SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ ] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended _________________
[X] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from July 1, 1999 to November 26, 1999
Commission File Number 1-8989
The Bear Stearns Companies Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3286161
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
245 Park Avenue, New York, New York 10167
(Address of principal executive offices) (Zip Code)
(212)272-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (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 for 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. Yes [X] No [ ]
As of March 1, 2000, the latest practicable date, there were 112,333,634 shares
of Common Stock, $1 par value, outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition at November 26,
1999 (Unaudited) and June 30, 1999
Consolidated Statements of Income (Unaudited) for the
five-month periods ended November 26, 1999 and November 27,
1998
Consolidated Statements of Cash Flows (Unaudited) for the
five-month periods ended November 26, 1999 and November 27,
1998
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signature
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Assets
November 26, June 30,
1999 1999
-------------------- ---------------------
(Unaudited)
(In thousands)
Cash and cash equivalents $ 1,570,483 $ 2,129,080
Cash and securities deposited with clearing organizations
or segregated in compliance with federal regulations 1,188,788 2,891,397
Securities purchased under agreements to resell 35,999,998 32,996,226
Receivable for securities provided as collateral 2,571,404 1,735,293
Securities borrowed 60,429,297 54,173,726
Receivables:
Customers 16,839,040 14,510,628
Brokers, dealers and others 542,038 1,452,590
Interest and dividends 422,402 366,110
Financial instruments owned, at fair value 40,764,802 41,942,878
Property, equipment and leasehold improvements,
net of accumulated depreciation and amortization 504,040 486,735
Other assets 1,205,670 1,209,677
---------------- ----------------
Total Assets $ 162,037,962 $ 153,894,340
================ ================
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Liabilities and Stockholders' Equity
November 26, June 30,
1999 1999
-------------------- ---------------------
(Unaudited)
(In thousands, except share data)
Short-term borrowings $ 13,424,201 $ 14,145,410
Securities sold under agreements
to repurchase 53,323,109 50,673,644
Obligation to return securities received as
collateral 3,999,229 1,944,286
Payables:
Customers 42,843,757 40,822,913
Brokers, dealers and others 5,596,577 2,195,691
Interest and dividends 532,023 542,478
Financial instruments sold, but not
yet purchased, at fair value 19,704,921 21,506,372
Accrued employee compensation and benefits 733,241 1,306,357
Other liabilities and accrued expenses 527,565 654,588
-------------------- ---------------------
140,684,623 133,791,739
-------------------- ---------------------
Commitments and contingencies
Long-term borrowings 15,911,392 14,647,092
-------------------- ---------------------
Guaranteed Preferred Beneficial Interests in Company
Subordinated Debt Securities 500,000 500,000
-------------------- ---------------------
Stockholders' Equity
Preferred Stock 800,000 800,000
Common Stock, $1.00 par value;
200,000,000 shares authorized;
184,805,848 and 176,011,113 shares issued at
November 26, 1999 and June 30, 1999, respectively 184,806 176,011
Paid-in capital 2,509,801 2,269,927
Retained earnings 1,916,516 1,931,957
Capital Accumulation Plan 1,179,101 1,144,329
Treasury stock, at cost
Adjustable Rate Cumulative Preferred
Stock, Series A - 2,520,750 shares (103,421) (103,421)
Common Stock - 66,367,276 shares and 56,333,508
shares at November 26, 1999 and
June 30, 1999, respectively (1,544,856) (1,263,294)
-------------------- ---------------------
Total Stockholders' Equity 4,941,947 4,955,509
-------------------- ---------------------
Total Liabilities and Stockholders' Equity $ 162,037,962 $ 153,894,340
==================== =====================
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Five-Months Ended
-------------------------------------
November 26, November 27,
1999 1998
---------------- ------------------
(In thousands, except share data)
Revenues
Commissions $ 419,619 $ 411,204
Principal transactions 745,679 397,045
Investment banking 434,410 217,711
Interest and dividends 1,810,598 1,916,799
Other income 59,984 32,422
---------------- ------------------
Total Revenues 3,470,290 2,975,181
Interest expense 1,531,787 1,650,885
---------------- ------------------
Revenues, net of interest expense 1,938,503 1,324,296
---------------- ------------------
Non-interest expenses
Employee compensation and benefits 973,990 732,884
Floor brokerage, exchange
and clearance fees 63,088 71,335
Communications 65,445 57,440
Depreciation and amortization 62,714 54,281
Occupancy 45,414 43,372
Advertising and market development 39,927 38,234
Data processing and equipment 39,709 19,683
Other expenses 194,624 117,339
---------------- ------------------
Total non-interest expenses 1,484,911 1,134,568
---------------- ------------------
Income before provision for
income taxes 453,592 189,728
Provision for income taxes 167,778 59,460
---------------- ------------------
Net income $ 285,814 $ 130,268
================ ==================
Net income applicable to
common shares $ 269,517 $ 113,654
================ ==================
Earnings per share (1) $ 1.78 $ 0.73
================ ==================
Weighted average common and
common equivalent shares
outstanding (1) 165,584,457 167,240,877
================ ==================
Cash dividends declared
per common share (1) $ 0.29 $ 0.27
================ ==================
(1) Reflects all stock dividends declared through October 29, 1999.
