 1,888
====== =========== ====== ===========
June 30, 2003 2003 Average
------------------------------ -------------------
(Dollars in millions) Fair Value Fair Value
Notional ------------------- -------------------
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 62,181 $ 43 $ - $ 86 $ -
Swaps 158,635 1,952 537 2,089 698
Written Options 119,304 - 1,502 - 1,432
Purchased Options 63,197 268 - 271 -
Foreign Exchange Contracts:
Swaps 2,791 - - - -
Written Options 16,387 - 96 - 79
Purchased Options 18,912 73 - 520 -
Commitments to Purchase
and Sell Foreign
Exchange 63,020 407 456 374 489
Debt Securities - 3,488 26 4,360 35
Credit Derivatives 1,801 5 4 6 4
Equity Derivatives - 16 - 22 17
------ ----------- ------ -----------
Total Trading Account $6,252 $ 2,621 $7,728 $ 2,754
====== =========== ====== ===========
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 overnight
36
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.
(Dollars in millions) 2nd Quarter 2004 Year-to-Date 2004
--------------------------- -------------------------------------
Average Minimum Maximum Average Minimum Maximum 6/30/04
------- ------- ------- ------- ------- ------- -------
Interest rate $ 5.2 $ 3.0 $ 7.8 $ 4.8 $ 2.2 $ 7.8 $ 3.0
Foreign Exchange 1.0 0.4 3.1 1.0 0.4 3.1 2.3
Equity 1.6 1.4 2.4 1.4 0.6 2.4 1.6
Credit Derivatives 1.7 1.6 2.1 1.9 1.6 2.1 1.7
Diversification (1.9) NM NM (1.3) NM NM (3.0)
Overall Portfolio 7.6 5.6 12.8 7.8 4.9 12.8 5.6
(Dollars in millions) 2nd Quarter 2003 Year-to-Date 2003
--------------------------- -------------------------------------
Average Minimum Maximum Average Minimum Maximum 6/30/03
------- ------- ------- ------- ------- ------- -------
Interest rate $ 6.4 $ 3.2 $ 10.4 $ 5.6 $ 2.2 $ 11.2 $ 9.7
Foreign Exchange 0.9 0.5 1.9 0.8 0.5 1.9 0.9
Equity 0.1 - 0.3 0.1 - 0.4 0.3
Credit Derivatives 2.0 1.6 2.8 1.0 - 2.8 1.8
Diversification (1.9) NM NM (0.6) NM NM (1.2)
Overall Portfolio 7.5 5.1 14.7 6.9 2.0 14.7 11.5
NM - Because the minimum and maximum may occur on different days for different risk components,
it is not meaningful to compute a portfolio diversification effect.
During the first six months of 2004, interest rate risk generated
approximately 53% of average VAR, credit derivatives generated 21% of average
VAR, foreign exchange accounted for 11% of average VAR, and equity generated
15% of average VAR. During the second quarter and first six months of 2004,
the Company's daily trading loss did not exceed the Company's calculated VAR
amounts on any given day.
The following table of total daily revenue or loss captures trading
volatility and shows the number of days in which the Company's trading revenues
fell within particular ranges during the past year.
Distribution of Revenues
- ------------------------
For the Quarter Ended
------------------------------------------------
Revenue Range 6/30/04 3/31/04 12/31/03 9/30/03 6/30/03
------------------------------------------------
(Dollars in millions) Number of Occurrences
- ---------------------- -------- --------- ---------- --------- --------
Less than $(2.5) 1 0 0 1 1
$(2.5)~ $ 0 11 2 5 11 8
$ 0 ~ $ 2.5 32 48 46 33 40
$ 2.5 ~ $ 5.0 17 10 15 17 15
More than $5.0 3 2 0 4 1
37
Counterparty Risk Ratings Profile
- ---------------------------------
The table below summarizes the risk ratings of the Company's foreign
exchange and interest rate derivative counterparty credit exposure for the past
year.
For the Quarter Ended
------------------------------------------------
Rating (1) 6/30/04 3/31/04 12/31/03 9/30/03 6/30/03
- --------------------- ------------------------------------------------
AAA to AA- 70% 61% 59% 60% 67%
A+ to A- 16 24 25 23 19
BBB+ to BBB- 11 12 12 13 9
Noninvestment Grade 3 3 4 4 5
------- ------- -------- ------- -------
Total 100% 100% 100% 100% 100%
======= ======= ======== ======= =======
(1) Represents credit rating agency equivalent of internal credit ratings.
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.
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) June 30, 2004
$ %
--------- ---------
+200 bp Ramp vs. Stable Rate $ 26 1.48%
+100 bp Ramp vs. Stable Rate 17 0.95
-50 bp Shock vs. Stable Rate (2) (0.11)
The 100+ basis point ramp scenario assumes short-term rates rise 25 basis
points in each of the next four quarters, while the 200+ ramp scenario assumes
a 50 basis point per quarter increase. The scenarios assume a flattening of
the yield curve with 10 year rates rising only 70 basis points in the 100+
basis point scenario and 82 basis points in the 200+ basis point scenario.
These scenarios do not reflect strategies that management could employ to limit
the impact as interest rate expectations change.
38
The Company's interest rate positioning has been slightly asset sensitive
over the past two quarters and is expected to become more so over time. The
Company's current positioning assumes a gradual rise in rates which should be
beneficial to earnings.
The above table relies on certain critical assumptions including
depositors' behavior related to interest rate fluctuations and the prepayment
and extension risk in certain of the Company's assets. For example, based on
the level of interest rates at June 30, 2004, the Company believes it has a
limited ability to reduce rates on its deposit products if there are declines
in interest rates. In addition, if interest rates decline, the Company's
portfolio of mortgage-related assets would have reduced returns if the
borrowers pay off their mortgages earlier 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.
