SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 25, 1998
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____________ to ______________
Commission File Number 1-8989
The Bear Stearns Companies Inc.
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(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 November 5, 1998, the latest practicable date, there were 112,582,906
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 September 25,
1998 (Unaudited)and June 30, 1998
Consolidated Statements of Income (Unaudited) for the three-
month periods ended September 25, 1998 and September 26, 1997
Consolidated Statements of Cash Flows (Unaudited) for the
three-month periods ended September 25, 1998 and September 26,
1997
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 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
Signatures
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Assets
September 25, June 30,
1998 1998
------------- ------------
(Unaudited)
(In thousands)
Cash and cash equivalents $ 847,410 $ 1,073,821
Cash and securities deposited with
clearing organizations or
segregated in compliance with
federal regulations 7,382,208 2,282,729
Securities purchased under agreements
to resell 36,498,918 29,846,716
Receivable for securities provided as
collateral 3,790,308 2,041,546
Securities borrowed 50,699,542 56,844,009
Receivables:
Customers 10,932,654 14,228,678
Brokers, dealers and others 1,082,104 1,337,146
Interest and dividends 373,101 467,456
Financial instruments owned, at
fair value 49,688,152 44,619,672
Property, equipment and leasehold
improvements, net of accumulated
depreciation and amortization 457,280 448,044
Other assets 1,322,741 1,306,078
------------- ---------------
Total Assets $163,074,418 $ 154,495,895
============= ===============
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Liabilities and Stockholders' Equity
September 25, June 30,
1998 1998
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(Unaudited)
(In thousands, except share data)
Short-term borrowings $ 14,425,882 $ 14,613,565
Securities sold under agreements
to repurchase 51,984,953 45,346,472
Obligation to return securities received as
collateral 4,599,989 5,257,279
Payables:
Customers 44,629,807 42,119,042
Brokers, dealers and others 3,905,210 5,055,988
Interest and dividends 670,430 636,021
Financial instruments sold, but not
yet purchased, at fair value 22,607,976 21,070,596
Accrued employee compensation and benefits 347,934 1,217,337
Other liabilities and accrued expenses 1,497,436 1,242,110
------------- ---------------
144,669,617 136,558,410
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Commitments and contingencies
Long-term borrowings 13,732,169 13,295,952
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Guaranteed Preferred Beneficial Interests in Company
Subordinated Debt Securities 200,000 200,000
Preferred stock issued by subsidiary 150,000 150,000
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Stockholders' Equity
Preferred Stock 800,000 800,000
Common Stock, $1.00 par value;
200,000,000 shares authorized;
167,784,941 shares issued 167,785 167,785
Paid-in capital 1,965,728 1,963,788
Retained earnings 1,627,401 1,590,574
Capital Accumulation Plan 987,212 833,427
Treasury stock, at cost
Adjustable Rate Cumulative Preferred
Stock, Series A - 2,520,750 shares (103,421) (103,421)
Common Stock - 54,529,441 shares
and 50,191,531 shares at September 25,
1998 and June 30, 1998, respectively (1,114,959) (953,506)
Note receivable from ESOP Trust (7,114) (7,114)
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Total Stockholders' Equity 4,322,632 4,291,533
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Total Liabilities and Stockholders' Equity $163,074,418 $154,495,895
============= ===============
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three-Months Ended
------------------------------
September 25, September 26,
1998 1997
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(In thousands, except share data)
Revenues
Commissions $ 240,800 $ 213,444
Principal transactions 197,049 391,514
Investment banking 121,776 219,328
Interest and dividends 1,147,839 964,571
Other income 16,140 24,148
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Total Revenues 1,723,604 1,813,005
Interest expense 982,703 816,915
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Revenues, net of interest expense 740,901 996,090
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Non-interest expenses
Employee compensation and benefits 405,881 499,197
Floor brokerage, exchange
and clearance fees 42,064 39,585
Communications 33,095 28,133
Depreciation and amortization 32,394 26,017
Occupancy 25,888 23,546
Advertising and market development 23,038 15,954
Data processing and equipment 10,985 12,234
Other expenses 74,247 84,286
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Total non-interest expenses 647,592 728,952
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Income before provision for
income taxes 93,309 267,138
Provision for income taxes 29,206 105,520
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Net income $ 64,103 $ 161,618
============= ===============
Net income applicable to
common shares $ 54,008 $ 155,693
============= ===============
Earnings per share $ 0.40 $ 1.11
============= ===============
Weighted average common and
common equivalent shares
outstanding 152,084,654 152,011,423
============= ===============
Cash dividends declared
per common share $ 0.15 $ 0.15
============= ===============
See Notes to Consolidated Financial Statements.
