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THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended September 30, 2004
The Quarterly Report on Form 10-Q and cross reference index is on page 58.
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
- Third Quarter 2004 Highlights 3
- Consolidated Income Statement Review 5
- Other Developments 9
- Business Segments Review 10
- Consolidated Balance Sheet Review 23
- Critical Accounting Policies 31
- Liquidity 33
- Capital Resources 35
- Trading Activities 37
- Asset/Liability Management 39
- Statistical Information 41
- Forward Looking Statements and
Factors That Could Affect Future Results 43
- Website Information 44
- Supplemental Information 45
Consolidated Financial Statements
- Consolidated Balance Sheets
September 30, 2004 and December 31, 2003 46
- Consolidated Statements of Income
For the Three Months and Nine Months
Ended September 30, 2004 and 2003 47
- Consolidated Statement of Changes In
Shareholders' Equity For the Nine
Months Ended September 30, 2004 48
- Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2004 and 2003 49
- Notes to Consolidated Financial Statements 50 - 57
Form 10-Q
- Cover 58
- Controls and Procedures 59
- Legal Proceedings 59
- Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities 60
- Exhibits 60
- Signature 61
1
THE BANK OF NEW YORK COMPANY, INC.
Financial Highlights
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, June 30, September 30,
2004 2004 2003
------------ ------------ ------------
Quarter
-------
Revenue (tax equivalent basis) $ 1,747 $ 1,775 $ 1,647
Net Income 354 371 260
Basic EPS 0.46 0.48 0.34
Diluted EPS 0.46 0.48 0.34
Cash Dividends Per Share 0.20 0.20 0.19
Return on Average Common
Shareholders' Equity 15.90% 17.14% 12.82%
Return on Average Assets 1.45 1.49 1.06
Efficiency Ratio 65.2 63.9 70.7
Year-to-date
------------
Revenue (tax equivalent basis) $ 5,197 $ 3,450 $ 4,676
Net Income 1,089 735 850
Basic EPS 1.41 0.95 1.14
Diluted EPS 1.40 0.94 1.13
Cash Dividends Per Share 0.59 0.39 0.57
Return on Average Common
Shareholders' Equity 16.73% 17.15% 15.23%
Return on Average Assets 1.47 1.48 1.27
Efficiency Ratio 66.0 66.3 65.5
Assets $ 93,175 $ 97,536 $ 95,193
Loans 37,119 38,205 37,540
Securities 23,246 22,986 22,862
Deposits - Domestic 34,786 36,279 35,660
- Foreign 23,654 24,781 23,283
Long-Term Debt 6,137 6,025 6,298
Common Shareholders' Equity 9,054 8,785 8,223
Common Shareholders'
Equity Per Share $ 11.66 $ 11.29 $ 10.63
Market Value Per Share
of Common Stock 29.17 29.48 29.11
Allowance for Loan Losses as
a Percent of Total Loans 1.61% 1.57% 1.77%
Allowance for Loan Losses as
a Percent of Non-Margin Loans 1.92 1.86 2.07
Allowance for Credit Losses as
a Percent of Total Loans 2.04 2.03 2.18
Allowance for Credit Losses as
a Percent of Non-Margin Loans 2.42 2.42 2.55
Tier 1 Capital Ratio 8.09 7.70 7.08
Total Capital Ratio 12.09 11.63 11.18
Leverage Ratio 6.38 6.00 5.64
Tangible Common Equity Ratio 5.49 4.95 4.65
Employees 23,034 23,001 22,926
Assets Under Custody (In trillions)
Total Assets Under Custody $ 8.9 $ 8.7 $ 7.9
Equity Securities 33% 34% 32%
Fixed Income Securities 67 66 68
Cross-Border Assets Under Custody $ 2.5 $ 2.4 $ 2.2
Assets Under Administration
(In billions) $ 31 $ 32 $ 32
Assets Under Management (In billions)
Total Assets Under Management 97 93 85
Equity Securities 35% 36% 31%
Fixed Income Securities 21 22 22
Alternative Investments 15 14 10
Liquid Assets 29 28 37
2
Management's Discussion and Analysis of Financial Condition and
- ---------------------------------------------------------------
Results of Operations
---------------------
INTRODUCTION
The Bank of New York Company, Inc.'s (the "Company") actual results of
future operations may differ from those estimated or anticipated in certain
forward-looking statements contained herein for reasons which are discussed
below and under the heading "Forward Looking Statements and Factors That Could
Affect Future Results". When used in this report, the words "estimate,"
"forecast," "project," "anticipate," "expect," "intend," "believe," "plan,"
"goal," "should," "may," "strategy," "target, " and words of similar meaning
are intended to identify forward looking statements in addition to statements
specifically identified as forward looking statements.
OVERVIEW
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
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.
3
The Company's business model is well positioned to benefit from a number
of long-term secular trends. These include the growth of worldwide financial
assets, globalization of investment activity, structural market changes, and
increased outsourcing. These trends benefit the Company by driving higher
levels of financial asset trading volume and other transactional activity, as
well as higher asset price levels and growth in client assets, all factors by
which the Company prices its services. In addition, international markets
offer excellent growth opportunities.
THIRD QUARTER 2004 HIGHLIGHTS
The Company reported third quarter net income of $354 million and diluted
earnings per share of 46 cents, compared with net income of $371 million and
diluted earnings per share of 48 cents in the second quarter of 2004, and net
income of $260 million and diluted earnings per share of 34 cents in the third
quarter of 2003. On an operating basis, third quarter 2003 net income was
$322 million and diluted earnings per share were 42 cents. Third quarter of
2003 reported results included merger and integration costs associated with
the Pershing acquisition of 2 cents per share and the cost of the settlement
of claims related to the Company's 1999 sale of BNY Financial Corporation to
General Motors Acceptance Corporation ("GMAC") of 6 cents per share.
Year-to-date net income was $1,089 million, or $1.40 diluted earnings per
share, compared to $850 million, or $1.13 diluted earnings per share in 2003.
These 2003 reported results included Pershing merger and integration costs of
4 cents and GMAC settlement costs of 6 cents per share. In 2003 on an
operating basis, year-to-date net income was $928 million while diluted
earnings per share were $1.23.
Third quarter highlights include strong sequential fee performance in
global payment services, broker-dealer services and asset management. Net
interest income was up $7 million, or 2%, on a sequential quarter basis. The
Company continues to be positioned to benefit from a rise in interest rates.
The Company made no provision for credit losses as credit quality trends
remained excellent.
The weak capital markets environment, particularly in equities and
foreign exchange, where volumes were lackluster and volatility very low,
adversely impacted the Company's securities servicing and trading businesses.
Securities servicing, where execution and clearing revenues were particularly
affected, declined by 4% sequentially, although servicing revenues were up 4%
versus a year ago demonstrating the benefits of the Company's diverse business
model. Foreign exchange and other trading revenues decreased sharply both
sequentially and versus a year ago to $67 million, which represents the lowest
quarter for trading revenues since the first quarter of 2003.
The performance this quarter in a challenging environment reinforces the
value of the breadth and diversification of the Company's securities servicing
and fiduciary businesses. The market environment this quarter was weak,
continuing a trend the Company first saw in June which intensified through the
seasonally slow summer months. The Company's equity-linked and foreign
exchange businesses were most directly affected, yet the Company's fixed
income-linked and asset management areas performed reasonably well, cushioning
the softness in the global capital markets.
The Company's balance sheet continues to be appropriately positioned for
the expected gradual rise in interest rates and credit quality remains strong.
Expense control was important to the Company's performance in the third
quarter, and will continue to be a major focus as the Company continues to
implement its reengineering initiatives.
While the Company cannot predict when the market environment will
improve, economic indicators remain favorable. Geopolitical factors still
appear to be restraining investment activity, yet untapped liquidity in the
market continues to increase, offering a basis for future growth. The Company
is confident that its diverse businesses and client base position the Company
to capitalize as market volumes and investment flows increase.
4
During the third 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. New business
momentum remains strong as the Company is gaining traction with growth
initiatives such as hedge fund servicing, Pershing's registered investment
advisor ("RIA") offering and independent research. The outlook for Ivy Asset
Management ("Ivy") continues to be very positive, given increased allocations
by institutions to alternative investments, including hedge funds, as an asset
class.
5
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
- ------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ----------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ----------------
Servicing Fees
Securities $ 685 $ 717 $ 657 $ 2,117 $ 1,728
Global Payment Services 84 81 80 245 238
------- ------- ------- ------- -------
769 798 737 2,362 1,966
Private Client Services
and Asset Management Fees 113 113 97 333 281
Service Charges and Fees 98 94 89 287 278
Foreign Exchange and
Other Trading Activities 67 100 92 273 246
Securities Gains 14 12 9 59 26
Other 49 49 39 191 107
------- ------- ------- ------- -------
Total Noninterest Income $ 1,110 $ 1,166 $ 1,063 $ 3,505 $ 2,904
======= ======= ======= ======= =======
Total noninterest income for the third quarter of 2004 was $1,110
million, a decrease of 5% sequentially but an increase of 4% from the third
quarter of 2003. Noninterest income for the nine months ended September 30,
2004 was $3,505 million, an increase of 21% over the comparable 2003 period.
Securities servicing fees were up $28 million, or 4%, from the third
quarter of 2003. On a year-to-date basis, securities servicing fees were
$2,117 million up $389 million from 2003. For a discussion of securities
servicing fees see "Securities Servicing Fees" in the segment results section
under "Servicing and Fiduciary Businesses."
Global payment services fees were up $3 million, or 4%, from the second
quarter of 2004, and $4 million, or 5% from the third quarter of 2003,
primarily resulting from new business wins. Global payment services increased
by 3% on a year-to-date basis over 2003.
Private client services and asset management fees for the third quarter
were flat from the prior quarter and increased 16% from the third quarter of
2003. For the nine months ended September 30, 2004, private client services
and asset management fees were $333 million, a 19% increase over the same
period in 2003. The increase from the third quarter of 2003 and on a year-to-
date basis reflects strong growth in Ivy Asset Management as well as higher
equity price levels. Total assets under management were $97 billion at
September 30, 2004, up from $93 billion at June 30, 2004 and $85 billion a
year ago.
Service charges and fees were up 4% from the second quarter of 2004 and
10% from the third quarter of 2003 due to higher capital market fees and
improved pricing on retail products.
Foreign exchange and other trading revenues declined sharply to $67
million, down 33% from the second quarter and 27% from the third quarter of
2003, reflecting lower exchange rate volatility and lower levels of cross-
border trading activity as well as weak demand for interest rate hedging
products. For the nine months ended September 30, 2004, foreign exchange and
other trading activities were up 11% over the nine months ended September 30,
2003 due to more active and volatile markets in the first half of 2004.
Securities gains in the third quarter were $14 million, compared with $12
million in the second quarter of 2004 and $9 million in the third quarter of
2003. The gains in the third quarter were primarily attributable to the
6
Company's private equity portfolio. For the nine months ended September 30,
2004, securities gains were $59 million, up $33 million from the nine months
ended September 30, 2003, primarily reflecting realized gains of $19 million
in the first quarter on four sponsor fund investments.
Other noninterest income was $49 million, compared with $49 million in
the second quarter of 2004 and $39 million in the third quarter of 2003. For
the first nine months of 2004, other noninterest income was $191 million, an
increase of $84 million from $107 million for the first nine months of 2003.
The increase primarily reflects the $48 million pre-tax gain on the sale of a
portion of the Company's investment in Wing Hang Bank Limited in the first
quarter of 2004.
Net Interest Income
- -------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
(Dollars in millions) -------- -------- -------- ------------------------
Reported Reported Reported Reported Core** Reported
-------- -------- -------- -------- ------ --------
2004 2004 2003 2004 2004 2003
-------- -------- -------- -------- ------- -------
Net Interest Income $ 428 $ 421 $ 407 $ 1,118 $ 1,263 $ 1,190
Tax Equivalent Adjustment* 8 8 9 20 20 27
-------- -------- -------- -------- ------- -------
Net Interest Income on a
Tax Equivalent Basis $ 436 $ 429 $ 416 $ 1,138 $ 1,283 $ 1,217
======== ======== ======== ======== ======= =======
Net Interest Rate
Spread 1.88% 1.84% 1.87% 1.62% 1.86% 1.99%
Net Yield on Interest
Earning Assets 2.18 2.08 2.10 1.87 2.11 2.24
* 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 $436 million in the
third quarter of 2004, compared with $429 million in the second quarter of
2004, and $416 million in the third quarter of 2003. The net interest income
rate spread was 1.88% in the third quarter of 2004, compared with 1.84% in the
second quarter of 2004, and 1.87% in the third quarter of 2003. The net yield
on interest earning assets was 2.18% in the third quarter of 2004, compared
with 2.08% in the second quarter of 2004, and 2.10% in the third quarter of
2003.
The sequential quarter increase in net interest income in the third
quarter of 2004 reflects the collection of past due interest on nonperforming
loans as well as the benefit of a rise in short-term interest rates. This was
partially offset by a reduction in liquid earning assets during the quarter, a
result of less active capital markets. The increase in net interest income
from the third quarter of 2003 reflects the benefit of higher short-term
rates, the collection of past due interest on non-performing loans, and a
higher level of investment securities.
For the first nine months of 2004, reported net interest income on a
taxable equivalent basis was $1,138 million, compared with $1,217 million in
the first nine months of 2003, as the full year impact of Pershing and the
benefit of rising rates were outweighed by the first quarter 2004 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"). Excluding this charge, net interest income on
a taxable equivalent basis for the first nine months of 2004 equaled $1,283
million, an increase of $66 million from last year. The reported year-to-date
net interest income spread was 1.62% in 2004 compared with 1.99% in 2003,
while the net yield on interest earning assets was 1.87% in 2004 and 2.24% in
2003.