39
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended June 30, 2004 ended June 30, 2003
---------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- ---------- --------- --------- ---------- ---------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 12,779 $ 78 2.47% $ 7,049 $ 41 2.37%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 7,340 17 0.92 7,931 24 1.20
Margin Loans 6,495 35 2.18 3,492 21 2.42
Loans
Domestic Offices 22,236 209 3.79 20,281 220 4.35
Foreign Offices 8,947 62 2.80 11,964 90 3.01
--------- ---------- --------- ----------
Non-Margin Loans 31,183 271 3.50 32,245 310 3.85
--------- ---------- --------- ----------
Securities
U.S. Government Obligations 479 3 2.46 209 2 4.16
U.S. Government Agency Obligations 4,008 33 3.27 3,019 29 3.84
Obligations of States and
Political Subdivisions 235 5 7.96 352 6 7.30
Other Securities 18,260 158 3.44 15,140 140 3.67
Trading Securities 2,082 9 1.69 4,346 32 2.95
--------- ---------- --------- ----------
Total Securities 25,064 208 3.29 23,066 209 3.62
--------- ---------- --------- ----------
Total Interest-Earning Assets 82,861 609 2.95% 73,783 605 3.29%
---------- ----------
Allowance for Credit Losses (629) (826)
Cash and Due from Banks 2,842 2,748
Other Assets 15,299 15,219
--------- ---------
TOTAL ASSETS $ 100,373 $ 90,924
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,864 $ 12 0.68% $ 7,239 $ 17 0.94%
Savings 9,357 15 0.66 9,039 18 0.81
Certificates of Deposit
$100,000 & Over 3,917 12 1.21 4,649 19 1.63
Other Time Deposits 953 4 1.60 1,350 5 1.55
Foreign Offices 26,568 83 1.26 23,827 79 1.32
--------- ---------- --------- ----------
Total Interest-Bearing Deposits 47,659 126 1.06 46,104 138 1.20
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,612 3 0.68 1,428 4 1.10
Payables to Customers and Broker-Dealers 6,813 12 0.69 3,886 9 0.88
Other Borrowed Funds 2,387 9 1.51 1,386 5 1.57
Long-Term Debt 6,139 30 1.92 6,469 42 2.53
--------- ---------- --------- ----------
Total Interest-Bearing Liabilities 64,610 180 1.11% 59,273 198 1.33%
---------- ----------
Noninterest-Bearing Deposits 14,803 12,383
Other Liabilities 12,256 11,661
Common Shareholders' Equity 8,704 7,607
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 100,373 $ 90,924
========= =========
Net Interest Earnings
and Interest Rate Spread $ 429 1.84% $ 407 1.96%
========== ========= ========== =========
Net Yield on Interest-Earning Assets 2.08% 2.21%
========= =========
40
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the six months For the six months
ended June 30, 2004 ended June 30, 2003
---------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- ---------- --------- --------- ---------- ---------
ASSETS
- ------
Interest-Bearing
Deposits in Banks
(primarily foreign) $ 12,235 $ 147 2.41% $ 6,024 $ 71 2.38%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 7,228 33 0.93 6,475 39 1.21
Margin Loans 6,337 69 2.18 1,970 24 2.43
Loans
Domestic Offices 21,655 264 2.46 19,471 435 4.50
Foreign Offices 9,074 125 2.77 12,424 186 3.03
--------- ---------- --------- ----------
Non-Margin Loans 30,729 389 2.55 31,895 621 3.93
--------- ---------- --------- ----------
Securities
U.S. Government Obligations 459 5 2.39 267 5 3.88
U.S. Government Agency Obligations 4,154 68 3.25 3,135 63 4.02
Obligations of States and
Political Subdivisions 241 8 6.73 367 13 7.07
Other Securities 18,135 311 3.44 14,582 278 3.80
Trading Securities 2,417 24 1.95 5,025 76 3.05
--------- ---------- --------- ----------
Total Securities 25,406 416 3.28 23,376 435 3.72
--------- ---------- --------- ----------
Total Interest-Earning Assets 81,935 1,054 2.59% 69,740 1,190 3.44%
---------- ----------
Allowance for Credit Losses (654) (828)
Cash and Due from Banks 2,907 2,780
Other Assets 15,838 14,036
--------- ---------
TOTAL ASSETS $ 100,026 $ 85,728
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,736 $ 23 0.68% $ 7,409 $ 35 0.97%
Savings 9,253 31 0.66 8,814 38 0.86
Certificates of Deposit
$100,000 & Over 3,952 24 1.23 4,687 39 1.69
Other Time Deposits 984 7 1.53 1,311 11 1.68
Foreign Offices 26,201 159 1.22 23,847 161 1.36
--------- ---------- --------- ----------
Total Interest-Bearing Deposits 47,126 244 1.04 46,068 284 1.24
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,612 5 0.67 1,360 7 1.04
Payables to Customers and Broker-Dealers 6,893 24 0.71 2,219 9 0.80
Other Borrowed Funds 2,393 18 1.50 823 7 1.73
Long-Term Debt 6,174 60 1.94 5,958 80 2.68
--------- ---------- --------- ----------
Total Interest-Bearing Liabilities 64,198 351 1.10% 56,428 387 1.38%
---------- ----------
Noninterest-Bearing Deposits 14,410 11,871
Other Liabilities 12,805 10,261
Common Shareholders' Equity 8,613 7,168
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 100,026 $ 85,728
========= =========
Net Interest Earnings
and Interest Rate Spread $ 703 1.49% $ 803 2.06%
========== ========= ========== =========
Net Yield on Interest-Earning Assets 1.72% 2.32%
========= =========
41
FORWARD LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS
The information presented with respect to, among other things, earnings
and revenue 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 nonperforming loans and 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," "target," "expect," "intend," "think,"
"continue," "seek," "believe," "plan," "goal," "could," "should," "may,"
"will," "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, some of
which by their nature are dynamic and subject to rapid and possibly abrupt
changes which the Company is necessarily unable to predict with accuracy,
including:
General business and economic conditions - Disruptions in general economic
activity in the United States or abroad, to the Company's operational functions
or to financial market settlement functions. The economic and other effects of
the continuing threat of terrorist activity following the WTC disaster and
subsequent U.S. military actions. Changes in customer credit quality, future
changes in interest rates, inflation, general credit quality, the levels of
economic, capital market, and merger and acquisition activity, consumer
behavior, government monetary policy, competition, credit, market and operating
risk, and loan demand. The pace of recovery of the domestic economy,
technological change in our industry, market demand for the Company's products
and services, the savings rate of individuals and future global political,
economic, business and market conditions. Variations in management
projections, methodologies used by management to set adequate reserve levels
for contingent liabilities, evaluate risk or market forecasts and the actions
that management could take in response to these changes.
