EXHIBIT 13
THE BEAR STEARNS COMPANIES INC.
TEN-YEAR SUMMARY OF
SELECTED FINANCIAL DATA
Fiscal Year Fiscal Year Fiscal Year FiscalYear Fiscal Year
Ended Ended Ended Ended Ended
April 30, April 30, June 30, June 30, June 30,
In thousands, except share and employee data 1987 1988 1989 1990 1991
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OPERATING RESULTS
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Revenues $ 1,774,003 $ 1,893,678 $ 2,364,737 $ 2,386,053 $ 2,379,953
Interest expense 549,998 673,823 1,089,879 1,217,212 1,141,029
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Revenues, net of interest expense 1,224,005 1,219,855 1,274,858 1,168,841 1,238,924
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Non-interest expenses
Employee compensation and benefits 628,997 613,373 627,378 608,291 652,186
Other 265,883 405,227 360,097 368,018 357,237
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Total non-interest expenses 894,880 1,018,600 987,475 976,309 1,009,423
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Income before provision for income taxes 329,125 201,255 287,383 192,532 229,501
Provision for income taxes 152,652 58,371 114,979 73,164 86,636
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Net income $ 173,134(5) $ 142,884 $ 172,404 $ 119,368 $ 142,865
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Net income applicable to common shares $ 171,469(5) $ 131,972 $ 164,621 $ 114,877 $ 139,028
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FINANCIAL POSITION
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Total assets $ 25,247,152 $ 32,299,523 $ 36,410,438 $ 31,574,487 $ 39,284,913
Long-term borrowings $ 386,830 $ 385,854 $ 384,873 $ 383,890 $ 681,846
Stockholders' equity $ 938,221 $ 1,024,686 $ 1,065,699 $ 1,076,057 $ 1,096,023
Common shares outstanding(2) 159,985,443 159,702,557 156,850,830 151,420,279 138,803,199
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PER SHARE DATA
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Earnings per share(2), (3) $ 1.07 $ .83 $ 1.04 $ .75 $ .98
Cash dividends declared per common share $ .45 $ .49 $ .49 $ .56 $ .57
Book value per common share(2) $ 4.93 $ 5.53 $ 6.33 $ 6.73 $ 7.35
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OTHER DATA
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Return on average common equity 25.0% 16.2% 17.9% 11.5% 13.6%
Profit margin(4) 26.9% 16.5% 22.5% 16.5% 18.5%
Employees 5,715 6,063 5,994 5,732 5,612
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[TABLE RESTUBBED FROM ABOVE]
Fiscal Year Fiscal Year Fiscal Year FiscalYear Fiscal Year
Ended Ended Ended Ended Ended
June 30, June 30, June 30, June 30, June 30,
In thousands, except share and employee data 1992 1993 1994 1995 1996
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OPERATING RESULTS
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Revenues $ 2,678,933 $ 2,853,185 $ 3,440,638 $ 3,753,572 $ 4,963,863
Interest expense 834,859 710,086 1,023,866 1,678,515 1,981,171
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Revenues, net of interest expense 1,844,074 2,143,099 2,416,772 2,075,057 2,982,692
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Non-interest expenses
Employee compensation and benefits 909,916 1,037,099 1,227,061 1,080,487 1,469,448
Other 426,533 491,602 546,912 606,488 678,318
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Total non-interest expenses 1,336,449 1,528,701 1,773,973 1,686,975 2,147,766
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Income before provision for income taxes 507,625 614,398 642,799 388,082 834,926
Provision for income taxes 213,047 251,951 255,834 147,471 344,288
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Net income $ 294,578 $ 362,447 $ 386,965 $ 240,611 $ 490,638
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Net income applicable to common shares $ 291,350 $ 355,696 $ 362,592 $ 215,474 $ 466,145
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FINANCIAL POSITION
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Total assets $ 45,768,333 $ 57,439,505 $ 67,392,018 $ 74,597,160 $ 92,085,157
Long-term borrowings $ 1,040,396 $ 1,883,123 $ 3,408,096 $ 4,059,944 $ 6,043,614
Stockholders' equity $ 1,276,984 $ 1,776,530 $ 2,316,566(1) $ 2,502,461(1)$ 2,895,414(1)
Common shares outstanding(2) 142,390,426 142,241,455 142,103,257 144,253,301 144,071,156
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PER SHARE DATA
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Earnings per share(2), (3) $ 2.12 $ 2.59 $ 2.62 $ 1.62 $ 3.43
Cash dividends declared per common share $ .65 $ .60 $ .60 $ .60 $ .60
Book value per common share(2) $ 8.66 $ 10.84 $ 12.92 $ 14.01 $ 16.83
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OTHER DATA
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Return on average common equity 27.6% 28.8% 23.3% 13.5% 25.6%
Profit margin(4) 27.5% 28.7% 26.6% 18.7% 28.0%
Employees 5,873 6,306 7,321 7,481 7,749
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<FN>
(1) Includes $150,000 of Exchangeable Preferred Income Cumulative Shares, which
were issued by a subsidiary of the Company.
See Note 8 of Notes to Consolidated Financial Statements.
(2) Adjusted to reflect stock dividends.
(3) See Note 1 of Notes to Consolidated Financial Statements.
(4) Represents the ratio of income before provision for income taxes to
revenues, net of interest expense.
(5) Includes extraordinary item, net of income tax benefit, of $3,339.
</FN>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's principal business activities, investment banking, securities
trading, and brokerage, are, by their nature, highly competitive and subject to
various risks, particularly 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,
and the size and timing of transactions.
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BUSINESS ENVIRONMENT
The business environment during fiscal 1996 was generally characterized by
moderate economic growth and declining interest rates, which contributed to
strong domestic equity and fixed income markets, and robust underwriting and
merger and acquisition activity. Bond prices rose steadily for most of the year
with interest rates falling to their lowest levels in two years. The New York
Stock Exchange and the NASDAQ average daily trading volumes reached record
levels in fiscal 1996. Additionally, major stock indices, such as the Dow Jones
Industrial Average, the Standard & Poor's 500 Index, and the NASDAQ Composite,
climbed into new territory, each setting an impressive series of records. These
improved financial conditions led to increased investor activity and improved
commissions and trading revenues. Additionally, the favorable environment
created by rising stock prices and falling interest rates provided a strong
investment banking backdrop.
Financial market conditions during fiscal 1995 were driven by investor
concerns regarding the level and direction of inflation and interest rates.
During the first half of fiscal 1995 the Federal Reserve Board raised interest
rates on three occasions, which impaired investor confidence and resulted in
price volatility and declining trading volume in the fixed income markets. In
addition, in December 1994, the government of Mexico moved to devalue the peso,
which resulted in a significant disruption in the markets for Mexican and other
Latin American debt and equity instruments. As a result, commissions, trading,
and underwriting revenues derived from the Company's fixed income activities
declined, which placed downward pressure on the Company's results of operations
during this period.
The business environment improved dramatically in the latter half of fiscal
1995. As the Federal Reserve Board lowered interest rates, the Dow Jones
Industrial Average rose 300 points, and the yield on 30-year treasury bonds
dropped 150 basis points. These changes resulted in increased investor activity
causing a rise in commissions and trading revenues. While underwriting activity
generally continued to decline from prior year levels, there was a significant
increase in merger and acquisition activity during this period.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS
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RESULTS OF OPERATIONS
The Company reported net income of $490.6 million, or $3.43 per share, in fiscal
1996, which represented an increase of 103.9% from $240.6 million, or $1.62 per
share, in fiscal 1995. The Company reported net income of $387.0 million, or
$2.62 per share, in fiscal 1994.
Revenues, net of interest expense ("net revenues"), increased 43.7% to $3.0
billion in fiscal 1996 from $2.1 billion in fiscal 1995, reflecting increases in
all revenue categories. Net revenues in fiscal 1994 amounted to $2.4 billion.
Commission revenues in fiscal 1996 increased 25.5% to $686.5 million, from
$546.9 million in fiscal 1995. Commission revenues derived from retail and
institutional investors increased, reflecting higher levels of activity
throughout the period. Securities clearance revenues increased, reflecting
higher levels of activity and continued growth in the Company's client base.
Fiscal 1995 commission revenues improved 13.2% from $483.0 million in fiscal
1994, reflecting higher levels of activity and continued growth of the Company's
securities clearance client base.
Revenues from principal transactions in fiscal 1996 increased 47.1% to $1.2
billion, from $842.6 million in fiscal 1995, reflecting increases in revenues
from the Company's fixed income activities, particularly in the mortgage-backed
securities, US government, and bankruptcy/high yield areas. These increases
reflected a favorable interest rate environment and increased customer demand.
Increases were also noted in the Company's equity trading activities,
particularly in the convertible bonds and over-the-counter market-making areas.
Additionally, revenues from the Company's derivative activities increased, due
to expansion of the Company's derivative business. Fiscal 1995 principal
transactions revenues decreased 26.8% from $1.2 billion in fiscal 1994,
reflecting decreases in revenues from the Company's fixed income activities,
partially offset by increases in the Company's equity activities.
Investment banking revenues in fiscal 1996 increased 74.1% to $607.3
million, from $348.9 million in fiscal 1995. Underwriting revenues increased,
due to increases in volume most notably from investment- and
non-investment-grade debt, common equity, and municipal issuances. Merger and
acquisition fees also increased, reflecting both increased activity and growth
in the Company's market share. Fiscal 1995 investment banking revenues decreased
29.3% from $493.7 million in fiscal 1994, reflecting decreases in underwriting
revenues, due to lower new issue volume. The decrease in investment banking
revenues was partially offset by increases in merger and acquisition and
advisory fees.
Net interest and dividends (revenues from interest and net dividends less
interest expense) in fiscal 1996 increased 33.5% to $412.1 million, from $308.8
million in fiscal 1995, principally due to the large increase in customer margin
debt and growth in customer securities lending activities associated with the
Company's clearance business. Net interest and dividends in fiscal 1995
increased 18.3% from $261.1 million in fiscal 1994, reflecting higher levels of
interest-earning assets due to favorable equity market conditions and an
increase in the Company's securities clearance client base.