7
Noninterest Expense and Income Taxes
- ------------------------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- --------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------ ------
Salaries and Employee Benefits $ 564 $ 570 $ 533 $1,708 $1,454
Net Occupancy 77 72 69 230 192
Furniture and Equipment 51 51 50 153 134
Clearing 39 44 42 131 111
Sub-custodian Expenses 21 22 18 65 53
Software 52 50 45 151 123
Communications 22 23 24 69 68
Amortization of Intangibles 9 8 8 26 18
Merger and Integration Costs - - 23 - 48
GMAC Settlement - - 78 - 78
Other 164 172 149 492 402
------- ------- ------- ------ ------
Total Noninterest Expense $ 999 $ 1,012 $ 1,039 $3,025 $2,681
======= ======= ======= ====== ======
Noninterest expense for the third quarter of 2004 was $999 million,
compared with $1,012 million in the prior quarter and $1,039 million in the
third quarter of 2003. The decrease principally reflects lower incentive
compensation tied to revenues, lower volume-related clearing and sub-custodian
expenses as well as a decline in legal and travel & entertainment expenses.
Incentive compensation was lower in the quarter reflecting the lower revenues
partially offset by higher outside help and merit increases. Net occupancy
increased by $5 million reflecting expansion of regional facilities, including
the opening of the new Brooklyn facility which is part of the Company's
business continuity plans. In the third quarter of 2004, the Company
continued to engage in a multi-year effort to expand operations from the New
York metropolitan area to lower cost areas such as Utica and Syracuse.
The third quarter of 2003 results included $23 million of merger and
integration costs related to the Pershing acquisition and $78 million of net
costs related to the GMAC settlement. After excluding these items, the net
growth in expenses from a year ago principally reflects higher staff and
occupancy costs. Salaries and employee benefits were up reflecting higher
staffing levels due to business expansion as well as higher stock option
expense and a lower pension credit. Occupancy increased due to the expansion
of regional facilities.
For the first nine months of 2004, noninterest expense was $3,025
million, up 13% compared to $2,681 million from the equivalent period of 2003.
Noninterest expense in 2003 includes $126 million of costs related to the
Pershing merger and integration and the GMAC settlement. The growth in
expenses versus a year ago mainly reflects the full period impact of the
Pershing acquisition as well as the same factors affecting the comparisons
with last year's third quarter.
The effective tax rate for the third quarter of 2004 was 34.3%, compared
to 34.2% in the second quarter and 33.4% in the third quarter of 2003. The
increase from the third quarter of 2003 reflects the tax benefit on the GMAC
settlement in 2003. The effective tax rate for the nine month period ended
September 30, 2004 was 30.9%, compared with 34.3% for the nine month period
ended September 30, 2003. The year-over-year decrease reflects the benefit
associated with the SFAS 13 adjustment in the first quarter of 2004.
8
Credit Loss Provision and Net Charge-Offs
- -----------------------------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- --------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------ ------
Provision $ - $ 10 $ 40 $ 22 $ 120
======= ======= ======= ====== ======
Net Charge-offs:
Commercial $ (4) $ (11) $ (25) $ (21) $ (85)
Foreign (9) (8) (12) (26) (18)
Other (1) - (4) (1) (15)
Consumer (5) (6) (6) (22) (16)
------- ------- ------- ------ ------
Total $ (19) $ (25) $ (47) $ (70) $ (134)
======= ======= ======= ====== ======
Other Real Estate Expenses $ - $ - $ - $ - $ -
No provision was taken in the third quarter of 2004 compared to $10
million in the second quarter of 2004 and $40 million in the third quarter of
2003. The absence of any provision reflects the improved quality of the loan
portfolio and the continued decline in nonperforming and criticized assets.
For the first nine months of 2004, the provision was $22 million compared with
$120 million in 2003.
The allowance for credit losses was $756 million at September 30, 2004,
$775 million at June 30, 2004, and $817 million at September 30, 2003. The
allowance for credit losses as a percent of non-margin loans was 2.42% at
September 30, 2004, compared with 2.42% at June 30, 2004, and 2.55% at
September 30, 2003.
Net charge-offs were $19 million in the third quarter of 2004 versus $25
million in the second quarter of 2004 and $47 million in the third quarter of
2003. These represent 0.21% of total loans in the most recent quarter, down
from 0.26% and 0.50% in the respective prior periods. For the first nine
months ended September 30, 2004, net charge-offs were $70 million, compared to
$134 million for the same period in 2003.
9
OTHER DEVELOPMENTS
In September 2004, the Company formed a strategic alliance with Wilshire
Associates, one of the world's leading providers of global risk services, to
meet the increasingly sophisticated risk management demands of institutional
investors. As part of the strategic alliance, the Company and Wilshire
Analytics, a business unit of Wilshire Associates, will integrate their
comprehensive selection of risk services, including performance measurement,
analytics, fixed income and equity attribution, universe comparisons,
compliance, risk budgeting, and advanced risk measures. Altogether, the
Company and Wilshire provide global risk services to more than 600
institutional investor clients that manage approximately $14 trillion in
assets.
In September 2004, the Company agreed to acquire the execution and
commission management assets of Wilshire Associates. Under the terms of the
agreement, BNY Brokerage will assume Wilshire's client relationships in these
businesses.
In September the Company announced its appointment by RCM (UK) Ltd, part
of the Allianz Dresdner Asset Management Group, to offer comprehensive middle
and back office outsourcing services in the UK for $8.75 billion of assets
under management. This follows the Company's appointment earlier this year by
RCM Capital Management LLC to provide outsourcing services to its San
Francisco operations. Taken together these two appointments mark the first
time an asset manager has outsourced operations on two continents to a single
strategic global platform, demonstrating the Company's market leading
capabilities.
In August the Company announced its appointment by Threadneedle
Investments to outsource its fund administration and transfer agency
operations in the UK. This deal provides the Company with added scale and
expertise in these businesses, positioning it well for further expansion in
continental Europe.
10
BUSINESS SEGMENTS REVIEW
The Company has an internal information system that produces performance
data for its four business segments along product and service lines.
Business Segments Accounting Principles
- ---------------------------------------
The Company's segment data has been determined on an internal management
basis of accounting, rather than the generally accepted accounting principles
used for consolidated financial reporting. These measurement principles are
designed so that reported results of the segments will track their economic
performance. Segment results are subject to restatement whenever improvements
are made in the measurement principles or organizational changes are made. In
the first quarter of 2004, the Company changed its methodology for allocating
its pension credit to the segments. Prior periods have been restated.
The measure of revenues and profit or loss by operating segment has been
adjusted to present segment data on a taxable equivalent basis. The provision
for credit losses allocated to each reportable segment is based on
management's judgment as to average credit losses that will be incurred in the
operations of the segment over a credit cycle of a period of years.
Management's judgment includes the following factors among others: historical
charge-off experience, and the volume, composition and size of the loan
portfolio. This method is different from that required under generally
accepted accounting principles as it anticipates future losses which are not
yet probable and therefore not recognizable under generally accepted
accounting principles. Assets and liabilities are match funded. Support and
other indirect expenses are allocated to segments based on general internal
guidelines.
Description of Business Segments
- --------------------------------
The results of individual business segments exclude unusual items such as
the GMAC settlement and the Pershing related merger and integration costs of
2003, which are included within reconciling amounts.
The Company reports data for the four business segments: Servicing and
Fiduciary, Corporate Banking, Retail Banking, and Financial Markets.
The Servicing and Fiduciary businesses segment comprises the Company's
core services, including securities servicing, global payment services, and
private client services and asset management. These businesses all share
certain favorable attributes: they are well diversified and fee-based; the
Company serves the role of an intermediary rather than principal, thereby
limiting risk and generating more stable earnings streams; and the businesses
are scalable, which result in higher margins as revenues grow. Long-term
trends that 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.
11
In issuer services, the Company's American and global depositary receipt
business has over 1,180 programs representing over 60 countries. As a
trustee, the Company provides diverse services for corporate, municipal,
mortgage-backed, asset-backed, derivative and international debt securities.
Over 90,000 appointments for more than 30,000 worldwide clients have resulted
in the Company being trustee for more than $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 maintained on its recordkeeping system.
The Company is the second largest custodian with $8.9 trillion of assets
under custody and administration at September 30, 2004. The Company is the
second largest mutual fund custodian for U.S. funds and one of the largest
providers of fund services in the world with over $1.6 trillion in total
assets. The Company is the largest U.K. custodian. The Company services more
than $35 billion or 20% of total U.S. 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 and financial services
outsourcing in over 80 global markets, executing trades for nearly 575 million
shares and clearing 600,000 trades daily. The Company has 21 seats on the New
York Stock Exchange. Pershing services nearly 1,100 institutional and retail
financial organizations and independent investment advisors who collectively
represent more than 5 million individual investors.
Global payment services facilitates the flow of funds between the
Company's customers and their clients through such business lines as funds
transfer, cash management and trade services. Private client services and
asset management includes traditional banking and trust services to affluent
clients and investment management services for institutional and high net
worth clients.
The Company's strategy is to be a market leader in these businesses and
continue to build on its product and service capabilities and add new clients.
The Company has completed 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.
12
The Retail Banking segment includes retail deposit services, branch
banking, and consumer and residential mortgage lending. The Company operates
341 branches in 23 counties in the Tri-State region. The retail network is a
stable source of low cost funding and provides a platform to cross-sell core
services from the Servicing and Fiduciary businesses to both individuals and
small businesses in the New York metropolitan area.
The Financial Markets segment includes trading of foreign exchange and
interest rate risk management products, investing and leasing activities, and
treasury services to other business segments. The segment offers a
comprehensive array of multi-currency hedging and yield enhancement
strategies, and complements the other business segments. The Financial
Markets segment centralizes interest rate risk management for the Company.
There were no major customers from whom revenues were individually
material to the Company's performance.
Servicing and Fiduciary Businesses
- ----------------------------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ----------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Net Interest Income $ 144 $ 144 $ 132 $ 428 $ 357
Provision for
Credit Losses 1 1 - 2 -
Noninterest Income 953 994 905 2,937 2,439
Noninterest Expense 749 764 707 2,270 1,883
Income Before Taxes 347 373 330 1,093 913
Average Assets $20,937 $22,891 $20,902 $22,195 $14,799
Average Deposits 33,370 35,520 34,039 34,671 32,899
Nonperforming Assets 3 3 16 3 16
(Dollars in billions)
Assets Under Custody $ 8,906 $ 8,662 $ 7,878 $ 8,906 $ 7,878
Equity Securities 33% 34% 32% 33% 32%
Fixed Income Securities 67 66 68 67 68
Cross-Border Assets $ 2,494 $ 2,425 $ 2,206 $ 2,494 $ 2,206
Assets Under Administration $ 31 $ 32 $ 32 $ 31 $ 32
Assets Under Management 97 93 85 97 85
Equity Securities 35% 36% 31% 35% 31%
Fixed Income Securities 21 22 22 21 22
Alternative Investments 15 14 10 15 10
Liquid Assets 29 28 37 29 37
S&P 500 Index (Period End) 1,115 1,141 996 1,115 996
NASDAQ Index (Period End) 1,897 2,048 1,787 1,897 1,787
NYSE Volume (In billions) 84.9 90.8 87.3 271.1 266.9
NASDAQ Volume (In billions) 99.6 108.3 110.7 334.2 312.0
Third quarter results showed continued strength in several of the
Company's primary businesses, including global payment services, broker-dealer
services and asset management. Offsetting this strength were volume related
declines in the Company's execution and clearing services businesses. In the
third quarter of 2004, pre-tax income was $347 million, compared with $373
million in the second quarter of 2004 and $330 million a year ago. On a year-
to-date basis, pre-tax income was $1,093 million, up 20% from $913 million in
2003.
Noninterest income decreased by 4% to $953 million from $994 million in
the second quarter of 2004 but increased by $48 million, or 5%, compared with
$905 million in the third quarter of 2003.
13
Securities Servicing Fees
- -------------------------
3rd 2nd 3rd
Quarter Quarter Quarter
------- ------- -------
(Dollars in millions) 2004 2004 2003
------- ------- -------
Execution and Clearing Services $ 262 $ 280 $ 271
Investor Services 228 229 212
Issuer Services 141 155 127
Broker-Dealer Services 54 53 47
------- ------- -------
Securities Servicing Fees $ 685 $ 717 $ 657
======= ======= =======
Securities servicing fees were $685 million in the third quarter, a
decrease of $32 million, or 4%, from the second quarter of 2004, but up $28
million, or 4% from the third quarter of 2003. For the first nine months of
2004, securities servicing fees were $2,117 million, an increase of $389
million from the first nine months of 2003, principally due to the full period
impact of the Pershing acquisition which closed on May 1, 2003 and better
market conditions for most of the servicing businesses.
Execution and clearing services fees decreased $18 million, or 6%, from
the second quarter of 2004 and $9 million, or 3% from the third quarter of
2003. The execution business was impacted by lower equity market trading
volumes in the third quarter, as combined NYSE and NASDAQ trading volumes,
excluding program trading, were down 10% from the second quarter and 15% from
the third quarter of 2003. BNY Brokerage volumes were down 4% from the second
quarter, while institutional B-Trade volumes and G-Trade principal volumes
were down 1% and 8%, respectively. The sluggish market environment has
pressured revenues in these businesses but the Company is encouraged that it
has continued to gain market share. BNY Research and commission management
performed well as the Company's positioning in the independent research space
continued to be well received by the marketplace. The Company's correspondent
clearing business conducted by its Pershing subsidiary was impacted by lower
volumes and lower equity prices both sequentially and compared to the third
quarter of 2003. As a result, domestic billable trades declined by 7%,
slightly better than the market trend. The majority of Pershing's revenues
are generated from non-transactional activities, such as asset gathering and
technology services to broker-dealers, with revenues tied to both assets under
administration and services provided. Despite a 2% sequential decline in the
S&P 500 Index, Pershing's assets under administration were $649 billion at
quarter-end, compared with $647 billion at June 30, 2004.