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Five-Months Ended
---------------------------------------------
November 26, November 27,
1999 1998
--------------------- ------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 285,814 $ 130,268
Adjustments to reconcile net income to cash provided by (used in)
operating activities:
Depreciation and amortization 62,714 54,281
Deferred income taxes (54,023) (82,008)
Other 22,506 26,179
Decreases (increases) in operating assets:
Cash and securities deposited with clearing organizations or
segregated in compliance with federal regulations 1,702,609 (1,745,518)
Securities purchased under agreements to resell (3,003,772) (6,881,984)
Securities borrowed (6,255,571) (4,003,150)
Receivables:
Customers (2,328,412) 3,446,752
Brokers, dealers and others 910,552 195,373
Financial instruments owned 2,396,908 (849,513)
Other assets (37,188) 396,947
Increases (decreases) in operating liabilities:
Securities sold under agreements to repurchase 2,649,465 16,621,746
Payables:
Customers 2,020,844 4,140,575
Brokers, dealers and others 3,394,914 (2,800,058)
Financial instruments sold, but not yet purchased (1,801,451) (3,567,784)
Accrued employee compensation and benefits (618,866) (742,307)
Other liabilities and accrued expenses (141,618) 499,260
--------------------- -----------------
Cash (used in) provided by operating activities (794,575) 4,839,059
--------------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net payments on short-term borrowings (721,209) (2,689,879)
Net proceeds from issuance of long-term borrowings 1,942,107 1,481,606
Capital Accumulation Plan 70,406 153,785
Tax benefit of Common Stock distributions 2,568 1,053
Payments for:
Retirement of long-term borrowings (681,751) (1,042,180)
Treasury stock purchases (311,289) (209,057)
Cash dividends paid (54,548) (53,691)
--------------------- -----------------
Cash provided by (used in) financing activities 246,284 (2,358,363)
--------------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold
improvements (80,019) (69,206)
Purchases of investment securities and other assets (24,546) (19,870)
Proceeds from sales of investment securities and other assets 94,259 30,459
--------------------- -----------------
Cash used in investing activities (10,306) (58,617)
--------------------- -----------------
Net (decrease) increase in cash and cash equivalents (558,597) 2,422,079
Cash and cash equivalents, beginning of period 2,129,080 1,073,821
--------------------- -----------------
Cash and cash equivalents, end of period $ 1,570,483 $ 3,495,900
===================== =================
Statement of Financial Accounting Standards No. 125 requires balance sheet recognition of collateral related to certain
secured financing transactions, which is a non-cash activity and did not impact the Consolidated Statements of Cash Flows.
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of The Bear Stearns Companies Inc. and its subsidiaries (the
"Company"). All material intercompany transactions and balances have been
eliminated. Certain prior period amounts have been reclassified to conform
to the current period's presentation. The Board of Directors declared a 5%
stock dividend on the Company's Common Stock in January 1999 and October
1999. Earnings per share data for all periods included in the consolidated
financial statements reflect such 5% stock dividends.
On January 18, 2000, the Company's Board of Directors elected to change its
fiscal year-end to November 30 from June 30, effective with the year
beginning November 27, 1999, as announced in its Form 8-K filed on January
21, 2000. The five-month period ended November 26, 1999 is the Company's
"Transition Period". This Transition Report on Form 10-Q presents the
results of the Company's operations for the five-month periods ended
November 26, 1999 and November 27, 1998.
The consolidated financial statements reflect all adjustments which, in the
opinion of management, are normal and recurring and are necessary for a fair
statement of the results for the interim periods presented. The consolidated
financial statements are prepared in conformity with generally accepted
accounting principles which require management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. The nature of the Company's business is such that the results of
any interim period may not be indicative of the results to be expected for
an entire fiscal year.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments owned and financial instruments sold, but not yet
purchased consist of the Company's proprietary trading and investment
accounts, at fair value, as follows:
November 26, June 30,
In thousands 1999 1999
- -----------------------------------------------------------------------------------------------------------------------
Financial instruments owned:
US government and agency $ 7,662,482 $ 8,211,944
Other sovereign governments 2,785,025 2,742,486
Corporate equity and convertible debt 9,421,251 14,578,501
Corporate debt 4,835,056 4,972,621
Derivative financial instruments 4,734,149 3,035,278
Mortgages and other mortgage-backed securities 10,911,528 7,869,884
Other 415,311 532,164
------------- ------------
$ 40,764,802 $ 41,942,878
============= ============
Financial instruments sold, but not yet purchased:
US government and agency $ 4,074,379 $ 5,250,633
Other sovereign governments 2,116,448 2,639,952
Corporate equity 7,665,516 6,134,317
Corporate debt 1,228,338 1,707,998
Derivative financial instruments 4,599,592 5,687,296
Other 20,648 86,176
------------- ------------
$ 19,704,921 $ 21,506,372
============= ============
3. COMMITMENTS AND CONTINGENCIES
At November 26, 1999, the Company was contingently liable for unsecured
letters of credit of approximately $1.9 billion and letters of credit
secured by financial instruments of approximately $23.9 million, both of
which are principally used as deposits for securities borrowed or to satisfy
margin deposits at option and commodity exchanges. The Company had various
other commitments aggregating $1.1 billion at November 26, 1999.
In the normal course of business, the Company has been named as a defendant
in several lawsuits, which involve claims for substantial amounts. Although
the ultimate outcome of these matters cannot be ascertained at this time, it
is the opinion of management, after consultation with counsel, that the
resolution of such matters will not have a material adverse effect on the
results of operations or the financial condition of the Company.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. NET CAPITAL REQUIREMENTS
The Company's principal operating subsidiary, Bear, Stearns & Co. Inc.
("Bear Stearns") and Bear Stearns' wholly owned subsidiary, Bear, Stearns
Securities Corp. ("BSSC"), are registered broker-dealers and, accordingly,
are subject to Rule 15c3-1 of the Securities Exchange Act of 1934 (the "Net
Capital Rule") and the capital rules of the New York Stock Exchange, Inc.
("NYSE") and other principal exchanges of which Bear Stearns and BSSC are
members. Included in the computation of net capital of Bear Stearns is net
capital of BSSC in excess of 5% of aggregate debit items arising from
customer transactions, as defined. At November 26, 1999, Bear Stearns' net
capital, as defined, of $1.84 billion exceeded the minimum requirement by
$1.80 billion.
Bear, Stearns International Limited ("BSIL") and Bear Stearns International
Trading Limited ("BSIT"), London-based broker-dealer subsidiaries, which are
indirectly wholly owned by the Company, are subject to regulatory capital
requirements of the Securities and Futures Authority, a self-regulatory
organization established pursuant to the United Kingdom Financial Services
Act of 1986.
Bear Stearns Bank plc ("BSB"), which is indirectly wholly owned by the
Company, is incorporated in Dublin and is subject to the regulatory capital
requirements of the Central Bank of Ireland.
At November 26, 1999, Bear Stearns, BSSC, BSIL, BSIT and BSB were in
compliance with their respective regulatory capital requirements.
5. EARNINGS PER SHARE
Earnings per share is computed by dividing net income applicable to common
shares by the weighted average number of common shares outstanding during
each period presented. Common shares include the assumed distribution of
shares of common stock issued or issuable under certain employee benefit
plans, including certain of the Company's deferred compensation
arrangements, with appropriate adjustments made to net income for expense
accruals related thereto.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. CASH FLOW INFORMATION
Cash payments for interest approximated interest expense for the five-months
ended November 26, 1999 and November 27, 1998. Income taxes paid totaled
$57.8 million and $17.9 million for the five-months ended November 26, 1999
and November 27, 1998, respectively.