Employee compensation and benefits in fiscal 1996 increased 36.0% to $1.5
billion, from $1.1 billion in fiscal 1995. The increase was principally
attributable to increased incentive and discretionary bonuses associated with
the increase in net revenues and earnings in fiscal 1996. Employee compensation
and benefits, as a percentage of net revenues, decreased to 49.3% for fiscal
1996, from 52.1% in fiscal 1995. Employee compensation and benefits in fiscal
1995 decreased 11.9% from $1.2 billion in fiscal 1994, reflecting decreased
discretionary and incentive bonuses associated with the decrease in net revenues
and earnings in fiscal 1995.
Other non-interest expenses in fiscal 1996 increased 11.8% to $678.3
million, from $606.5 million in fiscal 1995. Floor brokerage, exchange, and
clearance fees increased 18.8% in fiscal 1996, reflecting the increase in the
volume of securities transactions processed during the fiscal year. The balance
of other non-interest expenses increased 10.3% in fiscal 1996, primarily
reflecting increases in depreciation and amortization, communications expenses,
and professional fees. Other non-interest expenses in fiscal 1995 increased
10.9% from $546.9 million in fiscal 1994, principally reflecting expansion of
the Company's business activities.
The increase in the Company's effective tax rate to 41.2% in fiscal 1996,
from 38.0% in fiscal 1995, was principally attributable to increases in state
and local taxes. The effective tax rate in fiscal 1995 decreased, from 39.8% in
fiscal 1994, due to proportionately higher levels of tax preference items and
lower levels of pre-tax earnings.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS
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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, and customer margin loans and securities borrowed, which
are typically secured by marketable corporate debt and equity securities. The
nature of the Company's business as a securities dealer requires it to carry
significant levels of securities inventories in order to meet its customer and
proprietary trading needs. Additionally, the Company's role as a financial
intermediary for customer activities which it conducts on a principal basis,
together with its customer-related activities attributable to its clearance
business, result in significant levels of customer-related balances, including
customer margin debt, securities lending, and repurchase activity. Accordingly,
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 June 30, 1996 had increased to $92.1 billion
from $74.6 billion at June 30, 1995. The increase is primarily attributable to
the growth in securities purchased under agreements to resell, financial
instruments owned, and securities borrowed. The Company funded this increase
with secured borrowings (principally repurchase agreements), unsecured
commercial paper and medium-term notes, and an increase in the Company's
capital, including long-term borrowings and stockholders' equity.
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. 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 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 continued to increase its utilization of medium-term note financing
during fiscal 1996 in order to extend maturities 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.
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. A key
factor in this analysis is determining margin levels for each asset category
that may be required by a lender in providing secured financing in accordance
with legal and regulatory guidelines and market practices. The next component of
the analysis is the determination of the estimated length of time that would be
required to convert the asset into cash, based upon the depth of the market in
which the asset is traded versus the size of the position, assuming conventional
settlement periods. For each class of assets, the Company categorizes the
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
margin requirement by maturity from overnight to in excess of one year. The
Company attempts to match the schedule of its liabilities with its prospective
funding needs in terms of timing and amount.
Through the use of 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, as necessary, in light of market conditions and funding alternatives.
As part of the Company's alternative funding strategy, the Company
maintains a committed revolving-credit facility (the "facility") totaling $2.0
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 provides that up to $1.0 billion of the total facility
may be borrowed by the Company 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. There were no borrowings outstanding under the
facility at June 30, 1996.
Capital Resources
The Company conducts a substantial portion of all of its operating activities
within its regulated broker-dealer subsidiaries Bear Stearns, BSSC, Bear,
Stearns International Limited ("BSIL"), and Bear Stearns International Trading
Limited ("BSIT"). In connection therewith, a substantial portion of the
Company's long-term borrowings and equity has 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
liquidity of the assets being financed.
During fiscal 1996 the Company expanded its long-term borrowing base to
$6.0 billion through the issuance of $2.7 billion of long-term debt, which along
with the growth in retained earnings, increased total capital to $8.9 billion.
The increases in the Company's long-term borrowings and equity capital base
reflect both the availability of long-term financing opportunities and the
growth in the Company's balance sheet and liquidity needs.
At June 30, 1996, the Company's long-term debt ratings were as follows:
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Moody's Investors Services A2
Standard & Poor's Rating Group A
IBCA Inc. A+
Thomson BankWatch AA-
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The Company's Capital Accumulation Plan for Senior Managing Directors (the
"CAP Plan") allows participants to defer portions of their annual compensation
and ultimately to receive shares of the Company's Common Stock in satisfaction
thereof. In connection with the CAP Plan, during the fiscal year ended June 30,
1996, the Company repurchased a total of 8,513,944 shares of Common Stock
through open market transactions at a cost of approximately $187.2 million.
During the year ended June 30, 1996, a total of 8,262,120 shares were credited
to the participants of the CAP Plan in consideration of the related compensation
deferrals and earnings thereon at a cost of approximately $181.7 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 in respect of all compensation deferred and
any additional amounts allocated to participants under the CAP Plan.
On July 30, 1996, the Company announced the adoption of a Stock Repurchase
Plan (the "Repurchase Plan"). The Repurchase Plan allows for the purchase of up
to $250.0 million of Common Stock from time to time, in the open market or
otherwise, at prices then prevailing. Purchases of shares under the Repurchase
Plan will be in addition to any shares regularly purchased under the CAP Plan.
As of August 26, 1996, there have been no purchases under the Repurchase Plan.
Cash Flows
Cash and cash equivalents decreased to $127.8 million at the end of fiscal 1996,
from $700.5 million at the end of fiscal 1995, a decrease of $572.7 million.
Fiscal 1995 year-end cash and cash equivalents increased $405.9 million from
$294.6 million at the end of fiscal 1994. Fiscal 1994 year-end cash
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
and cash equivalents decreased $23.3 million from $317.9 million at the end of
fiscal 1993. Cash provided from financing activities was primarily used to
support the growth in operating activities in each of the three fiscal years.
Cash used in operating activities in fiscal 1996 was $3.6 billion. The
usage was primarily attributable to increases in securities purchased under
agreements to resell of $5.6 billion, securities borrowed of $5.0 billion, and
financial instruments owned of $4.7 billion. This increase was partially offset
by increases in customer payables of $5.7 billion, and securities sold under
agreements to repurchase of $3.8 billion.
Cash used in operating activities in fiscal 1995 was $823.1 million. The
usage was primarily attributable to increases in financial instruments owned of
$7.1 billion and securities borrowed of $3.6 billion, partially offset by
increases in financial instruments sold, but not yet purchased of $2.9 billion
and in securities sold under agreements to repurchase of $2.7 billion, and
decreases in cash and securities deposited with clearing organizations or
segregated in compliance with Federal regulations of $1.7 billion and customer
receivables of $1.3 billion.
Cash used in operating activities in fiscal 1994 was $3.4 billion and was
primarily attributable to increases in securities borrowed of $4.4 billion,
customer receivables of $2.3 billion, and securities purchased under agreements
to resell of $3.5 billion. These were offset by an increase in customer payables
of $3.3 billion and securities sold under agreements to repurchase of $4.8
billion.
Cash provided by financing activities in each of the three fiscal years
ended June 30, 1996, 1995, and 1994 was primarily attributable to increased net
borrowings which were used to support the Company's growth over the same periods
while taking advantage of favorable long-term financing opportunities.
Investing activities in fiscal 1996 used $203.5 million primarily for
purchases of $134.3 million of investment securities and other assets, as well
as purchases of $88.9 million of property, equipment, and leasehold
improvements.
Investing activities in fiscal 1995 used $69.2 million of cash primarily
for purchases of $100.3 million of property, equipment, and leasehold
improvements, partially offset by proceeds of $32.3 million from the sale of
investment securities and other assets.
Investing activities in fiscal 1994 used $66.1 million in cash, primarily
for purchases of $80.9 million of property, equipment, and leasehold
improvements and $17.2 million of investment securities and other assets,
partially offset by proceeds of $31.9 million from the sale 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 and Exchange Commission, the New York
Stock Exchange, Inc., and the Commodity Futures Trading Commission, which are
designed to measure the general financial soundness and liquidity of
broker-dealers. Bear Stearns and BSSC have consistently operated in excess of
the minimum net capital requirements imposed by these agencies. 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. BSIL and BSIT have consistently operated in compliance with these
capital adequacy 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 or subordinated loans and have
not required significant levels of capital investment. At June 30, 1996 the
Company held direct equity investments in 13 leveraged transactions with an
aggregate carrying value of approximately $24.6 million. The Company did not
make any significant direct investments in leveraged acquisitions during fiscal
1996.
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 June 30, 1996 and 1995, the Company held in inventory approximately
$1.5 billion and $2.0 billion, respectively, of high yield securities. These
investments generally involve greater risk than investment-grade debt securities
due to credit
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
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
continuously 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.
Derivative Financial Instruments
Derivative financial instruments represent contractual commitments between
counterparties which derive their value from changes in the underlying interest
rate, currency exchange rate, index (e.g., S&P 500), reference rate (e.g.,
LIBOR), or asset value referenced in the related contract. Some derivatives,
such as futures contracts, certain options, and indexed referenced warrants can
be traded on an exchange. Other derivatives, such as interest rate and currency
swaps, caps, floors, collars, and swaptions, equity swaps and options,
structured notes, and forward contracts are negotiated in the over-the-counter
markets. Derivatives generate both on- and off-balance sheet considerations
depending on the nature of the contract.
The Company is engaged as a dealer in over-the-counter derivatives and,
accordingly, enters into transactions involving derivative instruments as part
of its customer-related and proprietary trading activities. The Company's dealer
activities require it to make markets and trade a variety of derivative
instruments. In connection with these activities, the Company attempts to
mitigate its exposure to market risk by entering into essentially offsetting
hedging transactions which may include over-the-counter derivative contracts or
the purchase or sale of interest-bearing securities, equity securities,
financial futures, and forward contracts. The Company also utilizes derivative
instruments in order to hedge proprietary market-making and trading activities.
In this regard, the utilization of derivative instruments is designed to reduce
or mitigate market risks associated with holding dealer inventories or in
connection with arbitrage-related trading activities. The Company also utilizes
interest rate and currency swaps to hedge its fixed-rate debt issuances as part
of its asset and liability management.