THE BEAR STEARNS COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three-Months Ended
------------------------------
September 27, September 26,
1998 1997
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(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 64,103 $ 161,618
Adjustments to reconcile net income to cash used in operating activities:
Depreciation and amortization 32,394 26,017
Deferred income taxes 1,937 (29,652)
Other 21,927 25,735
(Increases) decreases in operating assets:
Cash and securities deposited with clearing
organizations segregated in compliance with
federal regulations (5,099,479) (328,784)
Securities purchased under agreements to resell (6,652,202) (6,532,146)
Securities borrowed 6,144,467 (2,716,878)
Receivables:
Customers 3,296,024 (1,153,590)
Brokers, dealers and others 255,042 248,607
Financial instruments owned (7,474,532) (9,231,322)
Other assets 57,553 80,395
Increases (decreases) in operating liabilities:
Securities sold under agreements to repurchase 6,638,481 9,796,228
Payables:
Customers 2,510,765 991,320
Brokers, dealers and others (1,153,808) 383,910
Financial instruments sold, but not yet purchased 1,537,380 6,678,273
Accrued employee compensation and benefits (881,403) (419,396)
Other liabilities and accrued expenses 289,492 278,505
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Cash used in operating activities (411,859) (1,741,160)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from short-term borrowings (187,683) 252,016
Net proceeds from issuance of long-term borrowings 1,201,791 1,727,457
Capital Accumulation Plan 153,785 7,405
Tax benefit of Common Stock distributions 1,941 7,552
Payments for:
Retirement of Senior Notes (770,633) (349,808)
Treasury stock purchases (158,423) (5,201)
Cash dividends paid (27,034) (23,591)
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Cash provided by financing activities 213,744 1,615,830
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (41,630) (45,350)
Purchases of investment securities and other assets (14,422) (46,353)
Proceeds from sales of investment securities and other
assets 27,756 5,402
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Cash used in investing activities (28,296) (86,301)
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Net decrease in cash and cash equivalents (226,411) (211,631)
Cash and cash equivalents, beginning of period 1,073,821 1,249,132
--------------- ------------
Cash and cash equivalents, end of period $ 847,410 $ 1,037,501
=============== ============
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. 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.
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:
September 25, June 30,
In thousands 1998 1998
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Financial instruments owned:
US government and agency $ 8,493,301 $ 9,388,387
Other sovereign governments 3,678,892 2,955,515
Corporate equity and convertible debt 10,820,602 12,255,749
Corporate debt 3,812,234 4,938,541
Derivative financial instruments 4,095,236 3,545,236
Mortgages and other mortgage-backed securities 17,962,233 10,582,090
Other 825,654 954,154
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$ 49,688,152 $ 44,619,672
============ ============
Financial instruments sold, but not yet purchased:
US government and agency $ 7,190,360 $ 6,327,074
Other sovereign governments 5,087,566 3,107,789
Corporate equity 3,013,319 4,336,280
Corporate debt 1,460,746 1,398,025
Derivative financial instruments 5,854,762 5,835,491
Other 1,223 65,937
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$ 22,607,976 $ 21,070,596
============ ============
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. COMMITMENTS AND CONTINGENCIES
At September 25, 1998, the Company was contingently liable for unsecured
letters of credit of approximately $2.2 billion and letters of credit
secured by financial instruments of approximately $24.2 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 $0.5 billion at September 25, 1998.
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 suits cannot be ascertained at this time, it
is the opinion of management, after consultation with counsel, that the
resolution of such suits will not have a material adverse effect on the
results of operations or the financial condition of the Company.