Acquisitions - Lower than expected performance or higher than expected costs in
connection with acquisitions and integration of acquired businesses, changes in
relationships with customers, entering new and unfamiliar markets, incurring
undiscovered liabilities, incorrectly valuing acquisitions, the ability to
satisfy customer requirements, retain customers and realize the growth
opportunities of acquired businesses and management's ability to achieve
efficiency goals.
Competition - Increased competition from other domestic and international banks
and financial service companies such as trading firms, broker dealers and asset
managers as well as from unregulated financial services organizations. Rapid
technological changes require significant and ongoing investments in technology
to develop competitive new products and services or adopt new technologies.
Dependence on fee based business - Revenues reflect changes in the volume of
financial transactions in the United States and abroad, the level of capital
market activity affects processing revenues, changes in asset values affect
fees which are based on the value of assets under custody and management, the
level of cross-border investing, investor sentiment, the level of debt issuance
and currency exchange rate volatility all impact our revenues.
42
Reputational and legal risk - Adverse publicity and damage to our reputation
arising from the failure or perceived failure to comply with legal and
regulatory requirements, financial reporting irregularities involving other
large and well known companies and regulatory investigations of the mutual fund
industry could affect our ability to attract and retain customers, maintain
access to the capital markets or result in suits, enforcement actions, fines
and penalties.
Legislative and regulatory environment - Changes or potential changes in
domestic and international legislation and regulation as well as domestic or
international regulatory investigations impose compliance and response costs
and may allow additional competition, facilitate consolidation of competitors,
or attract new competitors into the Company's businesses.
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 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.
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.
A wide variety of domestic and foreign companies compete for processing
services. For securities servicing and global payment services, 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.
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. 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.
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.
43
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
June 30, 2004 December 31, 2003
-------------- -----------------
Assets
- ------
Cash and Due from Banks $ 3,102 $ 3,843
Interest-Bearing Deposits in Banks 9,846 8,286
Securities
Held-to-Maturity (Fair value of $1,402 in 2004
and $256 in 2003) 1,438 261
Available-for-Sale 21,548 22,642
------------- -----------------
Total Securities 22,986 22,903
Trading Assets at Fair Value 3,462 5,406
Federal Funds Sold and Securities Purchased
Under Resale Agreements 8,091 4,829
Loans (less allowance for loan losses of $598 in 2004
and $668 in 2003) 37,607 34,615
Premises and Equipment 1,404 1,398
Due from Customers on Acceptances 311 170
Accrued Interest Receivable 277 214
Goodwill 3,373 3,276
Intangible Assets 792 816
Other Assets 6,285 6,641
------------- -----------------
Total Assets $ 97,536 $ 92,397
============= =================
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 16,119 $ 14,789
Interest-Bearing
Domestic Offices 20,574 19,282
Foreign Offices 24,367 22,335
------------- -----------------
Total Deposits 61,060 56,406
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 1,315 1,039
Trading Liabilities 2,576 2,519
Payables to Customers and Broker-Dealers 9,439 10,192
Other Borrowed Funds 1,100 834
Acceptances Outstanding 313 172
Accrued Taxes and Other Expenses 4,037 4,256
Accrued Interest Payable 136 82
Other Liabilities (including allowance for
lending-related commitments of
$177 in 2004 and $136 in 2003) 2,750 2,348
Long-Term Debt 6,025 6,121
------------- -----------------
Total Liabilities 88,751 83,969
------------- -----------------
Shareholders' Equity
Class A Preferred Stock - par value $2.00 per share,
authorized 5,000,000 shares, outstanding 3,000 shares
in 2004 and 3,000 shares in 2003 - -
Common Stock-par value $7.50 per share
authorized 2,400,000,000 shares, issued
1,043,348,210 shares in 2004 and
1,039,968,482 shares in 2003 7,825 7,800
Additional Capital 1,696 1,647
Retained Earnings 5,764 5,330
Accumulated Other Comprehensive Income (53) 72
------------- -----------------
15,232 14,849
Less: Treasury Stock (265,321,337 shares in 2004
and 264,649,827 shares in 2003), at cost 6,446 6,420
Loan to ESOP (126,960 shares in 2004
and 126,960 shares in 2003), at cost 1 1
------------- -----------------
Total Shareholders' Equity 8,785 8,428
------------- -----------------
Total Liabilities and Shareholders' Equity $ 97,536 $ 92,397
============= =================
- ---------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2003 has been derived from the audited financial
statements at that date.