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company, in its capacity as a dealer in over-the-counter derivative
financial instruments and in connection with its proprietary market-making
and trading activities, enters into transactions in a variety of cash and
derivative financial instruments in order to reduce its exposure to market
risk, which includes interest rate, exchange rate and equity price risk.
Statement of Financial Accounting Standards ("SFAS") No. 119, "Disclosure
about Derivative Financial Instruments and Fair Value of Financial
Instruments," defines a derivative as a future, forward, swap, or option
contract, or other financial instrument with similar characteristics such as
caps, floors and collars. Generally, these financial instruments represent
future commitments to exchange interest payment streams or currencies or to
purchase or sell other financial instruments at specific terms at specified
future dates. Option contracts provide the holder with the right, but not
the obligation, to purchase or sell a financial instrument at a specific
price on or before an established date. These financial instruments may have
market and/or credit risk in excess of amounts recorded in the Consolidated
Statements of Financial Condition.
In order to measure derivative activity, notional or contract amounts are
frequently used. Notional/contract amounts, which are not included on the
balance sheet, are used to calculate contractual cash flows to be exchanged
and are generally not actually paid or received, with the exception of
currency swaps and foreign exchange forwards and mortgage-backed securities
forwards. The notional/contract amounts of financial instruments that give
rise to off-balance-sheet market risk are indicative only of the extent of
involvement in the particular class of financial instrument and are not
necessarily an indication of overall market risk.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (continued)
The following table represents the notional/contract amounts of the
Company's outstanding derivative financial instruments as of November 26,
1999 and June 30, 1999:
November 26, June 30,
In billions 1999 1999
----------------------------------------------------------------------------------------------
Interest Rate:
Swap agreements, including options, swaptions,
caps, collars, and floors $371.4 $339.1
Futures contracts 47.3 52.5
Options held 43.8 24.0
Options written 18.4 3.9
Foreign Exchange:
Futures contracts 39.9 19.3
Forward contracts 10.0 15.6
Options held 5.5 2.6
Options written 4.1 3.1
Mortgage-Backed Securities:
Forward Contracts 51.9 63.4
Equity:
Swap agreements 15.1 11.9
Futures contracts 2.1 0.8
Options held 6.5 7.5
Options written 6.3 7.3
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (continued)
The derivative financial instruments used in the Company's trading and
dealer activities are recorded at fair value with the resulting unrealized
gains or losses recorded in the Consolidated Statements of Financial
Condition and the related income or loss reflected in revenues derived from
principal transactions.
The fair values of derivative financial instruments held or issued for
trading and hedging purposes as of November 26, 1999 and June 30, 1999, were
as follows:
November 26, June 30,
1999 1999
---------------------------------------------------------------
In millions Assets Liabilities Assets Liabilities
-------------------------------------------------------------------------------------------------
Swap agreements $3,016 $2,952 $1,375 $2,290
Futures and forward
Contracts 264 158 278 259
Options held 1,454 1,397
Options written 1,490 3,164
The average monthly fair values of the derivative financial instruments for
the five-months ended November 26, 1999 and the fiscal year ended June 30,
1999 were as follows:
November 26, June 30,
1999 1999
-----------------------------------------------------------------
In millions Assets Liabilities Assets Liabilities
-------------------------------------------------------------------------------------------------
Swap agreements $2,421 $2,625 $2,227 $2,317
Futures and forward
Contracts 244 287 334 368
Options held 1,178 1,154
Options written 1,577 3,156
The notional/contract amounts of these instruments do not represent the
Company's potential risk of loss due to counterparty nonperformance. Credit
risk arises from the potential inability of counterparties to perform in
accordance with the terms of the contract. The Company's exposure to credit
risk associated with counterparty nonperformance is limited to the net
replacement cost of over-the-counter contracts, which are recognized as
assets in the Company's Consolidated Statements of Financial Condition.
Exchange-traded financial instruments, such as futures and options,
generally do not give rise to significant counterparty exposure due to the
margin requirements of the individual exchanges. Generally, options written
do not
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (continued)
give rise to counterparty credit risk since they obligate the Company (not
its counterparty) to perform. The Company has controls in place to monitor
credit exposures by limiting transactions with specific counterparties and
assessing the creditworthiness of counterparties. The Company also seeks to
control credit risk by following an established credit approval process,
monitoring credit limits and requiring collateral where appropriate.
The following table summarizes the credit quality of the Company's
over-the-counter derivatives by showing counterparty credit ratings for the
replacement cost of contracts in a gain position, net of $1.7 billion of
collateral as of November 26, 1999 and June 30, 1999:
November 26, June 30,
In millions 1999 1999
--------------------------------------------------------
RATING(1) NET REPLACEMENT COST
AAA $ 192.2 $ 140.0
AA 597.1 627.1
A 600.7 303.4
BBB 79.8 56.6
BB and Lower 56.9 39.7
Non-rated 0.0 3.4
(1) Internal designations of counterparty credit quality are
based on actual ratings made by external ratings agencies or
comparable ratings established and utilized by the Company's
Credit Department.
8. SEGMENT DATA
The Company operates in three principal segments: Capital Markets,
Execution Services and Wealth Management. These segments are strategic
business units that offer different products and services. They are managed
separately as different levels and types of expertise are required to
effectively manage the segments' transactions.
The Capital Markets segment is comprised of Equities, Fixed Income and
Investment Banking areas. Equities combines the efforts of sales, trading
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. SEGMENT DATA (continued)
and research in such areas as block trading, convertible bonds,
over-the-counter equities, equity derivatives and risk arbitrage. Fixed
Income includes the efforts of sales, trading and research for
institutional clients in a variety of products such as mortgage-backed and
asset-backed securities, corporate and government bonds, municipal and high
yield securities and foreign exchange and derivatives. Investment Banking
provides capabilities in capital raising, strategic advisory, mergers and
acquisitions and merchant banking.
The Execution Services segment is comprised of clearance and predominantly
commission-related areas, including institutional equity sales,
institutional futures sales and specialist activities. Clearance provides
clearing, margin lending and securities borrowing to facilitate customer
short sales to approximately 2,800 clearing clients worldwide. The
commission-related areas provide research and execution capabilities in US
equity securities and financial futures to our institutional clients.
The Wealth Management segment is comprised of the Private Client Services
("PCS") and Asset Management areas. PCS provides high-net-worth individuals
with an institutional level of service. Asset Management serves the diverse
investment needs of corporations, municipal governments, multi-employer
plans, foundations, endowments, family groups and high-net-worth
individuals.