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 September 25, 1998, Bear Stearns' net capital,
as defined, of $1.45 billion exceeded the minimum requirement by $1.40
billion.
Bear, Stearns International Limited ("BSIL") and certain other wholly owned,
London-based subsidiaries are subject to regulatory capital requirements of
the Securities and Futures Authority.
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 various employee benefit
plans including certain of the
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Company's deferred compensation arrangements, with appropriate adjustments
made to net income for expense accruals related thereto.
6. CASH FLOW INFORMATION
Cash payments for interest approximated interest expense for the
three-months ended September 25, 1998 and September 26, 1997. Income taxes
paid totaled $17.9 million and $85.5 million for the three-months ended
September 25, 1998 and September 26, 1997, 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, equity price and
commodity price risk. SFAS 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
instruments 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 utilized. 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)
The following table represents the notional/contract amounts of the
Company's outstanding derivative financial instruments as of September 25,
1998 and June 30, 1998:
September 25, June 30,
In billions 1998 1998
---------------------------------------------------------------------------
Interest Rate:
Swap agreements, including options, swaptions,
caps, collars, and floors $306.7 $277.5
Futures contracts 50.0 49.8
Options held 9.3 4.0
Options written 8.1 1.6
Foreign Exchange:
Futures contracts 25.8 20.8
Forward contracts 20.7 29.6
Options held 8.2 9.9
Options written 8.2 7.7
Mortgage-Backed Securities:
Forward Contracts 80.3 70.2
Equity:
Swap agreements 12.2 11.6
Futures contracts 1.2 1.1
Options held 8.9 5.3
Options written 7.1 4.6
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (continued)
The derivative instruments used in the Company's trading and dealer
activities are recorded at fair value on a daily basis 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
purposes as of September 25, 1998 and June 30, 1998 were as follows:
September 25, June 30,
1998 1998
In millions Assets Liabilities Assets Liabilities
Swap agreements $2,404 $2,391 $1,872 $2,100
Futures and forward
contracts 376 382 450 551
Options held 1,331 1,279
Options written 3,207 3,189
The average monthly fair values of the derivative financial instruments for
the three-months ended September 25, 1998 and the fiscal year ended June 30,
1998 were as follows:
September 25, June 30,
1998 1998
In millions Assets Liabilities Assets Liabilities
Swap agreements $2,088 $2,282 $1,154 $1,494
Futures and forward
contracts 390 470 318 329
Options held 1,238 2,207
Options written 3,071 3,709
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 in a gain position which are
recognized 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
give rise to
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
counterparty credit risk since they obligate the Company (not its counterparty)
to perform. The Company's net replacement cost of derivatives in a gain position
after consideration of collateral at September 25, 1998 and June 30, 1998 was
approximately $1.8 billion and $1.3 billion, respectively.
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.
In fact, the domestic and international securities markets have experienced
significant price and volume volatility during the September 1998 quarter
creating uncertainty in trading and investment banking activity in the
marketplace. Marketplace volatility has and may continue to have a negative
impact on a number of transactions and business activities in which the Company
is involved. Industry earnings are likely to be adversely affected during any
prolonged period of market instability. Moreover, the results of operations for
a particular interim period may not be indicative of results to be expected for
an entire fiscal year.
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, 1998.
Results of Operations
Three-Months Ended September 25, 1998 Compared to September 26, 1997
Net income in the September 1998 quarter was $64.1 million, a decrease of 60.3%
from the $161.6 million in the comparable prior year quarter. Revenues, net of
interest expense ("net revenues"), decreased 25.6% to $740.9 million from $996.1
million in the 1997 quarter. Earnings per share were $.40 for the 1998 quarter
versus $1.11 for the comparable 1997 quarter.
Commission revenues increased 12.8% in the 1998 quarter to $240.8 million from
$213.4 million in the comparable 1997 quarter. The Company benefited from a
34.6% increase in average daily NYSE volume and a 13.8% increase in average
daily NASDAQ volume in the 1998 quarter from the 1997 quarter. Commission
revenues derived from institutional equities and securities clearance increased,
partially offset by a decrease in commission revenues derived from private
client services.