Investor services fees held steady at $228 million, down $1 million from
the second quarter of 2004, but up $16 million, or 8% from the third quarter
of 2003. The sequential quarter decrease reflects lower transaction activity
and seasonally lower securities lending revenues, offset in part by new
business wins in global fund services, as well as the continued addition of
new clients to the Company's hedge fund servicing platform. At quarter-end,
hedge fund assets under administration totaled $48 billion up from $30 billion
at year-end 2003. The increase in investor service fees relative to the third
quarter of 2003 was a result of good organic growth in most areas. This was
offset in part by weaker equity and fixed income transaction volumes, and
lower average equity price levels. Securities lending fees declined modestly
relative to the second quarter because of slightly lower spreads resulting
from the timing of the Federal Reserve interest rate increases, as well as the
decline in equity lending the Company typically experiences following the
second quarter European dividend season. Global liquidity services fees were
up, benefiting from higher fees related to rising interest rates.
At September 30, 2004 assets under custody rose to $8.9 trillion, from
$8.7 trillion at June 30, 2004 and $7.9 trillion at September 30, 2003.
Cross-border custody assets were $2.5 trillion at September 30, 2004. A
substantial portion of the increase in assets under custody was due to new
business, as well as the acquisition of a unit investment trust ("UIT")
14
business. In addition, while equity prices declined during the quarter, fixed
income values rose as the yield curve flattened and longer term interest rates
declined. As a result, the market value of fixed income assets under custody
increased, and the percentage of fixed income assets under custody rose from
66% to 67%.
Issuer services fees were $141 million in the third quarter, down $14
million or 9% from the second quarter of 2004, but up $14 million or 11% from
the third quarter of 2003.
Depositary receipts ("DR") revenues decreased sequentially due to
seasonally lower trading and dividend activity. While issue/cancel fees were
negatively impacted by the seasonal slowdown in DR trading volumes, which were
down 6% sequentially, the Company continued to experience positive net DR
issuance in the third quarter, demonstrating investors' commitment to cross-
border investing. Dividend-related activity decreased from the seasonally
strong second quarter, while other corporate actions such as initial public
offerings, mergers and acquisitions, secondary offerings and rights issues
declined in the third quarter.
Corporate trust revenues declined sequentially but the Company continues
to perform near record levels as a slowdown in overall issuance levels was
partially offset by strength in global issuance as well as demand for
corporate specialty products in the third quarter.
The increase in issuer services revenues relative to the third quarter of
2003 primarily reflects growth in corporate trust, due to higher debt issuance
as well as acquisitions, and in DR, because of higher volumes
and dividend activity.
Broker-dealer services fees showed good growth, increasing $1 million, or
2%, from the second quarter of 2004 and $7 million, or 15% from the third
quarter of 2003. On a sequential basis, new business wins offset lower market
volumes. Year-over-year, new business was the dominant driver, particularly
in collateral management, as volumes have been relatively stable.
Global payment services fees were up $3 million, or 4%, from the second
quarter of 2004, and $4 million, or 5% from the third quarter of 2003,
primarily resulting from new business wins. Global payment services increased
by 3% on a year-to-date basis over 2003. The year-over-year growth is
attributable to higher funds transfer volumes and increased multi-currency
activity from existing clients as well as the addition of new clients.
Private client services and asset management fees continues to
demonstrate solid performance with fees up 16% from the third quarter of 2003
and stable on a sequential quarter basis despite lower equity market prices.
For the nine months ended September 30, 2004, private client services and
asset management fees were $333 million, a 19% increase over the same period
in 2003. The increase from the third quarter of 2003 and on a year-to-date
basis reflects strong growth in Ivy. The Company is also experiencing good
new business momentum in institutional equity management as a result of
improved sales efforts.
Assets under management ("AUM") were $97 billion at September 30, 2004,
up from $93 billion at June 30, 2004 and $85 billion at September 30, 2003.
Assets under administration were $31 billion compared with $32 billion at June
30, 2004 and $32 billion at September 30, 2003. The sequential quarter and
year-over-year increases in AUM reflect growth in the Company's alternative
investments business as assets at Ivy grew to $14.6 billion. In addition, the
growth in AUM reflects an inflow of funds into personal trust assets and
short-term money market product for institutional/corporate investors.
Institutional clients represent 67% of AUM while individual clients equal 33%.
AUM at September 30, 2004, are 35% invested in equities, 21% in fixed income,
15% in alternative investments and the remainder in liquid assets.
Foreign exchange and other trading revenues declined sharply to $67
million, down 33% from the second quarter and 27% from the third quarter of
2003, reflecting lower exchange rate volatility and lower levels of cross-
15
border trading activity. Foreign exchange experienced a slow down in client
activity beginning in late June that persisted through the end of September,
which was exacerbated by a 25% sequential quarter drop in exchange rate
volatility. For the nine months ended September 30, 2004, foreign exchange
and other trading activities were up 11% over the nine months ended
September 30, 2003 due to more active and volatile markets in the first half
of 2004.
Net interest income in the Servicing and Fiduciary businesses segment was
$144 million for the third quarter of 2004 compared with $144 million for the
second quarter of 2004 and $132 million in the third quarter of 2003. The
increase in net interest income from the third quarter of 2003 is primarily
due to the rise in interest rates. Net interest income for the nine months
ended September 30, 2004 was $428 million compared with $357 million in the
first nine months of 2003. The increase in net interest income primarily
reflects the Pershing acquisition and the rise in interest rates. Average
assets for the quarter ended September 30, 2004 were $20.9 billion compared
with $22.9 billion in the second quarter of 2004 and $20.9 billion in the
third quarter of 2003. Average assets for the nine months ended September 30,
2004 were $22.2 billion compared with $14.8 billion in the first nine months
of 2003. The increase in assets in the year-to-date 2004 average compared
with 2003 is attributable to the Pershing acquisition. The third quarter of
2004 average deposits were $33.4 billion compared with $35.5 billion in the
second quarter of 2004 and $34.0 billion in the third quarter of 2003. The
sequential quarter decline in deposits reflects lower market volumes in the
third quarter of 2004. Average deposits for the first nine months of 2004
were $34.7 billion compared with $32.9 billion for the first nine months of
2003.
Net charge-offs in the Servicing and Fiduciary Businesses segment were
$10 million in the third quarter of 2004, compared with zero in the second
quarter of 2004 and the third quarter of 2003. The increase in charge-offs
reflects a credit loss in Pershing's UK clearing business as a result of an
alleged deceptive scheme perpetrated on Pershing. On a year-to-date
basis, net charge-offs were $15 million in 2004, compared to zero in 2003.
Nonperforming assets were $3 million at September 30, 2004, compared with $3
million at June 30, 2004 and $16 million at September 30, 2003.
Noninterest expense for the third quarter of 2004 was $749 million,
compared with $764 million in the second quarter of 2004 and $707 million in
the third quarter of 2003. The decline in noninterest expense from second
quarter of 2004 was primarily due to lower incentive compensation tied to
revenues as well as lower volume-related clearing and sub-custodian expenses.
The increase in noninterest expense from third quarter of 2003 reflects the
Pershing acquisition. Noninterest expense for the first nine months of 2004
was $2,270 million, compared with $1,883 million for the same period in 2003,
reflecting the Pershing acquisition.
16
Corporate Banking
- -----------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ----------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Net Interest Income $ 89 $ 87 $ 95 $ 265 $ 282
Provision for Credit Losses 15 15 27 50 87
Noninterest Income 81 84 71 245 224
Noninterest Expense 53 54 53 160 152
Income Before Taxes 102 102 86 300 267
Average Assets $17,485 $17,308 $19,378 $17,384 $19,916
Average Deposits 6,422 6,345 6,699 6,522 6,832
Nonperforming Assets 269 293 368 269 368
Net Charge-offs 3 9 41 24 118
In the third quarter of 2004, pre-tax income was $102 million, compared
with $102 million in the second quarter of 2004 and $86 million in the third
quarter of 2003. On a year-to-date basis, pre-tax income was $300 million, up
12% from $267 million in 2003. The improvement over the prior year 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 $89 million in
the third quarter of 2004, compared with $87 million in the second quarter of
2004 and $95 million in the third quarter of 2003. The sequential quarter
increase reflects the collection of past due interest on nonperforming loans
and slightly higher loan volumes. The decline from the third quarter of 2003
reflects continued reduction in lending to corporate borrowers as well as a
decline in deposits. Average assets for the quarter were $17.5 billion
compared with $17.3 billion in the second quarter of 2004 and $19.4 billion in
the third quarter of last year. Average deposits in the Corporate Banking
segment were $6.4 billion versus $6.3 billion in the second quarter of 2004
and $6.7 billion in third quarter of 2003. On a year-to-date basis, net
interest income for 2004 was $265 million compared with $282 million in 2003.
For the nine months ended September 30, 2004, average assets were $17.4
billion compared to $19.9 billion for the first nine months of 2003. For the
first nine months of 2004 and 2003, average deposits were $6.5 billion and
$6.8 billion.
The third quarter of 2004 provision for credit losses was $15 million
compared with $15 million in the second quarter of 2004 and $27 million in the
third quarter of last year. On a year-to-date basis, the provision for credit
losses was $50 million for 2004 and $87 million for 2003. The decline in the
provision from the third 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 $3 million in the third quarter of 2004, $9
million in the second quarter of 2004, and $41 million in the third quarter of
2003. Net charge-offs for the first nine months of 2004 were $24 million
compared with $118 million in 2003. The charge-offs for the first nine months
of 2004 primarily relate to loans to media and foreign borrowers.
Nonperforming assets were $269 million at September 30, 2004, down from $293
million at June 30, 2004 and $368 million at September 30, 2003. The decrease
in nonperforming assets from the third quarter of 2003 primarily reflects
paydowns and charge-offs of foreign loans.
Noninterest income was $81 million in the current quarter, compared with
$84 million in the second quarter of 2004 and $71 million in the third quarter
of 2003. On a sequential quarter basis, the decrease reflects lower credit
derivatives and foreign exchange revenues partially offset by higher advisory
fees. The increase year-over-year reflects increased advisory fees and higher
income from the Company's investment in Wing Hang Bank. On a year-to-date
basis, noninterest income was $245 million, up $21 million from $224 million
in 2003, reflecting increased advisory fees and foreign exchange revenues as
well as higher income from the Company's investment in Wing Hang Bank.
17
Noninterest expense in the third quarter was $53 million, compared with
$54 million in the second quarter of 2004 and $53 million in the third quarter
of 2003. On a year-to-date basis, noninterest expense was $160 million,
compared with $152 million in 2003, reflecting higher stock option expense and
performance related incentives.
Retail Banking
- --------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ----------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ----------------
Net Interest Income $ 128 $ 126 $ 120 $ 377 $ 354
Provision for Credit Losses 6 5 5 16 14
Noninterest Income 28 28 30 85 92
Noninterest Expense 97 95 90 285 268
Income Before Taxes 53 54 55 161 164
Average Assets $ 5,639 $ 5,317 $ 5,023 $ 5,445 $ 5,246
Average Noninterest
Bearing Deposits 5,398 5,209 4,738 5,212 4,711
Average Deposits 15,312 15,162 14,585 15,094 14,321
Nonperforming Assets 15 15 4 15 4
Net Charge-offs 6 5 6 17 16
Number of Branches 341 341 341 341 341
Total Deposit Accounts
(In Thousands) 1,124 1,129 1,170 1,124 1,170
Number of ATMs 379 379 377 379 377
The Retail Banking segment continues to demonstrate stable results in
spite of increased competition in the New York metropolitan area. In the
third quarter of 2004, pre-tax income was $53 million, compared with $54
million in the second quarter of 2004 and $55 million a year ago. On a year-
to-date basis, pre-tax income was $161 million, compared with $164 million in
2003. The Company has been able to steadily grow its deposit balances, with
average deposits reaching $15.3 billion during the quarter.
Net interest income in the third quarter of 2004 was $128 million,
compared with $126 million in the second quarter of 2004 and $120 million in
the third quarter of 2003. Net interest income on a year-to-date basis for
2004 and 2003 was $377 million and $354 million. Net interest income has
increased as rates have risen and as the segment has been able to increase its
deposit base. 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 Online and the
debit card along with promotional campaigns have helped build deposit volumes.
Noninterest income was $28 million for the quarter compared with $28
million in the second quarter and $30 million in the third quarter of last
year. Noninterest income for the first nine months of 2004 was $85 million
compared with $92 million in the first nine months of 2003. The decreases in
noninterest income compared to 2003 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.
Noninterest expense in the third quarter of 2004 was $97 million,
compared with $95 million in the second quarter of 2004 and $90 million last
year. The increase from the third quarter of 2003 reflects higher
compensation and marketing costs. Noninterest expense for the first nine
months of 2004 was $285 million compared with $268 million in the first nine
months of 2003. The year-over-year change reflects same factors influencing
the quarterly increase.
Net charge-offs were $6 million in the third quarter of 2004, compared
with $5 million in the second quarter of 2004 and $6 million in the third
quarter of 2003. For the first nine months of 2004, net charge-offs were $17
18
million compared with $16 million for the first nine months of 2003.
Nonperforming assets were $15 million at September 30, 2004, compared with $15
million at June 30, 2004, and $4 million at September 30, 2003.