In connection with the Company's dealer activities, the Company formed Bear
Stearns Financial Products Inc. ("BSFP") and Bear Stearns Trading Risk
Management Inc. ("BSTRM"). BSFP and BSTRM were established to provide clients
with a AAA-rated counterparty offering a wide range of global fixed income and
equity derivative products. Additionally, the Company is able to provide either
a termination or continuation structure.
As of June 30, 1996 and 1995, respectively, the Company had
notional/contract amounts of $288.2 billion and $127.8 billion of derivative
financial instruments, of which $69.2 billion and $17.3 billion were listed
futures and option contracts. The aggregate notional/contract value of
derivative contracts is a reflection of the level of activity and does not
represent the amounts that are recorded in the Consolidated Statements of
Financial Condition. The Company's derivative financial instruments, which are
used to either hedge trading positions or are part of its derivative dealer
activities, are marked to fair value. Fair value on exchange-traded derivative
financial instruments is based upon quoted market values, while over-the-counter
derivative financial instruments are generally valued at mid-market, based upon
dealer price quotations and valuation pricing models. Valuation pricing models
consider time value and volatility factors underlying each of the financial
instruments, as well as other relevant economic factors such as market, credit,
and liquidity risk. The unrealized gains or losses are recorded in net income.
Unrealized gains and losses on derivative financial instruments used to
hedge the Company's long-term debt issuances are deferred, and related income
and expense is recorded on an accrual basis, together with the interest expense
incurred on the underlying debt instrument. The Company hedges its long-term
debt issuances principally by converting fixed-rate instruments to floating-rate
debt, generally based on LIBOR, using interest rate swaps. This strategy allows
the Company to manage interest rate exposure on its assets and liabilities, and
has enabled the Company to reduce its interest expense by $15.9 million, $21.1
million, and $54.4 million during fiscal years 1996, 1995, and 1994,
respectively.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS
Exposures to market risk arising from derivative financial instruments are
often similar to the market risks of cash securities. The Company actively
manages its market risk profile through the use of pricing and risk management
models. These techniques include projecting the effects of potential changes,
such as the level or volatility of interest and foreign exchange rates or equity
prices, on the Company's derivative portfolio, in order to measure market risk
sensitivity.
Credit risk from derivative financial instruments arises from the potential
failure of counterparties to perform in accordance with the terms of their
contracts. The Company's exposure to credit risk associated with counterparty
non-performance is measured by the current replacement cost of derivative
contracts in a gain position, net of any related collateral held. The Company
attempts to control its exposure to credit risk arising from derivatives by
adhering to an established credit approval process, including the establishment
of credit limits and the use of credit enhancement techniques. Such techniques
include requiring the posting of collateral to secure replacement cost exposures
or, in the event of a counterparty being downgraded, requiring the posting of
additional collateral or the termination of the contract. The Company also
attempts to obtain master netting agreements which provide protection in the
event of counterparty default by allowing for the net settlement of open
obligations. Credit exposures are monitored on a daily basis and are analyzed to
verify that current and potential credit exposures are within prescribed limits.
For further discussion of the Company's derivative activities and the associated
risks, see Note 11 to the Consolidated Financial Statements.
================================================================================
RISK MANAGEMENT
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. As a financial intermediary, the Company often
acts as principal in customer-related transactions in financial instruments,
which exposes the Company to the risk of market price movements. The Company
seeks to manage this risk by entering into hedging transactions designed to
offset the market risk the Company has taken for its customers.
The Company also engages in proprietary trading and arbitrage activities.
The Company makes dealer markets in investment-grade corporate debt and equity
securities, non-investment-grade corporate debt securities, US government and
agency securities, mortgages and mortgage-backed securities, and municipal
bonds. In connection therewith, the Company may be required to maintain
significant inventories in order to ensure availability and facilitate customer
order flow. The Company attempts to hedge its exposure to market risk with
respect to its dealer inventories by entering into essentially offsetting
transactions, including options, futures, and forward contracts, designed to
reduce or mitigate the Company's market risk profile. Additionally, the Company
marks to market its securities inventories daily, and regularly monitors the
aging of inventory positions.
The Company's arbitrage activities are designed to take advantage of market
price discrepancies between securities trading in different markets or between
related products or derivative securities. Arbitrage activities involve
maintaining offsetting positions in other financial instruments. In many
instances, the Company may be required to purchase or sell derivative financial
instruments as part of the arbitrage of a cash market security. These
transactions may involve forward-settling transactions such as forwards or
futures, where the objective may be to capture differences in the time value of
money, or option transactions, which seek to capture differences between the
expected and actual volatility of the underlying instrument.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS
In addition to those specific methods discussed above, the Company takes
other risk management measures. These measures include daily profit and loss
statements, position reports, and weekly meetings of Bear Stearns' Risk
Committee, composed of Senior Managing Directors of the various trading
departments and chaired by Alan C. Greenberg, Chairman of the Board of the
Company and of Bear Stearns. In addition, the Company's Risk Management
Department, together with departmental management principally consisting of
Senior Managing Directors who have day-to-day responsibility for management
oversight, review the age and composition of their departments' proprietary
accounts and the profits and losses of each portfolio on a daily basis. This is
to ensure that trading strategies are being adhered to within acceptable risk
parameters. Additionally, trading department management reports positions,
profits and losses, and trading strategies to the Risk Committee on a weekly
basis. The Company utilizes highly automated analytical systems in order to
monitor the Company's risk profile and enhance management oversight.
Bear Stearns' Credit Policy Committee and its subcommittee, the Global
Credit Committee, establish and review appropriate credit limits for
institutional customers. The Credit Policy Committee is primarily composed of
Senior Managing Directors who are generally management personnel not involved in
the operations of the departments seeking credit approval for customers. The
Credit Policy Committee is scheduled to meet weekly and establishes policies and
guidelines, which the Global Credit Committee enforces by setting credit limits
and by monitoring exposure for customers seeking repurchase and resale agreement
facilities, derivative financial instruments, and other forms of secured and
unsecured credit, including derivative contracts.
================================================================================
EFFECTS OF INFLATION
Since the Company's assets are primarily recorded at their current market value,
they are not significantly affected by inflation. However, the rate of inflation
affects the Company's expenses, such as employee compensation, office leasing
costs, and communications charges, which may not be readily recoverable in the
price of services offered by the Company. To the extent that inflation causes
interest rates to rise and has other effects on the securities markets and on
the value of securities held in inventory, it may adversely affect the Company's
financial position and results of operations.
================================================================================
EFFECTS OF STATEMENTS
OF FINANCIAL ACCOUNTING
STANDARDS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, ("SFAS 125"). SFAS 125
introduces the financial-components approach which results in the recognition of
financial assets based upon control and the derecognition of financial assets
when control has been surrendered.
SFAS 125 requires that, in cases where the secured party has taken control,
debtors reclassify financial assets that are pledged as collateral and that
secured parties recognize those assets and their obligation to return them. If
the secured party is permitted to sell or repledge such collateral on reverse
repurchase agreements where the debtor does not have the right to redeem the
collateral on short notice, the secured party shall recognize the collateral as
its assets and also the obligation to return it. Based on this approach, SFAS
125 will affect the current accounting for reverse repurchase and repurchase
agreements and securities lending transactions. This statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. The effect of the Company adopting SFAS 125
cannot be determined at this time.
34
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Income
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
In thousands, except share data June 30, 1996 June 30, 1995 June 30, 1994
- ------------------------------------------------------------------------------------------------------------------------------------
REVENUES
========
Commissions $ 686,548 $ 546,939 $ 482,988
Principal transactions 1,239,697 842,575 1,150,890
Investment banking 607,338 348,886 493,739
Interest and dividends 2,393,266 1,987,297 1,284,982
Other income 37,014 27,875 28,039
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 4,963,863 3,753,572 3,440,638
Interest expense 1,981,171 1,678,515 1,023,866
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 2,982,692 2,075,057 2,416,772
- ------------------------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSES
=====================
Employee compensation and benefits 1,469,448 1,080,487 1,227,061
Floor brokerage, exchange and clearance fees 129,509 109,040 98,592
Communications 92,827 85,711 75,406
Occupancy 85,899 83,247 76,317
Depreciation and amortization 69,878 59,274 47,984
Advertising and market development 56,797 57,036 52,693
Data processing and equipment 34,305 33,650 27,404
Other expenses 209,103 178,530 168,516
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,147,766 1,686,975 1,773,973
- ------------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 834,926 388,082 642,799
Provision for income taxes 344,288 147,471 255,834
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 490,638 $ 240,611 $ 386,965
====================================================================================================================================
Net income applicable to common shares $ 466,145 $ 215,474 $ 362,592
====================================================================================================================================
Earnings per share $ 3.43 $ 1.62 $ 2.62
====================================================================================================================================
Weighted average common and
common equivalent shares outstanding 141,766,713 140,719,983 141,176,539
====================================================================================================================================
See Notes to Consolidated Financial Statements.
35
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Financial Condition
In thousands, except share data June 30, 1996 June 30, 1995
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS
======
Cash and cash equivalents $ 127,847 $ 700,501
Cash and securities deposited with clearing organizations
or segregated in compliance with Federal regulations 1,702,124 1,309,573
Securities purchased under agreements to resell 24,517,275 18,940,744
Securities borrowed 29,611,207 24,632,088
Receivables:
Customers 7,976,373 5,993,772
Brokers, dealers, and others 811,391 578,676
Interest and dividends 305,725 227,069
Financial instruments owned, at fair value 26,222,134 21,509,498
Property, equipment, and leasehold improvements, net of accumulated depreciation
and amortization of $318,657 and $257,199 in 1996 and 1995, respectively 331,924 312,867
Other assets 479,157 392,372
- ---------------------------------------------------------------------------------------------------------------------------
Total Assets $ 92,085,157 $ 74,597,160
- ---------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
====================================
Short-term borrowings $ 9,867,619 $ 8,570,777
Securities sold under agreements to repurchase 33,353,899 29,584,724
Payables:
Customers 21,905,015 16,236,611
Brokers, dealers, and others 1,847,599 1,167,311
Interest and dividends 448,121 311,101
Financial instruments sold, but not yet purchased, at fair value 13,916,581 11,241,118
Accrued employee compensation and benefits 712,962 469,189
Other liabilities and accrued expenses 1,094,333 453,924
- ---------------------------------------------------------------------------------------------------------------------------
83,146,129 68,034,755
- ---------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Long-term borrowings 6,043,614 4,059,944
- ---------------------------------------------------------------------------------------------------------------------------
Preferred Stock issued by subsidiary 150,000 150,000
- ---------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
====================
Preferred Stock 437,500 437,500
Common Stock, $1.00 par value; 200,000,000 shares authorized;
159,803,764 shares and 152,202,724 shares issued in 1996 and 1995, respectively 159,804 152,203
Paid-in capital 1,696,217 1,557,237
Retained earnings 694,108 430,330
Capital Accumulation Plan 471,191 344,338
Treasury stock, at cost
Preferred Stock: 2,341,350 shares and 2,118,550 shares in 1996 and 1995, respectively (95,389) (85,507)
Common Stock: 41,664,729 shares and 34,866,529 shares in 1996 and 1995, respectively (598,217) (458,193)
Note receivable from ESOP trust (19,800) (25,447)
- ---------------------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 2,745,414 2,352,461
- ---------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 92,085,157 $ 74,597,160
===========================================================================================================================
See Notes to Consolidated Financial Statements.