Revenues from principal transactions decreased 49.7% in the 1998 quarter to
$197.0 million from $391.5 million in the comparable 1997 quarter, reflecting
the difficult market conditions experienced throughout the global markets during
the 1998 quarter. The Company's revenues from principal transactions during the
1998 quarter were negatively impacted both by the volatility experienced in the
equity and fixed income markets and by the widening of credit spreads. These
conditions led to declines of 66.1%, 20.8% and 39.7% in revenues derived from
fixed income, equity and foreign exchange & other derivative financial
instruments, respectively.
The Company's principal transaction revenues by reporting categories, including
derivatives, are as follows:
Three-Months Ended Three-Months Ended
September 25, 1998 September 26, 1997
------------------ ------------------
Fixed Income $ 72,554 $ 214,221
Equity 73,620 92,899
Foreign Exchange & Other
Derivative Financial Instruments 50,875 84,394
------ ------
$ 197,049 $ 391,514
========== =========
Investment banking revenues decreased 44.5% to $121.8 million in the 1998
quarter from $219.3 million in the comparable 1997 quarter. This decrease
reflects decreases in underwriting, primarily in the equity and high yield areas
as well as decreases in mergers and acquisitions and advisory fees. Investor and
issuer concerns arising from market conditions worldwide dampened the Company's
underwriting and financial advisory activities for the quarter, with transaction
volume at lower levels than in the 1997 quarter.
Net interest and dividends (revenues from interest and net dividends, less
interest expense) increased 11.8% to $165.1 million in the 1998 quarter from
$147.7 million in the comparable 1997 quarter. This increase was primarily
attributable to higher levels of margin debt and customer short activity.
Average margin debt increased to $44.6 billion in the 1998 quarter from $42.7
billion in the comparable 1997 quarter and average customer shorts increased to
$64.1 billion from $54.0 billion. Average free credit balances increased to
$13.1 billion in the 1998 quarter from $9.4 billion in the comparable
1997 quarter.
Employee compensation and benefits decreased 18.7% to $405.9 million in the 1998
quarter from $499.2 million in the comparable 1997 quarter. The decrease was
attributable to a decrease in discretionary bonuses related to decreased
revenues. Employee compensation and benefits, as a percentage of net revenues,
increased to 54.8% in the 1998 quarter from 50.1% in the comparable 1997
quarter.
Floor brokerage, exchange and clearance fees increased $2.5 million or 6.3% in
the 1998 quarter from the comparable 1997 quarter reflecting the increase in the
volume of securities transactions processed. Depreciation expense increased
reflecting computer equipment upgrades. The decrease in other operating expenses
was primarily related to a $12.0 million or 50.0% decrease in accruals for
expenses associated with the Capital Accumulation Plan for Senior Managing
Directors (the "CAP Plan"), offset by a $3.4 million or 27.0% increase in EDP
professional fees. EDP professional fees increased due to costs related to
various technology initiatives, including costs relating to the Year 2000 issue.
The Company's effective tax rate decreased to 31.3% in the 1998 quarter compared
to 39.5% in the comparable 1997 quarter due to a higher level of tax preference
items.
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 U.S.
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 September 25, 1998 increased to $163.1 billion
from $154.5 billion at June 30, 1998. The increase is primarily attributable to
an increase in securities purchased under agreements to resell, cash and
securities deposited with clearing organizations or segregated in compliance
with federal regulations and financial instruments owned, at fair value and,
partially offset by a decrease in securities borrowed and receivables from
customers.
The Company's ability to support fluctuations 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 U.S. government and agency securities,
typically are funded by the use of repurchase agreements and securities lending
arrangements, which require very low levels of margin. In contrast, assets of
lower quality or liquidity require higher levels of overcollateralization, or
margin, and consequently increased levels of capital, in order to obtain secured
financing. 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 securities are sold with a commitment for
repurchase by the Company at a future date, represent the dominant component of
secured short-term funding.