The three business segments are comprised of the many business areas with
interactions among each as they serve the needs of similar clients.
Revenues and expenses reflected below include those which are directly
related to each segment. Revenue from inter-segment transactions are
credited based upon specific criteria or agreed upon rates with such
amounts eliminated in consolidation. Individual segments also include
revenues and expenses relating to various items including corporate
overhead and interest which are internally allocated by the Company
primarily based on balance sheet usage or expense levels. The Company
generally evaluates performance of the segments based on net revenues and
profit or loss before provision for income taxes.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. SEGMENT DATA (continued)
For the five-months ended November 26, 1999:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- ---------------------
Capital Markets $ 1,017,482 $ 322,155 $ 105,441,874
Execution Services 566,995 210,704 54,401,790
Wealth Management 269,028 52,340 2,982,637
Other (a) 84,998 (131,607) (788,339)
- -----------------------------------------------------------------------------------------------------------
Total $ 1,938,503 $ 453,592 $ 162,037,962
===========================================================================================================
For the five-months ended November 27, 1998:
(in thousands) Net Revenues Pre-Tax Income (Loss) Segment Assets
- ----------------------------------- ---------------------- -------------------------- ---------------------
Capital Markets $ 519,661 $ (49,539) $ 111,856,697
Execution Services 499,857 203,635 49,881,166
Wealth Management 212,144 31,247 3,191,443
Other (a) 92,634 4,385 909,557
- -----------------------------------------------------------------------------------------------------------
Total $ 1,324,296 $ 189,728 $ 165,838,863
===========================================================================================================
(a) Other is comprised of consolidation/elimination entries, unallocated
revenues (predominantly interest) and corporate administrative functions,
including costs related to the Capital Accumulation Plan for Senior
Managing Directors (the "CAP Plan") which were $45.8 million and $14.0
million for the five-months ended November 26, 1999 and November 27, 1998,
respectively.
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. STOCK AWARD PLAN
On October 28, 1999, the stockholders of the Company approved the Company's
Stock Award Plan (the "Stock Award Plan"). The purpose of the Stock Award
Plan is to secure for the Company and its stockholders the benefits of the
additional incentive, inherent in the ownership of the Company's stock, by
selected key employees of the Company who are important to the success and
growth of the business. Pursuant to the Stock Award Plan, such employees
may be offered the opportunity to acquire common stock through the grant of
options and stock appreciation rights in tandem with such options. In
January 2000, the Company granted 3,886,334 options under such plan. The
stock options were issued with an exercise price equal to the market price
of the common stock on the date of the grant. These options vest after
three years and have a ten-year expiration.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this discussion are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to risks and uncertainties, which could
cause actual results to differ materially from those discussed in the
forward-looking statements.
The Company's principal business activities, investment banking, securities
trading and brokerage, are, by their nature, highly competitive and subject to
various risks, in particular volatile trading markets and fluctuations in the
volume of market activity. Consequently, the Company's net income and revenues
in the past have been, and are likely to continue to be, subject to wide
fluctuations, reflecting the impact of many factors, including securities market
conditions, the level and volatility of interest rates, competitive conditions,
liquidity of global markets, international and regional political events,
regulatory developments and the size and timing of transactions.
For a description of the Company's business, including its trading in cash
instruments and derivative products, its underwriting and trading policies, and
their respective risks, and the Company's risk management policies and
procedures, see the Company's Annual Report on Form 10-K for the fiscal year
ended June 30, 1999.
Business Environment
The business environment during the Company's five-month period ended November
26, 1999 was characterized by strong US economic growth and low inflation, which
resulted in robust domestic equity markets and growth in both New York Stock
Exchange ("NYSE") and NASDAQ trading volume. In an effort to slow the nation's
economic growth and mitigate the risk of rising inflationary pressures, the
Federal Reserve raised the Federal Funds rate twice during the period by a total
of 50 basis points. For the five-months ended November 26, 1999, the Dow Jones
Industrial Average, Standard and Poor's 500 Index and NASDAQ Composite Index
increased 0.2%, 3.2% and 28.4%, respectively. These factors contributed to
strong equity underwriting and mergers and acquisitions activities. The fixed
income markets improved over the comparable prior year period, which had
reflected the impact of difficult market conditions in the Far East and emerging
markets. However, the fixed income markets in the 1999 period were characterized
by rising interest rates and reduced trading volume predominantly as a result of
uncertainty surrounding the Year 2000 , which led to lower investor and issuer
activity.
The first three months of the 1998 period were marked by extreme fixed income
market volatility attributed to economic turmoil in the Far East and emerging
markets nations and the default by Russia on its debt obligations, which
triggered the flight to quality by investors who sought safer, less risky
investments. This caused yield spreads between US Treasury securities and
lower-rated issues to widen dramatically and resulted in a decline in liquidity
in the global markets. As a result, the Federal Reserve reduced the Federal
Funds rate on three occasions during the months of September, October and
November. The reduction in the Federal Funds rate by a total of 75 basis points,
coupled with the US economy's resilience, resulted in the recovery of US
financial markets in October 1998 and November 1998. Credit spreads tightened,
which led to improved, but still weak, conditions in both the primary and
secondary domestic fixed income markets. Rising domestic equity markets during
October 1998 and November 1998 reflected strong investor interest in the
internet and technology sectors.
Results of Operations
Five-Months Ended November 26, 1999
Compared to Five-Months Ended November 27, 1998
On January 18, 2000, the Company's Board of Directors approved a change in the
Company's fiscal year-end to November 30 from June 30, effective with the year
beginning November 27, 1999. The discussion that follows compares the results of
operations for the five-months ended November 26, 1999 to the five-months ended
November 27, 1998.
Net income for the five-months ended November 26, 1999 was $285.8 million, an
increase of 119.4% from $130.3 million for the comparable 1998 period. Net
revenues increased 46.4% to $1.9 billion in the 1999 period from $1.3 billion in
the 1998 period. The increase was primarily attributable to increased principal
transactions and investment banking revenues, as further discussed below.
Earnings per share were $1.78 for the 1999 period versus $0.73 for the
comparable 1998 period. Earnings per share amounts for all periods reflect the
adjustment for stock dividends declared by the Company in January 1999 and
October 1999.
Commission revenues increased 2.0% in the 1999 period to $419.6 million from
$411.2 million in the comparable 1998 period. This increase was primarily
attributable to higher commissions earned in the clearance area due to higher
customer activity and increases in average daily volume in the 1999 period when
compared to the 1998 period. The increase was also attributable to increased
revenues from the institutional area, partially offset by a decrease in futures
commissions in the 1999 period when compared to the 1998 period.