44
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
For the three months For the six months
ended June 30, ended June 30,
2004 2003 2004 2003
-------- -------- -------- --------
Interest Income
- ---------------
Loans $ 272 $ 310 $ 389 $ 620
Margin loans 35 21 69 24
Securities
Taxable 180 155 360 315
Exempt from Federal Income Taxes 10 13 19 26
-------- -------- -------- --------
190 168 379 341
Deposits in Banks 78 41 147 71
Federal Funds Sold and Securities Purchased
Under Resale Agreements 17 24 33 39
Trading Assets 9 32 23 76
-------- -------- -------- --------
Total Interest Income 601 596 1,040 1,171
-------- -------- -------- --------
Interest Expense
- ----------------
Deposits 126 138 244 284
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 3 4 5 7
Other Borrowed Funds 9 5 18 7
Customer Payables 12 9 24 9
Long-Term Debt 30 42 60 80
-------- -------- -------- --------
Total Interest Expense 180 198 351 387
-------- -------- -------- --------
Net Interest Income 421 398 689 784
- -------------------
Provision for Credit Losses 10 40 22 80
-------- -------- -------- --------
Net Interest Income After Provision for Credit Losses 411 358 667 704
-------- -------- -------- --------
Noninterest Income
- ------------------
Servicing Fees
Securities 717 598 1,433 1,071
Global Payment Services 81 80 160 158
-------- -------- -------- --------
798 678 1,593 1,229
Private Client Services and Asset Management Fees 113 94 221 184
Service Charges and Fees 94 92 190 189
Foreign Exchange and Other Trading Activities 100 88 206 154
Securities Gains 12 9 45 16
Other 49 35 141 69
-------- -------- -------- --------
Total Noninterest Income 1,166 996 2,396 1,841
-------- -------- -------- --------
Noninterest Expense
- -------------------
Salaries and Employee Benefits 570 498 1,144 921
Net Occupancy 72 64 153 122
Furniture and Equipment 51 49 102 85
Clearing 44 40 92 69
Sub-custodian Expenses 22 19 44 35
Software 50 43 99 78
Communications 23 23 47 44
Amortization of Intangibles 8 7 16 10
Merger and Integration Costs - 25 - 25
Other 172 135 328 253
-------- -------- -------- --------
Total Noninterest Expense 1,012 903 2,025 1,642
-------- -------- -------- --------
Income Before Income Taxes 565 451 1,038 903
Income Taxes 194 156 303 313
-------- -------- -------- --------
Net Income $ 371 $ 295 $ 735 $ 590
- ---------- ======== ======== ======== ========
Per Common Share Data:
- -----------------------------
Basic Earnings $ 0.48 $ 0.39 $ 0.95 $ 0.80
Diluted Earnings 0.48 0.39 0.94 0.80
Cash Dividends Paid 0.20 0.19 0.39 0.38
Diluted Shares Outstanding 779 757 778 742
45
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the six months ended June 30, 2004
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,800
Issuances in Connection with Employee Benefit Plans 25
-------
Balance, June 30 7,825
-------
Additional Capital
Balance, January 1 1,647
Issuances in Connection with Employee Benefit Plans 49
-------
Balance, June 30 1,696
-------
Retained Earnings
Balance, January 1 5,330
Net Income $ 735 735
Cash Dividends on Common Stock (301)
-------
Balance, June 30 5,764
-------
Accumulated Other Comprehensive Income
Balance, January 1 72
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $(63) Million (112) (112)
Reclassification Adjustment, Net of Taxes of $(1) Million (1) (1)
Foreign Currency Translation Adjustment,
Net of Taxes of $(2) Million (6) (6)
Net Unrealized Derivative Gains on Cash Flow Hedges,
Net of Taxes of $(4) Million (4) (4)
Minimum Pension Liability Adjustment,
Net of Taxes of $(1) Million (2) (2)
------- -------
Balance, June 30 (53)
-------
Total Comprehensive Income $ 610
=======
Less Treasury Stock
Balance, January 1 6,420
Issued (21)
Acquired 47
-------
Balance, June 30 6,446
-------
Less Loan to ESOP
Balance, January 1 1
-------
Balance, June 30 1
-------
Total Shareholders' Equity, June 30, 2004 $ 8,785
=======
- --------------------------------------------------------------------------------------
Comprehensive Income for the three months ended June 30, 2004 and 2003 was $160 million
and $331 million.
Comprehensive Income for the six months ended June 30, 2004 and 2003 was $610 million
and $614 million.
See accompanying Notes to Consolidated Financial Statements.