Average deposits generated by the Retail Banking segment were $15.3
billion in the third quarter of 2004, compared with $15.2 billion in the
second quarter of 2004 and $14.6 billion in the third quarter of 2003. For
the first nine months of 2004, average deposits were $15.1 billion compared to
$14.3 billion in the first nine months of 2003. Average noninterest bearing
deposits for the first nine months of 2004 were $5.2 billion compared with
$4.7 billion in the first nine months of 2003. Average assets in the Retail
Banking sector were $5.6 billion, compared with $5.3 billion in the second
quarter of 2004 and $5.0 billion in the third quarter of 2003. On a year-to-
date basis, average assets were $5.4 billion for 2004 and $5.2 billion in
2003.
Financial Markets
- -----------------
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
------- ------- ------- ----------------
(Dollars in millions) 2004 2004 2003 2004 2003
------- ------- ------- ------- -------
Net Interest Income $ 86 $ 83 $ 80 $ 249 $ 237
Provision for Credit Losses 5 5 5 15 16
Noninterest Income 36 43 53 129 136
Noninterest Expense 29 28 25 84 74
Income Before Taxes 88 93 103 279 283
Average Assets $49,148 $50,728 $47,920 $49,973 $46,252
Average Deposits 5,316 5,460 4,356 4,882 4,473
Average Investment
Securities 22,473 22,982 20,604 22,816 19,110
Net Charge-offs - 10 - 14 -
In the third quarter of 2004, pre-tax income was $88 million, compared
with $93 million in the second quarter of 2004 and $103 million a year ago.
The sequential quarter decline is due to a drop in trading revenue. On a
year-to-date basis, pre-tax income was $279 million, down 1% from $283 million
in 2003. The decreases over the third quarter and year-to-date 2003 periods
are primarily due to a decline in trading income and increased compensation
expense.
Net interest income for the third quarter was $86 million compared with
$83 million for the second quarter and $80 million a year ago. The increase
from the second quarter of 2004 reflects the benefit associated with having
positioned for a rising rate environment, as well as an additional day in the
quarter. The increase from the third quarter of 2003 reflects higher average
balances of investment securities as well as the benefit from the rising rate
environment. Net interest income was $249 million in the first nine months of
2004 compared to $237 million in the first nine months of 2003. Average third
quarter 2004 assets in the Financial Markets segment composed primarily of
short-term liquid assets and investment securities were $49.1 billion, down
from $50.7 billion on a sequential quarter basis and up compared with $47.9
billion in the third quarter last year. Average assets for the first nine
months of 2004 were $50.0 billion compared to $46.3 billion for the first nine
months of 2003. The increase in assets from 2003 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 $36 million in the third quarter of 2004, compared
with $43 million in the second quarter of 2004 and $53 million in the third
quarter of 2003. On a year-to-date basis, noninterest income was $129 million
in 2004 and $136 million in 2003. The negative variance versus the second
quarter of 2004 reflects weaker trading results, as there was an earlier than
expected flattening of the yield curve which hurt interest rate derivative
19
results, and demand for hedging products decreased given lower bond issuance
and a fall-off in mortgage prepayments.
Net charge-offs were zero in the third quarter of 2004, compared with $10
million in the second quarter of 2004 and zero a year ago. Net charge-offs
for the first nine months of 2004 and 2003 were $14 million and zero,
respectively. Charge-offs in 2004 are primarily related to the Company's
airline leasing exposure. Noninterest expense was $29 million in the third
quarter of 2004, compared with $28 million in the second quarter of 2004 and
$25 million in last year's third quarter. The increase from last year's third
quarter is attributable to higher employee incentive and other compensation.
Noninterest expense for the nine months ended September 30, 2004 was $84
million, compared with $74 million for the first nine months ended September
30, 2003.
20
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
September 30, 2004 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 144 $ 89 $ 128 $ 86 $ (19) $ 428
Provision for Credit Losses 1 15 6 5 (27) -
Noninterest Income 953 81 28 36 12 1,110
Noninterest Expense 749 53 97 29 71 999
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 347 $ 102 $ 53 $ 88 $ (51) $ 539
========== ========= ========= ========= =========== ============
Contribution Percentage 59% 17% 9% 15%
Average Assets $ 20,937 $ 17,485 $ 5,639 $ 49,148 $ 4,146 $ 97,355
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
Servicing
and
For the Quarter Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2003 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 132 $ 95 $ 120 $ 80 $ (20) $ 407
Provision for Credit Losses - 27 5 5 3 40
Noninterest Income 905 71 30 53 4 1,063
Noninterest Expense 707 53 90 25 164 1,039
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 330 $ 86 $ 55 $ 103 $ (183) $ 391
========== ========= ========= ========= =========== ============
Contribution Percentage 57% 15% 10% 18%
Average Assets $ 20,902 $ 19,378 $ 5,023 $ 47,920 $ 3,930 $ 97,153
21
(Dollars in millions)
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2004 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 428 $ 265 $ 377 $ 249 $ (201) $ 1,118
Provision for Credit Losses 2 50 16 15 (61) 22
Noninterest Income 2,937 245 85 129 109 3,505
Noninterest Expense 2,270 160 285 84 226 3,025
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 1,093 $ 300 $ 161 $ 279 $ (257) $ 1,576
========== ========= ========= ========= =========== ============
Contribution Percentage 60% 16% 9% 15%
Average Assets $ 22,195 $ 17,384 $ 5,445 $ 49,973 $ 4,132 $ 99,129
Servicing
and
For the Nine Months Ended Fiduciary Corporate Retail Financial Reconciling Consolidated
September 30, 2003 Businesses Banking Banking Markets Items Total
- -------------------------- ---------- --------- --------- --------- ----------- ------------
Net Interest Income $ 357 $ 282 $ 354 $ 237 $ (40) $ 1,190
Provision for Credit Losses - 87 14 16 3 120
Noninterest Income 2,439 224 92 136 13 2,904
Noninterest Expense 1,883 152 268 74 304 2,681
---------- --------- --------- --------- ----------- ------------
Income Before Taxes $ 913 $ 267 $ 164 $ 283 $ (334) $ 1,293
========== ========= ========= ========= =========== ============
Contribution Percentage 56% 17% 10% 17%
Average Assets $ 14,799 $ 19,916 $ 5,246 $ 46,252 $ 3,366 $ 89,579
22
Reconciling Items
- -----------------
Description - Reconciling items for net interest income primarily relate
to the recording of interest income on a taxable equivalent basis,
reallocation of capital and the funding of goodwill and intangibles.
Reconciling items for noninterest income primarily relate to the sale of
certain securities and certain other gains. Reconciling items for noninterest
expense primarily reflects corporate overhead as well as amortization of
intangibles and severance.
In the first nine months 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 $19 million. In the third
quarter of 2003, merger and integration costs associated with Pershing and the
GMAC settlement are also reconciling items.
The adjustment to the provision for credit losses reflects the difference
between the aggregate of the credit provision over a credit cycle for the
reportable segments and the Company's recorded provision. The reconciling
items for average assets consist of goodwill and other intangible assets.
3rd 2nd 3rd
Quarter Quarter Quarter Year-to-date
--------- --------- --------- ------------------
(Dollars in millions) 2004 2004 2003 2004 2003
--------- --------- --------- -------- --------
Segments' revenue $ 1,545 $ 1,589 $ 1,486 $ 4,715 $ 4,121
Adjustments:
Earnings associated with
assignment of capital (21) (23) (33) (73) (81)
Securities gains - - - 19 -
SFAS 13 cumulative
lease adjustment - - - (145) -
Taxable equivalent basis and
other tax-related items 4 3 13 17 41
Other 10 18 4 90 13
--------- --------- --------- -------- --------
Subtotal-revenue adjustments (7) (2) (16) (92) (27)
--------- --------- --------- -------- --------
Consolidated revenue $ 1,538 $ 1,587 $ 1,470 $ 4,623 $ 4,094
========= ========= ========= ======== ========
Segments' income before tax $ 590 $ 623 $ 574 $ 1,833 $ 1,627
Adjustments:
Revenue adjustments (above) (7) (2) (16) (92) (27)
Provision for credit losses
different than GAAP 27 15 (3) 61 (3)
Severance - - (2) (11) (8)
Goodwill and
intangible amortization (9) (8) (8) (26) (18)
Pershing-related
integration expenses - - (23) - (48)
GMAC settlement - - (78) - (78)
Lease termination - - - (8) -
Corporate overhead (62) (63) (53) (181) (152)
--------- --------- --------- -------- --------
Consolidated income
before tax $ 539 $ 565 $ 391 $ 1,576 $ 1,293
========= ========= ========= ======== ========
Segments' total
average assets $ 93,209 $ 96,244 $ 93,223 $ 94,997 $ 86,213
Adjustments:
Goodwill and intangibles 4,146 4,129 3,930 4,132 3,366
--------- --------- --------- -------- --------
Consolidated average assets $ 97,355 $ 100,373 $ 97,153 $ 99,129 $ 89,579
========= ========= ========= ======== ========
23
Allocation to Segments - Earnings associated with the assignment of capital
relate to preferred trust securities which are assigned as capital to
segments. Since the Company considers these issues to be capital, it does not
allocate the interest expense associated with these securities to individual
segments. If this interest expense were allocated to segments, it could be
assigned based on segment capital, assets, risks, or some other basis.
The reconciling item for securities gains relates to the Financial
Markets business. 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 associated with Pershing would be allocated to the
Securities and Fiduciary Businesses segment. The GMAC settlement would be
allocated to Corporate Banking.
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $93.2 billion at September 30, 2004, compared with
$97.5 billion at June 30, 2004, and $95.2 billion at September 30, 2003. The
decrease in assets reflects lower market activity levels throughout the
quarter, which resulted in a lower level of customer deposits at quarter end.
Total assets at the end of the second quarter was unusually high as clients
left funds on deposit rather than invested in the equity and fixed income
markets. Total shareholders' equity increased to $9.1 billion at September
30, 2004, compared with $8.8 billion at June 30, 2004, and $8.2 billion at
September 30, 2003. The increase in shareholders' equity from the prior
quarter reflects retention of earnings and an increase in the securities
valuation allowance. 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 third quarter of 2004 was 15.90%,
compared with 17.14% in the second quarter of 2004, and 12.82% in the third
quarter of 2003. Return on average assets for the third quarter of 2004 was
1.45%, compared with 1.49% in the second quarter of 2004, and 1.06% in the
third quarter of 2003. For the nine months of 2004, return on average common
equity was 16.73% compared with 15.23% in 2003, while return on average assets
was 1.47% compared with 1.27% in 2003. The 2003 ratios were impacted by the
Pershing merger and integration costs and the GMAC settlement.
24
Investment Securities
- ---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment Securities (at Fair Value)
(Dollars in millions) 09/30/04 12/31/03
---------- ----------
Fixed Income:
Mortgage-Backed Securities $ 18,991 $ 18,703
Asset-Backed Securities - 20
Corporate Debt 1,264 1,326
Short-Term Money Market Instruments 926 917
U.S. Treasury Securities 370 505
U.S. Government Agencies 393 241
State and Political Subdivisions 215 251
Emerging Market Debt 116 109
Other Foreign Debt 505 518
---------- ----------
Subtotal Fixed Income 22,780 22,590
Equity Securities:
Money Market Funds 343 200
Federal Reserve Bank Stock 99 96
Other 19 12
---------- ----------
Subtotal Equity Securities 461 308
---------- ----------
Total Securities $ 23,241 $ 22,898
========== ==========
Total investment securities were $23.2 billion at September 30, 2004,
compared with $23.0 billion at June 30, 2004, and $22.9 billion at December
31, 2003. Average investment securities were $22.5 billion in the third
quarter of 2004, compared with $23.0 billion in the second quarter of 2004 and
$20.6 billion in the third quarter of last year. Average investment
securities were $22.8 billion in the nine months ended September 30, 2004,
compared with $19.1 billion in the nine months ended September 30, 2003. The
increases were primarily due to growth in the Company's portfolio of highly
rated mortgage-backed securities which are 89% rated AAA, 6% AA, and 5% A.
Since December 31, 2002, the Company has added approximately $5.9 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 effective duration of the
Company's mortgage portfolio at September 30, 2004 was approximately 1.9
years.
Net unrealized gains for securities available-for-sale were $150 million
at September 30, 2004, compared with $14 million at June 30, 2004 and $201
million at December 31, 2003. The increase in unrealized gains since June 30,
2004 reflects the decline in long-term interest rates in the third quarter.
The decline in unrealized gains from the third quarter of 2003 reflects the
increase in these rates since last year. 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.
25
Loans
- -----
(Dollars in billions) Quarterly Year-to-date
Period End Average Average
------------------------- ------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------ ----- ---------- ------
Sept. 30, 2004 $37.1 $ 31.2 $ 5.9 $37.6 $ 31.3 $ 6.3 $37.2 $ 30.9 $ 6.3
December 31, 2003 35.3 29.6 5.7 37.3 31.5 5.8 35.6 31.8 3.8
Sept. 30, 2003 37.5 32.0 5.5 37.4 32.0 5.4 35.0 31.9 3.1
Total loans were $37.1 billion at September 30, 2004, compared with $38.2
billion at June 30, 2004 and $35.3 billion at December 31, 2003. The decline
in total loans from June 30, 2004 primarily reflects a decrease 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 $37.6
billion in the third quarter of 2004, compared with $37.4 billion in the third
quarter of 2003 while for the nine months ended September 30, 2004, average
loans were $37.2 billion compared with $35.0 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 credit
exposures and outstandings at September 30, 2004 in comparison to December 31,
2003.