36
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Cash Flows
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
In thousands June 30, 1996 June 30, 1995 June 30, 1994
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
====================================
Net income $ 490,638 $ 240,611 $ 386,965
Adjustments to reconcile net income to cash used in operating activities:
Depreciation and amortization 69,878 59,274 47,984
Deferred income taxes (189) (11,488) (63,381)
Other 61,474 28,351 (9,414)
(Increases) decreases in operating receivables:
Securities borrowed (4,979,119) (3,558,880) (4,351,804)
Brokers, dealers, and others (232,715) 401,776 35,616
Customers (1,982,601) 1,272,837 (2,312,205)
Other (74,530) (65,253) (85,730)
Increases (decreases) in operating payables:
Brokers, dealers, and others 675,016 330,678 (1,324,645)
Customers 5,668,404 (151,321) 3,349,552
Other 137,020 23,775 109,378
(Increases) decreases in:
Cash and securities deposited with clearing organizations or
segregated in compliance with Federal regulations (392,551) 1,680,375 (697,956)
Securities purchased under agreements to resell (5,576,531) 575,020 (3,477,107)
Financial instruments owned (4,712,636) (7,065,580) 795,307
Other assets 7,091 (20,605) 165,322
Increases (decreases) in:
Securities sold under agreements to repurchase 3,769,175 2,721,602 4,804,768
Financial instruments sold, but not yet purchased 2,675,463 2,889,860 (622,581)
Accrued employee compensation and benefits 207,023 (146,346) 108,491
Other liabilities and accrued expenses 636,188 (27,739) (227,934)
- -----------------------------------------------------------------------------------------------------------------------------
Cash used in operating activities (3,553,502) (823,053) (3,369,374)
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
====================================
Net proceeds from issuance of Cumulative Preferred Stock 96,689
Net proceeds from issuance of Preferred Stock by subsidiary 145,000
Net proceeds from short-term borrowings 1,296,842 710,466 1,741,417
Issuance of long-term borrowings 2,654,134 1,040,090 1,795,979
Capital Accumulation Plan 181,702 87,560 137,084
Common Stock distributions 6,497 18,088 3,733
Note repayment from ESOP trust 5,647 5,229 4,841
Payments for:
Retirement of Senior Notes (674,000) (400,300) (273,000)
Retirement of Subordinated Notes (1,000)
Treasury Stock purchases (191,474) (70,373) (147,763)
Cash dividends paid (95,001) (92,642) (90,769)
- -----------------------------------------------------------------------------------------------------------------------------
Cash provided by financing activities 3,184,347 1,298,118 3,412,211
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
====================================
Purchases of property, equipment, and leasehold improvements (88,935) (100,334) (80,855)
Purchases of investment securities and other assets (134,321) (1,172) (17,192)
Proceeds from sale of investment securities and other assets 19,757 32,338 31,928
- -----------------------------------------------------------------------------------------------------------------------------
Cash used in investing activities (203,499) (69,168) (66,119)
- -----------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (572,654) 405,897 (23,282)
Cash and cash equivalents, beginning of year 700,501 294,604 317,886
- -----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 127,847 $ 700,501 $ 294,604
=============================================================================================================================
Non-cash financing activities totaled $7,522, $2,250, and $1,947 for the
years ended June 30, 1996, 1995, and 1994, respectively.
See Notes to Consolidated Financial Statements.
37
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Changes in Stockholders' Equity
Treasury Stock
-------------------
Adjustable
Adjustable Rate
Rate Cumulative
Cumulative Cumulative Cumulative Preferred
Preferred Preferred Preferred Stock
Stock, Stock, Stock, Common Capital Series Common Note
Series A-$50 Series B-$200 Series C-$200 Stock Accumu- A-$50 Stock Receivable
In thousands, Liquidation Liquidation Liquidation $1 Par Paid-In Retained lation Liquidation $1 Par from ESOP
except share data Preference Preference Preference Value Capital Earnings Plan Preference Value Trust
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1993 $150,000 $187,500 $ $131,507 $1,225,557 $328,414 $138,331 $(85,507) $ (263,755)$(35,517)
Net income 386,965
Cash
dividends
declared:
Common
($ .60 per
share) (67,150)
Preferred (24,667)
Issuance of
Cumulative
Preferred
Stock,
Series C 100,000 (3,311)
Purchase of
treasury stock:
Common Stock
(7,477,587
shares) (149,710)
Common Stock
issued out
of treasury
(416,769
shares) 1,150 2,583
Income tax
benefits
attributable
to Common Stock
issued out of
treasury 2,251
5% stock
dividends
(13,457,916
shares) 13,458 221,419 (234,877)
Note repayment
from ESOP
trust 4,841
Allocations
under Capital
Accumulation
Plan 137,084
- --------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1994 150,000 187,500 100,000 144,965 1,447,066 388,685 275,415 (85,507) (410,882) (30,676)
- --------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
38
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Changes in Stockholders' Equity
Treasury Stock
-------------------
Adjustable
Adjustable Rate
Rate Cumulative
Cumulative Cumulative Cumulative Preferred
Preferred Preferred Preferred Stock
Stock, Stock, Stock, Common Capital Series Common Note
Series A-$50 Series B-$200 Series C-$200 Stock Accumu- A-$50 Stock Receivable
In thousands, Liquidation Liquidation Liquidation $1 Par Paid-In Retained lation Liquidation $1 Par from ESOP
except share data Preference Preference Preference Value Capital Earnings Plan Preference Value Trust
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1994 150,000 187,500 100,000 144,965 1,447,066 388,685 275,415 (85,507) (410,882) (30,676)
Net income 240,611
Cash
dividends
declared:
Common
($ .60 per
share) (67,475)
Preferred (25,137)
Purchase of
treasury stock:
Common Stock
(4,293,726
shares) (72,915)
Common Stock
issued out
of treasury
(2,561,732
shares) 6,475 (18,637) 25,604
Income tax
benefits
attributable
to Common Stock
issued out of
treasury 4,674
5% stock
dividend
(7,237,630
shares) 7,238 99,022 (106,354)
Note repayment
from ESOP
trust 5,229
Allocations
under Capital
Accumulation
Plan 87,560
- --------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1995 $150,000 $187,500 $100,000 $152,203 $1,557,237 $430,330 $344,338 $(85,507) $(458,193)$(25,447)
- --------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
38
THE 1996 FINANCIAL REPORT
THE BEAR STEARNS COMPANIES INC.
Consolidated Statements of Changes in Stockholders' Equity
Treasury Stock
-------------------
Adjustable
Adjustable Rate
Rate Cumulative
Cumulative Cumulative Cumulative Preferred
Preferred Preferred Preferred Stock
Stock, Stock, Stock, Common Capital Series Common Note
Series A-$50 Series B-$200 Series C-$200 Stock Accumu- A-$50 Stock Receivable
In thousands, Liquidation Liquidation Liquidation $1 Par Paid-In Retained lation Liquidation $1 Par from ESOP
except share data Preference Preference Preference Value Capital Earnings Plan Preference Value Trust
- -------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1995 $150,000 $187,500 $100,000 $152,203 $1,557,237 $430,330 $344,338 $(85,507) $(458,193)$(25,447)
Net income 490,638
Cash
dividends
declared:
Common
($ .60 per
share) (70,293)
Preferred (24,493)
Issuance of
Cumulative
Preferred
Stock,
Series B
Purchase of
treasury stock:
Adjustable
Rate Cumulative
Preferred
Stock,
Series A
(222,800
shares) (9,882)
Common Stock
(8,513,944
shares) (186,863)
Common Stock
issued out
of treasury
(3,289,549
shares) 9,213 (54,849) 46,839
Income tax
benefits
attributable
to Common Stock
issued out of
treasury 5,294
5% stock
dividend
(7,601,040
shares) 7,601 124,473 (132,074)
Note repayment
from ESOP
trust 5,647
Allocations
under Capital
Accumulation
Plan 181,702
- --------------------------------------------------------------------------------------------------------------------------------
Balance, June
30, 1996 $150,000 $187,500 $100,000 $159,804 $1,696,217 $694,108 $471,191 $(95,389) $(598,217)$(19,800)
================================================================================================================================
See Notes to Consolidated Financial Statements.
39
THE BEAR STEARNS COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
-1-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The 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 year amounts have
been reclassified to conform with the current year's presentation or restated
for the effects of stock dividends. 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 these estimates.
The Company, through its principal subsidiaries, Bear, Stearns & Co. Inc.
("Bear Stearns"), Bear, Stearns Securities Corp. ("BSSC") and Bear, Stearns
International Limited ("BSIL"), is primarily engaged in a single line of
business as a securities broker and dealer, which comprises several classes of
services, such as principal transactions, agency transactions, and underwriting
and investment banking.
Financial Instruments
Proprietary securities and commodities transactions, commission revenues, and
related expenses are recorded on a trade date basis. Financial instruments owned
and financial instruments sold, but not yet purchased, including contractual
commitments arising pursuant to futures, forward and option contracts, interest
rate swaps, and other derivative contracts are recorded at fair value with the
resulting net unrealized gains and losses reflected in net income.