The Company's principal transactions revenues by reporting categories, including
derivatives, are as follows:
Five-Months Ended Five-Months Ended
November 26, 1999 November 27, 1998
----------------- -----------------
Fixed Income $366,359 $171,245
Equity 223,266 151,036
Foreign Exchange & Other
Derivative Financial Instruments 156,054 74,764
------- --------
$745,679 $397,045
======== ========
Revenues from principal transactions increased 87.8% in the 1999 period to
$745.7 million from $397.0 million in the comparable 1998 period. This increase
reflects increased revenues derived from each of the Company's reporting
categories. Revenues derived from fixed income activities increased as a result
of increases in revenues in the high yield, mortgage-backed securities,
corporate bonds and emerging markets areas. The 1998 period reflects decreased
activities due to the volatility experienced in the equity and fixed income
markets and the widening of credit spreads during the early months of the
period. These conditions led to the declines in revenues derived from several
business areas including the high yield, emerging markets and corporate bonds
areas. Revenues derived from both equity and fixed income derivatives increased
due to strong market conditions and customer flow. Revenues derived from equity
activities also increased in the 1999 period as a result of increases in
revenues in the arbitrage and over-the-counter stock areas.
Investment banking revenues increased 99.5% to $434.4 million in the 1999 period
from $217.7 million in the comparable 1998 period. The increase is principally
attributable to higher equity underwriting revenues reflecting a strong domestic
equity underwriting calendar and mergers and acquisitions revenues earned during
the 1999 period compared to the weak levels and relative inactivity in the
comparable 1998 period. Equity underwriting revenues increased 279.3%, due to a
strong volume of technology-related IPOs. Revenues from merchant banking
activities also increased reflecting gains realized from certain of the
Company's investments.
Net interest and dividends increased 4.9% to $278.8 million in the 1999 period
from $265.9 million in the comparable 1998 period. The increase was primarily
attributable to increased levels of customer margin debt. The increase in net
interest profit was partially offset by generally higher funding costs incurred
by the Company as debt maturities were extended into the Year 2000. Customer
margin debt at November 26, 1999 approximated $48.4 billion compared to $39.1
billion at November 27, 1998. Average customer margin debt increased to $51.4
billion in the 1999 period from $40.2 billion in the comparable 1998 period.
Average customer shorts decreased to $57.6 billion in the 1999 period from $62.9
billion in the comparable 1998 period. Average free credit balances increased to
$13.3 billion in the 1999 period from $10.8 billion in the comparable 1998
period.
Employee compensation and benefits increased 32.9% to $974.0 million in the 1999
period from $732.9 million in the comparable 1998 period. The increase in
employee compensation and benefits was primarily attributable to an increase in
incentive and discretionary bonus accruals related to increased net revenues and
earnings in the 1999 period as well as an increase in headcount. Employee
compensation and benefits, as a percentage of net revenues, decreased to 50.2%
in the 1999 period from 55.3% in the comparable 1998 period primarily due to
improved five-month net revenue performance.
All other expenses increased 27.2% to $510.9 million in the 1999 period from
$401.7 million in the comparable 1998 period. CAP Plan expense increased by
$31.8 million in the 1999 period from the comparable 1998 period, reflecting
higher pre-tax earnings. Data processing, communications and depreciation
increased $36.5 million or 27.7% as a result of both increased usage and the
upgrading of existing communication and computer systems. EDP professional fees
increased by $11.8 million in the 1999 period due to various technology
initiatives, including the Year 2000 issue, which accounted for $5.0 million of
the increase in the 1999 period.
The Company's effective tax rate increased to 37.0% in the 1999 period compared
to 31.3% in the comparable 1998 period due to higher levels of earnings and a
lower level of tax preference items in the 1999 period.
Business Segments
The Company is primarily engaged in business as a securities broker and dealer
operating in three principal segments: Capital Markets, Execution Services and
Wealth Management. These segments are strategic business units analyzed
separately due to the distinct nature of the products they provide and the
clients they serve. Certain Capital Markets products are distributed by the
Wealth Management and Execution Services distribution network with the related
revenues of such intersegment services allocated to the respective segments
through transfer pricing.
The following segment operating results exclude certain corporate items. See
Note 8, footnote (a), of Notes to Consolidated Financial Statements.
Five-Months Ended November 26, 1999
Compared to Five-Months Ended November 27, 1998
- -------------------------------------------------------------
Capital Markets
- --------------------------------------------------------------------------------
Five-Months Ended Five-Months Ended
In thousands November 26, 1999 November 27, 1998
- --------------------------------------------------------------------------------
Net revenues $ 1,017,482 $ 519,661
Pre-tax income (loss) 322,155 (49,539)
- --------------------------------------------------------------------------------
Net revenues for Capital Markets approximated $1.0 billion in the 1999 period,
up 95.8% from $519.7 million in the comparable 1998 period. Pre-tax income for
Capital Markets was $322.2 million in the 1999 period, up from a loss of $49.5
million in the comparable 1998 period. Fixed income results in the 1999 period
improved over the 1998 period due to improved results in the Company's high
yield, derivatives, mortgage-backed securities and corporate bonds operations.
Fixed income results in the 1998 period were adversely impacted as a result of
market volatility resulting from the dislocation in the emerging markets areas.
The default by Russia in its sovereign debt resulted in dramatic spread widening
across the various fixed income asset classes and dramatically reduced levels of
customer activity. Equity results improved in the 1999 period as active markets
and strong deal flow resulted in improved performances from equity derivatives,
risk arbitrage and block trading. Investment banking revenues increased sharply
in the 1999 period reflecting strong levels of equity underwriting activity, as
well as increases in merchant banking and mergers and acquisitions activities.
Investment banking revenues in the 1998 period were significantly lower than the
1999 period reflecting the weakness in the fixed income and equity markets
during the period which resulted in a substantial decline in new issue and
mergers and acquisitions activity.
Execution Services
- --------------------------------------------------------------------------------
Five-Months Ended Five-Months Ended
In thousands November 26, 1999 November 27, 1998
- --------------------------------------------------------------------------------
Net revenues $ 566,995 $ 499,857
Pre-tax income 210,704 203,635
- --------------------------------------------------------------------------------
At November 26, 1999, the Company provided clearing, margin lending and
securities borrowing to facilitate customer short sales to approximately 2,800
clearing clients worldwide. Such clients include approximately 2,400 prime
brokerage clients including hedge funds and clients of money managers, short
sellers, arbitrageurs and other professional investors and approximately 400
fully disclosed clients, who engage in either the retail or institutional
brokerage business. The Company processes trades in over 70 countries and
accounts for approximately 10% of the average daily NYSE volume, and processed
an average of in excess of 192,000 trades per day during the 1999 period versus
approximately 160,000 trades per day in the comparable 1998 period.