The Company continues to increase the utilization of its medium-term note
financing in order to extend maturities of its debt and achieve additional
diversification of its funding sources. In addition to short-term funding
sources, the Company utilizes long-term senior debt, including medium-term
notes, as a longer term source of unsecured financing. During the three months
ended September 25, 1998 the Company issued $1.2 billion in long-term debt
which, net of retirements, served to increase long-term debt to $13.7 billion at
September 25, 1998 from $13.3 billion at June 30, 1998.
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 maturing within one year 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.
In October 1998, the Company negotiated a new $2.875 billion credit facility
which permits borrowing on a secured basis by Bear Stearns, BSSC and certain
affiliates, as well as allowing borrowing up to $1.4375 billion of the total
facility on an unsecured basis. Secured borrowings can be collateralized by both
investment-grade and non-investment-grade financial instruments. In addition,
this agreement 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 1999 with all loans outstanding, at
this date, payable in October 2000.
Capital Resources
The Company conducts a substantial portion of all of its operating activities
within its regulated broker-dealer subsidiaries, Bear Stearns, BSSC, BSIL and
Bear, Stearns International Trading Limited ("BSIT"). 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, Bear Stearns, BSSC, BSIL and BSIT.
The Company regularly monitors the nature and significance of those assets or
activities conducted outside the broker-dealer subsidiaries and attempts to fund
such assets with either capital or borrowings having maturities consistent with
the nature and the liquidity of the assets being financed.
During the three-months ended September 25, 1998, the Company repurchased
4,000,100 million shares of Common Stock in connection with the CAP Plan at a
cost of approximately $162.1 million. Included in the shares purchased during
the quarter were 3,763,083 shares with a cost of $153.8 million which were
credited to participants' deferred compensation accounts with respect to
deferrals made during fiscal 1998. 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
in respect of all compensation deferred and any additional amounts allocated to
participants under the CAP Plan. Repurchases of Common Stock pursuant to the CAP
Plan are not made pursuant to the Company's Stock Repurchase Plan (the
"Repurchase Plan") authorized by the Board of Directors and are not included in
calculating the maximum aggregate number of shares of Common Stock that the
Company may repurchase under the Repurchase Plan. As of November 5, 1998 there
have been no purchases under the Repurchase Plan.
Cash Flows
Cash and cash equivalents decreased by $226.4 million during the three-months
ended September 25, 1998 to $847.4 million. Cash used in operating activities
during the three-months ended September 25, 1998 was $411.9 million, mainly
representing increases in financial instruments owned, securities purchased
under agreements to resell and cash and securities deposited with clearing
organizations or segregated in compliance with federal regulations, offset by an
increase in securities sold under agreements to repurchase, and decreases in
securities borrowed and customer receivables. Financing activities provided cash
of $213.7 million, primarily derived from the issuance of long-term borrowings
and partially offset by the retirement of senior notes.
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 New York
Stock Exchange, 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, Bear Stearns Bank Plc ("BSB")is
subject to the regulatory capital requirements of the Central Bank of Ireland.
At September 25, 1998 Bear Stearns, BSIL, BSIT and BSB were in compliance
with regulatory requirements.
Merchant Banking and Non-Investment-Grade Debt 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 or subordinated loans, and have
not required significant levels of capital investment. At September 25, 1998,
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 and the securities of companies
that are the subject of pending bankruptcy proceedings (collectively "high yield
securities"). Non-investment-grade mortgage loans are principally secured by
residential properties and include both non-performing loans and real estate
owned. At September 25, 1998 the Company held high yield instruments of $1.8
billion in assets and $.2 billion in liabilities, as compared to $1.8 billion
in assets and $.3 billion in liabilities as of June 30, 1998.
These investments generally involve greater risk than investment-grade debt
securities due to credit considerations, liquidity of secondary trading markets
and vulnerability to general economic conditions.
The level of the Company's high yield securities 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 demands and economic and market
considerations. Bear Stearns' Risk Committee monitors exposure to market and
credit risk with respect to high yield securities 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 is the result of legacy computer programs being 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 may not be able to accurately process dates ending in the
year 2000 and thereafter. The Company has determined that it needs to modify or
replace portions of its software and hardware so that its computer systems will
properly utilize dates beyond December 31, 1999.