46
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the six months
ended June 30,
2004 2003
-------- --------
Operating Activities
Net Income $ 735 $ 590
Adjustments to Determine Net Cash Attributable to
Operating Activities:
Provision for Credit Losses
and Losses on Other Real Estate 22 80
Depreciation and Amortization 234 194
Deferred Income Taxes 41 210
Securities Gains (45) (16)
Change in Trading Activities 2,049 891
Change in Accruals and Other, Net 411 (979)
-------- --------
Net Cash Provided by Operating Activities 3,447 970
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks (2,377) (1,386)
Change in Margin Loans (402) (249)
Purchases of Securities Held-to-Maturity (946) -
Paydowns of Securities Held-to-Maturity 105 567
Maturities of Securities Held-to-Maturity - 10
Purchases of Securities Available-for-Sale (7,377) (13,273)
Sales of Securities Available-for-Sale 2,318 2,556
Paydowns of Securities Available-for-Sale 4,446 4,202
Maturities of Securities Available-for-Sale 1,162 3,880
Net Principal Disbursed on Loans to Customers (1,949) (1,128)
Sales of Loans and Other Real Estate 51 410
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (3,262) (6,492)
Purchases of Premises and Equipment (130) (69)
Acquisitions, Net of Cash Acquired (87) (1,769)
Proceeds from the Sale of Premises and Equipment 6 2
Other, Net 8 626
-------- --------
Net Cash Used in Investing Activities (8,434) (12,113)
-------- --------
Financing Activities
Change in Deposits 4,770 8,856
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 276 (234)
Change in Payables to Customers and Broker-Dealers (753) 942
Change in Other Borrowed Funds 365 (803)
Proceeds from the Issuance of Long-Term Debt 107 1,811
Repayments of Long-Term Debt (101) (804)
Issuance of Common Stock 95 1,105
Treasury Stock Acquired (47) (15)
Cash Dividends Paid (301) (273)
-------- --------
Net Cash Provided by Financing Activities 4,411 10,585
-------- --------
Effect of Exchange Rate Changes on Cash (165) 133
-------- --------
Change in Cash and Due From Banks (741) (425)
Cash and Due from Banks at Beginning of Period 3,843 4,748
-------- --------
Cash and Due from Banks at End of Period $ 3,102 $ 4,323
======== ========
- -----------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 298 $ 347
Income Taxes 257 292
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) - -
- -----------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
47
THE BANK OF NEW YORK COMPANY, INC.
Notes to Consolidated Financial Statements
1. General
-------
The accounting and reporting policies of The Bank of New York Company,
Inc., a financial holding company, and its consolidated subsidiaries (the
"Company") conform with generally accepted accounting principles and general
practice within the banking industry. Such policies are consistent with those
applied in the preparation of the Company's annual financial statements.
The accompanying consolidated financial statements are unaudited. In the
opinion of management, all adjustments necessary for a fair presentation of
financial position, results of operations and cash flows for the interim
periods have been made.
2. Accounting Changes and New Accounting Pronouncements
----------------------------------------------------
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.
During the first six months ended June 30, 2004, approximately 7 million
options were granted. In the second quarter and first six months of 2004, the
Company recorded $11 million and $18 million of stock option expense,
respectively.
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.
(Dollars in millions, Second Quarter Year to date
except per share amounts) 2004 2003 2004 2003
------ ------ ------ ------
Reported net income $ 371 $ 295 $ 735 $ 590
Stock based employee compensation costs,
using prospective method, net of tax 6 5 11 7
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (14) (21) (30) (40)
------ ------ ------ ------
Pro forma net income $ 363 $ 279 $ 716 $ 557
====== ====== ====== ======
Reported diluted earnings per share $ 0.48 $ 0.39 $ 0.94 $ 0.80
Impact on diluted earnings per share (0.01) (0.02) (0.02) (0.04)
------ ------ ------ ------
Pro forma diluted earnings per share $ 0.47 $ 0.37 $ 0.92 $ 0.76
====== ====== ====== ======
48
The fair value of options granted in 2004 and 2003 were estimated at the
grant date using the following weighted average assumptions:
Second Quarter Year to date
2004 2003 2004 2003
------ ------ ------ ------
Dividend yield 2.50% 3.00% 2.50% 3.00%
Expected volatility 25.10 33.54 25.00 32.78
Risk free interest rates 3.73 2.22 2.60 2.66
Expected options lives 5 5 5 5
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 entity (VIE) is
such that the company will absorb a majority of the VIE's expected losses
and/or receives a majority of the entity's expected residual returns. FIN 46
also requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The consolidation requirements of FIN
46 applied immediately to VIEs created after January 31, 2003. Various
amendments to FIN 46 delayed the effective date for certain previously
established entities until the first quarter of 2004. The adoption of FIN 46
did not have a significant impact on the Company's results of operations or
financial condition.
As of December 31, 2003, the Company had variable interests in 9
securitization trusts. These trusts are qualifying special-purpose entities,
which are exempt from the consolidation requirements of FIN 46. See Footnote
"Securitizations" in the 2003 Annual Report.
The most significant impact of FIN 46 on the Company was to require that
the trusts used to issue trust preferred securities be deconsolidated. As a
result, the trust preferred securities no longer represent a minority interest.
Under regulatory capital rules, minority interests count as Tier 1 Capital.
The Company has $1,150 million of trust preferred securities outstanding. 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. On May 6, 2004, the Board of Governors of the Federal Reserve issued
a Notice of Proposed Rulemaking which would be more restrictive as to the
amount of trust preferred securities that could be included in Tier 1. While
the Company is currently reviewing the impact of the proposed rule, both the
Company and the Bank are expected to remain "well capitalized" under the
proposed rule.
In January 2004, the FASB issued Staff Position No. 106-1, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003" ("FSP 106-1"). FSP 106-1 permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 ("the Act"). The
guidance in FSP 106-1 is effective for interim or annual financial statements
of fiscal years ending after December 7, 2003. The Company has elected to
defer accounting for any effect of the Act until specific authoritative
accounting guidance is issued. Therefore, the amounts included in the
financial statements related to the Company's postretirement benefit plans do
not reflect the effects of the Act. The Company is currently assessing the
provisions of FSP 106-1 and the Act and is unable to estimate their impact on
the Company's consolidated financial statements.
Certain other prior year information has been reclassified to conform its
presentation with the 2004 financial statements.
49
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing and
asset management businesses.
During the second quarter of 2004, 2 businesses were acquired for the
total cost of $35 million, primarily paid in cash. During the first six months
of 2004, 4 businesses were acquired for the total cost of $52 million,
primarily paid in cash. The Company frequently structures its acquisitions
with both an initial payment and a later contingent payment tied to post-
closing revenue or income growth. The Company records the fair value of
contingent payments as an additional cost of the entity acquired in the period
that the payment becomes probable.