Net revenues for Execution Services approximated $567.0 million in the 1999
period, up 13.4% from $499.9 million in the comparable 1998 period. Pre-tax
income for Execution Services was $210.7 million in the 1999 period, up 3.5%
from $203.6 million in the comparable 1998 period. Results reflect improved
domestic and European sales volume which benefitted the Company's institutional
equity business. In addition, increased levels of customer margin debt and
transaction volumes benefitted the Company's clearance revenues. Partially
offsetting these revenue increases were increased data processing expenses
corresponding to systems development initiated in the clearance area.
Wealth Management
- --------------------------------------------------------------------------------
Five-Months Ended Five-Months Ended
In thousands November 26, 1999 November 27, 1998
- --------------------------------------------------------------------------------
Net revenues $ 269,028 $ 212,144
Pre-tax income 52,340 31,247
- --------------------------------------------------------------------------------
PCS provides high-net-worth individuals with an institutional level of service,
including access to the Company's resources and professionals. PCS maintains a
select team of approximately 500 account executives in seven regional offices.
PCS had approximately $41.0 billion in client assets at November 26, 1999, an
increase of 16.8% compared to November 27, 1998.
The Asset Management area, through Bear Stearns Asset Management Inc. ("BSAM"),
had approximately $13.0 billion in assets under management at November 26, 1999
which reflected a 29.4% increase over November 27, 1998. The largest components
of the increase were attributable to alternative investments and mutual funds.
Alternative investments include mortgage hedge funds which increased 454.6% from
the 1998 period, and equity hedge funds which increased 74.9% from the 1998
period, as well as real estate and venture capital investments. Asset Management
serves the diverse investment needs of corporations, municipal governments,
multi-employer plans, foundations, endowments, family groups and high-net-worth
individuals.
Net revenues for Wealth Management were $269.0 million in the 1999 period, up
26.8% from $212.1 million in the comparable 1998 period. Pre-tax income for
Wealth Management was $52.3 million in the 1999 period, up 67.5% from $31.2
million in the comparable 1998 period. Growth in assets under management, active
equity markets and strong customer volumes resulted in the increase in
management fees and commissions in the 1999 period. Strong performances by
certain of the Company's managed funds led to sharp increases in incentive-based
fees during the period.
Liquidity and Capital Resources
Financial Leverage
The Company maintains a highly liquid balance sheet with a majority of the
Company's assets consisting of marketable securities inventories, which are
marked-to-market daily, and collateralized receivables arising from
customer-related and proprietary securities transactions.
Collateralized receivables consist of resale agreements secured predominantly by
US government and agency securities, customer margin loans and securities
borrowed, which are typically secured by marketable corporate debt and equity
securities. The Company's total assets and financial leverage can fluctuate
significantly, depending largely upon economic and market conditions, volume of
activity, customer demand and underwriting commitments.
The Company's total assets at November 26, 1999 increased to $162.0 billion from
$153.9 billion at June 30, 1999. The increase is primarily attributable to an
increase in securities borrowed, securities purchased under agreements to resell
and receivables from customers.
The Company's ability to support increases in total assets is a function of its
ability to obtain short-term secured and unsecured funding and its access to
sources of long-term capital in the form of long-term borrowings and equity,
which together form its capital base. The Company continuously monitors the
adequacy of its capital base, which is a function of asset quality and
liquidity. Highly liquid assets, such as US government and agency securities,
typically are funded by the use of repurchase agreements, which require very low
levels of margin. In contrast, assets of lower quality or liquidity require
higher levels of margin or overcollateralization and consequently increased
levels of capital. Accordingly, the mix of assets being held by the Company
significantly influences the amount of leverage the Company can employ and the
adequacy of its capital base.
Funding Strategy
The Company's general funding strategy provides for the diversification of its
short-term funding sources in order to maximize liquidity. Sources of short-term
funding consist principally of collateralized borrowings, including repurchase
transactions and securities lending arrangements, customer free credit balances,
unsecured commercial paper, medium-term notes and bank borrowings generally
having maturities from overnight to one year.
Repurchase transactions, whereby the Company sells securities with an agreement
to repurchase at a future date, represent the dominant component of secured
short-term funding.
In addition to short-term funding sources, the Company utilizes long-term debt,
including medium-term notes, as a longer-term source of unsecured financing.
During the five- months ended November 26, 1999, the Company received proceeds
approximating $1.9 billion from the issuance of long-term debt which, net of
retirements, served to increase long-term debt to $15.9 billion at November 26,
1999 from $14.6 billion at June 30, 1999.
The Company maintains an alternative funding strategy focused on the liquidity
and self-funding ability of the underlying assets. The objective of the strategy
is to maintain sufficient sources of alternative funding to enable the Company
to fund debt obligations without issuing any new unsecured debt, including
commercial paper. The most significant source of alternative funding is the
Company's ability to hypothecate or pledge its unencumbered assets as collateral
for short-term funding.
As part of the Company's alternative funding strategy, the Company regularly
monitors and analyzes the size, composition, and liquidity characteristics of
the assets being financed and evaluates its liquidity needs in light of current
market conditions and available funding alternatives. Through this analysis, the
Company can continuously evaluate the adequacy of its equity base and the
schedule of maturing term-debt supporting its present asset levels. The Company
can then seek to adjust its maturity schedule, in light of market conditions and
funding alternatives.
The Company currently has in place a committed revolving-credit facility (the
"facility") totaling $3.225 billion, which permits borrowing on a secured basis
by Bear, Stearns & Co. Inc. ("Bear Stearns"), Bear, Stearns Securities Corp.
("BSSC") and certain affiliates. The facility also provides that the Company may
borrow up to $1.6125 billion of the facility on an unsecured basis. Secured
borrowings can be collateralized by both investment-grade and
non-investment-grade financial instruments. In addition, the facility provides
for defined margin levels on a wide range of eligible financial instruments that
may be pledged under the secured portion of the facility. The facility
terminates in October 2000 with all loans outstanding at that date payable no
later than October 2001.