Over three years ago, the Company established a task force to review and develop
an action plan to address the Year 2000 issue. The Company's action plan
addresses both information technology and non-information technology system
compliance issues. Since then, the ongoing assessment and monitoring phase has
continued and includes assessment of the degree of compliance of its significant
vendors, facility operators, custodial banks and fiduciary agents to determine
the extent to which the Company is vulnerable to those third parties' failure to
remediate their own year 2000 issues. The Company has contacted all significant
external vendors in an effort to confirm their readiness for the Year 2000 and
plans to test compatibility with such converted systems. The Company also
participates actively in industry-wide tests.
The Company has and will continue to utilize both internal and external
resources to reprogram, or replace, and test the software and hardware for Year
2000 modifications. To date, the amounts incurred and expensed related to the
assessment of, and efforts in connection with, the Year 2000 and the development
of a remediation plan have approximated $26.1 million. The Company's total
projected Year 2000 project cost, including the estimated costs and time
associated with the impact of third party Year 2000 issues, are based on
currently available information. The total remaining Year 2000 project
cost is estimated at approximately $33.9 million which will be funded through
operating cash flows and expensed as incurred.
The Company presently believes that the activities that it is undertaking in
Year 2000 project should satisfactorily resolve Year 2000 compliance exposures
within its own systems worldwide. The Company has substantially completed the
reprogramming and replacement phase of the project. Testing has commenced and
will proceed through calendar 1999. However, if such modifications and
conversions are not operationally effective on a timely basis, the Year 2000
issue could have a material impact on the operations of the Company.
Additionally, there can be no assurance that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
While the Company does not have a specific, formal contingency plan, the
Company's action plan is designed to safeguard the interests of the Company and
its customers. The Company believes that this action plan significantly reduces
the risk of a Year 2000 issue serious enough to cause a business disruption.
With regard to Year 2000 compliance of other external entities, the Company is
monitoring developments closely. Should it appear that a major utility, such as
a stock exchange, would not be ready, the Company will work with other firms in
the industry to plan an appropriate course of action.
The Euro Conversion
On January 1, 1999, eleven member countries of the European Union are scheduled
to establish fixed conversion rates between their national currencies and the
"euro," which will ultimately result in the replacement of the currencies of
these participating countries with the euro ( the "Euro Conversion"). Costs
associated with the Euro Conversion are being expensed by the Company during the
period in which they are incurred and are not currently anticipated to be
material. The Company presently believes that with remediation measures planned
to be completed in the fourth quarter of calendar 1998, any risks associated
with the Euro Conversion can be mitigated.
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------- -----------
The Company's principal business activities by their nature engender significant
market and credit risks. 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. In addition to market risk, the Company is also
subject to credit risk, operating risk and funding risk.
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 commodity
prices, changes in the implied volatility of interest rate, foreign exchange
rate, equity and commodity 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 extends beyond
derivatives to include 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 includes 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, 1998.
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 are 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 recently
become 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 may 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 which describe possible curve
movements. These were generated from principal component analysis. In addition,
volatility and spread risk factors were used, where appropriate. Inter-country
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 forty. Parameter estimates, such as volatilities and correlations,
were based on daily tests through September 25, 1998. 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:
September 25, June 30,
in millions 1998 1998
- ----------- ----- -----
MARKET RISK
Interest $ 12.3 $ 11.1
Currency 2.2 0.9
Equity 10.3 8.9
Diversification benefit (8.6) (6.6)
----- ------
Total $ 16.2 $ 14.3
====== ======
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 1. Legal Proceedings
A.R. Baron & Company, Inc.
As previously reported in the Company's 1998 Form 10-K, Bear Stearns is a
defendant in litigation pending in the Supreme Court of the State of New York,
County of New York.
On October 8, 1998, plaintiff filed a notice of appeal in the Schwarz action.
In re Donna Karan International Inc. Securities Litigation
As previously reported in the Company's 1998 Form 10-K, Bear Stearns is a
defendant in litigation pending in the United States District Court for the
Southern District of New York.
On October 9, 1998, plaintiffs filed a notice of appeal.