Fair value is generally based on quoted market prices. If quoted market
prices are not available, or if liquidating the Company's position is reasonably
expected to impact market prices, fair value is determined based on other
relevant factors, including dealer price quotations, price activity for
equivalent instruments and valuation pricing models. Valuation pricing models
consider time value and volatility factors underlying financial instruments as
well as other relevant economic measurements.
Equity securities acquired as a result of leveraged acquisition
transactions are reflected in the financial statements at their initial cost
until significant transactions or developments indicate that a change in the
carrying value of the securities is appropriate. Generally the carrying values
of these securities will be increased only in those instances where market
values are readily ascertainable by reference to substantial transactions
occurring in the marketplace. Reductions in the carrying value of these
securities are made in the event that the Company's estimate of net realizable
value has declined below the carrying value.
Securities Transactions
Customer transactions are recorded on a settlement date basis, which is
generally three business days after trade date, while the related commission
revenues and expenses are recorded on a trade date basis.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Collateralized Securities Transactions
Transactions involving purchases of securities under agreements to resell
("reverse repurchase agreements") or sales of securities under agreements to
repurchase ("repurchase agreements") are treated as collateralized financing
transactions and are recorded at their contracted resale or repurchase amounts
plus accrued interest. It is the Company's policy to take possession of
securities with a market value in excess of the principal amount loaned plus
accrued interest, in order to collateralize reverse repurchase agreements.
Similarly, the Company is required to provide securities to counterparties in
order to collateralize repurchase agreements. The Company's agreements with
counterparties generally contain contractual provisions to allow for additional
collateral to be obtained, or excess collateral returned, when necessary. It is
the Company's policy to value collateral daily and to obtain additional
collateral or retrieve excess collateral from counterparties when deemed
appropriate.
Securities borrowed and securities loaned are recorded at the amount of
cash collateral advanced or received. Securities borrowed transactions require
the Company to deposit cash, letters of credit, or other collateral with the
lender. With respect to securities loaned, the Company receives collateral in
the form of cash or other financial instruments. The amount of collateral
required to be deposited for securities borrowed or received for securities
loaned is an amount generally in excess of the market value of the applicable
securities borrowed or loaned. The Company monitors the market value of
securities borrowed and loaned on a daily basis, with additional collateral
obtained or refunded as necessary.
Fixed Assets
Depreciation of property and equipment is provided by the Company on a
straight-line basis over the estimated useful life of the asset. Amortization of
leasehold improvements is provided on a straight-line basis over the lesser of
the respective estimated useful life of the asset or the remaining life of the
lease.
Translation of Foreign Currencies
Assets and liabilities denominated in foreign currencies are translated at
year-end rates of exchange, while income statement items are translated at
average rates of exchange for the year. Gains or losses resulting from foreign
currency transactions are included in net income.
Income Taxes
The Company and certain of its wholly owned subsidiaries file a consolidated
federal income tax return. The Company accounts for income taxes under the
provisions of Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" ("SFAS 109"). Under SFAS 109, deferred income taxes are
provided based upon the net tax effects of temporary differences between the
financial reporting and tax bases of assets and liabilities. In addition,
deferred income taxes are determined using the enacted tax rates and laws which
will be in effect when the related temporary differences are expected to be
reversed.
Earnings Per Share
Earnings per share is computed by dividing net income applicable to Common and
Common Equivalent Shares by the weighted average number of Common and Common
Equivalent Shares outstanding during each period presented. Common Equivalent
Shares include the assumed distribution of shares of Common Stock issuable under
certain of the Company's deferred compensation arrangements, with appropriate
adjustments made to net income for expense accruals related thereto.
Additionally, shares of Common Stock issued or issuable under various employee
benefit plans are included as Common Equivalent Shares.
Statement of Cash Flows
For purposes of the Consolidated Statements of Cash Flows, the Company has
defined cash equivalents as liquid investments not held for sale in the ordinary
course of business with original maturities of three months or less. Cash
payments for interest approximated interest expense for the years ended June 30,
1996, 1995, and 1994. Income taxes paid totaled $279.0 million, $125.6 million,
and $276.6 million for the fiscal years ended June 30, 1996, 1995, and 1994,
respectively.
================================================================================
-2-
FAIR VALUE OF
FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments," requires the Company to report the fair value
of financial instruments, as defined. Approximately 99.1% of the Company's
assets and 99.6% of the Company's liabilities are carried at fair value or
contracted amounts which approximate fair value.
Financial instruments owned and financial instruments sold, but not yet
purchased are carried at fair value. Assets
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
which are recorded at contracted amounts approximating fair value consist
largely of short-term secured receivables, and include reverse repurchase
agreements, securities borrowed, and certain other receivables. Similarly, the
Company's short-term liabilities pursuant to bank loans, commercial paper,
medium-term notes, repurchase agreements, securities loaned, and certain other
payables are recorded at contracted amounts approximating fair value. These
instruments generally have variable interest rates or short-term maturities, in
many cases overnight, and, accordingly, are not materially affected by changes
in interest rates.
The estimated market value of the Company's long-term borrowings, based
upon market rates of interest available to the Company at June 30, 1996 for debt
obligations of similar maturity, was approximately $6.0 billion, which is less
than the aggregate carrying value by approximately $27.8 million. However, the
Company enters into interest rate swaps and other transactions designed to
either convert its fixed rate debt into floating rates or otherwise hedge its
exposure to interest rate movements. Accordingly, unrecognized gains and losses
on interest rate swaps and other transactions hedging the Company's long-term
borrowings substantially offset the effect of changes in interest rates on the
fair value of the Company's long-term borrowings. For discussion of the
Company's financial instruments with off-balance sheet risk see Note 11.
================================================================================
-3-
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:
In thousands June 30, 1996 June 30, 1995
- --------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS OWNED:
US government and agency $ 8,258,074 $ 8,688,713
Other sovereign governments 656,699 1,256,859
State and municipal 149,697 100,224
Corporate equity and convertible debt 8,492,570 5,235,219
Corporate debt 4,739,512 2,723,564
Derivative financial instruments 1,855,617 1,223,258
Mortgages and other mortgage-backed securities 1,796,322 1,771,735
Other 273,643 509,926
- --------------------------------------------------------------------------------
$26,222,134 $21,509,498
- --------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS SOLD, BUT
NOT YET PURCHASED:
US government and agency $ 5,502,459 $ 6,111,612
Other sovereign governments 964,808 765,230
Corporate equity and convertible debt 4,482,426 2,424,455
Corporate debt 877,576 781,792
Derivative financial instruments 2,088,621 1,155,527
Other 691 2,502
- --------------------------------------------------------------------------------
$13,916,581 $11,241,118
================================================================================
Financial instruments sold, but not yet purchased represent obligations of the
Company to deliver the specified financial instrument at the contracted price,
and thereby create a liability to repurchase the financial instrument in the
market at prevailing prices. Accordingly, these transactions result in
off-balance sheet risk as the Company's ultimate obligation to satisfy the sale
of financial instruments sold, but not yet purchased may exceed the amount
recognized in the Consolidated Statements of Financial Condition.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
-4-
SHORT-TERM FINANCING
The Company's short-term financing is generally obtained on a secured basis
through the use of repurchase agreements and securities lending arrangements.
Additionally, the Company obtains short-term financing on an unsecured basis
through the issuance of commercial paper, medium-term notes, and bank loans.
Repurchase agreements are collateralized principally by US government and agency
securities. Securities lending arrangements are typically secured by corporate
equity and debt securities, utilizing both securities owned by the Company and
customers' securities. The interest rates on such short-term borrowings reflect
money market rates of interest at the time of the transactions.
At both June 30, 1996 and 1995, the Company had outstanding $33.4 billion
and $29.6 billion of repurchase agreements. During the years ended June 30, 1996
and 1995, the weighted average interest rates on the repurchase agreements were
5.41% and 5.30%, respectively. The weighted average rates at June 30, 1996 and
1995 were 5.15% and 6.10%, respectively.
Short-term borrowings at June 30, 1996 and 1995, included $651.1 million
and $731.2 million, respectively, of bank loans. During the years ended 1996 and
1995, the weighted average interest rates on such bank loans were 5.40% and
5.44%, respectively. The weighted average rates at June 30, 1996 and 1995 were
5.33% and 7.24%, respectively.
Borrowings made under the Company's commercial paper programs were $4.3
billion and $3.9 billion, respectively. During the years ended June 30, 1996 and
1995, the weighted average interest rates on such borrowings were 5.66% and
5.38%, respectively. The weighted average rates at June 30, 1996 and 1995 were
5.33% and 6.07%, respectively.
At June 30, 1996 and 1995, the Company had outstanding $4.9 billion and
$3.9 billion, respectively, principal amount of Medium-Term Notes maturing from
six to eighteen months from the date of issue. The Medium-Term Notes generally
bear interest at variable rates based upon the London Interbank Offered Rate
("LIBOR"). During the years ended June 30, 1996 and 1995, the weighted average
interest rates on the Medium-Term Notes were 5.85% and 5.64%, respectively. The
weighted average rates at June 30, 1996 and 1995 were 5.55% and 6.29%,
respectively.
================================================================================
-5-
LONG-TERM BORROWINGS
Long-term borrowings at June 30 consisted of the following:
In thousands 1996 1995
- --------------------------------------------------------------------------------
Floating-Rate Notes due 1995 to 2030 $ 924,129 $ 865,148
Fixed-Rate Senior Notes due 1996 to 2005;
interest rates ranging from 5 3/4% to 9 3/8% 2,568,696 1,946,232
Medium-Term Notes and Other 2,550,789 1,248,564
- --------------------------------------------------------------------------------
$6,043,614 $4,059,944
================================================================================
The Floating-Rate Notes are unsecured and bear interest at rates primarily
related to LIBOR. For those Floating-Rate Notes which are not based upon LIBOR,
the Company has entered into interest rate swaps and certain other transactions
in order to convert them into floating rates based upon LIBOR. During the years
ended June 30, 1996 and 1995, the weighted average effective interest rates on
the Floating-Rate Notes were 6.29% and
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6.00%, respectively. The weighted average effective interest rates on the
Floating-Rate Notes at June 30, 1996 and 1995 were 5.85% and 6.43%,
respectively.