Capital Resources
The Company conducts a substantial portion of all of its operating activities
within its regulated subsidiaries Bear Stearns, BSSC, Bear, Stearns
International Limited ("BSIL"), Bear Stearns International Trading Limited
("BSIT") and Bear Stearns Bank plc ("BSB"). In connection therewith, a
substantial portion of the Company's long-term borrowings and equity have been
used to fund investments in, and advances to, these regulated subsidiaries. The
Company regularly monitors the nature and significance of assets or activities
conducted outside the regulated subsidiaries and attempts to fund such assets
with either capital or borrowings having maturities consistent with the nature
and liquidity of the assets being financed.
During the five-months ended November 26, 1999, the Company repurchased a total
of 6,936,936 shares of Common Stock through open market transactions in
connection with the CAP Plan at a cost of approximately $272.0 million. The
Company intends, subject to market conditions, to continue to purchase, in
future periods, a sufficient number of shares of Common Stock in the open market
to enable the Company to issue shares with respect to all compensation deferred
and any additional amounts allocated to participants under the CAP Plan.
On October 28, 1999, the stockholders of the Company approved the Company's
Stock Award Plan (the "Stock Award Plan"). The purpose of the Stock Award Plan
is to secure for the Company and its stockholders the benefits of the additional
incentive, inherent in the ownership of the Company's stock, by selected key
employees of the Company who are important to the success and growth of the
business. See Note 9 of Notes to Consolidated Financial Statements.
Separately, on January 18, 2000, the Board of Directors of the Company approved
an amendment to the Stock Repurchase Program (the "Repurchase Program") to allow
the Company to purchase up to an additional $500 million of Common Stock. The
Repurchase Program will be utilized primarily to acquire shares of Common Stock
in order to mitigate the dilutive effect of the Company's Stock Award Plan.
Purchases under the Repurchase Program may be made periodically in fiscal year
2000 or beyond either in the open market or through privately negotiated
transactions. During the five-months ended November 26, 1999, the Company
repurchased, under the previous repurchase program authorization, a total of
1,312,500 shares of Common Stock through open market transactions in connection
with the Stock Award Plan at a cost of approximately $45.6 million. Purchases of
Common Stock pursuant to the CAP Plan are not made pursuant to the Repurchase
Program and are not included in calculating the maximum aggregate number of
shares of Common Stock that the Company may purchase under the Repurchase
Program.
Cash Flows
Cash and cash equivalents decreased by $558.6 million during the five-months
ended November 26, 1999. Cash used in operating activities during the
five-months ended November 26, 1999 was $794.6 million, primarily due to
increases in securities borrowed, securities purchased under agreements to
resell and customer receivables. Financing activities provided cash of $246.3
million, primarily derived from proceeds from the issuance of long-term
borrowings, partially offset by payments for the retirement of short-term and
long-term borrowings, as well as purchases of treasury stock. Cash used in
investing activities of $10.3 million was primarily attributable to purchases of
property, equipment and leasehold improvements, offset by net proceeds from
sales of investment securities and other assets.
Regulated Subsidiaries
As registered broker-dealers, Bear Stearns and BSSC are subject to the net
capital requirements of the Securities Exchange Act of 1934, the NYSE, and the
Commodity Futures Trading Commission, which are designed to measure the general
financial soundness and liquidity of broker-dealers. BSIL and BSIT, London-based
broker-dealer subsidiaries, are subject to the regulatory capital requirements
of the Securities and Futures Authority, a self-regulatory organization
established pursuant to the United Kingdom Financial Services Act of 1986.
Additionally, BSB is subject to the regulatory capital requirements of the
Central Bank of Ireland. At November 26, 1999 Bear Stearns, BSSC, BSIL, BSIT,
and BSB were in compliance with their respective regulatory capital
requirements.
Merchant Banking and High Yield Securities
As part of the Company's merchant banking activities, it participates from time
to time in principal investments in leveraged acquisitions. As part of these
activities, the Company originates, structures and invests in merger,
acquisition, restructuring, and leveraged capital transactions, including
leveraged buyouts. The Company's principal investments in these transactions are
generally made in the form of equity investments, equity-related investments or
subordinated loans, and have not historically required significant levels of
capital investment. At November 26, 1999, the Company's aggregate investments in
leveraged transactions and its exposure related to any one transaction was not
material to the Company's consolidated financial position.
As part of the Company's fixed-income securities activities, the Company
participates in the trading and sale of high yield, non-investment-grade debt
securities, non-investment-grade mortgage loans, non-investment-grade commercial
loans and securities of companies that are the subject of pending bankruptcy
proceedings (collectively "high yield investments"). Non-investment-grade
mortgage loans are principally secured by residential properties and include
both non-performing loans and real estate owned. At November 26, 1999 the
Company held high yield instruments of $1.5 billion owned and $0.3 billion sold
short, as compared to $1.4 billion owned and $0.2 billion sold short as of June
30, 1999.
These investments generally involve greater risk than investment-grade debt
securities due to credit considerations, illiquidity of secondary trading
markets, and increased vulnerability to general economic conditions.
The level of the Company's high yield investment inventories, and the impact of
such activities upon the Company's results of operations, can fluctuate from
period to period as a result of customer demand and economic and market
considerations. The Company's Risk Committee monitors exposure to market and
credit risk with respect to high yield investment inventories and establishes
limits with respect to overall market exposure and concentrations of risk by
both individual issuer and industry group.
Year 2000 Issue
The Year 2000 issue was the result of legacy computer programs having been
written using two digits rather than four digits to define the applicable year
and therefore without consideration of the impact of the upcoming change in the
century. Such programs, unless corrected, may not have been able to accurately
process dates ending in the Year 2000 and thereafter.
Through November 26, 1999, the amounts incurred related to the assessment of,
and efforts in connection with, the Year 2000 and the development and execution
of a remediation plan have approximated $74.0 million of which approximately
$11.0 million in hardware and software has been capitalized. The total remaining
Year 2000 project cost as of November 26, 1999 is estimated at approximately
$4.0 million.
Nothing has come to the Company's attention which would cause it to believe that
its Year 2000 compliance effort was not successful. While the Company will
continue to monitor for Year 2000 related problems, to date no significant Year
2000 issues have been encountered.
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's principal business activities by their nature engender significant
market and credit risks. In addition, the Company is also subject to operating
risk and funding risk. Managing these risks is critical to the success and
stability of the Company. As a result, comprehensive risk management policies
and procedures have been established to identify, control and monitor each of
these major risks. Additionally, the Company's diverse portfolio of business
activities helps to reduce the impact that volatility in any particular market
may have on its net revenues.