Overall Loan Portfolio
- ----------------------
Unfunded Total Unfunded Total
(Dollars in billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
09/30/04 09/30/04 09/30/04 12/31/03 12/31/03 12/31/03
-------- -------- -------- -------- -------- --------
Financial Institutions $ 10.8 $ 22.0 $ 32.8 $ 9.2 $ 21.8 $ 31.0
Corporate 3.7 19.6 23.3 4.0 20.5 24.5
-------- -------- -------- -------- -------- --------
14.5 41.6 56.1 13.2 42.3 55.5
-------- -------- -------- -------- -------- --------
Consumer & Middle Market 8.8 4.3 13.1 8.2 4.1 12.3
Leasing Financings 5.7 0.1 5.8 5.8 - 5.8
Commercial Real Estate 2.2 0.9 3.1 2.4 0.8 3.2
Margin loans 5.9 - 5.9 5.7 - 5.7
-------- -------- -------- -------- -------- --------
Total $ 37.1 $ 46.9 $ 84.0 $ 35.3 $ 47.2 $ 82.5
======== ======== ======== ======== ======== ========
26
Financial Institutions
- ----------------------
The financial institutions portfolio exposure was $32.8 billion at
September 30, 2004 compared to $31.0 billion at December 31, 2003. These
exposures are of high quality, with 87% meeting the investment grade criteria
of the Company's rating system. The exposures are generally short-term, with
78% expiring within one year and are frequently secured. For example,
mortgage banking, securities industry, and investment managers often borrow
against marketable securities held in custody at the Company. The diversity
of the portfolio is shown in the accompanying table.
(Dollars in billions)
September 30, 2004 December 31, 2003
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 4.2 $ 3.7 $ 7.9 71% 88% $ 2.6 $ 3.1 $ 5.7
Securities Industry 2.4 3.3 5.7 89 96 1.9 3.5 5.4
Insurance 0.4 4.9 5.3 95 60 0.3 5.0 5.3
Government 0.1 5.1 5.2 99 64 0.2 5.6 5.8
Asset Managers 3.3 3.6 6.9 86 79 3.6 3.5 7.1
Mortgage Banks 0.3 0.6 0.9 84 72 0.4 0.5 0.9
Endowments 0.1 0.8 0.9 98 62 0.2 0.6 0.8
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $10.8 $ 22.0 $ 32.8 87% 78% $ 9.2 $ 21.8 $ 31.0
===== =========== ========= ===== ===== ===== =========== =========
Corporate
- ---------
The corporate portfolio exposure declined to $23.3 billion at September
30, 2004 from $24.5 billion at year-end 2003. Approximately 76% of the
portfolio is investment grade while 27% of the portfolio matures within one
year.
(Dollars in billions)
September 30, 2004 December 31, 2003
--------------------------- ----- ----- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
- ------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 1.0 $ 2.0 $ 3.0 62% 15% $ 0.9 $ 2.3 $ 3.2
Cable 0.6 0.5 1.1 30 1 0.7 0.7 1.4
Telecom 0.1 0.5 0.6 78 14 0.3 0.6 0.9
----- ----------- --------- ----- ----- ----- ----------- ---------
Subtotal 1.7 3.0 4.7 57% 12% 1.9 3.6 5.5
Energy 0.4 4.4 4.8 84 31 0.4 4.2 4.6
Retailing 0.2 2.2 2.4 80 43 0.1 2.3 2.4
Automotive 0.1 1.9 2.0 72 52 0.1 2.1 2.2
Healthcare 0.2 1.4 1.6 90 15 0.2 1.3 1.5
Other* 1.1 6.7 7.8 80 25 1.3 7.0 8.3
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 3.7 $ 19.6 $ 23.3 76% 27% $ 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 of 2004 and exposures have since declined to $551 million.
The percentage of investment grade borrowers in the telecom portfolio has
increased to 78% 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 $548 million
leasing portfolio (including a $15 million real estate lease exposure) as well
as $23 million of direct lending. The airline leasing portfolio consists of
$254 million to major U.S. carriers, $205 million to foreign airlines and $89
million to U.S. regionals.
During the third quarter of 2004, the industry continued to face the
dilemma of an increasingly uncompetitive cost structure, weak demand, high
energy costs, and strong competition from the regionals. The industry's
27
stagnant demand and considerable excess capacity continues to negatively
impact 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.
Nonperforming Assets
- --------------------
Change Change
9/30/04 vs. 9/30/04 vs.
(Dollars in millions) 09/30/04 06/30/04 06/30/04 12/31/03 12/31/03
-------- -------- ---------- -------- ----------
Category of Loans:
Commercial $ 209 $ 208 $ 1 $ 219 $ (10)
Foreign 27 53 (26) 79 (52)
Other 50 50 - 51 (1)
-------- -------- ---------- -------- ----------
Total Nonperforming Loans 286 311 (25) 349 (63)
Other Real Estate 1 - 1 - 1
-------- -------- ---------- -------- ----------
Total Nonperforming Assets $ 287 $ 311 $ (24) $ 349 $ (62)
======== ======== ========== ======== ==========
Nonperforming Assets Ratio 0.9% 1.0% 1.2%
Allowance for Loan
Losses/Nonperforming Loans 209.0 192.2 191.2
Allowance for Loan
Losses/Nonperforming Assets 208.1 192.2 191.2
Allowance for Credit
Losses/Nonperforming Loans 264.4 249.1 230.2
Allowance for Credit
Losses/Nonperforming Assets 263.3 249.1 230.2
Nonperforming assets declined by $24 million, or 8% during the third
quarter of 2004 to $287 million and are down 26% from a year ago. The
sequential quarter decrease primarily reflects paydowns and charge-offs of
foreign loans. The ratio of the allowance for credit losses to nonperforming
assets increased to 263.3% at September 30, 2004, compared with 249.1% at June
30, 2004, and 210.5% at September 30, 2003.
28
Activity in Nonperforming Assets
(Dollars in millions) Quarter End Year-to-date
September 30, 2004 September 30, 2004
------------------ ------------------
Balance at Beginning of Period $ 311 $ 349
Additions 27 106
Charge-offs (7) (47)
Paydowns/Sales (44) (121)
------------------ ------------------
Balance at End of Period $ 287 $ 287
================== ==================
Interest income would have been increased by $1 million and $4 million
for the third quarters of 2004 and 2003 if loans on nonaccrual status at
September 30, 2004 and 2003 had been performing for the entire period.
Interest income would have been increased by $8 million and $12 million for
the nine months ended September 30, 2004 and 2003 if loans on nonaccrual
status at September 30, 2004 and 2003 had been performing for the entire
period.
Impaired Loans
- --------------
The table below sets forth information about the Company's impaired
loans. The Company uses the discounted cash flow, collateral value, or market
price methods for valuing its impaired loans:
September 30, June 30, September 30,
(Dollars in millions) 2004 2004 2003
------------ -------- ------------
Impaired Loans with an Allowance $ 160 $ 168 $ 352
Impaired Loans without an Allowance(1) 108 121 -
------------ -------- ------------
Total Impaired Loans $ 268 $ 289 $ 352
============ ======== ============
Allowance for Impaired Loans(2) $ 57 $ 69 $ 150
Average Balance of Impaired Loans
during the Quarter $ 293 $ 305 $ 387
Interest Income Recognized on
Impaired Loans during the Quarter $ 2.4 $ 0.6 $ -
(1) When the discounted cash flows, collateral value or market price equals
or exceeds the carrying value of the loan, then the loan does not require
an allowance under the accounting standard related to impaired loans.
(2) The allowance for impaired loans is included in the Company's allowance
for credit losses.
Allowance
- ---------
September 30, June 30, September 30,
(Dollars in millions) 2004 2004 2003
------------ -------- ------------
Margin Loans $ 5,911 $ 6,114 $ 5,472
Non-Margin Loans 31,208 32,091 32,068
Total Loans 37,119 38,205 37,540
Allowance for Loan Losses 598 598 665
Allowance for Lending-Related
Commitments 158 177 152
Total Allowance for Credit Losses 756 775 817
Allowance for Loan Losses As a
Percent of Total Loans 1.61% 1.57% 1.77%
Allowance for Loan Losses As a
Percent of Non-Margin Loans 1.92 1.86 2.07
Allowance for Credit Losses
As a Percent of Total Loans 2.04 2.03 2.18
Allowance for Credit Losses As a
Percent of Non-Margin Loans 2.42 2.42 2.55
29
The Company adopts new accounting policies as they become accepted as a
best practice or required by generally accepted accounting principles.
Accordingly, at December 31, 2003, the Company split its allowance for credit
losses into an allowance for loan losses and an allowance for lending-related
commitments such as unfunded loan commitments, and standby letters of credit.
This resulted in a decrease in the allowance for loan losses of $136 million
and a corresponding increase in other liabilities (which includes the
allowance for lending-related commitments). Prior period balance sheets have
been restated. Credit expenses related to the allowance for loan losses and
the allowance for lending-related commitments are reported in the provision
for credit losses in the income statement. To aid in the comparison of the
Company's results with other companies that have not yet adopted this
practice, the Company provides various credit ratios based both on the
allowance for credit losses and the allowance for loan losses.
The allowance for credit losses to total loans was $756 million, or 2.04%
of loans at September 30, 2004, compared with $775 million, or 2.03% of loans
at June 30, 2004, and $817 million, or 2.18% of loans at September 30, 2003.
The Company has $5.9 billion of secured margin loans on its balance sheet
at September 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 remained
at 2.42% at September 30, 2004, compared with 2.42% at June 30, 2004 and 2.55%
at September 30, 2003, reflecting continued improvement in the credit quality
in the third 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 have continued to improve.
Nonperforming assets declined another 8% this quarter, and have declined
by 26% from a year ago. The Company's criticized and classified loans
experienced a mid-teens decline from the second quarter of 2004 and are down
by approximately half from a year ago.
The ratio of the allowance for loan losses to nonperforming assets was
208.1% at September 30, 2004, up from 192.2% at June 30, 2004, and 191.2% at
December 31, 2003. Included in the Company's allowance for credit losses at
September 30, 2004 is an allocated transfer risk reserve related to Argentina
of $7 million.
The allowance for loan losses and the allowance for lending related
commitments consists of four elements: (1) an allowance for impaired credits
(nonaccrual commercial credits over $1 million), (2) an allowance for higher
risk rated credits, (3) an allowance for pass rated credits, and (4) an
unallocated allowance based on general economic conditions and risk factors in
the Company's individual markets.
The first element (impaired credits) is based on individual 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
30
the loss factors assigned to each exposure pool. Past due consumer
obligations are included in specific risk categories based on the length of
time the loan is past due.
The third element (pass rated credits) is based on the Company's expected
loss model. Borrowers are assigned to pools based on their credit rating, the
maturity of the loan, the estimated exposure at default, and the loss given a
default. The credit rating is derived from the borrower's probability of
default. The loss given default incorporates an analysis of structure and
collateral. These ratings are frequently reviewed by the relationship
managers and their respective division portfolio managers and more formally on
a semi-annual basis. The ratings are mapped to independent parties, including
the rating agencies in order to ensure consistency and validity. At the time
of approval, loans are individually analyzed and assigned a risk rating and
loss given default rating. Performing consumer loans are included in the pass
rated consumer pools. The Company uses an exposure at default estimate as a
way of quantifying the amount the Company will lose in case of default. This
estimate varies depending on the level of commitment, the type of exposure,
and the credit rating of the borrower.
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:
September 30, December 31,
2004 2003
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 77 74
Consumer 1 1
Foreign 4 9
Unallocated 16 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.
31
Deposits
- --------
Total deposits were $58.4 billion at September 30, 2004, compared with
$61.1 billion at June 30, 2004 and $58.9 billion at September 30, 2003. The
decrease on a sequential quarter basis was primarily due to lower market
activity levels, which resulted in a lower level of customer deposits at
quarter end. Noninterest-bearing deposits were $15.5 billion at September 30,
2004, compared with $14.8 billion at December 31, 2003. Interest-bearing
deposits were $42.9 billion at September 30, 2004, compared with $41.6 billion
at December 31, 2003.
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; and
- 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 September 30,
2004, the unallocated allowance was 16% of the total allowance. If the
unallocated allowance were five percent higher or lower, the allowance would
have increased or decreased by $38 million, respectively.
32
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 $64 million, while if each
pass credit were rated one grade worse, the allowance would have increased by
$157 million.
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 $21 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 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 September
30, 2004, approximately $2.8 billion of the Company's portfolio of securities
and derivatives is not priced based on quoted market prices. A change of 2.5%
in the valuation of these securities and derivatives would result in a change
in pre-tax income of $69 million.
Goodwill and Other Intangibles
- ------------------------------
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill, indefinite-lived intangibles, and other
intangibles, at fair value as required by SFAS 141. Goodwill ($3,386 million
at September 30, 2004) and indefinite-lived intangible assets ($370 million at
September 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
33
amount of that goodwill. An impairment loss is recorded to the extent that
the carrying amount of goodwill exceeds its implied fair value. Indefinite-
lived intangible assets are evaluated for impairment at least annually by
comparing its fair value to its carrying value.
Other identifiable intangible assets, $414 million at September 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 made with 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 September 30, 2004. The impact
of a 5% impairment charge would result in a change of pre-tax income of
approximately $209 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 $14.5 billion and $14.9 billion on an
average basis for the first nine months of 2004 and 2003. Stable foreign
deposits, primarily from the Company's European based securities servicing
business, were $25.9 billion and $24.1 billion at September 30, 2004 and 2003.
Savings and other time deposits were $10.2 billion on a year-to-date average
basis at September 30, 2004 compared to $10.2 billion at September 30, 2003.
Payables to customers and broker-dealers increased to $6.5 billion from $3.2
billion reflecting the Pershing acquisition. A significant reduction in the
Company's securities businesses would reduce its access to foreign deposits.
The Parent has five major sources of liquidity: dividends from its
subsidiaries, a collateralized line of credit with the Bank, the commercial
paper market, a revolving credit agreement with third party financial
institutions, and access to the capital markets.
At September 30, 2004 the Bank could pay dividends of approximately $961
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 $263 million. These assets could be liquidated and
the proceeds delivered by dividend or loan to the Parent.
34
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 September 30, 2004.