Goodwill related to acquisitions in the second quarter and first six
months of 2004 was $21 million and $31 million, respectively. The tax
deductible portion of goodwill for the second quarter and first six months of
2004 is $21 million and $31 million. All of the goodwill was assigned to the
Company's Servicing and Fiduciary Businesses segment. At June 30, 2004, the
Company was liable for potential contingent payments related to acquisitions in
the amount of $654 million. During the second quarter and first six months of
2004, the Company paid $8 million and $8 million for contingent payments
related to acquisitions made in prior years. The pro forma effect of the 2004
acquisitions is not material to year-to-date 2004 net income.
2004
- ----
In February 2004, the Company acquired the corporate trust business of The
Bank of Hawaii. The transaction includes 80 bond trust and agency agreements
representing approximately $3 billion of principal debt outstanding to BNY
Western Trust Company.
In March 2004, the Company acquired software and other assets of Sonic
Financial Technologies LLC, a leading provider of direct access electronic
trading solutions. The acquisition brings in-house advanced electronic trading
capabilities that will enhance the trading platforms of Pershing and BNY
Brokerage.
In May 2004, the Company made a strategic investment in London-based
Netik, LLC. Netik provides market-leading data management and consolidated
reporting capabilities that leverage its data warehouse for portfolio and
investment information, reference data, and analytics. The Company uses Netik
products as part of its BNY SmartSourceSM outsourcing solution, and will also
partner with Netik to make the product available to other financial
institutions.
Late in the second quarter of 2004, the Company acquired a unit investment
trust business that services approximately $20 billion in assets for over 4,200
different series of unit investment trusts.
During the second quarter of 2004, the Company agreed to acquire Osprey
Partners LLC's portfolio accounting technology to broaden its managed account
services offering. The acquisition will allow the Company to integrate the
portfolio accounting function within its proprietary managed account services
offering and fully support the comprehensive portfolio view created by unified
managed account platforms.
50
4. Goodwill and Intangibles
------------------------
Goodwill by business segment is as follows:
(Dollars in millions)
June 30, 2004 December 31, 2003
--------------- -------------------
Servicing and
Fiduciary Businesses $ 3,233 $ 3,136
Corporate Banking 31 31
Retail Banking 109 109
Financial Markets - -
---------------- ------------------
Consolidated Total $ 3,373 $ 3,276
================ ==================
The Company's business segments are tested annually for goodwill
impairment.
Intangible Assets
- ---------------------
June 30, 2004 December 31, 2003
---------------------------------------------- ------------------------------
Weighted
Gross Net Average Gross Net
Carrying Accumulated Carrying Amortization Carrying Accumulated Carrying
(Dollars in millions) Amount Amortization Amount Period in Years Amount Amortization Amount
-------- ------------ -------- --------------- -------- ------------ --------
Trade Names $ 370 $ - $ 370 Indefinite Life $ 370 $ - $ 370
Customer Relationships 457 (51) 406 17 461 (39) 422
Other Intangible
Assets 40 (24) 16 7 43 (19) 24
The aggregate amortization expense of intangibles was $8 million and $7
million for the quarters ended June 30, 2004 and 2003, respectively. The
aggregate amortization expense of intangibles was $16 million and $10 million
for the six months ended June 30, 2004 and 2003, respectively. Estimated
amortization expense for the next five years is as follows:
For the Year Ended Amortization
(Dollars in millions) December 31, Expense
-------------------- ----------------
2004 $ 32
2005 35
2006 35
2007 33
2008 32
51
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 Risk Committee
of the Company's Board of Directors reviews the allowance at the end of each
quarter.
The portion of the allowance for credit losses allocated to impaired loans
(nonaccrual commercial loans over $1 million) is measured by the difference
between their recorded value and fair value. Fair value is the present value
of the expected future cash flows from borrowers, the market value of the loan,
or the fair value of the collateral.
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:
Three Months Ended Three Months Ended
(Dollars in millions) June 30, 2004 June 30, 2003
--------------------------------------------- -----------------
Allowance for
Allowance for Lending-Related Allowance for Allowance for
Loan Losses Commitments Credit Losses Credit Losses
------------- --------------- ------------- -----------------
Balance, Beginning of Period $ 632 $ 158 $ 790 $ 830
Charge-Offs (27) - (27) (49)
Recoveries 2 - 2 3
------------- --------------- ------------- -----------------
Net Charge-Offs (25) - (25) (46)
Provision (9) 19 10 40
------------- --------------- ------------- -----------------
Balance, End of Period $ 598 $ 177 $ 775 $ 824
============= =============== ============= =================
Allowance for Loan Losses $ 669
Allowance for Lending-Related
Commitments $ 155
Six Months Ended Six Months Ended
(Dollars in millions) June 30, 2004 June 30, 2003
--------------------------------------------- -----------------
Allowance for
Allowance for Lending-Related Allowance for Allowance for
Loan Losses Commitments Credit Losses Credit Losses
------------- --------------- ------------- -----------------
Balance, Beginning of Period $ 668 $ 136 $ 804 $ 831
Charge-Offs (56) - (56) (93)
Recoveries 5 - 5 6
------------- --------------- ------------- -----------------
Net Charge-Offs (51) - (51) (87)
Provision (19) 41 22 80
------------- --------------- ------------- -----------------
Balance, End of Period $ 598 $ 177 $ 775 $ 824
============= =============== ============= =================
Allowance for Loan Losses $ 669
Allowance for Lending-Related
Commitments $ 155
6. Capital Transactions
--------------------
At July 31, 2004, the Company had registration statements with a remaining
capacity of approximately $2.5 billion of debt, preferred stock, preferred
trust securities, or common stock.