The Company has entered into interest rate swaps and certain other
transactions in order to convert its Fixed-Rate Senior Notes into floating rates
based upon LIBOR. The weighted average effective interest rates on the Company's
Senior Notes during the years ended June 30, 1996 and 1995 were 6.45% and 6.30%,
respectively. The weighted average effective interest rates on the Company's
Senior Notes at June 30, 1996 and 1995 were 6.01% and 6.68%, respectively.
The Company's Medium-Term Notes have maturities ranging from 18 months to
30 years from the date of issue and bear interest at either a fixed-rate or a
variable-rate primarily based upon LIBOR. During the years ended June 30, 1996
and 1995, the weighted average interest rates on the Medium-Term Notes were
6.11% and 6.03%, respectively. The weighted average interest rates on the
Company's Medium-Term Notes at June 30, 1996 and 1995 were 5.81% and 6.46%,
respectively.
Maturities of long-term borrowings at June 30, 1996 consisted of the
following:
In thousands
-----------------------------------------------
FISCAL YEAR
1997 $ 955,892
1998 1,527,603
1999 515,036
2000 594,370
2001 1,203,904
Thereafter 1,246,809
-----------------------------------------------
$ 6,043,614
-----------------------------------------------
Instruments governing certain indebtedness of the Company contain various
covenants, the most significant of which require the maintenance of minimum
levels of stockholders' equity by the Company, Bear Stearns, and BSSC. At June
30, 1996, the Company, Bear Stearns, and BSSC were in compliance with all
covenants contained in these various debt agreements.
================================================================================
-6-
INCOME TAXES
The provision (benefit) for income taxes for the fiscal years ended June 30
consisted of:
In thousands 1996 1995 1994
- --------------------------------------------------------------------------------
Current:
Federal $ 212,686 $ 103,944 $ 206,010
State and local 108,652 40,681 83,746
Foreign 23,139 14,334 29,459
- --------------------------------------------------------------------------------
344,477 158,959 319,215
- --------------------------------------------------------------------------------
Deferred:
Federal 2,596 (8,322) (43,265)
State and local (2,785) (3,166) (20,116)
- --------------------------------------------------------------------------------
(189) (11,488) (63,381)
- --------------------------------------------------------------------------------
$ 344,288 $ 147,471 $ 255,834
================================================================================
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of the Company's deferred tax assets (liabilities) as of
June 30 were as follows:
In thousands 1996 1995 1994
- --------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation $ 214,484 $ 153,564 $ 121,463
Valuation reserves 77,047 38,154 41,089
Other 13,264 5,833 1,470
- --------------------------------------------------------------------------------
Total deferred tax assets $ 304,795 $ 197,551 $ 164,022
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Real estate partnership $ (82,314) $ (60,893) $ (51,348)
Unrealized appreciation (98,787) (4,864) (8,432)
Depreciation (19,026) (19,266) (7,985)
Accrued dividends (7,781) (4,343) (1,572)
Other (6,898) (18,385) (16,373)
- --------------------------------------------------------------------------------
Total deferred tax liabilities $(214,806) $(107,751) $ (85,710)
- --------------------------------------------------------------------------------
Net deferred tax asset $ 89,989 $ 89,800 $ 78,312
================================================================================
Undistributed earnings of foreign subsidiaries, which would be subject to
additional income taxes if repatriated, were not material as of June 30, 1996.
No deferred federal income taxes have been provided for these undistributed
earnings as the Company intends to permanently reinvest earnings of foreign
subsidiaries. In the event these undistributed earnings are repatriated, the
amount of potential federal income tax is not expected to be material.
A reconciliation of the statutory federal income tax rate and the Company's
effective tax rate is as follows:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
June 30, 1996 June 30, 1995 June 30, 1994
- --------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
State and local income taxes,
net of federal benefit 8.5 6.3 6.4
Dividend exclusion (1.9) (3.6) (1.1)
Other, net (0.4) 0.3 (0.5)
- --------------------------------------------------------------------------------
41.2% 38.0% 39.8%
================================================================================
This reconciliation table does not include approximately $5.3 million, $4.7
million, and $2.3 million of income tax benefits attributable to the
distribution of Common Stock under the Capital Accumulation Plan for Senior
Managing Directors, as amended (the "CAP Plan"), other deferred compensation
plans, and the exercise of stock options, credited directly to paid-in capital,
for fiscal 1996, 1995, and 1994, respectively.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
-7-
REGULATORY REQUIREMENTS
Bear Stearns and BSSC, a wholly owned subsidiary of Bear Stearns, are registered
broker-dealers and, accordingly, are subject to Securities and Exchange
Commission Rule 15c3-1 (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. Bear Stearns and BSSC have consistently operated
in excess of the minimum net capital requirements imposed by the capital rules.
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 June 30, 1996, Bear Stearns' net capital, as
defined, of $1.15 billion exceeded the minimum requirement by $1.12 billion.
BSIL and certain other wholly owned London-based subsidiaries 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. BSIL and the other subsidiaries have
consistently operated in excess of these requirements.
The regulatory rules referred to above, and certain covenants contained in
various instruments governing indebtedness of the Company, Bear Stearns, and
other regulated subsidiaries, may restrict the Company's ability to withdraw
capital from its regulated subsidiaries, which in turn could limit the Company's
ability to pay dividends. At June 30, 1996, approximately $1.7 billion of net
assets of consolidated subsidiaries were restricted as to the payment of cash
dividends and advances to the Company.
================================================================================
-8-
PREFERRED STOCK
Preferred Stock Issued
by The Bear Stearns Companies Inc.
The Company issued 3.0 million shares of Adjustable Rate Cumulative
Preferred Stock, Series A (the "Preferred Stock"). The Preferred Stock has a
liquidation preference of $50 per share and is entitled to dividends, on a
cumulative basis, at a rate equal to 135 basis points below the highest of the
Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Thirty Year
Constant Maturity Rate, as defined; however, the dividend rate for any dividend
period may not be less than 5.50% per annum, nor greater than 11.00% per annum.
The Company may redeem the Preferred Stock, either in whole or in part, at a
redemption price of $50 per share plus accumulated and unpaid dividends. The
weighted average dividend rate on the Preferred Stock was 5.65% during the year
ended June 30, 1996. During the year ended June 30, 1996 the Company repurchased
222,800 shares at a cost of approximately $9.9 million. At June 30, 1996 the
Company held 2,341,350 shares of Preferred Stock in treasury.
The Company has outstanding 7.5 million depositary shares representing
937,500 shares of Cumulative Preferred Stock, Series B ("Series B Preferred
Stock"), having an aggregate liquidation preference of $187.5 million. Each
depositary share represents a one-eighth interest in a share of Series B
Preferred Stock. Dividends on the Series B Preferred Stock are payable at an
annual rate of 7.88%. Series B Preferred Stock is redeemable at the option of
the Company at any time on or after April 15, 1998, in whole or in part, at a
redemption price of $200 per share (equivalent to $25 per depositary share),
plus accrued and unpaid dividends.
The Company has outstanding 4.0 million depositary shares representing
500,000 shares of Cumulative Preferred Stock, Series C ("Series C Preferred
Stock"), having an aggregate liquidation preference of $100.0 million. Each
depositary share represents a one-eighth interest in a share of Series C
Preferred Stock. Dividends on the Series C Preferred Stock are payable at an
annual rate of 7.60%. Series C Preferred Stock is redeemable at the option of
the Company at any time on or after July 15, 1998, in whole or in part, at a
redemption price of $200 per share (equivalent to $25 per depositary share),
plus accrued and unpaid dividends.
Preferred Stock Issued by Subsidiary
Bear Stearns Finance LLC ("BSF"), a wholly owned subsidiary of the Company, has
outstanding Exchangeable Preferred Income Cumulative Shares ("EPICS"), Series A,
which have a liquidation value of $25 per share, and an annual dividend rate of
8.00%. The EPICS are callable at the option of BSF, in whole or in part, at any
time, on or after February 28, 1999, at their stated liquidation value.
The proceeds of the EPICS issuance were loaned by BSF to the Company under
the terms of a 30-year subordinated loan agreement. This agreement allows the
Company to
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
extend the maturity of the loan through two 30-year renewal options. On any
given monthly dividend date, the Company has the right, subject to certain
conditions, to issue to BSF, in exchange for such note, depositary shares
evidencing Preferred Stock of the Company. In the event of such exchange, BSF is
required to redeem the EPICS, in their entirety, solely in exchange for such
depositary shares.
================================================================================
-9-
EMPLOYEE BENEFIT PLANS
The Company has a qualified noncontributory profit sharing plan covering
substantially all employees. Contributions are made at the discretion of
management in amounts that relate to the Company's level of income before
provision for income taxes. The Company's expense related to the profit sharing
plan for the years ended June 30, 1996, 1995, and 1994 was $11.1 million, $4.5
million, and $7.5 million, respectively.
The Company maintains a non-qualified defined contribution retirement plan
covering substantially all account executives. The plan provides for retirement
benefits to be paid based upon a percentage of each participant's compensation
and the performance of certain participant-selected investment options for
benefits accrued. The Company's expense for this plan for the years ended June
30, 1996, 1995, and 1994 was $7.2 million, $4.5 million, and $3.8 million,
respectively.
The Company maintains a $40 million leveraged employee stock ownership plan
(the "ESOP") covering substantially all full time employees. Pursuant to the
terms of a Brokerage and Loan Agreement, the Company advanced funds to the ESOP
trust to acquire shares of Common Stock in open market transactions. Advances
made under the ESOP Note (the "Note") bear interest at a rate of 8.00% per
annum. The Note is repayable in seven annual principal installments which
commenced December 31, 1992. The Note is expected to be repaid through a
combination of contributions by the Company and dividends on the shares of
Common Stock held by the ESOP trust. The note receivable from the ESOP trust is
reflected as a reduction in the Company's stockholders' equity. The Company's
expense related to the ESOP for the years ended June 30, 1996, 1995, and 1994
was $6.2 million, $6.0 million, and $6.2 million, respectively.
================================================================================
-10-
EMPLOYEE STOCK PLANS
Capital Accumulation Plan
The CAP Plan allows participants to defer a defined minimum percentage of their
total annual compensation. Participants' compensation generally must be deferred
for a minimum of five years from the date it was otherwise payable and is
credited to participants' deferred compensation accounts in the form of CAP
Units. The number of CAP Units credited is a function of the amount deferred by
each participant and the average per share cost of Common Stock acquired by the
Company in the open market on behalf of the CAP Plan. The aggregate number of
CAP Units that may be credited to participants in any fiscal year may not exceed
the number of shares of Common Stock acquired by the Company.