County of Orange v. Bear, Stearns & Co. Inc. et al.
As previously reported in the Company's 1998 Form 10-K, Bear Stearns is a
defendant in litigation pending in the United States District Court for the
Central District of California.
This action has been settled, subject to court approval, without any admission
of wrongdoing by Bear Stearns.
In re Granite Partners, L.P., Granite Corportation and Quartz Hedge Fund
As previously reported in the Company's 1998 Form 10-K, Bear Stearns is a
defendant in litigation pending in the United States District Court for the
Southern District of New York.
On September 24, 1998, Bear Stearns filed an answer to the complaint in the
Bambou Action denying liability and asserting affirmative defenses.
On October 16, 1998, the Litigation Advisory Board in the Granite Partners
Action filed a second amended complaint against the same individuals and
entities that were named as defendants in the first amended complaint. The
complaint alleges, among other things, that one or more of the defendants
induced and participated in breaches of fiduciary duty by Askin and ACM,
tortiously interfered with contracts between the Funds and ACM, breached their
contracts with and duty to the Funds through improper margin calls and
liquidations, violated the Sherman Act and the Donnelly Act in connection with
allegedly collusive liquidations, tortiously interfered with contracts between
the Funds and other dealers, committed common law fraud, negligent
misrepresentation and innocent
misrepresentation, and unjustly enriched themselves. The complaint seeks
compensatory and punitive damages in unspecified amounts (there is alleged to
have been approximately $400 million in equity invested in the Funds prior to
liquidation), rescission of the purchase price paid by the Funds for certain
securities, treble damages for the antitrust claims, and restitution of certain
profits and compensation earned by the defendants in connections with the Funds.
On October 22, 1998, ten purported investors in the Funds commenced an action in
the United States District Court for the Southern District of New York against
Askin, ACM and the Dealer Defendants. The action is captioned AIG Managed Market
Neutral Fund, et al. v. Askin Capital Management, L.P., et al. Plantiffs allege,
among other things, that the Dealer Defendants aided and abetted an alleged
fraud committed by the Askin Defendants and aided and abetted a breach of
fiduciary duty by ACM. Plaintiffs seek to recover their investment in the Funds
(alleged to have been approximately $39.5 million) and punitive damages in
excess of $1 billion from each Dealer Defendant.
Bear Stearns denies all allegations of wrongdoing asserted against it in this
litigation, intends to defend these claims vigorously, and believes that it has
substantial defenses to these claims.
Henryk de Kwiatkowski v. Bear Stears & Co., Inc., et al
As previously reported in the Company's 1998 Form 10-K, Bear Stearns is a
defendant in litigation pending in the United States District Court for the
Southern District of New York.
On October 22, 1998, a second amended complaint was filed against the same
individual and entities that were named as defendants in the first amended
complaint. As amended, the complaint alleges, among other things, claims for
breach of fiduciary duty and negligence and violations of Section 4(0) of the
Commodity Exchange Act. Plaintiff seeks to recover at least $300 million in
losses and at least $100 million in punitive damages.
NASDAQ Antitrust Litigation
As previously reported in the Company's 1998 Form 10-K, over 30 market-makers,
including Bear Stearns, are defendants in litigation pending in the United
States District Court for the Southern District of New York.
On August 6, 1998, the United States Court of Appeals for the Second Circuit
affirmed the district court order approving the settlement of the action brought
by the Antitrust Division of the United States Department of Justice.
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 quarter, the Company filed the following Current
Reports on Form 8-K.
(i) A Current Report on Form 8-K dated July 21, 1998,
pertaining to the Company's results of operations
for the three-months and fiscal year ended June
30, 1998.
(ii)A Current Report on Form 8-K dated August 26,
1998, pertaining to an opinion of Weil, Gotshal &
Manges LLP as to tax matters related to the
Company's Medium Term Note Program.
SIGNATURES
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: November 9, 1998 By: /s/ Marshall Levinson
---------------------
Marshall Levinson
Controller and Assistant Secretary
(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 28
(12) Statement Re Computation of Earnings to Fixed Charges 29
(27) Financial Data Schedule 30