52
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
(Dollars in millions, Three Months Ended Six Months Ended
except per share amounts) June 30, June 30,
------------------ ------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net Income (1) $ 371 $ 295 $ 735 $ 590
======== ======== ======== ========
Basic Weighted Average
Shares Outstanding 772 751 771 736
Shares Issuable on Exercise of
Employee Stock Options 7 6 7 6
-------- -------- -------- --------
Diluted Weighted Average
Shares Outstanding 779 757 778 742
======== ======== ======== ========
Basic Earnings Per Share: $ 0.48 $ 0.39 $ 0.95 $ 0.80
Diluted Earnings Per Share: 0.48 0.39 0.94 0.80
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
8. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Pension Healthcare Healthcare
Benefits Benefits Benefits Benefits
------------------ ---------------- ------------------ ----------------
Three Months Ended Six Months Ended Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
------------------ ---------------- ------------------ ----------------
(Dollars in millions) 2004 2003 2004 2003 2004 2003 2004 2003
- -------------------- --------- -------- -------- ------- --------- -------- -------- -------
Net Periodic Cost (Income)
Service Cost $ 14 $ 11 $ 28 $ 22 $ - $ 1 $ - $ 2
Interest Cost 15 12 30 24 3 2 6 4
Expected Return on Asset (35) (34) (70) (68) (2) (2) (4) (4)
Other 2 1 4 2 2 2 4 4
--------- -------- -------- ------- --------- -------- -------- -------
Net Periodic Cost (Income) $ (4)$ (10)$ (8)$ (20)$ 3 $ 3 $ 6 $ 6
========= ========= ======= ======= ========= ======== ======== =======
53
9. Commitments and Contingent Liabilities
--------------------------------------
In the normal course of business, various commitments and contingent
liabilities are outstanding which are not reflected in the accompanying
consolidated balance sheets. Management does not expect any material losses to
result from these matters.
A summary of the notional amount of the Company's off-balance-sheet credit
transactions, net of participations, at June 30, 2004 and December 31, 2003
follows:
Off-Balance-Sheet Credit Risks
- ------------------------------
June 30, December 31,
(Dollars in millions) 2004 2003
- ---------------------- ------------ ------------
Lending Commitments $ 34,615 $ 35,576
Standby Letters of Credit, net 9,713 10,168
Commercial Letters of Credit 1,231 1,013
Securities Lending Indemnifications 229,539 173,974
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 lending-related commitments at June 30, 2004
and December 31, 2003 was $177 million and $136 million.
In securities lending transactions, the Company generally requires the
borrower to provide 102% cash collateral which is monitored on a daily basis,
thus reducing credit risk. Security lending transactions are generally entered
into only with highly-rated counterparties. At June 30, 2004 and December 31,
2003, securities lending indemnifications were secured by collateral of $230.1
billion and $177.1 billion.
The notional amounts for other off-balance-sheet risks express the dollar
volume of the transactions; however, credit risk is much smaller. The Company
performs credit reviews and enters into netting agreements to minimize the
credit risk of foreign currency and interest rate risk management products.
The Company enters into offsetting positions to reduce exposure to foreign
exchange and interest rate risk.
Standby letters of credit principally support corporate obligations and
include $0.7 billion that were collateralized with cash and securities on June
30, 2004 and December 31, 2003. At June 30, 2004, approximately $6.9 billion
of the standbys will expire within one year, and the balance between one to
five years.
At June 30, 2004, the notional amounts and credit exposures for the
Company's credit derivatives swaps were $1,562 million and $2 million, compared
to $1,413 million and $3 million at December 31, 2003.
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 challenged. The IRS has recently proposed adjustments to the Company's tax
treatment of these transactions. The Company believes that its tax position
related to these transactions was proper based upon applicable statutes,
regulations and case law in effect at the time the transactions were entered
into and intends to defend its position vigorously in accordance with its view
of the law controlling these investments. However, a court or other judicial
or administrative authority, if presented with the transactions, could
54
disagree. The IRS has indicated that it may consider settlement with taxpayers
in such cases, and the Company has begun discussions with the IRS concerning
possible settlement of this particular tax issue. It is not known whether a
settlement could be reached that would be acceptable to the Company.
The Company currently believes it has adequate tax reserves to cover this
and any other potential tax exposures the IRS could raise, based on a
probability assessment of various potential outcomes. Probabilities and
outcomes are reviewed as events unfold, and adjustments to the reserves are
made when necessary.
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
upon the Company's consolidated financial statements. See "Legal Proceedings"
under Part II, Item 1 for further details.
55
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period June 30, 2004
Commission file number 1-6152
THE BANK OF NEW YORK COMPANY, INC.
Incorporated in the State of New York
I.R.S. Employer Identification No. 13-2614959
Address: One Wall Street
New York, New York 10286
Telephone: (212) 495-1784
As of July 31, 2004, The Bank of New York Company, Inc. had
778,306,085 shares of common stock ($7.50 par value) outstanding.
The Bank of New York Company, Inc. (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
The registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The following sections of the Financial Review set forth in the cross-reference
index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
- -----------------------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of
June 30, 2004 and December 31, 2003 43
Consolidated Statements of Income for
the three months and six months ended 44
June 30,2004 and 2003
Consolidated Statement of Changes in
Shareholders' Equity for the six months
ended June 30, 2004 45
Consolidated Statement of Cash Flows for the
six months ended June 30, 2004 and 2003 46
Notes to Consolidated Financial Statements 47 - 54
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 2 - 42
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 35 - 38
56
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) 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 II. 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.
As previously disclosed, the U.S. Attorney's Office for the Eastern
District of New York (the "Office") is conducting an investigation of an
alleged fraudulent scheme by RW Professional Leasing Services Corp. ("RW"), a
former customer of a Long Island branch of the Company's principal banking
subsidiary, The Bank of New York (the "Bank"). The Bank has been notified that
it and certain of its employees are subjects of the ongoing investigation.