Each CAP Unit gives the participant an unsecured right to receive, on an
annual basis, an amount equal to the Company's pre-tax income or loss per share,
as defined by the CAP Plan, less the value of changes in the Company's book
value per Common Share during such fiscal year resulting from increases or
decreases in the Company's consolidated retained earnings (the "earnings
adjustment"). The earnings adjustment will be credited to each participant's
deferred compensation account in the form of additional CAP Units, subject to
the limitations discussed above, based on the number of CAP Units in such
account at the end of each fiscal year. Upon completion of the deferral period,
participants are entitled to receive shares of Common Stock equal to the number
of CAP Units then credited to their respective deferred compensation accounts.
During the years ended June 30, 1996, 1995, and 1994, participants deferred
compensation of approximately $139.7 million, $71.8 million, and $120.6 million,
respectively. During the years ended June 30, 1996, 1995, and 1994, the Company
recognized expense of approximately $36.7 million, $20.9 million, and $13.3
million, respectively, attributable to CAP Units or cash credited to
participants' deferred compensation accounts with respect to earnings
adjustments. During September 1995, 245,456 CAP Units were credited to
participants' deferred compensation accounts with respect to the deferrals made
during fiscal year 1995. As of July 1, 1996, pursuant to the terms of the CAP
Plan, 8,016,664 CAP Units were credited to participants' deferred compensation
accounts with respect to the deferrals made during fiscal year 1996. The
aggregate number of shares of
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Common Stock distributable pursuant to the Company's obligation for CAP Units at
June 30, 1996, 1995, and 1994 was approximately 25.9 million, 21.1 million, and
16.9 million, respectively. Compensation deferred pursuant to the CAP Plan and
allocated to participants' deferred compensation accounts in the form of CAP
Units is shown as a separate component of the Company's stockholders' equity.
Performance Unit Plan
Effective January 1, 1993, the Company established the Performance Unit Plan
(the "PUP Plan") and granted 7.3 million Performance Units to eligible
employees. Each Performance Unit gave the participant solely an unsecured right
to receive an amount in cash or stock equal to the Company's annual pre-tax
income or loss per share, as defined by the PUP Plan, net of an adjustment which
reflects changes in the Company's book value per common share (the "PUP earnings
adjustment"). Effective June 30, 1994, the PUP Plan was terminated. During the
year ended June 30, 1994, the Company incurred costs of $3.3 million
attributable to the PUP earnings adjustment. The number of Earnings Units
credited for the years ended June 30, 1994 was 180,299. In October 1994, 456,900
shares of Common Stock were distributed to the participants in satisfaction of
the Company's obligations thereunder.
Stock Option Plan
The Company has a stock option plan providing for the issuance of up to 10.9
million shares of Common Stock to certain key employees of the Company. On
August 17, 1989, the Company granted stock options for 2.4 million shares of
Common Stock with an exercise price of $9 5/8. As of June 30, 1994, there were
1,575,831 options outstanding. These options were all exercised during the
fiscal year ended June 30, 1995.
================================================================================
-11-
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, currency and
interest rate risk. 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 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 to 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 before or on 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.
The Company's principal transactions revenues, including derivatives, by
reporting categories are as follows:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
In thousands June 30, 1996 June 30, 1995 June 30, 1994
- --------------------------------------------------------------------------------
Fixed income $ 677,475 $ 473,704 $ 738,248
Equity 389,898 306,326 320,504
Foreign exchange & other
derivative financial
instruments 172,324 62,545 92,138
- --------------------------------------------------------------------------------
$1,239,697 $ 842,575 $1,150,890
================================================================================
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Market Risk
Derivative financial instruments involve varying degrees of off-balance-sheet
market risk whereby changes in the level or volatility of interest rates,
foreign currency exchange rates, or market values of the underlying financial
instruments or commodities may result in changes in the value of the financial
instrument, in excess of the amounts currently reflected in the Consolidated
Statements of Financial Condition. The Company's exposure to market risk is
influenced by a number of factors, including the relationships among financial
instruments with off-balance sheet risk, and between financial instruments with
off-balance sheet risk and the Company's proprietary securities and commodities
inventories, as well as the volatility and liquidity in the markets in which the
financial instruments are traded. In many cases, the use of financial
instruments serves to modify or offset market risk associated with other
transactions and, accordingly, serves to decrease the Company's overall exposure
to market risk. The Company attempts to control its exposure to market risk
arising from the use of these financial instruments through the use of hedging
strategies and various analytical monitoring techniques. 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, foreign
exchange forwards, and exercised options. 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 following table represents the notional/contract amounts of the Company's
outstanding derivative financial instruments at June 30, 1996 and 1995:
In billions June 30, 1996 June 30, 1995
- --------------------------------------------------------------------------------
Interest Rate:
Swap agreements, including options, swaptions,
caps, collars, and floors $ 175.2 $ 68.0
Futures contracts 60.5 15.4
Options held 3.0 .5
Options written 3.1
Foreign Exchange:
Futures contracts 2.3 .7
Forward contracts 7.9 4.7
Options held 3.2 2.1
Options written 3.3 1.8
Mortgage-Backed Securities:
Forward contracts 23.0 28.1
Equity:
Swap agreements 3.8 3.0
Futures contracts .5 .3
Options held 1.1 1.6
Options written 1.3 1.6
================================================================================
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value
The derivative instruments used in the Company's trading and dealer activities,
as described further in Note 1, are marked to market daily with the resulting
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 June 30, 1996 and 1995 were as follows:
June 30, 1996 June 30, 1995
- ---------------------------------------------------------------------------------------------------------------------------
In millions Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------
Swap agreements $678 $846 $587 $492
Futures and forward contracts 280 307 209 181
Options held 897 427
Options written 968 483
The average monthly fair values of the derivative financial instruments for the
fiscal years ended June 30, 1996 and 1995 were as follows:
June 30, 1996 June 30, 1995
- ---------------------------------------------------------------------------------------------------------------------------
In millions Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------
Swap agreements $611 $698 $598 $398
Futures and forward contracts 286 275 131 120
Options held 704 393
Options written 795 262
The majority of the Company's transactions with off-balance sheet risk are
short-term in duration with a weighted average maturity of approximately 2.22
years and 2.25 years at June 30, 1996 and 1995, respectively. The remaining
maturities for notional/contract amounts outstanding for derivative financial
instruments are as follows:
Less than 1 to 3 3 to 5 Greater than
In billions (except percentages) 1 Year Years Years 5 Years Total
- ---------------------------------------------------------------------------------------------------------------------------
Swap agreements $ 83.7 $41.0 $28.0 $26.3 $179.0
Futures contracts 50.2 10.5 2.6 63.3
Forward contracts 30.9 30.9
Options held 6.7 .6 7.3
Options written 6.9 .8 7.7
- ---------------------------------------------------------------------------------------------------------------------------
Total $178.4 $51.5 $30.6 $27.7 $288.2
Percent of total 61.9% 17.9% 10.6% 9.6% 100%
===========================================================================================================================
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit Risk
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. Options written generally do not 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 future
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. Additionally, the Company
attempts to obtain master netting agreements which provide protection in the
event of counterparty default by allowing for the net settlement of open
obligations.
The following table summarizes the credit quality of the Company's
trading-related derivatives by showing counterparty credit ratings for the
replacement cost (net of $414.8 million of collateral) of contracts in a gain
position at June 30, 1996:
In millions
---------------------------------------------------
RATING NET REPLACEMENT COST
AAA $ 48.0
AA 86.1
A 93.2
BBB 25.6
BB and lower 2.6
Non-rated 21.3
---------------------------------------------------
Customer Activities
The Company's clearance activities for customers and correspondents
("customers") involve the execution, settlement, and financing of various
customer securities and commodities transactions. Customer securities activities
are transacted on either a cash or margin basis and customer commodity
transactions are generally transacted on a margin basis subject to various
exchange regulations. In connection with these activities, the Company executes
and clears customer transactions involving the sale of securities not yet
purchased ("short sales") and the writing of option contracts. These
transactions may expose the Company to off-balance sheet risk in the event the
customer is unable to fulfill its contracted obligations and margin requirements
are not sufficient to fully cover losses which customers may incur. In the event
the customer fails to satisfy its obligations, the Company may be required to
purchase or sell financial instruments at prevailing market prices in order to
fulfill the customer's obligations.
The Company seeks to control the risks associated with its customer
activities by requiring customers to maintain margin collateral in compliance
with various regulatory and internal guidelines. The Company monitors required
margin levels daily and, pursuant to such guidelines, requires the customers to
deposit additional collateral, or reduce positions, when necessary. The Company
also establishes credit limits for customers engaged in commodity futures
activities that are monitored daily. With respect to the Company's correspondent
clearing activities, introducing correspondent brokers are required to guarantee
the performance of their customers in meeting contracted obligations.
The Company's customer-financing and securities-settlement activities may
require the Company to pledge customer securities as collateral in support of
various secured-financing sources such as bank loans, securities loaned, and
repurchase agreements and to satisfy margin deposits of various exchanges. In
the event the counterparty is unable to meet its contracted obligation to return
customer securities pledged as collateral, the Company may be exposed to the
risk of acquiring the securities at prevailing market prices in order to satisfy
its customer obligations. The Company controls this risk by monitoring the
market value of securities pledged on a daily basis and by requiring adjustments
of collateral levels, when deemed appropriate, in the event of excess market
exposure. Moreover, the Company establishes credit limits for such activities
and monitors compliance on a daily basis.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentrations of Credit Risk
As a securities broker and dealer, the Company is engaged in various securities
underwriting, brokerage, and trading activities. These services are provided to
a diverse group of domestic and foreign corporations, governments, and
institutional and individual investors. A substantial portion of the Company's
transactions are collateralized and are executed with, and on behalf of,
institutional investors including other brokers and dealers, commercial banks,
insurance companies, pension plans and mutual funds, and other financial
institutions. The Company's exposure to credit risk, associated with the
nonperformance of these customers in fulfilling their contractual obligations
pursuant to securities and commodities transactions, can be directly impacted by
volatile or illiquid trading markets which may impair the customers' ability to
satisfy their obligations to the Company. The Company attempts to minimize
credit risk associated with these activities by monitoring customer credit
exposure and collateral values on a daily basis and requiring additional
collateral to be deposited with or returned to the Company when deemed
appropriate. A significant portion of the Company's securities processing
activities includes clearing transactions for specialists, market-makers, risk
arbitrageurs, hedge funds, and other professional traders. Due to the nature of
their operations, which may include significant levels of margin lending and
involve short sales and option writing, the Company may have significant credit
exposure due to the potential inability of these customers to meet their
commitments. The Company seeks to control this risk by monitoring margin
collateral levels on a daily basis for compliance with both regulatory and
internal guidelines and, requesting additional collateral where necessary.