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument as a result of
fluctuations in interest and currency exchange rates, equity and futures prices,
changes in the implied volatility of interest rate, foreign exchange rate,
equity and futures prices and also changes in the credit ratings of either the
issuer or its related country of origin. Market risk is inherent to both
derivative and non-derivative financial instruments, and accordingly, the scope
of the Company's market risk management procedures includes all market
risk-sensitive financial instruments. The Company's exposure to market risk is
directly related to its role as a financial intermediary in customer-related
transactions and to its proprietary trading and arbitrage activities. For a
discussion of the Company's primary market risk exposures, which include
interest rate risk, foreign exchange rate risk, and equity price risk, and a
discussion of how those exposures are managed, see the Company's Annual Report
on Form 10-K for the fiscal year ended June 30, 1999.
Value at Risk
The estimation of potential losses that could arise from changes in market
conditions is typically accomplished through the use of statistical models,
which seek to predict risk of loss based on historical price and volatility
patterns. The output of such statistical models is commonly referred to as value
at risk. Value at risk is used to describe a probabilistic approach to measuring
the exposure to market risk. This approach utilizes statistical concepts to
estimate the probability of the value of a financial instrument rising above or
falling below a specified amount. The calculation utilizes the standard
deviation of historical changes in value (i.e., volatility) of the market risk
sensitive financial instruments to estimate the amount of change in the current
value that could occur at a specified probability level.
Measuring market risk using statistical risk management models has been the main
focus of risk management efforts by many companies whose earnings are
significantly exposed to changes in the fair value of financial instruments.
The Company believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. While value at risk models are
relatively sophisticated, the quantitative risk information generated is limited
by the parameters established in creating the related models. The financial
instruments being evaluated, in some cases, have features which may trigger a
potential loss in excess of the amounts previously disclosed if the changes in
market rates or prices exceed the confidence level of the model used. Therefore,
such models do not substitute for the experience or judgment of senior
management and traders, who have extensive knowledge of the markets and adjust
positions and revise strategies, as they deem necessary. The Company uses these
models only as a supplement to other risk management tools.
For purposes of Securities and Exchange Commission disclosure requirements, the
Company has performed an entity-wide value at risk analysis of virtually all of
the Company's financial assets and liabilities, including all reported financial
instruments owned and sold, repurchase and resale agreements, and funding assets
and liabilities. The value at risk related to non-trading financial instruments
has been included in this analysis and not reported separately because the
amounts were not material. The calculation is based on a methodology, which uses
a one-day interval and a 95% confidence level. Interest rate and foreign
exchange rate risk use a "Monte Carlo" value at risk approach. Monte Carlo
simulation involves the generation of price movements in a portfolio using a
random number generator. The generation of random numbers is based on the
statistical properties of the securities in the portfolio. For interest rates,
each country's yield curve has five factors that describe possible curve
movements. These were generated from principal component analysis. In addition,
volatility and spread risk factors were used, where appropriate. Intercountry
correlations were also used. Equity price risk was measured using a combination
of historical and Monte Carlo value at risk approaches.
Equity derivatives were treated as correlated with various indexes, of which the
Company used approximately fifty. Parameter estimates, such as volatilities and
correlations, were based on daily tests through November 26, 1999. The total
value at risk presented below is less than the sum of the individual components
(i.e. Interest Rate Risk, Foreign Exchange Rate Risk, Equity Risk) due to the
benefit of diversification among the risks.
This table illustrates the value at risk for each component of market risk as
of:
November 26, June 30,
in millions 1999 1999
- ----------- --------- -------
MARKET RISK
Interest $ 11.9 $ 9.3
Currency 1.2 1.3
Equity 12.6 11.3
Diversification benefit (8.4) (7.2)
------- -------
Total $ 17.3 $ 14.7
======= =======
As previously discussed, the Company utilizes a wide variety of market risk
management methods, including: limits for each trading activity; marking all
positions to market on a daily basis; daily profit and loss statements; position
reports; aged inventory position reports; and independent verification of
inventory pricing. Additionally, management of each trading department reports
positions, profits and losses, and trading strategies to the Risk Committee on a
weekly basis. The Company believes that these procedures, which stress timely
communication between trading department management and senior management, are
the most important elements of the risk management process.
Part II- Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Statement Re Computation of Per Share Earnings
(12) Statement Re Computation of Ratio of Earnings to Fixed Charges
(27) Financial Data Schedule
(b) Reports on Form 8-K
During the five-month period, the Company filed the following Current
Reports on Form 8-K.
(i) A Current Report on Form 8-K dated and filed on July 21, 1999,
pertaining to the Company's results of operations for the three-months and
fiscal year ended June 30, 1999.
(ii) A Current Report on Form 8-K dated July 22, 1999 and filed on July 28,
1999, pertaining to an opinion of Cadwalader, Wickersham & Taft as to the
legality of Global Notes due 2001 and 2002 ("Global Notes") issued by the
Company and an opinion of Cadwalader, Wickersham & Taft as to certain
federal income tax consequences in connection with the offering of the
Global Notes.
(iii) A Current Report on Form 8-K dated August 5, 1999 and filed on August
6, 1999, pertaining to Bear, Stearns Securities Corp.'s settlement of an
administrative proceeding filed by the United States Securities and
Exchange Commission resolving allegations related to the firm's role as
clearing broker for A.R. Baron & Co.
(iv) A Current Report on Form 8-K dated August 9, 1999 and filed on August
11, 1999, pertaining to an opinion of Cadwalader, Wickersham & Taft as to
certain federal income tax consequences related to the Company's Medium
Term Note Program.
(v) A Current Report on Form 8-K dated October 13, 1999 and filed on
October 14, 1999, pertaining to the Company's results of operations for the
quarter ended September 24, 1999.
(vi) A Current Report on Form 8-K dated October 29, 1999 and filed on
November 3, 1999, announcing its declaration of quarterly cash dividends
and a 5% stock dividend on its outstanding shares of common stock.
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 thereunto duly authorized.
The Bear Stearns Companies Inc.
(Registrant)
Date: March 3, 2000 By: /s/ Marshall J Levinson
Marshall J Levinson
Controller
(Principal Accounting Officer)
THE BEAR STEARNS COMPANIES INC.
FORM 10-Q
Exhibit Index
Exhibit No. Description Page
(11) Statement Re Computation of Per Share Earnings 34
(12) Statement Re Computation of Earnings to Fixed Charges 35
(27) Financial Data Schedule 36