Criminal charges have been filed against RW, certain of its principals and
other individuals including a former employee who had served as a branch
manager of the Bank. The Bank is cooperating fully in the 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, Use of Proceeds and
Issuer Purchases of Equity Securities
- --------------------------------------------------
Under its stock repurchase program, the Company buys back shares from time
to time. The following table discloses the Company's repurchases of the
Company's common stock made during the second quarter of 2004.
Total Number of Average Price Maximum Shares
Month Shares Acquired Per Share That May be Repurchased
- ----- --------------- ------------- -----------------------
April 1-30 14,109 $ 32.26 15,953,186
May 1-31 819 29.41 15,952,367
June 1-30 874,846 29.33 15,077,521
57
All shares were repurchased through the Company's stock repurchase
programs, which were announced on December 11, 2001 and November 12, 2002.
Each plan permits the repurchase of 16 million shares. The December 11, 2001
plan has been completed. In June, 850,000 shares were repurchased in open
market transactions. All other shares repurchased in the second quarter
resulted from transaction related to employee benefit plans.
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 15, 2004, 9,600 shares of common stock were issued to serving
non-employee directors as part of their annual retainer.
Item 4. Submission of Matters to Vote of Security Holders
- ----------------------------------------------------------
The Company held its annual meeting on April 13, 2004 at The Bank of New
York at 101 Barclay St. in New York, New York. The shareholders:
(1) elected fifteen persons to serve as directors of the Company;
(2) ratified the appointment of Ernst & Young LLP as the Company's
independent public accountants for 2004;
(3) approved a proposal with respect to an amendment to the Company's
2004 Management Incentive Compensation Plan;
(4) defeated a shareholder proposal with respect to political
contributions;
(5) defeated a shareholder proposal with respect to executive
compensation;
(6) defeated a shareholder proposal with respect to the composition of
the Risk Committee; and
(7) approved a shareholder proposal with respect to the Company' Rights
Plan.
58
The number of votes cast for, against or withheld, and the number of
abstentions with respect to each such matter is set forth below, as are the
number of broker non-votes, where applicable. Pursuant to New York law,
abstentions and broker non-votes are not counted toward the election of
directors.
AGAINST/ BROKER
FOR WITHHELD ABSTAINED NON-VOTES
- ---------------------------- ----------- ---------- ----------- ------------
(1) Election of Directors:
Frank J. Biondi, Jr. 620,512,458 67,793,702
Nicholas M. Donofrio 631,620,376 56,685,784
Alan R. Griffith 638,192,770 50,113,390
Gerald L. Hassell 638,233,619 50,072,541
Richard J. Kogan 620,782,205 67,523,955
Michael J. Kowalski 631,446,786 56,859,374
John A. Luke, Jr. 620,099,337 68,206,823
John C. Malone 579,590,917 108,715,243
Paul Myners 634,703,169 53,602,991
Robert C. Pozen 636,362,165 51,943,995
Catherine A. Rein 629,673,074 58,633,086
Thomas A. Renyi 632,009,763 56,296,397
William C. Richardson 631,599,016 56,707,144
Brian L. Roberts 628,982,396 59,323,764
Samuel C. Scott III 639,137,131 49,169,029
(2) Ratification of Auditors 663,844,194 19,707,567 4,754,399
(3) Approval of Proposal With
Respect to an Amendment to
the 2004 Management
Incentive Compensation Plan 618,864,949 62,234,717 7,206,494
(4) Approval of Shareholder
Proposal With Respect to
Political Contributions 32,618,281 516,178,607 43,797,712 95,711,560
(5) Approval of Shareholder
Proposal With Respect to
Executive Compensation 34,532,101 548,882,846 9,179,653 95,711,560
(6) Approval of Shareholder
Proposal With Respect to
the Composition of the
Risk Committee 54,585,308 526,324,686 11,684,606 95,711,560
(7) Approval of Shareholder
Proposal With Respect to
the Company's Rights Plan 399,067,915 185,009,346 8,517,339 95,711,560
59
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) The exhibits filed as part of this report are as follows:
Exhibit 4(i) - First Supplemental Indenture, dated as of August 2, 2004
between the registrant and J.P. Morgan Trust Company, National
Association, (successor to Bank One, National Association), as Trustee, to
the Junior Subordinated Indenture.
Exhibit 12 - Statement Re: Ratio of Earnings to Fixed Charges for the
Three Months and Six months Ended June 30,2004 and June 30, 2003.
Exhibit 31 - Certification of Chairman and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.1 - Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32 - Certification of Chairman and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) The Company filed the following reports on Form 8-K since
March 31, 2004:
On April 21, 2004: 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 first quarter of 2004 contained in the
Company's press release dated April 21, 2004.
On July 21, 2004, the Company filed a Form 8-K Current report (Item 5 and
12), which report included unaudited interim financial information and
accompanying discussion for the second quarter of 2004 contained in the
Company's press release dated July 21, 2004.
60
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: August 6, 2004 By: /s/ Bruce W. Van Saun
-------------------------
Name: Bruce W. Van Saun
Title: Chief Financial Officer
61
EXHIBIT INDEX
-------------
Exhibit Description
- ------- -----------
4(i) Exhibit 4(i) - First Supplemental Indenture, dated as of August
2, 2004 between the registrant and J.P. Morgan Trust Company,
National Association, (successor to Bank One, National
Association), as Trustee, to the Junior Subordinated Indenture.
12 Ratio of Earnings to Fixed Charges for the
Three Months and Six Months Ended June 30, 2004 and 2003.
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.