For the quarter ended September 30, 2004, the Parent's quarterly average
commercial paper borrowings were $67 million compared with $74 million in
2003. At September 30, 2004, the Parent had cash of $777 million compared
with cash of $631 million at June 30, 2004 and $479 million at September 30,
2003. Net of commercial paper outstanding, the Parent's cash position at
September 30, 2004 was up $265 million compared with September 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 September 30, 2004 and September 30,
2003.
The Parent also has the ability to access the capital markets. At
September 30, 2004, the Parent had a shelf registration statement 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 September 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 September 30, 2004 and $100 million of long-term debt that is due
in 2005. In addition, at September 30, 2004, the Parent has the option to call
$50 million of subordinated debt in 2004 and $94 million in 2005, which it will
call and refinance if market conditions are favorable. The Parent expects to
refinance any debt it repays by issuing a combination of senior and
subordinated debt.
Double leverage is the ratio of investment in subsidiaries divided by the
Company's consolidated equity plus trust preferred securities. The Company's
double leverage ratio at September 30, 2004 and 2003 was 98.44% and 101.96%.
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 September 30, 2004, compared with $1.0 billion provided by
operating activities through September 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 nine months of 2004, cash used for investing activities was
$3.5 billion as compared to cash used for investing activities in the first
nine months of 2003 of $7.4 billion. In the first nine months of 2004 and
2003, purchases of securities available-for-sale were a significant use of
funds.
35
In the first nine months of 2004, cash used for financing activities was
$0.5 billion as compared to cash provided by financing activities in the first
nine months of 2003 of $5.4 billion. Sources of funds in 2004 include
deposits, other borrowed funds, and the issuance of long-term debt and common
stock. Deposits, payables to customers and broker-dealers, and the issuance of
long-term debt and common stock to acquire Pershing were the primary source of
funds in 2003.
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 September 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:
September 30, 2004 September 30, 2003 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1* 8.09% 7.59% 7.08% 7.19% 7.75% 6% 4%
Total Capital** 12.09 11.69 11.18 11.45 11.75 10 8
Leverage 6.38 5.98 5.64 5.71 5 3-5
Tangible Common
Equity ("TCE") 5.49 5.79 4.65 5.43 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 8.09% and 12.09% at September 30, 2004, compared with 7.70%
and 11.63% at June 30, 2004, and 7.08% and 11.18% at September 30, 2003. The
regulatory leverage ratio was 6.38% at September 30, 2004, compared with
6.00% at June 30, 2004, and 5.64% at September 30, 2003. The Company's
tangible common equity as a percentage of total assets was 5.49% at September
30, 2004, compared with 4.95% at June 30, 2004, and 4.65% at September 30,
2003. This ratio varies depending on the size of the balance sheet at
quarter-end and the impact of interest rates on unrealized gains and losses
among other things. The balance sheet size fluctuates from quarter to quarter
based on levels of market activity. In general, when servicing clients are
more actively trading securities, deposit balances are higher to finance these
activities. Since market activity was weak through September the balance
sheet contracted.
At September 30, 2004, the Company benefited from a smaller balance sheet
versus normal by approximately 15 basis points, while the remaining
improvement reflects earnings retention and a favorable mark on the available-
for-sale portfolio, given the flattening yield curve. The mark on the
available-for-sale portfolio on a pre-tax basis was a positive $150 million at
September 30 versus a positive $14 million at June 30 and a positive $201
million at the beginning of the year. 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. In the third quarter of 2004,
the Company restored all of its capital ratios to targeted levels and
repurchased 2.4 million shares during the quarter bringing the year-to-date
total to 4.0 million shares. The Company did not complete any material
acquisitions in the third quarter and may buy back additional shares in the
fourth quarter depending on the level of acquisition activity and balance
sheet demands.
36
The Federal Reserve is reviewing the treatment of preferred trust
securities as Tier 1 Capital. See "Accounting Changes and New Accounting
Pronouncements" in the Footnotes to the Consolidated Financial Statements.
The following table presents the components of the Company's risk-based
capital at September 30, 2004 and 2003:
(Dollars in millions) 2004 2003
------- -------
Common Stock $9,054 $ 8,223
Preferred Stock - -
Preferred Trust Securities 1,150 1,150
Adjustments: Intangibles (4,165) (3,967)
Securities Valuation Allowance (93) (161)
Merchant Banking Investments (6) (5)
------- -------
Tier 1 Capital 5,940 5,240
------- -------
Qualifying Unrealized Equity Security Gains - -
Qualifying Subordinated Debt 2,193 2,239
Qualifying Allowance for Loan Losses 749 797
------- -------
Tier 2 Capital 2,942 3,036
------- -------
Total Risk-based Capital $ 8,882 $ 8,276
======= =======
Risk-Adjusted Assets $73,447 $74,013
======= =======
37
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial instruments
held for trading purposes at September 30, 2004 and September 30, 2003 are as
follows:
September 30, 2004 2004 Average
--------------------------- ------------------
(Dollars in millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 38,572 $ 26 $ - $ 35 $ -
Swaps 222,255 1,717 725 1,655 744
Written Options 160,255 - 1,324 - 1,244
Purchased Options 112,129 186 - 210 -
Foreign Exchange Contracts:
Swaps 2,937 - - - -
Written Options 6,333 - - - 9
Purchased Options 9,356 39 - 50 -
Commitments to Purchase
and Sell Foreign Exchange 69,985 502 503 374 396
Debt Securities - 1,332 102 1,581 106
Credit Derivatives 1,497 2 5 2 7
Equity Derivatives 1,958 217 196 119 83
------ ---------- ------- -----------
Total Trading Account $4,021 $ 2,855 $ 4,026 $ 2,589
====== ========== ======= ===========
September 30, 2003 2003 Average
--------------------------- ------------------
Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
- --------------- -------- ------ ----------- ------ -----------
Interest Rate Contracts:
Futures and Forward
Contracts $ 74,988 $ 122 $ - $ - $ 41
Swaps 174,255 1,737 421 1,668 341
Written Options 136,286 - 1,465 - 1,314
Purchased Options 61,330 228 - 205 -
Foreign Exchange Contracts:
Swaps 2,973 - - - -
Written Options 11,939 - 73 - 71
Purchased Options 15,173 57 - 44 -
Commitments to Purchase
and Sell Foreign Exchange 59,797 553 621 342 392
Debt Securities - 4,164 257 4,345 162
Credit Derivatives 1,692 5 4 5 7
Equity Derivatives 102 23 8 9 7
------ ----------- ------ -----------
Total Trading Account $6,889 $ 2,849 $6,618 $ 2,335
====== =========== ====== ===========
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 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
38
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) 3rd Quarter 2004 Year-to-date 2004
----------------------- -------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/04
------- ------- ------- ------- ------- ------- -------
Interest rate $ 2.8 $ 2.1 $ 4.2 $ 4.1 $ 2.1 $ 7.8 $ 2.9
Foreign Exchange 0.9 0.5 1.6 1.0 0.4 3.1 1.4
Equity 0.8 0.6 1.6 1.2 0.6 2.4 1.3
Credit Derivatives 1.5 1.3 1.6 1.8 1.3 2.1 1.5
Diversification (1.4) NM NM (1.4) NM NM (2.2)
Overall Portfolio 4.6 3.6 6.2 6.7 3.6 12.8 4.9
3rd Quarter 2003 Year-to-date 2003
----------------------- -------------------------------
Average Minimum Maximum Average Minimum Maximum 9/30/03
------- ------- ------- ------- ------- ------- -------
Interest rate $ 7.2 $ 1.9 $ 13.8 $ 6.1 $ 1.9 $ 13.8 $ 1.9
Foreign Exchange 0.9 0.6 1.4 0.8 0.5 1.9 1.0
Equity 0.4 0.1 1.0 0.2 - 1.0 0.6
Credit Derivatives 2.2 2.1 2.3 2.0 1.4 2.8 2.1
Diversification (1.8) NM NM (1.6) NM NM (0.5)
Overall Portfolio 8.9 5.1 14.7 7.5 3.4 14.7 5.1
NM - Because the minimum and maximum may occur on different days for different risk
components, it is not meaningful to compute a portfolio diversification effect.
During the first nine months of 2004, interest rate risk generated
approximately 51% of average VAR, credit derivatives generated 22% of average
VAR, foreign exchange accounted for 12% of average VAR, and equity generated
15% of average VAR. During the third quarter and first nine 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 9/30/04 6/30/04 3/31/04 12/31/03 9/30/03
--------------------------------------------------
(Dollars in millions) Number of Occurrences
- ---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 1 0 0 1
$(2.5)~ $ 0 11 11 2 5 11
$ 0 ~ $ 2.5 48 32 48 46 33
$ 2.5 ~ $ 5.0 5 17 10 15 17
More than $5.0 0 3 2 0 4
39
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) 9/30/04 6/30/04 3/31/04 12/31/03 9/30/03
- --------------------- --------------------------------------------------
AAA to AA- 68% 70% 61% 59% 60%
A+ to A- 21 16 24 25 23
BBB+ to BBB- 8 11 12 12 13
Noninvestment Grade 3 3 3 4 4
-------- --------- ---------- --------- ----------
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) September 30, 2004
$ %
--------- --------
+200 bp Ramp vs. Stable Rate $ 16 0.86%
+100 bp Ramp vs. Stable Rate 14 0.75
-50 bp Shock vs. Stable Rate (32) (1.80)
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 123 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.
40
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. To the extent that
actual behavior is different from that assumed in the models, there could be a
change in interest rate sensitivity.
41
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months ended For the three months ended
September 30, 2004 September 30, 2003
-------------------------- --------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks (primarily foreign) $11,416 $ 77 2.69% $ 7,085 $ 38 2.12%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 6,443 20 1.22 9,200 22 0.96
Margin Loans 6,315 40 2.50 5,419 31 2.25
Loans:
Domestic Offices 21,333 218 4.06 21,409 208 3.86
Foreign Offices 9,939 72 2.89 10,571 76 2.85
------- -------- ------- --------
Non-Margin Loans 31,272 290 3.69 31,980 284 3.52
------- -------- ------- --------
Securities
U.S. Government Obligations 450 3 2.64 313 2 3.00
U.S. Government Agency Obligations 3,560 30 3.37 3,464 30 3.44
Obligations of States and
Political Subdivisions 227 4 8.29 311 6 7.17
Other Securities 18,236 162 3.55 16,516 144 3.49
Trading Securities 1,587 11 2.81 4,357 27 2.47
------- -------- ------- --------
Total Securities 24,060 210 3.50 24,961 209 3.35
------- -------- ------- --------
Total Interest-Earning Assets 79,506 637 3.19% 78,645 584 2.94%
------- -------- ------- --------
Allowance for Credit Losses (592) (822)
Cash and Due from Banks 3,027 2,914
Other Assets 15,414 16,416
------- -------
TOTAL ASSETS $97,355 $97,153
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits
Money Market Rate Accounts $ 6,474 $ 13 0.83% $ 7,657 $ 13 0.67%
Savings 9,296 16 0.70 9,281 17 0.72
Certificates of Deposit
$100,000 & Over 3,640 14 1.56 3,840 14 1.47
Other Time Deposits 934 4 1.61 1,183 4 1.49
Foreign Offices 25,227 92 1.44 24,452 65 1.06
------- -------- ------- --------
Total Interest-Bearing Deposits 45,571 139 1.22 46,413 113 0.97
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,572 4 1.12 1,687 3 0.68
Other Borrowed Funds 2,416 9 1.51 2,464 6 1.00
Payables to Customers and Broker-Dealers 5,785 14 0.95 5,407 10 0.72
Long-Term Debt 6,083 35 2.26 6,310 36 2.27
------- -------- ------- --------
Total Interest-Bearing Liabilities 61,427 201 1.31% 62,281 168 1.07%
------- -------- ------- --------
Noninterest-Bearing Deposits 14,576 13,266
Other Liabilities 12,489 13,555
Common Shareholders' Equity 8,863 8,051
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $97,355 $97,153
======= =======
Net Interest Earnings
and Interest Rate Spread $ 436 1.88% $ 416 1.87%
======= ======= ======== =======
Net Yield on Interest-Earning Assets 2.18% 2.10%
======= =======
42
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the nine months ended For the nine months ended
September 30, 2004 September 30, 2003
-------------------------- --------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- -------
ASSETS
- ------
Interest-Bearing
Deposits in Banks (primarily foreign) $11,960 $ 224 2.50% $ 6,381 $ 109 2.28%
Federal Funds Sold and Securities
Purchased Under Resale Agreements 6,964 53 1.02 7,394 61 1.11
Margin Loans 6,330 108 2.29 3,133 54 2.33
Loans:
Domestic Offices 21,547 483 2.99 20,124 642 4.27
Foreign Offices 9,364 197 2.81 11,799 262 2.97
------- -------- ------- --------
Non-Margin Loans 30,911 680 2.94 31,923 904 3.79
------- -------- ------- --------
Securities:
U.S. Government Obligations 456 8 2.47 282 8 3.55
U.S. Government Agency Obligations 3,955 98 3.29 3,246 93 3.82
Obligations of States and
Political Subdivisions 236 13 7.23 348 19 7.10
Other Securities 18,169 474 3.48 15,234 421 3.69
Trading Securities 2,139 34 2.17 4,802 103 2.88
------- -------- ------- --------
Total Securities 24,955 627 3.35 23,912 644 3.59
------- -------- ------- --------
Total Interest-Earning Assets 81,120 1,692 2.79% 72,743 1,772 3.26
------- -------- ------- --------
Allowance for Credit Losses (633) (826)
Cash and Due from Banks 2,947 2,825
Other Assets 15,695 14,837
------- -------
TOTAL ASSETS $99,129 $89,579
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Interest-Bearing Deposits:
Money Market Rate Accounts $ 6,648 $ 36 0.73% $ 7,493 $ 48 0.86%
Savings 9,267 47 0.68 8,971 54 0.81
Certificates of Deposit
$100,000 & Over 3,847 39 1.33 4,402 54 1.62
Other Time Deposits 967 11 1.55 1,268 16 1.62
Foreign Offices 25,874 251 1.30 24,051 225 1.25
------- -------- ------- --------
Total Interest-Bearing Deposits 46,603 384 1.10 46,185 397 1.15
Federal Funds Purchased and
Securities Sold Under Repurchase
Agreements 1,599 10 0.82 1,470 10 0.90
Other Borrowed Funds 2,400 27 1.50 1,510 13 1.17
Payables to Customers and Broker-Dealers 6,521 38 0.78 3,160 19 0.79
Long-Term Debt 6,143 95 2.04 6,077 116 2.54
------- -------- ------- --------
Total Interest-Bearing Liabilities 63,266 554 1.17% 58,402 555 1.27%
------- -------- ------- --------
Noninterest-Bearing Deposits 14,465 12,341
Other Liabilities 12,701 11,370
Common Shareholders' Equity 8,697 7,466
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $99,129 $89,579
======= =======
Net Interest Earnings
and Interest Rate Spread $ 1,138 1.62% $ 1,217 1.99%
======== ======= ======== =======
Net Yield on Interest-Earning Assets 1.87% 2.24%
======= =======
43
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.