Additionally, in order to further control this risk, the Company has developed
computerized risk control systems which analyze the customer's sensitivity to
major market movements. When deemed necessary, the Company will require the
customer to deposit additional margin collateral, or to reduce positions, if it
is determined that the customer's activities may be subject to above-normal
market risks.
Non-Trading Derivatives Activity
In order to modify the interest rate characteristics of its long- and short-term
debt, the Company also engages in non-trading derivatives activities. The
Company has issued dollar and foreign currency-denominated debt with both
variable and fixed-rate interest payment obligations. The Company has entered
into interest rate swaps in order to convert fixed-rate interest payments on its
debt obligations into variable-rate payments, primarily based on LIBOR. Interest
payment obligations on variable-rate debt obligations may also be modified
through interest rate swaps which may change the underlying basis or reset
frequency. In addition, for foreign currency debt obligations which are not used
to fund assets in the same currency, the Company has entered into currency swap
agreements which effectively convert the debt into dollar obligations.
These financial instruments with off-balance-sheet risk are subject to the
same market and credit risks as those which are traded in connection with the
Company's market-making and trading activities. The Company has the same
controls in place to monitor these risks.
At June 30, 1996 and 1995, the Company had outstanding interest rate and
currency swap agreements with notional principal amounts of $6.0 billion and
$4.2 billion, respectively. The interest rate swap agreements entered into
reduced net interest expense on the Company's long-term and short-term debt
obligations by $15.9 million, $21.1 million, and $54.4 million for the fiscal
years ended June 30, 1996, 1995, and 1994, respectively. The difference to be
received or paid on the swap agreements is included in interest expense as
incurred and any related receivable or payable is reflected accordingly as an
asset or liability.
================================================================================
-12-
COMMITMENTS AND CONTINGENCIES
Leases
The Company occupies office space under leases which expire at various dates
through 2016. The lease commitments include the lease of the Company's
headquarters at 245 Park Avenue, New York City which expires on December 31,
2002. At June 30, 1996, future minimum aggregate annual rentals payable under
these noncancelable leases (net of subleases) for the fiscal years ending 1997
through 2001, and the aggregate amount thereafter, are as follows:
In thousands
----------------------------------------------
Fiscal Year
1997 $ 50,579
1998 48,476
1999 47,277
2000 42,936
2001 42,516
Aggregate amount thereafter 113,578
----------------------------------------------
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The various leases contain provisions for periodic escalations to the
extent of increases in certain operating and other costs. Rental expense,
including escalations, under these leases was $77.0 million, $73.8 million, and
$65.3 million, for the years ended June 30, 1996, 1995, and 1994, respectively.
Letters of Credit
At June 30, 1996, the Company was contingently liable for unsecured letters of
credit of $2.0 billion and letters of credit of $213.4 million secured by
financial instruments. These letters of credit are principally used as deposits
for securities borrowed and to satisfy margin deposits at option and commodity
exchanges.
Borrow Versus Pledge
At June 30, 1996, US government and agency securities with a market value of
approximately $5.5 billion were pledged against borrowed securities with an
approximate market value of $5.4 billion.
Litigation
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.
================================================================================
-13-
SEGMENT AND GEOGRAPHIC AREA DATA
The Company is primarily engaged in a single line of business as a securities
broker and dealer, which comprises several classes of services, such as
principal transactions, agency transactions, and underwriting and investment
banking. These activities constitute a single industry segment for purposes of
Statement of Financial Accounting Standards No. 14. Information regarding the
Company's operations is as follows:
In thousands 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
Foreign revenues $ 460,055 $ 252,825 $ 199,461
Domestic revenues 4,503,808 3,500,747 3,241,177
- ---------------------------------------------------------------------------------------------------------------------------
Consolidated revenues $ 4,963,863 $ 3,753,572 $ 3,440,638
===========================================================================================================================
Foreign income before provision for income taxes $ 53,470 $ 3,147 $ 52,461
Domestic income before provision for income taxes 781,456 384,935 590,338
- ---------------------------------------------------------------------------------------------------------------------------
Consolidated income before provision for income taxes $ 834,926 $ 388,082 $ 642,799
===========================================================================================================================
Foreign assets $17,219,879 $10,428,506 $ 8,925,849
Domestic assets 74,865,278 64,168,654 58,466,169
- ---------------------------------------------------------------------------------------------------------------------------
Consolidated assets $92,085,157 $74,597,160 $67,392,018
===========================================================================================================================
Because of the international nature of the financial markets and the
resultant integration of US and non-US services, it is difficult to precisely
separate foreign operations. The Company conducts and manages these activities
with a view toward the profitability of the Company as a whole. Accordingly, the
foreign operations information is, of necessity, based upon management judgments
and internal allocations.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
-14-
QUARTERLY INFORMATION (UNAUDITED)
First Second Third Fourth
In thousands, except per share data Quarter Quarter Quarter Quarter Total
- ---------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED JUNE 30, 1996
Revenues $1,074,434 $1,190,063 $1,295,996 $1,403,370 $4,963,863
- ---------------------------------------------------------------------------------------------------------------------------
Interest expense 456,945 502,403 503,754 518,069 1,981,171
- ---------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 617,489 687,660 792,242 885,301 2,982,692
Non-interest expenses
Employee compensation and benefits 306,997 345,427 392,442 424,582 1,469,448
Other 154,082 161,352 177,985 184,899 678,318
- ---------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 461,079 506,779 570,427 609,481 2,147,766
- ---------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 156,410 180,881 221,815 275,820 834,926
Provision for income taxes 62,564 75,725 92,944 113,055 344,288
- ---------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 93,846 $ 105,156 $ 128,871 $ 162,765 $ 490,638
===========================================================================================================================
Earnings per share $ .63 $ .72 $ .90 $ 1.18 $ 3.43
===========================================================================================================================
Cash dividends declared per common share $ .15 $ .15 $ .15 $ .15 $ .60
===========================================================================================================================
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
- ---------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED JUNE 30, 1995
Revenues $ 808,425 $ 826,733 $1,027,422 $1,090,992 $3,753,572
- ---------------------------------------------------------------------------------------------------------------------------
Interest expense 374,800 400,130 439,091 464,494 1,678,515
- ---------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 433,625 426,603 588,331 626,498 2,075,057
Non-interest expenses
Employee compensation and benefits 231,029 223,259 300,243 325,956 1,080,487
Other 145,401 150,236 154,636 156,215 606,488
- ---------------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 376,430 373,495 454,879 482,171 1,686,975
- ---------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 57,195 53,108 133,452 144,327 388,082
Provision for income taxes 21,734 20,181 50,712 54,844 147,471
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 35,461 $ 32,927 $ 82,740 $ 89,483 $ 240,611
===========================================================================================================================
Earnings per share $ .22 $ .20 $ .58 $ .62 $ 1.62
===========================================================================================================================
Cash dividends declared per common share $ .15 $ .15 $ .15 $ .15 $ .60
===========================================================================================================================
54
================================================================================
INDEPENDENT AUDITORS' REPORT
Deloitte &
Touche LLP
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS
OF THE BEAR STEARNS COMPANIES INC.
We have audited the accompanying consolidated statements of financial
condition of The Bear Stearns Companies Inc. and Subsidiaries as of
June 30, 1996 and 1995, and the related consolidated statements of
income, cash flows, and changes in stockholders' equity for each of
the three years in the period ended June 30, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the financial position of The Bear
Stearns Companies Inc. and Subsidiaries at June 30, 1996 and 1995, and
the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1996 in conformity with
generally accepted accounting principles.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
New York, New York
August 26, 1996
55
CORPORATE
INFORMATION
================================================================================
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
The Common Stock of the Company is traded on the NYSE under the symbol BSC. The
following table sets forth for the periods indicated the high and low sales
prices for the Common Stock, as adjusted to reflect the 5% stock dividend
distributed on the Common Stock on May 31, 1996, and the cash dividends declared
on the Common Stock.
As of September 3, 1996, there were 3,344 holders of record of the
Company's Common Stock. On September 3, 1996, the last reported sales price of
the Company's Common Stock was $23 1/2.
Dividends are payable on January 15, April 15, July 15, and October 15 in
each year on the Company's outstanding Adjustable Rate Cumulative Preferred
Stock, Series A, Cumulative Preferred Stock, Series B, and Cumulative Preferred
Stock, Series C (collectively, the "Preferred Stock"). The terms of the
Preferred Stock require that all accrued dividends in arrears be paid prior to
the payment of any dividend on the Common Stock.
Since the Company is a holding company, its ability to pay dividends is
limited by the ability of its subsidiaries to pay dividends and to make advances
to the Company. See the Notes to Consolidated Financial Statements for a further
description.
Cash Dividends
Declared
Per Common
High Low Share
- --------------------------------------------------------------------------------
FISCAL YEAR ENDED JUNE 30, 1995
First Quarter (through September 30, 1994) $ 16 5/8 $ 14 1/2 $ .15
Second Quarter (through December 31, 1994) 15 1/8 13 3/8 .15
Third Quarter (through March 31, 1995) 17 1/8 14 1/8 .15
Fourth Quarter (through June 30, 1995) 21 3/4 16 7/8 .15
- --------------------------------------------------------------------------------
FISCAL YEAR ENDED JUNE 30, 1996
First Quarter (through September 29, 1995) $ 22 $ 18 3/4 $ .15
Second Quarter (through December 31, 1995) 20 7/8 18 3/8 .15
Third Quarter (through March 29, 1996) 24 1/8 18 1/8 .15
Fourth Quarter (through June 30, 1996) 24 5/8 21 7/8 .15
58