44
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.
45
SUPPLEMENTAL INFORMATION
The Company believes that providing supplemental non-GAAP financial
information is useful to investors in understanding the underlying operational
performance of the Company and its businesses and performance trends and,
therefore, facilitates comparisons with the performance of other financial
service companies. Specifically, the Company believes that the exclusion of
the merger and integration costs, and the settlement with GMAC, permits
evaluation and a comparison of results for ongoing business operations, and it
is on this basis that the Company's management internally assesses
performance. Although the Company believes that the non-GAAP financial
measures presented in this report enhance investors' understanding of the
Company's business and performance, these non-GAAP measures should not be
considered an alternative to GAAP.
The following is a reconciliation of 2003 reported net income to net
income on an operating basis:
For the quarter ended Year-to-date
(Dollars in millions) September 30, 2003 September 30, 2003
- ------------------------------- --------------------- ------------------
Reported Net Income $ 260 $ 850
Pershing Merger and
Integration Costs 23 48
GMAC Settlement 78 78
Tax Effect (39) (48)
--------------------- ------------------
Operating Net Income $ 322 $ 928
===================== ==================
The following is a reconciliation of 2003 reported earnings per share to
earnings per share on an operating basis:
For the quarter ended Year-to-date
September 30, 2003 September 30, 2003
- ------------------------------- --------------------- ------------------
Reported Earnings per Share $ 0.34 $ 1.13
Pershing Merger and
Integration Costs 0.02 0.04
GMAC Settlement 0.06 0.06
--------------------- ------------------
Operating Earnings per Share $ 0.42 $ 1.23
===================== ==================
46
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
September 30, 2004 December 31, 2003
------------------ -----------------
Assets
- ------
Cash and Due from Banks $ 3,057 $ 3,843
Interest-Bearing Deposits in Banks 8,856 8,286
Securities
Held-to-Maturity (fair value of $1,688 in 2004
and $256 in 2003) 1,694 261
Available-for-Sale 21,552 22,642
------------------ -----------------
Total Securities 23,246 22,903
Trading Assets at Fair Value 4,021 5,406
Federal Funds Sold and Securities Purchased
Under Resale Agreements 5,078 4,829
Loans (less allowance for loan losses of $598 in 2004
and $668 in 2003) 36,521 34,615
Premises and Equipment 1,426 1,398
Due from Customers on Acceptances 238 170
Accrued Interest Receivable 356 214
Goodwill 3,386 3,276
Intangible Assets 784 816
Other Assets 6,206 6,641
------------------ -----------------
Total Assets $ 93,175 $ 92,397
================== =================
Liabilities and Shareholders' Equity
- ------------------------------------
Deposits
Noninterest-Bearing (principally domestic offices) $ 15,536 $ 14,789
Interest-Bearing
Domestic Offices 19,551 19,282
Foreign Offices 23,353 22,335
------------------ -----------------
Total Deposits 58,440 56,406
Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 1,174 1,039
Trading Liabilities 2,855 2,519
Payables to Customers and Broker-Dealers 7,732 10,192
Other Borrowed Funds 851 834
Acceptances Outstanding 239 172
Accrued Taxes and Other Expenses 4,222 4,256
Accrued Interest Payable 174 82
Other Liabilities (including allowance for
lending-related commitments of
$158 in 2004 and $136 in 2003) 2,297 2,348
Long-Term Debt 6,137 6,121
------------------ -----------------
Total Liabilities 84,121 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
1,044,113,939 shares in 2004 and
1,039,968,482 shares in 2003 7,831 7,800
Additional Capital 1,736 1,647
Retained Earnings 5,964 5,330
Accumulated Other Comprehensive Income 28 72
------------------ -----------------
15,559 14,849
Less: Treasury Stock (267,225,571 shares in 2004
and 264,649,827 shares in 2003), at cost 6,504 6,420
Loan to ESOP (126,960 shares in 2004
and 126,960 shares in 2003), at cost 1 1
------------------ -----------------
Total Shareholders' Equity 9,054 8,428
------------------ -----------------
Total Liabilities and Shareholders' Equity $ 93,175 $ 92,397
================== =================
- ------------------------------------------------------------------------------------------------
Note: The balance sheet at December 31, 2003 has been derived from the audited financial
statements at that date.
47
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 nine months
ended September 30, ended September 30,
-------------------- -------------------
2004 2003 2004 2003
--------- -------- -------- --------
Interest Income
- ---------------
Loans $ 290 $ 284 $ 680 $ 904
Margin loans 40 31 108 54
Securities
Taxable 181 162 543 477
Exempt from Federal Income Taxes 10 11 30 37
--------- -------- -------- --------
191 173 573 514
Deposits in Banks 77 38 224 109
Federal Funds Sold and Securities Purchased
Under Resale Agreements 20 22 53 61
Trading Assets 11 27 34 103
--------- -------- -------- --------
Total Interest Income 629 575 1,672 1,745
--------- -------- -------- --------
Interest Expense
- ----------------
Deposits 139 113 384 397
Federal Funds Purchased and Securities Sold
Under Repurchase Agreements 4 3 10 10
Other Borrowed Funds 9 6 27 13
Customer Payables 14 10 38 19
Long-Term Debt 35 36 95 116
--------- -------- -------- --------
Total Interest Expense 201 168 554 555
--------- -------- -------- --------
Net Interest Income 428 407 1,118 1,190
- -------------------
Provision for Credit Losses - 40 22 120
--------- -------- -------- --------
Net Interest Income After Provision for Credit Losses 428 367 1,096 1,070
--------- -------- -------- --------
Noninterest Income
- ------------------
Servicing Fees
Securities 685 657 2,117 1,728
Global Payment Services 84 80 245 238
--------- -------- -------- --------
769 737 2,362 1,966
Private Client Services and Asset Management Fees 113 97 333 281
Service Charges and Fees 98 89 287 278
Foreign Exchange and Other Trading Activities 67 92 273 246
Securities Gains 14 9 59 26
Other 49 39 191 107
--------- -------- -------- --------
Total Noninterest Income 1,110 1,063 3,505 2,904
--------- -------- -------- --------
Noninterest Expense
- -------------------
Salaries and Employee Benefits 564 533 1,708 1,454
Net Occupancy 77 69 230 192
Furniture and Equipment 51 50 153 134
Clearing 39 42 131 111
Sub-custodian Expenses 21 18 65 53
Software 52 45 151 123
Communications 22 24 69 68
Amortization of Intangibles 9 8 26 18
Merger and Integration Costs - 23 - 48
GMAC Settlement - 78 - 78
Other 164 149 492 402
--------- -------- -------- --------
Total Noninterest Expense 999 1,039 3,025 2,681
--------- -------- -------- --------
Income Before Income Taxes 539 391 1,576 1,293
Income Taxes 185 131 487 443
--------- -------- -------- --------
Net Income $ 354 $ 260 $ 1,089 $ 850
- ---------- ========= ======== ======== ========
Per Common Share Data:
- ----------------------
Basic Earnings $ 0.46 $ 0.34 $ 1.41 $ 1.14
Diluted Earnings 0.46 0.34 1.40 1.13
Cash Dividends Paid 0.20 0.19 0.59 0.57
Diluted Shares Outstanding 778 774 778 753
48
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the nine months ended September 30, 2004
(Dollars in millions)
(Unaudited)
Common Stock
Balance, January 1 $ 7,800
Issuances in Connection with Employee Benefit Plans 31
-------------
Balance, September 30 7,831
-------------
Additional Capital
Balance, January 1 1,647
Issuances in Connection with Employee Benefit Plans 89
-------------
Balance, September 30 1,736
-------------
Retained Earnings
Balance, January 1 5,330
Net Income $ 1,089 1,089
Cash Dividends on Common Stock (455)
-------------
Balance, September 30 5,964
-------------
Accumulated Other Comprehensive Income
Balance, January 1 72
Change in Fair Value of Securities Available-for-Sale,
Net of Taxes of $(9) Million (35) (35)
Reclassification Adjustment, Net of Taxes of $1 Million 1 1
Foreign Currency Translation Adjustment,
Net of Taxes of $(9) million (11) (11)
Net Unrealized Derivative Gains on Cash Flow Hedges,
Net of Taxes of $1 million 3 3
Minimum Pension Liability Adjustment,
Net of Taxes of $(1) million (2) (2)
----------- -------------
Balance, September 30 28
Total Comprehensive Income $ 1,045
===========
Less Treasury Stock
Balance, January 1 6,420
Issued (35)
Acquired 119
-------------
Balance, September 30 6,504
-------------
Less Loan to ESOP
Balance, January 1 1
-------------
Balance, September 30 1
-------------
Total Shareholders' Equity, September 30 $ 9,054
=============
- -------------------------------------------------------------------------------------------
Comprehensive Income for the three months ended September 30, 2004 and 2003 was $435 million and
$207 million.
Comprehensive Income for the nine months ended September 30, 2004 and 2003 was $1,045 million and
$821 million.
See accompanying Notes to Consolidated Financial Statements.
49
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the nine months
ended September 30,
2004 2003
-------- --------
Operating Activities
Net Income $ 1,089 $ 850
Adjustments to Determine Net Cash Attributable to
Operating Activities
Provision for Credit Losses
and Losses on Other Real Estate 22 120
Depreciation and Amortization 367 307
Deferred Income Taxes 238 314
Securities Gains (59) (26)
Change in Trading Activities 1,753 501
Change in Accruals and Other, Net 5 (1,086)
-------- --------
Net Cash Provided by Operating Activities 3,415 980
-------- --------
Investing Activities
Change in Interest-Bearing Deposits in Banks (1,337) (16)
Change in Margin Loans (199) (734)
Purchases of Securities Held-to-Maturity (1,224) -
Paydowns of Securities Held-to-Maturity 154 670
Maturities of Securities Held-to-Maturity 6 10
Purchases of Securities Available-for-Sale (10,532) (22,408)
Sales of Securities Available-for-Sale 3,278 5,047
Paydowns of Securities Available-for-Sale 6,177 7,406
Maturities of Securities Available-for-Sale 1,708 4,642
Net Principal Received (Disbursed) on Loans to Customers (1,055) (434)
Sales of Loans and Other Real Estate 28 542
Change in Federal Funds Sold and Securities
Purchased Under Resale Agreements (249) (1,100)
Purchases of Premises and Equipment (222) (98)
Acquisitions, Net of Cash Acquired (100) (1,773)
Proceeds from the Sale of Premises and Equipment 8 7
Other, Net 23 826
-------- --------
Net Cash Used by Investing Activities (3,536) (7,413)
-------- --------
Financing Activities
Change in Deposits 2,098 2,961
Change in Federal Funds Purchased and Securities
Sold Under Repurchase Agreements 135 (310)
Change in Payables to Customers and Broker-Dealers (2,460) 1,689
Change in Other Borrowed Funds 137 (530)
Proceeds from the Issuance of Long-Term Debt 148 1,915
Repayments of Long-Term Debt (126) (1,029)
Issuance of Common Stock 155 1,153
Treasury Stock Acquired (119) (17)
Cash Dividends Paid (455) (418)
-------- --------
Net Cash (Used) Provided by Financing Activities (487) 5,414
-------- --------
Effect of Exchange Rate Changes on Cash (178) 1
-------- --------
Change in Cash and Due From Banks (786) (1,018)
Cash and Due from Banks at Beginning of Period 3,843 4,748
-------- --------
Cash and Due from Banks at End of Period $ 3,057 $ 3,730
======== ========
- -------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for:
Interest $ 462 $ 531
Income Taxes 324 386
Noncash Investing Activity
(Primarily Foreclosure of Real Estate) 1 -
- -------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
50
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 nine months ended September 30, 2004, approximately 7
million options were granted. In the third quarter and first nine months of
2004, the Company recorded $11 million and $29 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, 3rd Quarter Year-to-date
except per share amounts) 2004 2003 2004 2003
- ---------------------------------------- ------ ------ ------ ------
Reported net income $ 354 $ 260 $1,089 $ 850
Stock based employee compensation costs,
using prospective method, net of tax 6 6 17 13
Stock based employee compensation costs,
using retroactive restatement method,
net of tax (14) (22) (44) (62)
------ ------ ------ ------
Pro forma net income $ 346 $ 244 $1,062 $ 801
------ ------ ------ ------
Reported diluted earnings per share $ 0.46 $ 0.34 $ 1.40 $ 1.13
Impact on diluted earnings per share (0.01) (0.02) (0.03) (0.05)
------ ------ ------ ------
Pro forma diluted earnings per share $ 0.45 $ 0.32 $ 1.37 $ 1.08
====== ====== ====== ======
51
The fair value of options granted in 2004 and 2003 were estimated at the
grant date using the following weighted average assumptions:
3rd Quarter Year-to-date
2004 2003 2004 2003
------ ------ ------ ------
Dividend yield 3.00% 3.00% 2.50% 3.00%
Expected volatility 25.06 33.92 25.00 32.79
Risk free interest rates 3.35 3.25 2.61 3.49
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 May 2004, FASB issued FASB Staff Position No. 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003" ("FSP FAS 106-2"), which supersedes FSP FAS
106-1, in response to the December 2003 enactment of the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 ("the Act"). FSP FAS 106-2
provides guidance on the accounting for the effects of the Act for employers
that sponsor postretirement health care plans that provide prescription drug
benefits. The Company believes that its plans are eligible for the subsidy
provided by the Act and adopted FSP FAS 106-2 in the third quarter of 2004
retroactive to January 1, 2004. The adoption of FSP FAS 106-2 did not have a
significant impact on the Company's results of operations or financial
position.
The Company understands that the FASB may be currently reviewing the
accounting guidance under SFAS 13 surrounding leveraged leases. If FASB
modifies existing interpretations of SFAS 13 and associated industry
practice, a settlement of the tax matters associated with the Company's
structured leasing investments (see "Commitments and Contingencies" footnote)
could result in a one-time charge to earnings related to a change in the timing
of the lease cash flows. However, an amount approximating this one-time charge
would be recognized into income over the remaining term of the affected
leases. It is unclear at this point in time whether or when FASB will modify
lease accounting guidance.
52
Certain other prior year information has been reclassified to conform its
presentation with the 2004 financial statements.
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be an active acquirer of securities servicing
and asset management businesses.
There were no businesses acquired during the third quarter of 2004.
During the first nine 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 third quarter and first nine
months of 2004 was zero and $31 million. The tax deductible portion of
goodwill for the third quarter and first nine months of 2004 is zero and $31
million. All of the goodwill was assigned to the Company's Servicing and
Fiduciary Businesses segment. At September 30, 2004, the Company was liable
for potential contingent payments related to acquisitions in the amount of
$554 million. During the third quarter and first nine months of 2004, the
Company paid $5 million and $12 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 SmartSource (registered 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 September 2004, the Company agreed to acquire the execution and
commission management assets of Wilshire Associates. Under the terms of the
agreement, BNY Brokerage will assume Wilshire's client relationships in these
businesses. The transaction is expected to close in the fourth quarter.
53
4. Goodwill and Intangibles
------------------------
Goodwill by business segment is as follows:
(Dollars in millions)
September 30, 2004 December 31, 2003
------------------ -----------------
Servicing and
Fiduciary Businesses $ 3,246 $ 3,136
Corporate Banking 31 31
Retail Banking 109 109
Financial Markets - -
------------------ -----------------
Consolidated Total $ 3,386 $ 3,276
================== =================
The Company's business segments are tested annually for goodwill
impairment.
Intangible Assets
- -----------------
September 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 (58) 399 17 461 (39) 422
Other Intangible
Assets 40 (25) 15 7 43 (19) 24
The aggregate amortization expense of intangibles was $9 million and $8
million for the quarters ended September 30, 2004 and 2003, respectively. The
aggregate amortization expense of intangibles was $26 million and $18 million
for the nine months ended September 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 $35
2005 35
2006 35
2007 33
2008 32
54
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.
55
Transactions in the allowance for credit losses are summarized as
follows:
Three Months Ended Three Months Ended
(Dollars in millions) September 30, 2004 September 30, 2003
---------------------------------------------- ------------------
Allowance for
Allowance for Lending-Related Allowance for Allowance for
Loan Losses Commitments Credit Losses Credit Losses
------------- --------------- ------------- ------------------
Balance, Beginning of Period $ 598 $ 177 $ 775 $ 824
Charge-Offs (21) - (21) (55)
Recoveries 2 - 2 8
------------- --------------- ------------- ------------------
Net Charge-Offs (19) - (19) (47)
Provision 19 (19) - 40
------------- --------------- ------------- ------------------
Balance, End of Period $ 598 $ 158 $ 756 $ 817
============= =============== ============= ==================
Allowance for Loan Losses $ 665
Allowance for Lending-Related
Commitments $ 152
Nine Months Ended Nine Months Ended
(Dollars in millions) September 30, 2004 September 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 (76) - (76) (147)
Recoveries 6 - 6 13
------------- --------------- ------------- ------------------
Net Charge-Offs (70) - (70) (134)
Provision - 22 22 120
------------- --------------- ------------- ------------------
Balance, End of Period $ 598 $ 158 $ 756 $ 817
============= =============== ============= =================
Allowance for Loan Losses $ 665
Allowance for Lending-Related
Commitments $ 152
6. Capital Transactions
--------------------
At September 30, 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.
7. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in millions, ------------------ -----------------
except per share amounts) 2004 2003 2004 2003
- ---------------------------------- -------- -------- -------- -------
Net Income(1) $ 354 $ 260 $ 1,089 $ 850
======== ======== ======== =======
Basic Weighted Average
Shares Outstanding 772 766 772 746
Shares Issuable on Exercise of
Employee Stock Options 6 8 6 7
-------- -------- -------- -------
Diluted Weighted Average
Shares Outstanding 778 774 778 753
======== ======== ======== =======
Basic Earnings Per Share: $ 0.46 $ 0.34 $ 1.41 $ 1.14
Diluted Earnings Per Share: 0.46 0.34 1.40 1.13
(1) Net Income, net income available to common shareholders and diluted net
income are the same for all periods presented.
56
8. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
------------------------------------ ------------------------------------
Three Months Ended Nine Months Ended Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
------------------ ----------------- ------------------ -----------------
(Dollars in millions) 2004 2003 2004 2003 2004 2003 2004 2003
- --------------------- -------- --------- -------- -------- -------- --------- -------- --------
Net Periodic Cost (Income)
Service Cost $ 14 $ 11 $ 42 $ 33 $ - $ 1 $ - $ 3
Interest Cost 15 12 45 36 3 2 9 6
Expected Return on Asset (35) (34) (105) (102) (2) (2) (6) (6)
Other 2 1 6 3 2 2 6 6
-------- --------- -------- -------- --------- -------- -------- -------
Net Periodic Cost (Income)$ (4)$ (10)$ (12)$ (30)$ 3 $ 3 $ 9 $ 9
======== ========= ======== ======== ========= ======== ======== =======
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 September 30, 2004 and December
31, 2003 follows:
Off-Balance-Sheet Credit Risks
- ------------------------------
September 30, December 31,
(Dollars in millions) 2004 2003
- ----------------------------------- ------------ -----------
Lending Commitments $ 34,766 $ 35,576
Standby Letters of Credit, net 9,787 10,168
Commercial Letters of Credit 1,240 1,013
Securities Lending Indemnifications 231,727 173,974
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.
In securities lending transactions, the Company generally requires the
borrower to provide 102% cash collateral which is monitored on a daily basis,
thus reducing credit risk. Security lending transactions are generally
entered into only with highly-rated counterparties. At September 30, 2004 and
December 31, 2003, securities lending indemnifications were secured by
collateral of $234.3 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 $0.6 billion and $0.7 billion that were collateralized with cash and
securities on September 30, 2004 and December 31, 2003. At September 30,
2004, approximately $6.9 billion of the standbys will expire within one year,
and the balance between one to five years.
At September 30, 2004, the notional amounts and credit exposures for the
Company's credit derivatives swaps were $1,497 million and $1 million,
compared to $1,413 million and $3 million at December 31, 2003.
57
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 investments prior to mid-1999 that the IRS
has challenged. In 2004 the IRS 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 will 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 disagree.
The Company explored a settlement proposal with the IRS during the third
quarter of 2004 but was unable to reach an acceptable agreement. The matter
has now been submitted to the IRS Appeals Office for review. A conference
with officials from this office is scheduled for late in the fourth quarter of
2004. At this time it remains unknown whether a settlement acceptable to the
Company can be reached. If settlement negotiations with the IRS Appeals
Office fail, the Company will likely pursue litigation in the appropriate
federal court.
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.
58
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 2004
Commission file number 001-06152
THE BANK OF NEW YORK COMPANY, INC.
Incorporated in the State of New York
I.R.S. Employer Identification No. 13-2614959
Address: One Wall Street
New York, New York 10286
Telephone: (212) 495-1784
As of October 29, 2004, The Bank of New York Company, Inc. had
776,902,261 shares of common stock ($7.50 par value) outstanding.
The Bank of New York Company, Inc. (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months(or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
The registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The following sections of the Financial Review set forth in the cross-
reference index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
- ------------------------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of
September 30, 2004 and December 31, 2003 46
Consolidated Statements of Income for
the three months and nine months
ended September 30, 2004 and 2003 47
Consolidated Statement of Changes in
Shareholders' Equity for the nine months
ended September 30, 2004 48
Consolidated Statement of Cash Flows
for the nine months ended
September 30, 2004 and 2003 49
Notes to Consolidated Financial Statements 50 - 57
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 2 - 45
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 37 - 40
59
ITEM 4. CONTROLS AND PROCEDURES
At the end of the period covered by 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
- --------------------------
In the ordinary course of business, the Company and its subsidiaries are
routinely defendants in or parties to a number of pending and potential legal
actions, including actions brought on behalf of various classes of claimants,
and regulatory matters. Claims for significant monetary damages are asserted
in certain of these actions and proceedings. Due to the inherent difficulty
of predicting the outcome of such matters, the Company cannot ascertain what
the eventual outcome of these matters will be; however, based on current
knowledge and after consultation with legal counsel, the Company does not
believe that judgments or settlements, if any, arising from pending or
potential legal actions or regulatory matters, either individually or in the
aggregate, will have a material adverse effect on the consolidated financial
position or liquidity of the Company although they could have a material
effect on net income for a given period. The Company intends to defend itself
vigorously against all of the claims asserted in these matters.
The Company continues to cooperate with investigations by federal and
state law enforcement and bank regulatory authorities. As previously
disclosed, 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
Office has proposed to resolve its investigation through an agreement between
the Bank and the Office. The Bank is reviewing the Office's proposal. There
can be no assurance that an agreement will be reached.
The Company is broadly involved in the mutual fund industry, and various
governmental and self-regulatory agencies have sought documents and other
information from it in connection with investigations relating to that
industry. Those investigations have focused primarily on (i) possible market-
timing transactions cleared by Pershing LLC, a subsidiary of the Company, for
Mutuals.com and other introducing brokers; and (ii) the BNY Hamilton Funds,
Inc.'s relationship with the Company and the Funds' administrator as service
providers to the Funds.
60
The Company is broadly involved in issuer services, and governmental
agencies have sought documents and other information from it in connection
with investigations relating to that industry. Those investigations have
focused primarily on (i) The Company's role as transfer agent on behalf of
equity issuers in the United States and the process used by the Company's
stock transfer division to search for lost security holders of its issuer
clients; and (ii) The Company's role as auction agent in connection with
auction rate securities issued by various issuers.
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 third quarter of 2004.
Issuer Purchases of Equity Securities
- -------------------------------------
Total Number
Total Average of Shares
Number Price Purchased as
Period of Shares Paid Part of Maximum
Purchased Per Share Publicly Number of Shares
Announced Plans That May be
or Programs Repurchased
- -------------- ---------- ---------- --------------- ------------------
July 1-31 1,797 $ 28.79 1,797 15,075,724
August 1-31 2,240,000 29.32 2,240,000 12,835,724
September 1-30 188,100 29.13 188,100 12,647,624
---------- ---------------
Total 2,429,897 2,429,897
All shares were repurchased through the Company's stock repurchase
program, which was announced on November 12, 2002 and permits the repurchase
of 16 million shares. In August, 2 million shares were purchased in a single
transaction. In August and September, 420,000 shares were repurchased in the
open markets. The remaining shares repurchased in the third quarter resulted
from transactions related to employee benefit plans.
Item 6. Exhibits
- -----------------
(a) The exhibits filed as part of this report are as follows:
Exhibit 10.1 - Amended and Restated 2004 Management Incentive Compensation
Plan, incorporated by reference to Exhibit C in the Registrant's
Definitive Proxy Statement dated March 12, 2004 (file number 001-
06152);
Exhibit 10.2 - Form of Stock Option Agreement under the Registrant's 2003
Long-Term Incentive Plan;
Exhibit 10.3 - Form of Performance Share Agreement under the Registrant's
2003 Long-Term Incentive Plan;
Exhibit 10.4 - Form of Restricted Stock Agreement under the Registrant's
2003 Long-Term Incentive Plan;
Exhibit 12 - Ratio of Earnings to Fixed Charges
for the Three Months and Nine Months Ended September 30, 2004 and 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; and
Exhibit 32.1 - Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
61
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: November 9, 2004 By: /s/ Thomas J. Mastro
---------------------------------
Name: Thomas J. Mastro
Title: Comptroller
62
EXHIBIT INDEX
-------------
Exhibit Description
- ------- -----------
10.1 Amended and Restated 2004 Management Incentive Compensation
Plan, incorporated by reference to Exhibit C in the Registrant's
Definitive Proxy Statement dated March 12, 2004 (file number
001-06152).
10.2 Form of Stock Option Agreement under the Registrant's 2003 Long-
Term Incentive Plan.
10.3 Form of Performance Share Agreement under the Registrant's 2003
Long-Term Incentive Plan.
10.4 Form of Restricted Stock Agreement under the Registrant's 2003
Long-Term Incentive Plan.
12 Ratio of Earnings to Fixed Charges for the
Three Months and Nine Months Ended September 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.